Final Results

28th Mar 2006 07:03

SVB Holdings PLC28 March 2006 SVB HOLDINGS PLC Preliminary results for the year ended 31 December 2005 Highlights SVB Holdings PLC ("SVB"), the specialist insurance group, today announces its2005 preliminary results. Highlights: •Combined ratio: 95.2% (2004: 89.4%) •Operating profit: £2.9 million (2004: £101.5 million loss) •Profit before tax: £13.9 million loss (2004: £113.6 million loss) •Net assets per share: 31.2p (2004: 35.4p) •Net tangible assets per share: 28.9p (2004: 32.9p) Commenting on the results, Matthew Fosh, Group Chief Executive, said: "SVB's results in 2005 further demonstrate the quality of our currentunderwriting. Despite an unprecedented series of catastrophe events, and whilststill carrying a fading burden from our discontinued legacy business, we haveagain achieved a top quartile underwriting performance and generated anoperating profit." There will be an analyst and investor briefing at 10.00a.m. today at the officesof M:Communications, CityPoint, 1 Ropemaker Street, EC2Y 9HT in the Madrid Room,9th Floor. Enquiries: SVB Holdings PLC 020 7903 7300Matthew Fosh M: Communications 020 7153 1521Nick Miles SVB HOLDINGS PLC Preliminary results for the year ended 31 December 2005 Chairman's statement My statements of the past four years have inevitably been dominated by how wehave sought to rebuild SVB following the damaging underwriting years of 2001 andprior. Indeed, in 2005 much management time was again taken up addressing legacyissues. Nevertheless, 2005 was also a year in which confidence grew stronglythat the changes painstakingly introduced since 2004 to isolate and address ourpast problems were beginning to bear fruit. The logic of setting the exceptional provision in 2004 in respect of potentialadverse reserve movement from the discontinued classes (liability reinsurance,healthcare and third party liability) was proven in 2005. £36.5 million of theprovision was utilised in the six months to December 2004; and a further £40.0million during 2005. As at 1 January 2006 £27.1 million remains available tooffset future potential deterioration. The Discontinued Business Unit,established and resourced to manage the run-off of classes from which SVB haswithdrawn, has enabled the rest of the Group to concentrate on current businessunencumbered by the day-to-day burden of dealing with the past. The key challenge for SVB in the years since 2001 has been to protect andpreserve the excellent core of SVB's ongoing business. Throughout therehabilitation phase the Board's belief in management's ability to deliver SVB'sultimate revival has never faltered and, as every month has passed in 2005,confidence in this belief has grown. Two key achievements during the 2005 year were the sale of Fusion and thesignificant first steps taken to reduce the cost of our capital. The sale of Fusion marks a successful conclusion to our five year development ofthat business. The Fusion book of business had grown to £100 million of regionalproperty and liability business; but, as a partially-owned subsidiary, its rateof growth in terms of premium income, and the operational risk (for example inoverhead) that this presented, was potentially unbalancing the wider Group. Thesale of our stake in Fusion in November was a satisfactory outcome and generatedan attractive return for SVB. The second crucial development was the first step in reducing our cost ofcapital, which was re-financed by replacing a costly £20 million tranche of oursolvency capital at the end of June with more economic bank finance. This,coupled with a reduction in our overall capital requirement going into 2006,will result in significant future benefits for the Group. These two key milestones were possible in the context of a third key elementduring the year, namely our ability to maintain the support of our insureds, ourbrokers and our reinsurers. It was only by maintaining the confidence of thesekey constituencies that we were going to be able to maintain the momentum ofrecovery. Coupled with the continued loyalty and commitment of its employees,SVB has been able to maintain and build upon the confidence of its key partners.It has withstood the pressure from the past and from its competitors and hasplaced itself a critical further year closer to full rehabilitation. 2005 was of course a year in which the insurance industry as a whole sufferedthe most costly hurricane season on record. This was especially frustrating forus, at a time when we would otherwise have emerged healthily profitable.Nevertheless these windstorm losses were an industry-wide challenge, notspecific to SVB, and on this occasion the Group is well-placed to participate inthe strong underwriting environment which we anticipate will emerge during 2006/2007. It is in this context that on 10 February 2006 we announced our intention topublish proposals to form an FSA regulated insurance company focussed on UKmid-sized commercial risks. These proposals are aimed at achieving SVB's statedstrategy of establishing a wholly-owned insurance company outsideLloyd's, decoupled from the damaging legacy underwriting. SVB is todaypublishing detailed proposals which describe the formation and capitalisation ofthe insurance company under a new listed holding company created by a scheme ofarrangement. It has taken longer than all of us hoped to stem the losses from past years andto build a solid platform for SVB going forward. We are not there yet butquantum steps forward have been taken in 2005. The underwriting approach thatproved so damaging to SVB was pursued for four years, 1997-2000, and its effectswere felt into 2001 and 2002. Rehabilitating the business was never going to bea straightforward task; the complexity and tail characteristics of the legacybusiness needed the passage of time for the Group to recover. The fortitude andresilience shown by my colleagues at SVB has been exemplary in the face ofchallenges that have overwhelmed others. I would like to thank all my colleaguesfor their commitment to SVB during these years and we enter 2006 with growingconfidence that we shall soon be able to reward shareholders with a revitalisedbusiness, growing in confidence and growing in ambition. Paul Selway-SwiftChairman28 March 2006 Operating and financial review IntroductionThe 2005 Operating and Financial Review ("OFR") has been prepared to provideinformation to shareholders. It should not be relied upon by any other party orfor any other purpose. The OFR contains certain forward-looking statements which are made by theDirectors in good faith based on the information available to them at the timeof their approval of this review. Statements contained within the OFR should betreated with caution due to the inherent uncertainties, including economic,regulatory and business risk factors, underlying any such forward-lookingstatements. Long term strategy and business objectivesThe SVB Group's long term strategy is to build and develop a specialistinsurance business diversified by: • Product: Liability classes account for approximately 65 per cent. ofthe SVB Group's gross written premium with the balance from short tail classes,principally property. These liability classes are direct, and compriseprincipally claims made business within the Specialty segment (of which thefinancial institutions account is the single largest component) and mostlyoccurrence form business within the Liability segment. Such occurrence formliability business is limited to 20 per cent. of premium income. SVB'sreinsurance business is event-driven catastrophe reinsurance, primarily inphysical property and aviation classes. Around 55 per cent. of gross writtenpremium is sterling denominated and 40 per cent. is US dollar denominated (notall of which is US situs business). • Market: The Group has continued to explore operating platformsoutside Lloyd's. The frictional cost, capital requirements and mutualisation ofLloyd's make such options potentially more attractive for some classes ofbusiness. • Method of distribution: The Group is committed to diversifying itsmethod of distribution away from purely London-market, broker-sourced business.The objective of Novae Underwriting Limited ("NUL") is to source small ticket,regional liability business in a cost-effective way, making particular use ofinformation technology rather than regional infrastructure. This diversificationis intended to provide balance and reduce volatility to the Group as a whole. The medium term business objectives are as follows: • Ongoing business: The ongoing business is charged with generating across cycle return in excess of the Group's cost of capital. Underwriting unitsare judged primarily on their ability to generate profits in excess of theircost of capital. • Discontinued Units: Between 1997 and 2000 the SVB Group underwrote alarge volume of US liability business on a reinsurance-geared basis. Suchbusiness was seriously under-priced and its effects continue to distort SVB'sfinancial performance. Managing the run off in the most financially advantageousand effective way for shareholders, including possible transactional solutionsto achieve finality, is the key business objective for the Discontinued Units. These aims and objectives are to be pursued within the context of an explicitrisk tolerance which, wherever possible, delivers rewards consistent with thoserisks. It is in this context that SVB announced its intention on 10 February 2006 toform a new FSA regulated wholly-owned insurance company. SVB's stated strategyhas included for some time the formation of a wholly-owned insurance companyoutside Lloyd's, decoupled from its damaging legacy underwriting. Throughout2005 the Board has considered a number of options to achieve these aims, as aresult of which it became clear that the most appropriate operating structurewas an FSA regulated insurance company. Having consulted with the FSA, Lloyd's, major institutional shareholders andlenders, on 10 February 2006 SVB announced its intention to publish detailedproposals by the end of March 2006. These proposals, which are published today,include the formation and capitalisation of an FSA regulatedinsurance company focussed on UK mid-sized commercial risks. This will sitalongside the continuing Lloyd's business under a newly incorporated listedholding company established by way of a scheme of arrangement. Result for the 2005 financial yearThe Group reported a pre-tax loss of £13.9 million in 2005 (2004: £113.6 millionloss). Record pre-tax profits of £27.7 million in the first half were offset byan extreme series of property losses in the second half. However, such lossexperience in the second half is expected to reverse first half rate softening,resulting in a much more attractive operating environment for 2006. Net premium revenue in 2005, at £270.6 million, shows a reduction from theequivalent figure of £417.1 million in 2004. This reflects principally twonon-recurring items which added £122.9 million to the 2004 figure, referred toin note 6. In conformity with industry practice the combined ratio is nowcalculated by relating both claims and expenses to net premium revenue. The combined ratio of the ongoing business was 95.2 per cent. (2004: 89.4 percent.). The claims ratio for the year was 71.5 per cent., of which 24.9 percent. was accounted for by US windstorm losses in the second half (2004 claimsratio: 56.3 per cent., including 6.8 per cent. from windstorms). Reserve movements for the discontinued units were absorbed by the exceptionalloss provision established as at 30 June 2004. During the year some £40.0million of the provision was utilised, leaving £27.1 million to be carriedforward on 1 January 2006. In November 2005 SVB sold its majority stake in Fusion Insurance ServicesLimited ("Fusion") for £15.0 million, valuing the entire issued share capital ofFusion at £25.0 million. Fusion was acquired by a newly formed majority-ownedsubsidiary of Towergate Underwriting Limited managed by the existing Fusionmanagement team. The sale of SVB's stake in Fusion generated a cash inflow for the Group of £15.0million before transaction costs, representing a multiple of 2.5x SVB's originalinvestment made in 2000. No tax is payable on the transaction, which has addedapproximately 1.1p to the Group's net tangible assets per share. Future outlookRatingRates, terms and conditions softened in 2005, particularly in the first half ofthe year. Across the SVB Group's book of business, taking renewal and newbusiness together, rates fell by 4 per cent. in the first half. US windstorm losses in the second half were unprecedented in their severity.Hurricane Katrina is likely to be the single largest loss event in theindustry's history, possibly costing the insurance industry $60 billion, broadlydouble the size of the WTC loss in 2001. Including the cost of Hurricanes Ritaand Wilma the total cost of windstorm losses in 2005 is estimated to be inexcess of $80 billion. As a result, the rating environment and outlook has beentransformed. Although this will be most marked in property, it is likely to befelt in many classes of business. The SVB's rating index for the six years to 31 December 2005 is set out below: Class 2000 2001 2002 2003 2004 2005 Specialty 100 125 212 281 292 267 Property 100 118 159 165 158 157 Liability 100 117 171 196 207 204 Aviation & Marine 100 132 284 304 295 280 Whole account 100 123 193 228 230 217 Business mixIn recent years SVB's business mix by volume of gross premium written has beenapproximately 45 per cent. Specialty, 30 per cent. Property, 15 per cent.Liability and 10 per cent. Aviation & Marine. Variations to the business mixhave been seen from year to year reflecting market opportunities and rating,terms and conditions. Capacity outlookUntil Hurricane Katrina in August, rates, terms and conditions were softeningacross most classes. As a result, at that stage SVB intended to reduce thepremium capacity of its managed syndicates from £437 million in 2005 to £406million for 2006. However, US windstorms in the second half of the year changed the underwritingoutlook. In November SVB sold its interest in Fusion, which was budgeted toproduce around £100 million of gross written premium in 2005, spread across anumber of years of account. As a result of these developments in the second halfSVB revisited its 2006 business plan. The 2006 premium capacity of the managedsyndicates is now £360 million, with the impact of the Fusion disposal partiallyoffset by upward revision elsewhere post Katrina. Operating reviewOverviewIn the previous section, commentary has been provided on the impact of the 2005hurricanes, particularly Katrina. These events have major implications foroperating conditions in 2006. Competitive environmentSVB operates in a competitive industry, both domestically and internationally. By virtue of its rating and licences, Lloyd's remains an effective market inwhich to write specialist international insurance business. In 2005 there were44 Lloyd's managing agents, managing a total of 62 active syndicates. Althoughbarriers to entry are rising for managing agents, the ability to set up a newbespoke syndicate managed by an existing managing agency remains an attractiveroute into Lloyd's. The broader London company market is dominated by large,international insurers. International competition comes from a number of centres. EU passporting rightshave made Dublin and Gibraltar attractive locations, particularly for mid-sizedcommercial risks and UK personal lines insurers. The US and Bermudan markets,along with legacy European centres, are active competitors in large,international direct and reinsurance classes. The relatively light regulatoryburden, attractive tax status, ease of access to capital via the US capitalmarkets and low barriers to entry have resulted in successive waves of newentrants locating in Bermuda. Following the US windstorm losses inAugust-October 2005, some $11 billion of new capital has been raised forincumbent Bermuda insurers, and a number of new businesses have beenestablished. Regulatory environmentTransacting insurance business in the UK and overseas is a regulated activity.In the UK SVB is regulated by the FSA. In overseas markets SVB generallyoperates by virtue of relevant local Lloyd's licences. There were three major regulatory developments in 2005. First, with effect from 14 January 2005 the FSA assumed direct regulation ofinsurance brokers. Lloyd's is an intermediated market and the brokers play animportant role in the claims and settlement process as well as in businessproduction. Second, the FSA became directly involved in the Lloyd's capital setting processfor the first