liabilities share 2005 2005 £m £m At 1 January 2005 9,153.0 1,174.8
Acquisitions through business combinations 22,293.7 4,695.3
Premiums 444.8 50.4
Claims (1,253.3) (144.1)
Other changes in liabilities (267.3) (2,073.8)
As at 31 December 2005 30,370.9 3,702.6
The general insurance business is written by a subsidiary undertaking that was previously a subsidiary undertaking of Royal & Sun Alliance Insurance Group plc (RSA). The Group has in place a fall back perpetual reinsurance arrangement under which the full economic burden and benefit of the business rests with RSA. In addition, RSA has agreed to indemnify the Group against any general insurance liabilities which are not otherwise covered by the reinsurance treaty. This indemnity is unlimited as to time and amount.
In common with others in the life assurance business, the Group has experienced a number of complaints in respect of mortgage endowment business. A provision for the estimated redress has been established within liabilities under insurance contracts. The ultimate cost may be greater or smaller than the amount provided and is dependent on the level of complaints and the period over which the policies were written.
The movement in the provision is as follows:
2006 2005
£m £m
At 1 January 176.6 19.3
Acquisitions through business combinations – 95.3
Adjustments to provisions made in the year (67.0) 93.0
Compensation paid (33.7) (31.0)
At 31 December 75.9 176.6
£45.0 million of the provision at 31 December 2006 (2005: £143.1 million) is held in the with-profit funds.
24. Unallocated surplus
2006 2005
(restated) (restated)
£m £m
At 1 January, as previously reported 856.4 278.6
Transfer to retained earnings (note 21) (10.0) (10.0)
At 1 January, as restated 846.4 268.6
Acquisitions through business combinations 233.3 425.8
Foreign exchange adjustment 1.1 –
Transfer (to)/from income statement (378.4) 152.0
Notes to the consolidated
financial statements
(continued)
104
25. Provisions
Long term Pension
Restructuring incentive plan mis-selling Other Total
£m £m £m £m
At 1 January 2006, as previously stated 14.1 2.5 – 10.2 26.8
Prior year adjustment (note 3) – – – 18.7 18.7
At 1 January 2006, as restated 14.1 2.5 – 28.9 45.5
Acquisitions through business combinations – – – 8.8 8.8
Additions in the year 43.8 2.9 13.0 6.4 66.1
Utilised during the year (41.7) (0.3) – (10.5) (52.5)
Released during the year – – – (3.4) (3.4)
At 31 December 2006 16.2 5.1 13.0 30.2 64.5
The amount due for settlement after 12 months is £29.8 million (2005: £12.3 million), none of which has been discounted.
The long term incentive plan provision represents the estimated benefits accruing to members of the plan as per an independent valuation at the end of 2006. The scheme membership is made up of senior employees of the asset management business. There are two plans; the seven year plan provides entitlements to payments on the third anniversary of entry to the scheme with further entitlement due, in certain cases, in each of the subsequent four years. The three year plan matures after three years, with members being entitled to cash payments. Both plans provide for the ability to retain benefits beyond the seven and three year periods respectively.
26. Investment contracts liabilities
2006 2006
Gross Reinsurers’ liabilities share
£m £m
Amount due for settlement/recovery after 12 months 8,832.7 –
2005 2005
Gross Reinsurers’ liabilities share
£m £m
Amount due for settlement/recovery after 12 months 6,370.3 –
27. Insurance and investment contracts liabilities –
assumptions and sensitivities
(i) Assumptions
Process used to determine assumptions
For participating business in realistic basis companies the demographic assumptions about future experience are intended to be “best estimates”. They are determined after considering the companies’ recent experience and/or relevant industry data. Economic assumptions are market-consistent.
For other business, demographic assumptions are derived by adding a prudent margin to best estimate
assumptions. Economic assumptions are prudent estimates of the returns expected to be achieved on the assets backing the liabilities.
105
During 2006 a number of changes were made to assumptions to reflect FSA changes to reserving regulations, to harmonise the approach across the enlarged Group, and to reflect changes to expected experience. The impact of material changes during the year or since the acquisition date for businesses acquired during the year were as follows:
Increase/(decrease) in insurance liabilities £m
FSA changes to reserving regulations (535)
Harmonisation of valuation interest rate assumptions (14)
Valuation interest rate
For realistic basis companies the liabilities are determined stochastically using an appropriate number of risk neutral scenarios produced by proprietary economic scenario generators calibrated to market conditions and gilt yields as at the valuation date.
