Final Results - Part 1

6th Mar 2007 07:02

BRIT Insurance Holdings PLC06 March 2007 PART 1 OF 2 PRESS RELEASE6 March 2007 BRIT INSURANCE HOLDINGS PLC Preliminary results for the year ended 31 December 2006 Record results Brit Insurance Holdings PLC, the UK-domiciled international general insurer andreinsurer, today announces preliminary results for the year ended 31 December2006. HIGHLIGHTS • Profit before tax up 198.6% to £186.3m (2005: £62.4m) • Gross written premiums up 2.8% to £1,236.3m (2005: £1,202.5m) • Underlying gross written premium growth for ongoing business up 7.0% (premiums from ongoing business adjusted for reinstatements and exchange rate movements) • Net earned premiums up 11.3% to £1,048.7m (2005: £942.5m) • Profit before tax and before exchange adjustments arising from the IFRS treatment of non-monetary items £213.2m (2005: £41.1m) • Earnings per share up 178.7% to 41.3p (2005: 14.8p) • Proposed final dividend of 7.5p per share payable on 27 April 2007 to shareholders on the register on 16 March 2007; proposed ex-dividend date 14 March 2007. First year of new dividend policy • Proposed special dividend of 2p per share • Proposed share buy-back programme of up to £50m of ordinary shares by market value. It is intended that the programme will start on 26 March 2007. • Net tangible assets per share up 13.0% to 220.7p (2005: 195.3p) • Underwriting profit £137.2m (2005: loss of £37.5m) • Group combined ratio 86.9% (2005: 105.2%) • Share premium account reduction, providing the potential to increase distributable reserves by £180.0m • Leading role in industry-wide "contract certainty" success • 19.6% investment in specialist Bermuda-based retrocessional company, Norton Re • Disposal of stake in EPIC Investment Partners Limited in January 2007 OUTLOOK The outlook remains positive though challenging. The overall trend is towards asoftening market. The lack of any significant catastrophes in 2006 has resultedin increasing competition across most underwriting classes. The key question for the industry is how far the cycle will soften. At thisstage, price reductions show discipline and there are still good margins to bemade in most areas of the market. Unlike earlier softening cycles, interestrates are fairly low. This reduces the tendency for insurers to price businessat an underwriting loss in the expectation of making an overall profit based oninvestment returns. In addition, insurance capital providers are more demandingof management in terms of sustaining return on equity. In our opinion, it isextremely unlikely that industry-wide claims activity in future years will be asbenign as 2006, for either property or casualty markets globally. We believe that the spread and quality of our underwriting portfolio mean thatwe should not be unduly exposed to pricing pressure in individual classes or tolarge claims arising from single events in specific classes of business. We seemeaningful growth in the medium term, taking us to £2bn gross written premiumsand beyond. In a softening market we will continue to be selective about growthopportunities and not pursue growth at the expense of profitability andshareholder value. Dane Douetil, Chief Executive Officer of Brit Insurance Holdings PLC, said: "2006 was a remarkable year. We continued to implement our strategy of balancingour portfolio to provide long term earnings stability, we led the market reformagenda and are very pleased with the progress made on that front and we producedrecord results. "To have so little catastrophe activity in any one year is extremely unusual andhas helped produce these results. However, our goal is to perform well in morenormal years. Our portfolio is in the shape that we want it to be, it matchesour risk appetite and we are confident for the future." For further information, please contact Dane Douetil, Chief Executive Officer, Brit Insurance Holdings PLC 020 7984 8500David Haggie/Peter Rigby/Juliet Tilley, Haggie Financial 020 7417 8989 There will be a presentation to analysts at Brit Insurance's office at 55Bishopsgate at 9.30am today An audio webcast of the analysts' presentation will be available on our websitewww.britinsurance.com from 3pm today. Notes to Editors Brit Insurance's underwriting operations comprise, principally, threecustomer-facing centres: UK, London Market and Reinsurance. All three haveaccess to the two regulatory vehicles through which Brit Insurance underwrites:UK insurance company, Brit Insurance Limited and Lloyd's syndicate 2987 which ismanaged by Brit Syndicates Limited. Brit Insurance has UK underwriting officesin London, Reading, Birmingham, Bristol, Glasgow, Leeds, Darlington, Ilford andManchester. www.britinsurance.com CHAIRMAN'S STATEMENT Overview It is a pleasure to report on a year of record written and earned premium, lowclaims and record earnings. Indeed, this is my fifth Chairman's statement andthe fifth year of record premiums and the third year of record results in thatperiod. A Group is judged on not simply one set of results, but a series; and not juston the quantity of its earnings, but the quality and sustainability. In thiscontext, directors and management have taken some important decisions andactions in 2006. Some of the benefits are immediately apparent in the figures.The impact of other more complex decisions will take longer to come through: • The Group significantly reduced aggregate risk to any one catastrophic event or series of events. In hindsight, 2006 was a very benign year for catastrophes and we would have reported even higher profits for the year taken in isolation if we had taken more peak zone risk. However, it is not our intention to build the Group on such a short term view. The risk appetite constraints imposed in 2006 will not be materially relaxed for 2007 on the back of a single benign year. • The Group has played a leading role in the successful industry wide contract certainty initiative in 2005 and 2006, which has seen London leap-frog a number of overseas markets in this key area of process and performance. This has clear long-term implications for the London Market as a whole and Brit Insurance's position within it. Dane Douetil, as Chairman of the Market Reform Group has overseen this process and I congratulate him on this achievement. • We have reviewed our strategy, which is set out in this preliminary announcement. As well as growth targets, we have been careful to embed a number of risk tolerances to ensure that growth is not achieved at the expense of quality and profitability. Board and Committee Changes I would like to pay tribute to Don McCrickard, a founder member of the Boardfrom 1995, who retired on 31 December 2006. He was a tower of strength duringthe development phase of the Group through to its current robust form. During2006, we were pleased to appoint Kathy Lisson, Chief Operating Officer, as anExecutive Director. We were also pleased to appoint Cees Schrauwers as the new Senior IndependentDirector, Joe MacHale as the new Head of the Remuneration Committee and MichaelSmith as the new Head of the Nomination Committee. On 28 February 2007, Kenneth Culley CBE was appointed as a Non-ExecutiveDirector. Ken also joins the Audit and Nomination Committees. He has been aNon-Executive Director of Brit Insurance Limited since 2000, Chairman of thatcompany since 2003 and a Non-Executive Director of Brit Syndicates Limited since2004. Proposed dividend We are recommending a final dividend of 7.5p per share making a full-year totalof 15.0p, in line with our dividend policy. In addition to this, we arerecommending a 2.0p special dividend, reflecting the high level of earnings in2006. Conclusion A further improvement in results does not happen without a lot of hard work frommanagement and staff at all levels. I am proud to work with them at BritInsurance. CHIEF EXECUTIVE OFFICER'S REVIEW 2006 results Overall I am delighted to report: • record profits before tax of £186.3m and record return on net tangible assets of 21.6%, which are 60.5% and 50.0% respectively above the previous record year of 2004; • premium growth arising from ongoing business of 7.0% when exchange rates and reinstatement premiums are equalised; and • the implementation of a reduction in our exposures to catastrophe risks which should reduce the volatility of our earnings over time. Growth targets Our strategy does not just focus on growth but sustainable and profitablegrowth. Therefore, we have set not only a premium target of £2bn by 2010 butalso a minimum cross-cycle return of 6% above the risk free rate and a number ofoperational and risk parameters. These parameters include business mix and riskappetite for a single event or series of events. For 2006 we achieved 7.0% underlying growth in adjusted ongoing premiums; weachieved over twice our target return (as we should seek to do in a benignclaims year at this relatively hard point of the pricing cycle) and reduced ourpeak zone aggregate exposures by about 40%. During 2006 our growth pattern was in line with expectations. London Marketgrowth has been excellent. We could have written considerably more reinsurancebusiness but chose not to, on grounds of volatility management. The UK divisionis at a competitive point in its own pricing cycle and we will not pursuepremium volume for its own sake by pushing to write unprofitable business. Wewill seek to grow it rapidly at the right time; meanwhile the plan is to holdour discipline and continue to strengthen the infrastructure (staff, offices,brand, IT, broker relationships) that will allow us to grow when the opportunityis there. We never expected growth to be linear. Reserve releases I am pleased to report net back year reserve releases again. Net back year releases in 2006, excluding movements relating to the three largehurricanes of 2005, amounted to £109.5m, very similar to the 2005 figure of£110.8m. In 2006 however, there was adverse development of £75.6m on claimsarising from Hurricanes Katrina, Rita and Wilma. This brings the net overallrelease for 2006 down to £33.9m. It is part of the Group's reserving philosophythat the most recent years, with the greatest uncertainty of result, beprudently reserved leaving a potential for subsequent release. When we announced the initial claims estimates for these three hurricanes, weemphasised the complexity of these events and therefore the difficulty is makingan estimate to our normal standards of accuracy and prudence. We recognised£42.0m of the adverse development in our 2006 interim results. The adversedevelopment in 2006 was driven principally by additional claims in offshoreenergy, where our relevant reinsurances are exhausted, and by thereclassification of Rita to a market loss in excess of US$5bn and of Wilma to amarket loss in excess of US$10bn, resulting in several industry loss warrantypolicies in our retrocessional account being triggered. We no longer underwrite retrocessional industry loss warranties or Gulf ofMexico catastrophe exposed energy business, although we continue to beinterested in such risks through our investment in Norton Re. Group management expenses Group management expenses before foreign exchange and bonus pool increased from£95.9m to £116.8m. One of the key drivers of the Group's expense levels isheadcount, which increased from 601 to 751. This increase in management expenses and headcount is in line with our financialplan. It reflects a strengthening in both our underwriting and operationsplatforms in key areas, enabling Brit Insurance to take advantage of futureopportunities and to support the Group's strategic vision for profitable growth. In addition to these Group management expenses, a foreign exchange loss of£25.4m was incurred for the year. A foreign exchange profit of £11.6m for thesame period last year was included in "other income". The charge for the bonuspool, a product of the overall Group result, was £14.0m in 2006 compared with£4.9m in 2005. Investments Performance was again good - above external comparative benchmarks in each ofthe three main asset classes. On an opening invested asset base of £2.4bn, theweighted return was 4.74%. 