24th May 2005 07:30
Legal & General Group PLC24 May 2005 Part CLegal & General Group PlcEEV financial information------------------------------------------------------------------------------- IndexConsolidated Income Statement 1Consolidated Balance Sheet 2Statement of Recognised Income and Expense 2Methodology Basis of preparation 3 Covered business 3 Description of methodology 3 Embedded value 3 Service companies 4 New business 4 Projection assumptions 4 Tax 5 Allowance for risk 5 Required capital and free surplus 5 Financial options and guarantees 6 Risk discount rate 7 Analysis of profit 8Notes to Financial Statements 10Assumptions 16Reconciliations Reconciliation of shareholders' equity 20 Reconciliations from AP to EEV 21Audit Report 22=============================================================================== Legal & General Group Plc P1Consolidated Income Statement - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- Notes EEV AP £m £mProfit on continuing operationsLife and pensions- UK 1 474 494- USA 72 73- Netherlands 30 32- France 11 14 -------- -------- 587 613Institutional fund management 104 103General insurance 32 32Other operational income 22 34 -------- --------Operating profit on continuing operations 745 782Profit on discontinuing operations 7 7 -------- --------Operating profit 752 789Variation from longer term investment return 2 414 408Change in equalisation provision - (7)Effect of economic assumption changes 1 34 32Property income attributable to minorities 32 - -------- --------Profit before tax 1,232 1,222Tax (351) (352) -------- --------Profit for the period 881 870Minority interests 3 (32) - -------- --------Profit attributable to equity holders 849 870 ======== ========Basic earnings per share p pBased on operating profit after tax 8.35 8.80Based on profit for the financial period 13.10 13.40Diluted earnings per shareBased on operating profit after tax 8.19 8.57Based on profit for the financial period 12.72 12.97=============================================================================== Legal & General Group Plc P2Consolidated Balance Sheet - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- Notes EEV AP £m £mAssetsInvestments 7 147,761 146,700Reinsurers' share of contract provisions 2,977 2,977Long term in-force business asset 2,535 2,764Other debtors 2,111 1,934Non-current assets held for sale 733 - -------- -------- 156,117 154,375 ======== ========LiabilitiesShareholders' equity 9 6,182 6,116Minority interests 214 -Technical provisions 144,569 141,990 -------- -------- 150,965 148,106Borrowings 8 1,846 1,788Other creditors 2,672 4,481Non-current liabilities held for sale 634 - -------- -------- 156,117 154,375 ======== ========Statement of Recognised Income and ExpenseYear ended 31 December 2004------------------------------------------------------------------------------- EEV AP £m £mFair value losses on cash flow hedges (4) -Exchange differences on translation of foreign operations (8) (9)Pension fund actuarial losses (26) -Net change in available for sale investments (2) - -------- --------Net income recognised directly in equity (40) (9)Profit for the year 881 870Dividends (321) (329) -------- --------Total recognised income and expense for the year 520 532Minority interests (32) - -------- --------Attributable to equity holders of the company 488 532=============================================================================== Legal & General Group Plc P3MethodologyYear ended 31 December 2004------------------------------------------------------------------------------- Basis of Preparation The purpose of this section is to set out the detailed methodology for producingthe Group's supplementary financial statements. The statements have beenprepared in accordance with the European Embedded Value (EEV) Principles issuedin May 2004 by the European CFO Forum. Due to the continuing work of the CFOForum and the IASB, and the possible amendment to the interpretive guidance, theGroup's accounting policies and consequently, the information presented maychange prior to the publication of the Group's first published Interim EEV andIFRS results in July 2005. These supplementary financial statements have been audited byPricewaterhouseCoopers LLP and prepared in conjunction with our consultingactuaries - Tillinghast Towers-Perrin and, in the US, Milliman USA. Covered BusinessThe Group uses EEV methodology to value Individual and Group life assurance,pensions and annuity business written in the UK, Continental Europe and the USand our UK managed funds business. All other business units are accounted for on the IFRS basis adopted in theprimary financial statements. Under EEV, there is no distinction made between insurance and investmentcontracts in our life and pensions businesses as there is under IFRS. Description of MethodologyThe objective of EEV is to provide shareholders with more realistic informationon the financial position and current performance of the Group than is providedwithin the primary financial statements. The methodology requires assets of an insurance company as reported in theprimary financial statements to be attributed between those supporting thecovered business (restricted assets) and the