Chesnara Regulatory News (CSN)

27 Apr 2010 14:29

Chesnara plc (the 'Company') ANNUAL FINANCIAL REPORT

Financial Statements for the year ended 31 December 2009

Notice of Annual General Meeting

Form of Proxy for the Annual General Meeting

Copies of the above documents which were issued to shareholders on 12 April2010 have been submitted to the UK Listing Authority and will be available forinspection at the UK Listing Authority's Document Viewing Facility, which issituated at: The Financial Services Authority, 25 The North Colonade, CanaryWharf, London E14 5HS. The Company's Financial Statements and Notice of AnnualGeneral Meeting may also be found on its website at www.chesnara.co.uk. The Company announced its preliminary results for the year ended 31 December2009 on 31 March 2010 which included audited financial statements and a fairreview of business. The Company today provides the following additionalregulated information, included within its Financial Statements, in fullunedited text as required to be made public under the disclosure andtransparency rules.

STATEMENT OF DIRECTORS' RESPONSIBILITIES IN RESPECT OF THE FINANCIAL STATEMENTS.

The directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations.

Company law requires the directors to prepare financial statements for eachfinancial year. Under that law the directors are required to prepare the groupfinancial statements in accordance with International Financial ReportingStandards (IFRSs) as adopted by the European Union and Article 4 of the IASRegulation and have also chosen to prepare the parent company financialstatements under IFRSs as adopted by the EU. Under company law the directorsmust not approve the accounts unless they are satisfied that they give a trueand fair view of the state of affairs of the company and of the profit or lossof the company for that period. In preparing these financial statements,International Accounting Standard 1 requires that directors:

- properly select and apply accounting policies;

- present information, including accounting policies, in a manner that provides

relevant, reliable, comparable and understandable information;

- provide additional disclosures when compliance with the specific requirements

in IFRSs are insufficient to enable users to understand the impact of

particular transactions, other events and conditions on the entity's financial

position and financial performance; and

- make an assessment of the company's ability to continue as a going concern.

The directors are responsible for keeping adequate accounting records that aresufficient to show and explain the company's transactions and disclose withreasonable accuracy at any time the financial position of the company andenable them to ensure that the financial statements comply with the CompaniesAct 2006. They are also responsible for safeguarding the assets of the companyand hence for taking reasonable steps for the prevention and detection of fraudand other irregularities.

The directors are responsible for the maintenance and integrity of the corporate and financial information included on the company's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Responsibility statement

We confirm that to the best of our knowledge:

- the financial statements, prepared in accordance with International Financial

Reporting Standards, give a true and fair view of the assets, liabilities,

financial position and profit or loss of the company and the undertakings

included in the consolidation taken as a whole; and

- the management report, which is incorporated into the directors' report,

includes a fair review of the development and performance of the business and

the position of the company and the undertakings included in the consolidation

taken as a whole, together with a description of the principal risks and

uncertainties that they face.

THIS RESPONSIBILITY STATEMENT WAS APPROVED BY THE BOARD OF DIRECTORS ON 30 MARCH 2009 AND WAS SIGNED by Peter Mason, Chairman and Graham Kettleborough, Chief Executive

PRINCIPAL RISKS AND UNCERTAINTIES

The Group's management of insurance risk is a critical aspect of the business.The primary insurance activity carried out by the Group comprises theassumption of the risk of loss from persons that are directly subject to therisk. Such risks in general relate to life, accident, health and financialperils that may arise from an insurable event, with the majority of the Group'sexposure relating to mortality risk on individual lives, predominantly in theUK and Sweden. As such, the Group is exposed to the uncertainty surrounding thetiming and severity of claims under the related contracts.The Group is also exposed to a range of financial risks through its lifeassurance contracts, financial assets, financial liabilities, includinginvestment contracts and borrowings, and its reinsurance assets. In particular,the key financial risk is that in the long-term its investment proceeds are notsufficient to fund the obligations arising from its insurance and investmentcontracts. The most important components of this financial risk are market risk(interest rate risk and equity price risk), and credit risk, including the riskof reinsurer default. The Group has procedures for setting and monitoring theGroup's assets and liability position with the objective of ensuring that theGroup can always meet its obligations without undue cost and in accordance withthe Group's internal and regulatory capital requirements.Detailed information on the characteristics and management of insurance andfinancial risks borne by the Group is provided in Notes 5 and 6 respectively ofthe Company's published financial statements for the year ended 31 December2009 and included below under Management of Insurance Risk and Management ofFinancial Risk.

In addition, detailed information on accounting estimates and judgements is included in Note 3 of the Company's published consolidated financial statements for the year ended 31 December 2009 and included below under the heading Accounting Estimates and Judgements.

The significant changes in the nature and incidence of risks and uncertaintiesduring the twelve months ended 31 December 2009 relate to the acquisition on 23July 2009 of Moderna F¶rs¤kringar Liv AB, which, together with its subsidiaryand associated companies, comprises the Swedish Business. These changes ariseat both the Swedish entity and Group corporate levels, the latter principallythrough the assumption of foreign currency exchange risk, as a significantproportion of the Group's assets and liabilities are now denominated in SwedishKronor. The information set out under Accounting Estimates and Judgements,Management of Insurance Risk and Management of Finance Risk below clearlyidentifies these newly-arising risks and uncertainties. Further, in view ofrecent investment market turbulence there is continuing uncertainty as to thefuture direction of investment markets and attention is drawn particularly tothe sensitivity of the reported embedded value of the Group to the economicsensitivities set out in Note 7 to the European Embedded Value BasisSupplementary Information in the financial statements.

ACCOUNTING ESTIMATES AND JUDGEMENTS

The Group makes estimates and assumptions that affect the reported amounts ofassets and liabilities and also makes critical accounting judgements inapplying the Group's accounting policies. Such estimates and judgements arecontinually evaluated and are based on historical experience and other factors,including expectations of future events that are believed to be reasonable. Themore critical areas, where accounting estimates and judgements are made, andwhich relate variously to the UK and Swedish businesses together, or to eachseparately, are described below.

UK and Swedish Businesses

(a) Classification of long-term contracts

The Group has exercised judgement in its classification of long-term businessas between insurance and investment contracts, which fall to be accounted fordifferently in accordance with the policies set out in Note 2 SignificantAccounting Policies, in the financial statements. Insurance contracts are thosewhere significant risk is transferred to the Group under the contract andjudgement is applied in assessing whether the risk so transferred issignificant, especially with regard to pensions contracts, which arepredominantly, but not exclusively, created for investment purposes.

(b) Deferred acquisition costs and deferred income - investment contracts

The Group applies judgement in deciding the amount of direct costs that areincurred in acquiring the rights to provide investment management services inconnection with the issue of investment contracts. Judgement is also applied inestablishing the amortisation of the assets representing these contractualrights and the recognition of initial fees received in respect of thesecontracts. The assets are amortised over the expected lifetime of theinvestment management service contracts and deferred income, where applicable,is amortised over the expected period over which it is earned. Estimates areapplied in determining the lifetime of the investment management servicecontracts and in determining the recoverability of the contractual rightsassets by reference to expected future income and expense levels. This test forrecoverability is performed using best estimates of future cash flows, using amarket consistent estimate of future investment returns.As at 31 December 2009, the carrying values of deferred acquisition costs, netof amortisation, and of deferred income, in respect of the UK Business, were £7.7m and £13.1m respectively (as at 31 December 2008 £8.6m and £14.6mrespectively). An increase in the estimate of the lifetime of the investmentmanagement service contract by one year in respect of deferred acquisitioncosts would have increased profit before tax for the year ended 31 December2009 by £0.1m and shareholders' equity as at 31 December 2009 by £0.1m and anincrease of one year in the length of the amortisation period in respect ofdeferred income would have reduced profit before tax for the year ended 31December 2009 by £0.1m and shareholders' equity as at 31 December 2009 by £0.1m.As at 31 December 2009, the carrying values of deferred acquisition costs, netof amortisation, in respect of the Swedish Business, was £1.6m (as at 31December 2008 £nil). An increase in the length of the amortisation period byone year would have increased profit before tax for the year ended 31 December2009 by £0.1m and shareholders' equity as at 31 December 2009 by £0.1m.

(c) Amortisation of acquired value of in-force business

The Group applies accounting estimates and judgement in determining the fairvalue, amortisation and recoverability of acquired in-force business relatingto insurance and investment contracts. The acquired value of in-force businesshas been amortised on a basis that reflects the expected profit stream arisingfrom the business acquired at the date of acquisition. This profit stream isestimated from the experienced termination rates, expenses of management andage of the individual contract holders as well as global estimates ofinvestment growth, based on recent experience at the date of acquisition.Acquired value of in-force business is tested for recoverability by referenceto expected future income and expense levels.As at 31 December 2009, the carrying value of acquired in-force business, netof amortisation, was £24.8m in respect of the UK Business (as at 31 December2008 £28.5m) and £61.7m in respect of the Swedish Business (as at 31 December2008 £nil).

(d) Fair value of financial assets and unit-linked investments

Fair value measurement has been adopted to reduce volatility in reported earnings in the income statement as the liabilities so determined are measured in a way which is consistent with the fair value of the underlying invested financial assets.

Fair value is the amount for which an asset could be exchanged, or a liabilitysettled, between willing, knowledgeable parties in an arm's length transaction.Fair values are determined by reference to observable market prices whereavailable and reliable. UKBusiness

(a) Estimates of future benefits payments arising from long-term insurance contracts

The Group makes estimates of the expected number of deaths for each of theyears that it is exposed to risk. These estimates are based on either standardmortality tables or reinsurers' rate tables as appropriate, adjusted to reflectthe Group's own experience. For contracts without fixed terms the Group hasassumed that it will be able to increase charges to policyholders in futureyears, in line with emerging mortality experience.The Group has offered guaranteed annuity options within certain contracts.Estimates have been made of the number of contract holders who will exercisethese options, in order to measure their value. Changes in investmentconditions could result in significantly more contract holders exercising theiroptions than the Group has assumed in determining the liabilities arising fromthese contracts.The Group makes estimates of future deaths, voluntary contract terminations,investment returns and administration expenses at the inception of long-terminsurance contracts with fixed and guaranteed terms. These estimates, which arereconsidered annually, form the assumptions used to calculate the liabilitiesarising from these contracts.The assumptions used to establish insurance contract liabilities andappropriate sensitivities relating to variations in critical assumptions aredisclosed in Note 33 of the financial statements and are included in Managementof Insurance Risk below.

As at 31 December 2009, the carrying value of insurance contract liabilities was £1,044m (as at 31 December 2008 £923.5m).

(b) Fair value of investment contracts - guaranteed income and guaranteed growth bonds

The fair value of investment contract liabilities, in respect of guaranteed income and guaranteed growth bonds, (which are fully described in Note 34 to the financial statements and are included in Management of Financial Risk below) is established using a valuation technique, which approximates the following methodology:

The fair value of the contract, measured at inception, is the purchase pricepaid for it. This price implies a retail market rate of interest prevailing atthe inception of the contract, which is used to equate the contractual cashflows payable under the bond to the purchase price, including an allowance forexpenses incurred in managing the contract; and

Subsequent measurement of the liability at fair value reflects the impact of changes in retail market interest rates for these products: this is accomplished in practice by tracking movements in the less-than-5-year gilt index as the bonds are predominantly less than 5 years in term.

Fair value measurement has been adopted to reduce volatility in reported earnings in the income statement as the liabilities so determined are measured in a way which is consistent with the fair value of the underlying invested financial assets.

As at 31 December 2009, the carrying value of investment contract liabilitiesin respect of guaranteed income and guaranteed growth bonds was £22.9m (as at31 December 2008 £55.1m).

