2 SUPPLEMENTARY OPERATING PROFIT INFORMATION.


(i) Reconciliation between operating profit and profit from ordinary activities after income tax

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Notes

2011
£m

2010
£m

1.

Investment projects predominantly relates to [Solvency II] and other strategic investments.

From continuing operations

 

 

 

Risk

(ii)(a)

561

560

Savings

(iii)(a)

128

115

Investment management

(iv)

234

206

International

(v)

137

102

Group capital and financing

(vi)

52

58

Investment projects1

 

(56)

(39)

Operating profit

 

1,056

1,002

Asset related investment variances

 

(2)

185

Other investment variances

 

(95)

(95)

Variation from longer term investment return

(vii)

(97)

90

Property losses attributable to non-controlling interests

 

(3)

Profit before income tax attributable to equity holders of the Company

 

956

1,092

Tax expense attributable to equity holders of the Company

12

(233)

(272)

Profit for the year

 

723

820

This supplementary operating profit information (one of the Group’s [key performance indicators]) provides further analysis of the results reported under [IFRS] and we believe gives shareholders a better understanding of the underlying performance of the business.

Operating profit for the Risk segment represents the profit from the annuities business (individual and [bulk purchase annuities] and longevity insurance) and the profit from the housing and protection businesses (general insurance, and individual and group protection business). Operating profit reflects the investment returns that the business expects to make on the financial investments that back this business and on shareholder funds retained within our general insurance business.

Operating profit for the Savings segment represents the profit from the insured Savings businesses (non profit investment bonds and non profit pensions (including [SIPPs])), the with-profits transfer and the profit of our Savings investments business. Operating profit for the insured savings business reflects the investment returns that the business expects to make on the financial investments that back this business.

Operating profit for the Investment management and International segments includes a longer term expected investment return on the shareholders’ funds within the Investment management and LGN operations.

Investment return on Group capital incorporates a longer term expected investment return using longer term investment return assumptions applied to the average balance of Group invested assets (including interest bearing intra-group balances) calculated on a monthly basis. Profits or losses arising from actuarial movements on annuities held by the Group’s defined benefit pension schemes are excluded from operating profit. Profits or losses arising on the elimination of own debt holdings are also excluded from operating profit.

(ii) Risk

(a) Risk operating profit

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Notes

2011
£m

2010
£m

1.

The prior year annuities result includes a one-off benefit of £72m resulting from inflation modelling enhancements (see Note (ii)(d)) and an additional £25m in positive [new business strain].

2.

The protection result includes a £23m positive expense assumption change (see Note (ii)(d)) reflecting lower unit costs due to efficiency improvements.

3.

The current year result reflects the benign weather experienced during the year, with actual experience being below the long term expectations. The prior year general insurance result was impacted by two severe cold weather events, which resulted in approximately £30m of additional weather related claims (see Note (ii)(f)).

Annuities1

 

287

364

Protection2

 

242

207

General insurance3

(ii)(f)

42

(8)

Other

 

(10)

(3)

Total Housing and Protection

 

274

196

Total Risk operating profit

(ii)(b)

561

560

(b) Analysis of Risk operating profit

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Notes

Annuities
2011
£m

Housing and Protection
2011
£m

Total
2011
£m

Annuities
2010
£m

Housing and Protection
2010
£m

Total
2010
£m

Risk business segment operating profit comprises:

 

 

 

 

 

 

 

[Operational cash generation]

 

227

255

482

229

210

439

New business strain

 

35

(66)

(31)

60

(70)

(10)

[Net cash generation]

 

262

189

451

289

140

429

Experience variances

(ii)(c)

 

 

22

 

 

67

Changes to valuation assumptions

(ii)(d)

 

 

24

 

 

30

Movements in non-cash items

(ii)(e)

 

 

(86)

 

 

(122)

Other

 

 

 

 

 

(1)

 

 

 

 

411

 

 

403

Tax gross up

 

 

 

150

 

 

157

Total Risk operating profit

 

 

 

561

 

 

560

The annuities and protection (non profit business) operational cash generation represents the expected surplus to be generated in the period from the in-force non profit business which is broadly equivalent to the expected release of profit from the non profit Risk business using best estimate assumptions. The experience variances are calculated with reference to embedded value assumptions, including the apportionment of investment return and tax in the [EEV] model.

