Final Results

Chesnara plc

Continued dividend growth despite challenging market conditions

30 March 2012

Chesnara today reported final results for the year ended 31 December 2011. These are the first set of results which follow the transfer of the business of Save & Prosper Insurance Limited and its subsidiary Save & Prosper Pensions Limited (together 'S&P'), acquired in December 2010, into Chesnara's principal UK subsidiary, Countrywide Assured plc ('CA').

·; Profit on IFRS basis before tax for the year ended 31 December of £22.4m (2010: £18.3m excluding profit of £15.9m arising on acquisitions)

·; Reduction in EEV from £354.6m to £294.5m predominantly due to adverse economic experience and assumption changes of £49.4m giving rise to an EEV post-tax loss of £29.8m excluding exceptional items (2010:profit of £18.7m excluding exceptional items)

·; Pre-tax operating EEV profit increased to £12.5m (2010: £0.3m)

·; Strong cash generation continues at £25.4m (2010: £42.6m including £23.8m arising on acquisition of S&P)

·; Shareholder equity on EEV basis (pre proposed final dividend payment) now £2.56p per share (2010: £3.09p per share)

·; Earnings per share on IFRS basis of 22.35p (2010: 29.05p)

·; Successful operational integration of S&P business and transfer of funds from S&P into CA with strong capital, fiscal and operational benefits

·; Solvency ratios remain strong with Group at 198%(2010: 200%), CA at 183% (2010: 213%) and Movestic 245% (2010: 188%)

·; Final proposed dividend increased to 10.9p (2010:10.6p). Total dividend for the year increased by 2.8% to 16.85p (2010:16.4p).

·; Board remains committed to providing shareholders with an attractive dividend stream

·; Acquisition opportunities continue to be examined

Graham Kettleborough, Chief Executive said:

'2011 saw a great deal of uncertainty in the Eurozone which contributed to falls in equity markets and reductions in the yield curve. Both of these had a significant effect but, due to our prudent approach to the management of our businesses and the successful Part VII transfer of S&P, we have emerged in good financial health. The recovery in the markets in early 2012 is welcome and, even if this does not persist, we remain well placed to continue to deliver on our aims.

On the acquisition front we continue to seek suitable opportunities and will continue to be selective and only pursue opportunities which will deliver an acceptable value uplift and/or support Chesnara's future dividend paying capability.

The Board are pleased to recommend an increase in the final dividend to 10.9p per share. This gives rise to a total dividend for the year of 16.85p per share which represents a 2.8% increase.'

The Board approved this statement on 29 March 2012.

Enquiries

Graham Kettleborough

Chief Executive, Chesnara plc 07799 407519

Michael Henman

Cubitt Consulting 0207 367 5100

Notes to editors:

Chesnara plc, which listed on the London Stock Exchange in May 2004, is the owner of Countrywide Assured plc ("CA"), Save & Prosper Insurance Ltd and its subsidiary Save & Prosper Pensions Ltd (together 'S&P') and Movestic Livförsäkringar AB ('Movestic').

CA is a UK life assurance subsidiary that is substantially closed to new business. In June 2005 Chesnara acquired a further closed life insurance company - City of Westminster Assurance ('CWA')and with effect from 30 June 2006, CWA's policies and assets were transferred into CA. S&P was acquired on 20th December 2010. S&P was closed to new business prior to acquisition and it operated an outsourced business model which is complementary to Chesnara's existing UK operations. With effect from 31 December 2011, the business of S&P was transferred into CA.

Movestic, a Swedish life assurance company which originally focused on pensions and savings, was acquired on 23 July 2009. The company is open to new business and seeks to grow its position in the Swedish unit-linked market. Its proposition was strengthened in February 2010 with the acquisition of the operations of Aspis Försäkringar Liv AB which has a risk and health product bias.

Notes

1) Throughout the Chairman's Statement, Chief Executive Review and Financial Review sections following, all results quoted at business segment level exclude the impact of consolidation adjustments relating to the amortisation of acquired VIF and other consolidation adjustment arising on the acquisition of Movestic. These consolidation adjustments are analysed by business segment.

2) Net cash generation in the year is defined as the net amount of the following items:

(i) The change in the excess of actual regulatory capital resource over target capital resource in respect of the CA and S&P operating segments to the extent that distribution of the excess to shareholder funds is not restricted;

(ii) Capital contributions made by the Group to the Movestic operating segment; and

(iii) Cash utilised by Parent Company operations

Chairman's Statement

As with any Financial Services organisation, Chesnara is influenced by the general economic climate in which it operates. During 2011 there was a decline in both UK and Swedish equity markets and also a marked reduction in global bond yields, together with a general level of uncertainty and lack of confidence due to the Eurozone crisis. Whilst, clearly, the Board of Chesnara cannot directly influence market conditions, we do have the responsibility to ensure we make business decisions to ensure the Group can weather economic downturns and continue to create shareholder value.

I am reassured that the Chesnara Group has proven to be resilient to the current difficult economic climate in terms of IFRS earnings, solvency, cash and dividend paying capacity. The EEV results have, predominantly due to investment market effects, fared less well. We benefit from our long established values which put responsible risk management at the heart of all decisions we make. The cumulative impact of our responsible risk-based decision making has resulted in a business that has minimised the level of exposure to external economic conditions:

·; Unit-linked policies are at the core of Chesnara's in-force book (78% of our year-end UK and Swedish liabilities relate to unit-linked contracts), with the policyholder bearing market risk.

·; Our stringent acquisition assessment criteria and investment management frameworks have resulted in only minimal exposure to high risk sovereign debt.

·; Investment policy is strongly influenced by the objective to protect capital and minimise market and credit risk. Chesnara's outsourced investment management mandates and executive remuneration schemes create no positive incentive to pursue complex, short-term or high-risk investment portfolios and as such our financial assets have limited exposure to derivative instruments.

In short we have a relatively low-risk and transparent investment model and an efficient operating platform.

There has, however, inevitably been a degree of investment market strain on the underlying results. The S&P with-profit guarantees become, by their nature, increasingly onerous as bond yields decline and the core fund-based income streams for the Movestic Pensions and Savings business suffer as equity values fall. Results on an EEV basis are significantly more sensitive to investment market volatility than the IFRS results. This is because the EEV result recognises the cumulative future impact of any short term adverse investment market conditions. High-level analysis of the financial results, including specific reference to investment market impacts, is provided later in my statement.