91% of our assets were in cash and bonds. Amaterial amount of the Group's profit comes from investment return and we expectthis proportion to increase over the coming years. It is normal for investmentreturns to represent a large proportion of general insurance company profits. Looking forward, we intend to introduce a modest element of further diversity interms of asset class and fund manager. This could include some exposure toalternative assets and real estate. Contract certainty and market reform Contract certainty and market reform are essential to Brit Insurance and themarket as a whole. Contract certainty is not just a matter of getting an insurance policy agreedand issued on time - the point is much more profound than that. It is aboutwholesale reform of business practices and processes; the respective roles ofinsurers, brokers and other service providers; improving customer service;driving out historic practices which involved inherent inefficiencies andconflicts of interest; and making the UK a competitive place to do business froma cost perspective. Added to that, it is an FSA imperative. The industry-widesuccess of 2006 has been outstanding and based on wholesale collaboration. Itis a true example of principles-based regulation and membership-based solutionsworking at their best. Brit Insurance's interest is two-fold. First, to lead the market in essentialreforms to everyone's benefit in terms of UK market growth and profitabilitybecause more people choose to do business here; secondly, to ensure that inadopting this leadership role Brit Insurance equips itself to be a winner in theinevitable market dislocation and readjustment that will happen over time. Catastrophe retrocession business and Norton Re The specific risk and reward characteristics of catastrophe retrocessionalbusiness make it very appropriate for a separately capitalised company.Accordingly, with fellow investors, Norton Re, a specialist Bermuda-basedreinsurance company, was established and we have provided to it our experienceand expertise to assist it in writing new business. We believe that thisinnovative structure is attractive to capital markets and is a potentialblueprint that we may consider for other classes of business with similarcharacteristics. For the Group it will generate fee income whilst retainingexposure to a proportion of the insured risks. This is our first investment in an offshore underwriting business and a furthersignificant step in Brit Insurance's evolution into a widely diversifiedinsurance group. Group domicile Our policy on domicile remains to be UK-based. We note certain of our peersmoving head office offshore and the growing appetite of the capital markets foroffshore businesses. Some of these companies have seen a share price risefollowing the announcement of a change in domicile. To move offshore would notbe appropriate for Brit Insurance at the current stage of our development,bearing in mind the significant volume of UK-based premium and our statedambition of not materially growing catastrophe business (which is most easilyaccessed from offshore) as a proportion of our total book of business. Equally,as one of the leading London Market groups we must play an increasingly activerole in ensuring that London, and Brit Insurance, are not disadvantaged in thelong term by higher operating costs, taxes and regulatory burdens compared withglobal competition. Future market developments We believe the nature of insurance capital and the identity of its providers isevolving rapidly. Ten years ago, for example, everyone was predicting immediaterapid growth in securitisation and alternative risk transfer. Well, it tooksome time to happen but we now see a number of the 'new' products reaching astage of depth and maturity. For instance, in 2004 and 2005 we pioneered theuse of long term tier 2 subordinated debt as an alternative to equity or shortterm bank finance, which had previously been the only two markets open insufficient size for mid cap insurers in the UK. There are now at least threemore public hybrid issues in the market from the UK mid cap insurer peer group. With the increased availability and diversity of available insurance capital, weforesee an opportunity for the industry to become more capital efficient byaccessing these differential capital pools for specific purposes and by tradingrisks more quickly and efficiently, to enhance returns for shareholders. Dividends Our dividend policy is, in the absence of unforeseen circumstances, to pay up to50% of earnings over time subject to a minimum of 15p per ordinary share perannum. In the event that market conditions do not permit Brit to utilise fullyits capital then it would be the Board's intention to seek to return such excesscapital to shareholders in the most appropriate and efficient manner. 50% of earnings over time does not necessarily mean 50% each year. I am verypleased that in this year of benign claims we have been able to recommend aspecial dividend of 2.0p above the base level of 15p per share. Share buy-back programme We will buy back up to £50m of shares by market value in the coming months. Itis intended that the programme will start on 26 March 2007. In the light of the high level of earnings in 2006, reduced aggregate exposuresand strong reserve levels, we have reassessed the capital we require to supportour ongoing plans for profitable growth which remain on track. I am verypleased that our proactive and disciplined approach to both underwriting andcapital management will enable us to return this capital to shareholders. Our strengths Brit Insurance has a clear strategy for growth, realistic targets, a generousdividend policy, a diverse portfolio, a strong balance sheet, talented peopleand an approach to risk management which promotes low volatility of earnings. OUR STRATEGIC VISION Our Group's strategic vision is to be a leading and profitable UK-domiciledinternational general insurance and reinsurance group in a manner that improvesthe economic well-being and the quality of life of all our stakeholders. Ourgoals are: • To be a top five UK insurer by market capitalisation As at 31 December 2006, Brit Insurance's equity market capitalisation was£1,036.1m, ranking Brit Insurance the 217th largest company on the London stockmarket and the fourth largest UK-headquartered non-life insurer by marketcapitalisation. It is a member of the FTSE 250. In addition, the market valueof Brit Insurance's listed subordinated loan stock was £175.5m, giving a totalcapitalisation in excess of £1.2bn. • To be recognised for our financial strength Brit Insurance Limited's financial strength ratings are within the target high "A" range. These ratings were reaffirmed in August 2006 by Fitch as A+ (Strong)and as A (Excellent) by A M Best in July 2006, in each case with stable outlook. • To be the best in our industry for customer service Winner in 2006 of the "Major Loss Award" at the British Insurance Awards (forour response to the 2005 US windstorms). • To be the insurer that is best able to attract, train and retain talented people Staff turnover is 7.7%. 26.5% of staff have at least five years' service.Ranked 79th in the Sunday Times "Best 100 Companies to Work For" list. We want to be seen for and recognised as having: Integrity, Security,Expertise. These brand values are what will make Brit Insurance our customers' StrongerOption. OUR FINANCIAL STRATEGY Brit Insurance's aim is profitable growth while working within its risk appetiteparameters: • Premium growth target: Gross written premiums to exceed £2bn by 2010 - While this represents an annual average growth of 10% each year, Brit Insurance is prepared to accept short term reductions if market conditions across our three underwriting centres do not permit profitable growth at that point in time • Across cycle return target: 6% over risk-free rate • Risk appetite parameters: Aggregate exposure to any one event or series of events (Realistic Disaster Scenarios) set by the Board in the light of market conditions with the aim of producing good returns while reducing volatility; inwards reinsurance premiums less than 25% of total premium; long-tail business less than 40% of total premium; Lloyd's business less than 50% of total premium PROGRESS AGAINST OUR STRATEGY Premium Growth Target Year ended GWP £'m 31 December 2002 - actual 662.731 December 2003 - actual 1,015.7 31 December 2004 - actual 1,086.731 December 2005 - actual 1,202.531 December 2006 - actual 1,236.3 31 December 2010 - target 2,000.0 + Across Cycle Return Our target return of 6% over the risk free rate has been exceeded in three ofthe last five years. This emphasises that while we have a desire for top linegrowth, quality and discipline of underwriting are of primary importance. Year ended Post tax return % Target return Excess/(deficit) % % 31 December 2002 3.5 10.0 (6.5)31 December 2003 12.0 9.7 2.3 31 December 2004 14.4 10.4 4.031 December 2005 7.9 10.7 (2.8)31 December 2006 21.6 10.6 11.0 Notes: "Return" is defined as profit after tax and before dividends, adjustedfor the amortisation of intangibles, as a percentage of weighted average NTA (ieopening NTA per the published balance sheet, adjusted for equity raisings duringthe year). "Target return" is the risk free rate (defined as the weightedaverage UK bank base rate during the period) plus 6%. Risk appetite parameters The parameters are set annually and constantly reviewed by the Board in thelight of market conditions, our relative size and our profitability. The currentparameters are: Inwards RI Long Tail US$ Lloyd's Parameter 3.0 years) 422.3 34.2 1,236.3 100.0 * The business tail is the difference between the average claim payment term andthe average premium payment term. MARKET CONDITIONS As can be seen from the rating indices below, rates have increased significantlyfor US-wind exposed catastrophe classes, such as Property Treaty and Marine XL;ratings for UK business continued to soften; and other classes remained stableor showed modest reductions from historically high levels. While headline riskpricing remains an important metric, we also closely monitor any changes in theterms and conditions associated with the prices and in most areas these remainrobust. As in previous years, we emphasise that these indices are to be readwith caution. They are based on underwriters' estimates of rate changes,including adjustments to terms and conditions, and relate to renewal businessonly, since this represents the business on which we have the best year-on-yeardata. Particular caution should be taken with respect to the figures as at 31January 2007 as one month's data inevitably represents a smaller population andmay therefore be less statistically significant than that for a 12 month period. LONDON MARKET UNDERWRITING CENTRE Premium Rating Index (Year 2000 as base year) 31 31 31 31 31 31 31 31 December December December December December December December January 2000 2001 2002 2003 2004 2005 2006 2007 Accident & Health n/a 100 131 142 149 152 164 173Aerospace 100 158 202 237 260 268 254 216Financial & Professional 100 122 207 265 280 280 276 271Marine 100 112 144 156 160 171 182 182Property 100 112 150 155 152 151 171 171 REINSURANCE UNDERWRITING CENTRE Premium Rating Index (Year 2000 as base year) 31 31 