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Chesnaraplc (the 'Company') ANNUAL FINANCIAL REPORT* Financial Statements for the year ended 31 December 2010* Notice of Annual General Meeting* Form of Proxy for the Annual General Meeting
Copies of the above documents which were issued to shareholders on 11 April 2011 have been submitted to the National Storage Mechanism and are available for inspection at: www.Hemscott.com/nsm.do. The Company's Financial Statements and Notice of Annual General Meeting may also be found on its website at www.chesnara.co.uk.
The Company announced its preliminary results for the year ended 31 December 2010 on 31 March 2011 which included audited financial statements and a fair review of the business. The Company today provides the following additional regulated information, included within its Financial Statements, in full unedited text as required to be made public under the disclosure and transparency rules.
1 DIRECTORS' RESPONSIBILITY STATEMENT 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 each financial year. Under that law the directors are required to prepare the group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and Article 4 of the IAS Regulation and have also chosen to prepare the parent company financial statements under IFRSs as adopted by the EU. Under company law the directors must not approve the accounts unless they are satisfied that they give a true and fair view of the state of affairs of the company and of the profit or loss of 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 are sufficient to show and explain the company's transactions and disclose with reasonable accuracy at any time the financial position of the company and enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and 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.
By order of the BoardChairman Chief Executive Officer Peter Mason Graham Kettleborough 30 March 2011 30 March 2011
2 PRINCIPAL RISKS AND UNCERTAINTIES
Risk and uncertainties are assessed by reference to the extent to which they threaten, or potentially threaten, the ability of the Group to meet its core strategic objectives. These currently centre on the intention of the Group to maintain a reliable and progressive dividend policy.
The specific principal risks and uncertainties subsisting within the Group are determined by the fact that:
(i) the Group's core operations centre on the run-off of closed life and pensions
businesses in the UK;
(ii) notwithstanding this, the Group has a material segment, which comprises an open
life and pensions business operating in a foreign jurisdiction; and
(iii)these businesses are subject to local regulation, which significantly
influences the amount of capital which they are required to retain and which
may otherwise constrain the conduct of business.
The following identifies the principal risks and uncertainties, together with a description of their actual or potential impact and of the way in which the Group seeks to control them. Insurance and financial risks relating to (i) insurance and investment contracts provided by the Group to policyholders and to investors and to (ii) Group-level investment activities are set out in Notes 5 and 6 to the IFRS financial statements, where the information is provided on a segmented basis. The analysis below includes a re-presentation of the more significant risks identified therein on a generic basis.
Risk Impact Control
Adverse The Group provides benefits to The Group uses underwriting mortality/ policyholders in the event of techniques, reinsurance morbidity/ death or illness and to programmes and limits on levels longevity annuitants for their lifetime. of accepted risk on individuals, experience Premiums are partly fixed by in order to control the overall
reference to mortality/ level of risk. The Group has morbidity tables. To the extent also retained the right on that actual mortality or certain contracts to vary morbidity rates vary from the premium rates in the light of assumptions underlying product actual experience. pricing, so more or less profit Notwithstanding this, the Group will accrue to the Group. is exposed to the possible effects of pandemics, such as AIDS and SARS. The impact of overall mortality risk is mitigated to the extent that the Group has a portfolio of annuity contracts where the benefits cease on death.
Adverse Persistency risk is the risk The Group's exposure to persistency that insurance policyholders or persistency risk is naturally experience investors in investment limited to the extent that, in
contracts either discontinue closed life and pensions books, paying new premiums or which currently continue to investing new sums, or comprise the larger part of the otherwise exercise their rights Group's business, persistency to discontinue the contracts. rates tend to improve over time Persistency rates significantly due to policyholder/investor lower than those assumed will inertia. The Group otherwise lead to reduced Group promotes retention through (i) profitability in the medium to active review of the management long term. of, and returns arising on, policyholder investment funds and (ii) maintaining customer retention units. Expense For the closed UK life and For the UK businesses, the Groupoverruns pensions businesses, the Group pursues a strategy of is exposed to the impact of outsourcing functions, to the fixed and semi-fixed expenses, fullest extent possible, to in conjunction with a specialist outsourced services diminishing policy base, on providers. It seeks to do this profitability. For the Swedish on pricing terms which recognise open life and pensions the diminishing policy base and business, the Group is exposed which, in respect of contract to the impact of expense levels renewal, seeks to maintain varying adversely from those competitive tension between assumed in product pricing. service providers. For the Swedish business, periodic reviews are conducted to ensure that overall expense levels are appropriate, based on activity analysis and on medium-term projections. In addition, for both the UK and Swedish businesses, the Group maintains a strict regime of budgetary control.
