Financial review - Chief Financial Officer's report

Results

Results overview

2005 was a very strong year of financial performance for the Group. The table below sets out the key metrics of the Group's financial performance.

	Core Group		US		Total
	2005	2004	2005	2004	2005	2004
Net written premiums	£5.3bn	£5.0bn	£0.1bn	£0.1bn	£5.4bn	£5.1bn
Underwriting result	£263m	£185m	£(145)m	£(462)m	£118m	£(277)m
Insurance result	£843m	£686m	£(29)m	£(372)m	£814m	£314m
Operating result	£743m	£623m	£(45)m	£(365)m	£698m	£258m
Profit/(loss) after tax	£635m	£312m	£(30)m	£(392)m	£605m	£(80)m
Shareholders’ funds	£2.3bn	£1.9bn	£0.4bn	£0.4bn	£2.7bn	£2.3bn

Net written premiums

Net written premiums for the year were £5.4bn, up from £5.1bn in 2004.

As expected and highlighted in last year's report, the largest element of growth during 2005 was the recapture of the Munich Re quota share reinsurance arrangement. From 1 January 2005 this was reduced to nil from 8% in 2004 giving an overall benefit of 6%. The strength of the Group's capital position has allowed us to retain these premiums previously reinsured to Munich Re.

In a competitive environment we have also achieved targeted growth in Canada, Latin America, UK Marine, MORE TH>N^® and Scandinavia.

Operating result

Set out in the table below is the operating result for 2005 split between its component parts:

	2005 £m	2004 £m	Movement %
Insurance result
UK	475	377	26
Scandinavia	180	145	24
International	207	173	20
Group Re	(19)	(9)	(111)
Core Group insurance result	843	686	23
US	(29)	(372)	92
Total Group insurance result	814	314	159
Other activities	(116)	(56)	(107)
Operating result	698	258	171

Core Group

The insurance result for the Core Group is up 23% to £843m, representing a 42% increase in the underwriting result and a 16% increase in the investment result, with all regions improving. The split of the Core Group by both premiums and earnings is broadly 50% UK, and 25% each from Scandinavia and International, reflecting the balanced nature of our portfolio. The Core Group delivered an underlying return on equity of 21.6%, 3.9 points better than 2004.

This Core Group result has been achieved against the background of a mixed rating environment and significant weather losses, particularly in International. This result has also been achieved whilst we continued to significantly strengthen the Core Group's reserves.

The benefits of our prudent reserving policy and the actions we have taken over the last three years can be seen in both the positive prior year run off and current year underwriting profits.

The investment result of £580m is up 16%, predominantly due to a 12% growth in investment income. This growth reflects the increase in the average invested funds in the Core Group, which are up £1.4bn to £12.6bn, reflecting the positive cashflows and the proceeds of the sale of the Group's life businesses and the issue of the sterling subordinated debt. The yield on this portfolio stayed constant at just under 4%. Realised gains of £109m are broadly in line with prior year and included the disposals of previously occupied Group properties in France and Dublin.

US

There has been a significant reduction in the insurance losses incurred by the US operation from £372m for 2004, to £29m for 2005. The underwriting result has improved by £317m to a loss of £145m as management actions continue to take effect. Investment income in the US has benefited from a pick up in yields from 3.3% to 4.2%.

In the fourth quarter of 2005, the insurance result for the US operation was a profit of £3m. Whilst there are a number of uncertainties within the US operation, on a business as usual basis, we would expect the US insurance result to achieve broadly breakeven during 2006.

The US result included 10 months of profits from the Nonstandard Auto business prior to its sale in November.

Top

Other activities

Other activities predominantly comprise the central Group expenses and the investment expenses and charges. In 2005 the central expenses were £82m compared with £86m in 2004. Both years include approximately £13m relating to the costs of implementing IFRS, Sarbanes Oxley and the Prudential Sourcebook. Whilst we will continue to incur costs relating to these projects we anticipate them reducing from the 2005 levels.

Under IFRS, the movement in non insurance derivatives is also included in Other Activities. The 2004 result included a £75m positive contribution from these contracts. We have since exited the majority of these contracts and the net impact in 2005 is a benefit of £8m.

Profit after tax

Profit after tax of £605m shows a significant improvement over the £80m loss in 2004. This predominantly reflects the improvement in the operating result, a number of disposals and the impact of the change in the pension scheme design.

The table below sets out a reconciliation of operating result to profit after tax:

	2005 £m	2004 £m	Movement %
Operating result	698	258	171
Total interest costs	(107)	(75)	(43)
Amortisation	(17)	(22)	23
Reorganisation costs	(86)	(118)	(27)
Benefit from change in pension scheme design	180	–	–
Profit/(loss) on disposals	197	(109)	–
Discontinued life	–	104	–
Profit before tax*	865	38	–
Taxation	(260)	(118)	(120)
Profit after tax	605	(80)	–
*Profit before tax is shown on a management basis. Profit before tax on a statutory basis is shown in the Consolidated Income Statement.

Under IFRS, the interest costs on all of the Group's senior and subordinated debt is included below the operating result. The cost of £107m is an increase of £32m over 2004. This predominantly reflects the additional interest paid on the new subordinated debt raised in July 2004 plus the fact that in 2004 this debt and related interest was recognised in equity under International Accounting Standard 32. Following a change in the terms of the debt this has been reclassified and is recognised as debt for 2005.

Amortisation under IFRS is for software assets and goodwill on acquired claims provisions and this charge was £17m in 2005 compared with £22m in 2004.

Reorganisation costs relate to the costs of implementing the operating improvement programme and the restructure of the US operation. The charge for 2005 of £86m was £32m lower than 2004 reflecting lower redundancies and premises closure costs.

The profit on disposal of £197m (2004: £(109m)) includes to the disposals of the Japanese operation (£59m), our stake in Rothschilds (£62m) and the Nonstandard Auto business in the US (£71m).

The profit after tax also benefited from a one off credit of £180m relating to the change in the design of the two main UK defined benefit pension schemes. This is explained in more detail in the pension fund section later in this report.

The 2004 profit after tax also reflects the results from our life operations disposed of during the second half of 2004.

And finally, the tax charge of £260m reflects an effective rate of 29% for the Core Group and no tax relief on the US losses.

Top