Insurance & Investment

Insurance & Investment
Reported profit before tax and exceptional items for Insurance & Investment increased by 20% to £1,067m. After adjusting for the negative £76m timing impact from commencing household insurance underwriting from the start of the year, profit increased by 29% to £1,143m.

Reported Insurance profits, before the household insurance adjustment, fell by 8% to £409m whilst Insurance profits, after this adjustment, increased by 9% to £485m. Reported Investment profits increased by 48% to £658m and Investment profits based on long term investment return assumptions, i.e. after eliminating the effect of short term fluctuations in investment returns and changes to economic assumptions, also increased by 48% to £618m.

The momentum of the Insurance Business was maintained in 2004 with sales up by 9% overall. Of particular note was the performance of motor insurance, where sales increased by 34% against the previous year, and household insurance where sales advanced by 8%. Repayment insurance sales increased by 2%.

Overall sales for the Investment Business were 13% ahead of 2003 and in the UK sales were 8% ahead. We are now the number one investment business in the UK, based on 2004 effective premium income (‘EPI’). Bancassurance continued to build on its strong growth in recent years with sales up by 12%, Wealth Management recovered strongly with sales increasing by 19% and Intermediary sales grew by 11%.

Financial Performance

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Net interest income	86	55
Non-interest income	1,460	1,190
Income from long term assurance business	714	525
General insurance premium income	585	360
OEIC/Unit trust management income	107	91
Fund management income	64	57
Other fees and commissions receivable	230	376
Fees and commissions payable	(246)	(224)
Other operating income	6	5
Operating income	1,546	1,245
Operating expenses*	(256)	(250)
Staff	(86)	(93)
Accommodation, repairs and maintenance	(1)	(3)
Technology	(11)	(9)
Marketing and communication	(20)	(16)
Depreciation:
Tangible fixed assets	(7)	(6)
Other	(88)	(77)
Sub total	(213)	(204)
Recharges:
Technology	(18)	(22)
Accommodation	(19)	(20)
Other shared services	(6)	(4)
General insurance claims payable	(214)	(99)
Amounts written off fixed asset investments	1	3
Operating profit*	1,077	899
Share of losses of associates and joint ventures	(10)	(12)
Profit before tax and exceptional items	1,067	887

* Excluding exceptional items.

Insurance Business
Our Insurance businesses manufacture and distribute household, repayment and motor insurance products, each of which again grew in 2004. Our multi-brand portfolio includes Halifax for home insurance, St Andrew’s for repayment insurance, and esure and First Alternative for motor insurance. As a result of our low cost access to the Group’s retail customer base, excellent products and customer service, and a growing range of partnerships and affinity relationships, our Insurance Businesses have now established a major multi-brand, multi-channel presence in the UK personal lines market with an estimated 8.5% market share.

Financial Performance
Reported profit before tax and exceptional items for the Insurance Business fell by 8% to £409m before adjusting for the £76m timing impact from commencing household insurance underwriting from the start of 2004. Profit after this adjustment increased by 9% to £485m. As a result of commencing underwriting household business, premium income, net interest income and claims payable are all higher in 2004, whilst broking commission income is lower. Operating expenses fell in the year as a result of a continued strong focus on cost control.

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Net interest income	48	22
Non-interest income	689	640
Income from long term assurance business	100	81
General insurance premium income	585	360
Other fees and commissions receivable	180	361
Fees and commissions payable	(179)	(165)
Other operating income	3	3
Operating income	737	662
Operating expenses*	(103)	(107)
General insurance claims payable	(214)	(99)
Operating profit*	420	456
Share of losses of associates and joint ventures	(11)	(13)
Profit before tax and exceptional items	409	443

* Excluding exceptional items

Operational Performance
Insurance sales increased 9% to £1,732m gross written premiums in 2004 and the number of policies in-force rose to approximately 10 million.

Insurance Sales

	Gross Written Premiums		Number of In-force Policies
	Year ended 31.12.04 £m	Year ended 31.12.03 £m	Year ended 31.12.04 000’s	Year ended 31.12.03 000’s
Repayment - Group business	610	638	2,637	2,561
Third party	276	234	893	757
Household	483	448	2,570	2,463
Motor	282	211	910	713
Other	81	63	2,977	1,836
Total	1,732	1,594	9,987	8,330

Repayment
Sales of repayment insurance increased by 2% to £886m, with 18% growth in third party sales, achieved primarily from new third party relationships, more than offsetting a 4% fall in Group business, lower unsecured lending volumes and changes in channel mix being the most significant factors. Strong customer service and claims management are key strengths that have helped us acquire new third party clients, including MBNA, BMW and Argos, which are expected to contribute significantly to sales in 2005.

