Risk management.

Changes in regulation or legislation may have a detrimental effect on our strategy or profitability.
Regulation defines the overall framework for the design, marketing and distribution of our products; the acceptance and administration of business; and the prudential capital that we hold. Current areas of significant regulatory change include Solvency II and the Retail Distribution Review. In addition to these known areas of change, there remains potential for new regulation in response to recent market events as well as possible changes in the regulatory landscape following the 2010 general election.

Legislation and government fiscal policy can also influence our product design, the retention of existing business and our required reserves for future liabilities. Areas of new insurance law include that being developed by the Law Commission. Potential changes to personal and corporate taxation also present uncertainty with respect to the profitability and continued attractiveness of our products.

The Group bases its business strategy upon prevailing regulation and legislation, and known/anticipated change. To mitigate the risk of legislation or regulation adversely impacting the sectors in which we operate, the Group seeks to engage with regulatory and legislative authorities to assist in the evaluation of change and develop outcomes that meet the needs of all stakeholders.

Investment market performance or conditions in the broader economy may adversely impact our results.
The Group holds a broad range of investment assets to meet the obligations arising from writing insurance business. The performance and liquidity of investment markets, interest rate movements and inflation can impact the value of these assets as well as the value of the underlying obligations. The income derived by our investment management activities can also be impacted by significant falls in investment asset values, whilst broader economic conditions can influence the purchase by customers of retail financial services products and how long they are retained. Whilst 2009 has seen a recovery of major markets from their position in 2008, broader economic conditions remain less certain, with possible consequences to investment values. Investment markets may also suffer considerable disruption should a significant macro-economic event, for example a sovereign debt crisis, occur within a developed world economy.

The Group seeks to reduce the impact of these risks through ensuring the profile of cash flows of our assets and liabilities are appropriately matched. Matching techniques include using financial instruments as part of formal risk management strategies to reduce volatility in returns from investment assets, the effect of changes in interest rates and inflation, and the broader effects of adverse market conditions. We seek to reduce the impact of market and economic conditions upon our investment businesses through the utilisation of a low cost scalable business model and by maintaining a diversified portfolio of products.

In dealing with issuers of debt and other types of counterparty, the Group is exposed to the risk of default.
As part of our strategies to appropriately match long term assets and liabilities, exposures can arise to the issuers of corporate debt and other financial instruments.
As part of our day to day business we also have exposures to banking, money market and reinsurance counterparties, as well as the providers of investment settlement and custody services. Third party risks also arise through reliance upon external suppliers for certain administration and IT development services.

Recent market events have demonstrated the importance of sound counterparty management. In this context the Group seeks to limit the potential exposure to loss from counterparty and third party failure through setting robust selection criteria and exposure limits covering factors such as counterparty financial strength, sectors and geography. Exposures against limits are actively monitored, with trigger levels being set and management action being taken to pre-empt loss from default events.

As a UK based Group, earnings are influenced by the perception of the UK financial services sector as a whole.
Factors such as investment market performance, actions by regulators against organisations operating in the sector and shock events, including matters such as significant market failures, can impact the confidence of retail investors in the sector as a whole and their purchase or retention of financial service products.

2009 has seen a general downturn in business volumes across the sectors in which the Group operates. We continue to seek to differentiate our business model from that of our competitors. This includes a diversified portfolio of risk, savings and investment management businesses in the UK, further details of which are set out in the What We Do section, and a broad distribution mix. In addition, as set out in the International section, we are focused on developing our international businesses, with joint ventures in India and the Gulf being established in 2009, complementing our existing portfolio of overseas activities, as well as our investment management business winning its first mandates in the US.

Revisions to assumptions may require adjustments to reserves.
The writing of long term insurance business necessarily requires the setting of assumptions for long term trends in factors such as mortality, persistency, valuation interest rates and credit defaults. The writing of household insurance business also requires assumptions to be set for factors such as extreme weather and other catastrophic events. Whilst a prudent approach is taken to evaluating required reserves for these risks, extreme events, such as a rapid advance in medical science leading to significantly enhanced annuitant longevity or an event causing widespread mortality/morbidity, coupled with a reinsurer default may require assumptions to be recalibrated impacting profitability and capital.

The Group uses its pricing capabilities and the significant experience data it has accumulated to assess and charge an appropriate premium for known risk factors, and to ensure that reserves remain appropriate on an ongoing basis. The evaluation of reserves is supported by stress and scenario testing which seeks to validate the appropriateness of key assumptions to combinations of extreme events, including economic conditions, investment performance and product specific matters.

The Group may not maximise opportunities from structural changes within the financial services sector.
The financial services sector is going through a period of change and consolidation. This presents a range of challenges as well as opportunities to providers of sufficient scale such as Legal & General. Recent examples have included the merger of banks and building societies resulting in a change to the distribution landscape. The emergence of niche product providers with new business models continues to drive innovation within a number of the sectors in which the Group operates.

We seek to ensure it has market leading expertise in the core fields in which it operates, and actively focuses on retaining the best personnel with the knowledge to design and support our products, and manage their evolution as market and consumer expectations change. In response to consolidation by banks and building societies, we have established a number of new distribution partnerships. Within our annuities business, a disciplined and selective approach to pension buyout business was maintained throughout 2009, and whilst we continue to lead in the traditional smaller schemes bulk purchase market, increased product and pricing sophistication and increased distribution opportunities helped individual annuities sales to grow. Our savings business has seen a transformation of the mix of products sold towards more modern, less capital intensive offerings.