time. The FSA's capital regime is calibrated so as to provide a99.5 per cent. level of confidence that an individual regulated business willsurvive for the next 12 months. Lloyd's risk based capital regime is designed todeliver a more robust regime than the FSA and thus its capital requirement forthe market as a whole is set at an even higher level than that of the FSA. SVB submitted its Individual Capital Assessment in June 2005. The FSA undertooka routine ARROW visit to SVB in October 2005. The scrutiny and robustness of FSAregulation continues to increase, overlaid by the separate requirements of theLloyd's franchisor. Third, US regulators continue to probe the practices of the insurance industryin a variety of areas, including broker remuneration, the use of finiteinsurance and general market conduct. Some of these issues, in particular theenquiries into alleged bid rigging, do not affect SVB directly by virtue of thesubscription nature of the London market. However, meeting the informationrequests from such investigations has been a burden on the London market in2005. Macroeconomic environmentThere have been a number of major catastrophes in 2004 and 2005. Although notall property catastrophe events affect the insurance industry (for example theIndian Ocean tsunami and Kashmir earthquakes were generally uninsured), high andrising insured values in the USA and Europe have the potential to makecatastrophe events very expensive. Catastrophe modelling, on which pricingdecisions are based, has been shown to have limitations by the extreme natureand scale of Hurricane Katrina in 2005. Liability business, particularly in theUSA, continues to be dominated by high profile corporate claims and the US tortsystem makes pricing such risks challenging. Investment markets generated modest returns on the asset categories in which SVBis invested. We achieved a return of £25.8 million, representing a return of 3.2per cent. on year end assets of £789.9 million. A further breakdown of this isprovided in note 21. The mobility of capital continues to increase. As a result, whilst the insuranceindustry began the year committed to returning capital to investors, the lossesand consequential improvement in outlook in the second half attracted freshcapital into the industry. Segmental structureSVB continues to report its results by continuing underwriting segment, beingSpecialty, Property, Liability and Aviation & Marine. The Discontinued Units,which comprise liability reinsurance, healthcare and third party liability, arereported separately. There are some other lines of business, such as USprofessional indemnity, marine excess of loss reinsurance and kidnap & ransom,from which SVB has withdrawn but where financial performance remains withincontinuing underwriting so as to preserve the precision of the originaldefinition of Discontinued Units. SVB manages two active syndicates at Lloyd's, Syndicate 1007 and Syndicate 2147.The majority of underwriting units comprising the Specialty segment form part ofSyndicate 1007. The Property, Liability and Aviation & Marine segments are madeup of units forming part of Syndicate 2147. The key performance indicators used in managing the ongoing business are grosswritten premium, underwriting profit, combined ratio and economic value added.The critical key performance indicators for the Discontinued Units are theextent of any utilisation of the exceptional loss provision and data relating tothe satisfactory resolution of claims from the Discontinued Units. SpecialtyThe overall contribution to underwriting profit was £6.4 million, with grosspremiums written of £111.5 million and a combined ratio of 86.0 per cent.Healthy profits on business written in the 2003 and 2004 underwriting years wereoffset by adverse developments on business written in 2001 and 2002. While therewas some further adverse effect from high profile claim issues relating tofinancial institutions business, the principal problem was in respect of USDollar professional indemnity business, from which SVB has since withdrawn. The profits from more recent underwriting years were derived principally fromfinancial institutions and UK professional indemnity business, where SVB has astrong market franchise. While we expect such business to produce healthyprofits in respect of 2005 underwriting it is too early to contemplatesignificant profit recognition on an annual accounting basis from such mediumtail classes. PropertyOverall our Property business produced an underwriting loss of £29.9 million,with gross premiums written of £71.0 million and a combined ratio of 130.4 percent. This overall loss comprises principally a loss of £48.7 million onbusiness written for the 2005 underwriting year, which reflects the cost of 2005hurricanes amounting to £67.2 million, and profits on business transacted forthe 2003 and 2004 underwriting years. The assessment of the cost of windstorms that occurred in 2004 is unchanged at£23.0 million and the profits on previous underwriting years therefore reflectmainly a pleasing claims experience on unearned premiums brought forward. Basedon the terms on which business was written for the 2005 underwriting year, weexpect that the future emergence of profit on premium income unearned at 31December will offset the losses already suffered on Property business written inthe 2005 underwriting year. LiabilityOur Liability business contributed £11.5 million to underwriting profit, withgross premiums written of £40.7 million and a combined ratio of 79.0 per cent.This is a long tail class and a prudent approach to profit recognition istherefore critical. This produces a loss on business transacted for the 2005underwriting year, although ultimately we expect it to be profitable, andprofits in 2005 from favourable development on all prior years. This includesmeaningful levels of profit on business transacted in each of the 2001, 2002,2003 and 2004 underwriting years, with a small release from business written in2000 and prior. Aviation & MarineThis segment produced a profit of £14.7 million, with gross premiums written of£25.8 million and a combined ratio of 35.7 per cent. This exceptionally highlevel of profit from our smallest segment reflects the unwinding of previousdistortions on aviation reinsurance business and favourable reserve developmenton this business. In particular it reflects a cautious approach taken in thepast to reserving the major loss events which affected the 2001 underwritingyear, which was the first year of SVB's involvement in this class. The principalMarine involvement for SVB is marine liability where the profit is included inthe Liability segment, which depresses the scale of the marine profit includedin the Aviation & Marine segment. Discontinued UnitsThe Discontinued Units produced an overall loss of £40.2 million, of which £40.0million has been charged to the exceptional provision. This loss is whollyattributable to the dominant liability reinsurance element, with Healthcareproducing a small surplus in 2005. While the worst outcome was on the 2000underwriting year there was a more widespread negative effect, with adversedevelopment on all years from 1997 to 2002, when SVB exited this class. However,the overall impact was substantially lower than the equivalent deteriorationlast year. The extent of the negative impact from liability reinsurance business reflectsat least in part an aggressively proactive stance by SVB in getting to theultimate loss position. Actions to overcome issues such as the drip feed ofinformation by cedants, for example by commissioning more extensive and morethorough loss reviews, can help the process of estimating the ultimate lossposition. However, it can also amplify the impact in the short term and it isdifficult for actuarial modelling to cope with circumstances where there isdeliberate action to make the future different from the past as far asdevelopment profiles are concerned. The 2004 decision to form the DBU resultedfrom SVB's determination to capture fully the scale of the issues involved andin this respect it is clear that it has made further progress in 2005. Risks and uncertaintiesRisk is managed at the operating level by a series of committees made up ofexecutives from the Lloyd's sub group and NUL. The capital requirements of thesyndicates arising from risk assessment are determined by the Group's managingagent subsidiary. These committees in turn report directly or indirectly to theGroup Risk Committee. SVB has identified six key risk pillars against which capital is held. Thesemirror general risk types accepted throughout the insurance industry. Risk canalso be exerted on SVB from three other areas: regulatory uncertainty, thestructure of the London market and competition. Insurance riskInsurance risk is made up of underwriting risk and reserving risk. Underwritingrisk is set by reference to Willingness To Lose ("WTL"), being the maximum lossnet of reinsurance recoveries and reinstatement premiums the Group is preparedto absorb from any one specific catastrophic event. Various Realistic DisasterScenarios ("RDS") are modelled and related to WTL limits. Base case WTL variesaccording to the type of event concerned. For most natural disasters the basecase WTL is £30 million, although for extreme US property catastrophe events theWTL is £45 million. Further analysis is set out in note 2. Hurricane Katrina subjected our WTL methodology to a severe test.Instead of a net loss of £45.0 million, which our WTL methodology applied to aGulf windstorm assumed to produce insured losses of some $60 billion, HurricaneKatrina is currently assessed as likely to cost SVB £58.0 million, including anallowance for further future loss notifications. Important issues here are theproportions of wind and water related losses and of commercial and residentiallosses, which are radically different in the case of Hurricane Katrina from whatwould be expected from a normal hurricane loss. Nevertheless, Hurricane Katrina has also revealed certain weaknesses in the waywe have modelled loss potential in respect of US open market direct propertybusiness. Our initial response was to reduce the extent of our catastropheexposure through this aspect of our Property business. Subsequent review in thecontext of changing outwards reinsurance arrangements for 2006 has led us tocease transacting this business. This enables us to concentrate our WTL on thoseareas, property catastrophe reinsurance and US direct property facilities, whichhave demonstrated through our Katrina experience a better awareness of the losspotential from such a major catastrophe. Investment riskSVB has two pools of investment assets: solvency capital (or funds at Lloyd's)and syndicate premium trust funds. Both pools are managed by external managerswithin detailed investment guidelines. SVB has moved away from a relativeperformance bond benchmark to a cash-plus absolute performance approach. Avoidance of capital loss remains an overarching objective, and the investmentstrategy remains focussed exclusively on cash and high quality investment gradebonds. There is no current intention of moving away from this strategy. As aresult, SVB's exposure to market and currency risk is low. Risk stemming fromthe failure of individual issuers is controlled by concentration limits andverified by stress and scenario testing. Non-sterling investments are made bythe premium trust funds and are used to hedge reserves, reducing SVB's exposureto the impact of exchange rate movements. Credit riskCredit risk arises in instances where SVB is on risk but has not yet receivedthe cash to which it is entitled. The most significant form of credit risk is inrelation to reinsurance recoveries, where SVB has counter-party risk with areinsurer who may prove to be unable or unwilling to honour its obligations. Reinsurance credit risk is addressed in a number of ways. First, the financialstrength and market reputation of potential reinsurers is taken into accountbefore protection is purchased and aggregate exposure to individual reinsurersis monitored. Second, the brokers through which reinsurance is bought (and whoplay a key role in its collection) are monitored for service, and in particularthe speed of collection. SVB is wary of using brokers where service levels,financial strength or strategic direction are not robust. Third, collection ofreinsurance amounts due but not paid is monitored weekly and specific action istaken to resolve arrears. Liquidity riskSVB faces liquidity risk at three levels. First, its managed syndicates must be able to satisfy both claims (if necessarygross, prior to receipt of reinsurance recoveries) and overseas fundingrequirements, of which the US situs funding requirements are the most onerous. A$35 million stand-by bank facility is available if required to provideadditional liquidity to meet peak funding requirements. Part of this facilityamount was drawn down in February 2006 following 2005 hurricane losses. Second, the Group's regulated subsidiaries are required to meet the FSA's andLloyd's solvency requirements. Apart from the solvency capital requirements ofthe Group's Lloyd's corporate member, the managing agency and NUL are alsorequired to demonstrate that their own regulatory requirement is satisfied.Solvency capital is monitored and capital is moved around the Group to reflectany surpluses or deficits from time to time. Third, the parent company models its own free cash and the Group'sworking capital position up to two years into the future. Working capital straincan occur at Group level as a result of lags in the Lloyd's three yearsettlement process. Solvency and working capital have to be financed in theperiod prior to the point at which cash profits are released from Lloyd's. Inaddition to its free cash resources, SVB has an undrawn £5 million RevolvingCredit Facility to meet short term funding requirements. Operational riskSVB has identified a number of areas of operational risk encompassing businesscontinuity, IT, business process, pricing, reputational and regulatory issues.Systems and procedures mitigate individual risks, and are subject to a processof continuous improvement. The internal audit and compliance functions play akey role in these continuous business improvement initiatives. Group riskFollowing the sale of SVB's stake in Fusion, all subsidiaries are wholly-ownedand all are focused solely on the development of the Group's insurance business. Regulatory uncertaintySVB's principal operating subsidiaries are regulated by the FSA. As SVB operatesat Lloyd's as a franchisee, it is also subject to the rules set by thefranchisor, including those on capital adequacy. SVB's regulated subsidiaries and the individuals who carry out Control Functionswithin them may be subject to sanction if they breach FSA guidelines or rules.Similar risks apply if the bye laws and rules of the Lloyd's franchisor arebreached. Such risks are mitigated by internal processes and procedures. The London insurance market's operating practices may be affected by regulators,including those outside the UK. For example progress towards contract certainty,an area of FSA focus, requires the active support of both underwriters andbrokers. SVB is investing in technology and people as part of its drive tocontract certainty, but cannot change market behaviour in isolation. Unlessthere is tangible progress towards meeting the FSA's objectives, there is a riskthat a solution will be imposed on the market. The most significant regulatory risk to affect SVB in recent years has been therequirement of Lloyd's, first as regulator and then as franchisor, to increasethe amount of solvency capital required of the business. Between 2001 and 2006,SVB's solvency ratio has increased from 49 per cent. to 82 per cent. Therelentless rise in the solvency ratio has depressed return on capital employedand increased financial gearing. The transition to the FSA's Individual CapitalAssessment regime may ultimately ease this pressure, although for 2006 Lloyd'srequires substantially more capital than SVB would require were it to beregulated by the FSA but not franchised by Lloyd's. In 2005 regulatory costs, including listing costs, Lloyd's and FSA charges andprofessional advice and other services purchased to meet regulatory requirementswere some £690,000 (2004: £570,000). Such costs have risen over recent years andthere is no evidence to suggest that they will diminish in the future. Market structure riskSVB is exposed to two major risks as a result of the structure of its market. First, the insurance industry is both international and regulated. Barriers toentry in some jurisdictions are low. As a