Household
Sales of household insurance increased by 8% to £483m. The growth in non-mortgage related sales, which now account for 53% of all sales, is a significant achievement and is an important aspect of our strategy for increasing market share in the household insurance sector. This success was reinforced by a 5 star product rating from Defaqto together with a number of ‘Best Direct Home and Contents Insurance Provider’ awards.

The commencement of household underwriting from the start of 2004 went very smoothly, with no disruption to customer service or retention rates. Claims experience in 2004 was favourable as a result of benign weather conditions, our exposure to significant claim events being protected by a catastrophe reinsurance programme.

Motor
Sales of motor insurance increased by 34% to £282m. esure is believed to have achieved the fastest growth ever for a new UK motor insurance business, with sales increasing for the fourth consecutive year of trading. As a result, esure moved into profitability during 2004, contributing £4m to profits (2003 loss £11m). Following the launch of the First Alternative brand in April 2004, sales to customers who fall outside of esure’s “safer driver” customer segment totalled £46m for the year.

Other Insurances
Sales of other personal lines insurance, such as legal protection, home emergency and annual travel, continued to grow strongly, with a 29% increase in 2004. These insurances are value added additions to our mainstream personal lines products and overall make an important contribution to profits.

Investment Business
Our investment businesses have delivered impressive growth in profit and sales in 2004 based on our multi-brand, multi-channel approach to the market which delivers wide consumer reach and scale, and is able to leverage that scale to its advantage through low cost administration from a shared service platform. Our bancassurance business manufactures and distributes products principally through Halifax branded personal financial advisers to our Retail branch customer base and through specialist Bank of Scotland branded financial advisers to our high net worth and business banking customers. Clerical Medical investment and pension products are distributed in the UK and in Europe through intermediaries. St James’s Place is a wealth management business providing advisory services to high net worth individuals through its unique network of self employed Partners. Insight Investment is a leading UK investment manager, as well as being the Group’s in house fund manager.

Financial Performance
Reported profit before tax and exceptional items for the Investment Business increased by 48% to £658m. This growth in profits was driven by increased new business volumes, further efficiency improvements and favourable experience. Short term fluctuations in investment returns were also positive in the year reflecting growth in the values of both equities and fixed interest securities.

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Net interest income	38	33
Non-interest income	771	550
Income from long term assurance business	614	444
OEIC/Unit trust management income	107	91
Fund management income	64	57
Other fees and commissions receivable	50	15
Fees and commissions payable	(67)	(59)
Other operating income	3	2
Operating income	809	583
Operating expenses*	(153)	(143)
Amounts written off fixed asset investments	1	3
Operating profit*	657	443
Share of profits of associates and joint ventures	1	1
Profit before tax and exceptional items	658	444

* Excluding exceptional items.

Profit for the Investment Business based on long term assumptions, i.e. after eliminating the effect of short terms fluctuations and changes to economic assumptions, increased by 48% to £618m (2003 £418m).

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Reported profit before tax	658	444
Effect of short term fluctuations in investment returns	(40)	46
Changes to economic assumptions	-	(72)
Profit based on long term assumptions	618	418

Long Term Assurance Business
The sources of income from long term assurance business on an embedded value basis are set out below.

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Contribution from existing business	279	238
Contribution from new business	282	162
Investment earnings using long term assumptions	113	99
Changes to economic assumptions	-	72
Short term fluctuations in investment returns	40	(46)
Income before tax from long term assurance	714	525
Comprising:
Investment Business	614	444
Insurance Business	100	81

The contribution to profits from new business increased substantially compared to 2003 as a result of our focus on growing margins as well as volume in the UK market, further improvements to unit costs, and the strong recovery at St. James’s Place and in our European Intermediary business. The contribution from existing business is also higher than 2003, in particular reflecting further favourable experience against assumptions and a £58m positive adjustment relating to a tax agreement with the Inland Revenue. The table below provides further analysis to explain the favourable variance.

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Expected contribution from existing business	219	201
Efficiency improvements	52	25
Development expenditure	(74)	(55)
Profit on disposal of Life Assurance Holdings Corporation	13	-
Other experience (including tax in 2004)	69	67
Actual contribution from existing business	279	238

The embedded value of long term assurance business was £4,426m (2003 £3,950m) of which 45% (2003 43%) was shareholder funds and the balance was the value of in-force business.