remainder (residual assets). Themethod accounts for assets as follows:i. restricted assets on an EEV basis; andii. residual assets on the IFRS basis adopted in the primary financialstatements. The EEV methodology recognises as profit from the covered business the total of:i. cash transfers during the relevant period from the covered businessto the residual assets, as determined following a statutory valuation; andii. the movement in the present value of the expected future cash flowsfrom the covered business to the residual assets over the relevant period. Embedded ValueShareholders' equity on the EEV basis comprises the embedded value of thecovered business plus the balance of shareholders' equity on the IFRS basis,less the value included for purchased interests in long term business. The embedded value is the sum of the shareholder net worth (SNW) and the valueof the in-force business (VIF). SNW is defined as those amounts, held either inthe UK Long Term Fund (LTF) or by other companies writing long term business,which are regarded either as required capital for the covered business or whichrepresent surplus assets within those companies.=============================================================================== Legal & General Group Plc P4MethodologyYear ended 31 December 2004------------------------------------------------------------------------------- The VIF is the present value of the distributable profits to shareholdersarising from the covered business, projected using best estimate assumptions,less an appropriate deduction for the cost of holding the required level ofcapital and the time value of financial options and guarantees. Service CompaniesAll services relating to the UK life and pensions business, including investmentmanagement services, are charged on a cost recovery basis. New BusinessNew business premiums reflect income arising from the sale of new contractsduring the reporting period and any changes to existing contracts which were notanticipated at the outset of the contract. In force business comprises previously written single premium, regular premiumand recurrent single premium contracts. DWP rebates have not been treated as recurrent and they are included in newbusiness when received. New business contribution arising from the new business premiums written duringthe reporting period has been calculated on the same economic and operatingassumptions used in the embedded value at the end of the financial period. Thishas then been rolled forward to the end of the financial period using the riskdiscount rate applicable at the end of the reporting period. Traditionally, new business margins have been defined as new businesscontribution at the end of the reporting period divided by the annual premiumequivalent. Under EEV a new measure, the present value of future new businesspremiums (PVNBP), has been calculated and expressed at the point of sale. ThePVNBP is equivalent to the total single premiums plus the discounted value ofregular premiums expected to be received over the term of the contracts usingthe same economic and operating assumptions used for the embedded value at theend of the financial period. A revised new business margin has been definedunder EEV as new business contribution at the end of the reporting perioddivided by the PVNBP. The premium volumes and projection assumptions used tocalculate the PVNBP are the same as those used to calculate new businesscontribution. Projection AssumptionsCash flow projections are determined using realistic assumptions for eachcomponent of cash flow and for each policy group. Future economic and investmentreturn assumptions are based on year end conditions. Future investment returnsare projected by one of two methods. The first method is based on an assumedinvestment return attributed to assets at their market value. The second, whichis used in the US, where the investments of that subsidiary are substantiallyall fixed interest, projects the cash flows from the current portfolio of assetsand assumes an investment return on reinvestment of surplus cash flows. Theassumed discount and inflation rates are consistent with the investment returnassumptions. Detailed projection assumptions including mortality, persistency, morbidity andexpenses reflect recent operating experience and are reviewed annually.Allowance is made for future improvements in annuitant mortality based onexperience and externally published data. Favourable changes in operatingexperience are not anticipated until the improvement in experience has beenobserved.