Overview of Business Performance - Investis

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Overview of Business Performance the group, and the life industry in general, is of the view that the new IFRS basis is less satisfactory in terms of the measurement and reporting of the profi tability and the value added from writing long-term life assurance business, specifi cally what is now categorised as “investment” business. Accordingly, the group continues to manage all of its life assurance business on the basis of embedded value metrics and to provide embedded value results to shareholders and the market by way of supplementary fi nancial reporting. Embedded value seeks to measure the value of the shareholders’ interest in a life assurance business. This consists of the shareholders’ equity - represented by net assets - plus the present value (i.e. a discounted cash fl ow) of future profi ts to be earned from the existing book of in-force business less the cost of required capital. Future profi ts are estimated using actuarial methods and best estimate assumptions regarding future expenses, lapses, mortality, interest rates etc. Embedded value does not include any value attributable to future new business. The embedded value methodology adopted is in accordance with the European embedded value principles introduced by the CFO forum in May 2004, and updated in October 2005. The IL&P group has adopted the EV framework for the fi nancial reporting of its group results. In the group EV basis results, life assurance activities - covering both insurance and investment contracts - are accounted for on an embedded value basis and banking and other activities are accounted for on an IFRS basis. Supplementary Group Reporting - European Embedded Value Basis (“EV”) 2007 2006 bm Operating profi t on continuing operations am Insurance and investment business 346 274 Banking 219 202 Other (4) (2) 561 474 Share of associate / joint venture Operating profi t before tax on 29 55 continuing operations 590 529 Short-term investment fl uctuations (114) 101 Effect of economic assumption changes (14) (38) Other non operational costs (3) – Profi t on sale of property 1 – Profi t before tax 460 592 Taxation (52) (28) Profi t after tax 408 564 Minority interest Profi t after tax attributable to (4) (3) equityholders 404 561 Group Income Statement Total profi t after tax attributable to equityholders was a404m compared to a561m in 2006. This outcome refl ects strong growth in pre-tax operating profi t - which was ahead 12% to a590m (2006: a529m) - but which was offset by the impact of weaker investment markets and rising interest rates on the embedded value of the group’s life business which resulted in negative short term investment fl uctuations of a114m, compared to a positive a101m in 2006, and economic assumption changes which were a negative a14m (2006: negative a38m). At the operating level pre-tax profi ts of the group’s core banking and life assurance business grew 18% to a561m from a474m in 2006. This principally refl ects growth of 26% in the life business embedded value profi ts to a346m (2006: a274m) - driven by strong growth in the new business contribution and the expected return on the existing business - and 8% growth in the banking business to a219m (2006: a202m). The outturn in the banking business was depressed by a once off charge of a11.7m in respect of exposures created by the fraudulent activities of a rogue solicitor. Excluding this once-off specifi c provision the underlying level of growth in the bank was 14% refl ecting good growth in net interest income driven by balance sheet growth. The post tax return from the group’s interest in Allianz (Ireland) Limited was a31m compared to a56m in 2006. This reduction in profi ts principally refl ects a lower underwriting result due to further softening of premium rates in the market in 2007 combined with the fact that the 2006 outcome benefi ted from signifi cant prior year claims reserve releases. Short-term investment fl uctuations refl ect the impact of actual against assumed investment returns on the embedded value of the group’s life operations. The outcome was a negative a114m in 2007 compared to a positive a101m in 2006 and refl ects the signifi cant down turn in investment markets in the second half of 2007. In 2007, changes in the economic assumptions used to calculate the life assurance embedded value resulted in a negative a14m outcome (2006: negative a38m). This principally relates to the impact of an increase in the risk discount rate used to compute the embedded value from 7.4% to 7.8%, refl ecting increases in medium term euro bond rates. In 2006, changes in the risk discount rate from 6.5% to 7.4% had a a38m negative impact on the embedded value. The taxation charge of a52m is comprised of two elements, a a54m (2006: a42m) charge on insurance and banking operating profi ts and a credit of a2m (2006: a14m) attributable to investment fl uctuations and economic assumption changes in the life embedded value. The effective tax rate of 10% on operating profi t (combined insurance and banking) is lower than expected, benefi ting from the release of some a10m of 15