For funds not subject to realistic reporting, the method used to determine valuation interest rates generally follows the regulations set out in Section 7.3 of the Prudential Sourcebook.
Assets are firstly hypothecated to classes of business being valued. The valuation interest rates for each block of business are based on the expected returns of the hypothecated assets. The yield is then adjusted to make allowance for credit risk, reinvestment risk and investment management expenses.
Valuation interest rates (after tax for life policies) are typically in the following ranges: Life policies 3.00% to 4.00%
Pension policies 3.25% to 4.25%
Investment contracts with discretionary participation features are not measured at fair value as there is currently no agreed definition of fair valuation for discretionary participation features under IFRS.
Expense inflation
For all companies other than SPILA, expenses are assumed to increase at the rate of increase in the RPI plus a fixed margin in accordance with the management service agreements (MSAs) that the companies have in place with Resolution Management Services. For SPILA, expenses are assumed to increase at the rate of increase in the RPI plus 1%.
For realistic basis companies the rate of RPI inflation is determined within each stochastic scenario. For other companies it is based on the difference between the yields on long dated fixed interest gilts and long dated inflation linked gilts (2006: 3.3%). For MSAs with contractual increases set by reference to National Average Earnings inflation, this is approximated as RPI inflation plus 1%. In instances in which inflation risk is not mitigated, a further margin for adverse deviations is then added to the rate of expense inflation.
Mortality and longevity rates
Mortality rates are based on published tables, adjusted appropriately to take account of changes in the underlying population mortality since the table was published, company experience and forecast changes in future mortality. Where appropriate, a margin is added to assurance mortality rates to allow for adverse future deviations. Annuitant mortality rates are adjusted to make allowance for future improvements in pensioner longevity.
Notes to the consolidated
financial statements
(continued)
106
27. Insurance and investment contracts liabilities –
assumptions and sensitivities(continued)
Lapse and surrender rates (persistency)
The assumed rates for surrender and voluntary premium discontinuance depend on the length of time a policy has been in force and the company. Surrender or voluntary premium discontinuances are only assumed for realistic basis companies. Withdrawal rates used in the valuation of with-profit policies are based on observed experience and adjusted when it is considered that future policyholder behaviour will be influenced by different considerations than in the past. In particular, it is assumed that withdrawal rates for unitised with-profit contracts will be higher on policy anniversaries on which Market Value Adjustments do not apply.
Discretionary participating bonus rates
For realistic basis companies, the regular bonus rates assumed in each scenario are determined in accordance with each company’s Principles and Practices of Financial Management (PPFM). Final bonuses are assumed at a level such that maturity payments will equal asset shares subject to smoothing rules set out in the PPFM.
(ii) Sensitivities
The tables below indicate the stand alone impact of certain key assumption changes to insurance and investment contracts.
Fluctuations in with-profit business are taken to the unallocated surplus and have no direct impact on profit or equity holders’ funds. Consequently these do not feature in the table below.
Impact on Impact on Change in profit before equity holders’ assumption equity holders’ tax funds
% £m £m
Fixed interest yield assumptions -1% 47.7 33.3
Fixed interest yield assumptions +1% (65.7) (45.9)
Equity and property values -10% (35.5) (24.8)
Mortality assumptions for annuities -5% (52.3) (36.6)
Mortality assumptions for assurances -5% 80.0 56.0
In reality, given the correlation between the assumptions, it is not often possible to demonstrate the effect of key assumptions whilst other assumptions remain unchanged. It should also be noted that in some instances these sensitivities are non-linear.
28. Capital statement
Set out below is a statement of the Group’s capital resources related to UK life assurance business at 31 December 2006. This information is presented for each of the Group’s major UK with-profit funds. All of the with-profit funds fall under the Financial Services Authority’s (FSA’s) realistic capital regime. As stated in note 2(b), the with-profit and non- profit funds of six Group companies were transferred to Phoenix Life Limited (PLL) as of 31 December 2006. These included the with-profit funds previously falling within Britannic Assurance plc (Britannic) and Phoenix Life & Pensions Limited (Phoenix). In addition to the Britannic and Phoenix with-profit funds, the statement below covers Phoenix & London Assurance Limited (PALAL) and the significant with-profit funds arising from the acquisition of Abbey’s life businesses, namely Scottish Mutual Assurance Limited (SMA) and Scottish Provident Limited (SPL). The capital resources for the remaining with-profit funds have been aggregated in other with-profit funds. The equity holders’ funds of PLL and of the regulated entities which have transferred their businesses to PLL are included within the non-profit funds. Surplus funds related to PALAL are primarily held outside the long-term fund.