2008 Preliminary Results

2008 Preliminary Results

A solid performance in difficult market conditions

Operating profit resilient in difficult markets

* EEV operating profit before tax up 6% to £933m (2007: £881m), generating a return on embedded value of 10.9% (2007: 11.5%) after making provision for customer payments to the Pension Sterling Fund

Cash flow robust with strong coverage of new business strain

* Core capital and cash generation after tax £303m (2007: £334m)
* Full year dividend of 11.77p, representing 2.3% growth

Balance sheet strength maintained

* Group Embedded Value per share of 286p (2007: 285p) stable in the face of challenging markets
* IFRS equity per share excluding intangible assets and minority interests of 151p (2007: 148p), with IFRS profit after tax attributable to equity holders of £100m (2007: £465m)
* Financial Groups Directive surplus of £3.3bn (2007: £3.4bn) after allowing for the payment of the final dividend

Efficiency target achieved

* Annual efficiency target of £100m cost savings achieved one year early, and a further target of £75m set

Unless otherwise stated, all comparisons are in Sterling and are with the twelve months ended 31 December 2007.

Group Chief Executive Sir Sandy Crombie said:

“Standard Life has delivered a solid performance in 2008, against a backdrop of the challenging economic conditions in which we have been operating.

“We have announced good profits, healthy capital and cash generation, and have achieved efficiency improvements a year ahead of target. Our capital position is among the strongest in the industry and is relatively resilient in the event of further deterioration in market conditions.

“Whilst we are pleased with this performance, our culture of continuous improvement is underlined by the next phase of efficiency savings we have set for the business today. A further £75m of annual savings are planned by the end of 2010 by driving further operational excellence, which also underpins our market-leading service to customers.

“With the outlook for world financial markets remaining difficult, we will continue to follow our proven conservative strategy, with a focus on driving efficiencies while pursuing growth to an extent consistent with the prevailing conditions and our limited appetite for capital exposure.”

Core return

Core return comprises new business contribution, expected return, development costs for covered business [2] and normalised IFRS underlying profit for non-covered business [3,4].

Core EEV operating profit before tax was 13% lower at £685m (2007: £791m) delivering a core RoEV of 8.0% (2007: 10.2%). This has been principally driven by new business contribution, which was 23% lower at £264m (2007: £345m), due to reduced sales volumes and changes to our business mix against challenging markets. Our key new business metrics of internal rate of return (IRR) and discounted payback period were 16% (2007: 19%) and 8 years (2007: 8 years) respectively, the slight decrease in IRR having been driven by reduced asset values and product mix. The continued relative strength of these metrics reflects the benefit of our capital-lite approach.

We have continued to invest in our market leading SIPP and Wrap propositions in the UK and our fast growing Asian operations. This has led to an increase in development expenses and IFRS losses for our Asia Pacific operations, the impact of which has been partly offset by a further reduction in Group Corporate Centre costs to £50m (2007: £57m).
Continued drive for efficiency

Efficiency comprises covered business maintenance expense variances and assumption changes. In 2008 efficiency savings contributed 0.8% to our RoEV (2007: 1.5%).

In March 2007 we announced the Continuous Improvement Programme to reduce underlying costs by £100m by the end of 2009. During 2008 we have built on the strong performance achieved in 2007, with the continued integration of UK financial services. This has enabled us to deliver the full £100m of efficiency savings one year early. The efficiency savings achieved in 2008 have been reflected in a £64m benefit to embedded value operating profit (2007: £109m).

Following the early delivery of the Continuous Improvement Programme benefits we are announcing today the next phase of efficiency savings. This has a target of achieving a further £75m of annual efficiency savings over the next two years through operational excellence.
Active back book management

We remain committed to driving increased value from the management of our back book. This category includes all non-expense related operating variances and assumption changes for covered business plus those development costs directly related to back book management initiatives and, for non-covered business, specific costs attributed to back book management. During the year, back book management generated an operating profit before tax of £184m (2007: loss of £19m), delivering a back book management RoEV of 2.1% (2007: (0.2%)).