Both new business strain and operational cash generation exclude required solvency margin from the liability calculation as required by the ABI SORP.

An analysis of the experience variances, valuation assumption changes and non-cash items, all net of tax, is provided below:

(c) Experience variances

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2011
£m

2010
£m

1.

Mortality/morbidity in 2011 primarily relates to the group protection experience in H1 2011, driven by a number of high value claims. This has trended back to assumptions in H2 2011, and the total impact for the year was £35m.

2.

This principally relates to the utilisation of brought forward tax losses.

Persistency

(4)

(3)

Mortality/morbidity1

(32)

(8)

Expenses

(2)

(1)

Bulk purchase annuity data loading

42

59

Project and development costs

(7)

(9)

Tax2

33

37

Other

(8)

(8)

 

22

67

(d) Changes to valuation assumptions

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2011
£m

2010
£m

1.

Expenses in 2011 relates to efficiency improvements in protection and annuities leading to lower unit costs. 2010 related to a change in the reserving basis for custodian fees.

2.

Prior year Other reflects the £72m benefit from inflation modelling enhancement on the annuity business.

Persistency

(1)

(5)

Mortality/morbidity

(1)

(19)

Expenses1

28

(9)

Other2

(2)

63

 

24

30

(e) Movements in non-cash items

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2011
£m

2010
£m

Deferred tax

(77)

(125)

Other

(9)

3

 

(86)

(122)

(f) General insurance operating profit/(loss)

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Net cash
generation
2011
£m

Tax
2011
£m

Operating
profit
2011
£m

Net cash
generation
2010
£m

Tax
2010
£m

Operating
profit
2010
£m

1.

The current year result reflects the benign weather experienced during the year, with actual experience being below long term expectations. The prior year general insurance result was impacted by two severe cold weather events, which resulted in approximately £30m of additional weather related claims.

Household1

27

10

37

(10)

(4)

(14)

Other business

4

1

5

4

2

6

 

31

11

42

(6)

(2)

(8)

(g) General insurance underwriting result

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2011
£m

2010
£m

1.

The current year result reflects the benign weather experienced during the year, with actual experience being below long term expectations. The prior year general insurance result was impacted by two severe cold weather events, which resulted in approximately £30m of additional weather related claims.

Household1

23

(27)

Other business

4

5

 

27

(22)

(h) General insurance combined operating ratio

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2011
%

2010
%

1.

The current year result reflects the benign weather experienced during the year, with actual experience being below long term expectations. The prior year general insurance result was impacted by two severe cold weather events, which resulted in approximately £30m of additional weather related claims.

Household1

90

109

Other business

75

77

 

88

106

(iii) Savings

(a) Savings operating profit

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Note

2011
£m

2010
£m

1.

Savings investments operating profit includes £34m (2010: £29m) from our mutual funds business and the results from our structured SIPPs and platform businesses.

2.

Insured savings includes non profit investment bonds and pensions (including workplace savings and SIPPs), Nationwide Life Savings business and International (Ireland).

3.

With-profits business operating profit is the shareholders’ share of total with-profits bonuses.

Savings investments1

 

23

21

Insured savings2

 

36

31

With-profits3

 

69

63

Total Savings operating profit

(iii)(b)

128

115

(b) Analysis of Savings operating profit

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Notes

Insured
savings
2011
£m

With-profits
2011
£m

Savings
investments
2011
£m

Total
2011
£m

1.

Insured savings net cash generation of £38m (2010: £1m) reflects the benefit of higher fees on higher opening asset values coupled with continued expense savings and commission savings resulting in a lower new business strain.