=============================================================================== Legal & General Group Plc P5MethodologyYear ended 31 December 2004------------------------------------------------------------------------------- All costs relating to the covered business, whether incurred in the coveredbusiness or elsewhere in the Group, are allocated to that business. The expenseassumptions used for the cashflow projections therefore include the full cost ofservicing this business. TaxThe projections take into account all tax which is expected to be paid undercurrent legislation, including tax which would arise if surplus assets withinthe covered business were eventually to be distributed. Allowance for RiskAggregate risks within the covered business are allowed for through thefollowing principal mechanisms:i. Setting required capital levels with reference to both the Group'sinternal risk based capital models, and an assessment of the strength ofregulatory reserves in the covered business;ii. Allowing explicitly for the time value of financial options andguarantees (FOGs) within the Group's products; andiii. Setting risk discount rates by deriving a Group level risk margin tobe applied consistently to local risk free rates. Required Capital and Free SurplusRegulatory capital for UK life and pensions business is provided by assetsbacking the with-profits sub-fund or by the SNW. The SNW comprises theShareholder Retained Capital (SRC) and the Sub-Fund. For the UK with-profits sub-fund, the required capital will be covered by thesurplus within the fund and no effect will be attributed to shareholders exceptfor the burn-through cost which is described later. This treatment is consistentwith the Principles and Practices of Financial Management for this fund. For UK non profit business, the required capital will be maintained at no lessthan the level of the EU minimum solvency requirement. This level together withthe margins for adverse deviation in the regulatory reserves is, in aggregate,in excess of internal capital targets assessed in conjunction with theIndividual Capital Assessment (ICA) exercise. The SRC is either required to cover EU solvency margin or is encumbered becauseits distribution to shareholders is restricted due to previous understandingswith the FSA. It is therefore classified as required capital. SRC is valued byassuming it is distributed from the LTF over a 20 year period with allowance fortax payable on distribution. For this purpose, distribution of the SRC isrestricted such that there is always sufficient SRC and subordinated debt leftto cover the EU solvency margin for non profit business. The initial strains relating to new non profit business, together with therelated EU solvency margin, are supported by releases from existing non profitbusiness and the SRC. As a consequence, the writing of new business defers therelease of capital from the SRC to free surplus. As the investment return, netof tax, on that capital is less than the risk discount rate, there is aresulting cost of capital which is reflected in the value of new business. Costof holding required capital is defined as the difference between the value ofthe required capital and the present value of future releases of that capital.For new business, the cost of capital is taken as the difference in the value ofthat capital assuming it was available for release immediately and the presentvalue of the future releases of that capital.=============================================================================== Legal & General Group Plc P6MethodologyYear ended 31 December 2004------------------------------------------------------------------------------- The Sub-Fund is also treated as required capital, because its distribution toshareholders is restricted by Legal & General Assurance Society's Articles ofAssociation. For our UK managed pension funds business, risk based capital has been used tomodel required capital. The balance of net assets within the UK Managed Fundsbusiness is treated as free surplus. For L&G America, the Company Action Level (CAL) of capital has been treated asrequired capital for modelling purposes. The CAL is the regulatory capital levelat which the company would have to take prescribed action, such as submission ofplans to the state insurance regulator, but would be able to continue operatingon the existing basis. The CAL is currently twice the level of capital at whichthe regulator is permitted to take control of the business. For L&G Netherlands (LGN), required capital has been set at 100% of EU minimumsolvency for all products which do not have any related FOGs. For those productswith FOGs, capital of between 112.5% and 175% of the EU minimum solvency marginhas been used. The level of capital has been determined using risk based capitaltechniques. In France (LGF), 100% of EU minimum solvency margin has been used for EVmodelling purposes for all products without FOGs. For those products with FOGs,200% of EU minimum solvency margin has been used. The level of capital has beendetermined using risk based capital techniques. The contribution from new business for our Overseas businesses reflects anappropriate allowance for the cost of holding the required capital. Financial Options and GuaranteesIn the UK, all financial options and guarantees (FOGs) are within the UK Life &Pensions business. Under the EEV Principles an allowance for time value of FOGs is required where afinancial option exists which is exercisable at the discretion of thepolicyholder. These types of option principally arise within the with-profitssub-fund and their time value is recognised within the with-profits burn-throughcost described below. Additional financial options within the non profit fundexist only for a small amount of deferred annuity business where guaranteedearly retirement and cash commutation terms apply when the policyholder