Despite the short term pressure on the results of the recently acquired businesses, I am encouraged by the continued development and integration of both S&P and Movestic.

As expected, the acquisition of S&P has resulted in an increased level of earnings volatility for the UK business. In light of this the successful integration of S&P into the Group governance and risk management framework has been a priority during 2011. A key requirement to drive shareholder value from the S&P acquisition was to transfer the long-term insurance funds into the CA fund. The successful Part VII Transfer during the year was, therefore, a significant achievement and the year-end results incorporate fiscal and capital synergies arising from the transfer. Such benefits have effectively sheltered the Group from any underlying with-profit strain during the year resulting from the decline in bond yields. In light of the above, I remain confident that the long-term value from the S&P acquisition will significantly outweigh the impacts from short-term volatility.

Trading conditions have been difficult for Movestic. The short-term focus has been on enhancing the core Pension and Savings proposition. Operating platforms have been improved and new products are being developed such that we are in a good position to take advantage of any future recovery in the investment and new business markets. This is evidenced by an encouraging increase in new business market share towards the end of 2011.

CA IFRS profits have continued to prove relatively immune to investment market movement and this, together with the effect of distributions from surplus funds arising on the acquisition of S&P in 2010, has contributed to a strong proposed cash distribution to Chesnara of £44m. The CA operation remains at the heart of our business model and as such the level of continuing cash generation is encouraging.

IFRS Results

On the IFRS basis, we have achieved a pre-tax profit of £22.4m for the year ended 31 December 2011. This compares to a pre-tax profit, excluding £15.9m of profits arising on the acquisition of S&P and Aspis, of £18.3m for the year ended 31 December 2010. Profits from the core CA closed book which is in run-off, have remained relatively resilient to adverse investment market conditions (2011 - £25.7m: 2010 - £29.4m). The 2011 result includes a £7.5m profit from the recently acquired S&P business for which the benefits accruing from the Part VII Transfer, including the recognition of a £12.4m profit arising from the alignment of actuarial assumptions, have exceeded the adverse impact of a reduction in bond yields. There is a £2.8m improvement in the Movestic result which has moved from loss to a small profit. The IFRS results are analysed in more detail within the "Financial Review" section.

EEV Results

On the EEV basis of reporting, excluding the profit arising on the acquisition of S&P and Aspis and the effects of modelling adjustments in Movestic, we made a loss after tax of £(29.8)m for the year ended 31 December 2011, compared with a profit after tax of £18.9m for the year ended 31 December 2010. Investment market factors directly account for a year-on-year decline of £71.9m. Adverse economic experience and assumption items of £49.4m dominate the 2011 loss. However, in contrast to this, the underlying operating result has improved by £12.2m in 2011. The EEV results are analysed in more detail within the "Financial Review" section.

Solvency and Cash Generation

The capacity of the Group to pursue its dividend policy relies on the continuing generation of cash in the UK businesses. During 2011 cash generation was £25.4m including significant synergies of £12.4m arising from the Part VII Transfer. This healthy outcome supports a proposed dividend of £44m from CA to Chesnara and is reinforced by a strong post-dividend solvency ratio of 183% in CA as at 31 December 2011. The associated Group solvency ratio was also strong at 198%.

We have continued to make good progress on the implementation of Solvency II requirements.

Dividend

Continuing surplus generated from the CA book together with the positive impact of the Part VII Transfer of S&P, enables the Group to continue its progressive dividend policy. The 2011 full year dividend of £19.3m represents a 2.8% increase over the prior year.

People and Business Partners

The fact that we end the year in good shape and well positioned for the future is largely due to the skill and dedication of our people and those within our outsource partners.

I greatly value the professional relationship with our operational and investment management partners. In light of this, the ongoing renegotiation of the outsourcing contract with HCL is a positive development which is expected to ensure UK CA policyholders and shareholders will continue to benefit from the servicing and commercial benefits of our UK operating model for the long term.

Delivery of the strategic objectives of the Group is highly dependent on the skills, professionalism and integrity of our people. The successful implementation of the Part VII Transfer, the continued positive relationship with regulators and the significant level of business change undertaken in Sweden are all testament to the quality and dedication of all involved.

In recognition of this key dependence on our people, we have invested in the governance infrastructure during the year and have achieved impressive levels of staff retention.

During the year we set up a Share-save scheme that enables UK staff to invest in the future success of the Group.

Business Development

Whilst the Group has weathered the storms in investment markets in 2011 we are not complacent regarding future challenges particularly as regards the economic impact that may arise from any Euro bond default. Therefore we will continue to work to protect shareholder value whilst not unnecessarily restricting any upside the expected recovery in markets may bring. As part of this we will continue to investigate acquisition opportunities and we will only progress these where we see value and a clear strategic fit. Businesses in the UK and Western Europe will be considered and, as ever, we will continue to apply strict financial and risk criteria when we assess them.

Outlook

Investment markets have shown signs of recovery in the first quarter of 2012. However, we do not take market recovery for granted and our financial and capital management procedures will continue to recognise the risk of continued poor or indeed worsening economic conditions. The decline in EEV earnings for 2011 is considered to be of a short-term nature and even if investment market recovery does not arise, the modelling of our business, indicates continued healthy cash generation and a solvency capital surplus in both base and adverse stress scenarios.

Peter Mason

Chairman

29 March 2012

Chief Executive's Review

Challenging times, especially in investment markets, but we remain well placed to meet our objectives. The highlights are:

·; Despite difficult investment market conditions the Group delivered an IFRS pre-tax profit of £22.4m (2010: £18.3m excluding exceptional profits on the acquisition of S&P of £15.9m).

·; The increase in IFRS pre-tax profits for 2011 includes £12.4m arising from the alignment of actuarial assumptions following the Part VII Transfer.

·; Movestic has generated a first-time IFRS pre-tax profit of £0.4m (2010: £2.6m loss).

·; Equity market performance and the falling yield curve, have had an adverse impact of £49.4m on the EEV result.

·; Despite investment market conditions both cash generation and group solvency remain strong.

·; Full and effective integration of Save & Prosper, including completion of the Part VII Transfer.

·; Constructive ongoing re-negotiation of the core outsource arrangement to provide longevity of the UK business model.