Savings business segment operating profit comprises:

 

 

 

 

 

Operational cash generation

 

101

51

22

174

New business strain

 

(63)

(63)

Net cash generation1

 

38

51

22

111

Insured savings

 

 

 

 

 

Experience variances

(iii)(c)

 

 

 

(12)

Changes to valuation assumptions

(iii)(d)

 

 

 

(5)

Movements in non-cash items

(iii)(e)

 

 

 

6

Other

 

 

 

 

Savings investments

 

 

 

 

 

Movements in non-cash items and other

 

 

 

 

(6)

 

 

 

 

 

94

Tax gross up

 

 

 

 

34

Total Savings operating profit

 

 

 

 

128

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Notes

Insured
savings
2010
£m

With-profits
2010
£m

Savings
investments
2010
£m

Total
2010
£m

Savings business segment operating profit comprises:

 

 

 

 

 

Operational cash generation

 

71

46

21

138

[New business strain]

 

(70)

(70)

Net cash generation

 

1

46

21

68

Insured savings

 

 

 

 

 

Experience variances

(iii)(c)

 

 

 

10

Changes to valuation assumptions

(iii)(d)

 

 

 

28

Movements in non-cash items

(iii)(e)

 

 

 

(21)

Other

 

 

 

 

4

Savings investments

 

 

 

 

 

Movements in non-cash items and other

 

 

 

 

(9)

 

 

 

 

 

80

Tax gross up

 

 

 

 

35

Total Savings operating profit

 

 

 

 

115

The insured savings [operational cash generation] represents the expected surplus generated in the period from the in-force investment bonds and pensions business (non profit Savings) which is broadly equivalent to the expected release of profit from non profit savings business using best estimate assumptions and the IFRS profit after tax of the Nationwide Life Savings business and International (Ireland). The experience variances are calculated with reference to embedded value assumptions, including the apportionment of investment return and tax in the EEV model.

Both new business strain and operational cash generation exclude required solvency margin from the liability calculation as required by the ABI SORP.

An analysis of the experience variances, valuation assumption changes and non-cash items, all net of tax, is provided below:

(c) Experience variances

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2011
£m

2010
£m

1.

The 2011 project and development costs related to auto-enrolment £7m, expenditure on distribution channel enhancements of £2m and other costs of £3m.

Persistency

(1)

(3)

Mortality/morbidity

2

1

Expenses

1

3

Project and development costs1

(12)

(4)

Tax

(4)

14

Other

2

(1)

 

(12)

10

(d) Changes to valuation assumptions

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2011
£m

2010
£m

1.

In 2010, Other assumption changes includes £12m from the recognition of the benefit of tax exempt UK dividend income.

Persistency

(2)

Mortality/morbidity

1

2

Expenses

(2)

3

Other1

(2)

23

 

(5)

28

(e) Movements in non-cash items

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Note

2011
£m

2010
£m

Deferred tax

 

(6)

(39)

Deferred acquisition costs (DAC)

(iii)(f)

(20)

(16)

Deferred income liabilities (DIL)

 

27

33

Other

 

5

1

 

 

6

(21)

(f) Deferred acquisition cost movement, net of associated deferred tax

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2011
£m

2010
£m

As at 1 January

612

628

Amortisation through income

(74)

(66)

Acquisition costs deferred

54

50

As at 31 December

592

612

The Group’s balance sheet deferred acquisition costs of £2.1bn (2010: £2.0bn) is presented gross of associated deferred tax. The main contributors to the balance are LGA £1.0bn (2010: £1.0bn), non profit savings of £0.7bn (2010: £0.7bn), retail investments £0.1bn (2010: £0.1bn), savings with-profit £0.1bn (2010: £0.1bn) and other business totalling £0.2bn (2010: £0.1bn).

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Expected amortisation profile:

2011
£m

2010
£m

Expected to be amortised within one year

65

69

Expected to be amortised between one year and five years

271

276

Expected to be amortised in over five years

256

267

 

592

612

(iv) Investment management

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2011
£m

2010
£m

1.

Other non-pension includes institutional segregated mandates, private equity and property (both in the UK and overseas). Interest income on shareholder funds of £9m (2010: £11m) on an average asset balance of £0.40 bn (2010: £0.37bn) has been included within other non-pension operating profit.