choosestheir actual retirement date. Further financial guarantees exist within the non profit fund, in relation toindex-linked annuities where capped or collared restrictions apply. Due to thenature of these restrictions and how they vary depending on the prevailinginflation conditions we have also treated these as FOGs and recognised a timevalue cost of FOG accordingly. The time value of FOGs has been calculated stochastically using a large numberof real world economic scenarios derived from assumptions consistent with thedeterministic EEV assumptions and allowing for appropriate management actionswhere applicable. The management action primarily relates to the setting ofbonus rates where for example future regular and terminal bonuses onparticipating business within the projections are set in a manner consistentwith expected future returns available on assets deemed to back the policieswithin the stochastic scenarios. In recognising the residual value of any projected surplus assets within thewith-profits sub-fund in the deterministic projection, it is assumed thatterminal bonuses are increased to exhaust all of the assets in the fund over thefuture lifetime of the in-force with-profits policies. However, under stochasticmodelling there may be some extreme economic scenarios when the total projectedassets within the with-profits sub-fund are insufficient to pay all projectedpolicyholder claims and associated costs. =============================================================================== Legal & General Group Plc P7MethodologyYear ended 31 December 2004------------------------------------------------------------------------------ The average additional shareholder cost arising from this shortfall has been included in the time value cost of options and guarantees and is referred to as the with-profits burn-through cost. The same economic scenarios have been used to assess the time value of thefinancial guarantees within the non profit fund by using the inflation rategenerated in each scenario. The inflation rate used to project index-linkedannuities will be constrained in certain real world scenarios, for example wherenegative inflation occurs but the annuity payments do not reduce belowpre-existing levels. The time value cost of FOGs allows for the projectedaverage cost of these constrained payments for the index-linked annuities. Thetime value cost of FOGs also allows for the small additional cost of theguaranteed early retirement and cash commutation terms for the minority ofdeferred annuity business where such guarantees have been written. In the US, financial options and guarantees relate to guaranteed minimumcrediting rates and surrender values on a range of contracts. The guaranteedsurrender value of the contract is based on the accumulated value of thecontract including accrued interest. The crediting rates are discretionary butrelated to the accounting income for the amortising bond portfolio. The majorityof the guaranteed minimum crediting rates are between 4% and 5%. The assetsbacking these contracts are invested in US dollar denominated fixed interestsecurities. In the Netherlands, there are two types of guarantees: interest rate guaranteesand maturity guarantees. Certain contracts provide an interest rate guaranteewhere there is a minimum crediting rate based on the higher of 1-year Euriborand the policy guarantee rate. In accordance with market practice, it isexpected that guarantees will be financed from unrealised gains on assets. Thisguarantee applies on a monthly basis. Certain unit linked contracts provide aguaranteed minimum value at maturity where the maturity amount is the higher ofthe fund value and a guarantee amount. The fund values for both these contractsare invested in Euro denominated fixed interest securities. In France, financial options and guarantees relate to guaranteed minimumcrediting rates and surrender values on a range of contracts. The guaranteedsurrender value of the contract is the accumulated value of the contractincluding accrued bonuses. The bonuses are based on the accounting income forthe amortising bond portfolios plus income and releases from realised gains onany equity type investments. Policy liabilities equal guaranteed surrendervalues. Local statutory accounting rules require the establishment of a specificliability when the accounting income for a company is less than 125% of theguaranteed minimum credited returns however this has never been required. Ingeneral, the guaranteed annual bonus rates are between 2% and 4.5%. Risk Discount RateThe risk discount rate (RDR) is a combination of the risk free rate and a riskmargin, which reflects the residual risks inherent in the Group's coveredbusinesses, after taking account of prudential margins in the statutoryprovisions, the required capital and the specific allowance for financialoptions and guarantees. The risk margin has been determined based on an assessment of the Group'sweighted average cost of capital (WACC). This assessment incorporates a beta forthe Group which measures the correlation of movements in the Group's share priceto movements in a relevant index. Beta values therefore allow for the market'sassessment of the risks inherent in the