7. Long-term business investment return variance and economic assumption changes

7 – Long-term business investment return variances and economic assumption changes

(a) Definitions

Operating profit for long-term business is based on expected investment returns on financial investments backing shareholder and policyholder funds over the period, with consistent allowance for the corresponding expected movements in liabilities. Operating profit includes the effect of variance in experience for non-economic items, such as mortality, persistency and expenses, and the effect of changes in non-economic assumptions. Changes due to economic items, such as market value movement and interest rate changes, which give rise to variances between actual and expected investment returns, and the impact of changes in economic assumptions on liabilities, are disclosed separately outside operating profit.

(b) Economic volatility

The investment variances and economic assumption changes excluded from the long-term business operating profit were as follows:

	Long-term business
	2009 £m	2008 £m
Investment variances and economic assumptions	(75)	(1,631)

Positive variances on fixed interest assets in Europe and the United States were driven by the narrowing of credit spreads in the year. This impact was offset by losses from equity derivatives in Delta Lloyd reversing gains seen in these instruments in 2008. Credit default provisions for corporate bonds and commercial mortgages set up in 2008 were maintained in the UK and increased in Europe by £100 million.

(c) Assumptions

The expected rate of investment return is determined using consistent assumptions between operations, having regard to local economic and market forecasts of investment return and asset classification under IFRS.

Within the 2008 results, the expected rate of investment return was calculated by reference to the one year swap rate in the relevant currency plus an appropriate risk premium for equities and properties. At the half year we reported that the return over the typical duration of the assets held was more appropriate and more consistent with the group’s expectation of long term rates of return. Therefore, the expected return on equities and properties has been calculated by reference to the 10 year swap rate in the relevant currency plus an appropriate risk premium.

If the IFRS operating profit had been calculated by reference to the one year swap rate, IFRS operating profit would have been £240 million lower. There is no impact on IFRS profit before tax. The benefit to operating profit from the change in rate has been more than offset by the reduction in swap rates in the year.

The principal assumptions underlying the calculation of the expected investment return for equities and property are:

		Equities			Properties
	2009 %	2008 %		2009 %	2008 %
United Kingdom	7.0%	9.2%		5.5%	7.7%
Eurozone	7.3%	8.3%		5.8%	6.8%

For fixed interest securities classified as fair value through profit and loss, the expected investment returns are based on average prospective yields for the actual assets held. Where fixed interest securities are classified as available for sale, such as in the United States, the expected investment return comprises the expected interest or dividend payments and amortisation of the premium or discount at purchase.