result, SVB's market position could beaffected by regulatory or capital arbitrage, particularly from offshore centressuch as Bermuda. Second, the structure of Lloyd's exposes SVB to potential risk. In particular,the mutualisation of Lloyd's through the Central Fund means that the failure ofa Lloyd's underwriter could result in a Central Fund call on SVB and othersurviving market participants even if they had declined the risks that gave riseto that failure. Competitive riskThe insurance industry is fragmented. New entrants can attract capital rapidlyif market conditions are attractive, as they are expected to be in 2006. Capitaldiscipline is not always robustly enforced. As a result, profits can be competedaway by poor underwriting discipline, and assureds and their brokers may beinfluenced by price competition between insurers. ResourcesCapitalAs at 1 January 2006 some £239.0 million was employed by SVB as solvency capitalat Lloyd's (1 January 2005: £215.8 million). A further £15.6 million wasemployed elsewhere in the business (1 January 2005: £11.0 million). PeopleAs at 31 December 2005 the SVB Group had 199 employees, deployed as follows: 2005 2004Lloyd's sub group - ongoing 143 127 - DBU 7 7NUL 49 44Fusion - 139--------------------------------- ----------- --------Total 199 317--------------------------------- ----------- -------- Staff turnover is monitored as a key performance indicator. In 2005 staffturnover (excluding the effects of the Fusion disposal) was 11.7 per cent.,compared with 18.3 per cent. in 2004 and 23.8 per cent. in 2003. Staff turnoveris managed to provide business continuity whilst constantly improving quality. Intellectual propertySVB has a strong market position in Specialty lines, where certain technicalaspects such as policy wordings, coverage issues and claims management areimportant. Other areas of SVB's account are highly specialised. As a result,investment in training and personal development is a commercial imperative aswell as a regulatory requirement. Business in frastructureThe SVB Group contained 11 continuing corporate entities at year end, comparedto 61 two years earlier. These form two major operating components. The Lloyd's sub group contains the managing agency, investment companies andLloyd's corporate member, which underwrites solely on SVB managed syndicates.The Group is the only participant on Syndicate 2147 and accounts for 82 percent. of the 2006 capacity on Syndicate 1007. It remains the Group's intentionto acquire the third party capacity on Syndicate 1007 on reasonable financialterms and merge the syndicates. SVB Distribution Limited is the parent of NUL, the Group's wholly-owned servicecompany, which provides professional indemnity, liability and credit insurance,largely to the UK regional market. SVB's stake in Fusion was held by SVBDistribution until its sale on 4 November 2005. Excluding cost of capital and Lloyd's charges, the 2006 budgeted overhead of theLloyd's sub group (including Central Group) is £36 million, of which theDiscontinued Business Unit is £2 million (2005: £26 million and £3 millionrespectively on a comparable basis). NUL's 2006 budgeted overhead is £8 million(2005: £6 million). Fusion's 2005 overhead budget was £16 million. Cash cost savings of £2.7 million excluding cost of capital were achieved,compared to a target of £2.5 million. The annualised cash saving from the June2005 refinancing is a further £4.0 million. Further cost reductions are likely to be more limited. The businessinfrastructure will require future investment, particularly as SVB moves from astrategy of damage control and recovery to measured growth and diversification. Financial reviewCapital management and cost of capitalSVB is required to post solvency capital at Lloyd's to support its underwriting.In addition, the Group requires working capital to support its overhead and meetthe cash cost of capital payable in the period prior to which underwritingprofits are released under the Lloyd's three year settlement process. The over-riding objective is for the Group to have adequate capital. Thereafter,the aims are to diversify capital by provider and manage its cost. Theseobjectives are monitored through monthly key performance indicators. 2005 out turn and return on capitalIn 2005 the pre tax return on capital employed was 6 per cent. (2004: 25.8 percent. loss), compared to a pre tax hurdle rate of 15.0 per cent. (2004: 15.0 percent.). The return on equity capital employed was a loss of 23 per cent. Thecomponents of the return calculation, including separate identification of theeffect of losses from the US windstorms, are set out below: £m unless stated Equity capital Gross capital employed employedOperating profit before windstorm losses 53.6 53.6US windstorm losses (67.5) (67.5)Financing costs - 20.8Profit before tax (13.9) 6.9Average equity capital employed 120.2 120.2Average geared capital employed - 124.3Pre tax return on capital employed: - including US windstorm losses (23%) 6%- excluding US windstorm losses 45 % 30%2004 comparator (66%) (31%) 2006 capital stack and cost of capitalThe solvency capital required to support the Group's 2006 underwriting is £279.1million (2005: £312.0 million). This represents 82 per cent. of the alignedpremium income capacity for 2006 of £360.0 million (2004: 79 per cent. and£394.4 million respectively). The stack supporting the Group's 2006 underwriting requirement is made up of thefollowing components: • Own capital, including assets held as solvency capital (2006:£239.1 million; 2005: £232.0 million); • Reinsurer letter of credit (2006: £20.0 million; 2005: £60.0million). The letter of credit is an annual commitment expiring in December2006, although the principal may, depending on Lloyd's rules from time to time,be available to support run off years; and • Bank letter of credit (2006: £20.0 million; 2005: £20.0 million).The bank letter of credit facility, which is on normal banking terms includingcovenants and a security package, is a two year commitment covering the 2005 and2006 underwriting years. The estimated pre tax weighted average cost of capital for the 2006 stack is10.0 per cent. (2005 stack: 11.6 per cent.). The Group's pre tax hurdle rate for2006 is 12.5 per cent. (2005: 15 per cent.). Investment assetsAs at 31 December 2005 investment assets (including cash) amounted to £798.9million (2004: £726.9 million), held in three distinct categories: • Solvency capital (2005: £239.0 million; 2004: £215.8 million):assets used to provide solvency capital to support the Group's underwriting atLloyd's. These assets are managed by Credit Agricole and are kept exclusively insterling. Approximately half is invested in cash and short durationcertificates of deposits, and the balance in high grade sterling bonds,principally those of sovereign and quasi sovereign issuers. As at 31 December2005 the average duration of the solvency capital portfolio was 0.7 years; andsome 52 per cent. of the bond portfolio was invested in AAA-rated issuers. • Premium trust funds and client assets (2005: £544.3 million;2004: £500.1 million): assets arising from time to time from the receipt ofpremium payments less claims and other costs. These assets are managed byInvesco, Wise Peck & Greer and Insight, and (save in respect of US and otherlocal funding rules) are retained in the currencies in which they arise. Assetsare held in high grade bonds, principally sovereign and quasi sovereign issuers.As at 31 December 2005 the average duration of the premium trust fund portfolioswas 1.3 years; and some 92 per cent. of the bond portfolio was invested inAAA-rated issuers. • Corporate free cash funds (2005: £15.6 million; 2004: £11.0million): corporate free cash is the surplus over and above that required assolvency capital, either in relation to the Group's underwriting or by theGroup's regulated managing agency and NUL subsidiaries. Such balances aremanaged by Royal London Cash Management and are retained in sterling. Corporatefree cash is generally invested in short duration investment grade certificatesof deposit. Reinsurance assetSVB's reinsurance asset at 31 December 2005 was £561.5 million (2004: £499.2million). The scale of the reinsurance asset is a function of business mix,depth of reinsurance, heavy use of proportional and surplus treaty capacitybetween 1997 and 2000 and recent natural catastrophe losses. The reinsurance asset is made up of two components. First, £453.5 million (2004:£342.5 million) in respect of claim-specific amounts, either notified orawaiting formal notification to reinsurers; and second, £108.0 million (2004:£156.7 million) in respect of gross claims incurred but not reported. A bad debtprovision continues to be carried against both components, based on S&P defaultfactors adjusted for specific reinsurer circumstances. At the year end the totalbad debt provision was £15.2 million (2004: £15.0 million). In October 2004, specific management action was commenced to pursue overduereinsurance recoveries. Aside from the interest foregone, experience suggestedthat delay in collecting reinsurance was frequently a prelude to dispute and insome extreme cases reinsurer insolvency. Willingness to pay can be as importantin managing this asset as ability to pay. In the fourteen months to December 2005 substantial progress has been made incollecting reinsurance arrears and disputed amounts. The amount of reinsuranceuncollected 60 days or more after notification has fallen by 70 per cent. andthe number of individual balances over 60 days in arrears over £75,000 hasfallen by two thirds. This understates the underlying rate of recovery asexchange rate effects added 8 per cent. to dollar-denominated reinsuranceassets. Reinsurance recoveries are monitored through regular performanceindicators. Cash flow and liquidityThe corporate cash flow is made up of three financial components: • Underwriting cash flow;• Cash flow from other group companies; and• Central items, including cash cost of capital. Until 2005, under the Lloyd's three year settlement pattern, cash flow fromunderwriting was generally received in the July three years after the year ofinception. Thus, in 2005 profits of £14.6 million were received from the 2002closed year of account on syndicate 2147. Syndicates 1007 and 1241 have yet toclose for their 2002 years of account. In future, following the adoption of annual accounting within Lloyd's and thecoming-into-line process, profits on open years of account will be recognised asthey are earned. Any surplus earned open year profits over earned open yeardeficits may be released to the Group as cash prior to the natural closure ofeach year of account. Years of account will still normally close after threeyears. Other Group companies had an immaterial effect on overall cash flow,save for the disposal of Fusion for cash proceeds of £13.5 million net ofexpenses. Central costs include the day-to-day expenses of the holding companyinfrastructure together with the cash cost of capital. At 31 December 2005 Group free corporate cash balances were £15.6 million. TaxationThe Group has brought forward trading and capital losses. A deferred tax assetof £41.4 million has been recognised on the balance sheet as a prudent estimateof the amount of tax that may be recovered by setting trading losses againstfuture profits. The deferred tax asset does not include any credit for capitallosses. Claims activityClaims activity is divided between the continuing and discontinued businessunits, to which fifteen and seven adjusters are allocated respectively.Settlement of outwards reinsurance follows from SVB's acceptance of the grossinwards claim amount. During 2005, the claims activity was focused in three areas: • Large Specialty claims, such as Enron-related matters• Hurricane Katrina property claims• Discontinued units The Group closely monitors the legacy business, including an ongoing programmeof internal and external review of large contracts. Detailed managementinformation assesses the performance of the claims function and the movement ofunderlying claims balances. Management in formation and accounting in frastructure During 2005 continued investment was made in management information systems andthe accounting infrastructure. The two key projects were an upgrade to the SUNgeneral ledger system in the third quarter and the implementation of Eclipseannual accounting software in the fourth quarter. Work scheduled for 2006 includes upgrades to the ELGAR reinsurance system andongoing enhancements to the IRIS and Risk Write underwriting and insuranceaccounting software. International Financial Reporting StandardsSVB prepared annual accounts under IFRS for the first time in 2005. Theprincipal differences between UK GAAP and IFRS were set out in the June 2005interim statement and include: • Stating financial assets at bid rather than mid price• Treating deferred acquisition costs and the unearned premiumreserve as non-monetary assets and therefore valuing them at historic ratherthan period end exchange rates• Disaggregating convertible debt into debt and equity components,and accreting the debt component to par value through charges to profit and loss• Changing the basis on which employee equity incentives arecharged to the profit and loss account SVB and its predecessor entities have only operated defined contribution pensionschemes. There is therefore no pension deficit or funding issue (other thanaccruals for monthly contributions) to include on the balance sheet. IFRS requires companies to make certain disclosures over and above thoserequired by UK GAAP. Of these the most significant are: • Management of insurance and financial risk• Share based incentive schemes, distinguishing between theprincipal extant schemes and the basis on which related profit and loss chargeshave been calculated• Insurance contracts, including insurance liabilities and lossdevelopment tables 28 March 2006 Consolidated Income Statementfor the year ended 31 December 2005 Note Year ended Year ended 31 December 31 December 2005 2004 £m £mGross premium revenue 6 366.6 466.9Less premium ceded to reinsurers 6 (96.0) (49.8) ----------- ----------Net premium revenue 270.6 417.1Fees and commission income 7 7.3 5.7Investment income 8 25.8 26.0 ----------- ----------Net income 303.7 448.8Gross claims incurred 9 (350.0) (582.4)Reinsurers' share of claims incurred 9 162.3 167.7 ----------- ----------Net claims incurred (187.7) (414.7)Policy acquisition costs 10 (49.8) (91.4)Operating expenses 11 (63.3) (44.2) ----------- ----------Operating profit/(loss) 2.9 (101.5)Profit on disposal of subsidiary 12 4.0 -Financing costs 13 (20.8) (12.1) ----------- ----------Loss before income taxes (13.9) (113.6)Income taxes 14 (3.2) 23.5 ----------- ----------Loss for the year (17.1) (90.1) ----------- ----------Attributable to: Equity holders of the parent (17.2) (90.6)Minority interest 0.1 0.5 ----------- ---------- (17.1) (90.1) ----------- ----------Earnings per share Basic earnings per share (pence) 3 (4.8) (25.0)Diluted earnings per share (pence) 3 (4.8) (25.0) Consolidated Statement of Recognised Income andExpenses for the year ended 31 December 2005 Note Year ended Year ended 31 December 31 December 2005 2004 £m £m Loss for the year (17.1) (90.1) --------- ---------Total recognised income and 30 (17.1) (90.1)expense for the year --------- ---------Attributable to: Equity holders of the parent (17.2) (90.6)Minority interest 0.1 0.5 Consolidated Balance Sheetas at 31 December 2005 Note Year Year ended ended 31 December 31 December 2004 2005 £m £mAssets Property, plant and equipment 16 1.8 3.4Intangible assets 17 8.3 9.3Deferred acquisition costs 18 25.3 46.9Deferred tax assets 19 41.4 44.3Financial assets 21 579.3 535.5Reinsurance contracts 22 587.2 546.0Insurance and other receivables 23 234.4 406.6Cash and cash equivalents 24 220.0 191.4 ---------- --------Total assets 1,697.7 1,783.4 Liabilities Insurance contracts 25 (1,461.1) (1,471.7)Financial liabilities, due after one year 26- Convertible debt (45.5) (43.9)- Loan notes (19.6) (19.5)Deferred income (15.3) (10.8)Income taxes 14 - (1.4)Insurance and other payables 27 (43.8) (107.0) ---------- --------Total liabilities (1,585.3) (1,654.3) ---------- --------Net assets 112.4 129.1 ---------- -------- Shareholders' equity Share capital 30 114.4 114.4Share premium 30 83.6 83.6Retained earnings 30 (154.5) (138.9)Other reserves 30 63.4 63.4Equity component of convertible debt 30 5.5 5.5 ---------- --------Total shareholders' equity 112.4 128.0Minority interests - 1.1 ---------- --------Total equity 112.4 129.1Net asset value per share (p) 31.2 35.4Net asset value per share excluding