(c) Liability for future redress in respect of mortgage endowment misselling complaints

Included within insurance contract liabilities is a liability in respect ofamounts anticipated to be payable as redress for upheld mortgage endowmentmisselling complaints. In establishing this liability the Group makes estimatesabout the number of future upheld complaints (taking into account the number ofcomplaints received, the number of complaints time-barred and the number ofcomplaints which are admitted) and about the average cost of redress per upheldcomplaint. These estimates are determined, taking into account historicalexperience and investment return projections. Variations in these estimatescould result in higher or lower than expected numbers of upheld complaints andhigher or lower than expected amounts of redress per upheld complaint. Theimpact of variations in these assumptions is disclosed in Note 33 to thefinancial statements.

As at 31 December 2009, the liability for future redress in respect of mortgage endowment misselling complaints was £2.9m (as at 31 December 2008 £4.2m).

Swedish Business(a) Insurance claim reservesProvisions are determined by management based on experience of claims settledand on statistical models which require certain assumptions to be maderegarding the timing, incidence and amount of claims. In order to calculatethe total provision required, the historical development of claims is analysedusing statistical methodology to extrapolate, within acceptable parameters, thevalue of outstanding claims. For more recent underwriting years the provisions will make more use oftechniques that incorporate expected loss ratios. As underwriting yearsmature, the reserves are increasingly driven by methods based on actual claimsexperience. The data used for statistical modelling is internally generated. Actual claims experience may differ from the historical pattern on which theestimate is based and the cost of individual claims may exceed that assumed.

Liabilities carried in respect of waiver of premium and income protection policies are sensitive to the Group's assessment of the length of period in which benefits will be paid to policyholders (which can be significant). Estimates are made based on the sex, age and occupation of the claimant as well as the length of time the claimant has been claiming on the policy.

As at 31 December 2009, the carrying value of the insurance claim reserves, gross of reinsurance, was £32.4m (as at 31 December 2008 £nil). The key sensitivities in respect of insurance claim reserves are considered in Note 5 of the financial statements and under Management of Insurance Risk below.

(b) Insurance claim reserves - reinsurance recoverable

A significant proportion of the insurance claims arising within the SwedishBusiness are ceded to reinsurers. In preparing the financial statements theDirectors have made an assessment as to whether claims ceded to reinsurers arerecoverable. As at 31 December 2009, such claims ceded to reinsurers andreflected on the balance sheet were £27.3m (31 December 2008 £nil). Theapplication of a 10 per cent bad debt provision on the reinsurance balancewould reduce 2009 profit before tax by £2.7m and shareholders' equity by £2.0m.

(c) Accounting for pension plans

The Group participates in a defined benefit pension scheme on behalf of itsSwedish employees. The scheme is a multi-employer plan to which a number ofthird party employers also contribute. The underlying assets and liabilitiesof the scheme are pooled and are not allocated between the contributingemployers. As a result, information is not available to account for the schemeas a defined benefit scheme and the Group has accounted for the scheme as a

defined contribution scheme. (d) Income tax expenseCommissions payable and receivable from fund managers in respect of theunit-linked business have been included as part of the unit-linked funds andsubject to fund yield tax. Management is aware that the Swedish tax authorityhas questioned, in respect of another unit-linked business, whether suchcommissions receivable from fund managers should be part of the Group's incomeand be subject to corporation tax of 26.3 per cent (being the Swedishcorporation tax for the year 2009). Management consider that the currentaccounting treatment remains appropriate. MANAGEMENT OF INSURANCE RISKIntroductionThe Group's management of insurance risk is a critical aspect of the business.Notwithstanding that the Group pursues common overarching objectives andemploys similar techniques in managing this risk, the disparate characteristicsof the products and of the market and regulatory environments of the UK andSwedish businesses are such that this risk is managed separately for therespective businesses, as follows:

UKBusiness

The primary insurance activity carried out by the Group's UK Business comprisesthe assumption of the risk of loss from persons that are directly subject tothe risk. Such risks in general relate to life, accident, health and financialperils that may arise from an insurable event, with the majority of the UKBusiness's exposure relating to mortality risk on individual lives,predominantly in the UK. As such, the UK Business is exposed to the uncertaintysurrounding the timing and severity of claims under the related contracts.The UK Business manages its insurance risk through underwriting limits,approval procedures for new products or for policies that exceed set limits,pricing guidelines, reinsurance and monitoring of emerging issues. The UKBusiness is substantially closed to new insurance business in the UK and, inpractice, only sells a limited amount of new insurance business to existingpolicyholders: the assumption of new insurance risks is, accordingly, limited.The principal risk is that the frequency and severity of claims is adverse tothat expected. The theory of probability is applied to the pricing andprovisioning for a portfolio of insurance contracts. Insured events are, bytheir nature, random, and the actual number and size of events during any oneyear may vary from those estimated using established statistical techniques.The risk under assurance policies is partly naturally hedged by risks underannuity policies where the exposure is to the risk of longevity.

Underwriting strategy

The aim of the underwriting strategy is to avoid the assumption of undue concentration of risk on any one life and there are defined underwriting procedures embracing the limits on cover for individual policies.

Reinsurance strategy

The aim of the reinsurance strategy is to reinforce the underwriting strategyby avoiding the retention of undue concentration of risk on any one life.Accordingly, there is a policy on reinsurance, which limits the total exposureon any one policy. However, there are a small number of policies which breachthese limits due to historical reasons.The UK Business holds a wide range of reinsurance treaties, including whollyreinsured business and risk premium reinsurance which includes original termsreinsurance and facultative reinsurance.Ceded reinsurance contains credit risk, and such reinsurance recoverables arereported after deductions for known insolvencies and uncollectable items. TheUK Business monitors the financial condition of reinsurers on an ongoing basisand reviews its reinsurance arrangements periodically.

The UK Business has a policy in place of only entering into new reinsurance contracts with reinsurers rated A and above.

Terms and conditions of insurance contracts

The terms and conditions of insurance contracts that have a material effect onthe amount, timing and uncertainty of future cash flows arising from insurancecontracts are set out in the product analyses below, which give an assessmentof the main products of the UK Business and of the ways in which the associatedrisks are managed. Sums assured - gross and net of reinsurance 31 December 2009 31 December 2008 Gross Net Gross Net £000 £000 £000 £000 Annuities-immediate (per annum) 4,899 4,812 4,568 4,514 Long-term with DPF 68,633 204 72,728 204 Long-term without DPF 4,488,927 3,280,348 5,024,349 3,632,144 --------- --------- --------- --------- Total 4,562,459 3,285,364 5,101,645 3,636,862 ========= ========= ========= =========

Long-term insurance contracts - immediate annuities

Product features

This type of annuity is purchased with a single premium at outset, and is paid to the policyholder for the remainder of his/her lifetime. Annuities may be level or escalate at a fixed rate.

There are two types of immediate annuities: retirement and voluntary. Voluntary annuities are made at the discretion of the policyholder. Policyholders of personal pensions may have to purchase an immediate annuity on retirement. Other variations (joint life annuities) are to continue the annuity (at the same level or lower) to the surviving spouse or partner.

Payments are often guaranteed to be paid for a minimum term regardless of survival (e.g. 5 or 10 years).

Profit on existing contracts arises when mortality and investment experienceare better than expected. All risks and rewards associated with this type ofproduct accrue to shareholders.

Management of risks

The main risks associated with this product are longevity and investment risks.Longevity risks arise as the annuities are paid for the lifetime of thepolicyholder, and this risk is managed through the initial pricing of theannuity. Investment risk depends on the extent to which the annuity paymentsunder the contracts have been matched by suitable assets. The UK Businessregularly monitors the asset matching for these contracts as explained in theMarket Risk Management section of Note 6 of the financial statements andincluded below under Management of Financial Risks.

The key risks are managed through appropriate pricing and product design. Reinsurance is not generally used for this product, although there is a small number of reinsured policies. Underwriting is not used for this product.

In respect of mortality risk (longevity), the pricing assumption is based onboth historic in-house and industry available information on mortalityexperience for the population of policyholders, including allowances for futuremortality improvements. In respect of investment risk, with this type of product the lump sum premiumis available for the UK Business to invest at the start of the contract. Theasset mix will consist of fixed interest securities, including gilts, withvarying redemption dates. The income earned on the investment will not usuallybe sufficient to cover the annuity and the expense outgo, so each year part ofthe lump sum will be disinvested, which is taken account of in the asset mix,in order to balance the fund. If annuitants die as expected the assets referredto above would be appropriate. However, in most cases annuitants will not dieas expected and, therefore, the UK Business will need to buy and sell assets asnecessary throughout the term of the policies to minimise the risk of mismatch.This position is monitored on a regular basis. Details of default risk on thefixed interest securities are set out in the Credit Risk Management section ofNote 6 of the financial statements and included below under Management ofFinancial Risks.

Concentration of insurance risks

The tables for immediate annuity contracts set out below illustrate the concentration of risk based on two bands of contracts grouped by the annuity payable each year for each annuity policy insured.

Annuity payable each year for Total annuities payable each year

each life insured Before reassurance After reassuranceAs at 31 December 2009 £000 % £000 % £0 - £25,000 4,854 99.1 4,803 99.8 More than £25,000 45 0.9 9 0.2 --------- --------- --------- --------- 4,899 100.0 4,812 100.0 ========= ========= ========= ========= As at 31 December 2008 £0 - £25,000 4,523 99.0 4,505 99.8 More than £25,000 45 1.0 9 0.2 --------- --------- --------- --------- 4,568 100.0 4,514 100.0 ========= ========= ========= =========

Long-term insurance contracts - with discretionary participation features

Product features

The UK Business historically wrote with-profits business in the UK, where thepolicyholder benefits comprise a guaranteed sum assured payable on death or atmaturity, to which may be added a discretionary annual bonus and adiscretionary terminal bonus. Management of risksThis business is wholly reassured to Guardian Assurance plc ("Guardian") andhence the only risk retained by the Group for this business is the risk ofdefault by the reinsurer. This risk is detailed in the Credit Risk Managementsection of Note 6 of the financial statements and Management of Financial riskbelow.

Long-term insurance contracts - without discretionary participation features

Product features

The UK Business has written both non-linked and unit-linked contracts, which include death and morbidity benefits on a whole life, endowment and term assurance basis.

For contracts where death is the insured risk, the most significant factors that could increase risk are epidemics (such as AIDS, SARS or a flu pandemic) or widespread changes in lifestyle, such as eating, smoking and exercise habits, resulting in earlier or more claims than expected.

Management of risks

Unit-linked insurance contracts are contracts where monthly reviewable chargesare made for insurance risk and administration charges and consist mainly ofregular unit-linked endowments where the primary purpose is to provide aninvestment return. In addition, the policyholder is insured against death andserious injury. Unit-linked contracts operate by investing the policyholders'premiums into pooled investment funds of the UK Business, the policyholders'share of the fund being represented by units. The benefit is payable on death,or maturity if earlier, the amount payable on death being subject to aguaranteed minimum amount. Therefore, the UK Business is exposed only toinsurance risk insofar as the value of the unit-linked fund is lower than theguaranteed minimum death benefit. The maturity or surrender value depends onthe investment performance of the underlying fund and on the level of chargeslevied by the UK Business for policy administration fees, mortality and othercharges.

For contracts with fixed and guaranteed benefits and fixed future premiums, there are no mitigating terms and conditions that reduce the insurance risk accepted. This is the case for a small proportion (approximately 5% of total sums assured) of the life assurance business sold by the UK Business.

For the remainder of the business, operated on a quasi-linked basis, the UKBusiness charges for mortality risk on a monthly basis and has the right toalter these charges based on its mortality experience and hence minimise itsexposure to mortality risk. The UK Business also reserves the right at regularintervals to change the premium payable in the light of charges made forinsurance risk and administration services and the investment performance ofthe assets notionally backing these contracts. Delays in implementing increasesin charges and market or regulatory restraints over the extent of the increasesmay reduce this mitigating effect.A number of these contracts also include Permanent Health Insurance (PHI)benefits which have reviewable charges and the UK Business reserves the rightto alter these charges based on its morbidity experience and hence to minimiseits exposure to morbidity risk. Delays in implementing increases in charges andmarket or regulatory restraints over the extent of the increases may reducethis mitigating effect.