Significant A significant part of the Notwithstanding that individual and prolonged Group's income and, therefore, fund mandates may give rise to equity and overall profitability derives diversification of risk and property from fees received in respect that, within those funds, market falls of the management of
hedging techniques are used policyholder and investor where appropriate, there is funds. Fee levels are generally clearly a significant residual related to the value of funds risk to adverse global equity under management and, as the market conditions. The Group has managed investment funds taken the explicit decision not overall comprise a significant to mitigate the residual risk, equity and property content, by way of hedging, because of the Group is particularly the significant cost relative to exposed to the impact of the risk: it does, however, significant and prolonged periodically review the costs of equity market falls. hedging. Adverse The Group maintains portfolios The Group maintains rigorous movements in of fixed interest securities matching programmes to ensure yields on (i) in order to match its that exposure to mismatch loss fixed interest insurance contract liabilities, is minimised: there may be some securities in terms of yield and cash flow reversal of the extent of loss characteristics, and (ii) as an through the natural effluxion of integral part of the investment time as dated securities funds it manages on behalf of approach their redemption date. policyholders and investors. It The Group does not seek to hedge is exposed to mismatch losses against adverse movements in arising from a failure to match fixed interest securities, as its insurance contract the cost is prohibitive when liabilities or from the fact compared with the residual risk. that sharp and discrete fixed The proportion of fixed interest interest yield movements may securities in policyholder and not be associated fully and investor managed funds is immediately with corresponding significantly less than the changes in actuarial valuation proportion of equities. interest rates. Adverse The Swedish business, whose The Group actively monitors sterling: functional and reporting exchange rate movements and the Swedish Krona currency is the Swedish Krona, cost of hedging the currency exchange rate is a material part of the risk on cash flows when movements Group. Exposure to adverse appropriate. The Group does not sterling/Swedish Krona exchange seek to hedge the risk of rate movements arises from adverse currency movements on actual planned cash flows its reported results. between the Swedish subsidiary and its UK parent company and from the impact on reported IFRS and EEV results which are expressed in sterling. Counterparty The Group carries significant Risk to counterparty failure is failure inherent risk of counterparty mitigated generally by the failure in respect of; operation of guidelines which limit the level of exposure to - its fixed interest security any one counterparty and which portfolio; impose limits on exposure to credit ratings. In respect of - cash deposits; and exposure to one major reinsurer, Guardian Assurance plc - amounts due from reinsurers. ('Guardian'), the Group has a floating charge over the reinsurer's related investment assets, which ranks the Group equally with Guardian's policyholders. In addition, the Group reviews the regulatory returns filed by Guardian, in order to identify issues which may arise in connection with the financial viability of Guardian.
Failure of The Group's UK life and The Group specifies rigorous outsourced pensions businesses are heavily service level measures and service dependent on outsourced service management information flows providers to providers to fulfill a under its contractual
fulfil significant number of their arrangements. Following from contractual core functions. In the event of this, the Group maintains obligations failure by either or both continuing and close oversight
service providers to fulfill of the performance of both their contractual obligations, service providers. Under the in whole or in part, to the terms of the contractual requisite standards specified arrangements the Group may in the contracts, the Group may impose penalties and/ or suffer loss as its functions exercise step-in rights in the degrade. event of specified adverse circumstances.
