Chesnara Regulatory News (CSN)

22 Mar 2005 07:00

22 March 2004Chesnara plc * Chesnara moves into profit and exceeds full year dividend forecast Chesnara, which owns the life assurance business formerly part of Countrywide Assured Group plc, today reported its first full year results, for the twelvemonths ended 31 December 2004. Chesnara is committed to offering investors anattractive long-term dividend yield from the profits arising from its lifeassurance business. * Profit on ordinary activities before taxation (Modified Statutory Solvency Basis) of ‚£4.6m (2003: loss ‚£15.5m) * Final dividend recommended of 7.1p per share making total dividend for year 11.85p (2003:nil), ahead of dividend forecast of 11.825p * Capital adequacy ratio substantially increased to 190% (1 January 2004: 157%) * Basic Earnings per share 6.34p (2003: loss of 12.73p) * Embedded Value now ‚£143.1m, with strong NAV backing of ‚£58.5m (after dividend payment) * Full year performance adversely affected by; * increased provisioning in H1 of ‚£16.6m for mortgage endowment misselling redress; no further increase in H2 * adjustment of ‚£(6.2)m to Value In-Force to reflect adverse persistency experience * Key Retirement Solutions sold for ‚£2.8m (pre-tax) * Successful outsourcing of back office to Liberata (w.e.f. 1 February 2005) on favourable terms. Addition of ‚£3m to Value In-Force and mitigation of potential fixed cost issues Graham Kettleborough, Chief Executive said:"This is a good first full year. A strong and steady emerging surplus combinedwith tight management of operational costs has meant we have been able tomitigate the increased provisions we announced in the first half. We havefurther strengthened our balance sheet and exceeded our dividend forecast. Wewill continue to focus on delivering a steady, progressive and long term yieldto shareholders in a sector where recent corporate activity has highlighted thevalue inherent in well-managed life companies."EnquiriesGraham KettleboroughChief Executive, Chesnara plc 01772 840001Michael HenmanCubitt Consulting 0207 367 5106Notes to Editors:Chesnara plc, which was listed on the London Stock exchange on 25 May 2004, wasformed to become the holding company of the life assurance activities formerlyowned by Countrywide Assured Group plc. Although substantially closed to newbusiness it continues to write Guaranteed Income and Growth Bonds and a smallamount of protection business. Chesnara plc Report and Accounts For the Year Ended 31 December 2004 Note : All page references in this document refer to the original document available at www.chesnara.co.uk.FINANCIAL HIGHLIGHTS Year ended 31 December Modified Statutory Solvency Basis (MSSB) 2004 2003 ‚£m ‚£M Operating profit/(loss) before tax 2.7 (15.5) Profit on sale of discontinued operation 1.9 - ---------- ---------- Profit/(loss) on ordinary activities before 4.6 (15.5)tax ---------- ---------- Shareholders' funds 74.0 78.7 ---------- ---------- Achieved Profit Basis Operating loss before tax and exceptional (5.9) (44.7)items Profit on sale of a discontinued operation 1.9 - Other investment variances and economic 1.0 0.2assumption changes ---------- ---------- Loss on ordinary activities before tax (3.0) (44.5) ---------- ---------- Embedded Value Value in-force 84.6 98.5 Net asset value 58.5 54.2 ---------- ---------- Shareholders' funds 143.1 152.7 ---------- ---------- Life annual premium income (API) ‚£123.3m ‚£146.0m ---------- ---------- Life single premium income (SPI) ‚£78.9m ‚£27.7m ---------- ---------- Life annualised premium income (API + 1/10 ‚£131.2m ‚£149.0mSPI) ---------- ---------- Basic earnings/(loss) per share (MSSB) 6.34p (12.73)p ---------- ---------- Diluted earnings/(loss) per share 6.33p (12.73)p Final dividend per share 7.1p - ---------- ---------- Full-year dividend per share 11.85p - ---------- ----------CHAIRMAN'S STATEMENTI am pleased to present the first annual statements of Chesnara plc, thecompany formed to hold the life assurance operations of Countrywide AssuredGroup plc ("CAG"). These operations were demerged from CAG on 24 May 2004 andChesnara plc was then listed on the London Stock Exchange on 25 May 2004.BackgroundChesnara's primary subsidiary - Countrywide Assured plc ("CA") - administers aportfolio of some 208,000 life assurance and personal pension policies. Itcontinues to service its existing clients and to sell and market GuaranteedIncome and Growth Bonds. As a substantially closed book, it is expected thatthe embedded value of the Group will decline over time, as the number ofpolicies in force reduces and surplus emerging in the life business isdistributed by way of dividends. As the portfolio runs off, the regulatorycapital supporting the life business may also be reduced and returned toshareholders.Business ReviewThroughout the year we have seen a strong and steady emergence of underlyingsurplus from the policy-based cashflows. In the first six months of the year,the results were adversely affected by mortgage endowment mis-selling claimsexperience. However, the considered action taken in response to this challengeresulted