Review of the Year

Insurance Group Directive Solvency 198% (2010: 200%)

Group IFRS pre-tax profit £22.4m (2010: £18.3m excluding exceptional profits on the acquisition of S&P of £15.9m)

Group EEV net of tax result £(29.8)m loss (2010: £18.9m profit) excluding exceptional profits on acquisition and the impact of EEV modeling adjustments (2011: £(10.3)m loss; 2010: £13.2m profit).

Both IFRS and EEV results during the year have been impacted by the downturn in equity markets and the general decline in bond yields, although benefits from the successful Part VII Transfer of S&P have mitigated this impact. Other than a slight positive effect, on both the IFRS and EEV bases, arising from falling bond yields in the CA book of business, market movements have been universally adverse. The acquisitions of S&P, in December 2010, and Movestic have increased the volatility of profits, particularly in terms of short-term sensitivities. S&P is, as highlighted at the time of purchase, sensitive to falling bond yields due to a portion of the product base having investment return guarantees for policyholders whilst Movestic is sensitive to equity market movements as a significant part of its current and future earnings arise from the value of funds under management.

Investment in our operating model, which is required to ensure we continue to provide high quality service to our policy-holders and to protect the longevity of the UK business outsource operating model upon which our strategy is based, has had an adverse impact on the Group cost base. Revised commercial terms have been agreed in principle with HCL, which has resulted in an increase in IFRS reserves of some £8m and EEV reserves of some £7m. The impact on the 2011 results is partially mitigated by the release of an opening £4.5m provision. Further information regarding the performance of our major business segments, namely the UK closed book operations and Movestic, our open book operation in Sweden, is presented in the following sections together with a number of Key Performance Indicators. The IFRS and EEV results are analysed in more detail within the Financial Review. On the positive side, cash generation from the UK book has proved resilient to the adverse market conditions and the Group and subsidiary solvency positions remain strong, which enables us to continue with our progressive dividend policy. We have minimal exposure to euro-denominated sovereign debt.

Outlook

Clearly management does not take market recovery for granted and our financial and capital management procedures recognise the risk of continued poor or indeed worsening economic conditions. However, we regard decline in earnings for 2011 as being of a short-term nature. Even if this is not the case, the projections we produce as an integral part of our financial management procedures indicate continued healthy cash generation and a solvency capital surplus in both base and adverse stress scenarios.

The Group continues to investigate further acquisition opportunities and we will progress these where we see value and a clear strategic fit. We remain open-minded as to location in the UK and Western Europe and, as ever, we will continue to apply our strict financial and risk criteria when we assess them.

UK Business Review

Despite difficult investment market conditions the core CA business reported a pre-tax IFRS profit of £25.7m (before consolidation adjustment) which contributed to a proposed distribution to the Chesnara parent company of £44m.

Highlights:

·; Benefits from the Part VII Transfer of S&P, including the recognition of a £12.4m profit arising from the alignment of actuarial assumptions, exceed the adverse impact of reductions in bond yields such that S&P has posted a £7.5m IFRS pre-tax profit during the year.

·; Continued, effective operational integration of S&P into the Chesnara Group, with full integration of governance procedures.

·; Successful Part VII Transfer of the S&P business into CA.

·; Good progress regarding renegotiation of the core outsource arrangement with HCL.

·; Policy attrition rates better than expected and prior year.

·; Good regulatory compliance record continues.

Review of the Year

This year has been focused on three areas - management of the assets in the light of the turmoil in equity markets and a falling UK yield curve, integration of S&P into the CA business including completion of the Part VII Transfer and seeking longevity as regards our outsourcing arrangements.

Management of Assets

The acquisition of S&P has resulted, as signalled at the time of acquisition, in an increased level of earnings volatility for the UK business. S&P has a proportion of its product base that provides guaranteed returns. As asset values fall the cost of guaranteeing those returns increases, with a consequential impact on profitability. The converse of this is that as asset values rise, as might be expected in the medium term, the cost of the guarantees will fall. Linked to the cost of guarantees is the return we use in calculating our liabilities to policyholders - which in turn is linked to the yield curve. As the yield curve falls the rate we can use to value the liabilities to meet those guarantees also falls. Although there is a rise in the capital value of the matching assets this is outweighed by the effect of the yield drop in calculating the future returns. However, there are two elements of mitigation. Firstly the CA book of business acts as a partial hedge as the effect on that book is the reverse of the effect on the S&P book. This has mitigated, but clearly not wholly negated, the effects of the fall in the yield curve. The second element of mitigation has been the purchase of further higher-yielding fixed interest securities in the fourth quarter which has the effect of moving the valuation rate slightly upwards.

KEY PERFORMANCE INDICATORS:

IFRS Profit Before Tax £33.2m (2010: £29.6m) Excluding profits on the acquisition of S&P and AVIF amortisation.

Cash Transfer to Chesnara Parent Company £44m (2010:£26m) Includes the effect of the distributions from surplus funds arising on acquisition of S&P in 2010.

EEV Result net of tax £(13.7)m loss (2010: £18.0m profit) Excluding profit on acquisition of S&P.

Annual Policy Attrition Rate

Fund Performance

Relative outperformance in the unit-linked funds helps promote policy retention and, when positive, increases the embedded value of the Group as future management charges received will be of a higher magnitude. Returns on two of the funds in 2011 are below the comparable sector average although not considerably so and the longer term returns continue to be above benchmarks.

We have taken a measured approach to this as, in the medium to long-term, we see the yield curve moving upwards and do not want to significantly restrict the upside. It follows that the effective steps we have undertaken, together with the continued earnings stability from the CA and CWA books, mitigate the impact of short term S&P earnings volatility, such that, on a UK consolidated basis, the Board remain confident that the long-term value from the S&P acquisition will significantly outweigh short-term volatility experience.

Integration of S&P

We are very pleased that we have completed the operational integration of S&P within expected timescales. The business now operates in line with practice and procedures that have proven resilient for CA and, where appropriate, we have adopted existing S&P practices. In particular we have established a With-Profits Committee which is responsible for ensuring that the interests of the with-profits policyholders are maintained. We are also particularly pleased that the Part VII Transfer was completed at the end of the year. Despite some testing timescales the team worked hard to ensure that the process was completed before year end which allowed the transfer of the S&P long-term business into CA on 31 December 2011. Capital efficiencies will accrue immediately and we anticipate that further funds will be released when we deregulate the two S&P companies in the second quarter of 2012.