In February 2008 we reinsured £6.7bn of our UK immediate annuity liabilities to Canada Life International Re. This generated a one-off benefit to EEV operating profit before tax of £119m. Other positive factors within the back book management result include a £96m EEV profit from the release of deferred annuity reserves in the UK (2007: £191m [5]) following an ongoing review of annuity data, as well as experience variances and operating assumption changes in respect of tax, mortality and morbidity. Offsetting these positive factors, we have made modest revisions to lapse and paid up assumptions, relating to UK pension and Canadian products in light of more difficult economic conditions. In the UK, a strengthening of paid up assumptions reflects the decision of a number of customers to defer payment into their pension schemes during the current volatile market conditions, with assumptions regarding longer-term lapse trends remaining broadly unchanged. Overall, lapse-related experience variances and assumption changes have reduced embedded value operating profit by £39m.

As announced on 11 February 2009, we have made a cash injection into the Pension Sterling Fund to reverse a 4.8% valuation adjustment relating to 2008 mark to market movements that was made to the fund earlier in 2009. This injection, which has been reflected as a £108m [6] charge within “other” experience variances, was made in light of feedback from customers and key business partners and our own review of the fund information we provided, and is consistent with our ongoing commitment to treat customers fairly.
Capital and cash generation

Overall, operating capital and cash generation amounted to £423m (2007: £563m). Core capital and cash generation was 9% lower at £303m (2007: £334m). Capital and cash generation from new business and the expected return from existing covered business have remained largely unchanged at £322m (2007: £324m), despite the tough economic environment and the cash impact of accelerated reserve releases in 2007. This demonstrates the resilience of our capital-lite approach to writing new business, with capital and cash generated from existing business comfortably covering new business strain by more than two times. The impact of these factors has been offset by increased development expenses in respect of our covered businesses and lower returns from cash held by Group.

Capital and cash generated from efficiency savings amounted to £7m (2007: £20m). Capital and cash generated from back book management amounted to £113m (2007: £209m). This principally reflects the reinsurance of UK immediate annuity liabilities in February 2008 and a reserve release in respect of UK deferred annuities. These positive factors have been partly offset by the £78m post tax impact of the cash injection into the Pension Sterling Fund that we announced in February 2009.

After allowing for adverse investment variances and other non-operating items in the period, total EEV capital and cash generation was £336m (2007: £600m).

The Board proposes a final dividend of 7.70p per share, making a total of 11.77p for 2008, an increase of 2.3%. This reflects the solid progress made during the year. Looking forward the Group will continue to apply its existing progressive dividend policy taking account of market conditions and the Group’s financial performance.

Normalised underlying profit excluding the impact of market volatility on Canadian surplus assets and reserves was £349m (2007: £432m). As highlighted in our Q4 2008 new business press release on 28 January, our IFRS profitability has been adversely affected by the weakness and volatility of investment markets during 2008. The impact of this volatility has been significant within our Canadian operations due to the way Canadian life companies typically structure non-segregated funds, with assets backing both policyholder liabilities and the shareholder surplus. Mark to market value adjustments in respect of surplus assets, coupled with reserve increases in respect of tax and guarantees have reduced Canadian normalised underlying profit by £187m compared with the prior year. Under EEV this volatility is treated as a non-operating item.

Including the impact of this volatility normalised underlying profit was £206m (2007: £476m). Within this, the UK life and pensions profit was £156m (2007: £122m). Other items impacting normalised underlying profit include bond impairments and defaults of £32m, lower management charges due to reduced asset values, and increased new business development costs incurred in respect of our growing Asian franchises.

IFRS underlying profit before tax of £154m (2007: £714m) is after a number of one-off items which are not included in the normalised underlying profit figure. In 2007 these included reserve releases of £138m in respect of PS06/14 and £143m in respect of deferred annuities as well as a strengthening of mortality reserves amounting to £137m. In 2008 these included a £105m benefit arising from the reinsurance of UK immediate annuity liabilities, the impact of which was more than offset by the £102m cash injection into the Pension Sterling Fund and total charges of £124m arising from the restructure of a sub-fund of Standard Life Investments (Global Liquidity Funds) plc and subsequent mark to market movements in associated asset backed securities[7].
Balance sheet strength

Despite falling financial markets Group Embedded Value has increased marginally to £6,245m (31 December 2007: £6,211m), representing an embedded value per share of 286p (31 December 2007: 285p). IFRS equity excluding intangible assets and minority interests has increased to £3,295m (31 December 2007: £3,213m), representing 151p per share (31 December 2007: 148p).