in a more positive second half result.On the Modified Statutory Solvency Basis ("MSSB"), Chesnara has posted apre-tax profit of ‚£4.6m for the year ended 31 December 2004 (2003:pre-tax lossof ‚£15.5m). This is after taking a total charge of ‚£16.6m for mortgageendowment complaints redress, an acceleration of ‚£1.7m in the amortisation ofDeferred Acquisition Costs, being a charge to profits, and a credit of ‚£1.9m inrespect of the sale of Key Retirement Solutions Limited ("KRS").In the first half, the level of provision required for mortgage endowmentcomplaints redress required strengthening over and above that set out in theSupplementary Listing Particulars issued on 10 May 2004, this as a consequenceof adverse experience in the early months of the year. Subsequently, on 25 May2004, the Financial Services Authority and the Association of British Insurersissued new rules and guidance regarding endowment complaints. Chesnara soughtclarification and guidance on the new regime and, as a result, the Boarddecided that further significant strengthening of the provision was required. Iam pleased to be able to report that, in the second half of the year, it hasnot been necessary to further increase the provision for mortgage endowmentcomplaints redress as this strengthening has proved adequate.During the year we realised a one-off profit of ‚£1.9m on the sale, to itsmanagement, of KRS, an independent financial adviser, which specialises in thesale of equity release products.On the operational side, management maintained close control of expenditure andensured the business ran within its budgeted operating costs.Despite the adverse impact of the increase in the mortgage endowment redressprovision on earnings in the first half of the year, the strong emergence ofsurplus throughout the year enables the Board to recommend a final dividend of7.1p per share, making a total dividend for the year of 11.85p. The totalpayment for the year of ‚£10.15m exceeds our stated target of ‚£10m to ensure nodilution of return to shareholders following the exercise of share optionsawarded to Numis Securities Limited in connection with the listing of Chesnaraplc.On the alternative Achieved Profit basis of reporting the pre-tax loss for theyear ended 31 December 2004 is ‚£3.0m (2003: pre-tax loss of ‚£44.5m). A majorfactor affecting this result, over and above the charge for mortgage endowmentcomplaints redress, is a reduction of ‚£6.2m in the value of polices in forceconsequent upon persistency experience and updated persistency assumptions forProtection policies.During the year, our Protection policy base was not demonstrating the expectedconvergence of actual experience to assumed underlying rates. The Boardreflected this in their assessment of the Value In-Force at the half-year and afurther adjustment to the persistency assumptions, but of a lower order, wasnecessary at the year-end. However, these adjustments are offset by expensesavings that will be generated as a result of the terms negotiated with ouroutsourcing partner. The successful negotiations resulted in the transfer ofour "back office" operations and 184 employees to Liberata Financial ServicesLimited on 1 February 2005. This arrangement largely mitigates the fixed andsemi-fixed expense issues that are associated with a declining book ofbusiness.The Embedded Value has, after the dividend appropriation of ‚£10.15m, reducedfrom ‚£152.7m at 31 December 2003 to ‚£143.1m at 31 December 2004, the Net AssetValue has increased by ‚£4.3m from ‚£54.2m to ‚£58.5m. Whereas the Net Asset Valuerepresented 35% of Embedded Value at 31 December 2003 it has increased to 41%at the 2004 year-end.CA's capital requirement (the ratio of available capital resources to capitalresource requirements) remains at a premium to the target level of 150% set bythe Board and in excess of the actual level of 157% at 1 January 2004. At 31December 2004 it had, after allowing for the final dividend, increased to 190%.New insurance regulations mean that, from 2005 onwards, the FSA will use a newmethodology, Individual Capital Assessment, ("ICA"), to assess the financialstrength of life companies. CA completed its ICA during the second half of 2004and submitted it to the FSA, from whom the company expects to receive guidanceduring 2005.OutlookRising investment markets have helped the recovery of the Life Assurance sectorand the increased consolidation activity which has taken place over the lastyear has highlighted the value inherent in well-managed life companies. We lookforward, with confidence, to the year ahead and will continue to focus ondelivering a stable and progressive dividend flow to shareholders.The Board wishes to extend its thanks to all employees for their contributionand dedication in what has been a particularly challenging year.Christopher SporborgChairman21 March 2005DIRECTORS INFORMATIONChristopher H Sporborg CBEAged 65, is the Non-executive Chairman of Chesnara plc. He is also Chairman ofthe Remuneration Committee and the Nomination Committee. He was formerlyDeputy Chairman of Hambros PLC, Deputy Chairman of Hambros