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Financial Statements

Notes to the Financial Statements

Notes 1 to 6

First time adoption of International Financial Reporting Standards
Net investment return
Net claims and benefits
Profit before tax
Income tax expense
Earnings per share attributable to the equity holders of the Parent Company

1. First time adoption of International Financial Reporting Standards

The Group’s financial statements for the year ended 31 December 2005 are the first annual financial statements that comply with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU).

The Group has applied IFRS 1 ‘First Time Adoption of International Financial Reporting Standards’, in preparing these consolidated financial statements. The Group’s transition date is 1 January 2004 and an opening IFRS Balance Sheet has been prepared at that date.

IFRS 1 allows some exemptions from full retrospective application of certain standards. In preparing these consolidated financial statements in accordance with IFRS 1, the Group has applied the mandatory exceptions and certain of the optional exemptions from full retrospective application of IFRS.

The Group has applied the provisions in IFRS 4 ‘Insurance Contracts’, which leaves existing accounting policies for insurance contracts unchanged.

The Group has elected to apply the following optional exemptions from full retrospective application:

Business combinations exemption
The Group has applied the business combinations exemption in IFRS 1. It has not restated business combinations that took place prior to the 1 January 2004 transition date.

Cumulative translation differences exemption
The Group has elected to set the previously accumulated cumulative translation differences to zero at 1 January 2004. This exemption has been applied to all subsidiaries in accordance with IFRS 1.

Designation of financial assets and financial liabilities exemption
The Group reclassified various securities as available for sale investments with fair value movements recognised in equity.

The Group has applied the following mandatory exceptions from retrospective application:

Derecognition of financial assets and liabilities exception
Financial assets and liabilities derecognised before 1 January 2004 are not rerecognised under IFRS.

Hedge accounting exception
The Group has applied hedge accounting from 1 January 2004 only if the hedge relationship meets all the hedge accounting criteria under IAS 39 ‘Financial Instruments: Recognition and Measurement’.

Estimates exception
Estimates under IFRS at 1 January 2004 are consistent with estimates made for the same date under UK Generally Accepted Accounting Principles (UK GAAP).

The Group has also chosen to adopt IFRS 5 ‘Non Current Assets Held for Sale and Discontinued Operations’, early. The 2004 financial statements have been prepared in accordance with the relevant requirements.

Reconciliations between IFRS and UK GAAP

The following reconciliations provide a quantification of the effect of the transition to IFRS on both the Income Statement for the year ended 31 December 2004 and Balance Sheets as at 31 December 2004 and 1 January 2004.

Explanations of the adjustments are set out below.

	Notes	£m
Loss for the year ended 31 December 2004 as reported under UK GAAP		(109)
Adjusted for:
Discontinued life	a	10
Insurance contracts reclassified to financial instruments	b	42
Investment return	c	(69)
Equalisation provisions	d	37
Internal software costs capitalised	e	21
Foreign exchange	f	(32)
Reversal of amortisation of goodwill	g	11
Loan capital interest	h	3
Subordinated guaranteed perpetual notes	i	14
Deferred tax	j	(8)
Loss for the year ended 31 December 2004 as reported under IFRS		(80)

Equity at 31 December 2004 and 1 January 2004
	Notes	31 December 2004 £m	1 January 2004 £m
Total equity and reserves as reported under UK GAAP		3,039	3,332
Adjusted for:
Discontinued life	a	–	9
Insurance contracts reclassified to financial instruments	b	(93)	(147)
Equalisation provisions	d	356	319
Internal software costs capitalised	e	39	18
Reversal of amortisation of goodwill	g	11	–
Subordinated guaranteed perpetual notes	i	444	–
Deferred tax	j	31	34
Pensions	k	(759)	(681)
Dividends	l	86	83
Other	m	(21)	4
Total equity and reserves as reported under IFRS		3,133	2,971

Explanations

Discontinued life
Adjustments relating to discontinued life operations primarily relate to contracts reclassified to investments, valuation differences taken to funds for future appropriations and mid to bid adjustments. This caused an increase in the life profit of £10m for the year ended 31 December 2004. The impact on equity was to increase shareholder funds by £9m at 1 January 2004. There was no adjustment at 31 December 2004 as the life operations were disposed of during the year. All other adjustments below relate to continuing business.
Insurance contracts reclassified to financial instruments
Under IFRS, insurance contracts that do not contain an element of insurance risk are either classified as investment contracts if considered as such or as derivatives. Derivative contracts are marked to market on the Balance Sheet with the movement in the fair value taken through the Income Statement. At 31 December 2004 the impact of reclassifying certain contracts previously classified as insurance contracts was to increase the pre tax profit for the year by £42m and decrease equity and reserves by £93m pre tax.
Investment return
Under UK GAAP, investment income comprises dividend income from equities, income on bonds based on accrued interest, rental income on properties, interest accrued on deposits and realised and unrealised gains and losses on investments.