Outsourcing Arrangements

Following the acquisition of S&P we decided to investigate the possibility of extending the term of our outsourcing agreements. The original CA agreement with HCL was due to end in early 2015 and the S&P agreement was of indefinite term but contained provisions that allowed either party to terminate the agreements at two years notice or less. We took the view that we would seek a longer-term agreement and, as well as negotiating with HCL, we benchmarked costs by comparing with other potential suppliers indicative terms. The commercial terms were agreed in principle in late December and give rise to an increase in the total cost base. An opening provision of £4.5m to cover this potential outcome restricted the adverse impact on the IFRS result to £3.5m and the impact on the EEV loss to £2.8m. Legal negotiations continue and we fully expect to sign the formal agreement in the very near future. The agreement will give us certainty of terms for the next 10 years with an agreed pricing basis for administrative services thereafter.

Unit Costs

A key area of focus for the UK operations is the management of expenses incurred in servicing the in-force life and pensions policy base. In particular we seek, through outsourcing arrangements, to maximise the proportion of costs which vary with policy volume. Continued attention to expense management, combined with the positive in-force book retention and the apportionment of fixed overheads across the broadening business segment base following the acquisitions of Movestic and S&P, has resulted in a small reduction in the maintenance unit costs for the CA fund (2011: £42.50 per policy; 2010: £44.60 per policy).

No corresponding analysis is provided for S&P because prior year comparisons are not available. That said, management are confident that S&P unit costs are effectively controlled due to:

i) a significant proportion of the cost base is variable in line with book run off, due to both asset management and policy administration being outsourced with variable charging structures;

ii) policy attrition is relatively low; and

iii) the S&P operation has been integrated into the Chesnara Group without a significant increase in total governance overhead thereby creating significant synergies.

Unit-linked Funds Under Management

The continuing level of unit-linked funds under management is an indicator of the ongoing level of profitability of the UK businesses as fund-related charges are an important component of profit. The movement in the value of unit-linked funds under management is a function of:

i) performance of the funds across UK equities, international equities, property and fixed interest securities;

ii) received and invested premiums; and

iii) policies closed due to surrender, transfer or claim.

The combined impact of these three drivers has resulted in a reduction in Unit-linked Assets under Management from £2,475m at the end of 2010 to £2,190m at the end of 2011.

Other Issues

With regard to Solvency II implementation, a significant and increasing amount of work means that our progress remains in line with plans. Based on QIS5 calculations we do not foresee that any increase in solvency capital will be required.

Cash generation, despite the adverse market influences, remains strong. Whilst, in the short term, the expectation of cash releases from S&P has diminished, we do not see this as a particular issue as S&P was acquired as a medium to long-term underpin to the stronger, shorter-term cash generation from CA and CWA.

Swedish Business Review

First time IFRS pre-tax profit but Embedded Value negatively affected by investment markets and modelling adjustments.

Highlights:

·; First time IFRS pre-tax profit of £0.4m (2010: £(2.6)m loss) before consolidation adjustments.

·; Market shares showing gradual improvement 

·; EEV adversely impacted by falls in value of investments and modelling adjustments

·; Expansion of fund range with new distributor agreements

·; Measures introduced to stem policy attrition

Review of the year

2011 was a challenging year for Movestic. In particular investment market performance, both in equities and fixed interest securities, has dented investor confidence and, in turn, affected Movestic's results and business opportunities. As well as this, a system migration, necessary to prepare the business for future growth, allow greater product development flexibility and deliver administrative efficiencies, introduced some short-term administrative issues. These, in turn, led to a reduction in IFA support. As previously reported, errors found in the company's EEV modelling systems have also contributed to a testing year. It is, therefore, particularly pleasing that we are able to report a profit on an IFRS pre-tax basis of £0.4m (2010: £(2.6)m loss). Unfortunately the picture is less attractive on the EEV measure. Although a profit was made on new business of £3.1m (2010: £2.1m), the adverse impact of investment markets outweighed this significantly such that a net of tax loss of £14.2m (2010: £3.1m profit) was incurred: these amounts excludes the impact of modeling adjustments and exceptional profits arising on the acquisition of Aspis. A detailed breakdown of the constituents of this is provided in the Financial Review. EEV modelling adjustments have affected the Movestic EEV for the last two years, with a £13.2m positive impact in 2010 and a £9.7m adverse impact in 2011. In light of this, we undertook a line-by-line review of the model used to calculate embedded value and are not expecting any further significant adjustments to be necessary.

 It is clear that the Swedish market as a whole has suffered and, although our new business premiums have reduced, our market share has slightly increased. This demonstrates the viability of our business model and is particularly pleasing bearing in mind the systems and consequent administrative issues we have had. In the fourth quarter we introduced measures aimed at reducing the attrition in the business and, although they will not be reflected in these results, initial indications show that they are proving to be successful with reductions in attrition beginning to be seen.

Movestic has continued to move administrative functions away from Stockholm to its lower cost base operation in Norrköping. This process is now nearing completion and cost benefits are expected to flow through in 2012.

Looking forward we continue to seek to build on the good relationships that we have with IFAs. In particular we have recently launched bespoke funds for one of the larger IFA organisations and we maintain close relationships with all the key broker organisations. In terms of systems we aim to capitalise on the investments we made in 2011 and we are recruiting internally in the IT area to bring more expertise in-house and improve our specification and testing capabilities for future changes. As for new initiatives, we will continue to research new fund and investment opportunities, plan to launch a new single premium product in the second quarter and are also planning revisions and new offerings within our risk and health product portfolio.

Financial Review

Key Financial Performance Indicators

The Group's key financial performance indicators as at 31 December 2011 and for the year ended on that date demonstrate the financial performance and strength of the Group as a whole. A summary of these is shown below and further analysis is provided in the following sections:

1. IFRS pre-tax Earnings £22.4m (2010: £34.2m)

The presentation of the results in accordance with International Finance Reporting Standards (IFRS) aims to smooth the recognition of profit arising from written business over the life of insurance and investment contracts. For businesses in run-off the reported profit is closely aligned with, and a strong indicator of, the emergence of surpluses arising within the long-term insurance funds of those businesses. 

Highlights

·; IFRS pre-tax profit of £22.4m, shows a decline from the prior year. The prior year comparison includes one-off profits arising on business combinations of £15.9m.

·; Profits from the core CA closed book have remained relatively resilient to book run-off and adverse investment market conditions (2011: - £25.7m; 2010: - £29.4m).