31 31 31 31 31 31 December December December December December December December January 2000 2001 2002 2003 2004 2005 2006 2007 Property Treaty 100 110 149 154 153 155 198 218Treaty Casualty 100 115 182 215 230 228 234 233Marine XL 100 115 171 179 183 193 286 289Aviation XL 100 100 167 159 139 128 125 125 UK UNDERWRITING CENTRE Premium Rating Index (Year 2000 as base year) 31 31 31 31 31 31 31 31 December December December December December December December January 2000 2001 2002 2003 2004 2005 2006 2007 Employers' / Public n/a 100 200 286 284 257 237 227LiabilityProfessional Indemnity / n/a n/a 100 130 132 130 118 112D&OMotor 100 108 115 120 122 111 104 101Property 100 104 123 132 131 130 125 124 INSURANCE RISK Insurance business, by its nature, always requires a level of estimation offuture claims payments, and the reported result for any single accounting periodis sensitive to the accuracy of these estimates. In our opinion, insurers'results are best judged over a multi-year period. The reserves are assessed and reviewed on a quarterly basis. The Group'sReserving Panel is responsible for reviewing and setting the reserves. Thepanel is chaired by the CFO and includes the CEO, the Group Actuary, theUnderwriting Directors and Claims representatives. The reserves selected by theReserving Panel are based on quarterly reserve reviews performed by the internalactuarial department. In addition to the internal actuarial department, thereserves are also reviewed semi-annually by external auditors and annually byexternal actuarial consultants. The analysis of claims development by accident year shows how our ultimate claimestimates have stood the test of time: Ultimate gross claims Accident year All prior 2002 2003 2004 2005 2006 Total years £'000 £'000 £'000 £'000 £'000 £'000 £'000 At end of accident year 1,837,503 251,793 439,714 690,742 1,126,293 651,809One year later 1,870,895 252,564 413,775 640,281 1,156,672Two years later 1,891,832 248,693 382,312 614,910Three years later 1,893,193 251,037 364,384Four years later 1,891,030 245,595Five years later 1,871,516 Estimate of cumulative claims 1,871,516 245,595 364,384 614,910 1,156,672 651,809 4,904,886Cumulative paid claims (3,103,270)Less third party (609)participations on syndicatesGross liability as per the 1,801,007balance sheet Ultimate net claims Accident year All prior 2002 2003 2004 2005 2006 Total years £'000 £'000 £'000 £'000 £'000 £'000 £'000 At end of accident year 1,276,186 194,126 389,280 570,357 779,566 575,937One year later 1,314,245 194,020 365,860 502,338 790,341Two years later 1,323,594 190,765 330,405 480,248Three years later 1,316,002 186,827 318,089Four years later 1,316,123 182,417Five years later 1,310,274 Estimate of cumulative claims 1,310,274 182,417 318,089 480,248 790,341 575,937 3,657,306Cumulative paid claims (2,169,857)Less third party (509)participations on syndicatesNet liability as per the 1,486,940balance sheet The tables above show the development of claims over a period of time on a grossand net of reinsurance basis. The tables show the cumulative incurred claims,including both notified and IBNR claims, for each successive accident year ateach balance sheet date since 2001. The claims have been adjusted to make themcomparable on a year by year basis. They have been grossed up to include 100%of the managed syndicate claims rather than the claims that reflects the BritInsurance percentage ownership of each syndicates capacity during the respectiveaccident years. In addition, claims in currencies other than sterling have beenretranslated at 31 December 2006 exchange rates. Prior year reserves have again proved robust in aggregate with an overallrelease of £33.9m (2005: £110.8m). Within this overall figure we havestrengthened reserves for the 2005 hurricanes by £75.6m (of which £42.0m wasannounced in our 30 June 2006 Interim Results), driven principally by additionalclaims in offshore energy and by the reclassification of Rita to a market lossin excess of US$5bn and of Wilma to a market loss in excess of US$10bn,resulting in several industry loss warranty policies in our retrocessionalaccount being triggered. We no longer underwrite retrocessional industry losswarranties or Gulf of Mexico catastrophe exposed energy business. Releases in 2006 have been further analysed below: Reserve movementsUnderwriting Centre Class Year ended Year ended 31 December 2006 31 December 2005 £'m £'m London Market Accident & Health 0.3 9.4 Aerospace 9.0 7.5 Financial & Professional 17.2 22.6 Marine (15.9) 11.5 Property 6.4 15.1 17.0 66.1 Reinsurance Property Treaty 3.7 2.0 Treaty Casualty 1.3 0.5 Marine XL (3.9) (2.1) Aviation XL 2.0 0.8 Property Retrocessional (15.1) (6.2) (12.0) (5.0) UK Employers' / Public Liability 7.7 18.4 Professional Indemnity / D&O 6.5 4.1 Motor 1.2 8.8 Property and commercial 16.6 12.3 Combined ("Package") 32.0 43.6 Other (3.1) 6.1 Total 33.9 110.8 AGGREGATE EXPOSURE MANAGEMENT The Group's Realistic Disaster Scenario ("RDS") Committee monitors and controlsthe accumulation of risk for over thirty key RDSs. These RDSs reflect thediversity of the Group's exposures. There are specific scenarios for elemental,man-made and economic disasters, and for different business classes such as forthe marine, aerospace, casualty and property. The RDSs are regularly reviewedin light of Group exposures and environmental factors. For example in 2006, anumber of new scenarios relating to aviation terrorism and avian influenza wereintroduced. The Group's RDS Committee reviews each scenario quarterly, with more frequentreviews of the peak zone natural peril catastrophe RDSs which present thegreatest exposure to the Group. During 2006 the Group carried out an extensive review of the way it managed itscatastrophe exposures and its tolerance for downside risk and the followingimprovements were instigated: • Measurement of Group catastrophe risk tolerance was refined; • Proprietary industry models used by the Group were updated; and • Data used for modelling was enhanced. As a result, the Group's peak zone exposures were reduced. Portfolio Re-Engineering The Group manages its overall gross and net aggregate sums insured at risk bytype and location. It has reduced its aggregation to natural perils byre-engineering its portfolio. The table below shows a summary of the peak zonerisk aggregate reductions achieved since 30 September 2005. Class of Business Contribution to 2005 Reduction in Reduction in Reduction in exposure gross hurricane claims exposure exposure 31 December 2006 1 January 2006 1 July 2006 % % % %Property Retrocessional 26 42 96 100Property Reinsurance 30 26 30 30US Property Direct 19 - 30 30Energy Offshore 18 - 42 92Other 7 - - -Total 100 An estimated 12.8% of the Group's gross written premiums are exposed to naturalcatastrophes (2005: 17.6%). For a notional US$50bn US windstorm, our RealisticDisaster Scenario modelling shows that our gross claims would be downapproximately 70% compared with Hurricane Katrina. To take a single class ofbusiness as a further example, our property treaty reinsurance account shows "asif" reductions of 43% in gross claims on a repeat of Hurricane Katrina, 40% on arepeat of Hurricanes Katrina, Rita, and Wilma and a 64% reduction in grossclaims on a notional repeat of the four major US windstorms of 2004. Industry Claim Severity Bands The Group monitors and controls accumulation exposure through the RDS Committeereview process. However, during 2006, the Group further refined how its peakzone catastrophe risk tolerance is measured. The Group uses several approaches to measure its exposures. A key approach isto assess the Group's exposure to an industry loss. For each peril within agiven region, the feasible ranges of industry loss have been allocated into oneof seven severity bands. This band is comparable with the industry lossesspecified in the Lloyd's US windstorm RDS regulatory returns. Each band refers to loss/losses resulting from US Windstorm, Californian Quake,Japan Quake, Japan Wind or European Windstorm events. The bands refer toprobabilistically - equivalent industry loss bands for different perils. Thesehave been selected so that the occurrence exceedance probability of the industryloss for each peril is approximately equivalent for each band. The modelledindustry losses are generated using the latest Industry Exposure Databaselicensed from Risk Management Solutions, with secondary perils and lossamplification included. The underlying frequency and severity of catastrophe events varies by peril andterritory. For instance a US$20bn US windstorm is expected to occur much morefrequently than a US$20bn Japanese earthquake. Therefore in terms of riskappetite and loss tolerance, it is not appropriate to treat these eventsequally. The severity bands show the industry losses for each peril which areprobabilistically equivalent. An example band is shown below. US Windstorm California Earthquake European Windstorm Japanese Earthquake Japanese Typhoon US$70bn-US$100bn US$30bn-US$40bn US$10bn-US$15bn US$20bn-US$30bn US$10bn-US$15bn Aggregate Claim Tolerance The Group's tolerance for catastrophe risk is a function of expectedprofitability and available capital. This tolerance is expressed as the maximumnet claims acceptable under a number of scenarios. The Group's mandated maximumtolerances for one, two, and three of these events for the above claims severityband is shown below. Event Severity Tolerance for 1 Event Tolerance for 2 Events Tolerance for 3 Events in Calendar Year in same Calendar Year in same Calendar Year US$70bn-US$100bn US Windstorm, (or Net Incurred Claims Aggregate Net Incurred Aggregate Net Incurredprobabilistic equivalent for other perils) not to exceed £128m Claims not to exceed Claims not to exceed £199m £263m This table shows the maximum tolerances at the date of this report, not theGroup's actual exposure. The Group's exposure and compliance with the severityband matrix is formally reviewed on a quarterly basis, with informal reviewsbeing conducted more frequently. The Group may have an appetite to allow themaximum tolerances to increase or decrease based on market conditions. The Group's portfolio contains a mix of business and so there is a large rangeof possible aggregate claims to the Group, given an industry event with aspecified industry damage level. In order to capture this claim distributionwhilst being able to measure compliance, the measure used is a weighted 75thpercentile of the claim distribution within a particular band. Ultimately, thesize of a probable maximum loss ("PML") arising from an event or series ofevents will always remain judgemental for Brit Insurance and others in theindustry. The Group's exposure and compliance with the severity band matrix is formallyreviewed on a quarterly basis. Informal reviews are conducted more frequently.The Group's risk appetite criteria will be reassessed periodically, with anychanges reflecting market conditions, recent experience, projected profitabilityand the Group's net tangible assets. During 2006 the Group took delivery of new risk management software; includingincreasing use of detailed loss modelling, and updated industry exposure data.In addition, the Group has continued to develop its own proprietary 'blast zone'software for monitoring certain high value peak zone war and terrorism propertyexposures in real time and in more detail than would be possible usingcommercially available systems and traditional zip code analysis. The Grouphave invested in a high-performance hardware environment to facilitate fulldetailed analysis, even at busy renewals. The Group has also embarked on a dataquality initiative with its coverholders, and employed the RMSI Data