syndicatecapacity (p) 28.9 32.9 These financial statements were approved by the Board of Directors on 28 March2006 and were signed on its behalf by: P E Selway-Swift O R P CorbettChairman Group Finance Director Consolidated Cash Flow Statement Year ended Year endedFor the year ended 31 December 2005 31 December 31 December 2005 2004 Note £m £mProfit/(loss) before tax (13.9) (113.6)Cash flow from syndicates 32.7 (33.1)Depreciation and amortisation 2.6 2.4Unrealised losses on financial assets (0.4) (0.7)Employee equity incentives 1.6 0.6Change in receivables less payables 42.5 32.1Movement in exceptional loss provision (40.0) 67.1 ---------- ----------Cash generated from operations 25.1 (45.2)- Interest paid (5.2) (4.1)- Interest received 12.4 18.7- Income taxes paid (1.1) (2.0) ---------- ----------Net cash from operating activities 31.2 (32.6) Cash flows from investing activities - Portfolio investment sales and purchases (24.1) (45.0)- Acquisition of property, plant and equipment (1.5) (2.9)- proceeds from disposal of subsidiary, net ofcash and cash equivalents disposed of 12 0.5 - ---------- ----------Net cash used in investing activities (25.1) (47.9) Cash flows from financing activities - Receipts from issue of loan notes - 20.0- Expenses relating to issue of loan notes - (0.5)- Dividends paid - (2.2) ---------- ----------Net cash used in financing activities - 17.3 ---------- ----------Movement in cash holdings 6.1 (63.2) ---------- ----------Movement in syndicate funds 22.5 2.8Opening cash and cash equivalents 191.4 251.8 ---------- ----------Closing cash and cash equivalents 220.0 191.4 ---------- ---------- Notes to the Financial Information 1. Significant accounting policiesSVB Holdings PLC is a company incorporated in the UK. The group financial statements consolidate those of SVB Holdings and itssubsidiaries (together referred to as the "Group"). The parent company financialstatements present information about SVB Holdings as a separate entity and notabout its group. The group financial statements have been prepared and approved by the directorsin accordance with International Financial Reporting Standards as adopted by theEU ("Adopted IFRSs"). The Company has elected to prepare its parent company financial statements inaccordance with UK GAAP; its balance sheet is presented in the audited AnnualReport. The financial statements of the parent company have been prepared inaccordance with the provisions of Section 226A of, and Schedule 4 to, theCompanies Act 1985. No individual profit and loss account is presented for SVBHoldings PLC, as permitted by Section 230(4) of the Act. The accounting policies set out below have, unless otherwise stated, beenapplied consistently to all periods presented in this financial information andin preparing an opening IFRS balance sheet at 1 January 2004 for the purposes ofthe transition to Adopted IFRSs. (a) Transition to Adopted IFRSsThe Group is preparing its financial statements in accordance with Adopted IFRSfor the first time and consequently has applied IFRS 1. An explanation of howthe transition to Adopted IFRSs has affected the reported financial position,financial performance and cash flows of the Group is provided in note 35. IFRS 1 grants certain exemptions from the full requirements of IFRSs in thetransition period: • The exemption on pre 7 November 2002 options for share-basedpayments has been taken. • The SVB Group has applied the business combinations exemption inIFRS 1. It has not restated business combinations that took place prior to the 1January 2004 transition date. The exemptions for IFRS 4 - Insurance Contracts, IAS 32 - Financial Instruments:Disclosure and Presentation and IAS 39 - Financial Instruments: Recognition andMeasurement have not been taken as the group has applied these standards inpreparing the comparatives. SVB has considered the impact of standards not yet effective. IFRS 6(Explanation for and Evaluation of Mineral Resources) is not relevant to SVB.IFRS 7 (Financial Instruments: Disclosures) is expected to have no significantimpact on the balance sheet or income statement. (b) Basis of preparationThe financial statements are presented in pounds sterling unless otherwisestated. They have been prepared under the historical cost convention, asmodified by the revaluation of financial assets and financial liabilities atfair value through profit or loss. The preparation of financial statements in conformity with IFRS requiresmanagement to make judgements, estimates and assumptions that affect theapplication of policies and reported amounts of assets and liabilities, incomeand expenses. The estimates and associated assumptions are based on historicalexperience and various other factors that are believed to be reasonable underthe circumstances, the results of which form the basis of making the judgementsabout carrying values of assets and liabilities that are not readily apparentfrom other sources. Where estimates had previously been made under UK GAAP,consistent estimates (after adjustments to reflect any difference in accountingpolicies) have been made on transition to IFRS. Actual results may differ fromthese estimates. The Group makes use of certain hedging contracts, to which itapplies hedge accounting. The accounting policies set out below have beenapplied consistently to all years presented in these consolidated financialstatements. The estimates and assumptions are reviewed on an ongoing basis.Revisions to accounting estimates are recognised in the year in which theestimate is revised if the revision only affects that year, or in the year ofthe revision and future years if the revision affects both current and futureyears. (c) Basis of consolidationSubsidiaries are entities controlled by SVB Holdings. Control exists when SVBHoldings has the power, directly or indirectly, to govern the financial andoperating policies of an entity so as to obtain benefits from its activities. Inassessing control, potential voting rights that presently are exercisable orconvertible are taken into account. The financial statements of subsidiaries areincluded in the consolidated financial statements from the date that controlcommences until the date that control ceases. All subsidiaries are consolidated within the Group financial statements.Intragroup balances and any unrealised gains and losses or income and expensesarising from intragroup transactions are eliminated in preparing theconsolidated financial statements. (d) Classification and accounting for insurance contractsInsurance contracts are those contracts that transfer significant insurance riskat the inception of the contract. Insurance risk is transferred when an insureragrees to compensate a policyholder if a specified uncertain future eventadversely affects the policyholder. (i) PremiumsWritten premiums comprise the premiums on contracts entered into during theyear, irrespective of whether they relate in whole or in part to a lateraccounting period. Premiums are disclosed gross of commission payable tointermediaries and exclude taxes and levies based on premiums. Premiums writteninclude adjustments to premiums written in prior accounting periods andestimates for future premiums. An estimate is made at the balance sheet date torecognise retrospective adjustments to premiums or commissions. Outwardreinsurance premiums are accounted for in the same accounting period as thepremiums for the related inwards insurance or reinsurance business. (ii) Unearned premium provisionThe provision for unearned premiums comprises the proportion of gross premiumswritten which is estimated to be earned in the following or subsequent financialyears, computed separately for each insurance contract using the daily pro ratamethod. (iii) ClaimsClaims incurred consist of claims and claims handling expenses paid during thefinancial year together with the movement in the provision for outstandingclaims. Claims outstanding comprise provisions for the estimated cost of settling allclaims incurred but unpaid at the balance sheet date whether reported or not,and related internal and external claims handling expenses. The ultimate liability as a result of outstanding claims will vary due tosubsequent information and events and may result in significant adjustments tothe amounts provided. Adjustments to the amounts of claims provisionsestablished in prior years are reflected in the financial statements for theperiod in which the adjustments are made, and disclosed separately if material. The main assumptions used in the calculation of the ultimate cost of outstandingclaims are detailed in note 25. (iv) Liability adequacy testingAt each balance sheet date, liability adequacy tests are performed to ensure theadequacy of the insurance liabilities net of deferred acquisition costs. Inperforming these tests, current best estimates of future contractual cash flows,claims handling and administration expenses as well as investment income fromthe assets backing such liabilities are used. Any deficiency is immediatelycharged to the profit or loss initially by writing off deferred acquisitioncosts and by subsequently establishing a provision for losses arising fromliability adequacy tests ('unexpired risk provision'). (v) ReinsuranceThe Group cedes reinsurance in the normal course of business for the purpose oflimiting its net loss potential through the diversification of its risks.Premiums on reinsurance assumed are recognised as revenue on the same basis asdirect business, taking into account the product classification. Reinsurance assets include amounts recoverable from reinsurers for losses andloss adjustment expenses. If a reinsurance asset is impaired, the Group reducesits carrying amount accordingly, and will immediately recognise the impairmentloss in the income statement. A reinsurance asset will be deemed to be impairedif there is objective evidence, as a result of an event occurring after initialrecognition of the asset, that the Group may not receive all amounts due to itunder the terms of the contract, and that the event has a reliable measurableimpact on the amounts that the Group will receive from the reinsurer. Reinsurance arrangements do not relieve the Group from its direct obligations toits policyholders. (e) Segment reportingA segment is a distinguishable component of the Group that is either engaged inproviding a type of insurance (business segment), or in providing insurancewithin a particular economic environment (geographical segment), which issubject to risks and rewards that are different from those of other segments. (f) RevenueRefer to accounting policy (d) for details of premium revenue recognition.Premium revenue comprises written premium less any amounts of unearned premium.Revenue also includes investment income; accounting policy (m) contains furtherdetails on its recognition. (g) Fees and commission incomeFees and commission income comprise managing agent's fees receivable from thirdparty capital providers and commission receivable by the Group's servicecompanies. Commission income is accounted for at the time when the client ischarged, and a proportion is deferred to meet the future costs for the claimsassociated with the premiums that have been written. In addition, commission isaccrued to cover the underwriting costs that have been incurred prior toinception of the policy. (h) Expenses(i) Operating lease paymentsPayments made under operating leases are recognised in the income statement on astraight-line basis over the term of the lease. Lease incentives received arerecognised in the income statement as an integral part of the total leaseexpense. (ii) Financing costsFinancing costs comprise interest payable on borrowings and letter of creditfacilities provided by third parties calculated using the effective interestrate method. (j) Income taxIncome tax on the profit or loss for the year comprises current and deferredtax. Income tax is recognised in the income statement except to the extent thatit relates to items recognised directly in equity, in which case it isrecognised in equity. Current tax is the expected tax payable on the taxable income for the year andany adjustment to tax payable in respect of previous years. The Group calculatesincome tax using the current income tax rate. A deferred tax asset is recognised only to the extent that it is probable thatfuture taxable profits will be available against which the asset can beutilised. (k) Foreign currencyTransactions in foreign currencies are translated at the foreign exchange rateprevailing at that transaction date. Monetary assets and liabilities denominatedin foreign currencies at the balance sheet date are translated at the foreignexchange rate ruling at that date. Foreign exchange differences arising ontranslation are recognised in the income statement. Non-monetary assets andliabilities are translated using the historical transaction rate. (l) Intangible assets Purchased syndicate capacity has been classed as a finite life asset. It isincluded at cost and amortised over the directors' estimate of its usefuleconomic life, currently fifteen years. Amortisation commences in the financialyear in which the underwriting results from the purchased capacity are firstrecognised. Provision is made for any impairment in the carrying amount ofpurchased capacity. (l) Property, plant and equipment(i) Owned assetsProperty, plant and equipment are stated at cost less accumulated depreciation(see below) and any impairment in value. Where categories of property, plant and equipment have different useful lives,they are accounted for as separate items. (ii) DepreciationDepreciation is charged to the income statement on a straight-line basis overthe estimated useful lives of each part of an item of property, plant andequipment. The estimated useful lives are as follows: Furniture and equipment 3 - 5 yearsComputer equipment 3 yearsOffice refurbishment 3 - 5 years The residual value, if significant, is reassessed annually. (m) Financial assetsFinancial assets have been designated as fair value through profit and loss onconversion to IFRS (see note 8). This has been deemed the most appropriatevaluation methodology for these assets. Purchases and sales of financial assetsare recognised on a trade date basis. Any gain or loss as a result of a changein fair value is recognised directly through the income statement. The fair value of financial instruments classified as fair value through profitor loss are held at their quoted bid price at the balance sheet date. Investmentincome and charges are recognised on an accruals basis. (n) Derivative financial instrumentsThe Group uses derivative financial instruments to hedge its exposure to foreignexchange and interest rate risks arising from operational, financing andinvestment activities. In accordance with its treasury policy, the Group doesnot hold or issue derivative financial instruments for trading purposes. TheGroup monitors its derivative financial instruments with regards to therequirements of IAS 39. (o) Deferred acquisition costsAcquisition costs comprise all direct costs arising from the conclusion ofinsurance contracts. Deferred acquisition costs represent the proportion ofacquisition costs incurred which corresponds to the unearned premiums provision.Acquisition costs are deferred only to the extent that available future marginsare expected to cover them. (p) ReceivablesReceivables are stated at amortised cost less impairment losses. (q) Cash and cash equivalentsCash and cash equivalents comprise cash balances and call deposits. Includedwithin cash and cash equivalents are balances that are not freely available tothe Group, details of which are set out in note 24. These can be used to settlepolicyholder claims. (r) ImpairmentThe carrying amounts of the Group's assets are reviewed at each balance sheetdate to determine whether there is any indication of impairment. If any suchindication exists, the carrying value is reduced to the estimated recoverableamount by means of a charge to the consolidated income statement. The recoverable amount of other assets is the greater of their netselling price and value in use. In assessing value in use, the estimated futurecash flows are discounted to their present value using a pre-tax discount ratethat reflects current market assessments of the time value of money and therisks specific to the asset. For an asset that does not generate largelyindependent cash inflows, the recoverable amount is determined for thecash-generating unit to which the asset belongs. (s) Convertible debtThe fair value of the liability portion of the convertible loan stock isdetermined by discounting contractual cash outflows using the