Reinsurance is used extensively on the business described above to mitigate concentrations of insurance risk. The insurance risk is further managed through pricing, product design and, for non-linked and quasi-linked contracts, appropriate investment strategy.

For units held under unit-linked contracts all of the investment risk is borne by the policyholder with the exception of a small number of contracts which provide for a minimum guaranteed rate of return, as investment performance directly affects the value of the unit fund and hence the benefits payable.

Concentration of insurance risk

The tables for long term insurance contracts set out below illustrate the concentration of risk based on five bands of contracts grouped by benefits assured for each policy assured.

Benefits assured for each life assured Total benefits assured Before reinsurance After reinsurance In £000's bands £m % £m % As at 31 December 2009 0 - 250 4,407 96.7 3,259 99.3 250 - 500 102 2.3 20 0.6 500 - 750 27 0.6 2 0.1 750 - 1,000 13 0.2 - - More than 1,000 8 0.2 - - --------- --------- --------- ---------- 4,557 100.0 3,281 100.0 ========= ========= ========= ========== As at 31 December 2008 0 - 250 4,930 96.8 3,611 99.4 250 - 500 116 2.3 20 0.6 500 - 750 27 0.5 1 - 750 - 1,000 12 0.2 - - More than 1,000 12 0.2 - - --------- --------- --------- --------- 5,097 100.0 3,632 100.0 ========= ========= ========= =========

In addition to the above the UK Business has, at 31 December 2009, a total ofapproximately £13.8m per annum of retained PHI sums assured (31 December 2008:approximately £15.5m). The UK Business does not retain PHI sums assured on anyone life greater than £25,000 per annum.

Long-term insurance contracts - guaranteed annuity options

Product features

There are a small number of unit-linked deferred annuity policies withguarantees regarding the rate at which the policyholder is able to convert theunit fund into an annuity at retirement, which creates an insurance liability.At retirement the fund available can either be transferred to another provider,used to purchase an annuity with a Group company at the annuity rates thenapplying, or used to purchase an annuity from a Group company at guaranteedannuity rates written into the policy document. The guaranteed annuity ratesare only available in certain circumstances. Policyholders gain the benefit ofwhichever of the then-current annuity rates and guaranteed annuity rates givethem the higher benefits.Management of risks

The main risks associated with this product are longevity and market risks. These were controlled through product design and pricing. However, the guaranteed annuity rates were set during the 1960s and 1970s, when these products were sold. As these rates are no longer suitable in current conditions, appropriate technical provisions are held to reflect the risk arising from the guarantees.

The longevity assumptions underlying the technical provisions are based on bothhistoric in-house and industry available information on mortality experiencefor the population of policyholders, including allowances for future mortalityimprovements.

Concentration of insurance risks

There are 251 such policies in force as at 31 December 2009 (as at 31 December2008: 292). The underlying contracts have total unit funds of £2.4m (as at 31December 2008: £2.6m), with the largest fund being less than £0.2m.

Other risks on insurance contracts

Apart from financial risks relating to the financial assets, which support lifeassurance contracts, as set out in Note 6 of the financial statements andincluded below under Management of Financial Risks, there are other significanttypes of risk pertaining to life insurance contracts, as follows:

Expense risk

The strategy of the UK Business is to outsource all operational activities tothird party administrators in order to reduce the significant expenseinefficiencies that would arise with fixed and semi-fixed costs on adiminishing policy base. There are, however, risks associated with the use ofoutsourcing. In particular, there will be a need in future to renegotiate theterms of the outsourcing arrangements as the existing agreements expire. Thereis also a risk that, at some point in the future, third party administratorscould default on their obligations. The UK Business monitors the financialsoundness of third party administrators and it has retained step-in rights onthe more significant of these agreements. There are also contractualarrangements in place which provide for financial penalties in the event ofdefault by the administration service providers.

Mortgage endowment misselling complaints

The life businesses have experienced a significant level of complaints frommortgage endowment policyholders since their first regulatory mailing programmein 2000. In response to this, the life businesses hold mortgage endowmentcomplaints redress provisions. The UK Business continues to monitor closely,among other factors, the volume of complaints and the value of compensationpaid to policyholders in order to assess the continuing adequacy of theprovisions.There remains however a residual risk that at some point in future the levelsof complaints received may prove to be higher than those anticipated within

theprovision. Persistency riskPersistency risk is the risk that the investor cancels the contract ordiscontinues paying new premiums into the contract, thereby exposing the UKBusiness to a loss resulting from an adverse movement in the actual experiencecompared to that expected in the product pricing. Although changes in thelevels of persistency would not adversely affect the result in the short termthey would reduce future profits available from the contract.

Assumptions

The principal assumptions underlying the calculation of the insurance contract provisions are:

MortalityA base mortality table is selected which is most appropriate for each type ofcontract taking into account rates charged to the UK Business by reinsurers.The mortality rates reflected in these tables are periodically adjusted,allowing for emerging experience and changes in reinsurer rates.

Morbidity

Morbidity tables are derived based on reinsurer tables. These are periodically adjusted to take into account emerging experience where appropriate.

Persistency

In general, no allowance is made for lapses or surrenders within the valuation of insurance contract liabilities.

Discount rates

The UK Business has used the following rates of interest in discounting theprojected liabilities: 31 December 2009 31 December 2008 CA CWA CA CWA Rate of interest business business business business Assurances without profit: non linked 3.40% 3.70% 3.40% 3.20% business without profit: annual 3.40% 3.70% 3.40% 3.20% premium Annuities without profit: deferred 3.40% 3.70% 3.40% 2.80% without profit: vested 4.10% 3.70% 3.80% 3.10%

The rates of interest shown above have been set after consideration of the riskof default on non-government bonds by applying the following adjustments to theearned yield:

(i) a standard risk deduction, varying by credit rating, of 0.1% for 'AAA'-rated

bonds, 0.3% for 'AA'-rated bonds and 0.5% for 'A'-rated bonds, based on ratings

according to Standard and Poors credit rating system. No assets are held with a

credit rating less than 'A'; and

(ii)an overall maximum margin over the equivalent term government fixed interest

security of 0.5%.

For many of the life insurance products the interest rate risk is managedthrough asset/liability management strategies that seek to match the interestrate sensitivity of the assets to that of the underlying liabilities. Theoverall objective of these strategies is to limit the net change in value ofassets and liabilities arising from interest rate movements. While it is moredifficult to measure the interest rate sensitivity of the UK Business'sinsurance liabilities than those of the related assets, to the extent that theUK Business can measure such sensitivities, it believes that interest ratemovements will generate asset changes that substantially offset changes invalue of the liabilities relating to the underlying products.Under the gross premium method and to a lesser extent the net premium method,the insurance contract provision is sensitive to the interest rate used whendiscounting. For annuities in payment and assurances, the provision issensitive to the assumed future mortality experience of policyholders.

Renewal expenses and inflation

The renewal expenses assumed are based on the charges made to the UK Businessby its two third party insurance administration services providers, withappropriate margins. These are assumed to inflate at a mix of current inflationrates in the UK, being the Retail Price Index and the National Average EarningsIndex. Explicit allowance is also made for Governance expenses incurred by

theUK Business.Taxation

The UK Business has assumed that current tax legislation and tax rates will not change.

Changes in assumptions and sensitivity to changes in assumptions

Assumptions are adjusted for changes in mortality, investment return, policymaintenance expenses and expense inflation to reflect anticipated changes inmarket conditions and market experience and price inflation.

The major changes to the bases used for the calculation of the provisions were as follows.

As a consequence of the fact that the valuation basis makes no allowance forlapses, when lapses occur it is necessary to allocate fixed expenses across asmaller number of in-force policies. Consequently the per policy expensereserve has increased. This increased the reserves by £0.8m as at 31 December2009 (31 December 2008: £0.3m).The reserve held in respect of the CWA business for guaranteed annuity rateswas reduced by £0.1m, making allowance principally for the vesting of policieswith the guarantee, changes in unit values and interest rates.

The basis for the calculation of the reserve held for complaints, principally mortgage endowment complaints, is given below.

The UK Business re-runs its valuation models on various bases. An analysis ofsensitivity around various scenarios provides an indication of the sensitivityof the estimates to changes in assumptions in respect of its life assurancecontracts. The table presented below demonstrates the sensitivity of assets andinsured liability estimates to particular movements in assumptions used in theestimation process. Certain variables can be expected to impact on lifeassurance liabilities more than others, and consequently a greater degree ofsensitivity to these variables may be expected.Impact on reported net of tax profits and equity to changes in key variables: Change in Change in net of tax profits and variable equity 2009 % £m Investment return +1 (1.8) Investment return -1 0.9 Mortality/morbidity +10 0.8 Mortality alone +10 1.5 Morbidity alone +10 (0.7) Policy maintenance +10 (1.3) expenses

The above sensitivities are calculated as an expected impact on IFRS-based profits, net of reinsurance and tax and the analysis has been prepared for a change in the stated variable, with all other assumptions remaining constant.

The sensitivities to the changes in investment returns are calculated taking into account the consequential changes to valuation assumptions.

The sensitivities to mortality and morbidity (critical illness) rates shown above are calculated on the assumption that there would be no consequential change in rates to policyholders. In practice, Group policy is to pass costs on to policyholders where it considers that the impact of the change is significant.

An increase in mortality rates would have a negative impact on the CA businessdue to the preponderance of assurance business. In contrast, there would be apositive impact occurring in the CWA business due to its preponderance ofannuity business. On a consolidated basis the impacts are closely balanced. Adecrease in mortality rates would have the contrary effect in each business butthe results would remain closely balanced.Changes in mortality and morbidity rates are not correlated: one may increasewhilst the other remains unchanged or reduces. The figure shown above assumesboth rates increase by 10%. The effects of separate 10% increases would be anincrease in consolidated net of tax profits and equity by £1.3m for increasedmortality rates and a reduction in consolidated net of tax profits and equityby £0.7m for increased morbidity rates. The sensitivities to changes in theseassumptions in the opposite direction will result in changes of similarmagnitude but in the opposite direction.

Increases in expenses due to inflation would predominantly be passed on to policyholders through higher policy fees.

The main expense risk is that of unforeseen changes to third party administration expenses. The impact shown above quantifies a 10% increase in those expenses.

Swedish BusinessThe terms and conditions of insurance contracts which have a material effect onthe amount, timing and uncertainty of future cash flows arising from insurancecontracts are set out in the product analyses below, which give an assessmentof the main products of the Swedish Business and of the ways in which theassociated risks are managed. The breakdown of the insurance products of theSwedish Business, by gross and net premiums written and by claims outstanding,which reflects the scale of business written, is as follows. Certain of theinformation includes amounts and balances relating to the pre-acquisitionperiod and is provided for illustrative purposes.Premiums Before reinsurance After reinsurance Year ended 31 December Year ended 31 December 2009 2008 2009 2008Group £000 £000 £000 £000 Sweden 11,312 8,625 2,652 2,181 Norway 5,291 7,524 978 1,256 Individual Death 471 450 53 56 Waiver of premium 4,344 4,155 850 892 Income protection 3,213 3,073 623 654 --------- --------- --------- --------- 24,631 23,827 5,156 5,039 ========= ========= ========= ========= Claims outstanding Before reinsurance After reinsurance Year ended 31 December Year ended 31 December 2009 2008 2009 2008Group £000 £000 £000 £000 Sweden 12,131 9,920 1,377 1,135 Norway 8,869 7,996 1,450 1,234 Individual Death 422 333 75 66 Waiver of premium 5,931 5,276 1,110 1,047 Income protection 5,000 4,414 1,079 872 --------- --------- --------- --------- 32,353 29,739 5,091 4,354 ========= ========= ========= ========== Terms and conditions

Product features - Group Contracts

Group Contracts insure policyholders in respect of death with the option to include additional accident and disability benefits. Policyholders may also include their spouse and children (up to the age of 25) on the policy.