Bank Limited andChairman of Hambro Insurance Services Group PLC. At Hambros, he was responsiblefor the acquisition of Bairstow Eves PLC in 1985 and the formation of HambroCountrywide plc, now Balanus Limited, a subsidiary of Countrywide plc, and, in1988, the creation of the life company then called Hambro Guardian AssuredLimited and now part of the Chesnara plc group of companies. He is Chairman ofCountrywide plc, Atlas CopCo UK Holdings Limited and a director of Getty ImagesInc., Lindsey Morden Group Inc. and the Horserace Totalisor Board.Graham KettleboroughAged 48, is the Chief Executive of Chesnara plc. He joined Countrywide Assuredplc in July 2000 with responsibility for marketing and business development andwas appointed as Managing Director and to the Board in July 2002. Prior tojoining Countrywide Assured plc, he was Head of Servicing and a Director of thePension Trustee Company at Scottish Provident. He has lifetime experience ofthe Life Assurance industry, primarily in customer service, marketing, productand business development, gained with Scottish Provident, Prolific Life, Cityof Westminster Assurance and Target Life.Ken RomneyAged 53, is the Finance Director and Company Secretary of Chesnara plc. Hejoined Countrywide Assured plc in 1989 and became a member of the Board in1997. He has worked in the life assurance industry for the last 21 years. Hewas Chief Accountant at Laurentian Life (formerly Imperial Trident) up to 1987and was Financial Controller at Sentinel Life between 1987 and 1989. He workedfor Price Waterhouse in their audit division until 1983 in both the UK andSouth Africa. He is a Fellow of the Institute of Chartered Accountants inEngland and Wales.Frank HughesAged 47, is the Business Services Director of Chesnara plc. He joinedCountrywide Assured plc in November 1992 as an IT Project Manager and wasappointed to the Board as IT Director in May 2002. He has 21 years' experiencein the life assurance industry, primarily in IT, gained with Royal Life,Norwich Union and CMG.Peter MasonAged 54, is the Senior Independent Non-executive Director of Chesnara plc andis Chairman of the Audit Committee. He also serves on the Remuneration andNomination Committees. He joined the Board of Countrywide Assured Group plc asNon-executive Director in May 1992 and is currently a Non-executive Director ofCountrywide plc and Countrywide Assured plc. He is the Investment Director andActuary of Neville James Group, an investment management company. He wasadmitted as a Fellow of the Institute of Actuaries in 1979.Mike GordonAged 57, is an Independent Non-executive Director of Chesnara plc and serves onthe Audit Committee, the Remuneration Committee and the Nomination Committee.He spent 12 years as Group Sales Director of Skandia Life Assurance Holdings.He is a Non-executive Director of Countrywide plc and of Bankhall InvestmentManagement Limited, a Skandia-owned subsidiary.Terry MarrisAged 55, is a Non-executive Director of Chesnara plc and serves on the AuditCommittee, the Remuneration Committee and the Nomination Committee. He joinedCountrywide Assured Group plc in 1992 and was Managing Director of CountrywideAssured plc until July 2002 and is currently Chairman of Countrywide plc'sConveyancing Division. He was formerly a Director of Countrywide Assured Groupplc. Previous roles included senior management positions at Lloyds Bank andGeneral Accident.OPERATING AND FINANCIAL REVIEWThe Business, its Objectives and StrategyBackgroundChesnara plc, which was listed on the London Stock Exchange on 25 May 2004, wasformed to become the new holding company of the life assurance activitiesformerly owned by Countrywide Assured Group plc ("CAG"). Details relating tothe demerger are set out in Note 1 to the financial statements.The demerger followed a year-long review by CAG which had, inter alia, beenconsidering ways in which to rationalise its corporate structure around itsestate agency, professional property services and life businesses. In thecontext of the different business profiles and investment propositions offeredby these businesses and, as the activities of the life business arefundamentally different in nature from the rest of the members of the CAGgroup, it was considered that a separate listing would be appropriate for thelife business. This listing would enable shareholders to better assess the riskand rewards associated with the life business and its cash flows and wouldallow management to create additional value for shareholders through greaterfocus as an independent business.Chesnara's principal subsidiary - Countrywide Assured plc ("CA") - wasestablished in 1988 as the life assurance division of CAG, sellingmortgage-related life assurance products through CAG's financial servicesdivision. In 1995, CA acquired Premium Life Assurance Company Limited, a lifeassurance company, and integrated it into its existing operations. In August2002, CAG entered into a distribution agreement with Friends Provident Life andPensions Limited ("Friends Provident") which resulted in new business beingswitched to Friends Provident in August 2003. As part