·; The 2011 result includes a £7.5m profit from the recently acquired S&P business for which benefits from the Part VII Transfer, including the recognition of a £12.4m profit arising from the alignment of actuarial assumptions, more than offset the adverse impact of a reduction in bond yields.

·; There was a £3.0m improvement in the Movestic result which has moved from loss to a small profit.

2. Cash Generation £25.4m (2010: £42.6m)

Cash generation is a key measure, because it is the net cash flows to the Chesnara Parent Company from its Life and Pensions businesses which support Chesnara's dividend capacity. The dominating aspect of cash generation is the change in amounts freely transferable from the operating businesses, taking into account target statutory solvency requirements which are determined by the boards of the respective businesses. It follows that cash generation is not only influenced by the level of surplus arising but also by the level of target solvency capital.

Highlights

·; At £21.8m cash generation in CA continues to be robust and shelters a net depletion in S&P of £2.6m.

·; Significant favourable synergistic effects of £12.4m arising from the Part VII Transfer

3. EEV Earnings, net of tax£(29.8)m loss (2010: £59.9m profit) excluding modelling adjustments (2011: £(10.3)m; 2010: £13.2m profit).

In recognition of the longer-term nature of the Group's insurance and investment contracts, supplementary information is presented in accordance with European Embedded Value 'EEV' principles. By recognising the net present value of expected future cash flows arising from the contracts (in-force value), a different perspective is provided in the performance of the Group and on the valuation of the business.

The principal underlying components of the EEV result are:

i) The expected return from existing business (being the effect of the unwind of the rates used to discount the value in force).

ii) value added by the writing of new business

iii) variations in actual experience from that assumed in the opening valuation.

iv) the impact of restating assumptions underlying the determination of expected cash flows.

Highlights

·; The marked reduction in EEV profits is dominated by two factors. Firstly, the 2010 result included an exceptional business combinations profit of £41m. Secondly investment market conditions had an adverse impact during 2011 of £49.5m compared with a positive impact of £22.5m in 2010.

·; The underlying operating profit has improved by £12.2m

4. European Embedded Value (EEV) £294.5m (2010: £354.6m)

As it takes into account expected future earnings streams on a discounted basis, EEV is an important reference point by which to assess Chesnara's market capitalisation. A life and pensions group may typically be characterised as trading at a discount or premium to its embedded value. Analysis of EEV, distinguishing value in force by segment and by product type, provides additional insight into the development of the business over time.

Highlights

·; EEV reduction follows from decline in investment markets over the year.

·; Good balance of EEV across the operating segments.

·; Good product diversification within value in-force.

IFRS pre-tax Earnings - £22.4m (2010:£34.2m)

Executive summary

IFRS earnings arising from CA have historically proved to be relatively stable and resilient to external economic market movements. This has continued to be the case during 2011 with a CA IFRS pre-tax result of £25.7m (2010:£29.4m). The acquisition of S&P in late 2010 has added a more volatile component to the Group IFRS result due to the cost of with-profit guarantees being sensitive to movements in equity values and interest rates. The operating IFRS pre-tax result for Movestic has moved into profit during 2011.

The Group IFRS result is analysed by operating segment as follows:

S&P was acquired by Chesnara plc late in 2010 and therefore the 2010 figures reflect an 11 days trading period only.

The increase in losses in the Chesnara parent company component relates to the setting up of a £1.5m provision to cover future vacant property costs associated with the head office building in Preston.

The adjustments arising on consolidation are analysed below.

The IFRS results by business segment are analysed in more detail as follows:

CA

Despite continued run off of the CA in force book and a general decline in investment market conditions during 2011, the CA pre-tax IFRS result has held up well. There are many complex aspects to the IFRS result but the primary drivers of the decline in profit from 2010 to 2011 are illustrated as follows:

The key components of the 2011 IFRS result are summarised as follows:

Note 1 - Product-based deductions and returns on retained surplus remain significantly in excess of recurring administration expenses.

Note 2 - The impact of investment market conditions is generally muted for the CA book. That said, during 2011, the surplus generated from non-linked income exceeded associated actuarial and tax reserve movements.

Note 3 - During the year we have agreed in principle, terms for extending the outsourcing contract with HCL. The new terms result in a general increase in servicing charges. The majority of the potential impact of the increased costs was recognised in the 2010 closing valuations and hence the 2011 IFRS charge is less marked than the total contract charge increase might suggest.

S&P

S&P posted a pre-tax IFRS profit of £7.5m for 2011, the key components of the result being:

Note 1 - The S&P IFRS result is sensitive to equity values and bond yields, both of which have declined during 2011. This has resulted in a total loss of £10.2m, largely arising from the strain in the with profits funds due to the increased cost of guarantees.

Note 2 - During the year we agreed in principle, terms for extending the outsourcing contract with HCL. This has resulted in an increase in actuarial reserves of £3.5m. This together with other expense related assumption changes leads to a total expense assumption change loss of £4.4m.

Note 3 - The alignment of actuarial assumptions, to be consistent with those adopted for the CA fund, as a result of the Part VII Transfer has resulted in the recognition of profit of £12.4m. The pre-existing S&P methodology was to artificially reduce valuation interest rates to remove the need for a resilience capital reserve. Changing this approach results in an increase in effective valuation interest rates and a corresponding reduction in the strain of with-profits guarantees.

Note 4 - Furthermore the S&P Insurance component of with-profits reserves has reduced by £5m primarily as a result of improving mortality assumptions. This does not result in a corresponding IFRS profit due to the fact that an "Unallocated Divisible Surplus (UDS)" reserve is set up to reflect the future potential policyholder liabilities regarding this value.

Movestic

Note 1 - The Pensions and Savings business model is directly dependent upon fees and rebates earned on assets under management (AUM). Average AUM during the year were higher than in 2010 (despite the closing position being lower than the prior year equivalent). The resultant increase in fee and rebate income of £1.4m is broadly offset by an increase in internal costs. The internal costs were higher in 2011 due to significant investment in the policy administration systems. In addition, some employees joined part way through 2010 and hence the cost impact in 2011 is more marked.

Note 2 - The Risk and Health result has improved as a direct result of a 20% increase in retained earned premiums. This is the combined impact of gross premiums increasing by 2.5% and premiums ceded to reinsurers falling by 7%. This is due to a reduction in levels of reinsurance for certain lines of business. In addition the product mix within the old Aspis business (ceded to Swiss Re) differs somewhat between the two years and as the reinsurance programme is different for different products, the result is that the reinsurer is attributed with a lower share in 2011.