Key Man The nature of the Group is such The Group promotes the sharing dependency that, for both its Group-level of knowhow and expertise to the
functions and for its UK life fullest extent possible. It and pensions operations, it periodically reviews and relies on a small, professional assesses staffing levels, and, team. There is, therefore, where the circumstances of the inevitably a concentration of Group justify and permit, will experience and knowhow within enhance resource to ensure that particular key individuals and knowhow and expertise is more the Group is, accordingly, widely embedded. exposed to the sudden loss of the services of these To minimise the risk of individuals. knowledge loss, the Group maintains succession plans and remuneration structures which comprise a retention element. Should a skills gap appear the Group seeks to utilise external resource until such time as a permanent solution can be identified. These processes are supplemented by the maintenance of procedures to assess the competence of, and training requirements for, all key individuals. Adverse The Group operates in The Group controls these risks
regulatory and jurisdictions which are and addresses the related legal changes currently subject to
uncertainties by assessing significant change arising from potential outcomes and by taking regulatory and legal appropriate action to minimise requirements. These may either the impact of adverse be of a local nature, or of a circumstances. It monitors wider nature, following from industry comment and takes EU-based regulation and law. specialist professional advice, Significant issues which have where necessary. arisen and where there is currently uncertainty as to It is in the nature of these their full impact on the Group issues, however, particularly in include: those areas where specific regulatory rules and/or law have (i) review of the UK tax regime not yet been framed and in respect of life assurance implemented, that there remains business; significant uncertainty as to their impact on the Group's (ii)review of the tax treatment longer-term profitability and on of fees rebated by investment the capacity and capability of fund managers to Movestic; its life and pensions subsidiaries to distribute (iii) the implementation of regulatory determined surpluses. Solvency II requirements; (iv)the implications of a ruling made by the ECJ, applicable to insurance companies, in connection with gender; and (v) the impact of IFRS Insurance Accounting Phase 2 developments.
The outcomes of these issues may variously impact the level of reported profitability in the Group and the capacity and capability of its life and pensions subsidiaries to distribute regulatory-determined surpluses.
Further information in connection with item (iv) is provided in the Post Balance Sheet Event section below.
Significant changes in the nature and incidence of risks and uncertainties arising during the twelve months ended 31 December 2010 related to:
(i) review by HMRC of the UK tax regime in respect of life assurance business;
and
(ii) the implications of a ruling made by the ECJ, applicable to insurance companies
in connection with gender
as set out under "adverse regulatory and legal changes" above.
Further, in view of continuing economic uncertainty there is continuing uncertainty as to the future direction of investment markets and attention is drawn particularly to the sensitivity of the reported embedded value of the Group to the economic sensitivities set out in Note 7 to the European Embedded Value Basis Supplementary Information in the Financial Statements.
3 ACCOUNTING ESTIMATES AND JUDGEMENTS
The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities and also makes critical accounting judgements in applying the Group's accounting policies. Such estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable. The more critical areas, where accounting estimates and judgements are made, are set out below. Each item identifies whether it relates to the UK or Swedish businesses or both, and where necessary it identifies the UK operating segments (jointly "UK business"), being Countrywide Assured Life Holdings Limited ('CA') and Save & Prosper Insurance Limited ('S&P').
(a) Classification of long-term contracts (UK and Swedish businesses)
The Group has exercised judgement in its classification of long-term business as between insurance and investment contracts, which fall to be accounted for differently in accordance with the policies set out in Note 2 to the IFRS Financial Statements, "Significant Accounting Policies". Insurance contracts are those where significant risk is transferred to the Group under the contract and judgement is applied in assessing whether the risk so transferred is significant, especially with regard to pensions contracts, which are predominantly, but not exclusively, created for investment purposes.
(b) Acquired value of in-force business (UK and Swedish businesses)
The Group applies accounting estimates and judgements in determining the fair value, amortisation and recoverability of acquired in-force business relating to insurance and investment contracts. In the initial determination of the acquired value of in-force business, the Group uses actuarial models to determine the expected net cash flows (on a discounted basis) of the policies acquired. The key assumptions applied in the models are driven by the expected behaviour of policyholders on termination rates, expenses of management and age of individual contract holders as well as global estimates of investment growth, based on recent experience at the date of acquisition. The assumptions applied within the models are considered against historical experience of each of the relevant factors. No amendments are made for any changes that may arise as a result of changes in operational procedures or customer interaction as a result of ownership by Chesnara.
The acquired value of in-force business has been amortised on a basis that reflects the expected profit stream arising from the business acquired at the date of acquisition. Acquired value of in-force business is tested for recoverability by reference to expected future income and expense levels.
During the year ended 31 December 2010 the amortisation profile of the acquired value of in-force business associated with the acquisition of Movestic, the Swedish business, as referred to in Note 7(iii) to the IFRS Financial Statements, was refined to better reflect the matching of the consumption of this asset with the expected emergence of profit. The impact of this refinement is to reduce the amortisation charge in the Group financial statements by £2.7m during the year ended 31 December 2010.
As at 31 December 2010, the carrying value of acquired in-force business, net of amortisation, was £21.1m in respect of CA (as at 31 December 2009: £24.8m), £9.1m in respect of S&P (as at 31 December 2009: £nil) and £62.9m in respect of Movestic (as at 31 December 2009: £61.7m).
