Preliminary results year ended 31 December 2008
05 March 2009
4. Margin on assets
We are committed to improving the explanation of our results to generalist investors. A number of requests have been received to present our long-term business result as a function of funds under management, consistent with practices elsewhere in the savings industry. This disclosure provides an additional perspective on the long-term business performance, as part of our intention to continuously improve the external presentation of our IFRS result and enable these results to be better understood.
This disclosure presents the overall profit from the long-term business as if generated by a margin on the income bearing assets supporting that business. In the analysis which follows two net margin figures are highlighted. Firstly, the operating profit margin is based on our definition of life operating profit, which excludes the effect of economic volatility in the period. Secondly, the margin based on profit before shareholder tax includes the impact of economic volatility and other non-operating items.
| As margin on average assets (basis points) | |||||||
|---|---|---|---|---|---|---|---|
| 2008 | Average assets (£bn) |
Operating revenue |
Acquisition & Admin costs |
Operating profit |
Economic items |
Other non- operating items |
Profit before shareholder tax |
| UK | 119.4 | 265 | (202) | 63 | (58) | (6) | (1) |
| France | 58.4 | 112 | (65) | 47 | (15) | – | 32 |
| Netherlands | 35.9 | 294 | (239) | 55 | 20 | (42) | 33 |
| Other | 48.0 | 233 | (147) | 86 | (80) | (5) | 1 |
| Europe | 142.3 | 199 | (137) | 62 | (28) | (12) | 22 |
| North America | 22.1 | 207 | (200) | 7 | (196) | (25) | (215) |
| Asia Pacific | 4.9 | 452 | (358) | 94 | (213) | – | (119) |
| Total | 288.7 | 231 | (172) | 59 | (57) | (11) | (8) |
| As margin on average assets (basis points) | |||||||
|---|---|---|---|---|---|---|---|
| Restated 2007 |
Average assets (£bn) |
Operating revenue |
Acquisition & Admin costs |
Operating profit |
Economic items |
Other non- operating items |
Profit before shareholder tax |
| UK | 124.0 | 189 | (131) | 58 | (9) | (1) | 49 |
| France | 49.2 | 122 | (72) | 49 | 17 | – | 66 |
| Netherlands | 28.8 | 269 | (206) | 63 | 81 | (2) | 141 |
| Other | 40.7 | 274 | (187) | 87 | (1) | (5) | 80 |
| Europe | 118.7 | 210 | (144) | 65 | 26 | (2) | 89 |
| North America | 16.5 | 210 | (162) | 48 | (111) | (33) | (96) |
| Asia Pacific | 5.0 | 323 | (261) | 62 | 2 | (3) | 61 |
| Total | 264.2 | 202 | (141) | 61 | 1 | (3) | 59 |
The above tables are based on the IFRS income statement and balance sheet for the long-term business segment:
- average assets is the arithmetic average of the opening and closing balance sheet value of assets, together with non-consolidated funds under management and excluding certain non-financial assets; excluded assets are goodwill, acquired value of in-force business (AVIF) and other intangibles, reinsurance assets, deferred acquisition costs and other assets, and prepayments and accrued income;
- operating revenue items include premium and investment income, claims and movements in liabilities, based on expected investment returns on financial investments backing shareholder and policyholder funds;
- acquisition and administration costs include fee and commission expense, other operating expenses and finance costs;
- operating profit is equal to operating revenue less acquisition and administration costs;
- economic items include the effect of variances between actual and expected investment returns and the impact of changes in economic assumptions on liabilities, which are excluded from operating profit;
- other non-operating items include impairment of goodwill, amortisation of intangibles other than AVIF, profit on disposal of subsidiaries and integration and restructuring costs; and
- the final column is based on profit before tax attributable to shareholders’ profits, which combines the operating profit, economic items and other non-operating items.
Reconciliation of net margins to segmental result and balance sheet
| 2008 | Restated 2007 |
|||||
|---|---|---|---|---|---|---|
| Profit £m |
Average assets £bn |
Net margin bps |
Profit £m |
Average assets £bn |
Net margin bps |
|
| Long-term business result before tax | (1,310) | 1,549 | ||||
| less: tax attributable to policyholder returns | 1,068 | (15) | ||||
| Result after policyholder tax | (242) | 288.7 | (8) | 1,534 | 264.2 | 59 |
| Operating profit before tax attributable to shareholders' profits | 1,694 | 288.7 | 59 | 1,610 | 264.2 | 61 |
| 2008 | Restated 2007 |
|||||
|---|---|---|---|---|---|---|
| Closing £bn |
Average £bn |
Opening £bn |
Closing £bn |
Average £bn |
Opening £bn |
|
| Segment assets | 307.9 | 280.4 | 280.4 | 255.9 | ||
| Adjusted for: | ||||||
| Additional funds under management | 13.3 | 11.7 | 11.7 | 8.5 | ||
| Goodwill and other intangibles | (5.4) | (4.0) | (4.0) | (3.6) | ||
| Other excluded assets | (15.5) | (11.2) | (11.2) | (9.5) | ||
| Asset base | 300.3 | 288.7 | 276.9 | 276.9 | 264.2 | 251.3 |
The total operating profit margin on assets reduced from 61 bps in 2007 to 59 bps in 2008. The margin increased in the UK and Asia Pacific regions, with a small reduction in Europe and a larger fall in the USA. The overall margin movement of 2 bps can be further analysed between an increase of 3 bps for growth in operating profit less a reduction of 5 bps to allow for the increased asset base.
