UK assumptions
The assumed future pre-tax returns on fixed interest and [RPI] linked securities are set by reference to the portfolio yield on the relevant backing assets held at market value at the end of the reporting period. The calculated return takes account of derivatives and other credit instruments in the investment portfolio. Indicative yields on the total portfolios, after allowance for long term default risk, are shown below.
For annuities, separate returns are calculated for new and existing business.
Where cash balances are held at the reporting date in excess of or below strategic investment guidelines, then it is assumed that these cash balances are immediately invested, or disinvested at current yields.
Where interest rate swaps are used to reduce risk, it is assumed that these swaps will be sold before expiry and the proceeds reinvested in corporate bonds with a redemption yield 0.70% p.a. (0.70% p.a. at 31 December 2008) greater than the swap rate at that time (i.e. the long term credit rate).
Additionally where reinvestment or disinvestment is necessary to rebalance the asset portfolio in line with projected outgo, this is also assumed to take place at the long term credit rate above the swap rate at that time.
The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account of the credit rating, outstanding term of the securities and increase in credit defaults over the short term. The allowance expressed as a level rate deduction from the expected returns was 40bps at 31 December 2009 (32bps at 31 December 2008).
Economic assumptions
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31.12.2009 |
31.12.2008 | ||
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Equity risk premium |
3.5 |
3.5 | ||
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Property risk premium |
2.0 |
2.0 | ||
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Investment return |
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– Gilts: |
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– Fixed interest |
4.0 |
3.8 | ||
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– RPI linked |
4.5 |
3.7 | ||
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– Non gilts: |
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– Fixed interest |
4.4 – 6.2 |
4.2 – 8.2 | ||
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– RPI linked |
5.1 – 6.1 |
4.7 – 5.9 | ||
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– Equities |
8.0 |
7.3 | ||
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– Property |
6.5 |
5.8 | ||
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Risk free rate1 |
4.5 |
3.8 | ||
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Risk margin |
3.5 |
4.5 | ||
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Risk discount rate (net of tax) |
8.0 |
8.3 | ||
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Inflation |
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– Expenses/earnings |
4.6 |
3.6 | ||
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– Indexation |
3.6 |
2.6 | ||
UK covered business
i. Assets are valued at market value.
ii. Future bonus rates have been set at levels which would fully utilise the assets supporting the policyholders’ portion of the with-profits business. The proportion of profits derived from with-profits business allocated to shareholders has been assumed to be 10% throughout.
iii. The value of in-force business reflects the cost, including administration expenses, of providing for benefit enhancement or compensation in relation to certain products.
iv. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses (excluding the development costs referred to below). These are normally reviewed annually.
An allowance is made for future improvements in annuitant mortality based on experience and externally published data. Male annuitant mortality is assumed to improve in accordance with CMI Working Paper 30, projection [MC], with a minimum annual improvement of 1.5% for future experience, and 2.0% for statutory reserving. Female annuitant mortality is assumed to improve in accordance with 75% of projection MC, with a minimum annual improvement of 1.0% for future experience and 1.5% for statutory reserving. In each case, the annual improvement is assumed to reduce linearly after age 89 to zero at age 120.
On this basis, the best estimate of the expectation of life for a new 65 year old Male CPA annuitant is 24.5 years (31.12.2008: 25.2 years). The expectation of life on the regulatory reserving basis is 25.7 years (31.12.2008: 26.4 years).
v. Development costs relate to investment in strategic systems and development capability that are charged to the covered business. Projects charged to the non-covered business are included within Investment projects in Group capital and financing.
International
vi. Key assumptions:
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31.12.2009 |
31.12.2008 |
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USA |
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Reinvestment rate |
5.1 |
5.4 |
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Risk margin |
3.5 |
4.5 |
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Risk discount rate (net of tax) |
7.4 |
6.8 |
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Europe |
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Government bond return |
3.6 |
3.5 |
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Risk margin |
3.5 |
4.5 |
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Risk discount rate (net of tax) |
7.1 |
8.0 |
vii. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses.
Tax
viii. The profits on the covered business, except for the profits on the Society shareholder capital held outside the long term fund, are calculated on an after tax basis and are grossed up by the notional attributed tax rate for presentation in the income statement. The tax rate used for grossing up is the corporate tax rate in the territory concerned, which for the UK was 28% (31.12.2008: 28%). The profits on the Society shareholder capital held outside the long term fund are calculated before tax and therefore tax is calculated on an actual basis.