Pension funds (managed and segregated)

172

148

Other non-pension1

25

20

Investment management services for internal funds

37

38

Total Investment management operating profit

234

206

(v) International

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2011
£m

2010
£m

1.

Other includes our joint venture operations in Egypt, the Gulf, India and divisional overhead costs of £5m (2010: £5m).

2.

In the year, the International division paid £51m (2010: £44m) of sustainable dividends to the Group, which has been included in net cash generation. In addition, the LGN business paid a special dividend of £29m and the LGA business remitted a further £52m of capital representing the repatriation of profits in 2010 from the redemption of external debt during the first quarter of 2011. These amounts have been excluded from the Group’s [net cash generation].

USA (LGA)

104

85

Netherlands (LGN)

21

20

France (LGF)

20

6

Total Europe operating profit

41

26

Other1

(8)

(9)

Total International operating profit2

137

102

Exchange rates are provided in Note 11.

(vi) Group capital and financing

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2011
£m

2010
£m

1.

The increase in the average Group capital and financing assets has resulted in an increase in the smoothed investment return to £191m (2010: £187m). The smoothed investment return is calculated asset class by asset class and equates to an average smoothed investment return of 4.7% (2010: 5.8%) on the average balance of invested assets of £4.0bn (2010: £3.2bn). In GCF, the rate used to calculate the smoothed return on cash and LIBOR benchmarked bonds has been reduced. The cash rate previously used of 4% has been replaced with a 1 year LIBOR of 1%. This ensures our operating profit and cash metric maintains relevance in current macroeconomic conditions. This change has reduced operating profit by £52m, with an opposite impact on investment variance, and operational cash generation by £38m. It is our intention to continue with this prudent view in 2012.

2.

Interest expense excludes interest on non recourse financing (see Note 35).

Investment return1

191

187

Interest expense2

(123)

(121)

Investment expenses

(5)

(3)

Unallocated corporate expenses

(11)

(5)

Total Group capital and financing operating profit

52

58

(vii) Variation from longer term investment return

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2011
£m

2010
£m

1.

The positive investment variance has increased to £172m (2010: £102m). The contributing factors are: improved asset diversity which increased the risk adjusted yield, for example, sale and leaseback; no defaults in the portfolio; improved asset liability matching, for example, reinvestment into longer duration bonds; more efficient cash management and small one-off benefits from tax and interest rate movements.

2.

The positive Savings asset related investment variance was driven by movements in the gilt portfolio backing non-linked reserves.

3.

The International investment variance has arisen in LGN. The variance is caused by temporary timing differences in the valuation of the assets against the liabilities on the index linked margin business. The variance should be broadly neutral over the longer term.

4.

The GCF asset related investment variance was primarily driven by a fall in equity markets which contributed £(139)m to the adverse investment variance. In GCF, the rate used to calculate the smoothed return on cash and LIBOR benchmarked bonds has been reduced. The cash rate previously used of 4% has been replaced with a 1 year LIBOR of 1%. This ensures our operating profit and cash metric maintains relevance in current macroeconomic conditions. This change has reduced operating profit by £52m, with an opposite impact on investment variance, and operational cash generation by £38m. It is our intention to continue with this prudent view in 2012.

5.

Savings business other investment variance is primarily the difference between IFRS deferred policyholder tax and the amount included within the unit linked life funds.

6.

Treasury related investment variance relates to derivative contracts which have not been designated within hedge accounting relationships resulting in short term income statement volatility which, in 2011, resulted in a decrease in the relevant long term interest rates.

7.

The defined benefit pension scheme investment variance includes the actuarial gains and losses and valuation difference arising on annuity assets held by the defined benefit pension schemes that have been purchased from Legal & General Assurance Society Limited.

Risk1

172

102

Savings2

13

4

Investment management

(7)

(8)

International3

(21)

35

GCF asset related4

(159)

52

Asset related investment variances

(2)

185

Savings other investment variance5

(47)

(58)

Treasury related6

(68)

(72)

Defined benefit pension scheme7

20

35

Other investment variances

(95)

(95)

Total variation from longer term investment return

(97)

90

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