Insurance & Investment
continued
Repayment Insurance
Sales of Repayment Insurance fell by 10% to £948m GWP (2005 £1,048m) primarily as a result of lower unsecured personal lending volumes, with sales to Group customers down by 7% to £528m (2005 £565m). Whilst volumes of unsecured personal loan and credit card Repayment Insurance have fallen, sales of mortgage Repayment Insurance increased by 4% to £95m (2005 £91m).
Our claims management service continues to receive excellent results in industry-wide surveys whilst also delivering tight control of overall claims costs. This excellent customer service provides an important competitive advantage in attracting and retaining 3rd party business.
On 7 February, the OFT announced their decision to refer Repayment Insurance (otherwise known as Payment Protection Insurance) to the Competition Commission (‘CC’). The CC has now commenced an investigation of the repayment insurance market, which will take at least a year but no more than two years to complete. Whilst the OFT recognised that Repayment Insurance provides worthwhile cover and peace of mind for many customers, they cited a number of market features which could, in their opinion, reduce competition and lead to poor value for money. We will participate fully with the CC investigation and in doing so we will seek to lead the market in any market or product developments to the benefit of customers and shareholders alike.
In addition, the FSA announced in January 2007 that it would be undertaking a further thematic review of the repayment insurance industry. We will continue to work with the FSA to ensure that our claims management and sales processes address the needs of our customers.
Motor Insurance
Sales of Motor Insurance decreased by 9% to £298m GWP (2005 £327m). Highly competitive conditions have severely restricted scope for premium rate increases in the market for most of 2006, reducing the extent to which customers ‘shop around’ for a better price. This has limited the opportunities for us to grow market share.
Consistent with our focus on long term shareholder value, we have concentrated on retaining existing customers, maintaining underwriting disciplines and maximising operational efficiency to protect profitability. We expect the planned transfer of First Alternative’s book of business to esure to gain the appropriate regulatory and legal approvals in the first half of 2007, resulting in significant capital efficiency gains.
In the light of increasing claims inflation and low investment returns, current market pricing is, in our view, not sustainable and we therefore expect to see premium rate rises across the industry in 2007. This will stimulate increased switching activity and the opportunities for renewed sales growth. In the meantime, we will continue to innovate through brand and product differentiation as a means of generating new sales. The Sheilas’ Wheels brand, targeted at female drivers, is a clear example of success in this area with sales volumes far exceeding our initial expectations.
Investment Business
Financial Performance
Underlying profit before tax in the Investment Business increased by 18% to £277m (2005 £235m). Underlying non-interest income increased by 6% whilst underlying operating expenses increased by 2%.
| Year ended 31.12.2006 £m |
Year ended 31.12.2005 £m |
|
|---|---|---|
| Net interest income | (120) | (119) |
| Non-interest income | 9,925 | 12,153 |
| Fees and commission income | 103 | 123 |
| Fees and commission expense | (238) | (216) |
| Net earned premiums on insurance contracts | 3,846 | 3,241 |
| Change in value of in-force long term assurance business | 184 | 283 |
| Investment and other operating income | 6,030 | 8,722 |
| Net operating income | 9,805 | 12,034 |
| Operating expenses | (9,528) | (11,799) |
| Underlying operating expenses | (684) | (670) |
| Change in investment contract liabilities | (2,898) | (5,198) |
| Net claims incurred on insurance contracts | (1,863) | (1,538) |
| Net change in insurance contract liabilities | (3,514) | (4,024) |
| Change in unallocated surplus | (569) | (369) |
| Underlying profit before tax | 277 | 235 |
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The above income statement includes a number of items which relate solely to policyholder payments and benefits. When these are netted off against each other, the income statement can be simplified as follows:
| Year ended 31.12.2006 £m |
Year ended 31.12.2005 £m |
|
|---|---|---|
| Net interest income | (120) | (119) |
| Underlying non-interest income | 1,081 | 1,024 |
| Underlying net operating income | 961 | 905 |
| Underlying operating expenses | (684) | (670) |
| Underlying profit before tax | 277 | 235 |
Under IFRS, insurance contracts (i.e. investment business which carries significant insurance risk as well as ‘with-profit’ contracts) are accounted for on an embedded value (‘EV’) basis, whereas investment contracts (i.e. investment business which does not carry significant insurance risk) are accounted for under IAS 39. Consequently, on an IFRS basis the income statement incorporates two very different profit recognition patterns depending on the nature of the contract.The table below sets out the contribution from each type of contract.
| Year ended 31.12.2006 £m |
Year ended 31.12.2005 £m |
|
|---|---|---|
| Contribution from insurance contracts* | 485 | 491 |
| Contribution from investment contracts* | 50 | (2) |
| Development expenditure | (67) | (80) |
| Overheads associated with development activity* | (56) | (45) |
| Other income and costs | (7) | (11) |
| Debt financing cost ** | (128) | (118) |
| Underlying profit before tax | 277 | 235 |
* The figures for 2005 have been re-analysed to reflect changes to the overhead allocation methodology.