16 Overview of Business Performance life tax reserves. The adjusted operating return on capital employed (excluding associate/joint venture and own share adjustment) was 15.7% at the end of 2007 compared to 15.0% achieved in 2006. Asset Portfolios Movements in asset values, currencies and interest rates impact the embedded value of the group’s life business and the mark to market valuation of the bank’s liquidity / investment portfolios. Life Assurance Asset Portfolio The embedded value of the group’s life operations is exposed to market movements in asset currencies and interest rates due to the fact that the embedded value is calculated using assumptions regarding future investment returns and interest rates. To the extent that actual returns and interest rates differ from the assumptions used, variances will arise which may be positive or negative. As a result of the sharp fall in investment markets in the second half of 2007 the actual returns on investment markets fell signifi cantly short of the embedded value assumptions, resulting in a negative variance on short-term investment fl uctuations of a114m in 2007 compared to a positive a101m experienced in 2006. The bulk of this variance represents the present value of the reduction of future fund management fee income from unit linked funds as a consequence of the fall in unit prices. In addition, the increase in medium term euro interest rates has led to an increase in the risk discount rate used to compute the embedded value from 7.4% to 7.8%. This is the principal reason behind the negative economic variance of a14m recorded in 2007, which compares to a negative a38m in 2006 when the risk discount rate increased to 7.4% from 6.5% as a consequence of rising medium term euro bond rates. The sensitivity of the embedded value to changes in markets is set out in detail in note 14. In summary, a 1% increase in interest rates reduces the embedded value by a28m (1.4%) of the total embedded value, while a 1% decrease in rates increases the embedded value by a32m (1.6%). A 10% reduction in equity and property values would reduce the embedded value by a103m (5%). The group’s life business is a relatively low risk operation. With regard to the unit-linked portfolio of a27.9bln, which represents 94% (net of reinsurance) of the life company liabilities, the investment risk in this portfolio is primarily borne by the policyholders. In the non-linked or traditional insurance portfolio the group’s policy is to match liability fl ows with high quality assets, principally sovereign bonds. The average duration of the non-linked liabilities is 8.6 years while the average duration of the assets matching these liabilities is 8.5 years. The assets held in the fund total a1.7bln and the credit profi le of the portfolio is as follows: % Aaa 70 Aa 23 A 7 100 Given the close duration match, any mark to market adjustments in the portfolio due to changes in yield curves are generally matched by equal and opposite movements in the value of the liabilities. In the year ended 2007 one asset held in the portfolio, valued at a38m, was subject to an impairment writedown of a8m. Excluding this item there were no other impairment write-downs in the portfolio. The life company’s shareholder funds are principally invested in cash and owner occupied property. A full analysis of the life shareholder fund investments is set out in Note 5. Bank Asset Portfolio The bank’s liquidity portfolio of a4.2bln is principally held in sovereign bonds (59%), highly rated bank FRN’s (28%) and prime (non-US) euro denominated RMBS (13%). There are no sub-prime assets held within the portfolio. The portfolio is rated 73% Aaa, 20% Aa and 7% A. The mark to market adjustment to this portfolio at year end was a negative a19m gross which, in accordance with the IAS39 accounting treatment applied to “available for sale” assets, was taken to reserves. At 31 December 2007, the group held a a2.5bln debt securities portfolio designated as being “Held to Maturity”. This portfolio formed part of the group’s holdings with respect to liquidity management. At the year end the group had the ability and intention to hold the portfolio to maturity. However, in February 2008, increased market volatility presented the group with an opportunity to realise a gain of a29m on the sale of the portfolio. The group availed of this opportunity and disposed of the entire portfolio. The gain will be recognised in the 2008 results. Funding The regulatory regime under which the bank operates requires it to have suffi cient liquidity available to cover 100% of outfl ows over the next eight days and 90% of outfl ows over the next 30 days. Throughout the year the group operated comfortably within these limits. The diversifi cation and duration profi le of the group’s funding sources leave it in a strong position in the current credit environment. At the year end 64% of the
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Overview of Business Performance - Investis

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