The Swedish product provides a maximum coverage of insured benefits up to 40 times a base amount (as at 31 December 2009 SEK 42,700, being approximately

£3,700) although most policies are between 7.5 to 20 times the base amount.

The Norwegian product provides a maximum coverage of insured benefits up to 80 times a base amount (as at 31 December 2009 NOK 70,256, being approximately

£7,580) although most policies are around 40 times the base amount.

Policies are sold in both Sweden and Norway and all sales are intermediated. Group Contracts sold in Sweden allow the policyholder to choose the sum assuredlevel. Contracts sold in Norway have sum assured levels that are normallydetermined by the policyholders' employer and apply to all members of thatcompany scheme.

All contracts are for an annual period and premium payments are made usually on either an annual or quarterly basis.

Product features - Individual Contracts

In relation to Individual Contracts, the Swedish Business writes contracts,which include death and morbidity benefits on term assurance with disability,waiver of premium and income protection options. Policies are sold in Swedenand all sales are intermediated. In relation to the income protection and the waiver of premium benefits withinthe Individual Contracts, the monthly benefits upon a claim may be payable tothe policyholders over a long period up to their retirement. The contracts have been unbundled as between insurance and investmentcontracts. Risk in respect of investment contracts is described in Note 6 ofthe financial statements and under the Management of Financial Risks below. Allinsurance contracts are for an annual period and payments are made on a monthlybasis. Management of risk

The main risk associated with the Group and Individual Contracts is the frequency of claims (for either death or accident or sickness). Claims experience can be variable, with the main factors being the age, sex and occupation of the policyholder.

In addition, for the Group Contracts, the Swedish Business is exposed to a single loss event that covers a number of employees of an organisation.

The key risks are managed through appropriate product design and pricing of thepolicies to ensure that the potential cost to the Swedish Business of theseevents (and associated expenses of underwriting and administration) arereflected in the price charged to the policyholder. Key controls implementedinclude a defined pricing structure based on the characteristics of thepolicyholder and the regular review of management information on the type andfrequency of accidents.

Group Contracts are issued on an annual basis which means that the Swedish Business's exposure runs for a period of 12 months, after which the Swedish Business has the option to decline to renew or can increase the price on renewal.

Individual Contracts are long-term contracts but the Swedish Business has the option to review the premiums on an annual basis.

For both the Group and Individual Contracts, between 80 per cent to 90 per centof the premiums and claims relating to this product are ceded to a reinsurerwhich reduces the overall insurance risk exposure to the Swedish Business.

In addition, for Group Contracts, the loss arising from a single event to multiple employees is reinsured. The reinsurance provides indemnity for a single loss between SEK 5m (approximately £0.4m) and SEK 100m (approximately £8.7m).

Concentration of insurance risk

Concentration of insurance risk is determined by reference to benefits assured for Individual Contracts and by estimated maximum loss for Group Contracts.

The following tables highlight the maximum exposure to the Swedish Businessarising from Individual Contracts, grouped by sums assured, at each balancesheet date. Total benefits assured 31 December 2009 Benefit in £000 bands Before reinsurance After reinsurance £000 £0000-250 439,948 68,259 250-500 1,254 251 500-750 117 23 750-1000 70 14 Over 1,000 - - --------- --------- 441,389 68,547 ========= ========= In respect of Group Contracts, the business is exposed to multiple employees ofthe same organisation being involved in a single loss event. The SwedishBusiness estimates that its largest such exposures arise in Norway, where theGroup Contracts sold tend to cover all employees within that organisation(whereas in Sweden employees may opt in to the Group Contract). The SwedishBusiness forecasts that its maximum loss would be approximately SEK 27 million(approximately £2.3m) gross of reinsurance and SEK 5 million (approximately £0.4m) after reinsurance.

Assumptions and sensitivities for Group Contract and Individual Contract insurance provisions

Group Contracts are sold on an annual basis and the Individual contractsinclude an option for the Group to increase the premium on an ongoing basis.Therefore, for both Group and Individual Contracts, the Group adopts areserving approach that is similar to that of a non-life insurance business,with claim reserves projected using an estimated loss ratio with reference toprevious loss development for earlier years.The insurance contract provisions comprise unearned premium provisions,outstanding claims and associated reinsurance recoveries. Except for theincome protection and the waiver of premium benefits within the IndividualContracts, provisions for the insurance contracts are not discounted because ofthe short term nature of the liabilities, which are generally paid by thefourth year of development for a single accident year. Income protection andwaiver of premium contracts are discounted at a rate equivalent to a highquality (i.e. AA rated) corporate bond.

Unearned premiums

Unearned premiums represent a proportion of the premium relating to policies that expire after the balance sheet date. Unearned premiums are calculated automatically by the underwriting system on a straight-line basis over the period of the policy.

Outstanding claimsOutstanding claims include notified claims, claims incurred as at the balancesheet date but not reported and an estimate of the external cost of handlingthe claims.

The key risk in respect of notified claims is that they are paid or handled inappropriately (for example invalid or fraudulent claims are paid). All claims handling is outsourced, although physical payment of the claims is performed by the Swedish Business. The Swedish Business also inspects companies performing outsourced claims handling services on at least an annual basis.

Management information is also reviewed on a regular basis to identify unusual trends in the payment of claims.

The estimation of claims incurred but not reported ('IBNR') is generallysubject to a greater degree of uncertainty than the estimation of costs ofsettling claims already notified to the Swedish Business, where moreinformation about the claim event is generally available. In calculating theestimated cost of claims which have not been notified, the Swedish Businessuses a variety of estimation techniques, generally based upon statisticalanalyses of historical experience, which assumes that the development patternof the current claims will be consistent with past experience.The most common methods that are used are the chain ladder method and theBornhuetter-Ferguson method. Chain ladder methods involve the analysis ofhistorical claims development factors and the selection of estimateddevelopment factors based on this historical pattern. The selected factors areapplied to cumulative claims data for each accident year that is not fullydeveloped to provide an estimated ultimate claims cost. TheBornhuetter-Ferguson method uses a combination of an initial estimate of theexpected loss ratio and an estimate based on observed claims experience. Thetwo estimates are combined using a formula that gives more weight to theexperience-based estimate as time passes. The use of different approaches assists in giving greater understanding of thetrends inherent in the data being projected and also assists in setting therange of possible outcomes. The most appropriate estimation technique isselected taking into account the characteristics of the policies sold. Wheredeemed appropriate, an allowance is made for changes or uncertainties which maycreate distortions in the underlying statistics or which might cause the costof unsettled claims to increase or reduce when compared with the cost ofpreviously settled claims. Although claim reserves are considered reasonable,on the basis of information available to the Swedish Business, the ultimateliabilities will vary as a result of subsequent information and events.

Income protection and waiver of premium benefits within Individual Contracts

For reported claims, the liabilities are reviewed on a case by case basis. A discounted cash flow model is used to determine the liabilities and the key factors used are:

- the probability of 'recovery' (i.e. return to work). The recovery rates depend

on age, sex and length of time the claimant has been claiming the benefits;

- the mortality rate; and- the discount rate.

For unreported claims, the claims development table (as described below) is used.

Sensitivity analysisThe key sensitivities in the measurement of the Group and Individual Contractsinsurance claim reserves are a movement in the loss ratio applied to earnedpremium and the foreign exchange risk arising on business written in Norway. Inaddition, for the income protection and the waiver of premium benefits withinthe Individual Contracts, the claims reserves are impacted by the discount rateused. The impact of these sensitivities is shown below: the informationincludes pre-acquisition amounts and is presented for illustrative purposes. Pre-tax profit Shareholders' equity 2009 2008 2009 2008 £000 £000 £000 £000 5% increase in loss ratio Gross before reinsurance (1,193) (1,096) (910) (839) Net after reinsurance (174) (330) (132) (252) 5% decrease in loss ratio Gross before reinsurance 1,193 1,096 910 839 Net after reinsurance 174 330 132 252

10% increase in the Norwegian Krone

Gross before reinsurance (857) (752) (654) (576) Net after reinsurance (140) (41) (107) (31)

10% decrease in the Norwegian Krone

Gross before reinsurance 857 752 654 576 Net after reinsurance 140 41 107 31

1% increase in discount rate

Gross before reinsurance 788 751 601 575 Net after reinsurance 156 141 119 108

1% decrease in discount rate

Gross before reinsurance (896) (860) (683) (658) Net after reinsurance (178) (180) (136) (138) In addition to the scenario testing above, the development of insuranceliabilities provides a measure of the Swedish Business's ability to estimatethe ultimate value of claims. The top half of the table below illustrates howthe Swedish Business's estimate of total claims outstanding for each accidentyear has changed at successive year-ends. The bottom half of the tablereconciles the cumulative claims to the amount appearing in the balance sheet. An accident-year basis is considered to be the most appropriate for thebusiness written by the Swedish Business. The information is presented on botha gross and net of reinsurance basis.

Analysis of claims development - gross

2004 2005 2006 2007 2008 2009 £000 £000 £000 £000 £000 £000 Estimate of ultimates End of accident year 4,556 7,102 10,031 15,902 17,908 18,501 One year later 4,749 7,140 8,822 12,052 14,089 - Two years later 4,888 6,319 7,125 10,335 - - Three years later 4,938 5,440 6,954 - - - Four years later 4,887 4,744 - - - - Five years later 4,828 - - - - - Current estimate ofultimate claims 4,828 4,744 6,954 10,335 14,089 18,501 Cumulative payments (3,725) (3,864) (4,845) (5,744) (6,641) (3,214) --------- -------- -------- -------- -------- -------- In balance sheet 1,103 880 2,109 4,591 7,448 15,287 ========= ======== ======== ======== ======== ======== Provision for prior years 935 Liability in balance sheet 32,353 =========

Analysis of claims development - net

2004 2005 2006 2007 2008 2009 £000 £000 £000 £000 £000 £000 Estimate of ultimates End of accident year 493 787 1,220 2,474 2,469 3,162 One year later 547 769 988 1,567 2,144 - Two years later 550 675 700 1,499 - - Three years later 550 495 695 - - - Four years later 501 474 - - - - Five years later 483 - - - - - Current estimate of ultimate claims 483 474 695 1,499 2,144 3,162 Cumulative payments (373) (386) (485) (784) (991) (442) --------- ------- -------- -------- -------- -------- In balance sheet 110 88 210 715 1,153 2,720 ========= ======= ======== ======== ======== ======== Provision forprior years 95 Liability in balance sheet 5,091 ======== MANAGEMENT OF FINANCIAL RISKIntroductionThe Group is exposed to a range of financial risks through its insurancecontracts, financial assets, including assets representing shareholder assets,financial liabilities, including investment contracts and borrowings, and itsreinsurance assets: accordingly, the key financial risk is that, in thelong-term, its investment proceeds are not sufficient to fund the obligationsarising from its insurance and investment contracts. The most importantcomponents of this financial risk are market risk (interest rate risk, equityprice risk and foreign currency exchange risk), and credit risk, including therisk of reinsurer default. These risks arise from open positions in interestrate, equity and currency products, all of which are exposed to general andspecific market movements.For unit-linked contracts the Group's objective is to match the liabilities,both insurance and investment contract liabilities, with units in the assets ofthe funds to which the value of the liabilities is linked, such that thepolicyholder bears the market risk. This minimises the impact of market risksand of credit risk on these contracts, such that the primary exposure to marketrisk is the risk of volatility in asset management fees due to the impact ofinterest rate, equity price and foreign currency movements on the fair value ofthe unit-linked assets, on which management fees are based. For the UKBusiness, however, there is residual market risk, which arises generally fromthe specific terms and conditions of the related insurance and investmentcontracts, as described below.For non unit-linked business, the Group's objective is to match the timing ofcash flows from insurance and investment contract liabilities with the timingof cash flows from assets subject to identical or similar risks. By matchingthe cash flows of liabilities with those of suitable assets, market risk ismanaged effectively, whilst liquidity risk is minimised. These processes tomanage the risks, which the Group has not changed from previous periods, ensurethat the Group is able to meet its obligations under its contractualliabilities as they fall due.Notwithstanding that the Group pursues common overarching objectives andemploys similar techniques in managing financial risk, the disparatecharacteristics of the products and of the market and regulatory environment ofthe UK and Swedish Businesses are such that the operation of the Group'soverall management of financial risk is devolved as between the UK and SwedishBusinesses. In addition, there is specific foreign currency exchange risk,which arises at the Group Corporate level. Accordingly, the description of thespecific management of financial risk is set out separately below at the UKBusiness, Swedish Business and Corporate levels.

