Profitability on the EEV basis

EEV summary

	2007 £m	2006 £m
EEV underlying profit before tax:
– UK Life & Pensions	(95)	315
– International Life & Pensions	116	119
– Asset Management	78	89
– Corporate items	(83)	(14)
EEV underlying profit before tax	16	509
Other items	(64)	(111)
EEV (loss)/profit before tax	(48)	398
Contribution from new business	206	204
Life & Pensions new business margin	2.7%	2.9%
EEV underlying (loss)/earnings per share	(4.5p)	16.4p
EEV basic (loss)/earnings per share	(2.7p)	14.6p

EEV loss before tax is £(48)m (2006: £398m profit). This profit measure takes into account the impacts of investment return variances, economic assumption changes, non-recurring items and other charges. In total these were £(64)m loss in 2007 compared to £(111)m loss in 2006. 2006 included £58m impairment of Asset Management intangibles which did not recur.

Underlying profit before tax is £16m (2006: £509m). Within this total, basis changes and one-off items amount to £(461)m negative (2006: £26m positive), as follows:

EEV underlying profit

	2007 £m	2006 £m
EEV underlying profit before tax	16	509
Capitalisation of UK development and corporate expenses	(306)	-
UK persistency	(158)	(53)
Mortality, morbidity, longevity	(9)	27
Annuity reinsurance	12	-
Total basis changes and one-off items	(461)	(26)
EEV underlying profit before basis changes and one-off items	477	535

The underlying profit before basis changes and one-off items was £58m lower than 2006. The benefits of improved contribution from new business and from International persistency, are offset by lower burnthrough in underlying profit, higher development and International expenses and lower Asset Management profits.

The expenses impact of £306m has arisen due to the reallocation of £20m annual expenses previously classified as development to maintenance, and the inclusion of additional costs within the provision for corporate costs. The impacts arise within UK Life & Pensions £238m and Corporate items £68m.

The UK persistency charge of £158m results from increases in assumed lapse rates for the Investment Bond and Pensions portfolios. The impacts arise within operating assumption changes of £133m, contribution from new business £15m and expected return £10m.

UK Life & Pensions underlying profit

	2007 £m	2006 £m
Contribution from new business	96	108
Profit from existing business:
– Expected return	149	173
– Operating assumption changes and experience variances	(357)	10
Development costs	(41)	(26)
Other net expense	(5)	-
Expected return on shareholder net assets	63	50
UK Life & Pensions underlying (loss)/profit	(95)	315

UK contribution from new business

Total UK new business on an APE basis was up 15% from £654m to £751m, with strong performance in pensions and annuities offsetting declines in protection and savings & investments. New business on a PVNBP basis was up 7% as the increase in sales volume was offset by higher lapse assumptions in pensions. Contribution from UK new business was down 11% from £108m to £96m primarily as a result of the mix of business.

UK IRR and cash payback

In the UK, IRR increased from 10.3% to 11.7% as a result of favourable regulatory reserve changes following completion of the implementation of PS06/14, which was particularly helpful for protection. UK cash payback was unchanged at 12 years. Protection payback fell from 9 years to 8 years as a result of lower reserving requirements but savings & investments increased from 16 years to 24 years as a result of increased lapse assumptions. The main savings & investments product was replaced in October.

Impact of expense recategorisation

In reporting on the outcome of our strategic review we announced our intention to recategorise around £20m of costs, previously shown as development costs, as maintenance. The contribution from UK new business as reported above would reduce by £16m due to the change in treatment of development costs. The UK IRR would reduce by 0.8% and cash payback would increase by two years.

UK expected return on in-force

The expected return on the value of the in-force book decreased by 14% to £149m (2006: £173m), in part reflecting the reduction in VIF as a result of the impact of persistency operating assumptions changes made at the start of the period.

UK operating assumption changes and experience variances

	2007 £m	2006 £m
Persistency	(133)	(53)
Expenses	(238)	-
Mortality and morbidity	(9)	27
Annuity reinsurance	12	-
Burnthrough	16	36
Other	(5)	-
UK operating assumption changes and experience variances	(357)	10

The main factors are as follows:

Increased lapses in the year have resulted in an assumption change of £133m. This comprises: £65m from our Investment Portfolio Bond and With-Profits Bonds, £53m from Group Pensions and £15m other products.
The expense assumption changes recognise there will always be a recurring level of development costs not related to new markets or products. £20m of additional annual costs have been capitalised as maintenance costs resulting in a charge of £238m.
The mortality and morbidity charge of £9m arises mainly from strengthening assumed future annuitant mortality.
The annuity reassurance treaty entered into with Swiss Re early in 2007 produced a £12m EEV profit and has significantly reduced the exposure to longevity risk.
The burnthrough provision has remained largely unchanged at £48m (2006: £50m), with the underlying profit impact offset by investment return related variances reported below underlying profit.