business relative to other companies inthe chosen index. The WACC is derived from the Group's cost of equity and debt, and the proportionof equity to debt in the Group's capital structure measured using market values.Each of these three parameters should be forward looking, although informed byhistoric information. The cost of equity is calculated as the risk free rateplus the equity risk premium for the chosen index multiplied by the company'sbeta. Forward-looking or adjusted betas make allowance for the observed tendencyfor betas to revert to 1 and therefore a weighted average of the historic betaand 1 tends to be a better estimate of the company's beta for the future period.We have computed the WACC using an arithmetical average of forward-looking betasagainst the FTSE 100 index.=============================================================================== Legal & General Group Plc P8MethodologyYear ended 31 December 2004------------------------------------------------------------------------------- The cost of debt used in the WACC calculations takes account of the actuallocked-in rates for our senior and subordinated long term debt. For the Group'sconvertible debt, which matures in 2006, the probability of conversion isconsidered low given current market conditions. The cost of debt thereforeassumes an equivalent long term market cost for this debt based on 5-year swaprates rather than the actual rate of 2.75%. All debt attracts tax relief at arate of 30%. Whilst the WACC approach is a relatively simple and transparent calculation toapply, subjectivity remains within a number of the assumptions. Managementbelieve that the chosen margin, together with the levels of required capital,the inherent strength of the Group's regulatory reserves and the explicitdeduction for the cost of options and guarantees, is appropriate to reflect therisks within the covered business. A similar approach will be adopted when risk margins are reassessed in futureperiods. Currently, we do not expect the risk margin to change significantlyduring 2005. Key assumptions are set out below: Risk free rate: Derived from gross redemption yields on relevant gilt portfolioEquity risk premium 3.0% (UK only)Property risk premium 2.0% (UK only)Risk margin 3.0% The risk margin has been calculated by assuming a debt ratio of 20%, a net costof debt of 3.9% p.a. and an average beta of 1.35. In addition, the margin allowsspecifically for the risks covered by the time value of financial options andguarantees (deduction of 0.1%). Analysis of ProfitOperating profit is identified at a level which reflects an assumed longer termlevel of investment return. The contribution to operating profit in a period is attributed to four sources:i. new business;ii. the management of in-force business;iii. development costs; andiv. return on shareholder net worth. Further profit contributions arise from actual investment return differing fromthe assumed long term investment return (investment return variances), and fromthe effect of economic assumption changes. The contribution from new business represents the value recognised at the end ofeach period from new business written in that period, after allowing for theactual cost of acquiring the business and of establishing the required technicalprovisions and reserves and after making allowance for the cost of capital. Newbusiness contributions are calculated using closing assumptions.=============================================================================== Legal & General Group Plc P9MethodologyYear ended 31 December 2004------------------------------------------------------------------------------- The contribution from in-force business is calculated using opening assumptionsand comprises:i. expected return - the discount earned from the value of businessin-force at the start of the year;ii. experience variances - the variance in the actual experience over thereporting period from that assumed in the value of business in-force as at thestart of the year; andiii. operating assumption changes - the effects of changes in futureassumptions, other than changes in economic assumptions from those used invaluing the business at the start of the year. These changes are madeprospectively from the end of the year. Development costs are associated with investment in building a new enterprise orexceptional development activity over a defined period. The contribution from shareholder net worth comprises the increase in embeddedvalue based on assumptions at the start of the year in respect of:i. encumbered assets within the covered business - principally theunwind of the discount rate; andii. residual assets - the expected investment return. Investment return variances represent the effect of actual investmentperformance and changes to investment policy on shareholder net worth andin-force business from that assumed at the beginning of the period. Economic assumption changes comprise the effect of changes in economicvariables, beyond the control of management, including associated changes tovaluation bases to the extent that they are reflected in revised assumptions.