Under IFRS, investment return comprises dividend income from equities, income from bonds, rental income and unrealised gains from properties, realised gains and losses and associated impairment charges. Income on bonds is based on the effective interest rate method whereby any discount or premium is amortised over the life of the security. Unrealised movements, other than those relating to investment property, are taken directly to equity. Under IFRS, available for sale securities are tested for impairment and impairment losses are recognised in the Income Statement. The impact of the change in treatment of the investment return was to decrease the pre tax profit for the year ended 31 December 2004 by £69m.
Equalisation provisions
Under UK GAAP, equalisation provisions are established for future catastrophe and other unusual losses. Under IFRS, such losses are not provided for until incurred. The adjustment reflects the reversal of the equalisation provisions which resulted in an increase of £37m in the pre tax profit for the year ended 31 December 2004 and a pre tax increase of £356m in the equity at 31 December 2004.
Internal software costs capitalised
Under UK GAAP, the costs of software development are predominantly expensed as incurred. Under IFRS, these costs are capitalised and amortised over the useful life of the software, normally being three years. The impact is an increase of £21m in the pre tax profit for the year ended 31 December 2004 and a pre tax increase of £39m in the equity and reserves at 31 December 2004.
Foreign exchange
Under UK GAAP, income and expenses of foreign entities are translated using the closing exchange rate. Under IFRS, income and expenses are translated at the average rate of exchange.

On debt securities and other interest bearing available for sale investments, the changes in fair value due to foreign exchange movements are recognised in the Income Statement. The impact of this adjustment is to decrease the pre tax profit for the year ended 31 December 2004 by £32m.
Reversal of amortisation of goodwill
Amortisation of goodwill is not permitted under IFRS. This adjustment of £11m represents the reversal of goodwill amortised under UK GAAP during the year ended 31 December 2004.
Loan capital interest
Under UK GAAP, the financial statements reflect an accrual or prepayment for the interest accrued on derivatives hedging loan capital interest. Under IFRS, this accrual or prepayment is reversed and the fair value of the derivative contracts is reflected in the financial statements. At 31 December 2004 the impact was an increase in the pre tax profit for the year of £3m.
Subordinated guaranteed perpetual notes
Under UK GAAP, the subordinated guaranteed perpetual notes issued during 2004 are classified as a liability. As described in note 19, IFRS requires the perpetual notes to be classified as equity and the interest payments to be recognised directly in equity. The impact of this adjustment is to increase the pre tax profit for the year by £14m and to increase equity and reserves by £444m.
Deferred tax
Deferred tax is recognised under UK GAAP on all timing differences, whereas under IFRS deferred tax is recognised on temporary differences. Further, under UK GAAP, deferred tax balances are discounted whereas under IFRS, no allowance is made for the time value of money in calculating for the deferred tax provisions. The adjustments relate to both the change in basis in the calculation of deferred tax and the deferred tax impact of other IFRS adjustments made that affect the loss for the period. The impact of changes to deferred tax is to increase the loss for the year ended 31 December 2004 by £8m and to increase equity and reserves by £31m at that date.
Pensions
Under UK GAAP, the cost of providing pension benefits was accounted for over the employees’ working lives on a systematic basis as advised by qualified actuaries. Under IFRS the Income Statement charge comprises the current service cost, past service cost, interest cost, the impact of any curtailment or settlements in the period and the expected return on plan assets. There was no material impact on the loss for the year ended 31 December 2004.

Under UK GAAP, the accrual or prepayment included on the Balance Sheet represents the difference between the expenses charged in the Income Statement and the cash paid into the scheme. Under IFRS, the full pension asset or deficit is carried on the Balance Sheet. The impact of this adjustment at 31 December 2004 is a pre tax decrease in equity and reserves of £759m.
Dividends
Under UK GAAP, all dividends relating to an accounting period that are proposed up to the date of the approval of the financial statements by the Board of Directors are accrued in that accounting period. Under IFRS, only dividends approved during the year are accrued. The adjustment reflects the impact of reversing the proposed dividends, which at 31 December 2004 was £86m.
Other
Other includes the impact of adjustments relating to the determination of the fair value of an asset using bid price (mid market price under UK GAAP) and other miscellaneous adjustments.