The Financial Groups Directive (FGD) surplus of £3.5bn as at 31 December 2008 (31 December 2007: £3.6bn) has been largely insensitive to market movements, with a year end solvency cover of 218% (31 December 2007: 166%). The relative insensitivity of the FGD surplus reflects the unique structure of the Group post Demutualisation as well as the impact of the hedges we have put in place. FGD solvency is largely insensitive to a further 30% fall in equity markets from the position at the end of December, with the surplus maintained at £3.3bn. In the event of a 40% fall in markets from the year-end position our FGD surplus would remain strong at £2.9bn. At the end of February 2009 the FGD surplus was estimated to be £3.4bn. After allowing for the payment of the final dividend, our year end FGD surplus would be £3.3bn (2007: £3.4bn).

The Heritage With Profits Fund (HWPF) residual estate amounted to £0.5bn as at 31 December 2008 (31 December 2007: £1.5bn). The reduction in the estate over the year largely reflects both the direct and indirect effects of movements in corporate debt, property and equity markets, the impact of which has been exaggerated by technical changes in the way that realistic liabilities are calculated. The impact on the residual estate of further falls in equity markets continues to be mitigated by the hedges we have in place. The impact of most other adverse asset movements would, in the first instance, be met by policyholders with indirect impacts on shareholders via higher guarantee costs, and hence higher burnthrough cost. Shareholder exposure is also limited by the structure of the capital support mechanism set up at Demutualisation, with shareholder support being obtained by withholding the furthest out cash transfers from the HWPF to shareholders. At the end of February 2009 the HWPF residual estate was estimated to be £0.3bn.

Shareholders are exposed to debt securities which back annuity liabilities in the UK and Europe and the liability in respect of longevity risk reinsured from SLAL’s HWPF. These debt securities amount to £1.5bn and comprise £0.8bn of government and government backed bonds and £0.7bn of other corporate bonds. There were no defaults on the debt securities in this portfolio in 2008, however in light of the economic conditions the provision for future defaults within the valuation of liabilities has been increased to £40m (31 December 2007: £20m), representing a weighted average default assumption into perpetuity for corporate bonds of 87bps (31 December 2007: c37bps).

Debt securities in Canadian non-segregated funds amount to £5.4bn, including £2.2bn of corporate bonds. There were no defaults within this portfolio of debt securities during 2008. We have maintained our Canadian corporate bond default assumption at 36bps while the average quality of the portfolio has increased from A to A+. The overall provision for defaults on bonds in the portfolio amounts to £90m (31 December 2007: £71m).

Standard Life’s total investment (including third party funds) in the asset backed securities markets across both short-term treasury instruments and long-term fixed interest is approximately £5.3bn or 3.3% (31 December 2007: £7.7bn or 4.6%) of Group assets under administration, predominantly in UK securities. Of the total of £5.3bn, £1.3bn relates to shareholder funds, of which £1.2bn is AAA rated. The overall level of asset backed securities has reduced compared to 31 December 2007 as a result of a number of securities reaching maturity and also due to market movements. The Group has continued actively to manage its exposure to asset backed securities and the portfolio remains a high quality credit portfolio with no direct exposures to the US mortgage market, minimal exposure to leveraged structures, no current direct exposure to Monolines and very modest exposure to credit within a Monoline wrapper. Following the restructure of a sub-fund of Standard Life Investments (Global Liquidity Funds) plc, shareholder funds have a total exposure of £83m (31 December 2007: £27m) to assets within a Monoline wrapper or leveraged structures, representing 0.3% (31 December 2007: 0.1%) of shareholder financial assets.

The economic environment continues to be very challenging and the outlook for markets remains uncertain. While market conditions mean that the outlook for retail savings is likely to remain subdued, we continue to see opportunities in the profitable markets in which we operate, including group pensions and fixed income investment mandates.

As an asset managing business our revenues will inevitably be impacted by lower financial market levels. Our ongoing focus on efficiency will help mitigate the impact of this on profitability. In 2009 the Group will benefit from expense efficiencies achieved during the last year and will make a start on the next phase of delivering operational excellence, targeting a total of £75m of annual efficiency savings by 2010.

In these conditions Standard Life will continue to pursue a ‘capital-lite’ strategy and to operate conservatively, ensuring that balance sheet strength and cash generation remain priorities.

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