EnhancementService. LONDON MARKET UNDERWRITING CENTRE London Market - Aim London Market has historically been the Group's largest Underwriting Centre andthis is likely to continue to be so for the foreseeable future. We aim to growand continue to diversify its portfolio with a target to underwrite £1bn ofgross premiums per annum by 2010, subject to satisfactory pricing and marketconditions. London Market - Relevance to Group strategy The London Market Underwriting Centre's strategy is aligned to our Group goalsand strategy in terms of profitability, growth, market position and control ofrisks. It focuses on: • Key underwriting classes where Brit Insurance has clear lead capabilities and can sustain its market position and competitive advantage, particularly Aerospace, Casualty (including US Professional Indemnity, Directors & Officers and Financial Institutions), Hull, Personal Accident, Medical Expenses and US Property & Financial Property; • Improving relationship management with our brokers; and • Expanding underwriting teams by attracting talented individuals with market following. London Market - Measurement A summary of the Underwriting Centre's KPIs are shown below: Year ended Year ended Year ended Year ended 31 December 2006 31 December 2005 31 December 2004 31 December 2003 GWP (£'m) 706.9 558.6 431.6 468.3GWP growth 26.6% 29.4% (7.8)% n/aClaims ratio 46.5% 63.8% 58.0% 62.1% London Market - 2006 achievements • Premium growth of 26.6% and profit before tax of £127.5m (2005: £44.2m) • Catastrophe Aggregate reduced by in excess of 30.0% for US Property and almost 100.0% for Gulf of Mexico Energy London Market - 2007 priorities • Deliver the 2007 business plans which show, by class of business, continued double digit growth in premiums and an increase in underwriting personnel of 17.5%. • Recruit suitably qualified and experienced staff whilst maintaining acceptable expense ratios London Market - The Business Environment Markets The London Market Underwriting Centre provides a complete range of insuranceproducts for corporate clients worldwide. Distribution of our products isthrough leading London Market brokers. Additionally we use delegated authoritieswith carefully selected insurance experts to distribute our products into localmarkets. Our underwriters are able to analyse and select risks that provide a spread ofdiversification - either by type of peril or geographic or market segment. BritInsurance has an attractive proposition as it understands the marketenvironment, offers long term relationships for buyers of insurance and providesexcellent security. Customers 100% of the business is produced by intermediaries in the London Market. Ourultimate customers are predominantly corporate clients. Challenges • Managing the underwriting cycle in each class of underwriting • Market competition - not only pricing but terms and conditions of cover • Perception of buyers as to the value of insurance and the reputation of the industry • Increased loss activity from catastrophe or systemic events Meeting these challenges • Investing in resources and underwriting skills to select appropriate risks • Resisting "underwriting for premium" by empowering underwriters not to write business when the terms and conditions are unacceptable or markets are behaving irresponsibly • Developing close working relationships with brokers and coverholders • Buying reinsurance in appropriate structures that adequately protect the portfolio London Market - Risks and Uncertainties External risks • Increases in the frequency and severity of global catastrophe losses; • Deterioration in claims frequency and severity of claims, particularly Casualty; • Naive capital entering the market and undermining the disciplines required for underwriting liability business; • Coverholders operating outside the terms of their delegated authorities. Internal risks • Unknown or unexpected accumulations; • Failure to maintain Brit Insurance's security rating; and • Failure to attract the right calibre of individuals and the loss of key staff. Managing risks • An embedded culture focused on risk management and mitigation; • A strict approach to our underwriting and claims protocols from the business planning stage through to peer review of risks written; • The continued development of a diverse portfolio of business; • Continuing to broaden Brit Insurance's influence beyond the London and Lloyd's markets; • Maintaining a conservative approach to risk appetite and regulatory constraints ensuring strong capital ratios; • A proactive HR strategy; and • A robust rules based procedure for managing and monitoring delegated underwriting authorities. London Market - Financial Performance Year ended Year ended Year ended Year ended 31 December 2006 31 December 2005 31 December 2004 31 December 2003 £'m £'m £'m £'m Gross written premium:Accident & Health 140.2 93.2 54.0 54.7Aerospace 23.9 11.1 28.6 61.5*Financial & Professional 267.8 223.2 181.4 173.8Marine 143.4 115.7 80.0 81.3Property 131.6 115.4 87.6 97.0Total 706.9 558.6 431.6 468.3 Net earned premium 557.5 412.1 367.4 285.4Underwriting profit/(loss) 81.2 (0.8) 28.2 10.4Profit before tax 127.5 44.2 57.4 29.8Claims ratio 46.5% 63.8% 58.0% 62.1%Expense Ratio 38.9% 38.2% 34.5% 29.5%Combined Ratio 85.4% 102.0% 92.5% 91.6% * This included £44.8m of direct aviation which was last written in 2003. London Market - Outlook Markets The market generally remains at an attractive point in its cycle although someclasses of business are under pressure to reduce pricing following a sustainedperiod of profitability. Equally, certain classes are evidencing rate risesfollowing losses in previous years - eg Hurricane losses in 2005. This is anatural balance that occurs in the insurance market. Brit Insurance The outlook for this Underwriting Centre remains broadly positive. It willcontinue to grow its profile and presence in the market and expand itsrelationships with the major brokers. By having a clear understanding of therisk, its technical pricing and capital usage, our underwriters are able toselect appropriate risks to meet the business plan targets for this UnderwritingCentre. REINSURANCE UNDERWRITING CENTRE Reinsurance - Aim The Group's aim for this underwriting centre is to participate in thispotentially high margin global business whilst managing its risk profile. Thelevels of business written by this Underwriting Centre will be restricted to atarget limit of 25% of the Group's gross written premium because of the higherimplicit volatility in reinsurance compared with the Group's other markets. Reinsurance - Relevance to Group strategy The Reinsurance Underwriting Centre's strategy is aligned to our Group goals andstrategy in terms of profitability, growth, market position and control ofrisks. It focuses on: • Achieving steady growth with focus on bottom-line profitability; • Managing risk efficiently and cost-effectively; • Offering multi-class capability with capacity to quote and lead business; and • Enhancing technical approach and delivering a first-class all-round service to customers. Reinsurance - Measurement A summary of the Underwriting Centre's KPIs are shown below: Year ended Year ended Year ended Year ended 31 December 2006 31 December 2005 31 December 2004 31 December 2003 GWP (£'m) 260.9 328.8 280.0 221.8GWP growth (20.7)% 17.4% 26.2% n/aClaims ratio 50.0% 119.8% 68.5% 39.9% The underlying premium movement between 2005 and 2006, after adjusting forreinstatement premiums receivable, was a reduction of 11.2%. Reduced premiumscompared to 2005 were driven by low levels of reinstatement premiums anddecision to withdraw from property retrocessional. Reinsurance - 2006 achievements • Record profit before tax of £76.5m • Development of business written while making a significant contribution to the Group's profitability; • Delivered enhanced risk aggregation tools together with improved suite of pricing and modelling tools; and • Risk appetite refined and gross and net catastrophe exposures actively managed Reinsurance - 2007 priorities • Continue to focus on pricing, modelling and risk aggregation, further utilising the new tools delivered in 2006; and • Achieve steady underlying growth with focus on bottom-line profitability Reinsurance - The Business Environment Markets • Lloyd's and the London Market; • North American Market; • Continental European Market; and • Asian and Australasian Market. These markets offer a global spread and worldwide distribution of our products,enabling Brit Insurance to manage its risk profile by building a diversemulti-class and multi-territory book of business within reinsurance. Theyenable us to build relationships with long-term buyers of reinsurance andprovide us with access to customers that require reinsurance risk transfermechanisms. Customers The business of this underwriting centre is 100% broker produced. Its customersare: • Global insurance and reinsurance companies; • Domestic insurance and reinsurance companies; • Mutual insurers; • Lloyd's syndicates; and • Captives. Challenges • Market competition including rating, pricing and terms and conditions; • Risk appetite and risk awareness; • Global catastrophe loss frequency and severity; and • New products and approaches to risk transfer generated by the Capital Markets. Meeting these challenges • Strictly applying its underwriting philosophy of maintaining pricing discipline and technical approach in the face of competitive pressures; • Appreciating and understanding its gross and net exposures and managing them accordingly in conjunction with the Group's risk appetite; • Constraining the maximum proportion of Group income that can be written by this Underwriting Centre; and • Continually looking to enhance its external relationships. Reinsurance - Risks and Uncertainties External risks • Increases in the frequency and severity of global catastrophe losses; • A deterioration in claims frequency and severity of Casualty claims; and • A reduction in the global standing and influence of London and Lloyd's. Internal risks • Unknown or unexpected accumulations; • Failure to maintain Brit Insurance's security rating; and • Loss of key staff. Managing risks • The maintenance of a diverse portfolio of business; • The employment of catastrophe management tools; • Continuing to broaden Brit Insurance's influence beyond the London and Lloyd's markets including the development of our existing contact offices in Europe and Australia; • Maintaining a conservative approach to risk appetite and regulatory constraints ensuring strong capital ratios; and • A proactive HR strategy. Reinsurance - Financial Performance Year ended Year ended Year ended Year ended 31 December 2006 31 December 2005 31 December 2004 31 December 2003 £'m £'m £'m £'m Gross written premium:Property Treaty 139.5 140.8 133.3 102.9Treaty Casualty 95.5 73.3 60.9 55.1Marine XL 9.4 12.0 7.1 2.0Aviation XL 15.4 39.4 36.0 19.9Property Retrocessional 1.1 63.3 42.7 41.9Total 260.9 328.8 280.0 221.8 Net earned premium 237.0 224.2 179.9 150.3Underwriting profit/(loss) 50.4 (103.5) 9.0 50.7Profit/(loss) before tax 76.5 (81.1) 23.2 61.9Claims ratio 50.0% 119.8% 68.5% 39.9%Expense Ratio 28.8% 28.5% 26.6% 25.8%Combined Ratio 78.8% 148.3% 95.1% 65.7% Reinsurance - Outlook Market Pricing is still at what we deem to be attractive levels. During 2007 however,we believe that pricing discipline will come under pressure as this sector ofthe insurance market faces increased competition as a number of mono-linereinsurers and newer players seek to diversify their existing portfolios. Brit Insurance The outlook for this Underwriting Centre remains broadly positive. Theportfolio, which has been re-engineered in light of changes