Review of the Year

Operational Review

UK Protection

Strengths and strategy

We already have a strong position in this market. Our share of the market was 6.1% in 20071. This comprises a market share of 7.3% for individual protection business and 3.0% for group protection.

Life assurance makes up about two-thirds of our protection business, the remaining third being income protection.

Competitive advantage comes through the high levels of service we provide, enabled by our efficient systems. Our award winning eSelect system, available 24 hours a day, 7 days a week, offers online underwriting for term assurance, critical illness and waiver of premium, and our automated underwriting is capable of accepting online on ordinary rates or with special terms. Our income protection offering is market leading.

The majority of our new protection business is transacted online. This allows end-to-end electronic processing and account servicing ranging from new business quotations, new business tracking and in-force policy alterations. All of this helps to keep our unit costs low, enabling us to compete in what is an extremely price competitive market.

Distribution is through IFAs and mortgage intermediaries. Our ownership of Sesame, one of the largest providers of support services to financial advisers in the UK, also gives us further insight into how we can enhance our systems and products to present an even more attractive offer to all intermediaries. The intermediary distribution infrastructure supporting protection business can also be used to sell savings and investment products where this can be done profitably.

Our strategy is to maintain our strong presence in individual protection and grow our share of the group protection market.

Market and outlook

2007 was a fiercely competitive market for protection in the UK with nearly twice as many reprices across all companies than in any other year, leading to a general and significant fall in premiums. The previously subdued housing market finally went into decline towards the end of 2007 as higher interest rates, the introduction of Home Information Packs and the US credit crisis impacted on both consumer affordability and confidence.

The life protection market is closely linked to the housing market, with the majority of life cover policies being written in conjunction with a mortgage. It therefore struggled last year, with overall sales declining by 1%. We expect the market to remain difficult for the first half of 2008 but pick up in the second half as further interest rate reductions take effect. Overall, we expect the market to be flat or slightly negative in 2008.

Although there are short term challenges, we see opportunities to grow the protection business in the medium term. In early 2008, we launched business protection, which is a product not aligned to the UK housing market. Our strong position in the UK protection market also gives us the opportunity and ability to sell these products into the more profitable international markets.

Performance

New business was £68m, down 5% (2006: £72m). Life sales were down 9% and income protection sales were up 5%. Market share fell to 6.1% in a flat overall market. Group income protection market share rose from 2.6% to 3.0% but ground was given up in both independent and tied individual protection sales with market share falling from 7.8% to 7.3% amid tough price competition. Margin rose from 7.4% to 7.5% and as a result the contribution from new business was down only £1m at £31m. The benefit of reserving changes (PS06/14) was offset by price reductions in the market. IRR increased to 13.2% reflecting the reduction in reserving requirements. This also reduced new business strain to £40m and cash payback to 8 years.

The reduction in new business strain, and a corresponding change to in-force surplus, led to cash generation in the year being £4m. IFRS underlying profit was £5m, a reduction from £31m in 2006. The 2006 result benefited from the deferral of acquisition costs. Following completion of the implementation of PS06/14 acquisition costs for protection business are now amortised over a shorter period. As a result the IFRS profit in 2007 was largely the same as the cash generated in the year and influenced by the extent to which in-force surplus is able to fund new business strain. This will be the position going forwards.

The amount of new premiums written exceeded those lapsing. As a consequence, the total in-force premiums rose 8% to £311m.

Key Performance Indicators

New business – APE

Shareholder cash generation/outflow

Internal rate of return

IFRS underlying profit

New business – PVNBP

Contribution from new business

Cash payback

Additional information	2007	2006
In-force premiums (£m)	311	288