UKBusiness

The UK Business manages its market risks within an asset liability management(ALM) framework that has been developed to achieve long-term investment returnsat least equal to its obligations under insurance and investment contracts,with minimal risk. Within the ALM framework the business periodically producesreports at legal entity and asset and liability class level, which arecirculated to the UK Business's key management. The principal technique of theALM framework is to match assets to the liabilities arising from insurance andinvestment contracts by reference to the type of benefits payable topolicyholders, with separate portfolios of assets being maintained for eachdistinct class of liability.

Terms and conditions of investment contracts

The terms and conditions of insurance contracts that have a material effect onthe amount, timing and uncertainty of future cash flows arising from insurancecontracts are set out in Note 5 of the financial statements and included aboveunder Management of Insurance Risk. The terms and conditions of investmentcontracts that have a material effect on the amount, timing and uncertainty offuture cash flows arising from investment contracts are set out in the productanalyses below.

The UK Business provides three types of investment contract which are predominantly written in the UK.

(i) Unit-linked savings

These are typically single premium contracts, with the premiums invested in apooled investment fund (usually an internal fund of the life assurancecompany), where the policyholder's investment in the fund is represented byunits. There is a small additional benefit payable on death which does nottransfer significant insurance risk to the business for these contracts. Thebenefits payable at maturity or surrender of the contract are the bid value ofthese units less surrender penalties, where applicable. The key variablesaffecting the timing and uncertainty of future cash flows are investmentperformance, persistency and expense inflation.

(ii) Unit-linked pensions

The contractual features are similar to unit-linked savings, except they may be single or regular premium contracts. The benefits payable on retirement purchase an open market pension annuity.

The key variables affecting the timing and uncertainty of future cash flows are investment performance, interest risks, persistency and expense inflation.

(iii) Guaranteed Income and Growth Bonds

Guaranteed Income bonds are mainly single premium contracts for a fixed termoffering, either monthly or annually, fixed payments together with a return ofpremium at the maturity date. A guaranteed growth bond variant has also beenissued which offers no income but a higher guaranteed payment at the maturitydate.

The key variables affecting the timing and uncertainty of cash flows are expense inflation, interest rates, persistency and mortality.

Risks associated with investment contracts

The risks associated with investment contracts are expense risk, persistencyrisk and market risk. Market risk is the risk that the fair value of futurecash flows will fluctuate because of a change in interest or foreign currencyexchange rates or in equity prices and the consequent effect that this has onthe value of charges earned by the business and on any guarantees in thecontracts. Expense risk is of the same nature as described under other risks oninsurance contracts in Note 5 of the financial statements and included aboveunder Management of Insurance Risk. Persistency risk is the risk that theinvestor cancels the contract or discontinues paying new premiums into thecontract, thereby exposing the business to a loss resulting from an adversemovement in the actual experience compared to that expected in the productpricing. Although changes in the levels of persistency would not adverselyaffect the result in the short term they would reduce future profits availablefrom the contract.Market risk managementThe notes below explain how market risks are managed using the categoriesutilised in the UK Business's ALM framework. In particular, the ALM frameworkrequires the management of interest risk, equity price risk, and liquidity riskat the portfolio level, so that the appropriate risks for each portfolio may bemanaged in an effective way. The business is not significantly exposed toforeign exchange risk as the only assets denominated in foreign currencies arematched by corresponding insurance contract provisions and financialliabilities. To reflect the business's risk management approach the requireddisclosures for interest rate, equity price and liquidity risks, asappropriate, are given separately for each portfolio of the ALM framework. Thefollowing tables reconcile the balance sheet to the classes and portfolios usedin the business's ALM framework.31 December 2009 Other Insurance Unit- non-linked contracts linked Annuities contracts Guaranteed with DPF contracts in Total bonds payment OtherAssets £000 £000 £000 £000 £000 £000 £000 Intangible assets Deferred acquisition costs 7,683 - - - - - 7,683 Acquired value of in-force business Insurance contracts 14,195 - - - - - 14,195 Investment contracts 10,593 - - - - - 10,593 Reinsurers' share of insurance contract provisions 209,604 - 88,880 117,918 - 2,806 - Amounts deposited with reinsurers 27,056 - - 26,192 - - 864 Investment properties 3,355 - - 2,880 - - 475 Financial assets Equity securities at fair value through income 454,970 - 2 454,961 - 7 - Holdings in collective investment schemes at fair value through income 697,259 - 3,116 663,148 - 10,247 20,748 Debt securities at fair value through income 245,928 18,026 - 118,239 80,478 23,960 5,225 Insurance and other receivables 9,593 532 - - - 3,237 5,824 Prepayments 1,628 - - - - - 1,628 Derivativefinancial instruments 4,420 - - 4,420 - - - --------- --------- --------- --------- --------- --------- ------ Total financial assets 1,413,798 18,558 3,118 1,240,768 80,478 37,451 33,425 --------- --------- --------- --------- --------- --------- ------ Reinsurers' share of accrued policyholder claims 4,728 - - - - 900 3,828 Cash and cash equiva-lents 120,830 5,757 395 32,889 449 8,912 72,428 --------- --------- --------- --------- --------- --------- ------ Total assets 1,811,842 24,315 92,393 1,420,647 80,927 50,069 143,491 ========= ========= ========= ========= ========= ========= ======= Other Insurance Unit- non-linked contracts linked Annuities contracts Guarteed with DPF contracts in Total bonds payment OtherLiabilities £000 £000 £000 £000 £000 £000 £000 Bank overdraft 2,312 - - 235 - 1,593 484 Insurance contract provisions 1,044,680 - 92,393 835,884 80,927 35,476 - Financial liabilities Investment contracts 610,930 22,923 - 578,523 - 9,484 - Borrowings - - - - - - - Derivative financial instruments 54 - - 54 - - - --------- ------- --------- --------- --------- -------- ------- Total financial liabilities 610,984 22,923 - 578,577 - 9,484 - --------- ------- ---------- --------- --------- -------- ------- Provisions 1,452 - - - - 203 1,249 Deferred tax liabilities 9,613 30 - - - 19 9,564 Reinsurance payables 2,064 - - - - 225 1,839 Payables related to direct insurance and investment contracts 24,751 1,362 - - - 964 22,425 Deferred income 13,132 - - - - - 13,132 Income taxes 854 - - - - - 854 Other payables 3,825 - - - - 2,105 1,720 --------- ------- --------- --------- --------- -------- ------- Total liabilities 1,713,667 24,315 92,393 1,414,696 80,927 50,069 51,267 ========= ======= ========= ========= ========= ======== ======= 31 December 2008 Other Insurance non-linked contracts Unit-linked Annuities contracts Guarteed with DPF contracts in Total Bonds payment Other £000 £000 £000 £000 £000 £000 £000 Intangible assets Deferred acquisition costs 8,590 - - - - - 8,590 Acquired value of in-force business Insurance contracts 16,866 - - - - - 16,866 Investment contracts 11,610 - - - - - 11,610 Reinsurers' share of insurance contract provisions 182,693 - 79,484 100,093 - 3,116 - Amounts deposited with reinsurers 22,181 - - 22,181 - - - Investment properties 3,432 - - 2,932 - - 500 Financial assets Equity securities at fair value through income 363,879 - 2 363,872 - 5 - Holdings in collective investment schemes at fair value through income 576,502 - 2,578 554,817 - 8,041 11,066 Debt securities at fair value through income 279,104 51,360 - 129,517 70,957 21,392 5,878 Insurance and other receivables 9,879 2,127 - - - 1,423 6,329 Prepayments 1,600 - - - - - 1,600 Derivative financial instruments 5,570 - - 5,570 - - - --------- ------- -------- --------- --------- --------- ------- Total financial assets 1,236,534 53,487 2,580 1,053,776 70,957 30,861 24,873 --------- ------- ------- --------- --------- --------- ------- Reinsurers' share of accrued policyholder claims 4,100 - - - - 1,192 2,908 Cash and cash equiv- alents 155,009 3,031 368 50,257 7,260 13,135 80,958

--------- ------- ------- --------- --------- --------- -------

Total

assets 1,641,015 56,518 82,432 1,229,239 78,217 48,304 146,305

========= ======= ======== ========== ========= ========== ======= Other Insurance non-linked contracts Unit-linked Annuities contracts Guarteed with DPF contracts in Total bonds payment Other Liabilities £000 £000 £000 £000 £000 £000 £000 Bank overdraft 1,086 - - 38 - 822 226 Insurance contract provisions 923,506 - 82,432 728,179 78,217 34,678 - Financial liabilities Investment contracts 558,542 55,119 - 494,449 - 8,974 - Borrowings - - - - - - - Derivative financial instruments 70 - - 70 - - - --------- ------- --------- --------- --------- --------- ------- Total financial liabil-ities 558,612 55,119 - 494,519 - 8,974 - --------- ------- --------- --------- --------- --------- ------- Provisions 3,397 - - - - 179 3,218 Deferred tax liabilities 10,798 90 - - - 147 10,561 Reinsurance payables 1,397 - - - - 253 1,144 Payables related to direct insurance and investment contracts 23,891 1,309 - - - 942 21,640 Deferred income 14,575 - - - - - 14,575 Income taxes 1,213 - - - - - 1,213 Other payables 4,207 - - - - 2,309 1,898 --------- ------- --------- --------- --------- --------- ------- Total liabil-ities 1,542,682 56,518 82,432 1,222,736 78,217 48,304 54,475 ========= ======= ========= ========= ========= ========= ======= Guaranteed bonds

These contracts are for a fixed term with financial benefits that are fixed andguaranteed at the inception of the contract. The business manages its marketrisk, its only material risk on these products, by matching closely contractswritten with fixed interest debt securities of a suitable duration and quality,as indicated by their credit rating. The result is that, for these contracts,the business's primary financial risk is the risk that interest income andcapital redemptions from the financial assets backing the liabilities areinsufficient to fund the guaranteed benefits payable. By using fixed interestdebt securities, there is no exposure to equity price risk for this portfolio.

Regular monitoring of the interest rate risk is carried out by analysis of expected cash flows from the financial assets held with those for the liabilities. Cash flows for the liabilities are determined assuming all contracts continue until their expected maturity date. This analysis also enables the business to control its liquidity risk for this portfolio.

The following tables indicate the amount and timing of the cash flows arising from the liabilities in this category of the business's ALM framework.