interest ratepayable on an equivalent non-convertible bond. The amount is carried as aliability on an effective interest basis until extinguished on conversion orredemption. The remainder of the issue proceeds is allocated to the conversionoption and is recognised and included in shareholders equity. Transaction costsare amortised on an effective interest rate basis over the duration of the bond.These costs have been allocated between the debt and equity component of theconvertible bond in a way deemed most appropriate by the Group. Finance costsare calculated on an effective interest rate basis. (t) Interest-bearing loans and borrowingsInterest-bearing loans and borrowings are recognised initially at fair valueless attributable issue costs. Attributable issue costs are amortised on aneffective interest rate basis over the term of the borrowings. Borrowing costsare expensed rather than capitalised. (u) DividendsDividends are recognised as a liability in the period in which they are paid. (v) Employee benefits(i) Defined contribution plansObligations for contributions to defined contribution pension plans arerecognised as an expense in the income statement as incurred. (ii) Share-based payment transactionsThe Group equity incentive schemes allow Group employees to acquire shares ofSVB Holdings. The fair value of options and long term incentive plan sharesgranted are recognised as an expense with a corresponding increase in equity.The fair value is measured at grant date and spread over the period during whichthe employees become unconditionally entitled to the options. The fair value ofthe options granted is measured using a binomial lattice model, theBlack-Scholes formula and a Monte Carlo simulation, taking into account theterms and conditions upon which the options were granted. The amount recognisedas an expense is adjusted to reflect the actual number of share options thatvest except where forfeiture is due only to changes in market conditions, forexample share prices not achieving the threshold for vesting. IFRS 2 has notbeen applied to arrangements prior to 7 November 2002, that have vested at 1January 2005. (w) PayablesPayables are stated at amortised cost. 2. Management of financial and insurance risk Financial riskExposure to market (including foreign currency), credit, and liquidity risksarise in the normal course of the Group's business. Further details on these areprovided in the OFR, which also details operational, group, regulatory, marketstructure and competitive risks. Market riskThe SVB Group's exposure to market risk for changes in interest rates isconcentrated in SVB's investment portfolio, and to a lesser extent, the Group'sdebt obligations. Premium income cash flows from the underwriting of business originating outsideof the UK are the primary source of funds for the purchase of investmentsdenominated in foreign currencies. These investments are purchased primarily tohedge insurance reserves and other liabilities denominated in the same currency,effectively reducing SVB's exposure to exchange rate fluctuations. An analysisof investments by currency is provided in note 21. Credit riskThe Group's portfolios of fixed income securities are subject to credit risk.The risk is defined as the potential loss in market value resulting from adversechanges in the borrower's ability to repay the debt. The Group monitors itsexposure to such credit risk by comparing the value and credit rating of itsinvestments against a benchmark determined by the Investment Committee and thisis reported to the Board monthly. The credit worthiness of the Group's financialassets are detailed in note 21. The Group underwrites insurance risk and reinsures a substantial portion of thatrisk with third party reinsurers. There is a degree of credit risk associatedwith reinsuring to third parties and in order to manage this risk credit reviewsof the underlying financial stability of the reinsurance entity are performed.This is performed by the Reinsurance Security Vetting Committee. The reinsurers'share of paid and notified losses is analysed by credit rating in note 22. The Group also has other receivable amounts subject to credit risk. The mostsignificant of these are amounts due from brokers. To mitigate risk of thesecounterparties' non-payment of amounts due, business and financial standards forbroker approval are established. The Group's exposure to individual brokers ismonitored on a monthly basis by the Broker Vetting Committee. Liquidity riskThis exists to the extent that the Group must be able to satisfy claims, meetsolvency and funding requirements, and meet working capital needs. This isfurther outlined in the Operating and Financial Review of this document. Insurance riskReserving risk and the uncertainty in establishing claims reserves aremeasurement risks and are discussed further as part of the disclosure on claims(see note 25). Underwriting risk is an insurance risk that arises on the Group'sunderwriting activities within each of the business segments Specialty,Property, Liability and Aviation & Marine. These are discussed further in note5. Underwriting risk is managed by monitoring risk tolerance levels, referred tointernally as "Willingness to Lose" ("WTL"). This is set by the Board of themanaging agency in consultation with the Board of SVB Holdings PLC. WTL isdefined as being the maximum loss net of reinsurance and reinstatement premiumsthe Group is prepared to absorb from any one defined catastrophic event, beingthe main concentrations of insurance risks facing the Group. For example, thedefined event for Florida windstorm is assumed to be a generic scenario with anoverall insured loss of $60.0 billion. As at 31 December 2005 WTL (using £1-$1.79 to convert US dollar amounts) was setfor the Group as follows: RDS Gross loss Net loss WTLFlorida windstorm £m £m £m 84.8 39.5 45.0California earthquake 95.5 42.5 45.0European windstorm 68.6 26.4 30.0UK flood 114.0 33.7 37.5Japanese earthquake 44.0 16.9 30.0Aviation collision 56.6 21.9 25.0Liability (1007 severe version) 129.5 27.0 30.0Liability (2147 general liability version) 55.0 19.6 20.0 3. Earnings per share Basic earnings per shareThe calculation of earnings per share of a loss of 4.8 pence (2004: loss of 25.0pence) is based on a loss attributable to equity shareholders of £17.2 million(2004: loss of £90.6 million) and on 361.2 million shares (2004: 361.2 millionshares), being the number of shares in issue, excluding own shares held withinthe Group's Long Term Incentive Plan, during the year ended 31 December 2005. Diluted earnings per shareDiluted earnings per share are calculated adjusting the weighted average numberof shares outstanding to assume conversion of all dilutive potential shares. SVBHoldings has two categories of potentially dilutive ordinary shares: convertibledebt and share options. The convertible debt would be assumed to have beenconverted into shares and the net profit would be adjusted to eliminate theinterest effect less the tax effect. For share options, a calculation would bemade to determine the number of shares that could have been acquired at fairvalue (determined as the average annual market share price) based on themonetary value of the subscription rights attached to outstanding share options.The number of shares calculated as above is compared to the number of sharesthat would have been issued assuming the exercise of the share options. For the years ended 31 December 2005 and 2004, the convertible debt and shareoptions are not considered to have any dilutive effect as the average marketprice of ordinary shares during these years did not exceed the exercise price. Year Year ended ended 31 December 31 2004 December £m 2005 £mProfit for the year attributable to equity shareholdersof parent (17.2) (90.6)Interest expense on convertible debt (net of tax) - - --------- --------Profit used to determine diluted earnings per share (17.2) (90.6) --------- --------Weighted average number of shares in issue (millions) 361.2 361.2Adjustments for: - assumed conversion of convertible debt (millions) - -- share options (millions) - - --------- --------Weighted average number of shares for diluted earningsper share 361.2 361.2 --------- --------Diluted earnings per share (pence per share) (4.8) (25.0) --------- -------- 4. Principal exchange rates (to Sterling) Year ended Year ended 31 December 2005 31 December 2004 Year Year Year Year average end average end 1.82 1.72 1.83 1.92Euro 1.46 1.46 1.47 1.41Canadian dollar 2.21 2.01 2.38 2.30 5. Segmental information Segmental information is presented in respect of the Group's business andgeographic segments. The primary format, business segments, is based on theGroup's management and internal reporting structure. An analysis of the technical profit of the Group is presented below. Thisanalyses the underwriting return split by business segment, separating out theactivities of the ongoing business from the reserve deterioration on thediscontinued units. It is included to increase clarity over the performance ofthe ongoing units, but does not represent a discontinued business analysis forIFRS 5 purposes. Segment results, assets and liabilities include items that can be allocated on areasonable basis. Unallocated items comprise insurance working capital andcentral group items. The Group comprises the following main business segments in addition to theDiscontinued Units: (i) SpecialtyBusiness included within the Specialty segment includes financial institutions,professional indemnity, directors' and officers', political and credit risks,specie and special situations. (ii) PropertyThe property business consists of three distinct units. The largest of these isa property catastrophe reinsurance book with the other two units comprising USfacilities and International direct & facultative risks. (iii) LiabilityA general liability book is written comprising UK general and employers'liability risks supplemented by some Australian binder business and a marineliability account. (iv) Aviation & MarineThis segment is dominated by aviation reinsurance with a small specialistaccount of hull and marine war. All items from gross written premium to technical profit/(loss) - 100 per cent.level are stated at 100 per cent. ownership level. This is to avoid anydistortion from the effects of change in ownership of syndicates betweenunderwriting years. The segment results for the year ended 31 December 2005 are as follows: Specialty Property Liability Aviation & Total Discon- Total £m £m £m Marine (ongoing) tinued £m £m £m Units £mGrosswritten 111.5 71.0 40.7 25.8 249.0 (1.3 ) 247.7premiumNet writtenpremium 68.4 54.6 29.8 18.8 171.6 (4.5) 167.1Net premiumrevenue 109.1 95.3 61.0 22.9 288.3 (4.5) 283.8Net claimsincurred 75.1 98.3 30.8 1.9 206.1 43.5 249.6Netsyndicate 18.7 26.0 17.4 6.3 68.4 2.6 71.0expensesInvestmentreturn on 8.1 4.5 2.8 0.8 16.2 0.2 16.4syndicateinvestments Underwritingprofit/ 8.1 (31.5) 11.5 14.7 2.8 (50.5) (47.7)(loss)- 100 %level ------- ------- ------ ------- ------- ------- -----Underwritingprofit/ 6.4 (29.9) 11.5 14.7 2.7 (40.2) (37.5)(loss)- SVB shareInvestmentreturn on 12.0 - 12.0corporateFALExceptionalloss 40.0 40.0provisionmovement ------- ------- -----Net groupoperating (11.6) - (11.6)expenses ------- ------- -----Operatingprofit/ 3.1 (0.2) 2.9(loss)Profit onsale 4.0 - 4.0ofsubsidiaryFinancing (20.8) - (20.8)costs ------- ------- -----Loss before (13.7) (0.2) (13.9)tax ------- ------- ----- The segment results for the year ended 31 December 2004 are asfollows: Specialty Property Liability Aviation & Total Discon- Total £m £m £m Marine (ongoing) tinued £m £m £m Units £mGrosswritten 193.3 153.9 87.0 26.0 460.2 (0.3) 459.9premiumNet writtenpremium 171.0 116.3 86.3 19.5 393.1 21.4 414.5Net premiumrevenue 174.5 93.2 59.9 11.0 338.6 31.4 370.0Net claimsincurred 102.6 49.4 35.0 3.7 190.7 115.6 306.3Netsyndicate 4.7 31.0 21.8 4.5 112.0 (0.2) 111.8expensesInvestmentreturn on 9.6 2.5 0.9 0.9 13.9 3.8 17.7syndicateinvestments ------- ------- ------ ------- ------- ------- -----Underwritingprofit/ 21.2 17.6 7.9 4.8 51.5 (84.1) (32.6)(loss)- 100 %level ------- ------- ------ ------- ------- ------- -----Underwritingprofit/ 15.1 18.1 7.8 4.8 45.8 (79.5) (33.7)(loss)- SVB shareInvestmentreturn on 10.5 - 10.5corporateFALExceptionalloss - (67.1) (67.1)provisionmovement ------- ------- -----Net groupoperating (11.2) - (11.2)expenses ------- ------- -----Operatingprofit/ 45.1 (146.6) (101.5)(loss)Financing (12.1) - (12.1)costs ------- ------- -----Loss before 33.0 (146.6) (113.6)tax ------- ------- ----- Relevant balance sheet captions are deemed to be attributable to the businesssegments as follows:As at 31 Specialty Property Liability Aviation Total Discon- TotalDecember 2005 & £m £m £m Marine (ongoing) tinued £m £m £m Units £mGrossprovision forclaimsoutstanding 580.8 164.9 133.4 73.5 952.6 325.6 1,278.2 ------Balancesunallocated 307.1bySegment ------Totalliabilities 1,585.3 ------Reinsurers'share of 338.2 72.0 16.9 41.0 468.1 93.4 561.5claimsoutstanding ------- ------- ------ ------- ------- ------ ------Investmentassets 193.3 37.7 6.2 2.0 239.2 100.7 339.9attributable ------- ------- ------ ------- ------- ------ ------ 531.5 109.7 23.1 43.0 707.3 194.1 901.4 ------- ------- ------ ------- ------- ------ ------Balancesunallocated 796.3bysegment ------Total assets 1,697.7 ------ As at 31 December 2004 Specialty Property Liability Aviation & Total Discon- Total £m £m £m Marine (ongoing) tinued £m £m £m Units £mGrossprovision 500.7 87.7 121.1 81.0 790.5 335.0 1,125.5forclaimsoutstanding ------Balancesunallocated 528.8bysegment ------Totalliabilities 1,654.3 ------Reinsurers'share of 285.2 44.0 24.4 47.9 401.5 97.7 499.2claimsoutstanding ------- ------- ------ ------- ------- ------ ------Investmentassets 98.4 25.9 3.8 6.6 134.7 184.4 319.1attributable ------- ------- ------ ------- ------- ------ ------ 383.6 69.9 28.2 54.5 536.2 282.1 818.3 ------- ------- ------ ------- ------- ------ ------Balancesunallocated 965.1bysegment ------Total assets 1,783.4 ------ Gross premium revenue by market: the following table shows the distribution ofthe Group's consolidated gross premium revenue by geographical market at the 100per cent. syndicate level: Year ended Year ended 31 December 31 December 2005 2004 £m £mUnited Kingdom 111.5 217.0United States of America 66.2 104.3Elsewhere 70.0 138.6 --------- --------- 247.7 459.9 --------- --------- The assets and liabilities of the Group are not managed on a geographical basisand subsequently no geographical split has been provided. 6. Premium revenue Year ended Year ended 31 December 31 December 2005 2004 £m £mGross written premiums 244.3 507.8Change in the gross provision for unearnedpremiums 122.3 (40.9) --------- --------Gross premium revenue 366.6 466.9 --------- --------Outward reinsurance premiums (74.5) (47.8 )Change in reinsurers' share of provision forunearned premiums (21.5) (2.0) --------- --------Premium ceded to reinsurers (96.0) (49.8) --------- --------Net premium revenue 270.6 417.1 --------- -------- The Group has changed the way it estimates written and earned premium during theyear with the introduction of new software. This enables more accuraterecognition of written and earned premiums. The effect of this change has been areduction in gross written premium and a reduction in the gross provision forunearned premium. However the impact on net premium revenue from this change isnot significant. Net premium revenue has decreased from £417.1 million in 2004 to£270.6 million in 2005. This is principally due to two non-recurring items in2004. First, RITC premium arising from an increase in ownership of Syndicate1007's oldest Year of Account occurred during 2004 but not 2005. Secondly, thecommutation of the Adverse Development Cover affected reinsurance premiums in2004 but not 2005. The combined effect of these two factors was an increase innet premium revenue in 2004 of £122.9 million. 