The deepening global financial crisis has led to significantly negative investment variances in 2008, equating to 57 bps of average assets. The variances primarily relate to debt securities, where the unprecedented widening of credit spreads drove down market values, and to a lesser extent from falling equity and property values. For with-profit and unit-linked business the decline in asset values is largely offset by a corresponding reduction in liabilities. However for other non-profit business and surplus shareholder funds, the reduction in asset values was only partly mitigated by movements in liabilities. The economic items include additional credit default provisions for corporate bonds and commercial mortgages. Although equity markets suffered major downturns, the profit impact was limited by hedging activity in the Netherlands and limited shareholder exposure elsewhere in the Group.
This compares to a broadly neutral net impact of economic items on profit in 2007, with favourable investment variances in the Europe region offset by negative effects in the USA and UK.
The non-operating items relate mainly to reorganisation costs in the UK and Netherlands and amortisation of other intangibles arising from the acquisition in the USA in 2006.
For the UK business, the operating profit margin increased from 58 bps in 2007 to 63 bps in 2008. The 2008 margin includes 10 bps from recognition of the first tranche of a special with-profit bonus distribution, while a lower result from non-participating business reduced the overall margin by 7 bps.
The negative economic variance in the UK incorporates the effect of a £550 million allowance for future defaults in respect of corporate bonds and commercial mortgages supporting our £16 billion UK annuity business. The increase has the effect of doubling the total allowance for credit defaults with respect of these securities which is equivalent to a default allowance of 85 bps over the lifetime of the assets. Also included are specific default provisions of £53 million in relation to corporate bonds and commercial mortgages which have been offset by the annual allowances which we have for these types of securities of £60 million.
The UK margins on assets are blended margins combining our participating (with-profit) and non-participating business. Average assets of the UK with-profits business were £59.9 billion (2007 restated: £63.4 billion) with operating profit of 48 bps (2007 restated: 28 bps). This apparently low return reflects IFRS accounting for the share of bonuses accruing to policyholders, rather than the underlying performance within the participating funds. Average assets of the UK non-participating business were £59.5 billion (2007 restated: £60.6 billion) with operating profit of 75 bps (2007: 89 bps).
The French long-term business shows a stable operating margin progression, based on its well-established portfolios of AFER and other unit-linked investment contracts. The negative economic item in 2008 largely relates to minimum death benefit guarantees affected by market conditions.
In the Netherlands, the reduced operating profit margin was affected by new business strain on corporate pensions business (15 bps) and from strengthening annuitant mortality assumptions (13 bps). Positive economic variances were the result of investment hedging activity.
For this disclosure, Other Europe includes our well-established and profitable operations in Ireland, Italy, Poland and Spain as well as newer developing businesses in central and eastern Europe. Operating margins were generally stable, boosted by high margins on protection business portfolios in Poland and Spain. The newer smaller operations currently make a negative net contribution to margins due to the effect of the low asset base and development costs. Negative economic items were driven by credit spread widening, particularly in Spain.
The North America operating profit margin reduced from 48 bps in 2007 to 7 bps in 2008, with adverse economic conditions leading to investment margin compression, higher DAC amortisation and DAC unlocking.
The negative economic variance of 196 bps in the USA were driven by realised and unrealised losses on investments as a result of the widening of credit spreads on assets predominantly relating to funding agreement business (122 bps). The assets and liabilities for pre-2008 funding agreements are both carried at fair value, are matched in terms of duration, and the assets are of high quality. However, a temporary accounting mismatch has arisen due to the widening of credit spreads. This has resulted in a temporary adverse movement in the assets not matched by a corresponding movement in the liabilities, which it is anticipated will reverse prior to settlement of the contracts. Asset write-downs represent a further 74 bps of the variance.
The Asia Pacific region combines our well-established profitable business in Australia, which shows high stable operating profit margins, and the new and rapidly developing Asian operations.
From 2009 we intend to provide further disclosure of IFRS profit drivers, using a format similar to the embedded value analysis of movements. We consider that this will provide more relevant information on the sources of profit for all types of long-term business. In the meantime, however, we believe there is merit in presenting this “margin on average assets” disclosure as an additional perspective on the financial results of our life businesses.