to risk appetite, isexpected to have less volatile results. Enhanced pricing, modelling andcatastrophe management tools will allow our highly experienced team ofspecialist underwriters to manage their way through this stage of theunderwriting cycle. UK UNDERWRITING CENTRE UK - Aim The Group's medium term aim is for this underwriting centre to double in sizewhilst continuing to deliver upper quartile returns and making a significantcontribution to the Group's profits throughout the cycle. We will bedifferentiated by our expertise and skills in execution. UK - Relevance to Group strategy The UK Underwriting Centre's strategy is aligned to our Group goals and strategyin terms of profitability, growth, market position and control of risks. Itcontinues to position itself to take advantage of a market upturn by: • Effectively segmenting its business into small, corporate and specialist operations; • Significantly strengthening its distribution capabilities; and • Continuing to improve its talent pool. UK - Measurement A summary of the Underwriting Centre's KPIs are shown below: Year ended Year ended Year ended Year ended 31 December 2006 31 December 2005 31 December 2004 31 December 2003 GWP (£'m) 279.9 317.9 345.4 309.4GWP growth (12.0)% (8.0)% 11.6% n/aClaims ratio 69.6% 55.8% 68.1% 71.4% UK - 2006 achievements • Maintained our underwriting discipline in softening market conditions; • Developed our strategic direction for the medium term; and • Strengthened our leadership capabilities through the recruitment of Peter Burrows who was appointed on 1 July as Underwriting Centre Director, Ray Cox who joined on 1 December 2006 as Underwriting Director and Simon Cooter who will join us on 1 March 2007 as Distribution Director. • The expansion of our regional network and a successful recruitment initiative led to a modest increase in headcount. This reflects our continued confidence in our ability to achieve profitable growth over the medium term. The cost increase, coupled with the reduction in earned premiums has led to an increase in the expense ratio. UK - 2007 priorities Despite challenging market conditions, we believe 2007 represents an opportunityfor growth generated through a combination of new products, scaled distributionand the introduction of new staff into our regions. We are determined to maintain discipline and will not participate in a dash forgrowth based on inadequate pricing. UK - The Business Environment Markets The UK Underwriting Centre is essentially focused upon UK domiciled small andmid market enterprises ("SMEs"). We also have specialist teams focused uponidentified segments in Personal Motor and Household and our London basedLiability Underwriting Team also participate in a number of programmes placed inthe London Market which relate to exposures outside the UK. Within our portfolio we have a number of specialist areas including HousingAssociations and Motor Sports. The UK SME sector has proved to be attractive over the cycle and our aim is toenlarge our footprint through the widening of product offerings, combined withsignificantly expanding activities in e-trading. Customers The business of this Underwriting Centre is 100% broker / coverholder produced.Its customers are primarily small to medium sized enterprises with a minority oflarge corporates, mostly although not exclusively UK based. We write a smallelement of personal lines business. Challenges • Market competition including pricing and terms and conditions; • Growing the business while maintaining profitability. Meeting these challenges • Introducing new products and distribution in the short term to increase revenue; • Maintaining profitability through a rigorous adherence to our culture of focussing on the bottom line, combined with an absence of stretch revenue targets for underwriters; • Continuing to improve our distribution capabilities and relationship management skills alongside our plans to selectively expand distribution opportunities; and • Selectively continue to recruit high calibre individuals to improve our talent pool and to ensure that we are well placed to capitalise on the market upturn when it arrives. UK - Risks and Uncertainties External risks • Competitiveness leading to irresponsible underwriting with rating levels destroying margins; • Ongoing intermediary consolidation leading to restricted opportunities and increased acquisition costs; and • Current soft market continues longer than anticipated. Internal risks • Failure to position ourselves to take full advantage of future market opportunities; • Failure to attract the right calibre of individuals and the loss of key staff; and • Growth of top line premium income while failing to maintain profitability. Managing risks • Reviewing distribution strategy and infrastructure; • Focussing on moving into new channels and developing relationships; • Allocating senior time to target talented individuals who can bring new competencies into the organisation; and • Strengthening performance management to enhance the link between results and reward. UK - Financial Performance Year ended Year ended Year ended Year ended 31 December 31 December 31 December 31 December 2006 2005 2004 2003 £'m £'m £'m £'m Gross written premium:Employers' / Public Liability 91.4 112.8 129.2 87.8Professional Indemnity / D&O 36.7 35.6 37.3 39.6Motor 91.3 89.9 105.6 113.0Property and Commercial Combined ("Packages") 60.5 79.6 73.3 69.0Total 279.9 317.9 345.4 309.4 Net earned premium 251.2 302.6 301.0 221.2Underwriting profit/(loss) 7.7 65.7 24.5 2.7Profit/(loss) before tax 40.4 112.3 54.3 16.1Claims ratio 69.6% 55.8% 68.1% 71.4%Expense Ratio 27.3% 22.6% 23.9% 23.9%Combined Ratio 96.9% 78.4% 92.0% 95.3% UK - Outlook Market During 2007, we believe that margins will continue to reduce. This will be as aresult of increased competition, weakening prices, increased distribution costsand the lowering of standards by the market generally. Our assumption is thatthe commercial motor market will begin to strengthen in the second half of 2007,with other lines following suit from around the second half of 2008. Brit insurance The outlook for this Underwriting Centre remains positive. Whilst we will besubject to the ongoing challenging underwriting environment described above, ouraim will continue to be to outperform the sector through a continued adherenceto our underwriting disciplines and to grow the business rapidly when marketconditions allow, which is likely to be from 2009 onwards. INVESTMENTS Investments - Aim Brit Insurance aims to maximise investment return within the constraints of theGroup's risk appetite. Investments - Relevance to Group strategy Investment return is a significant element of our income. Investment allocationand management are key to achieving all of our Group goals and strategy in termsof profitability, growth and market position. Our investment strategy is aligned to our Group goals and strategy. It adopts abalanced approach weighted towards fixed income securities, with diversificationacross the portfolio to minimise the risk for the desired level of return. Ourfocus is to define the asset classes appropriate to our strategy and then toselect specialist investment managers for each specific investment. Investments - 2006 achievements • The gross investment return of the year was £110.5m, a total gross weighted average return of 4.74% (2005 5.4%). The fixed income and cash portfolio returned gross £79.0m (3.69%) and equities made a gross return of £31.5m (18.92%). • The fixed income portfolios exceeded the 1-3 year bond indices by an average of 27 basis points before fees and equities exceeded the FTSE 100 by 4.70% and the All Share Index by 2.42% before fees. • Significant process improvements have been implemented in the last quarter of 2006 to enhance our management of investment risk and selection of asset classes, including: • Implementing a process to actively monitor and manage the portfolio Value at Risk ("VaR"); and • Redefining appropriate limits of investment in asset classes. Equities will be constrained by their effect on the portfolio Value at Risk which supersedes the earlier measure of 30% of net tangible assets. The limits will be based on market volatility, the higher the volatility the lower the allocation in the asset class. Investments - 2007 priorities • Further diversification of the portfolio by adding assets with low correlation to interest rate and equity market driven movements, thus becoming less reliant on duration as a driver of investment return. This may include asset backed securities, investments in property, hedge funds and high yield products. The investment in these classes will increase the diversification of products by up to 20%, with no more than 2% to 4% in each asset class. • Actively manage credit risk by using specialist external credit managers. Classes of Investments The main classes of financial assets invested in by the Group are AAA ratedMoney Market Funds, Certificates of Deposit, Government Bonds, Corporate Bonds,Equities, Hedge Funds and Absolute Return Bond Funds. The portfolio provides a spread of return sources, with a diversified risk. Itenables us to target our desired return, whilst providing high levels ofliquidity, security and credit quality. Fund Managers We maintain a strong relationship with our former associated undertaking EquityInvestment Partners Limited, which managed 78.7% of our total invested assets asat 31 December 2006. Portions of the portfolio were also managed by ClosePrivate Asset Management, EEA Fund Management Limited, Artemis InvestmentManagement Limited and Ruffer LLP. In 2007 additional specialist investment managers have been engaged to enableBrit to access the return and diversification opportunities offered by differentasset classes. Asset Allocation by asset class As at As at 31 December 2006 31 December 2005 £m £m Equities 226.4 219.0Bonds 1,852.9 1,626.6Cash and deposits 421.1 526.6Derivatives and assets held for sale 1.1 1.5Total 2,501.5 2,373.7 Bonds, cash and deposits currency mix As at As at 31 December 2006 31 December 2005 % % Sterling 58.9 62.9US Dollar 31.1 28.2Euro 6.8 6.1Other 3.2 2.8Total 100.0 100.0 Bond portfolio duration As at As at 31 December 2006 31 December 2005 Yrs Yrs Sterling 1.96 1.57US Dollar 1.54 1.40Euro 1.54 1.40CAN Dollar 1.76 1.48 Bond portfolio credit ratings As at As at 31 December 2006 31 December 2005 % % Government 31 49AAA 17 14AA 39 26A 13 11Total 100 100 The Investment Environment Environment The traditional fixed income markets offer relatively low returns and the equitymarkets are driven more by unpredictable factors, such as takeover expectations,than real value and growth prospects. The emphasis is to rely less on predictingthe direction of markets in one or two asset classes and to move towards morevaried sources of return from a number of assets. As a consequence we arebecoming more pro-active in asset allocation decisions. Challenges • To capture value from rising stock markets but to be prepared for sharp corrections that could be caused by reasons such as the overleveraged state of the market; • Tight credit spreads; increased attention and resources required for credit selection and protection of the portfolio from any eventual spread widening; • Negative sloping yield curve environment; longer term investments are not compensated with extra return; • Identification of reasonably priced assets that have low correlation to interest rate and equity price movements. Meeting these challenges • Brit Insurance has implemented an investment database that records information on a daily basis from our fund managers. This enables us to monitor our positions on an up-to-date basis