The economic assumptions used in the embedded value calculation are unchanged from those used at the end of 2003. The discount rate contains an allowance for investment risk which is set at a level to ensure that, in accordance with ASB FRS 27, the embedded value excludes any amount that relates to expected future investment margins above the risk-free rate.

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Discount rate (net of tax)	8.0	8.0
Equity return (net of tax credits)	7.5	7.5
Gilt return (gross of tax)	5.0	5.0
Expense inflation	3.0	3.0

Modified Statutory Solvency Basis
Profits calculated using the modified statutory solvency basis (‘MSSB’) use the same long term assumptions as required to assess regulatory solvency but with certain prescribed accounting adjustments, e.g. the deferral of acquisition expenses. Because of the conservative nature of these regulatory solvency requirements, new business is normally reported as a loss in the year of sale. This depresses the MSSB result for businesses enjoying healthy sales and does not reflect the future value of such new business.

The consolidated MSSB result for our long term assurance business compared to the embedded value reporting basis is set out below.

Reporting Basis Comparison for Long Term Assurance Business

	2004 £m	2003 £m
Income reported on modified statutory solvency basis before tax	228	213
Income reported on embedded value basis before tax	714	525

New Business Profitability
New business profitability on an achieved profits basis of 28% EPI was well ahead of our medium term target of 25%. New business profitability on an achieved profits basis is higher than the contribution from new business to embedded value profits because it includes collective investment schemes, and allocates expenses on a directly attributable new business basis.

The overall improvement in profitability came, in the main, from Intermediary business where profitability increased from 18% EPI to 25% EPI. A continued focus on increasing margins and controlling costs generated 4% of this increase, with the remainder arising from the recovery in overseas sales.

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Bancassurance	28	27
Intermediary	25	18
Wealth Management	42	41
Total	28	25

* EPI = effective premium income = annual premiums plus 10% of single premiums

Long Term Assurance Business Capital
Solvency requirements for long term assurance business are now subject to the Integrated Prudential Sourcebook. This has introduced the resilience test for changes in market conditions as a capital requirement (rather than as a reserve) and, for with-profit funds, the “twin peaks” test which involves a comparison of the regulatory capital requirement with a realistic assessment of the capital required. At 31 December 2004, Clerical Medical’s with-profit fund realistic assessment produced a lower capital requirement than the regulatory assessment, and accordingly it is the latter that has determined the total capital required. Information regarding the capital surplus of Clerical Medical’s with-profit fund on a realistic basis is disclosed on page 28.

The free asset ratio of Clerical Medical as at 31 December, before the capital requirement, is estimated to be 11.8% (31 December 2003 9.7%). The comparative for 2003 has been restated to treat the resilience test as a capital requirement in accordance with the regulatory changes referred to above.

An alternative measure of financial strength is the amount of cover afforded by our available capital in relation to required capital. At 31 December 2004 this cover for Clerical Medical was estimated to be 239% (31 December 2003 202%). The estimated capital position of all the Group’s long term business in aggregate is set out in the table below.

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Total capital available	2,759	2,235
Total capital required	1,124	1,069
Surplus capital	1,635	1,166

Operational Performance
Investment sales detailed in the table on page 27 increased by 13% to £1,381m EPI. UK sales grew by 8% to £1,240m EPI, ahead of the overall market growth of 5.4% reported by the ABI, and as a result our market share increased to 12.2%. We are now the number one investment business in the UK based on sales as measured by EPI.

Bancassurance
Bancassurance sales increased by 12% to £685m EPI. This increase follows three years of strong performance well in excess of overall market growth and as a consequence we remain the UK’s leading bancassurer.

Our strategy of offering simple, transparent, value-for-money products is closely aligned with the Government’s recently announced plans for stakeholder investment products. By offering a full range of products with no initial or exit charges, and with annual charges already compliant with the 1.5% per annum Sandler charging “cap”, our business is in a strong position to maintain its leading position with further opportunities to grow profitability. As further confirmation of our approach, the Halifax brand received independent accreditation for its investment products and customer service under the Raising Standards Quality Mark Scheme during 2004. In addition, Halifax Life was one of only three businesses to receive a 5 star rating from Money Management for both single and regular premium pension products.