=============================================================================== Legal & General Group Plc P10Notes to Financial Statements - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- 1. Profit for the period from covered business Life and pensions Managed Intern- pension UK ational Total funds Total £m £m £m £m £m2004 - EEVContribution from:New business after cost of capital 241 35 276 36 312In-force business- expected return 273 49 322 18 340- experience variances 46 17 63 15 78- operating assumption changes (221) 1 (220) 18 (202)Development costs - - - (1) (1)Shareholder net worth 135 11 146 6 152 -------- -------- -------- -------- --------Operating profit 474 113 587 92 679Variation from longer terminvestment return 363 3 366 11 377Effect of economicassumption changes 15 19 34 0 34 -------- -------- -------- -------- -------- Profit before tax 852 135 987 103 1,090Tax (238) (46) (284) (31) (315) -------- -------- -------- -------- --------Profit for the period 614 89 703 72 775 ======== ======== ======== ======== ========2004 - APContribution from:New business 272 45 317 36 353In-force business- expected return 267 50 317 17 334- experience variances 43 14 57 16 73- operating assumption changes (219) 1 (218) 17 (201)Development costs - - - (1) (1)Shareholder net worth 131 9 140 6 146 -------- -------- -------- -------- --------Operating profit 494 119 613 91 704Variation from longer terminvestment return 364 0 364 12 376Effect of economicassumption changes 15 17 32 0 32 -------- -------- -------- -------- --------Profit before tax 873 136 1,009 103 1,112Tax (244) (46) (290) (31) (321) -------- -------- -------- -------- --------Profit for the period 629 90 719 72 791=============================================================================== Legal & General Group Plc P11Notes to Financial Statements - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- 2. Variation from longer term investment return EEV AP £m £mTotal covered business 377 376 ####### #######Institutional fund management : 0 : : 0 :General insurance : (3): : (3) :Other operational income : 40 : : 35 : ####### ####### 37 32 -------- -------- 414 408 ======== ========Investment return variances represent the effect of actual investmentperformance and changes to investment policy in respect of shareholder net worthand in-force business compared with assumptions at the beginning of the period. 3. Minority interestsMinority interests represents the share of profit relating to investmentsincluded in the consolidated balance sheet that are owned by third parties. 4. Present value of new business premiums (PVNBP) Capital- New Single Regular isation business premiums premiums factor PVNBP margin £m £m £m %UK 3,740 348 4.3 5,255 4.6International 272 77 6.9 802 4.4 -------- -------- -------- -------- 4,012 425 6,057 4.6 ======== ======== ======== ========The PVNBP on the EEV basis is defined as the present value of regular premiumsplus single premiums for any given year. It is calculated using the sameassumptions as for the new business contribution. There are no equivalentfigures on the AP basis. The capitalisation factor represents the PVNBP minus single premiums divided bythe annualised amount of new regular premiums.=============================================================================== Legal & General Group Plc P12Notes to Financial Statements - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- 5. Time value of options and guarantees EEV £mLife and pensions- UK - With-profits guarantees 8 - Non profit guarantees 24 -------- 32- International 8 --------Total time value of options and guarantees 40 ========6. Embedded value Life and pensions Managed Intern- pension UK ational Total funds Total £m £m £m £m £mYear ended 31.12.04 - EEVAt 1 JanuaryValue of in-force busines 2,552 377 2,929 158 3,087Shareholder net worth * 1,569 245 1,814 143 1,957 -------- -------- -------- -------- -------- 4,121 622 4,743 301 5,044Exchange rate movements - (28) (28) - (28) -------- -------- -------- -------- -------- 4,121 594 4,715 301 5,016Profit for the period 614 89 703 72 775Capital movements - 25 25 - 25Distributions (274) (1) (275) (20) (295)Movement in pension deficit (16) - (16) - (16) ###### ###### ###### ###### ######Value of in-force business :2,885: : 431: :3,316: : 191 : : 3,507:Shareholder net worth * :1,560: : 276: :1,836: : 162 : : 1,998: ###### ###### ###### ###### ######At 31 December 4,445 707 5,152 353 5,505 ======== ======== ======== ======== ========Year ended 31.12.04 - APAt 1 January 4,253 657 4,910 305 5,215Exchange rate movements - (29) (29) - (29) -------- -------- -------- -------- -------- 4,253 628 4,881 305 5,186Profit for the period 629 90 719 72 791Capital movements - 25 25 - 25Distributions (274) (1) (275) (20) (295) -------- -------- -------- -------- --------At 31 December 4,608 742 5,350 357 5,707 ======== ======== ======== ======== ========comprising:Value of in-force business 3,007 499 3,506 194 3,700Shareholder net worth * 1,601 243 1,844 163 2,007 -------- -------- -------- -------- -------- 4,608 742 5,350 357 5,707 ======== ======== ======== ======== ========* For the UK life and pensions business, shareholder net worth comprises theshareholder retained capital (SRC) on the IFRS basis for EEV and MSS basis forAP, adjusted for deferred acquisition costs, deferred tax and sterling reserves,and the Sub-Fund, both net of an appropriate allowance for tax. It also includesintra-group subordinated debt capital at its face value of £602m. Shareholder net worth comprises both required capital and free surplus. Freesurplus amounted to £310m at 31 December 2004 (2003: £245m) comprising UK lifeand pensions, £nil (2003: £nil); International life and pensions, £166m (2003:£120m); Managed Pension Funds, £144m (2003: £125m). Value of in-force business reflects a cost for holding capital of £58m at 31December 2004 (2003: £55m) comprising UK life and pensions, £8m (2003: £8m);International life and pensions, £48m (2003: £45m); Managed Pension Funds, £2m(2003: £2m).