and provides a solid base for making investment decisions; • Brit Insurance has resources in house for making asset allocation decisions and for adopting new products and / or fund managers. Brit Insurance has appointed a Chief Investment Officer with 20 years financial market experience. The Investment Committee is responsible for the asset allocation and investment strategy and for monitoring performance; • All external fund managers are FSA registered and provide a varied approach to managing assets. Investments - Risks and Uncertainties Risks • Unexpected movements in interest rates, equity prices and credit spreads; • A shift in inflationary and growth expectations; • A lack of liquidity as a result of the high degree of leverage in the markets; and • A significant world event would be likely to cause a significant change in asset prices. Managing risks • In 2006 Brit Insurance managed risk using duration as the main metric for the fixed income portfolios and the percentage of funds invested in each asset class as the risk control for the higher return seeking assets such as equities; • The fixed income duration was kept at an average of 1.5 years over the year in the main GBP and USD portfolios, but GBP was increased in December to 2 years to take advantage of market movements; • The credit quality of the fixed income portfolio is closely monitored and has an average credit quality of AA; • In 2007 Brit has implemented a "Value at Risk" methodology to monitor the risks within the investment portfolios. Emphasis being placed on obtaining the planned investment return at an acceptable level of risk; • The planned investment return for 2007 is 1% over the equivalent "cash" return; • The asset portfolio is structured to minimise the risk of loss of capital at the 95% VaR confidence levels; • The amount invested in Equities and other higher risk assets is restricted by the Value at Risk of the portfolio. If the volatility increases the portfolio composition will need adjusting to ensure the overall portfolio risk remains unchanged; • In addition to VaR, Brit Insurance limits and monitors any investments in insurance entities to correlating risk with its core insurance and reinsurance business. Investments - Financial Performance Sterling fixed income performance Year ended Year endedAbsolute Gross return for period 31 December 2006 31 December 2005 % % Group's Sterling fixed income performance 3.31 5.361 month sterling LIBID 4.71 4.721 to 3 year Gilt Index 3.04 4.98 US dollar fixed income performance Year ended Year endedAbsolute Gross return for period 31 December 2006 31 December 2005 % %Group's US dollar fixed income performance 4.30 1.871 month dollar LIBID 5.07 3.181 to 3 year US Treasury Bond Index 3.96 1.67 Equity returns Year ended Year endedAbsolute Gross return for period 31 December 2006 31 December 2005 % %The Group's equities 18.92 27.10FT All Share Index 16.50 20.91FTSE 100 14.22 19.63 The fixed income portfolios performed well in an environment of continuouslyrising interest rates, low credit spreads and negatively sloping yield curves.The fixed income managers outperformed the 1-3 year bond index in GBP by 27basis points before fees and in the US by 34 basis points. The strategy pursuedby the managers in the GBP portfolios was to increase duration as yields roseand this resulted in finishing the year with duration rising from 1.5 to 2years. US duration was predominantly kept at 1.5 due to concerns that the USyield curve would become less inverted. The Equity portfolios outperformed the FTSE 100 by 4.7% and the FTSE All Shareby 2.4%. The equity market suffered a material pullback in May and June and ourstrategy to stay invested in equities was rewarded by the robust performance ofthe last quarter. Norton Re In December 2006 the Group subscribed for a 19.6% interest in Norton HoldingsLimited ("Norton Holdings") at a cost of US$21.1 million. Norton Re InsuranceLimited ("Norton Re"), a 100% subsidiary of Norton Holdings, writes catastropheretrocession business. Brit Insurance has contracted with Norton Re to provideits retrocessional team, operating from Hamilton, Bermuda, to provideunderwriting expertise to the company. During 2006, terms and conditions andpricing in the retrocession market have strengthened further and we believe itis an appropriate time make such an investment. This is an example of Brit Insurance working with new capital markets providingdedicated capital for a single class of business which does not, for technicalor structural reasons, fit within the Group's parameters, but which isattractive to those markets. Sale of Epic Investment Partners Limited ("EIP") In January 2007, we sold our stake in EIP to Syndicate Asset Management plc ("SAM"). Under the terms agreed with SAM, we will derive initial consideration of£4.4m, of which £1.3m is cash and the remaining £3.1m is 4-year SAM loan notes.The redemption value of the loan notes would be reduced if revenues derived byEIP from us over that period were to fall below current levels, as we are notobliged to keep funds with EIP. In addition, there is deferred contingentconsideration of up to £1.1m based on the profitability of EIP in the threeyears post completion. As at 31 December 2006, the stake had a carrying valuein our consolidated balance sheet of £1.1m. We originally announced our willingness to dispose of our stake in EIP in March2006. We believe that EIP's prospects are better under separate ownership. Ourworking relationship with EIP remains strong and we look forward to continuingto work with them in the future. Investments - Outlook Market The investment market has become increasingly global with events in one marketalmost immediately affecting other markets. This in turn presents bothopportunities and a shortage of non correlating assets. Indications for 2007 are of a global economic slowdown with tighter monetarypolicy and higher commodity prices the main influences. Central banks arekeeping a tight watch on inflation, and further short term interest rate risesare still considered a possibility in keeping it under control. The long termtrend of rising equity and property markets may slow down or reverse in responseto the global slowdown or as a function of political and economic uncertainties.Credit spreads are expected to remain tight, and finding value in the creditmarkets will be challenging. Brit Insurance Current and forecast interest rate levels indicate that a strong investmentclimate should prevail and fixed income returns in 2007 and subsequent yearsshould be higher than recent years. OPERATIONS Market Reform and Contract Certainty The FSA challenged the insurance industry to achieve by the end of 2006 greatercertainty for buyers about what they had bought and for insurers about the risksthat they were covering or face regulatory intervention. Contract certainty is"achieved by the complete and final agreement of all terms including signedlines between the insured and insurers at inception". Our CEO, Dane Douetil, is Chairman of the Market Reform Group ("MRG"), theultimate body responsible for process reform and modernisation in the Londoninsurance market which oversees the market's response to the FSA challenge. On 24 January 2007, the FSA announced that while contract certainty willcontinue to be a supervisory priority in 2007, the insurance industry had metthe challenge laid down to achieve a solution to contract certainty in the UK. Brit Insurance and Contract Certainty Brit Insurance responded to the FSA challenge and implemented controls withinthe underwriting process, supported by reporting capabilities incorporatedwithin systems to monitor compliance and analyse those risks identified asexceptions. A communication and training programme was implemented to educate those involvedin contract certainty, initiating behavioural change and instilling a culture ofcontinuous learning and improvement. As a result of submissions made byunderwriters following the control framework introduced by the Group, BritInsurance has exceeded or substantially met each of the market targets - 60% asat 30 June, 75% at 30 September and 85% as at 31 December - on business it hasunderwritten. The results have been supported by feedback reports from samplestaken by the Market Reform Programme Office. Additionally, there has been aregular sampling of files and underwriting slips by Internal Audit to providefeedback to underwriters. Brit Insurance achieved 100% contract certainty this year on its 2007 outwardsnon-proportional reinsurance programme being 22 core programmes, comprising 81layers, using 12 broking houses and 45 reinsurers. It also placed 6proportional treaties of which all but one were contract certain under thestrictest definition. The remaining treaty was contract certain by 5 January2007. The second FSA challenge was for the industry to address the issue of legacypolicies and the Group has taken action to clear 25% of its legacy between themonths of October and December 2006 and is working towards exceeding the targetslaid down for 2007. RI3K RI3K, in which Brit Insurance has an 85.6% holding, is the only survivingelectronic marketplace for the insurance industry and has increasingly moved tothe heart of the insurance industry's reform and modernisation programme. Ithas over 150 companies which are signatories to its global interchange agreementand has been inter-connected to one of the world's leading broking houses toplay a vital role in their transition to paperless distribution. RI3Ksuccessfully launched a new version of its trading marketplace in 2006,including the ability to trade commercial insurance as well as reinsurance.RI3K now appears ideally placed to become a key component of the insurancemarket infrastructure. In December 2006, RI3K won the Reinsurance Magazine "Market Innovation of the Year" award. CAPITAL MANAGEMENT Strategy The capital strategy is aligned to our Group goals and strategy and focuses on: • having a strong balance sheet that is not dependent on short term gearing. This will give us a stable platform for growth. • having sufficient capital, both to satisfy regulator's capital requirements with a suitable margin and to achieve and maintain BIL's high "A" rating, which is consistent with our target rating range, while also ensuring that the Group does not have excessive capital which would diminish return on equity. Capital Requirements The Group's regulatory capital requirements are calculated by reference to boththe volume and the mix of three principal components: new business, reservesand assets. As the Group continues to grow, all three of these elementsincrease. In the next few years the reserving requirement will need to increasemore quickly than the other two components because it takes time for the reservetail to reach full maturity on longer tail classes. During 2006, in accordance with the regulatory timetable, we agreed our capitalrequirements for BIL and Syndicate 2987 with the FSA and Lloyd's respectively.These requirements were in line with our modelled expectations. In addition to current regulatory and rating capital requirements, the Groupneeds to anticipate changes to regulations - such as the impact of Solvency IIto be introduced from 2010. Capital Resources The Group's principal sources of actual and potential capital are equity,subordinated debt, reinsurance and other instruments, which may in due courseinclude catastrophe bonds or securitisations. As at As at As at 31 December 2006 31 December 2005 31 December 2004 £'m £'m £'m Net tangible assets 724.3 638.4 643.5Long-term subordinated debt* 147.2 147.1 -Total capital resources 871.5 785.5 643.5 * Subordinated borrowings which have at least five