7. Fees and commission income Year ended Year ended 31 December 31 December 2005 2004 £m £mManaging agency fees 1.1 1.7Other income 6.2 4.0 --------- -------- 7.3 5.7 --------- --------8. Investment income Year ended Year ended 31 December 31 December 2005 2004 £m £mInterest income 29.1 33.4Fair value gains/(losses) (2.6) (6.6)Investment management expenses (0.7) (0.8) --------- -------- 25.8 26.0 --------- -------- 9. Net claims incurred Year ended Year ended 31 December 31 December 2005 2004 £m £mClaims paid (321.8) (289.5)Change in gross claims provision (68.2) (225.8)Utilisation of exceptional loss provision 40.0 (67.1) --------- --------Gross claims incurred (350.0) (582.4) --------- --------Reinsurers' share of claims paid 137.4 116.6Change in reinsurers' share of claims provision 24.9 51.1 --------- --------Reinsurers' share of claims incurred 162.3 167.7 --------- --------Net claims incurred (187.7) (414.7) --------- -------- 10. Policy acquisition costs Year ended Year ended 31 December 31 December 2005 2004 £m £mBrokerage and other business acquisition costs 28.2 79.8 --------- --------Change in deferred brokerage and other business 21.6 11.6acquisition costs --------- -------- 49.8 91.4 --------- -------- 11. Operating expenses Year ended Year ended 31 31 December December 2004 2005 £m £mUnderwriting expenses 44.2 27.3Distribution company expenses 9.0 8.0Central group expenses 13.1 11.2Foreign exchange gain (3.0) (2.3) --------- -------- 63.3 44.2 --------- --------Operating expenses include auditors' remuneration asfollows: Audit services:Statutory audit - Corporate 0.2 0.2 - Syndicates 0.2 0.2Further assurance services: 0.2 0.3Actuarial reviewOther 0.1 0.1 --------- --------Tax services: Compliance 0.1 0.1 --------- -------- 0.8 0.9 --------- -------- 12. Disposal of subsidiary On 4 November 2005 the Group disposed of its investment in Fusion InsuranceServices Limited ("Fusion"). Profit on disposal was £4.0 million, arising fromproceeds of £15.0 million net of transaction costs of £1.5 million less SVB'sshare of Fusion's net assets of £9.5million. The carrying value of the assets and liabilities disposed of at 4 November 2005were as follows: £mCash and cash equivalents 14.2Accounts receivable 13.5Property, plant and equipment 0.8Trade payables (16.6) --------Carrying value at disposal 11.9Less: minority interest (2.4)Non cash transaction cost 1.2Profit on disposal 4.0 --------Proceeds from disposal, net of cash transaction costs 14.7Less: cash and cash equivalents disposed of (14.2) --------Cash flow on disposal, net of cash and cash equivalents disposed of 0.5 -------- 13. Financing costs Year ended Year ended 31 December 31 December 2005 2004 £m £mCost of convertible bond 4.8 4.6Loan note interest 2.0 1.0Letter of credit cost 14.2 6.5 --------- -------- 20.8 12.1 --------- -------- 14. Income taxes Recognised in income statement Year ended Year ended 31 December 31 December 2005 2004 £m £mCurrent tax expense: Current year 0.3 1.2Adjustments for prior years - 0.5 --------- -------- 0.3 1.7 --------- --------Deferred tax (see note 19): Effect of taxes losses de-recognised/(recognised) 2.9 (25.2) --------- --------Total income tax expense/(benefit) in incomestatement 3.2 (23.5) --------- -------- Reconciliation of effective tax rate 2005 2004 £m £mLoss before tax (13.9) (113.6)Income tax at the standard UK corporation tax rate (30%) (4.2) (34.1)Effect of tax losses not recognised 7.4 10.6 --------- -------- 3.2 (23.5) --------- -------- The future tax charge for the Group is dependent on the ability of the Group toutilise Group tax losses. 15. Employees (a) Employee numbersThe average number of persons employed during the period (including directors),analysed by business unit, was as follows: Year ended Year ended 31 31 December December 2004 2005Lloyd's business (including central Group) 141 133Distribution business - NUL 47 31 - Fusion 114 124 --------- -------- 302 288 --------- -------- As discussed in note 12, Fusion was disposed of on 4 November 2005. With effectfrom this date all employees of Fusion ceased to be employed by the Group. (b) Employee costs Year ended Year ended 31 31 December December 2004 2005 £m £mWages and salaries 17.8 16.5Performance related pay 3.8 2.6Contributions to defined contribution pension plans 2.4 2.4Social security costs 2.6 2.3Employee equity incentives 1.6 0.6Other related costs 0.2 0.1 --------- -------- 28.4 24.5 --------- -------- (c) Share based paymentsThe terms and conditions of the grants, and number of outstanding optionsgranted to directors and employees of the Group, are as follows, whereby alloptions are settled by physical delivery of shares:Issue Outstanding Vesting conditions Contractualdate instruments life of obligationsShareoptions24/07/ 262,131 Three years service. 10 years9804/11/ 189,909 Three years service. At date of exercise, 10 years99 increase in Net Asset Value of Group over preceding 3 year period to be 6% higher than increase in FTSE 350 Index.06/10/ 561,068 Three years service. 10 years0011/11/ 2,137,208 Three years service. 50% vest if share price 10 years02 is 150% of price at date of grant. Performance target rises to 175% and 200% for 2 subsequent 25% tranches.18/11/ 750,000 Three years service. 50% vest if share price 10 years03 10 years exceeds 150% of option price, a further 25 % vest at 175 % and the remaining 25% at 200%.18/11/ 1,297,500 Three years service. 50% vest if share price 10 years03 is 125% of option price with the remaining 50% at 150%.05/05/ 5,875,000 Three years service. Net tangible assets 10 years04 (NTA) must exceed 55.8p + RPI + 9% pa at 31/ 12/06 or NTA must exceed 55.8p + RPI + 12% pa at 31/12/07.05/05/ 100,000 Three years service. 50% vest if share price 10 years04 is 125% of option price with the remaining 50% at 150%. LTIPshares11/11/ 1,977,180 Three years service. 1,422,808 vest if share 3 years02 price is 150% x prevailing share price. 267,186 vest if share price is 175 % x prevailing share price and 267,186 vest if share price is 200% x prevailing share price.18/11/ 1,612,500 Three years service. Positive NTA. 3 years0305/05/ 150,000 Three years service. Positive NTA. 3 years0417/12/ 1,075,056 Three years service. Positive NTA. 3 years0405/0105 11,060,000 Three years service. 25% vest if NTA 3 years increases by RPI + 5%, a further 25% at NTA + RPI + 10% and the remaining 25% at NTA + RPI + 15% The options are exercisable between three and ten years after grant subject tothe satisfaction of the relevant performance targets. The expiry date of allshare options is ten years following the issue date. The expiry date of all LTIPawards is three years following the issue date. Prior to merger with the Group, CLM Insurance Fund plc (CLM) had granted optionsto certain employees under the CLM Insurance Fund plc Senior Executive ShareOption Scheme 1994. These were converted into options in SVB on equivalentterms. The number and weighted average exercise price of share options isas follows: Weighted Number of Weighted Number of average options average options exercise 2005 exercise 2004 price thousands price thousands 2005 2004 pence penceOutstanding at the beginning of 57 11,248 64 5,677the yearForfeited during the year 51 15 56 2,525Exercised during the year - - - -Granted during the year - - 52 8,097 -------- ---------- -------- --------Outstanding at the end of theyear 57 11,233 57 11,248 -------- ---------- -------- --------Exercisable at the end of theyear 57 11,233 57 11,248 -------- ---------- -------- -------- The options outstanding at 31 December 2005 have an exercise price in the rangeof £0.468 to £1.628 and a weighted average contractual life of 7 years. The fair value of services received in return for share options granted aremeasured by reference to the fair value of share options granted. The estimateof the fair value of the services received is measured based on a binomiallattice model. The contractual life of the option (10 years) is used as an inputinto this model. Expectations of early exercise are incorporated into thebinomial lattice model.Share Fair Share Exercise Expected Option Expected Risk freeoptions value price price volatility life dividends interest rateShare options11/11/02 £0.087 £0.346 £0.4679 50% pa 10 years nil 5 % pa18/11/03(a) £0.15 £0.49 £0.57 50% pa 10 years nil 5 % pa18/11/03(b) £0.184 £0.49 £0.49 50% pa 10 years nil 5 % pa05/05/04(a) £0.1514 £0.5083 £0.5083 35% pa 10 years nil 5 % pa05/05/04(b) £0.144 £0.5083 £0.5083 35% pa 10 years nil 5 % paLTIP shares 18/11/03 £0.49 £0.49 n/a n/a n/a nil n/a05/05/04 £0.51 £0.51 n/a n/a n/a nil n/a17/12/04 £0.325 £0.325 n/a n/a n/a nil n/a05/01/05 £0.1625 £0.325 n/a n/a n/a nil n/a The expected volatility is based on historic volatility. The actual volatilityover the period 2002-2003 was higher than has been the case in more recentperiods, which is reflected in the differential volatility assumptions onearlier and later incepting options. Vesting of options is conditional upon a service condition and a marketcondition in all cases except tranche (a) of the 05/05/04 grant which has aservice condition and a non-market condition. The fair value of this tranche hasbeen determined using the Black-Scholes formula, and the other tranches using aMonte Carlo simulation. Option life is in all cases 10 years from date of grant, with the option toexercise from three years subject to vesting conditions being met. Indetermining the fair value, it has been assumed that 50 per cent. of optionswill be exercised after three years, and 10 per cent. in each of the subsequentfive years. All the LTIP awards except the 05/01/05 grant have the same vesting condition,i.e. positive NTA at expiry. The fair value of these at grant has been taken asthe prevailing share price. The 05/01/05 grant vests in tranches based uponprogressively more onerous NTA targets. In determining the fair value it hasbeen assumed that the first 50 per cent. will vest, which is to say that NTAincreases by RPI plus between 10 per cent. and 15 per cent. pa over the threeyears. 16. Property, plant and equipment Group Computer Fixtures, Office Total equipment fittings, refurbishment £m £m tools & £m equipment £mCost As at 1 January 2004 7.7 0.5 2.3 10.5Additions 2.1 0.1 0.7 2.9Disposals - (0.3) - (0.3) --------- -------- ---------- --------As at 31 December 2004 9.8 0.3 3.0 13.1 --------- -------- ---------- --------Balance as at 1 January 2005 9.8 0.3 3.0 13.1Additions 1.0 0.3 0.1 1.4Disposals (8.3) (0.2) (2.4) (10.9) --------- -------- ---------- --------As at 31 December 2005 2.5 0.4 0.7 3.6 --------- -------- ---------- --------Depreciation As at 1 January 2004 6.1 0.5 2.2 8.8Charge for the period 0.9 - 0.3 1.2Disposals - (0.3) - (0.3) --------- -------- ---------- --------As at 31 December 2004 7.0 0.2 2.5 9.7 --------- -------- ---------- --------Balance as at 1 January 2005 7.0 0.2 2.5 9.7Charge for the period 1.9 0.2 0.3 2.4Disposals (7.7) (0.3) (2.3) (10.3) --------- -------- ---------- --------As at 31 December 2005 1.2 0.1 0.5 1.8 --------- -------- ---------- --------Net book value As at 31 December 2004 2.8 0.1 0.5 3.4As at 31 December 2005 1.3 0.3 0.2 1.8 17. Intangible assets Syndicate capacity 2005 2004 £m £mCostAs at beginning of period 14.6 14.6Additions - - --------- --------As at end of period 14.6 14.6 --------- --------AmortisationAs at beginning of period 5.3 4.4Charge for the period 1.0 0.9 --------- --------As at end of period 6.3 5.3 --------- --------Net book valueOpening 9.3 10.2 --------- --------Closing 8.3 9.3 --------- -------- The amortisation charge is included within operating expenses. The remainingamortisation period is 8 years. 18. Deferred acquisition costs 31 31 December December 2004 2005 £m £mBalance at start of the year 46.9 58.5Utilisation of balance brought forward (39.5) (52.5)Additional amounts provided in year 17.9 40.9 --------- --------Balance at end of the year 25.3 46.9 --------- -------- 19. Deferred taxRecognised deferred tax assetsThe deferred tax asset is attributable to the following: 31 December 31 December 2004 2005 £m £mOther temporary differences (0.8) (0.4)Unutilised tax losses 42.2 44.7 ---------- --------- 41.4 44.3 ---------- --------- Unrecognised deferred tax assetsDeferred tax assets have not been recognised in respect of the following items: 31 December 31 December 2005 2004 £m £mTax losses 17.9 10.9Capital losses 41.6 41.6 --------- -------- 59.5 52.5 --------- -------- Deferred tax assets have not been recognised in respect of these items due tothe uncertainty that future taxable profit will be available against which theGroup can utilise the benefits there from. Future utilisation of the asset hasbeen measured by reference to the Group's projected profit. 20. Principal subsidiary undertakings Country of Class of Principal activity Percentage of incorporation share ordinary held shares held England & Ordinary Wales 100% SVB L Limited England & Ordinary Intermediate 100% Wales holding company SVB SyndicatesLimited England & Ordinary Lloyd's managing 100% Wales agency Ordinary Lloyd's corporate 100%SVB Underwriting Limited England member& Wales Ordinary Investment company 100%SVB Capital 1 England &Limited WalesSVB Capital 2Limited England & Ordinary Investment company 100% WalesSVBDistributionLimited England & Ordinary Intermediate holding 100% Wales companyNovaeUnderwriting England & Ordinary Service company 100% WalesLimited England & Ordinary Not trading 100% WalesCredit Indemnity &FinancialServicesLimited England & Ordinary Not trading 100% WalesSVB Holdings AESOPTrusteeCompanyLimited England & Ordinary Not trading 100% WalesSyndicate CapitalUnderwritingLimited The results, assets and liabilities of all of the above subsidiaries areincluded in the consolidated financial statements. 21. Financial assets 31 31 December December 2004 2005Fair value through profit or loss: £m £mFixed interest securities 578.5 534.5Equities 0.8 1.0 --------- -------- 579.3 535.5 --------- --------Syndicate 339.9 318.7Corporate 239.4 216.8 --------- -------- 579.3 535.5 --------- --------Listed 579.3 534.5Unlisted - 1.0 --------- -------- 579.3 535.5 --------- -------- Breakdown of fixed interest securities by credit rating: 31 31 December December 2004 2005 % %Government/AAA 94.0 90.9AA+/AA/AA- 3.0 3.8A+/A/A- 3.0 5.3 --------- -------- 100.0 100.0 --------- Breakdown of investments by currency: 31 31 December December 2004 2005 % %US Dollar 46.4 45.6Sterling 47.1 47.1Canadian Dollar 6.5 7.3 --------- -------- 100.0 100.0 --------- -------- The maturity profile of investments based on the average duration is as follows: 31 December Average 2005 duration £m Years Funds at Lloyd's 239.0 0.7Premium trust funds 339.9 1.3 22. Reinsurance contracts 31 December 31 December 2005 2004 £m £mReinsurance contracts 587.2 546.0Less:Reinsurers' share of: - provisions for unearned premium (25.7) (48.8) - claims outstanding 561.5 499.2 - provision for losses incurred but not reported (108.0) (156.7) ----------- ----------Balance 453.5 342.5 ----------- ---------- Being:Recoveries on claims notified not yet due 465.2 351.7Impairment of bad debt (notified not yet due) (11.7) (9.2) ----------- ----------Net recoveries on claims notified not yet due 453.5 342.5Recoveries due on paid claims 44.5 69.6Impairment of bad debt (paid claims) (3.5) (5.8) ----------- ----------Net reinsurance balance before collateral 494.5 406.3Collateral received or available (38.5) (25.4) ----------- ----------Balances net of collateral 456.0 380.9 ----------- ---------- The reinsurers' share of paid and notified losses can be analysed by creditrating as follows*: 31 December 31 December 2005 2004 % %S&P: AAA AMB: A++ 13.1 12.2S&P: AA AMB: A/A- 32.7 33.9S&P: A (inc Lloyd's) AMB: B++/B+ 44.6 47.4Less than A 9.6 6.5 --------- -------- 100.0 100.0 --------- -------- * Due to the way the Group monitors its reinsurance balances, different ratingagencies are used depending upon the domicile of the reinsurer. Standard andPoors (S&P) and AM Best (AMB) ratings have been grouped together in a way thatthe Group has deemed most appropriate. 23. Insurance and other receivables 2005 2004 £m £mArising from underwriting business 196.1 360.4Arising from service companies and other subsidiaries 28.8 39.4Prepayments and accrued income 9.5 6.8 --------- ----- 234.4 406.6 --------- -----Receivables are stated at fair value.24. Cash and cash equivalents 2005 2004 £m £mCash 139.2 115.0Overseas deposits 80.8 76.4 --------- ----- 220.0 191.4 --------- ----- Of the total cash and cash equivalents £188.5 million (2004: (£161.9 million) isheld by the syndicates to meet policyholder liabilities. 