(c) Deferred acquisition costs and deferred income - investment contracts (CA and Swedish business)
The Group applies judgement in deciding the amount of direct costs that are incurred in acquiring the rights to provide investment management services in connection with the issue of investment contracts. Judgement is also applied in establishing the amortisation of the assets representing these contractual rights and the recognition of initial fees received in respect of these contracts. The assets are amortised over the expected lifetime of the investment management service contracts and deferred income, where applicable, is amortised over the expected period over which it is earned. Estimates are applied in determining the lifetime of the investment management service contracts and in determining the recoverability of the contractual rights assets by reference to expected future income and expense levels. This test for recoverability is performed using best estimates of future cash flows, using a market consistent estimate of future investment returns.
As at 31 December 2010, the carrying values of deferred acquisition costs, net of amortisation, and of deferred income, in respect of CA, were £6.7m and £ 11.6m respectively (as at 31 December 2009: £7.7m and £13.1m respectively). An increase in the estimate of the lifetime of the investment management service contract by one year in respect of deferred acquisition costs would have increased profit before tax for the year ended 31 December 2010 by £0.1m and shareholders' equity as at 31 December 2010 by £0.1m and an increase of one year in the length of the amortisation period in respect of deferred income would have reduced profit before tax for the year ended 31 December 2010 by £ 0.1m and shareholders' equity as at 31 December 2010 by £0.1m.
As at 31 December 2010, the carrying values of deferred acquisition costs, net of amortisation, in respect of the Swedish business, was £7.9m (as at 31 December 2009: £1.6m). An increase in the length of the amortisation period by one year would have increased profit before tax for the year ended 31 December 2010 by £2.4m and shareholders' equity as at 31 December 2010 by £2.4m.
(d) Fair value of financial assets and unit-linked investments (UK and Swedish businesses)
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 liability settled, between willing, knowledgeable parties in an arm's length transaction. Fair values are determined by reference to observable market prices where available and reliable.
(e) Estimates of future benefits payments arising from long-term insurance contracts (UK business)
The Group makes estimates of the expected number of deaths for each of the years that it is exposed to risk. These estimates are based on either standard mortality tables or reinsurers' rate tables as appropriate, adjusted to reflect the Group's own experience. For contracts without fixed terms the Group has assumed that it will be able to increase charges to policyholders in future years, 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 exercise these options, in order to measure their value. Changes in investment conditions could result in significantly more contract holders exercising their options than the Group has assumed in determining the liabilities arising from these contracts.
The Group makes estimates of future deaths, voluntary contract terminations, investment returns and administration expenses at the inception of long-term insurance contracts with fixed and guaranteed terms. These estimates, which are reconsidered annually, form the assumptions used to calculate the liabilities arising from these contracts.
The assumptions used to establish insurance contract liabilities and appropriate sensitivities relating to variations in critical assumptions are disclosed in Note 33 to the IFRS Financial Statements.
(f) Liability for future redress in respect of mortgage endowment misselling complaints (UK business)
Included within insurance contract liabilities is a liability in respect of amounts anticipated to be payable as redress for upheld mortgage endowment misselling complaints. In establishing this liability the Group makes estimates about the number of future upheld complaints (taking into account the number of complaints received, the number of complaints time-barred and the number of complaints which are admitted) and about the average cost of redress per upheld complaint. These estimates are determined, taking into account historical experience and investment return projections. Variations in these estimates could result in higher or lower than expected numbers of upheld complaints and higher or lower than expected amounts of redress per upheld complaint. The impact of variations in these assumptions is disclosed in Note 33 to the IFRS Financial Statements.
As at 31 December 2010, the liability for future redress in respect of mortgage endowment misselling complaints was £2.4m (as at 31 December 2009: £2.9m) for CA and as at 31 December 2010 £0.1m (as at 31 December 2009: £nil) for S&P.
(g) Fair value of investment contracts - guaranteed income and guaranteed growth bonds (CA)
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 IFRS Financial Statements) is established using a valuation technique, which approximates the following methodology:
(i) The fair value of the contract, measured at inception, is the purchase price
paid for it. This price implies a retail market rate of interest prevailing at the inception of the contract, which is used to equate the contractual cash flows payable under the bond to the purchase price, including an allowance for expenses incurred in managing the contract; and
(ii) 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 2010, the carrying value of investment contract liabilities in respect of guaranteed income and guaranteed growth bonds was £9.3m (as at 31 December 2009: £22.9m).