31 December 2009

Contractual cash flows (undiscounted)

Carrying values and cash flows Carrying 0-1 year 1-2 years 2-3 yearsarising from: amounts £000 £000 £000 £000 Assets backing liabilities: Debt securities at fair value through income 18,026 14,258 7,914 1,248

Insurance and other receivable 532 532 -

- Cash and cash equivalents 5,757 5,757 - - --------- --------- --------- --------- Total 24,315 20,547 7,914 1,248 Liabilities 24,315 15,617 7,938 1,075 --------- --------- --------- --------- Difference in expected cash - 4,930 (24) 173flows ========= ========= ========= ========= 31 December 2008 Contractual cash flows (undiscounted)Carrying values and cash flows Carrying 0-1 year 1-2 years 2-3 yearsarising from: amounts £000 £000 £000 £000 Assets backing liabilities: Debt securities at fair value through income 51,360 35,498 12,455 6,907 Insurance and other 2,127 2,127 - -receivables Cash and cash equivalents 3,031 3,031 - - Total 56,518 40,656 12,455 6,907 Liabilities 56,518 36,628 13,982 7,135 --------- --------- --------- --------- Difference in expected cash - 4,028 (1,527) (228)flows ======== ========= ========= ========= These contracts can be surrendered before maturity for a cash surrender value.For these contracts the business is not required to separately measure thisembedded derivative at fair value. The terms are such that the surrender valuewill broadly change in line with changes in the market value of the matchingassets, and so there is no significant risk of mismatch.

Sensitivity analysis - interest rate risk

The sensitivity analysis for interest rate risk illustrates how changes in the fair value or future cash flows of a financial instrument will fluctuate because of changes in market rates at the reporting date.

The carrying amount of both the liabilities and the assets, which are fixedinterest debt securities valued at fair value, will be sensitive to changes inthe level of interest rates. By reviewing the matching of the cash flows byterm, on a quarterly basis, management aims to minimise the impact of a changein values due to a parallel movement in all yield curves.

A 100 basis point increase or decrease in interest yields would not have a material effect on either profit for the year ended 31 December 2009 and for the year ended 31 December 2008 or shareholder equity as at those dates.

Insurance contracts with discretionary participation features

The business historically wrote with-profits business in the UK, where thepolicyholder benefits comprise a discretionary annual bonus and a discretionaryterminal bonus. The with-profits business is wholly reinsured to Guardian andhence the only risk retained by the business for this business is the risk ofdefault by the reinsurer. This risk is detailed under 'Credit Risk Management'below.With-profits business can be surrendered before maturity for cash surrenderspecified in the contractual terms and conditions. The impact on the business'scurrent year results would be minimal as any payments to policyholders arematched by payments from Guardian under the reinsurance contract. For all thesecontracts the Group is not required to separately measure this embeddedderivative at fair value.

A maturity analysis based on the earliest contractual repayment date would present all the liabilities as due in the earliest period of the table because these options can be exercised immediately by all policyholders.

For a small element of the with-profits business, policyholders have the optionto invest a portion of their investment in unit-linked funds as an alternativeto the with-profits fund. In this case a portion of the business is retained,with the management of financial risks of this portion being the same asdescribed under 'Unit-linked Contracts' below.

Unit-linked contracts

For unit-linked contracts, which may be insurance or investment contracts, thebusiness matches all the financial liabilities, which are linked to units inthe insurance company funds, with assets on which the unit prices are based. This approach results in the business having no significant market risk (beinginterest rate, equity price and currency risks) or credit risk on thesecontracts. Its primary exposure to market risk is the risk of volatility inasset management fees due to the impact of interest rate and equity pricemovements on the fair value of the assets held in the linked funds, on whichinvestment management fees are based.

In practice, there remain a number of areas where there is a residual risk as follows:

(i) Surplus unitsMarket risk arises from the existence of surplus units (over and aboverequirements to match policyholder unit liabilities) in the insurance companyfunds. Such surplus units (which effectively back surplus carried forward inthe long-term insurance funds) arise because the number of units in the fundsare in decline.

(ii) Mortgage endowment misselling redress provision

Market risk arises in two ways in respect of the redress provisions formortgage endowment misselling. The first is that a fall in equity pricesdirectly increases the cost of future redress payments. In addition it is alsolikely that a large fall in equity prices would increase the propensity forpolicyholders to make a complaint about their mortgage endowment policies. Thesensitivity of the redress provision to equity price changes is disclosed inNote 33 of the financial statements.

(iii) Guaranteed annuity options

For a small number of unit-linked contracts guarantees exist regarding the rateat which the policyholder is able to convert the unit fund into an annuity atretirement, as described above. As the policyholders gain the benefit ofwhichever of the then-current annuity rates and guaranteed annuity rates givethem the higher benefits, this creates an interest rate risk, in that yieldsavailable at the time the option is taken may be lower than those assumed inthe guaranteed rates. A provision of £0.6 m is held for the cost of thisguarantee (31 December 2008: £0.7m).

(iv) Guarantees in Timed Investment Funds

Investment guarantees have been made in respect of policies invested in thebusiness's Timed Investment Funds whereby the price paid to policyholders fortheir units on death or maturity will always be the highest price that theunits have reached during their period of investment in the funds. Althoughthere is a charge paid by policyholders for this guarantee there is a risk toshareholders that this will be insufficient to meet the full cost of thisguarantee: this risk is managed within the investment strategy of the fund (seeNote 32 of the financial statements for more details). A provision of £0.1m isheld to meet the full cost of this guarantee (31 December 2008: £1.2m).The key assumption underlying the provision is the level of potential futurefalls in equities and the sensitivity of the provision to the assumptionchanges depending on whether, at the valuation date, the guarantee is 'in themoney'. An increase in this assumption, from 24% to 34%, would result in a £1.6m decrease in profit for the year ended 31 December 2009 and in shareholderequity as at 31 December 2009 (an increase in the assumption from 25% to 35%would have resulted in a decrease of £0.4m in profit for the year ended 31December 2008 and in shareholder equity as at 31 December 2008).

(v) Change in insurance contract provisions

When calculating insurance contract provisions for the non-unit component ofliabilities under linked contracts, allowance is made for both futureinvestment management charges and investment expenses as a proportion of unitfunds. As investment charges are generally in excess of investment expensesthis surplus is used to offset future administration expenses on the contracts.In a falling market the absolute amount of the surplus of investment chargesover investment expenses would reduce and hence this might lead to an increasein insurance contract provisions.

(vi) Bonus units

Certain contracts (primarily investment contracts) contain a condition thatbonus units are allocated at fixed dates in the future, essentially as a rebateof a portion of the management fees charged during the period since the lastsuch bonus allocation. Financial assets are held to back the units that will beallocated, so as to remove the risk of adverse market price movements. Thisresults in an apparent excess of financial assets over liabilities with anexposure to market risk.Unit-linked contracts can be surrendered before maturity for cash surrenderspecified in the contractual terms and conditions. The terms are such that thesurrender value will either be equal to the carrying amount of the contractliability, or in some cases lower due to surrender penalties specified in thecontract terms and conditions. The impact on the business's current yearresults would therefore be minimal. For all these contracts the business is notrequired to separately measure this embedded derivative at fair value.

A maturity analysis based on the earliest contractual repayment date would present all the liabilities as due in the earliest period of the table because these options can be exercised immediately by all policyholders.

Sensitivity analysis - equity risk

A decrease of 10% in the value of the assets would reduce asset managementfees, which would result in a £0.8 m decrease in profit for the year ended 31December 2009 and to shareholder equity as at 31 December 2009 (year ended 31December 2008 and as at 31 December 2008: £0.8m decrease).

Annuities in payment

These are contracts which pay guaranteed financial benefits, generally monthly,for the lifetime of the policyholder, and in some cases of their spouse. Forcertain contracts payments are guaranteed to be paid for a minimum termregardless of survival (e.g. for 5 or 10 years). The terms are guaranteed atthe inception of the contract. The financial component of these contracts is aguaranteed fixed interest rate and hence the UK Business's primary financialrisk on these contracts is the risk that interest income and capitalredemptions from the financial assets backing the liabilities are insufficientto fund the benefits payable.The UK Business manages the interest rate risk by matching closely newcontracts written with fixed interest debt securities of a suitable durationand quality, as indicated by their credit rating. By using fixed interest debtsecurities, there is no exposure to equity price risk for this portfolio.

Regular monitoring of the interest rate risk is carried out by analysis of expected cash flows from the financial assets held with those for the liabilities. Cash flows for the liabilities are determined by means of projecting expected cash flows from the contracts using prudent estimates of mortality.

The following tables indicate the estimated amount and timing of the cash flows arising from the liabilities in this category of the ALM framework:

31 December 2009 Contractual cash flows

(undiscounted)

Carrying Carrying 0-5 years 5-10 10-15 15-20 >20 yearsvalues and amounts years years years cash flows arising from: £000 £000 £000 £000 £000 £000 Assets backing liabilities: Debt 80,478 26,342 23,738 17,508 28,962 52,216securities at fair value through income Cash and 449 449 - - - -cash equivalents --------- --------- --------- --------- --------- -------- Total 80,927 26,791 23,738 17,508 28,962 52,216 Liabilities 80,927 24,339 22,417 20,177 17,610 52,027 --------- --------- --------- --------- --------- --------- Difference - 2,452 1,321 (2,669) 11,352 189in expected cash flows ======== ========= ========= ========= ========= ========= 31 December 2008 Contractual cash flows (undiscounted)Carrying Carrying 0-5 years 5-10 10-15 15-20 >20 yearsvalues and amounts years years years cash flows arising from: £000 £000 £000 £000 £000 £000 Assets backing liabilities: Debt 70,957 21,085 19,958 16,581 22,341 41,035securities at fair value through income Cash and 7,260 7,260 - - - -cash equivalents --------- --------- --------- --------- --------- --------- Total 78,217 28,345 19,958 16,581 22,341 41,035 Liabilities 78,217 22,488 20,513 18,228 15,705 45,216 --------- --------- -------- -------- --------- --------- Difference - 5,857 (555) (1,647) 6,636 (4,181)in expected cash flows ========= ========= ========= ========= ========= =========

Sensitivity analysis - interest rate risk

The sensitivity analysis for interest rate risk illustrates how changes in the fair value or future cash flows of a financial instrument will fluctuate because of changes in market rates at the reporting date.

The carrying amount of both the liabilities and the assets, which are debtsecurities valued at fair value, will be sensitive to changes in the level ofinterest rates. By reviewing the matching of the cash flows by term, on aquarterly basis, management aim to minimise the impact of a change in valuesdue to a parallel movement in all yield curves.An increase of 100 basis points in interest yields of the matching assets wouldresult in a decrease of £0.1m in profit for the year ended 31 December 2009 andin shareholder equity as at 31 December 2009 (year ended 31 December 2008 andas at 31 December 2008: £0.3m decrease).

A decrease of 100 basis points in interest yields would result in an increase of £0.1m in profit for the year ended 31 December 2009 and in shareholder equity as at 31 December 2009 (year ended 31 December 2008 and as at 31 December 2008: £1.7m decrease).

Other non-linked contracts

This category consists of two groups of contracts. The first group,representing £12.1m of liabilities out of the total of £50.1m as at 31 December2009 (£10.1m out of the total of £48.3m as at 31 December 2008) is operated ona quasi-linked basis; these are contracts for which, while not classed asunit-linked due to the fact that there is no surrender value which depends onunit values, all other aspects of the risk management of these contracts arethe same as for unit-linked contracts. As a result the business operates thesame risk management processes as described under 'Unit-linked Contracts'above.The following is a maturity analysis of the contractual liabilities for thisgroup of contracts, prepared on an estimated basis using estimates ofmortality. The analysis represents the gross liabilities, before taking intoaccount offsetting linked assets that are scheduled to mature in a similar

profile. Contractual cash flows (undiscounted) 0-5 5-10 10-15 15-20 >20 years years years years years £000 £000 £000 £000 £000 As at 31 December 20,796 22,314 18,148 6,655 2,904 2009 ======== ========= ========= ======== ======== As at 31 December 22,686 24,813 21,543 10,105 4,080 2008 ======== ======== ======= ========= ========

Sensitivity analysis - equity risk

An increase or decrease of 10% in the value of the assets which back this group of contracts would not have a material effect on either profit for the year ended 31 December 2009 and the year ended 31 December 2008 or shareholder equity as at those dates.