25. Insurance contracts (a) Insurance contract liabilities £m 31 December £m £m 31 December £m 2005 2004 Gross £m Net Gross £m Net Reinsurance ReinsuranceUnearned 155.8 25.7 130.1 279.0 46.8 232.2premiumsClaims 357.9 105.0 252.9 404.5 156.7 247.8incurred butnot reported(IBNR)Notified 920.3 456.5 463.8 721.1 342.5 378.6claims ------- ----------- ------ ------- ----------- -----Exceptional 27.1 - 27.1 67.1 - 67.1lossprovision ------- ----------- ------ ------- ----------- -----Total 1,461.1 587.2 873.9 1,471.7 546.0 925.7insuranceliabilities ------- ----------- ------ ------- ----------- -----Contracts due 407.3 182.8 224.5 337.3 149.7 187.6< 1 year ------- ----------- ------ ------- ----------- -----Contracts due 1,053.8 404.4 649.4 1,134.4 396.3 738.1> 1 year ------- ----------- ------ ------- ----------- ----- 1,461.1 587.2 873.9 1,471.7 546.0 925.7 ------- ----------- ------ ------- ----------- ----- In addition to reserves established at syndicate level on the basis of actuarialbest estimate totalling £232.2 million (2004: £237.3 million), an additional£27.1 million of provision has been recognised as at 31 December 2005 (2004:£67.1 million) in respect of the uncertainty surrounding potential future claimsdevelopment from discontinued units. This provision, which is over and abovesyndicate reserves set at actuarial best estimate, was established as at 30 June2004 to meet possible future adverse claims development. During the year ended31 December 2005 £40.0 million of this provision was utilised, leaving £27.1million remaining at year end. The provision was established to strengthen reserves associated with thediscontinued business, in particular the liability reinsurance business, whichare subject to a high degree of uncertainty. This reflects market conditions inthe late 1990s and the claims environment in the US in the period covered by thecontracts written being significantly different from that in prior periods,which makes any projection methodology that relies upon extrapolation of pasttrends subject to an increased degree of subjectivity. For similar reasons Syndicates 1007 and 1241 have not closed their2002 Years of Account. The 2005 annual reports for both state that theuncertainty that led to the accounts going into run off at 36 months stillprevails at 48 months. This uncertainty arose due to deterioration in treatyreserves and late advices from assureds, which have produced some exhaustion ofthe excess of loss reinsurance programmes both on an incurred and on an incurredbut not reported basis. As a result of these matters, there exists significant uncertainty concerningthe amounts provided and subsequent information and events may result insignificant adjustments to the amounts provided. (b) Movement table for insurance contract liabilities (i) Unearned premium Year ended Year ended 31 31 December December 2004 2005 £m £m --------- --------Balance as at 1 January 279.0 237.7Premiums written during the year 243.4 508.2Less: premiums earned during the year (366.6) (466.9) --------- --------Balance at 31 December 155.8 279.0 --------- -------- (ii) Claims reserve Year ended Year ended 31 31 December December 2004 2005 £m £mBalance as at 1 January 1,125.5 899.8Movement in claims outstanding 198.9 223.9Movement in IBNR (47.4) 0.1Movement in claims handling provision 1.2 1.7 --------- --------Balance at 31 December 1,278.2 1,125.5 --------- -------- (iii) Exceptional loss provision Year ended Year ended 31 31 December December 2004 2005 £m £mBalance as at 1 January 67.1 -Movement during year (40.0) 67.1 --------- --------Balance at 31 December 27.1 67.1 --------- -------- (c) Claims development Claims development has been shown on an underwriting year basis. 2001 and prior 2002 2003 2004 2005 TotalUnderwriting year £m £m £m £m £m £mGross claims: Estimate of ultimategross claims:- at end ofunderwriting year 2,170.4 298.4 234.5 280.0 308.7- one year later 2,303.0 244.6 213.8 243.6- two years later 2,556.5 243.4 189.3- three years later 2,757.9 278.0- four years later 2,911.3 -------- ------- ------- ------- ------ ------Gross claims paid - at end of 929.4 4.8 4.3 11.6 25.1underwriting year- one year later 1,234.7 29.5 36.4 63.1- two years later 1,546.2 71.7 64.1- three years later 1,803.6 122.4- four years later 2,026.8 -------- ------- ------- ------- ------ ------Gross ultimate claimsreserve 884.5 155.6 125.2 180.5 283.6 1,629.4Gross unearned claimsreserve (101.4) -------- ------- ------- ------- ------ ------Third party (189.8)participation onsyndicates -------- ------- ------- ------- ------ ------Gross claims reserve 1,278.2 -------- ------- ------- ------- ------ ------ 2001 and prior 2002 2003 2004 2005 TotalUnderwriting year £m £m £m £m £m £mNet claims: Estimate of ultimatenet claims- at end ofunderwriting year 1,276.1 194.0 171.1 219.2 214.0- one year later 1,352.0 166.8 150.5 186.7- two years later 1,395.2 149.6 128.6- three years later 1,565.8 167.1- four years later 1,620.8 -------- ------- ------- ------- ------ ------Net claims paid - at end ofunderwriting year 621.1 4.5 4.3 11.5 10.3- one year later 800.5 23.6 22.7 50.4- two years later 938.8 51.3 42.9- three years later 1,087.2 79.8- four years later 1,202.9 -------- ------- ------- ------- ------ ------Net ultimate claims 417.9 87.3 85.7 136.3 203.7 930.9reserveNet unearned claims (128.7)reserve Third party (85.5)participation onsyndicates -------- ------- ------- ------- ------ ------Net claims reserve 716.7 -------- ------- ------- ------- ------ ------ The tables above show the development of claims over time on a gross and net ofreinsurance basis. These claims are shown on an ultimate basis for eachsuccessive underwriting year and are stated at the 100 per cent. syndicatelevel. Balances have been translated at exchange rates prevailing at 31 December2005 in all cases. (d) Assumptions and sensitivities (i) AssumptionsThe ultimate cost of outstanding claims is estimated by using a range ofstandard actuarial projection techniques, such as the Chain Ladder andBornhuetter-Ferguson methods. Such methods extrapolate the development of claimsnumbers for each underwriting year, based on the claims patterns of earlieryears and expected loss ratios. The main assumption underlying these techniques is that past claims developmentexperience can be used to project ultimate claims costs. Judgement is used toassess the extent to which past trends may not apply in future and alternativeapproaches are applied as appropriate for catastrophe exposed claims where lossdevelopment patterns are less regular. The approach adopted takes into account, inter alia, the nature and materialityof business and the type of data available. Specific estimates are set by theReserving Committee based on a blend of these techniques, applying theirexperience and knowledge to the circumstances of individual claims, and in thecase of certain US liability classes, the advice of US attorneys who specialisein claims of this nature. Additional qualitative input, such as allowance forone-off occurrences or changes in legislation, policy conditions or portfoliomix, is also used in arriving at the best estimate of claims with the input ofboth internal and independent actuaries. At the early stage of development of long-tail classes of business significantweight is given to changes in the rating environment and conditions on renewalof policies in arriving at ultimate claims costs. Provisions are calculatedallowing for reinsurance recoveries and a separate asset is recorded for thereinsurers' share, having regard to recoverability. (ii) Amount, timing and uncertainty of cash flowsFuture cash flows are estimated by taking the estimated cost of outstandingclaims, plus liabilities incurred in the future, and spreading these amountsover future calendar years based upon payment patterns observed from pastexperience. The payment patterns are essentially probabilistic and will allow for situationswhere significant reserves are settled in one time period, where that timeperiod is unknown. For example, claims arising for events surrounding Enron maywell settle over a relatively short period, but at present it is not clear whenthat period will start. The payment pattern applied will spread the paymentsover the potential settlement period. The uncertainty in the projected cash flows will be high because it is derivedfrom both the uncertainty in reserves and the uncertainty in the paymentpatterns of the cash flow projected in an individual time period. (iii) Sensitivity analysisThe insurance contract liabilities are the result of a process that blendsstatistical analysis of historical data with subjective interpretation ofqualitative information. These liabilities will therefore be sensitive tolimitations of the available data, and to the subjectivity employed ininterpreting both the qualitative and quantitative information. For example,certain potential scenarios may be not adequately represented in the data. Thebusiness written by the Group is diverse, and each line of business is analysedseparately so that to a large degree the sensitivity within any one class willbe immaterial at the Group level. Also, the diverse nature of the portfoliomeans that the potential downside risk within one class of business may beoffset by upside potential in another. There are, however, a number of areas in which the sensitivity is potentiallymaterial at the Group level. These are considered below: (a) Liability reinsuranceShortcomings in the data provided by the ceding companies mean that reservingfor this class of business is particularly subjective. The account was scaleddown in 2001 and ceased underwriting in 2002 so as time passes the uncertainty,and therefore the sensitivity of the Group result to the assumptions made forthis class, is reducing. Nevertheless, significant uncertainty remains at thepresent time. It was in recognition of this that the Group established anadditional provision for the Discontinued Businesses (of which liabilityreinsurance makes up by far the largest part). This was established afterconsidering alternative runoff scenarios and so provides some indication of thesensitivity of the syndicate level insurance contract liabilities to theassumptions made. The existence of the provision serves to shift the balance ofprobabilities relative to the liabilities held in the syndicate, and inparticular reduce the downside potential, although it is possible to constructscenarios that are worse than that underlying the provision so some downsiderisk remains. (b) Investment banking reservesThe Group has significant exposures to US investment banks which have beenaffected by events surrounding Enron and Worldcom, as well as IPO ladderingissues. Insurance contract liabilities for these potential exposures have beenestablished in consultation with the Group's legal advisors, based upon theirviews as to the likely outcome of the various legal cases and settlementnegotiations. As was the case in 2005 the situation can change, in turnillustrating significant sensitivity in the reserves to the assumptions made byattorneys and others. This sensitivity can be reduced significantly byreinsurance and has been tested by considering alternative outcomes. (c) US windstorm lossesThe 2005 year saw the worst US hurricane experience on record, with Katrinaproducing a substantial loss and Rita and Wilma adding to it, albeit on a muchlesser scale. The size of the losses and in particular the complications arisingfrom the flood situation following Katrina means that the complete picture istaking some time to emerge. In this context there is scope for the ultimateoutcome to diverge materially from current expectations. 26. Financial liabilities(a) Convertible bondThe Group issued 500,000 7 per cent. convertible bonds at a nominal value of £50million on 15 December 2003. The bonds mature five years from the date of issue at their nominal value of £50million or can be converted into shares at the holder's option at the rate ofone ordinary share per 61.22p (nominal value) of convertible debt. Bondholderscan convert their bonds to shares at any time until 9 December 2008. The fair value of the liability component and the equity conversion componentwere determined at issuance of the bond. The fair value of the liabilitycomponent was calculated using a market interest rate for an equivalentnon-convertible bond net of issue costs of £2.1 million. The residual amount,representing the value of the equity conversion component, is included inshareholders' equity. £mFace value of convertible bond issued on 15 December 2003 50.0Equity component (5.5)Issue costs deferred (2.1)--------------------------------------------- -----Liability component on initial recognition 42.4Interest expense 9.2Interest paid (7.0)Amortisation of issue costs 0.9--------------------------------------------- -----Liability component at 31 December 2005 45.5--------------------------------------------- -----Liability component at 31 December 2004 43.9--------------------------------------------- ----- (b) Loan notes During 2004, the Group issued $36.0 million of 30 year floating rate notes asfollows: Issue date Maturity date Earliest Margin rate above 3 month US LIBOR redemption per annum date$15 millionfloating ratenotes 30 June 2004 30 June 2034 15 August 2009 3.50%$11 millionfloating rate 30 June 2004 30 June 2034 15 August 2009 4.05%subordinated notes$10 millionfloating ratenotes 22 September 30 June 19 November 3.50% 2004 2034 2009 The notes constitute direct, unsecured and unsubordinated obligations of theissuer ranking pari passu and rateably, without any preference amongstthemselves, with all other existing and future unsecured unsubordinated debt ofthe issuer. Issue costs of £0.5 million are being amortised on an effectiveinterest rate basis. Interest is payable on a quarterly basis in arrears. Thenotes are listed on the Irish Stock Exchange. As at 31 December 2005 the fairvalue of the notes is £19.6 million (2004: £19.5 million), which is stated netof unamortised issue costs of £0.4 million (2004: £0.5 million). 27. Insurance and other payables 2005 2004Arising from underwriting business £m £m 18.7 58.7Arising from service companies and other subsidiaries 25.1 48.3-------------------------------------- --------- ----- 43.8 107.0 --------- ----- 28. Derivative financial instruments Forward contracts are used to hedge exposure to fluctuations in foreign exchangerates and interest rates in respect of the subordinated loan notes on thebalance sheet. A portion of the loan notes are denominated in US dollars (seenote 26b) with the interest payable pegged to US LIBOR. The forward contractswhich mature on the same date as interest is due for payment on the loans havethe effect of hedging 100 per cent. of the interest rate and foreign exchangerate risks associated with the loan notes. 29. Retirement benefit obligations For certain staff employed by SVB Group prior to the merger with CLM and for allemployees joining the Group thereafter the Group operates the SVB GroupRetirement Benefit Scheme ("RBS"). The RBS was established with effect from 1September 1995 by the Group's managing agency subsidiary. It is a definedcontribution scheme and will provide benefits based upon the level ofcontributions made. The contributions of employees to the RBS are at the rate of5 per cent. salary. SVB's contributions are dependent upon age and range from11.0 per cent. to 18.5 per cent. of salary. No additional contributions weremade during the year in respect of directors. The funds of the RBS are independent of the Group's assets. The pension chargeof the SVB Group for the year was £2.4 million (2004: £2.4 million), of which£nil (2004: £nil) was recharged to managed syndicates. There were nocontributions outstanding or prepaid at 31 December 2004 (2005: £nil). 30. Capital and reserves Reconciliation of movement in capital and reserves Attributable to equity holders of the parent Share Share Other Capital Profit Equity Total MinorityTotal capital premium reserve redemption and losscomponent interestequity £m account £m reserve account of £m £m £m £m £m convertible bond Balanceat 1 114.4 83.6 61.9 1.5 46.6 5.5 220.3 0.6 220.9January2004Dividends - - - - (2.2) - (2.2) - (2.2)(Loss)/profit - - - - (90.1) - (90.1) 0.5 (89.6)for the ------ ---- ----- ------- ------ ------ ----- --- -----periodAs at 31December 114.4 83.6 61.9 1.5 (138.9) 5.5 128 1.1 129.12004Loss forthe - - - - (17.1) - (17.1) (1.1)(18.2)period ------ ----- ----- ------- ------ ------ ----- ----------Movementin - - - - 1.5 - 1.5 - 1.5treasuryshares ------ ----- ----- ------- ------ ------ ----- ----- -----As at 31December 114.4 83.6 61.9 1.5 (154.5) 5.5 112.4 - 112.42005 ------ ----- ----- ------- ------ ------- ---- ----- ----- Share capital and Ordinary shares of 10p Deferred shares of 40pshare premium Number £ Number £ ---------- --------- ---------- --------Authorised 31 December 2003 572,023,200 57,202,320 194,494,200 77,797,680 ---------- --------- ---------- --------31 December 2004 572,023,200 57,202,320 194,494,200 77,797,680 ---------- --------- ---------- --------31 December 2005 572,023,200 57,202,320 194,494,200 77,797,680 ---------- --------- ---------- --------Issued and fully paid 366,106,728 36,610,673 194,494,200 77,797,68031 December 2003Additions - - - -Disposals - - - - ---------- --------- ---------- --------31 December 2004 366,106,728 36,610,673 194,494,200 77,797,680Additions - - - -Disposals - - - - ---------- --------- ---------- --------31 December 2005 366,106,728 36,610,673 194,494,200 77,797,680 ---------- --------- ---------- -------- The authorised and issued Deferred shares were created in the context of thecapital reorganisation approved by shareholders on 27 May 2003 and were designedto enable the re-designation of each of the Company's Ordinary 50 pence shares,as they were, into one 10 pence Ordinary share and one 40 pence Deferred share.The Deferred shares carry no voting, dividend or other rights and have nocommercial value. The authorised and issued Ordinary 10 pence shares weresimilarly created in the capital reorganisation approved by shareholders on 27May 2003. The Ordinary 10 pence shares carry full voting and dividend rights. The Group has also issued share options (see note 15c). Other reserve This is a non-distributable merger reserve which represents the premium createdon merger with CLM Insurance Fund plc in 1999. Capital redemption reserve This is a non-distributable reserve relating to the acquisition of shares forcancellation. In 1999 0.5 million shares were acquired and then cancelled at acost of £0.3 million. In 2000 2.5 million shares were acquired and thencancelled at a cost of £1.2 million. Equity component of convertible bond This represents the equity component of the Group's convertible bond issued in2003. See note 26(a). 