Cash Generation £25.4m (2010:£42.6m)

The Group's cash flows are generated principally from the interest earned on capital, the release of excess capital as the life funds run down, policyholder charges and management fees earned on assets under management. The Group's closed life funds provide predictable fund maturity and liability profiles, creating stable long-term cash flows for distribution to shareholders and for repayment of outstanding debt. Cash flow generation will naturally decline over time as the UK businesses run off.

Although investment returns are less predictable, a significant portion of the investment risk is borne by policyholders. However, the acquisition of S&P, while extending the longevity of cash generation within the Group, has introduced an element of volatility over shorter periods. This arises from the impact of investment market movements and the cost to shareholders of guarantees within the S&P with profits funds. Although the short-term measure of this cost follows the fortunes of investment markets, we proactively manage the risk taking a longer-term perspective.

The following identifies the source of internal net cash generation within the Group, representing the net change in funds available to service debt (interest and loan principal repayment) and equity (dividends):

This information illustrates that in spite of a challenging environment in 2011 net cash generation within the Group remains robust. Key aspects underpinning the outcome are:

·; Continuing strong emergence of surplus in CA which offsets net adverse impacts in S&P.

·; S&P surplus arising in the year of £9.1m includes £12.4m surplus arising from the alignment of actuarial assumptions following the Part VII Transfer. This gave rise to a consequential significant increase in S&P target capital requirement.

·; Significant beneficial effects arising from the Part VII Transfer, reflected through significant solvency capital synergies.

·; Movestic capital contributions, which support the ongoing development of the Swedish business and which are in line with expectations.

In addition to the above a further cash generation of £7m is expected to arise in 2012 on the winding up of the S&P companies subsequent to the Part VII Transfer.

EEV Earnings (excluding modelling adjustments) £(29.8)m loss (2010:£59.9m profit)

EEV Result

Summary

The headline EEV result for the year deteriorated significantly in 2011. The following chart shows the major components of the year on year decline. 

EEV results presented above exclude the impact of Movestic and S&P modelling adjustments. The 2010 EEV result benefited by £13.2m from modelling adjustments whereas similar items identified during 2011 have resulted in a reduction in EEV of £10.3m.

The year-on-year movement is dominated by two aspects:

i) Investment markets in 2010 generally performed better than assumed resulting in a significant EEV profit, whereas in 2011, falls in both equity markets and bond yields have resulted in a large corresponding loss. This 2011 investment market driven loss is the primary reason for the absolute EEV loss in the year.

ii) The 2010 result benefited from the one-off impact of the acquisition of S&P.

The operating result, upon which management have the most direct and immediate influence, has improved by £12.1m from the prior year. This is primarily due to Movestic year-on-year improvements. Movestic strengthened operating assumptions in 2010 resulting in a £10.1m operating assumption loss. The Risk and Health result has also improved year on year.

The following tables analyse the Group EEV result by operating segment and by profit category:

Analysis of the EEV result in the year by business segment

Analysis of the EEV result in the year by earnings type

Economic conditions

As referred to in the earlier movements analysis, the EEV result is heavily influenced by economic conditions. Economic experience and assumption variances contribute a loss in 2011 of £49.5m as compared to a profit in 2010 of £22.4m. During 2011 there has been a general decline in equity markets and bond yields and the Chesnara result is sensitive to both these factors (further sensitivity analysis is provided in Note 3 of EEV Supplementary Information). The impact of such economic effects on each operating segment is illustrated below:

The Movestic business is adversely impacted by any reduction in equity markets due to its core income stream being dependent upon management charges levied primarily on equity based funds under management. S&P is also adversely affected by any falls in equity markets but, in addition, the strain of guarantees on with-profit contracts is more prominent when bond yields and hence discount rates decline. The CA result is less volatile.

New business contribution

The new business contribution relates to the Movestic Pensions and Savings business. Movestic also writes Risk and Health policies but due to their more short term nature the Risk and Health business is reported as uncovered business and hence does not contribute to the new business result.

Experience variances

The CA 2011 experience variance relates to policy persistency and mortality experience being better than assumed. The level of persistency variance has fallen from the prior year figure, primarily due to assumption changes at the end of 2010. In addition, the 2010 comparison benefits from a one off claims provision release of £3.2m.

Operating assumption changes

The UK 2011 figures include £2.8m relating to an increase in expense assumptions as a direct result of the ongoing renegotiation of the HCL outsource arrangements during the year. Other operating assumption changes, including persistency, partially compensate such that the UK components are broadly in line with 2010.

During 2010 Movestic strengthened its persistency and expense assumptions. Despite continued adverse experience variances in 2011 no corresponding assumption changes were considered appropriate in 2011 due to the introduction of new retention initiatives.

Tax

The significant movement in tax includes the positive impact of tax synergies arising on the Part VII transfer of S&P into CA.

Uncovered business and other Group activities

The uncovered result includes an element of Chesnara parent company costs relating to corporate governance and business development, and as such not attributable to the covered life fund results.

The Movestic result relates primarily to its Risk and Health business which is less long term in nature and hence not modelled as covered business. The Risk and Health result has improved due to a 20% increase in retained earned premiums.

Exceptional items

The 2010 result included the one off impact of profit of £40.7m arising on the acquisition of S&P together with a profit of £0.3m arising on the acquisition of Aspis.

European Embedded Value (EEV) £294.5m (2010:£354.6m)

Movement in EEV

The following summarises the movement in EEV:

EEV at end of year is stated before recognition of the final proposed dividend of £12.5m (2010: £12.2m). The net-of-tax results for 2010 and 2011 are commented on in detail in the preceding section.

The effect of modelling adjustments arises from the introduction in 2010 by Movestic of a new system for modelling the value of its in-force policies. This provided the capacity to project cash flows at a greater level of granularity. In 2010 this led to a significant accretion to embedded value arising from the capability to more accurately model (i) the impact on commission outflows of policies becoming paid-up and of (ii) future fee income on a case-by-case basis, whereas previously it was necessary to adopt high-level estimates, particularly as regards investment mix. In 2011 a further improvement in respect of projected fee income from investment contracts where the fee is premium-based, rather than investment-asset based, was introduced, giving rise to a further accretion to embedded value of £2.7m. However as previously reported, during 2011 errors were detected relating to certain parameters and discounting periods utilised in the new model, which gave rise to a diminution in embedded value of £12.4m and are the major constituents of the 2011 modelling adjustments of £10.3m reduction in EEV presented above.