years remaining to maturityor call and are of the types which qualify as regulatory capital Our gearing ratio at 31 December 2006 was 24.0% (31 December 2005: 30.4%). Asthe Group grows its capital and its premium written, it would seek to raiseadditional long-term subordinated debt in order to keep gearing in the desiredratio of 20 to 30% of net tangible assets. Financing Growth Following the equity capital raisings of 2001 to 2003, the Group has grown itspremiums to utilise that capital, as shown by the following table: As at As at As at As at As at 31 December 31 December 31 December 31 December 31 December 2006 2005 2004 2003 2002 % % % % % Ratio of gross written premium to 193.6 186.9 178.9 185.2 229.7weighted average NTA* * Weighted average NTA are opening NTA adjusted for equity capital raisingduring the year Process The Group's Capital Committee is responsible for managing all capital issuesaffecting the Group. The Capital Committee is responsible for ensuring: • The Group has appropriate capital; • Capital allocation to line of business to allow measurement and comparison of return on capital ("ROC") by line of business; • The Group's optimal mix of capital; and • A full review of internal capital model assumptions and results. The Capital Committee, which meets quarterly, is chaired by the Group FinanceDirector and includes the underwriting directors and actuarial representatives.In order to assess the level of capital required by the Group current and futurefinancial projections of capital requirements are made. Capital requirementsare assessed using a number of approaches such as: • Internal capital models ("ICAS") • Rating agency capital models • Regulatory benchmarks ("ECR") • Results of discussions with regulators Brit has been at the forefront of capital modelling for a number of years,having been one of the first UK insurers successfully to take part in the FSA'sICAS pilot study in 2004. Since then we have continued to embed capitalmodelling into our business. The main areas where we are using capitalmodelling are: • Business Planning: Return on capital as a performance management tool is embedded into our business planning process. The capital models are used to allocate capital to each line of business and the return on capital generated by each line of business is used as a key performance measure in the business planning process. • Outwards Reinsurance Purchase: We have used the capital model to assess our outwards reinsurance programme. This has resulted in a more efficient purchase of reinsurance. Underwriting Capital Allocation We use our dynamic underwriting capital allocation process to deliver capacityto business areas providing the best return. Each class of business acquires orreturns capital throughout the year rather than being restricted by a fixedannual budget. During 2006, this resulted in 115 (2005: 94) internal trades inrespect of £195.6m (2005: £144.1m) of underwriting capital. FINANCIAL MANAGEMENT Outwards Reinsurance Strategy Our Reinsurance Purchasing strategy is aligned to our Group goals and strategy.Our strategy is to use outwards Reinsurance to reduce risk, reduce volatility,enhance earnings, control aggregations and create capital efficiency. OutwardsReinsurance is an instrument allowing the Group to obtain its desired andprudent risk profile. Cover purchased The Group reviews and models different outwards reinsurance strategies to obtainthe most effective programmes to protect our balance sheet. Underwriters proposethe outwards reinsurance structure for their class of business and discuss thoseproposals with the appropriate Underwriting Centre Director and the GroupActuary. The Group Actuary will then recommend the proposed programme structureto the Reinsurance Co-ordination Committee, which approves the final programmeand pricing levels. When determining the quality of reinsurers, consideration is given to securityrecommendations, counter-party exposure and claims experience. All proposedreinsurers must be on the Brit Insurance Approved Security List. Over 90% of the Group's outwards reinsurance policies are placed electronicallythrough RI3K. Reinsurance spend as a percentage of gross written premiums was as follows: Year ended Year ended 31 December 31 December 2006 2005 % %Headline rate 15.5 19.3Underlying rate* 15.9 15.1 * The rate for ongoing business adjusted for reinstatement premiums inwards andoutwards. While the headline rate decreased the underlying rate remained more constant.This reflects the purchase of less catastrophe protection in light of ourreduced aggregates. It also reflects the increase in reinsurance rates in 2006. Reinsurance expenditure: Year ended Year ended 31 December 2006 31 December 2005 £'m £'mProportional 34.2 41.7Non-proportional 157.2 189.9Total 191.4 231.6 Reinsurance Recoverables Our reinsurance recoverables by financial strength rating are as follows. Theincrease in credit quality of reinsurance was assisted during 2006 by an upgradeto Munich Re and by Swiss Re's acquisition of GE. As at As at 31 December 2006 31 December 2005 % %AAA 0.6 0.4AA 40.6 17.7A 39.6 62.6BBB and below 2.1 2.1Not rated 6.0 2.2Collateralised 11.1 15.0Total 100.0 100.0 Counterparty/credit risk The Group's principal exposures to reinsurers are analysed by rating above. TheGroup also runs, at any time, shorter term credit exposures in respect ofpremium income due from clients and/or brokers. The Group believes it has agood track record of avoiding credit losses, due in part to its highlyexperienced underwriting and finance professionals and in part to itsinvestment, several years ago, in hiring a senior specialist in-house creditanalyst team with experience gained at leading ratings agencies. Liquidity risk Brit Insurance manages its liquidity risk as follows: • The nature of the Group's investment portfolio (high cash component, low bond duration and high bond quality); • The Group also has facilities for overdrafts and letters of credit should these be required. At 31 December 2006 it had US$175.0m (2005: US$175.0m) of facilities of which only US$37.3m (2005: US$18.3m) was drawn; and • The Group manages its liabilities carefully against early crystallisation. An example of this is our use of lower tier two long-term subordinated debt rather than bank debt. Such debt has a number of 'shock absorption' characteristics which can help a borrower withstand an unexpected event. During 2006 the Group refined its internal liquidity guidelines to align them tothe estimated liquidity impact of a number of Realistic Disaster Scenario ("RDS") events. The Group metric is to have sufficient liquidity at all times in BIL, Syndicate 2987 and the remainder of the Group, for each of these threeliquidity centres to cope without recourse to any other with a minimum of twoand an appetite of three RDSs. Repurchase of loan stock On 12 January, 2006, the Group made a tender offer for the Group's 8.5%subordinated unsecured loan stock 2008 ('ULS') at a price of 109p per £1 nominalof stock including accrued interest. This offer, plus a small number ofsubsequent purchases at the same price, led to the purchase and cancellation of20,573,132 units at a total price of £22.4m. This was an overall take-up of51.0% and removed some gearing which had become short term and was being givenno credit in our key capital calculations. It had the effect of marginallyreducing reported profits for 2006 but will increase them for 2007 and 2008.This transaction was funded from part of the £147m net proceeds of thesubordinated bond issued by Brit Insurance in December 2005 and was one of thestated intended uses of these funds at the time they were raised. Distributable Reserves In March 2006 the Company reduced its share premium account by £180.0m, whichwas credited to the capital reorganisation reserve. On 2 March 2007, theCompany placed £29.4m in ring-fenced bank accounts, enabling it to transfer the£180.0m to retained earnings and reclassify it as distributable. Suchring-fenced bank accounts are designed to protect the Company's creditors as atthe date of the capital reduction. This effective transfer from the share premium account provides maximumflexibility for capital management for the Group in a number of ways, including: • Facilitating regular dividends at parent company level without reducing capital strength in key operating subsidiaries; and • Allowing a return of cash to shareholders by way of share buy-back or special dividend should excess capital build up at any time in the light of prevailing market conditions. Dividend Policy The Group's dividend policy is to seek to pay, in the absence of unforeseencircumstances, 50% of post tax earnings over time, subject to a minimum of 15pper share per annum. This policy allows a sufficient level of retained earningsto finance the Group's stated medium-term strategic growth ambitions. Share Buy-Back When the Group's dividend policy was revised in March 2006, the Board also madeclear that should the group accumulate excess capital, various ways to returncapital to shareholders would be examined. Following the high level of earningsin 2006, the Board now believes that there is an opportunity to return £50m ofcapital to shareholders in excess of that required to support its growth plans.As a result, the Board is pleased to announce that it intends to pursue anon-market share buy-back programme of up to £50m of ordinary shares by marketvalue in the coming months, subject to market conditions, unforeseencircumstances and appropriate regulatory and other clearances. It is intendedthat the programme will start on 26 March 2007. Share Consolidation The Group consolidated its share capital on the basis of one new share for everythree existing shares held at close of business on 12 May 2006. Prior tothis, Brit Insurance had almost one billion shares in issue. The Board believesthe consolidation has benefited shareholders by facilitating a more appropriatetrading range and also make the Company's shares more attractive to investors.All 'per share' figures in these financial statements, including comparatives,have been restated to reflect this change. Defined Benefit Pension Scheme The pension fund deficit as calculated under IAS 19 fell by 45.6% in 2006, from£22.8m to £12.4m. The average reduction in FTSE 350 company pension schemedeficits during the year is estimated at 29.0%. This reduction was because ofan additional contribution of £2m made by the Group during the year and risingbond rates, partially offset by lower than expected investment return. Theadditional contributions are intended to increase to £5m per annum from 2007. As a percentage of the Group's market capitalisation and liquid resources, thedeficit is small compared with many in the FTSE 350. The scheme has been closedto new members since October 2001. With effect from May 2006, Matthew Scales, Group Finance Director, stepped downas a trustee of the Brit Group Services Retirement Benefit Scheme and AntonyUsher, Group Financial Controller, has been appointed in his place. Expense Management Group management expenses before foreign exchange and bonus pool totalled£116.8m (2005: £95.9m). The key drivers of this increase were: • Headcount increase in underwriting and operational functions; • Investment in creating an efficient operational capability, delivering enhanced structures and processes; and • Expansion of our regional platform. The increase in expenses is in line with our financial plan to support theGroup's long term growth. These areas of expansion and investment will be a keycontributor to the Group achieving its goals and strategy in terms ofprofitability, growth, market position and customer service. In addition