**Debt financing cost includes the interest cost of subordinated debt finance previously included within the contribution from insurance contracts.
Insurance Contracts (accounted for on an EV basis)
The contribution from insurance contracts decreased by 1% in 2006 to £485m (2005 £491m) as a result of lower actual vs expected experience on existing business.
The contribution from new business increased by 23% to £216m (2005 £176m) reflecting continued growth in sales of insurance contracts (up 18%), with bonds sold in our Bancassurance channel making an important contribution. The expected contribution from existing business increased by 5% to £140m (2005 £133m) as a result of the growth of the in-force book. Actual vs expected experience was lower at £16m (2005 £77m) reflecting a strong 2005 comparative.
| Year ended 31.12.2006 £m |
Year ended 31.12.2005 £m |
|
|---|---|---|
| Contribution from existing business: | ||
| Expected contribution | 140 | 133 |
| Actual vs expected experience* | 16 | 77 |
| 156 | 210 | |
| Contribution from new business | 216 | 176 |
| Investment earnings on net assets using long term assumptions | 113 | 105 |
| Contribution from insurance contracts* | 485 | 491 |
* The figures for 2005 have been re-analysed to reflect changes to the overhead allocation methodology.
Investment Contracts (accounted for on an IAS 39 basis)
Under IAS 39, profit recognition on investment contracts is deferred to later years with a loss typically recorded in the year of sale. Continued growth in investment contract sales (up 25%) increased this new business strain in 2006. However, strong growth in the contribution from existing business, which grew 35% to £279m (2005 £206m), as our in-force book increased in size and asset values rose, resulted in investment contracts making an overall net positive contribution of £50m (2005 £(2)m) to underlying profit despite the strong sales growth.
| Year ended 31.12.2006 £m |
Year ended 31.12.2005 £m |
|
|---|---|---|
| Contribution from existing business* | 279 | 206 |
| Contribution from new business* | (229) | (208) |
| Contribution from investment contracts* | 50 | (2) |
*The figures for 2005 have been re-analysed to reflect changes to the overhead allocation methodology.
Total liabilities for investment contracts (which provide an indication of the funds under management) amounted to £37.3bn at the end of 2006 (2005 £29.3bn).
Full EV Basis Supplementary Information
To assist in the understanding of the underlying performance and value generation of the Investment Business, supplementary information is set out on pages 20 to 24, providing income statement and balance sheet information for our UK Investment Business on a consistent EV accounting basis for both insurance and investment contracts. We refer to this basis as the ‘Full EV’ basis.
New Business Profitability
With the publication of the Full EV basis supplementary information (set out on pages 20 to 24) and with the industry-wide demise of the Achieved Profits basis previously used to report the new business profitability of our Investment Business, new business profitability will, from now onwards, be reported by reference to the Full EV basis.
This results in new business profitability for 2005 which is 2% of APE lower than previously reported because the Full EV basis allocates a higher proportion of overhead expenses to new business.
New business profitability by channel and product type on the Full EV basis is set out below.
New Business Profitability (Full EV basis)
| Year ended 31.12.2006 % APE |
Year ended 31.12.2005 % APE |
|
|---|---|---|
| Bancassurance | 33 | 29 |
| Intermediary | 10 | 8 |
| Wealth Management | 36 | 37 |
| Total | 27 | 24 |
| Life & Pensions | 26 | 26 |
| Mutual Funds | 29 | 20 |
| Total | 27 | 24 |
New business profitability increased strongly in 2006 to 27% (2005 24%) reflecting our continued focus on value creation. In Wealth Management, profitability remains strong at 36% (2005 37%), with the decrease in margin being due to higher sales of pensions business post Pensions ‘A-Day’. Our Bancassurance channel continues to deliver strong margins through the efficiency of our model and the productivity of our sales forces, and margins in this channel increased to 33% (2005 29%). There has also been an increase in profitability in the Intermediary channel to 10% (2005 8%) reflecting reducing unit costs and increased average policy sizes.
Overall Life & Pensions margins remained strong at 26%. The increase in Mutual Funds profitability largely reflects efficiencies from increased scale, larger case sizes and changes in the mix of funds.