The significant foreign exchange reserve movements arise from the impact of a 1% depreciation of the Swedish Krona against Sterling during 2011, following its appreciation of 9% during 2010.

The amounts relating to the issue of share capital and to the disposal of Treasury Shares in 2010 arose in connection with the acquisition of S&P.

Composition of EEV

The tables below show the composition of EEV by operating segment:

The tables below set out the components of the value of in-force business by major product line at each period end:

The value-in-force represents the discounted value of the future surpluses arising from the insurance and investment contracts in force at each respective period end. The future surpluses are calculated by using realistic assumptions for each component of the cash flows.

'Other' valuation adjustments in CA principally comprise expenses of managing policies which are not attributed at product level. In S&P they represent the estimated cost of guarantees to with-profits policyholders.

As at 31 December 2011, following the Part VII Transfer, taxation in the value in force is modelled on a combined CA and S&P basis and, in the analysis above, is attributed wholly to the CA segment. As at 31 December 2010 taxation in the value in force was modelled for CA and S&P separately.

Financial Management

Objectives

The Group's financial management framework is designed to provide security for all shareholders, while meeting the expectations of policyholders and shareholders. Accordingly it:

i) safeguards policyholders' interests by meeting regulatory requirements established by the regulators of the insurance markets in which the Group's regulated companies operate, while not retaining unnecessary excess capital;

ii) seeks to meet the dividend expectations of shareholders and to optimise the gearing ratio to ensure an efficient capital base;

iii) ensures there is sufficient liquidity to meet obligations to policyholders, debt financiers and creditors as they fall due; and

iv) maintains the Group as a going concern so that it continues to provide returns and to meet obligations to all shareholders.

Capital Structure and Cash Flows

The Group's UK operations are ordinarily financed through retained earnings and through the current emergence of surplus in the UK life businesses. Movestic is financed by a combination of external financial reinsurance arrangements and capital contributions from Chesnara. With respect to acquisitions the Group seeks to finance these through a suitable mix of debt and equity, within the constraints imposed by the operation of regulatory rules over the level of debt finance which may be borne by Insurance Groups without breaching solvency requirements. The acquisition of S&P in December 2010 for £63.5m was accomplished by way of debt:equity financing broadly in a ratio of 2:1. This introduced a modest level of gearing to the structure of Group financing.

Other factors which may place a demand on capital resources in the future include the costs of unavoidable large scale systems development such as those which may be involved with changing regulatory requirements. To the extent that ongoing administration of the UK life businesses is performed within the terms of its third-party outsourcing agreements, the Group is sheltered, to a degree, from these development costs as they are likely to be on a shared basis.

The Group's longer-term cash flow cycle continues to be characterised by the strong inflow to shareholders' funds of transfers from the long-term insurance funds of CA, which is supported by the emergence of surplus within those funds. These flows are used (i) to repay our debt obligations as set out in the note to the IFRS of these financial statements; (ii) to support dividend distributions to shareholders; and (iii) to support the medium-term requirements of Movestic to meet regulatory solvency capital requirements as it expands.

Methods

In order to meet our obligations we employ and undertake a number of methods which are centered on:

i) regulatory solvency capital resource and capital requirements analysis, where the relevant Boards set minimum targets for solvency capital resources; and

ii) longer-term projections of key financial variables, including the regulatory solvency calculations set out in (i); and

iii) the setting of policies and investment manager guidelines for the investment of policyholder and shareholder funds.

Regulatory solvency capital resources and requirements

The Group's businesses are subject to the operation of the UK, Swedish and EU regulatory regimes with respect to solvency capital requirements at the individual regulated company and Group level. Minimum target solvency ratios are set and established at a level which aims to balance policyholder and shareholder interests. A higher target affords a greater degree of protection to policyholders, but constrains the level of cash generated and transferable by the UK businesses which are in run-off and absorbed by Movestic which is in a development phase. In respect of the UK businesses, statutory regulations require:

i) a Pillar 1 calculation, which compares regulatory capital resource requirements, based on the characteristics of the in-force life business, with an associated measure of capital as prescribed by regulation; and

ii) a Pillar 2 calculation which compares a risk-based assessment of solvency capital with an associated measure of capital based on a realistic assessment of insurance liabilities; and

iii) the amount of required regulatory solvency capital is then determined by the method which gives rise to the lower excess of regulatory capital over requirements.

These calculations are updated quarterly (at least on a high level).

Longer-term projections

On a six monthly basis, longer-term projections are prepared on a Group basis embracing:

(i) Segmental earnings and surplus arising in the long-term insurance funds;

(ii) Chesnara company cash flows;

(iii) Regulatory solvency and capital resources and requirements on a regulated individual entity basis and on a consolidated Group basis; and

(iv) European embedded value.

The projections are prepared for a base case and for various sensitivities, the base case follows the latest assumptions approved by the respective boards, regarding:

i) the calculation of actuarial liabilities for longer-term insurance contracts; and

ii) cash flows within the embedded value calculation.

The sensitivities which are prepared include the impact of adverse movements in;

i) the equity, property and bond markets;

ii) variations in anticipated new business volumes in the Swedish business; and

iii) adverse movements in the Sterling: Swedish Krona exchange rate.

In addition,

·; for the UK businesses, financial condition reports are prepared on an annual basis which include assessments of the ability of the business to withstand key adverse events, including increased rates of policy lapse, expense overruns and unfavourable market conditions, and

·; Reverse stress testing techniques are employed which identify the circumstances in which Chesnara would become incapable of paying a dividend and the probability of those circumstances arising.

Investment management

An element of meeting policyholders' expectations and thereby, promoting customer retention is the pursuit of good relative investment performance in the policyholder funds;

·; The CA funds are primarily managed by Schroder Investment Management Limited while the CWA funds continue to be managed by Irish Life Investment Managers Limited and the S&P funds continue to be managed by JPMorgan.

·; We meet formally with fund managers on a quarterly basis to assess past performance and future strategy. Investment guidelines for investment fund managers are established for each fund having regard to the nature of the fund and to contractual obligations to policyholders. For the with profits funds these are also in accordance with the published Principles and Practice of Financial Management.