to these management expenses a foreign exchange loss of £25.4m wasincurred for the year. The foreign exchange profit for the same period lastyear of £11.6m was included in other income. The charge for the bonus pool, aproduct of the overall Group result, was £14.0m in 2006 (2005: £4.9m). The commission cost ratio for the period was 23.6% (2005: 22.0%). The changereflects the increase in the proportion of Group business emanating from theLondon Market Underwriting Centre and a change in business mix within the UKUnderwriting Centre. Expense Year ended Year ended 31 December 31 December 2006 2005 Expenses Ratio* Expenses Ratio* £'m % £'m % Staff costs before bonus pool 54.4 5.2 44.6 4.7Accommodation costs 7.3 0.7 5.7 0.6Legal & professional charges 11.0 1.0 6.2 0.7IT costs 5.9 0.6 4.7 0.5Regulatory levies and charges 14.3 1.4 14.8 1.6Other 23.9 2.3 19.9 2.1Management expenses before foreign exchange and bonus 116.8 11.1 95.9 10.2poolForeign exchange 25.4 2.4 - -Bonus pool 14.0 1.3 4.9 0.5Expenses before commissions 156.2 14.9 100.8 10.7Commission costs 247.6 23.6 207.4 22.0Total expenses 403.8 38.5 308.2 32.7 Insurance related expenses 107.9 10.3 83.3 8.8Commission costs 247.6 23.6 207.4 22.0Insurance expenses 355.5 33.9 290.7 30.8Group overheads 48.3 4.6 17.5 1.9Total expenses 403.8 38.5 308.2 32.7 * Ratio calculated as the expense as a proportion of net earned premiums. It is expected that as our premium base grows, the overall insurance expenseratio will remain broadly in line with current levels. Headcount During 2006, the total headcount of the Group has increased by 25.0%. Thisgrowth in both underwriting and operational functions supports our strategicgrowth objectives and was in line with expectations. Employees by division As at As at 31 December 31 December 2006 2005Division No. % No. % Underwriting 270 36.0 254 42.3Claims 114 15.2 105 17.5Operations and IT 146 19.4 72 12.0Finance and Actuarial 100 13.3 64 10.6Other 82 10.9 71 11.8 712 94.8 566 94.2RI3K 39 5.2 35 5.8 751 100.0 601 100.0 Employees by location As at As at 31 December 31 December 2006 2005Location No. % No. % Birmingham 13 1.7 11 1.8Bristol 5 0.7 7 1.2Darlington 26 3.5 28 4.7Glasgow 14 1.9 9 1.5Ilford 122 16.2 119 19.8Leeds 11 1.5 11 1.8London 502 66.8 371 61.7Manchester 12 1.6 10 1.7Reading 7 0.9 - 0.0 712 94.8 566 94.2RI3K 39 5.2 35 5.8 751 100.0 601 100.0 Growth has occurred across the organisation, with emphasis on the followingareas: • Group Operations: This follows the re-organisation of this division to strengthen our operations platform, enabling Brit Insurance to take advantage of future opportunities and to support the Group's strategic vision for profitable growth. Two key areas of expansion are Change Management and Management Information resources. There has also been a significant reduction in contract workers during 2006; • UK Underwriting Centre: This Centre's headcount increased by 10.8% to 154 during 2006 and includes the expansion of our regional network; • Finance: The Finance headcount increase includes 11 in respect of the UK Underwriting Centre credit control and cash processing function. This function was previously out-sourced and has been moved in-house at a net cost saving to the Group of £1.5m; and • Actuarial: During 2006 the actuarial headcount increased from 15 to 26. The department was restructured and strengthened considerably in the disciplines of Reserving Reviews, Technical Pricing, Catastrophe modelling and Capital modelling. Foreign Exchange The Group's overall foreign exchange policy is to remain broadly matched interms of assets and liabilities in its four biggest currencies - Sterling, USdollars, Euros and Canadian dollars. Following the hurricane activity of late 2005, the Group had a net "short"position in US dollars. In line with the above policy, the Group decided topurchase dollars over an extended period rather than immediately, in order totake advantage of the dollar exchange rate which we expected to weaken. Anoption to purchase US$200m at 1.72 was purchased at a cost of £2.1m to allow thedollar purchases to be conducted over time and to protect against any loss inthe event of dollar strengthening. While this policy was successful in realising a foreign exchange profit for theGroup of £4.7m and left the Group with a full economic hedge, a furtherweakening dollar has had one particular impact on the Group's reported results.IFRS requires the use of the transaction rate rather than the closing rate forcertain currency items, notably the unearned premium reserve ("UPR") anddeferred acquisition costs ("DAC"). The effect on the year-on-year comparativereported profits is even more significant as shown by the following table: Year ended Year ended 31 December 31 December 2006 2005 £m £m Profit on currency trades 4.7Profit on restatement of opening net assets 5.7(Loss) on restatement of income statement to average rates (8.9)Profit/(loss) on exchange before exchange adjustments arising from the IFRS 1.5 (9.7)treatment of non-monetary itemsExchange adjustments arising from the IFRS treatment of non-monetary items (26.9) 21.3Loss/(profit) on exchange (25.4) 11.6 Taxation The Group's effective tax rate was 28.2% (2005: 23.7%). It has benefited from anumber of previously unutilised reliefs from prior years which can be moreclearly measured now that the Group is a corporate tax payer, which it was notuntil 2005. The effective rate is expected to trend up to 30% over time. Brit Insurance is not only a substantial payer of UK and overseas corporationtax on its profits but also both incurs and collects significant amounts ofindirect tax, notably IPT, PAYE, National Insurance and VAT. The following arethe principal UK taxes payable or accounted for by the Group for the year ended31 December 2006. Tax Borne by Collected by Brit Insurance Brit Insurance £'m £'m Corporation Tax 53.2 -PAYE / NIC 5.2 13.0IPT 0.1 16.7VAT 3.0 0.7Business rates 0.9 -Stamp duty 0.2 -TOTAL 62.6 30.4 We expect this figure to increase as our business expands. This is a businessrisk which we monitor as part of our tax risk strategy. Given the growth in thefigures and the ever increasing complexity of tax regulations, we have this yearappointed a Head of Group Tax to manage this. During the year there have been a number of developments which will have animpact on the tax burden suffered by UK insurers. Most recently we welcomed theannouncement in the Pre Budget Report of the proposal to reform and modernisethe current taxation rules for general insurers' reserves. Consolidated Income Statementfor the year ended 31 December 2006 Year ended Year ended 31 December 2006 31 December 2005 Note £'000 £'000RevenueGross premiums written 4 1,236,289 1,202,503Less premiums ceded to reinsurers 4 (191,371) (231,616)Premiums written, net of reinsurance 1,044,918 970,887Gross amount of change in provision for unearned premiums 4,945 (29,078)Reinsurers' share of change in provision for unearned premiums (1,200) 738Net change in provision for unearned premiums 3,745 (28,340)Earned premiums, net of reinsurance 1,048,663 942,547 Fees, commissions and other income 5 775 13,434Investment income 6 101,265 85,504Net realised gains recorded in the income statement 7 1,638 2,595Net fair value gains recorded in the income statement 7,575 33,729Total revenue 1,159,916 1,077,809 ExpensesClaims incurred:Claims paid:Gross amount (690,705) (487,687)Reinsurers' share 324,101 87,358Claims paid, net of reinsurance (366,604) (400,329) Change in the provision for claims:Gross amount 59,683 (604,564) Reinsurers' share (249,121) 303,499Net change in the provision for claims (189,438) (301,065)Claims incurred, net of reinsurance 4 (556,042) (701,394)Acquisition costs 8 (289,450) (247,067)Other operating expenses 8 (114,354) (61,142)Total expenses excluding finance costs (959,846) (1,009,603)Operating profit 200,070 68,206 Finance costs (14,864) (5,941)Share of profit after tax of associated undertakings 1,058 138Profit on ordinary activities before tax 186,264 62,403 Income tax expense 9 (52,495) (14,771) Profit attributable to equity holders of the parent 133,769 47,632Basic earnings per share (restated due to share consolidation) 10 41.25p 14.80p Diluted earnings per share (restated due to share consolidation) 10 41.05p 14.76p Consolidated Statement of Recognised Income and Expensefor the year ended 31 December 2006 Year ended Year ended 31 December 2006 31 December 2005 £'000 £'000 Foreign exchange translation differences (1,340) -Actuarial gains / (losses) on defined benefit pension scheme 16 8,869 (3,901)Tax on items taken to equity 9(ii) (2,661) 1,170Net income/(expense) recognised directly in equity 4,868 (2,731)Profit for the period 133,769 47,632Total recognised income and expense for the period 138,637 44,901attributable to equity holders of the parent Consolidated Balance Sheetas at 31 December 2006 Note 31 December 31 December 2005 2006 £'000 £'000AssetsProperty, plant and equipment 10,144 8,236Intangible assets 88,982 86,241Deferred acquisition costs 122,225 125,097Investments in associated undertakings 21,093 -Deferred taxation - 1,648Reinsurance contracts 11 374,068 653,182Financial investments 12 2,079,313 1,845,710Trade and other receivables 13 540,322 597,883Assets held for sale 14 1,080 1,380Cash and cash equivalents 15 421,090 526,638Total assets 3,658,317 3,846,015 Liabilities and Equity LiabilitiesInsurance contracts 11 2,400,057 2,596,660Employee benefits 16 12,422 22,818Borrowings 173,863 194,213Current taxation 22,158 14,263Deferred taxation 18 4,484 -Provisions 443 489Trade and other payables 17 231,598 292,912Total liabilities 2,845,025 3,121,355 EquityCalled up share capital 19 & 20 246,107 245,236Share premium account 20 135,767 314,758Capital redemption reserve 20 586 586Translation reserve 20 (1,340) -Capital reorganisation reserve 20 180,000 -Own shares 20 (5,777) (7,550)Retained earnings 20 257,949 171,630 Total equity attributable to equity holders of the parent 813,292 724,660Total liabilities and equity 3,658,317 3,846,015 Consolidated Cash Flow Statementfor the year ended 31 December 2006 Note Year ended Year ended 31 December 31 December 2006 2005 £'000 £'000Cash generated from operations Cash flows provided by operating activities 21 209,644 343,231 Income tax paid (41,129) (6,954)Interest paid (11,411) (5,303)Interest received 84,866 76,956Dividends received 2,182 2,777 Net cash inflows from operating activities 244,152 410,707 Cash flows from investing activities Net purchase of investments (235,028) (595,646)Purchase of property, plant and equipment and related (4,444) (6,408)exchange adjustmentsPurchase of intangible assets (6,630) (10,278)Proceeds from disposal of property, plant and equipment 2 10Repayment of loan from assets held for sale 300 352Investment in associate (10,737) - Net cash outflows from investing activities (256,537) (611,970) Cash flows from financing activities Proceeds from exercised share options 2,497 655Equity dividends paid (53,555) (48,462)Net proceeds from issue of lower tier twodebt - 147,054Repurchase of unsecured loan stock (22,425) -Acquisition of own shares for employee incentive schemes (288) (107)Proceeds from sale of own shares 288 - Net cash (outflows)/inflows from financing activities (73,483) 99,140 Net decrease in cash and cash equivalents (85,868) (102,123)Cash and cash equivalents at beginning of theyear 526,638 610,969Effect of exchange rate fluctuations on cash (19,680) 17,792and cash equivalents Cash and cash equivalents at the end of the 15year 421,090 526,638 MORE TO FOLLOW This information is provided by RNS The company news service from the London Stock Exchange

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