31. Contingencies and other commitments (a) If at 31 December 2005 the Group's corporate member subsidiary, SVBUnderwriting Limited, or the corporate members disposed of in 2000, namelySyndicate Capital Nos 1-5 Limited and CLM A-H, J and K, failed to meet any ofits or their Lloyd's obligations, Lloyd's will: (1) be entitled to require the other subsidiaries to cease or reducetheir underwriting; and/or (2) having regard to the fact that the Central Fund may be applied todischarge the obligations of the defaulting subsidiary, be entitled to requireeach of the other corporate member subsidiaries to make contributions to theCentral Fund up to the amount of their respective net profits held from time totime in premiums trust funds, sufficient to reimburse the Central Fund in fullfor any payment made on behalf of the defaulting member. At the date of thesefinancial statements the directors are not aware of any of its corporate membersubsidiaries failing to meet any of its Lloyd's obligations. (b) Certain of the Group's assets are used as security for covenants used asFunds at Lloyd's by the corporate member subsidiary members. The assets chargedto Lloyd's at 31 December 2005 comprise fixed asset investments and cash with avalue of approximately £239.0 million. In addition SVB Holdings has grantedLloyd's a floating charge over its entire assets and undertakings. In certaincircumstances the charged assets may be required to meet obligations topolicyholders should SVB corporate members be unable to do so. (c) On 19 August 1999, SVB Holdings, as the then ultimate parent company of thecorporate members Syndicate Capital 1-5 Limited, entered into a guarantee infavour of a European reinsurer in respect of the performance of the obligationsunder the reinsurance contract of the same date covering the 1997 and 1998underwriting years. On 30 November 1999, SVB Holdings, as the then ultimateparent company of the corporate members CLM A-H, J and K Limited, entered into aguarantee in favour of a European reinsurer on that date in respect of theperformance of the obligations under the reinsurance contract of the same datecovering the 1997, 1998 and 1999 underwriting years. The Group disposed of thecorporate members, Syndicate Capital 1-5 Limited and CLM A-H, J and K Limited,on 10 March 2000 to Mayheld Limited. As part of this disposal, Syndicate CapitalUnderwriting Limited, a subsidiary of SVB Holdings, agreed to indemnify MayheldLimited and the shareholders of Mayheld Limited against any loss, damage, costs,liabilities, claims, cash calls and expenses to the extent that the same are notcovered by the reinsurance contracts referred to above. (d) On 21 November 2002, SVB Holdings entered into a guarantee in favour of aBermudan reinsurer in respect of the obligations, including the payment ofpremiums due, of the Group's corporate member subsidiary, arising under anexcess of loss reinsurance contract provided by that reinsurer. On 25 September2002, SVB Holdings entered into a contract in favour of the European reinsurerreferred to in (c) above, providing an excess of loss indemnity in respect of ahigh level layer of risk covered by a successor reinsurance contract to thosereferred to above. 32. Operating leases The Group leases office premises under operating leases. The leases run until2015, with a break at 2010 and an option to renew them after that date. None ofthe leases include contingent rentals. The future aggregate minimum leasepayments under operating leases are as follows: 31 31 December December 2004 2005 £m £mWithin one year 1.5 1.5In the second to fifth years inclusive 5.3 6.0Over five years - 0.9 --------- -------- 6.8 8.4 --------- -------- During the year ended 31 December 2005, £1.5 million was recognised as anexpense in the income statement in respect of operating leases (2004: £1.5million). 33. Related party transactions (a) Certain of the directors of SVB Holdings and its subsidiaries areor have been Names on the Lloyd's syndicates which are managed by the Group. Thedirectors do not pay profit commission on the underwriting result but aretreated the same as other Names in all other respects. (b) L Santambrogio is a non-executive director of Hardy Underwriting(Agencies) Limited (Hardy) for which he is paid a director's fee of £13,500. Anybusiness transacted between the companies of the SVB Group, SVB managedsyndicates and any syndicate managed by Hardy was conducted on an arm's lengthbasis and on normal commercial terms. (c) C A C Chaplin is a partner in Ogier which purchases insurance fromsyndicates managed by the Group on normal commercial terms on an arm's lengthbasis. The premium paid in 2005 by Ogier to the syndicates managed by the Groupwas £88,019 (2004: £151,098). C A C Chaplin is also a director of othercompanies that purchase Directors' and Officers' insurance from the SVB managedsyndicates. (d) Ogier Employee Benefit Trustee Limited, a company owned by thePartners of Ogier, provides trustee services to SVB's Employee Share OwnershipTrust. These services are provided on an arm's length basis and at normalcommercial terms. The fees payable are not expected to exceed £17,500 per annum. 34. Events after the balance sheet date On 10 February 2006, SVB Holdings announced proposals designed to achieve itsstated strategic aims of isolating its damaging legacy underwriting andestablishing a wholly-owned FSA-regulated insurance company. This new companywill be focussed on UK mid-sized commercial risks to sit alongside thecontinuing Lloyd's business under a newly incorporated listed holding company. 35. IFRS transition As stated in note 1(a), these are the Group's first consolidated annualfinancial statements prepared in accordance with International FinancialReporting Standards. The accounting policies set out in note 1 have been applied in preparing thefinancial statements for the year ended 31 December 2005, the comparativeinformation presented in these financial statements for the year ended 31December 2004 and in the preparation of an opening balance sheet at 1 January2004 (the Group's date of transition). In preparing its opening IFRS balance sheet, the Group has adjusted amountsreported previously in financial statements prepared under UK GAAP. Thefollowing tables set out the impact of those adjustments (there has been nosignificant impact on the cash flow statement): 31 Investments Foreign Convertible DAC 31 December Note (a) exchange Note (c) Note December 2004 £m Note (b) £m £m (d) 2004 £m £m £m UK GAAP IFRS Assets 3.4 - - - - 3.4Property, plantand equipmentIntangibleassets 9.3 - - - - 9.3Deferredacquisitioncosts 49.3 - 1.6 - (4.0) 46.9Deferred taxassets 44.3 - - - - 44.3Financial assets 535.6 (0.1) - - - 535.5Reinsurancecontracts 545.6 - 0.4 - - 546.0Insurance andotherreceivables 405.3 - 1.3 - - 406.6Cash and cashequivalents 191.4 - - - - 191.4 ------- -------- ------ -------- ----- -------Total assets 1,784.2 (0.1) 3.3 - (4.0) 1,783.4Liabilities 1,472.6 - (0.9) - - 1,471.7InsurancecontractsFinancial - - - -liabilities,due after oneyear- Convertibledebt 48.3 - - (4.4) - 43.9- Loan notes 19.5 - - - - 19.5Deferred income 10.8 - - - - 10.8Income taxes 1.4 - - - - 1.4Insurance andother payables 107.0 - - - - 107.0 ------- -------- ------ -------- ----- -------Totalliabilities 1,659.6 - (0.9) (4.4) - 1,654.3 ------- -------- ------ -------- ----- -------Net assets 124.6 (0.1) 4.2 4.4 (4.0) 129.1Shareholders'equity Share capital 114.4 - - - - 114.4Share premium 83.6 - - - - 83.6Retainedearnings (137.9) (0.1) 4.2 (1.1) (4.0) (138.9)Other reserves 63.4 - - - - 63.4 ------- -------- ------ -------- ----- -------Equity componentof - - - 5.5 - 5.5convertible debt ------- -------- ------ -------- ----- -------Totalshareholders'equity 123.5 (0.1) 4.2 4.4 (4.0) 128.0Minorityinterests 1.1 - - - - 1.1 ------- -------- ------ -------- ----- -------Total equity 124.6 (0.1) 4.2 4.4 (4.0) 129.1 31 December Investments Foreign Convertible Dividends 31 December 2003 Note (a) exchange Note (c) Payable 2003 £m £m Note (b) £m Note (f) £mUK GAAP £m £m IFRSAssets 1.7 - - - - 1.7Property,plant andequipmentIntangibleassets 10.2 - - - - 10.2Deferredacquisitioncosts 57.7 - 0.8 - - 58.5Deferred taxassets 19.1 - - - - 19.1Financialassets 405.9 (0.1) - - - 405.8Reinsurancecontracts 496.9 - 0.1 - - 497.0Insurance andotherreceivables 328.1 - 0.8 - - 328.9Cash and cashequivalents 251.8 - - - - 251.8 ------- -------- ------ ------- ------ -------Total assets 1,571.4 (0.1) 1.7 - - 1,573.0Liabilities Insurance 1,137.8 - (0.4) - - 1,137.4contractsFinancialliabilitiesdue after oneyear - Convertible 47.9 - - (5.5) - 42.4debt- Loan notes 20.0 - - - - 20.0Deferred 7.4 - - - - 7.4incomeInsurance andother 144.9 - - - - 144.9payablesDividendspayable 2.2 - - - (2.2) - ------- -------- ------ ------- ------ -------Totalliabilities 1,360.2 - (0.4) (5.5) (2.2) 1,352.1 ------- -------- ------ ------- ------ -------Net assets 211.2 (0.1) 2.1 5.5 2.2 220.9Shareholders'equity Share capital 114.4 - - - - 114.4Share premium 83.6 - - - - 83.6Retainedearnings (50.8) (0.1) 2.1 - 2.2 (46.6)Other 63.4 - - - - 63.4reservesEquitycomponent ofconvertibledebt - - - 5.5 - 5.5 ------- -------- ------ ------- ------ -------Totalshareholders'equity 210.6 (0.1) 2.1 5.5 2.2 220.3Minorityinterests 0.6 - - - - 0.6 ------- -------- ------ ------- ------ -------Total equity 211.2 (0.1) 2.1 5.5 2.2 220.9 Year ended (a) (b) (c) (d) Year ended 31 December £m £m £m £m 31 December 2004 2004 UK GAAP (e) IFRS £m £m £mGross premium 461.8 - 5.1 - - - 466.9revenue ---------- ------ ------- ------- ------- ------ -----Less premium (43.3) - (6.5) - - - (49.8)ceded toreinsurers ---------- ------ ------- ------- ------- ------ -----Net premium 418.5 - (1.4) - - - 417.1revenueFees and 5.7 - - - - 5.7commissionincomeInvestment 27.4 ( 0.1) (1.3 ) - - - 26.0income ---------- ------ ------- ------- ------- ------ -----Net income 451.6 (0.1) (2.7) - - - 448.8Gross claims (572.4) - (10.0) - - - (582.4)incurred ---------- ------ ------- ------- ------- ------ -----Reinsurers 164.3 - 3.4 - - - 167.7share ofclaimsincurred ---------- ------ ------- ------- ------- ------ -----Net claims (408.1) - (6.6) - - - (414.7)incurredPolicyacquisition (87.2) - 0.6 - (4.0) - (90.6)costsOperating (55.5) - 11.1 - - (0.6) (45.0)expenses ---------- ------ ------- ------- ------- ------ -----Operating loss (99.2) (0.1) (2.2) - (4.0) (0.6) (101.5)Profit on - - - - - - -disposal ofsubsidiaryFinancing (10.9 ) - ( 0.1) (1.1) - - (12.1)costs ---------- ------ ------- ------- ------- ------ -----Loss beforeincome (110.1) (0.1) 2.3 (1.1) (4.0) (0.6) (113.6)taxesIncome taxes 23.5 - - - - - 23.5 ---------- ------ ------- ------- ------- ------ -----Loss for the (86.6) (0.1) 2.3 (1.1) (4.0) (0.6) (90.1)year ---------- ------ ------- ------- ------- ------ ----- (a) Under UK GAAP, listed investments are stated at mid-market values andstated at closing market prices on recognised stock exchanges. As a result ofapplying IAS 39 "Financial Instruments: Recognition and Measurement", the Groupnow carries all listed investments in debt and equity securities at closing bidprices on recognised stock exchanges. This has had the effect of decreasinginvestment valuation at 31 December 2003 of £0.1 million and 31 December 2004 of£0.1 million. (b) Under IAS 21 "The effects of changes in Foreign Exchange Rates"foreign currency transactions are translated into functional currency (Sterlingfor the SVB Group) using average exchange rates for the period. Monetary assetsand liabilities denominated in foreign currencies are translated at period endexchange rates. Non-monetary assets and liabilities are measured at historicalcost and translated at the historic exchange rate. The resulting exchangedifferences are recorded in the income statement. Under IFRS unearned premiumand deferred acquisition costs are deemed to be non-monetary liabilities andassets and are therefore translated at historic exchange rates. This differsfrom the UK GAAP treatment for these items which stipulated that they should betranslated at the exchange rate prevailing at the period end. (c) Under UK GAAP the Group's convertible bond was recognised as a singleinstrument in the balance sheet. Under IAS 32 "Financial Instruments: Disclosureand Presentation", the convertible debt is separated into its component parts,being a financial liability and equity. This results in a reduction in the debtliability and an increase to shareholders equity as indicated in there-statement tables. It also results in an annualised reduction in profit beforetax of £1.1 million representing the debt accretion to par value. (d) The Group has revised the way in which it recordsDeferred Acquisition Costs (DAC). Under UK GAAP an element of centralised costswas deemed to relate to the acquisition of business. This element was deferredand earned on the same basis as the underwriting results. While there is noguidance on the treatment of the deferral of such non-direct expenses underIFRS, the Group has further simplified its approach to the recognition ofdeferred costs by only recognising direct underwriting costs as acquisitioncosts. The financial impact of this has been disclosed separately in the IFRSre-statement table for clarity. This represents a change in estimationtechnique. (e) Under IFRS 2 "Share-Based Payments", charges in respect ofshare-based employee incentive plans that were granted after 7 November 2002,but had not yet vested at 1 January 2005, are determined based on the fair valueof the awards at grant date. This charge is recognised in the income statementover the vesting period of the expected life of the share based instrument. (f) Under UK GAAP, dividends were recognised in the period to whichthey related. Under IAS18 "Revenue" dividends should only be recognised when theshareholder's right to receive payment is established, normally when theshareholders have approved the dividend. Dividends of £2.2 million wererecognised as a liability at 31 Decmber 2003 under UK GAAP, though they wereonly declared and approved during 2004. IFRS requires these dividends to berecognised in the 2004 rather than the 2003 income statement. 36. Status of the financial information The financial information set out above does not constitute the Company'sstatutory financial statements for the years ended 31 December 2005 or 2004 butis derived from the 2005 accounts. Statutory accounts for 2004, which wereprepared under UK GAAP, have been delivered to the registrar of companies, andthose for 2005, prepared under International Financial Reporting Standards asadopted by the EU, will be delivered in due course. The auditors have reportedon these financial statements and their reports were unqualified, but bothincluded a reference to the uncertainty of the level of gross loss reserves fordiscontinued units to which the auditors drew attention by way of emphasis ofmatter without qualifying their reports. This uncertainty is further explainedin note 25 of this financial information. The auditor's report was unqualifiedand did not contain any statements under section 237(2) or (3) of the CompaniesAct 1985. This information is provided by RNS The company news service from the London Stock Exchange

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