·; Movestic funds are managed by a carefully selected range of fund managers who have strong performance records in the relevant sector. Performance is monitored very closely and regular meetings are held with fund managers. Should underperformance continue then an alternative manager is sourced and appointed to manage the relevant assets. Where a new market niche or specific opportunity is identified new funds may also be added.

·; The CA Board continues to have a conservative approach to the investment of shareholders' funds in the UK life businesses, which underpins our strong solvency position. For the UK businesses, where the greater part of shareholders' funds subsist, this approach targets the investment of 100% of available funds in cash and fixed interest securities. In the light of recent volatility in financial markets, particular attention is given to the mix and spread of these investments to ensure that we are not unduly exposed to particular sectors and that our counterparty limits are strictly adhered to.

Outcomes

Key outcomes from our financial management process, in terms of meeting our objectives are set out below:

Solvency and Regulatory Capital

For the whole of the periods presented below the Pillar 1 calculation for the UK business, as described above, gave rise to the lower measure of excess capital. The statutory solvency position of the individual businesses may accordingly be summarised as:

(i) The position as at 31 December 2011 reflects the impact of the Part VII Transfer, as a result of which CA includes the transfer of all the long-term business funds and certain of the share-holder funds of S&P.

(ii) The amounts reported as S&P as at 31 December 2011 accordingly represent residual S&P shareholder funds which have been retained to cover the minimum EU regulatory capital resource requirements for regulated entities.

(iii) Excess capital is determined by the minimum regulatory capital resource targets set by the respective boards, except for the Group solvency ratio for which no target is set above the regulatory minimum of 100%. Reliance is placed instead on the efficacy of targets set at the subsidiary level.

(iv) The information provided in respect of CA and the Group illustrates:

(a) A robust protection for policyholders; and

(b) a favourable position from which Chesnara, which relies on dividend distributions from CA, continues to service its loan commitments and to pursue a progressive dividend policy.

(v) The information in respect of Movestic also illustrates robust policyholder protection and provides the context in which Chesnara makes further capital contributions as the business expands.

Returns to Shareholders

The Board's primary aim is to continue to provide a reliable and progressive dividend flow to shareholders within the context of the emergence of surplus in the UK businesses. Returns to shareholders are underpinned by the emergence of surpluses in, and transfer of surpluses from long-term insurance funds to shareholder funds and by the return on shareholder net assets representing shareholder net equity. These realisations are utilised in the first instance for the repayment and servicing of debt. The surpluses arise from the realisation of in-force value of UK businesses, which are in run-off. The return on shareholder net assets is determined by the Group's investment policy. Shareholder funds bear central corporate governance costs which cannot be fairly attributed to the long-term insurance funds and which arise largely in connection with Chesnara's obligations as a listed company.

Between early March 2010 and the end of November 2010 the share price averaged 220p per share. During that period it generally traded within a range of 200p to 250p per share and was subject to sharp fluctuations within the range, generally reflecting wider market conditions.

Following the announcement of the acquisition of S&P on 20 December 2010 up to mid-March 2011, the share price steadily strengthened so that it was consistently trading within a range of 240p to 260p per share. Based on total proposed dividends for 2010 of 16.4p per share, this implied a yield of between 6.3% and 6.8%, with the shares trading at a discount of between 13% to 19% to the latest published embedded value of £354.6m at 31 December 2010.

Over the period from mid-March 2011 to mid-November 2011 the share price declined steadily from a high in the range of 255p to 260p per share to a low in the range of 160p to 165p per share. This fall was largely driven by the decline in global investment markets and followed the fortunes of the life insurance sector as a whole. However, the share price has, from mid-November 2011 to mid-March 2012, fluctuated within a range of 165p to 186p and this has not reflected the upturn in the sector as a whole. Based on total proposed dividends for 2011 of 16.85p per share this implies a yield of between 9.1% and 10.2% with the shares trading at a discount of between 29% and 36% to EEV as at 31 December 2011.

Returns to Policyholders

Key aspects of policyholder fund performance in respect of the UK Business and in respect of the Swedish Business are set out in the Chief Executive's Review.

Liquidity

The current profile and mix of investment asset holdings between fixed-interest securities is such that realisations to meet obligations to third parties and to support dividend distributions can be made in an orderly and efficient way.

Going Concern

The Group's cash flow position together with the return on financial assets in the parent company, supports the ability to trade in the short term. Accordingly, the underlying solvency position of the UK life businesses and their ongoing ability to generate surpluses which support cash transfers to shareholders' funds is critical to the ongoing ability of the Group to continue trading and to meet its obligations as they fall due.

The information set out in `Solvency and Regulatory Capital' above indicates a strong solvency position as at 31 December 2011 as measured at both the individual regulated life company levels in both the UK and Sweden and at the Group level. In addition, in respect of CA and S&P the financial condition report and reverse stress testing assessments indicate that the CA and S&P businesses are able to withstand the impact of adverse scenarios, including the effect of significant investment market falls, while the business's outsourcing arrangements protect it from significant expense overruns.

Notwithstanding that the Group is well capitalised, the current financial and economic environment continues to present specific threats to its short-term cash flow position and it is appropriate to assess other relevant factors. In the first instance, the Group does not rely on the renewal or extension of bank facilities to continue trading - indeed, as indicated, its normal operations are cash generative. The Group does, however, rely on cash flow from the maturity or sale of fixed interest securities which match certain obligations to policyholders: in the current economic environment there remains a continuing higher risk of bond default, particularly in respect of financial institutions. In order to manage this risk we ensure that our bond portfolio is actively monitored and well diversified. Other significant counterparty default risk relates to our principal reassurers. We monitor their financial position and are satisfied that any associated credit default risk is low. It is noteworthy that we have negligible exposure to Euro-denominated sovereign debt.

Our expectation is that, notwithstanding the risks set out above, the Group will continue to generate surplus in its UK long-term businesses sufficient to meet its debt obligations as they fall due, to continue to pursue a reliable and progressive dividend policy and to meet the short-term financing requirements of Movestic, which is expected to become cash-generative within one to two years.

Consolidated Financial Statements - IFRS Basis

Consolidated Statement of Comprehensive Income for the period ended 31 December 2011

Consolidated Balance Sheet at 31 December 2011

Consolidated Statement of Cash Flows for the year ended 31 December 2011