Cashflow reconciliation for year ended 31 December 2004

The Group’s consolidated Cashflow Statements are presented in accordance with IAS 7 ‘Cashflow Statements’. The statements present substantially the same information as that required under UK GAAP as required by UK Financial Reporting Standard 1, as revised, with the exception that the UK GAAP Cashflow Statements and related notes excludes the cashflows of the Group’s life insurance funds. Under IFRS these cashflows are required to be presented. These are presented as discontinued activities.

Under UK GAAP, the Group’s cash comprises cash at bank. Under IFRS, cash and cash equivalents include cash and short term investments with original maturities of three months or less. In addition, under UK GAAP, cashflows are presented for operating activities, returns on investments and servicing of finance, taxation, capital expenditure and financial investment, acquisitions and disposals, equity dividends paid, management of liquid resources and financing. IFRS requires the classification of cashflows as resulting from operating, investing and financing activities. Cashflows from capital expenditure and financial investment, acquisitions and disposals, shown separately under UK GAAP, are included as part of the investing activities under IFRS. The payment of dividends to shareholders is included as a financing activity under IFRS.

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2. Net investment return

A summary of the gross investment income, net realised and net unrealised gains/(losses) included in the Income Statement is given below.

	Investment Income		Net realised gains/(losses)		Net unrealised gains/(losses)		Impairments		Total investment return
	2005 £m	2004 £m	2005 £m	2004 £m	2005 £m	2004 £m	2005 £m	2004 £m	2005 £m	2004 £m
Investment property	11	18	43	38	27	9	–	–	81	65
Equity securities	59	58	128	21	–	–	(5)	(16)	182	63
Debt securities	454	389	35	48	–	–	–		489	437
Other investments:
Loans secured by mortgages	2	5	–	–	–	–	–	–	2	5
Other loans	4	3	–	–	–	–	–	–	4	3
Other	12	19	5	6	–	–	–	–	17	25
Deposits, cash and cash equivalents	61	59	–	–	–	–	–	–	61	59
Derivatives	–	–	(21)	–	(9)	(1)	–	–	(30)	(1)
Net investment return	603	551	190	113	18	8	(5)	(16)	806	656

Unrealised capital gains and losses recognised directly in equity for available for sale assets.

	Net unrealised gains/(losses)		Net realised gains transferred to Income Statement		Impairments transferred to Income Statement		Net movement recognised in equity
	2005 £m	2004 £m	2005 £m	2004 £m	2005 £m	2004 £m	2005 £m	2004 £m
Equity securities	186	56	(128)	(21)	5	16	63	51
Debt securities	(48)	11	(35)	(48)	–	–	(83)	(37)
Other	9	7	(5)	(6)	–	–	4	1
Total	147	74	(168)	(75)	5	16	(16)	15

Investment property income

Rental income during the year amounted to £11m (2004: £25m). Direct operating expenses (including repairs and maintenance) arising from investment properties were not material in 2005 and 2004.

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3. Net claims and benefits

	2005 £m	2004 £m
Gross claims paid	5,225	6,004
Gross changes in insurance contract liabilities for claims	(774)	(188)
Reinsurance recoveries on loss and loss expenses paid	(1,251)	(1,608)
Reinsurers’ share of change in insurance contract liabilities for claims	395	53
Net claims and benefits	3,595	4,261

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4. Profit before tax

The following items have been included in arriving at the profit before tax:

Other operating income
	2005 £m	2004 £m
Other income	103	66
Net gains on derivatives	8	75
Other operating income	111	141

Other operating expenses
	2005 £m	2004 £m
Administration and other expenses	102	99
Reorganisation expenses	86	118
Investment expenses and charges	46	58
Amortisation and impairment of intangible assets	17	22
Foreign exchange losses/(gains)	1	(6)
Other operating expenses	252	291

The operating lease payments recognised as an expense during the year were £65m (2004: £74m).

Finance costs
	2005 £m	2004 £m
Interest expense on loan capital	79	53
Other loan interest	26	21
Other finance costs	2	1
Finance costs	107	75

Auditors’ remuneration
	2005 £000	2004 £000
Audit of Group Accounts
PricewaterhouseCoopers LLP	3,234	2,515
Other	–	308
	3,234	2,823
Other statutory audit
PricewaterhouseCoopers LLP	757	1,035
Other	44	47
	801	1,082
	4,035	3,905

Remuneration for audit includes £16,000 (2004: £16,000) in respect of the Parent Company.

Non audit fees of £3,548,000 (2004: £2,803,000) in the UK during the year were payable to PricewaterhouseCoopers LLP. Of these £2,010,000 (2004: £1,267,000) were for assurance services, £299,000 (2004: £482,000) were for tax advisory services and £1,239,000 (2004: £1,054,000) were for other non audit services.