The second group of contracts comprises contracts which pay guaranteed benefitson death or other insurance events, the terms being guaranteed at the inceptionof the contract. The financial component of these contracts is a guaranteedfixed interest rate, and hence, the Group's primary financial risk on thesecontracts is the risk that interest income and capital redemptions from thefinancial assets backing the liabilities are insufficient to fund the benefitspayable.The business manages the interest rate risk for this group by closely matchingnew contracts written with financial assets of a suitable duration and quality,as indicated by their credit rating. By using fixed interest debt securitiesthere is no exposure to equity price risk. Regular monitoring of the interestrate risk is carried out by analysis of expected cash flows from the financialassets held with those for the liabilities. Cash flows for the liabilities aredetermined by means of projecting expected cash flows from the contracts usingprudent estimates of mortality.The following tables indicate the estimated amount and timing of the cash flowsarising from the liabilities in the second group of this category of the ALMframework:31 December 2009 Contractual cash flows (undiscounted)Carrying Carrying 0-5 years 5-10 10-15 15-20 >20 yearsvalues and amounts years years years cash flows arising from: £000 £000 £000 £000 £000 £000 Assets backing liabilities: Reinsurers' 5,701 375 694 1,027 1,305 5,926share of insurance contract provisions Debt 20,102 5,563 5,583 2,857 5,081 12,392securities at fair value through income Insurance 3,237 3,237 - - - -and other receivables Cash and 8,919 8,919 - - - -cash equivalents --------- --------- --------- --------- -------- --------- Total 37,959 18,094 6,277 3,884 6,386 18,318 Liabilities 37,959 16,502 7,140 6,283 6,198 19,514 --------- --------- --------- --------- --------- --------- Difference - 1,592 (863) (2,399) 188 (1,196)in expected cash flows ========= ========= ========= ========= ========= ========= 31 December 2008 Contractual cash flows (undiscounted)Carrying Carrying 0-5 years 5-10 10-15 15-20 >20 yearsvalues and amounts years years years cash flows arising from: £000 £000 £000 £000 £000 £000 Assets backing liabilities: Reinsurer's 6,072 411 760 1,124 1,429 6,487share of insurance contract provisions Debt 17,724 4,929 4,300 2,702 3,126 9,953securities at fair value through income Insurance 1,423 1,423 - - - -and other receivables Cash and 12,967 12,967 - - - -cash equivalents --------- --------- --------- --------- --------- --------- Total 38,186 19,730 5,060 3,826 4,555 16,440 Liabilities 38,186 15,022 7,048 6,211 6,182 20,601 --------- --------- --------- --------- --------- --------- Difference in expected cash flows - 4,708 (1,988) (2,385) (1,627) (4,161)

========= ========= ========= ========= ========= =========

Sensitivity analysis - interest rate risk

The sensitivity analysis for interest rate risk illustrates how changes in the fair value or future cash flows of a financial instrument will fluctuate because of changes in market rates at the reporting date.

The carrying amount of both the liabilities and the assets, which include debtsecurities valued at fair value, will be sensitive to changes in the level ofinterest rates. By reviewing the matching of the cash flows by term, on aquarterly basis, management aim to minimise the impact of a change in valuesdue to a parallel movement in all yield curves.

An increase of 100 basis points in interest yields would result in a decrease of £0.2m in profit for the year ended 31 December 2009 and in shareholder equity as at 31 December 2009 (year ended 31 December 2008 and as at 31 December 2008: £0.6m decrease).

A decrease of 100 basis points in interest yields would result in an increase of £0.1m in profit for the year ended 31 December 2009 and in shareholder equity as at 31 December 2009 (year ended 31 December 2008 and as at 31 December 2008: increase of £0.5m).

Certain of the contracts in this second group of contracts are invested in theGuaranteed Growth Fund which provides a return to policyholders which is linkedto the average mortgage rate. This creates a risk due to a mismatch of assetsand liabilities as there are no suitable assets available to back thisguarantee and hence the assets are held in cash. This means that the return onassets held is lower than the return given to policyholders. Provisions areheld to meet this shortfall, on appropriate assumptions as to future levels ofreturn on assets and return given to policyholders. There is a risk that thereturn given to policyholders will increase by more than the return on assetsdue to inability to match the guarantee - that is, that the spread betweenmortgage rates and cash deposit rates will increase.

Other

This category comprises two groups of assets and liabilities which have different risk characteristics.

(i) Intangible assets and deferred income

These comprise acquired value of in-force business, deferred acquisition costand deferred income which are non-monetary items. There is, therefore, nofinancial risk associated with these assets and liabilities which are amortisedin line with the related accounting policies.

(ii) Other assets and liabilities

These primarily comprise tradeable collective investment scheme assets, cashand debt securities and, as such, are exposed to limited counterparty creditrisk as explained below in 'Credit Risk Management'.

Net of associated liabilities, the items broadly match the shareholder equity of the UK Business and, therefore, contribute to the return on the Group's investment in the UK Business.

UKBusiness and Other Group Activities

Credit risk management

The UK Business has exposure to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. Key areas where the business is exposed to credit risk are:

- Reinsurers' share of insurance liabilities;

- Amounts deposited with reinsurer in relation to investment contracts;

- Amounts due from reinsurers in respect of claims already paid; and

- Counterparty risk with respect to corporate bond, deposits and debt securities.

In addition there will be some exposures to individual policyholders, on amounts due on insurance contracts. These are tightly controlled, with plans being terminated or benefits amended if amounts owed are for more than 3 months, so there is no significant risk to the results of the business.

The business structures the levels of credit risk it accepts by placing limits on its exposure to a single counterparty, or group of counterparties. Such risks are subject to at least an annual review.

By far the largest credit risk to the UK Business is in relation to itsreinsurance assets. Although the business holds a significant proportion of itsfinancial assets in securities, the risk of default on these is mitigated tothe extent that any losses arising in respect of unit-linked funds backing theinsurance and investment contracts which the business issues, would effectivelybe passed on to policyholders and investors through the unit-linked fundsbacking the insurance and investment contracts.The UK Business retains some residual risks on assets which support annuities,guaranteed investment bonds and shareholder's equity. These risks aremonitored: a key aspect of this is the business's current policy of investingnew monies only in high-quality bonds of supra-national corporations and ingovernment-backed debt. The business has never purchased assets rated below AAby Standard & Poors.The UK Business's objective is to earn competitive relative returns byinvesting in a diversified portfolio of securities. Watch lists are maintainedfor exposures requiring additional review and all credit exposures are reviewedmonthly.

The UK Business's exposure to credit risk in relation to its debt securities and cash balances is summarised below:

Cash Credit rating-debt securities balances Total AAA AA A Unrated As at 31 £000 £000 £000 £000 £000 £000 December 2009 Debt securities, deposits and cash balances with credit institutions Linked 41,284 51 410 - 41,630 83,375 Non-linked 25,959 4,748 4,026 - 98,835 133,568 Government or pseudo Government deposits Linked 63,475 - - - - 63,475 Non-linked 105,975 - - - - 105,975 -------- --------- ------- --------- --------- --------- Total debt, deposits and cash balances 236,693 4,799 4,436 - 140,465 386,393 ========= ========= ======= ========= ========= ========= Cash Credit rating-debt securities balances Total AAA AA A Unrated As at 31 £000 £000 £000 £000 £000 £000 December 2008 Debt securities, deposits and cash balances with credit institutions Linked 40,507 137 - - 45,046 85,690 Non-linked 44,937 15,385 3,520 - 147,335 211,177 Government or pseudo Government deposits Linked 72,999 - - - - 72,999 Non-linked 101,619 - - - - 101,619 --------- --------- ------- --------- --------- --------- Total debt, deposits and cash balances 260,062 15,522 3,520 - 192,381 471,485 ========= ========= ====== ========= ========== ========= Reinsurance credit riskReinsurance is used to manage insurance risk in the UK Business. This does nothowever discharge the business's liability as primary insurer. If a reinsurerfails to pay a claim for any reason, the business remains liable for thepayment to the policyholder. The creditworthiness of major reinsurers isconsidered on an annual basis by reviewing their financial strength.It should be noted that for historical reasons the UK Business has asignificant exposure of £232.9m as at 31 December 2009 (31 December 2008: £200.6m) to Guardian, which does not have a published credit rating. Of thisamount £204.1m (31 December 2008: £182.5m) is in respect of currentlyguaranteed benefits. The exposure which relates to reinsured insurance contractliabilities, and which relates to amounts deposited with Guardian in respect ofinvestment contract liabilities, was mitigated during 2006 when Guardiangranted to Countrywide Assured plc a floating charge over related investmentassets, which ranks that company equally with Guardian policyholders. In orderto monitor the ongoing creditworthiness of Guardian, the UK Business reviewsthe financial statements and regulatory returns submitted by Guardian to theFSA on an annual basis.

In addition the business also has an exposure on a number of its risk premium reinsurance contracts, although in general the premiums payable under these contracts in any period will be higher than the claims payments received.

Financial assets that are past due or impaired

In 2008, a cash deposit with Kaupthing Singer and Friedlander ('KSF') was written down by its full amount of £1,091,000 as a result of KSF entering administration.

During 2009, interim distributions totalling £326,000 were made from the administrators in respect of the deposit.

There are no other Group financial assets that are impaired, would otherwise bepast due, or impaired, whose terms have been negotiated, or past due but notimpaired. Swedish Business

Terms and conditions of unit-linked investment contracts

The insurance and investment elements of unit-linked contracts provided by theSwedish Business have been unbundled. The principal risks associated with theinsurance contracts are disclosed in Note 5 of the financial statements and theManagement of Insurance Risks above . The terms and conditions of investmentcontracts that could have a material effect on the amount, timing anduncertainty of future cash flows arising from investment contracts are set outin the product analyses below.

The Swedish Business provides two types of investment contract:

Unit-linked savings

These are single premium or regular premium contracts, with the premiumsinvested in unit-linked funds or trust accounts where the policyholder decideswhere to invest. On certain contracts there is a small additional benefitpayable on death which is deemed not to transfer significant insurance risk tothe business for these contracts. The benefits payable at maturity or surrenderof the contracts are the underlying value of the investment in the unit-linkedfunds or trust accounts.Unit-linked pensionsThe contractual features are similar to unit-linked savings. The savings can betransferred to another pension provider or can be cashed on retirement over aperiod of least five years. There is no annuity linked to the unit-linkedpensions.As the business matches all the financial liabilities with assets on which theunit liabilities are based, this approach results in the business having nosignificant market risk (being interest rate, equity price and currency risks)or credit risk on these contracts.

Contractual maturity analysis

The liquidity risk within the Swedish Business is limited, since the premiumsare collected in advance and any large claims payments are usually known withina short period of their occurrence. To reduce the remaining liquidity risk, thebusiness's cash flow is analysed continuously. The main part of the business'sassets is placed in securities which can be sold with short notice, without theprice being greatly affected. Investments are also made into listed securitieswhere the liquidity risk is deemed to be limited.The following table sets out the contractual maturity analysis of the financialassets and financial liabilities of the Swedish Business: the information as at31 December 2008 is in respect of the pre-acquisition period and is providedfor illustrative purposes. 31 December 2009 Carrying year years years years years Unit amounts 0-1 1-2 2-3 3-4 >4 linked* Carrying values £000 £000 £000 £000 £000 £000 £000 and cash flows arising from: Assets Equity securities at fair value through income - - - - - - - Collective investment schemes 915,602 5,963 - - - - 909,639 Policyholders' funds held by the group 41,107 - - - - - 41,107 Debt securities at fair value through income 1,908 1,908 - - - - - Reinsurers' share of insurance contract provisions 27,262 15,359 3,733 2,328 922 4,920 - Insurance and other receivables 10,208 9,548 660 - - - - Accrued income and prepayments 2,093 2,093 - - - - - Derivative financial instruments 3,544 1,051 1,437 863 183 10 - Cash and cash equivalents 14,776 14,776 - - - - - ---------- ------- ------ ------ ------ ------- --------- Total 1,016,500 50,698 5,830 3,191 1,105 4,930 950,746 --------- ------- ------ ------ ------ ------ --------- Liabilities Insurance contract provisions 32,353 17,893 4,397 2,774 1,151 6,138 - Investment contracts 918,291 - - - - - 918,291 Liabilities relating to policyholders' funds held by the group 41,107 - - - - - 41,107 Other liabilities 46,705 23,876 7,205 6,223 3,436 5,965 - --------- ------- ------ ------ ------ ------ --------- Total 1,038,456 41,769 11,602 8,997 4,587 12,103 959,398 --------- ------- ------ ------ ------ ------ --------- Difference in expected cash flows (21,956) 8,929 (5,772)(5,806)(3,462) (7,173) (8,652) ========= ======= ====== ====== ====== ====== =========

* Amounts included under unit linked funds are deemed to have a maturity up to one year as they are repayable or transferable on demand.