Intermediary
Overall Intermediary sales increased by 11% to £519m, with a 84% increase in overseas sales more than offsetting a fall in UK intermediary sales, which reduced by 3% to £378m.

In the past two years, our focus in the UK Intermediary market has been on profitability, not just volume and as a result the overall contribution from new business continues to grow. Our position as a leading player in the individual pensions IFA market was reinforced by winning ‘Best Pensions Provider’ in the Guardian Consumer Finance Awards and also a 5 star rating from Money Management. On the multi-tie front, our stance of competing for panel positions in the intermediary sector only where the economics are expected to be sound for both parties has so far resulted in us securing two ties (one of which has been announced) out of the four major positions that have so far been decided.

Sales outside the UK increased by 84% to £141m, driven by strong performance in Germany in the second half of the year as a result of changes in tax legislation and achieved despite exiting a number of less profitable overseas markets earlier in the year. This, together with our focus on managing for profitability in the UK business, resulted in a further increase in the new business profitability of Intermediary business in 2004.

Wealth Management
Sales at St. James’s Place (‘SJP’) were 19% higher at £177m EPI confirming a return in the confidence of higher net worth investors. Partner productivity rose by 18% and Partner numbers rose by 1%, the latter reflecting management’s continued focus on replacing lower productivity advisers with those of higher productivity. Funds under management increased to £9bn at 31 December 2004 (2003 £8bn). The disposal of SJP’s interest in Life Assurance Holdings Corporation to Swiss Re was completed in July.

Investment Management
Insight Investment’s funds under management increased by 11% to £78bn aided by a strong market recovery, by the successful launch of four new property products, including the Insight Foundation Property Trust and the Insight Property Portfolio Fund, and by winning a significant number of fixed income mandates. For the second calendar year running, the Insight Liquidity Fund (£3bn) was the top performing fund in its sector.

During 2004, Insight developed its investment capability beyond traditional benchmark products to include the absolute return and liability driven solutions increasingly demanded by institutional clients in the current climate. Furthermore, a number of business partnerships were established with major distributors to use our multi-manager range. Insight is in the process of outsourcing its middle and back office operations which will further improve operational efficiency and flexibility.

Total funds under management, including assets managed by St James’s Place, increased by 12% to £87bn at 31 December 2004 (31 December 2003 £78bn).

Investment Sales	Year ended 31.12.04 Single £m	Year ended 31.12.04 Annual £m	Year ended 31.12.04 Total £m	Year ended 31.12.04 Total EPI £m	Year ended 31.12.04 Single £m	Year ended 31.12.04 Annual £m	Year ended 31.12.04 Total £m	Year ended 31.12.04 Total EPI £m
Life	4,718	184	4,902	656	4,684	90	4,774	559
Pensions	1,975	219	2,194	416	1,999	197	2,196	397
Mutual funds	1,571	151	1,722	309	2,141	57	2,198	271
Total	8,264	554	8,818	1,381	8,824	344	9,168	1,227
Bancassurance	4,651	220	4,871	685	4,832	129	4,961	612
Intermediary	2,397	278	2,675	519	3,008	165	3,173	466
Wealth Management	1,216	56	1,272	177	984	50	1,034	149
Total	8,264	554	8,818	1,381	8,824	344	9,168	1,227

Prospects
The UK insurance and investment markets are experiencing a period of unprecedented regulatory and legislative change. Our multi-brand, multi-channel strategy, low cost access to banking customers and efficient administration provide a sound basis on which to build on the strong results reported in 2004.

A key objective for our Insurance business in the medium term is to profitably target market share of 15% or above. To achieve this, our strategy will be to continue to provide value for money products and excellent customer service to Group customers and to complement this by expanding our distribution beyond our traditional bank-based channels into new partnership arrangements and by growing telephone sales. This strategy will be complemented by the continued growth of esure and First Alternative.

In our Investment business, the size of the UK market, coupled with demographic pressures and the increasing awareness of the savings gap, presents a significant opportunity to grow both sales and shareholder returns, again targeting 15% or greater market share in the medium term. As a leading player in the UK pensions and investment markets, we are well placed for the launch of Stakeholder products, selective opportunities arising from the introduction of depolarisation and the implementation of pensions ‘A day’ simplification. Our Investment business is able to pursue its strategy from a position of financial strength and efficiency. Indeed the significant move away from with-profit sales in recent years means that the business is expected to be in a position to generate surplus capital in the coming years without compromising on its plans to grow new business or profits.