Directors’ emoluments

The aggregate emoluments of the directors, including amounts received from subsidiaries, were as follows:

	2005 £000	2004 £000
Emoluments of executive directors	4,056	2,427
Fees and other payments to non-executive directors	481	433
	4,537	2,860

A pension payment of £22,953 (2004: £22,650) was paid by a subsidiary to a former director in respect of services other than as a director.

Details of directors’ remuneration and pension benefits, including that of the highest paid director (Andy Haste), are included in the Directors’ Emoluments. Details of directors’ interests in the Parent Company are shown in the Directors’ Interests.

Employee information

Staff costs for all employees comprise:

	2005 £m	2004 £m
Wages and salaries	668	669
Social security costs	50	52
Pension costs	(93)	130
Share based payments to directors and employees	9	4
	634	855

Pension costs in 2005 include a one off benefit of £180m due to the change in pension scheme design.

The average number of employees of the Group during the year was as follows:

	2005 Number	2004 Number
UK	10,781	11,870
Scandinavia	6,709	7,298
International	6,036	6,365
US	1,766	2,822
	25,292	28,355

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5. Income tax expense

The tax amounts charged in the Income Statement are as follows:

	2005 Number	2004 Number
Current tax	(17)	115
Deferred tax	277	(27)
Taxation attributable to the Group	260	88
Share of taxation attributable to associates	–	4

UK corporation tax is calculated at 30% (2004: 30%) of the estimated assessable profit for the year. Since the Group operates around the world, it is subject to income taxes in many different tax jurisdictions. Taxation for other jurisdictions is calculated at the rates prevailing in those jurisdictions. Of the above taxation attributable to the Group £176m (2004: £34m) relates to UK corporation tax and £84m (2004: £54m) to overseas taxation.

	2005 Number	2004 Number
Profit before tax	865	35
Tax at the UK rate of 30% (2004: 30%)	260	10
Tax effect of:
Income not taxable	(41)	(44)
Expenses not deductible for tax purposes	13	37
Tax losses not recognised	25	120
Adjustment for prior year provisions	18	(24)
Different tax rates of subsidiaries operating in other jurisdictions	(15)	(11)
Income tax expense	260	88

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6. Earnings per share attributable to the equity holders of the Parent Company

The earnings per ordinary share is calculated by reference to the profit/(loss) attributable to the equity shareholders and the weighted average of shares in issue during the year.

Basic

Basic earnings per share is calculated by dividing the profit/(loss) attributable to equity holders of the Parent Company by the weighted average number of ordinary shares in issue during the period, excluding ordinary shares purchased by the Parent Company and held as treasury shares.

	Continuing operations		Discontinued operations
	2005 £m	2004 £m	2005 £m	2004 £m
Profit/(loss) attributable to equity holders of the Parent Company	555	(98)	–	(27)
Less: Interest on subordinated guaranteed perpetual notes (net of tax)	–	(10)	–	–
Less: Cumulative preference dividends	(9)	(9)	–	–
Profit/(loss) for the calculation of earnings per share	546	(117)	–	(27)
Weighted average number of ordinary shares in issue (thousands)	2,896,059	2,872,090	2,896,059	2,872,090
Basic earnings per share (p)	18.9	(4.1)	–	(0.9)

Diluted

Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares outstanding to assume conversion of all dilutive potential ordinary shares.

The Parent Company has only one category, share options, of dilutive potential ordinary shares.

The calculation is performed for the share options to determine the number of shares that could have been acquired at fair value (determined as the average annual market share price of the Parent Company’s shares) based on the monetary value of the subscription rights attached to outstanding share options. The number of shares calculated as above is compared with the number of shares that would have been issued assuming the exercise of the share options.

	Continuing operations		Discontinued operations
	2005 £m	2004 £m	2005 £m	2004 £m
Profit/(loss) for the calculation of earnings per share	546	(117)	–	(27)
Weighted average number of ordinary shares in issue (thousands)	2,896,059	2,872,090	2,896,059	2,872,090
Adjustments for share options (thousands)	17,445	–	17,445	–
Weighted average number of ordinary shares for diluted earnings per share (thousands)	2,913,504	2,872,090	2,913,504	2,872,090
Diluted earnings per share (p)	18.7	(4.1)	–	(0.9)

The number of contingently issuable shares that could potentially dilute basic earnings per share in the future, but were not included in the calculation of diluted earnings per share because they are antidilutive for the period, are nil (2004: 8.2million).

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