31 December 2008 Carrying year years years years years Unit amounts 0-1 1-2 2-3 3-4 >4 linked* Carrying values £000 £000 £000 £000 £000 £000 £000 and cash flows arising from: Assets Equity securities at fair value through income - - - - - - - Collective investment schemes 588,744 5,482 - - - - 583,262 Debt securities at fair value through income 613 613 - - - - - Reinsurers' share of insurance contract provisions 24,678 7,070 3,944 1,489 609 11,566 - Insurance and other receivables 8,876 8,876 - - - - - Accrued income and prepayments 1,119 1,119 - - - - - Cash and cash equivalents 21,769 8,557 - - - - 13,212 ---------- ------ ------ ------ ------- ------ --------- Total 645,799 31,717 3,944 1,489 609 11,566 596,474 --------- ------ ------ ------ ------- ------ --------- Liabilities Insurance contract provisions 27,938 7,131 4,730 1,777 715 13,585 - Investment contracts 596,474 - - - - - 596,474 Other liabilities 49,082 27,704 6,880 6,184 3,649 4,665 - --------- ------ ------ ------ ------- ------ --------- Total 673,494 34,835 11,610 7,961 4,364 18,250 596,474 --------- ------ ------ ------ ------ ------ --------- Difference in expected cash flows (27,695)(3,118)(7,666)(6,472) (3,755)(6,684) - ====== ====== ====== ====== ====== ====== ======

* Amounts included under unit linked funds are deemed to have a maturity up to one year as they are repayable or transferable on demand.

Foreign exchange exposure

The Swedish Business underwrites insurance contracts in Norway and itsexposures to foreign exchange risk arises primarily with respect to theNorwegian Krone. The business reinsures 90 per cent of the risk and has someassets denominated in the same currencies as the foreign insurance liabilities,which should eliminate most of the foreign currency exchange rate risk on theseoperations. The following table sets out the foreign exchange exposure of the financialassets and financial liabilities of the Swedish Business: the information as at31 December 2008 relates to the pre-acquisition period and is provided forillustrative purposes. 31 December 31 December 2009 2008 2009 2008 Foreign assets and NOK 000 NOK 000 EUR 000 EUR 000 liabilities Assets: Reinsurers' share of insurance contract provisions 85,543 76,952 - - Deferred acquisition costs 327 209 - - Equity securities at fair value through income - - - - Debt securities at fair value through income - - - - Insurance and other receivables (402) 2,030 - - Loans and other receivables - - 7,609 - Cash and cash equivalents 12,135 12,263 16 119 --------- --------- --------- --------- Total 97,603 91,454 7,625 119 --------- ---------- --------- --------- Liabilities Insurance contract provisions (102,262) (90,997) - - Other liabilities (762) (4,740) - - --------- --------- --------- --------- Total (103,024) (95,737) - - --------- --------- --------- --------- Foreign exchange mismatch (5,421) (4,283) 7,625 119 ========= ========== ========= ========= Credit risk exposure

The Swedish Business has exposure to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. Key areas where the business is exposed to credit risk are:

- Reinsurers' share of insurance liabilities;

- Amounts due from reinsurers in respect of claims already paid;

- Counterparty risk with respect to corporate bond, deposits and debt securities; and

- Amounts paid to independent financial advisers representing advances of

commission not yet earned by them.

Amounts due from policyholders are insignificant and claims againstpolicyholders carry a limited credit risk as non-payment leads to cancellationof the insurance policy. Unit-linked assets are only acquired upon receipt ofthe premium from the policyholder.The business structures the levels of credit risk it accepts by placing limitson its exposure to a single counterparty, or group of counterparties. Suchrisks are subject to at least an annual review. By far the largest credit riskto the business is in relation to its reinsurance assets.The business retains some residual risks on assets which support shareholders'equity. The business's objective is to earn competitive relative returns byinvesting in a diversified portfolio of securities. Watch lists are maintainedfor exposures requiring additional review and all credit exposures are reviewedmonthly.The exposure to credit risk of the Swedish Business in relation to its debtsecurities, receivables and cash balances is summarised below: the informationas at 31 December 2008 relates to the pre-acquisition period and is providedfor illustrative purposes. Credit rating- debt securities AAA AA A Unrated Total As at 31 £000 £000 £000 £000 £000 December 2009 Debt securities at fair value through income 1,908 - - - 1,908 Insurance and other receivables - - - 10,108 10,108 Cash balances - - - 14,776 14,776 --------- --------- --------- --------- --------- Total debt, receivables and cash balances 1,908 - - 24,884 26,792 ========= ========= ========= ========= ========= Credit rating- debt securities AAA AA A Unrated Total As at 31 £000 £000 £000 £000 £000 December 2008 Debt securities at fair value through income 613 - - - 613 Insurance and other receivables - 3,155 - 5,721 8,876 Cash balances - 20,607 1,076 86 21,769 --------- --------- --------- ---------- --------- Total debt, receivables and cash balances 613 23,762 1,076 5,807 31,258 ========= ========= ========= ========= ========= Reinsurance credit riskReinsurance is used to manage insurance risk in the Swedish Business. This doesnot however discharge the business's liability as primary insurer. If areinsurer fails to pay a claim for any reason, the business remains liable forthe payment to the policyholder. The creditworthiness of major reinsurers isconsidered on an annual basis by reviewing their financial strength. Thecurrent rules state that re-insurance should only be made using reinsurancecompanies with a credit rating from Standard & Poor's of A or higher (exceptfor the reinsurer which is an associate of the Group).The business has entered into reinsurance arrangements with four reinsurers. With the main reinsurer, there is an associated financial reinsurance agreementin place whereby the amount due to the reinsurer is more than the reinsurer'sshare of the claims.

In relation to the other significant reinsurer (which is an associate of the Group), there is a credit risk exposure which is managed by the Group being represented on the Board of the reinsurer. The Group is therefore closely involved and can influence its strategy.

Reinsurance Credit Risk Exposure

Credit rating- reinsurers AAA AA A Unrated Total £000 £000 £000 £000 £000 As at 31 December - 16,483 38 10,741 27,2622009 --------- --------- --------- --------- --------- As at 31 December - 9,917 3 17,913 27,8332008* --------- --------- --------- --------- ---------

* This information relates to the pre-acquisition period and is provided for illustrative purposes.

Financial assets that are past due or impaired

There are no financial assets that are impaired, would otherwise be past due or impaired whose terms have been renegotiated or past due but not impaired.

Sensitivity analysis

Certain of the information below relates to the pre acquisition period and is provided for illustrative purposes.

Sensitivity analysis - interest rate risk

The sensitivity analysis for interest rate risk within the Swedish Businessillustrates how changes in the fair value or future cash flows of a financialinstrument will fluctuate because of changes in market rates at the reportingdate.The carrying amount of both the liabilities and the assets, which are fixedinterest debt securities valued at fair value, will be sensitive to changes inthe level of interest rates. By reviewing the matching of the cash flows byterm, on a quarterly basis, management aim to minimise the impact of a changein values due to a parallel movement in all yield curves.The interest rate risk for the fixed interest debt securities of the SwedishBusiness is deemed to be low as these assets are mainly short term (less than ayear). A 100 basis point increase or decrease in interest yields would not havea material effect on either profit for the year ended 31 December 2009 orshareholder equity as at that date.

Sensitivity analysis - equity risk

The direct and indirect investment in equities of the Swedish Business and themanagement fees on the unit linked assets (which are based on the asset valueof the unit-linked assets) are impacted by movement in the equities market.A decrease of 10 per cent in equities markets would result in a £0.1m decreasein profit for the year ended 31 December 2009 and to shareholder equity as at31 December 2009, (year ended 31 December 2008 and as at 31 December 2008 £0.1m).An increase of 10 per cent in equities markets would result in a £0.1m increasein profit for the year ended 31 December 2009 and to shareholder equity as at31 December 2009 (year ended 31 December 2008 and as at 31 December 2008: £0.1m).

Sensitivity analysis - foreign exchange risks

An increase or decrease of 10% in exchange rates in relation to the Swedish Business has no material effect on profit and shareholder equity either for the year ended 31 December 2009 or for the year ended 31 December 2008 or as at those dates.

Corporate

The financial risks in relation to Other Group Activities relate to the risks associated with Chesnara plc company assets and liabilities. These comprise:

Cash and cash equivalents

The related risks are included in the analysis of credit risk management set out above.

BorrowingsBorrowings issued at variable rates of interest expose the Group to cash flowinterest risk. Information on borrowings is set out in Note 36 of the financialstatements. A 1% increase in interest rates would result in a decrease of lessthan £0.1m in profit after tax attributable to shareholders for the year ended31 December 2009 (year ended 31 December 2008: £0.1m decrease) and inshareholder equity as at 31 December 2009 (31 December 2008: £0.1m decrease)Foreign exchange rate risk

The Group has exposure to foreign exchange risk in relation to movements between the Swedish Krona and Sterling as a result of its ownership of the Swedish Business.

An increase of 10% in the 31 December 2009 SEK to £ rate from SEK 11.5305 to £1to SEK 12.6836 to £1 would result in a reduction in shareholder equity of £4.3mas at 31 December 2009.An increase of 10% in the average SEK to £ rate from SEK 11.5594 to £1 to SEK12.7153 to £1 for the year ended 31 December 2009 would result in an increasein the profit after tax attributable to shareholders of £0.2m for the yearended 31 December 2009.

POST BALANCE SHEET EVENT

On 19 February 2010, Chesnara plc's Swedish subsidiary, Moderna F¶rs¤kringarLiv AB ('Moderna'), entered into an agreement with the Swedish Regulatory Authority, Finansinspektionen ('FI'), to take over the operational managementof Aspis F¶rs¤krings Liv AB ('Aspis'). This means that Moderna will acquire the in force business, the personnel, expertise and systems of Aspis and willalso manage, but not be responsible for, the payment of in-force claims thathad occurred up to 12 November 2009. Moderna, under the terms of an assettransfer agreement entered into on 10 December 2009, acquired the right tooffer renewal policies to Aspis policyholders from 12 November 2009.The FI had recently determined to revoke the Aspis licence due to issuesregarding its solvency capital which remained unresolved. By taking this opportunity Moderna removes significant uncertainty for the Aspis customers,staff and supporting intermediaries and acquires a book of protection businesswhich represents an excellent strategic fit with its current pension and savingsbusiness. The transaction is expected to be earnings enhancing in the medium term but, given the recent timings of the transaction, we are unable to makea reliable estimate of the effect on the Group's financial results at this time.This is because the negative press coverage that Aspis received within Swedenprior to the agreement will have had a negative impact on lapse rates of policiesat the date of renewal which will impact the quantification of the value of thein-force intangible assets acquired. As a result, the fair value of the netassets acquired and the goodwill arising on acquisition cannot be assessed with reliability at this time.

For further information please contact

Graham Kettleborough 01772 840001Chief Executive, 07799 407519

Chesnara plc