=============================================================================== Legal & General Group Plc P13Notes to Financial Statements - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- 7. Funds under management EEV AP £m £mInvestment property 4,903 3,741Shares, variable yield securities and unit trusts - 11,529Equities 78,322 -Unit trusts 1,875 -Debt and other fixed income securities - 21,677Debt securities 58,604 -Accrued interest 753 -Derivative assets 23 -Deposits with credit institutions - 941Loans and receivables 289 567Assets held to cover linked liabilities - 108,297Amounts payable under a margining arrangement - (119)Cash and cash equivalents 2,992 67 -------- -------- 147,761 146,700Other funds 447 - -------- --------Funds included in the consolidated balance sheet 148,208 146,700Segregated funds 11,098 11,098Unit trusts, ISAs and PEPs 7,919 7,949 -------- --------Total funds under management 167,225 165,747 ======== ========IAS32 and 39, 'Financial Instruments' require that all investments are splitinto their respective asset classes. 8. Borrowings EEV AP £m £m2.75% Convertible bond 2006 493 521Undated subordinated notes 394 394Medium Term Notes 2031-2041 597 597Bank loans 2005 2 1Accrued interest 17 - -------- --------Core debt 1,503 1,513Non recourse financing- Triple X 2025 275 275- Property Partnership loans 2011 68 - -------- --------Total borrowings 1,846 1,788 ======== ========The convertible bond matures in 2006 and is convertible into ordinary shares ofthe Company at 184p per share. If converted, this bond would give rise to theissue of 285.3m new ordinary shares which represents approximately 4.4% of thecurrent issued share capital. On conversion, the bonds may be settled in sharesor in cash at the option of the Company. The fair value of the conversion option was calculated on issue using an optionpricing model. This is recognised as a derivative liability and is revalued tofair value at each reporting period. Fair value gains and losses are takenthrough the income statement. The remainder of the proceeds less attributableexpenses were allocated to the value of the debt portion of the convertiblebond. This amount is recorded as a liability on an amortised cost basis untilextinguished on conversion or maturity of the bond. In November 2004 a subsidiary of Legal & General America issued US$550m ofnon-recourse debt in the US domestic capital markets as floating rate DutchAuction Market Securities due 2025. The transaction provides capital to meet theRegulation Triple X reserve requirements on the US term insurance businesswithout affecting the Group's debt capacity or financial gearing.=============================================================================== Legal & General Group Plc P14Notes to Financial Statements - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- 9. Shareholders' equity segmental analysis EEV AP £m £mEmbedded value of life and pensions businesses:- UK * 4,445 4,608- USA 489 504- Netherlands 139 144- France 79 94 -------- -------- 5,152 5,350Institutional fund management ** 390 393 -------- -------- 5,542 5,743General insurance 149 149Corporate funds *** 491 224 -------- -------- 6,182 6,116 ======== ========MovementAt 1 January 5,680 5,584Fair value losses on cash flow hedges (4) -Exchange differences on translation offoreign operations (8) (9)Pension fund actuarial losses (26) -Net change in available for sale investments (2) - -------- --------Net income recognised directly in equity 5,640 5,575Profit for the year 881 870less: Minority interests (32) - -------- --------Total recognised income and expense for the year 6,489 6,445Dividends (321) (329)Employee share schemes costs 9 -Increase in share capital/share premium 1 1Allocation of Treasury shares 4 (1) -------- --------At 31 December 6,182 6,116 ======== ========* Includes £602m of intra-group subordinated debt capital attributed to the SRC.** Includes £353m net assets of managed pension funds business.*** Includes £493m of convertible debt, £602m of senior debt which has beenonlent to the Long Term Fund, £788m representing the net proceeds from the 2002Rights Issue and £188m representing the aggregate investment returns.