UK other net expense

Other net expense of £(5)m (2006: £nil) includes the income from the IFA businesses since their acquisition offset by the costs of developing the Wrap platform.

UK development costs

Development costs increased to £(41)m (2006: £(26)m). In 2007, as in previous years, development costs were treated as investment in the business in order to improve future EEV profits. The main increase in 2007 relates to the development of a Wrap platform, The Asset Hub. In January 2008, in line with our new strategy, we announced we would cease development of this project. We also announced that in future development costs would only include costs related to developing wholly new products or entering wholly new markets.

UK expected return on shareholder net assets

The expected return on shareholders' net assets has increased by 26% to £63m (2006: £50m), because of a 16% increase in the weighted average value of Life & Pensions shareholder assets during the year and higher expected returns. In August we largely eliminated the shareholder equity exposure, the majority of which took place at a FTSE level of 6,250.

International Life & Pensions underlying profit

	2007 £m	2006 £m
Contribution from new business	110	96
Profit from existing business:
– Expected return	38	34
– Operating assumption changes and experience variances	(24)	(12)
Development costs	(9)	-
Expected return on shareholders' net assets	1	1
International Life & Pensions underlying profit	116	119

International contribution from new business

International new business on the APE basis was up 18% from £326m to £385m, with a good performance in FPI outweighing a 5% decline in Lombard. New business on a PVNBP basis was up 11%. Contribution from International new business increased 15% from £96m to £110m. The Lombard contribution is £71m (2006: £70m) and the FPI contribution is £39m (2006: £26m).

International IRR and cash payback

FPI IRR was down from 20.1% to 17.8% primarily as a result of the mix of products sold in Hong Kong. Overall International IRR was down from 25.7% to 23.0%. International cash payback was unchanged at 4 years.

International expected return on in-force

The expected return on the value of the in-force book increased by 12% to £38m (2006: £34m), reflecting the increase in the value of the in-force business.

International operating assumption changes and experience variances

	2007 £m	2006 £m
Expenses	(39)	-
Persistency	12	(13)
Other	3	1
International operating assumption changes and experience variances	(24)	(12)

Changes to the assumed ongoing maintenance expenses within Lombard, together with the continued expense overrun for that growing business, contribute the majority of the £39m charge relating to expenses on International Life & Pensions business. Adverse persistency experience for International With-Profits Bonds led to revised persistency assumptions. This charge was more than offset by positive experience variances for Lombard and other product lines within FPI.

International development costs

Development costs within our International business increased as we have invested for growth. The £7m in respect of FPI represents our investment into the German pensions market and establishing capability in new markets.

Asset Management underlying profit

The Asset Management underlying profit is discussed here.

Corporate items

	2007 £m	2006 £m
Expected return on net pension liability	8	9
Expected return on corporate net assets	(9)	(10)
Corporate costs	(14)	(13)
Operating assumption changes for corporate costs	(68)	-
Total	(83)	(14)

The £68m operating assumption changes for corporate costs reflect our view that a substantial proportion of corporate costs are on-going and related to the Life & Pensions business.

Other items

	2007 £m	2006 £m
Investment return variances	(45)	(174)
Effect of economic assumption changes	(12)	181
Non-recurring items	38	(17)
Amortisation of Asset Management acquired intangibles	(42)	(43)
Amortisation of Sesame/Pantheon Financial acquired intangibles	(3)	-
Impairment of Asset Management acquired intangibles	-	(58)
Total other items	(64)	(111)

Other profit items excluded from underlying profit but included in profit before tax are shown in the table above. The main factors are:

Investment return variances and economic assumption changes include the impact of widening corporate bond spreads on life and pensions assets, partially offset by their impact on mark-to-market of corporate debt.
Non-recurring items are discussed here.
There is no impairment charge in respect of F&C's acquired intangible assets. The charge in 2006 related to the write down in value of management contracts following fund outflows notified in the year.