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EEV profitability and return on embedded value
Operating profit before tax increased by £267m to £881m (2006: £614m). The EEV operating profit before tax is analysed in the three components reflecting the focus of our business effort (core, efficiency and back book management) and demonstrates clear achievement of our objectives in all three areas. In particular, the core element of our operating profit has risen from £550m to £791m, efficiency operating profit has increased from £95m to £109m and our back book management return rose from a loss of £31m in 2006 to a loss of £19m in 2007.
Further details on the movements in operating profit by source are provided below along with a segmental analysis.
Core
The 44% increase in the core element of our operating profit is mainly driven by an increase in new business contribution (NBC) of over 68% from £205m in 2006 to £345m in 2007, a turnaround in the profitability of our core non-covered business from a loss of £2m to a profit of £51m and a £45m increase in expected return on in-force business. The growth in NBC is covered in detail in the new business sales and profitability section while the increase in non-covered business is analysed in the segmental analysis of EEV operating profit. The improvement in expected return is largely attributed to the receipt of a full year's interest income on the IPO proceeds in 2007 compared to half a year's interest income in 2006.Efficiency
We have demonstrated continued progress in respect of our covered business maintenance costs, with efficiency benefits of over £100m, primarily arising from the UK and Canada. These gains reflect our continued focus on cost control and have contributed towards the achievement of our 2007 expense targets.Back book management
To complement the growth in the value of the Group through the core and efficiency elements, we are focused on reducing risks to shareholder profits that are expected to emerge from the back book. This element illustrates the impact of changes in insurance experience and assumptions, along with the results of our efforts to actively manage the value of the in-force business.The two major insurance risks to which shareholders are exposed are lapses and mortality. Lapse variances and assumption changes have resulted in a charge of £249m in 2007 (2006: £266m), primarily arising in the UK. This includes significant strengthening of long-term lapse assumptions plus a further allowance for expected adverse experience on UK unit linked bonds where, general market volatility, the downturn in the UK commercial property market and the current uncertainty over proposed changes to capital gains tax (CGT) have led to increased lapse rates.
Mortality variances and assumption changes resulted in a charge of £95m in 2007 (2006: profit £92m), primarily from strengthened annuitant mortality assumptions in the UK and Canada. The reinsurance of £6.7bn of pre demutualisation UK annuity reserves, announced on 14 February 2008, represents a significant step in reducing the shareholders' exposure to annuitant mortality risk. The benefits of this reinsurance will be shown in our 2008 results.
The strengthening of our lapse and mortality assumptions plus the subsequent annuity reinsurance reduces the risk of future adverse variances. More detail on the UK provisions and in particular the lapse position is provided in the Supplementary EEV financial statements section.
In addition, as part of our focus to actively manage the value of the in-force business, a review of UK group deferred annuity data and models resulted in a £191m benefit to operating profits and activities to reduce risks within the Heritage With Profits Fund (HWPF) have generated £42m of operating profits (2006: £44m) from a reduction in the time value of options and guarantees (TVOG).
Operating profit after tax
Operating profit after tax increased by 44% to £617m (2006: £429m). The attributable tax rate was 30% in 2007 (2006: 30%).Return on embedded value
RoEV was 11.5% in 2007 compared to 8.9% in 2006 (after adjusting for the IPO proceeds and post tax notional interest of £21m thereon). The core area of the business contributed 2.1% of the total 2.6% increase in RoEV, driven in particular from a 1.7% increase from NBC. Efficiency and back book management recorded increases of 0.3% and 0.2% respectively, reflecting our focus on reducing risk and actively managing the value of the in-force business.
Diluted EEV operating EPS
The diluted EEV operating EPS grew significantly from 20.7p in 2006 to 28.3p in 2007. The basic EEV operating EPS also increased from 21.4p in 2006 to 28.9p in 2007. These increases were largely driven by the 37% increase in operating profit after tax since 2006 (as adjusted for IPO notional interest).EPS is based on operating profit after tax including notional interest on IPO proceeds where appropriate (2006: £21m) and on 2,138m shares for basic EPS (2006: 2,102m) and 2,177m shares for diluted EPS (2006: 2,173m).
EEV non-operating loss
The non-operating loss before tax totalled £43m (2006: profit £408m), a decrease of £451m. Our life and pensions businesses produced a non-operating profit of £10m (2006: profit £283m) from economic variances and assumption changes. This included long-term investment variances of negative £17m (2006: positive £252m) partially offset by £27m of positive changes to economic assumptions reflecting year end market conditions (2006: £31m).
For all periods after 10 July 2006 the impact of the market value movement on UK subordinated debt liabilities has been included in UK life and pensions results in line with the treatment of the assets, and flows through investment return variances. The 2006 results included a non-operating gain of £107m from the mark-to-market adjustment of the UK subordinated debt for the period ended 10 July 2006 within non-covered business.
Volatility arising on different asset and liability valuation bases reflects the economic hedge loss in our banking business of £39m (2006: gain £48m).
'Other' includes restructuring and corporate transaction expenses of £31m (2006: £17m) mainly in relation to corporate finance activity of £18m, costs of delivering efficiencies of £9m and healthcare business restructuring of £4m. This is partially offset by a profit of £17m on the part disposal of our investment in HDFC Asset Management Limited (HDFC AM) to our Indian joint venture partner.