=============================================================================== Legal & General Group Plc P15Notes to Financial Statements - EEV BasisYear ended 31 December 2004------------------------------------------------------------------------------- 10. Alternative assumptionsThe discount rate appropriate to any investor will depend on the investor's ownrequirements, tax and perception of the risks associated with the anticipatedcash flows to shareholders. The table below shows the effect of alternativeeconomic and non-economic assumptions on the long term embedded value and newbusiness contribution. Effect on embedded value at 31 December 2004Sensitivity to economic assumptions: 1% lower 1% higher 1% higher 1% lower risk risk equities/ equities/ As discount discount property property published rate rate yields yields £m £m £m £m £mLife and pensions- UK 4,445 288 (250) 220 (221)- International 707 52 (45) 6 (8) -------- -------- -------- -------- --------Total life and pensions 5,152 340 (295) 226 (229)Managedpension funds 353 8 (8) n/a n/a -------- -------- -------- -------- --------Total covered business 5,505 348 (303) 226 (229) ======== ======== ======== ======== ========Sensitivity to 10% dec- 10% dec- 10% dec- 10% dec-non-economic assumptions: rease in rease in rease in rease in maint- lapse mortality mortality As enance rates (UK (other published expenses Annuities) business) £m £m £m £m £mLife and pensions- UK 4,445 31 40 (215) 59- International 707 9 27 - 97 -------- -------- -------- -------- --------Total life and pensions 5,152 40 67 (215) 156Managedpension funds 353 10 8 n/a n/a -------- -------- -------- -------- --------Total covered business 5,505 50 75 (215) 156 ======== ======== ======== ======== ======== Effect on new business contribution for the periodSensitivity to 1% lower 1% higher 1% higher 1% lowereconomic assumptions: risk risk equities/ equities/ As discount discount property property published rate rate yields yields £m £m £m £m £mLife and pensions- UK 241 51 (45) 29 (29)- International 35 17 (14) 0 0 -------- -------- -------- -------- --------Total life and pensions 276 68 (59) 29 (29)Managedpension funds 36 2 (2) n/a n/a -------- -------- -------- -------- --------Totalcovered business 312 70 (61) 29 (29) ======== ======== ======== ======== ========Sensitivity to 10% dec- 10% dec- 10% dec- 10% dec-non-economic assumptions: rease in rease in rease in rease in maint- lapse mortality mortality As enance rates (UK (other published expenses Annuities) business) £m £m £m £m £mLife and pensions- UK 241 10 20 (17) 23- International 35 2 5 - 21 -------- -------- -------- -------- --------Total life and pensions 276 12 25 (17) 44Managedpension funds 36 2 2 n/a n/a -------- -------- -------- -------- --------Total covered business 312 14 27 (17) 44 ======== ======== ======== ======== =======In calculating the alternative values all other assumptions are left unchanged.=============================================================================== Legal & General Group Plc P16AssumptionsYear ended 31 December 2004------------------------------------------------------------------------------- 11. Assumptions UK life and pensions i. The assumed future pre-tax returns on fixed interest and RPI linkedsecurities are set by reference to redemption yields available in the market atthe end of the reporting period. The corresponding return on equities andproperty is equal to the fixed interest gilt assumption plus the appropriaterisk premium. An asset mix consistent with the current investment policy andfuture management intentions has been assumed within the projections. Theeconomic assumptions were: EEV AP EEV AP 2004 2004 2003 2003 Equity risk premium 3.0% 2.6% 3.0% 2.6%Property risk premium 2.0% 2.6% 2.0% 2.6% Investment return- Gilts:- Fixed interest 4.5% 4.5% 4.7% 4.7%- RPI linked 4.5% 4.5% 4.6% 4.6%- Non Gilts:- Fixed interest 4.9% - 5.3% 4.9% - 5.3% 5.1% - 5.5% 5.1% - 5.5%- RPI linked 4.7% - 5.1% 4.7% - 5.1% 5.1% - 5.4% 5.1% - 5.4%- Equities 7.5% 7.1% 7.7% 7.3%- Property 6.5% 7.1% 6.7% 7.3% Risk margin 3.0% 2.5% 3.0% 2.5%Risk discount rate(net of tax) 7.5% 7.0% 7.7% 7.2% Inflation- Expenses/earnings 3.8% 3.8% 3.8% 3.8%- Indexation 2.8% 2.8% 2.8% 2.8%The assumed returns on non-gilt securities are net of an allowance for defaultrisk of 0.2% p.a. (2003: 0.2% p.a.), other than for certain government-supportedsecurities where no such allowance is made. ii. Assets are valued at market value. For the projection of fixedinterest and RPI linked investment returns, asset values are adjusted to reflectthe assumed interest and inflation rates. iii. The value of the Sub-Fund is the discounted value of total projectedinvestment returns over its lifetime. iv. Future bonus rates have been set at levels which would fully utilisethe assets supporting the policyholders' portion of the with-profits business.The proportion of profits derived from with-profits business allocated toshareholders has been assumed to be 10% throughout. v. The value of in-force business reflects the cost of providing forbenefit enhancement or compensation in relation to certain products includingadministration expenses.=============================================================================== Legal & General Group Plc P17AssumptionsYear ended 31 December 2004------------------------------------------------------------------------------- vi. Other actuarial assumptions have been set at levels commensurate withRelated Shares:
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