(h) Contracts which contain discretionary participation features (S&P)
All S&P with-profits contracts contain a discretionary participation feature which entitles the holder to receive, as a supplement to guaranteed benefits, additional benefits or bonuses:
- that may be a significant portion of the total contractual benefits;- whose amount or timing is contractually at the discretion of the Group; and- that are contractually based on realised and/or unrealised investment returns on a specified pool of assets held by the Group.
The terms and conditions of these contracts, together with UK regulations, set out the bases for the determination of the amounts on which the additional discretionary benefits are based and within which the Group may exercise its discretion as to the quantum and timing of their payment to contract holders.
As at 31 December 2010, the carrying value of insurance contract liabilities which contain discretionary participation features was £359.2m (31 December 2009: £nil)
(i) Insurance claim reserves (Swedish business)
Provisions are determined by management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the timing, incidence and amount of claims. In order to calculate the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable parameters, the value of outstanding claims.
For more recent underwriting years the provisions will make more use of techniques that incorporate expected loss ratios. As underwriting years mature, the reserves are increasingly driven by methods based on actual claims experience. The data used for statistical modelling is internally generated. Actual claims experience may differ from the historical pattern on which the estimate 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 2010, the carrying value of the insurance claim reserves, gross of reinsurance, was £63.7m (as at 31 December 2009: £32.4m).The key sensitivities in respect of insurance claim reserves are considered in Note 5 to the IFRS Financial Statements.
(j) Insurance claim reserves - reinsurance recoverable (Swedish business)
A significant proportion of the insurance claims arising within the Swedish business are ceded to reinsurers. In preparing the financial statements the Directors have made an assessment as to whether claims ceded to reinsurers are recoverable. As at 31 December 2010, such claims ceded to reinsurers and reflected on the balance sheet were £41.8m (31 December 2009: £27.3m). The application of a 10 per cent bad debt provision on the reinsurance balance would reduce 2010 profit before tax by £4.5m and shareholders' equity by £3.3m.
(k) Accounting for pension plans (Swedish business)
The Group participates in a defined benefit pension scheme on behalf of its Swedish employees. The scheme is a multi-employer plan to which a number of third party employers also contribute. The underlying assets and liabilities of the scheme are pooled and are not allocated between the contributing employers. As a result, information is not available to account for the scheme as a defined benefit scheme and the Group has accounted for the scheme as a defined contribution scheme.
(l) Income tax expense (Swedish business)
Commissions payable and receivable from fund managers in respect of the Swedish business's unit-linked business have been included as part of the unit-linked funds and subject to fund yield tax.
Management is aware that the Swedish tax authority has questioned, in respect of other unit-linked businesses, whether such commissions receivable from fund managers should be part of the Group's income and be subject to corporation tax of 26.3 per cent (being the Swedish corporation tax for the year 2010). Management consider that the current accounting treatment remains appropriate.
4 POST BALANCE SHEET EVENT
ECJ ruling
It has been historical practice for insurance companies to consider the gender of the policyholder when pricing contracts as evidence has suggested that gender is a key determinant of insurance risk.
On 1 March 2011 the ECJ ruled that a EU directive (which had been subsequently enacted into EU law), which allowed for gender to be a factor when pricing insurance risk, was invalid and contravened other EU law.
The ruling means that from 21 December 2012 it will not be possible to continue using gender as a basis of pricing. However, it is not clear from the ruling whether this will apply only to new contracts written at that date or to all contracts in-force at that date. This will not be known with certainty until the judgement is enacted into UK and Swedish law.
On initial assessment, the Group has assessed that the most likely impact will be in respect of new business to be written from a future date, not yet known, but no later than 21 December 2012. For the UK business this will primarily impact annuity contracts written for vesting pensions, whilst for the Swedish business it will impact all new business. The exact date from which new business will be affected will depend on the legislation enacted within the UK and Sweden respectively.
There is uncertainty as to how, if at all, the ruling impacts existing business. In respect of the UK business with reviewable mortality or morbidity rates, primarily certain protection policies, the potential impact (if the ruling is deemed to apply to current in-force contracts) will be on the charges suffered by the policyholder from a date to be specified by UK legislation, but no later than 21 December 2012. For the Swedish business, it is expected that those products written on an annually renewable basis, will be repriced to apply gender neutral rates from a date to be specified by Swedish legislation, but no later than 21 December 2012.
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