of these arrangements, wecontinued to write significant volumes of protection business under areinsurance agreement with Friends Provident from September 2002 to August2003, at which point CAG's business was placed directly with Friends Provident.Following the consequent substantial closure to new business CA continues toadminister an existing portfolio of some 208,000 policies which, by number are38% endowment, 48% protection and whole life and 14% other. This split reflectsour history of providing mortgage-related policies to the estate agency-basedfinancial services sales force of CAG and our strategic decision to exit theendowment market in 2001 and sell only protection products in this marketplace.Most of the endowment and other investment-related business is unit-linked andalthough there is a small amount of with profits business (less than 2.5% bypolicy count) this is wholly reinsured to Guardian Assurance plc ("Guardian").Guardian is now a subsidiary of Aegon N.V., one of the world's largestinsurance groups. The investment management of the related unit-linked funds ispredominantly outsourced to Schroders plc ("Schroders") and Henderson GlobalInvestors plc ("Hendersons") with the remainder being managed by InvescoPerpetual Asset Management Limited.CA continues to sell and market Guaranteed Income and Growth Bonds throughIndependent Financial Advisers and directly to investors, resulting in ‚£73.5mof single premium income in 2004 (2003: ‚£23.1m). In addition it sells a smallamount of life protection business to existing customers, as well as offeringthem a limited range of other financial products supplied by third parties.Chesnara is not currently seeking any new major distribution outlets but willconsider writing new business, in partnership with third party distributors,where acceptable levels of risk and reward are available.As part of the demerger Chesnara inherited an Independent Financial Adviser -Key Retirement Solutions Limited ("KRS") - one of the leaders in the marketingof property-related equity release products and associated financial services.Originally it was an appointed representative of CA and it adopted IFA statusin May 2001. The future of KRS within Chesnara had been the subject ofdiscussion with its management prior to demerger, as there appeared to belittle strategic fit or synergy with the existing operations. Therefore,Chesnara agreed to sell KRS to its management, with limited warranties, forcash in the sum of ‚£2.8m (‚£2.6m net of the settlement of outstanding debt andcosts of disposal). The sale by CA was completed on 30 June 2004 and, as KRSwas held at nil value in that company, the net proceeds of ‚£2.6m represent aone-off addition to its pre-tax profit on both the Modified Statutory Solvencyand Achieved Profit bases. At the date of disposal the net assets of KRS were ‚£0.7m so that a pre-tax and net-of-tax profit of ‚£1.9m is recognised in theconsolidated profit and loss account. Continuing service and underleasearrangements with KRS allow CA to recover an element of its fixed overheadbase.Objectives of the BusinessChesnara's priority is to maximise shareholder returns through the efficientand compliant management of the existing business. It will seek to add valuethrough the sale of Guaranteed Income and Growth Bonds and may also choose tosell other low risk products in order to enhance future cash flows. Inaddition, Chesnara believes that there are opportunities for consolidation inthe small to medium sector of closed books and run-off situations in the lifeassurance industry. It will, therefore, continue to investigate these wherethere is potential to enhance shareholder value.As Chesnara has successfully concluded the outsourcing of its back office toLiberata Financial Services Limited ("Liberata"), a significant element of itsexpense base is now directly linked to the reducing policy base. This removesthe fixed and semi-fixed cost issues that would have had a potentially damagingeffect on shareholder returns. Our focus on customer retention has beencaptured in the service and performance levels agreed with Liberata andtherefore, barring external factors, a reasonably predictable level of incomecan be expected to flow from the policy base.Chesnara management retains regulatory responsibility for the business and willbuild on these requirements to ensure that key risks are identified and managedto maximise the flow of emerging surplus. As CA is regulated, as describedbelow, management will operate with a level of prudence but will seek to ensurethat shareholders receive distributions consistent with the constraints on thebusiness. In the absence of any value-enhancing consolidation opportunities orother developments that require capital then there is, in the medium term, thepossibility of the release of surplus capital to shareholders.The following is a summary of the key strengths and resources which underpinthe Group's ability to meet its objectives:Financial strength - Chesnara has a strong balance sheet and is wellcapitalised. CA maintains capital resource cover well in excess of regulatorycapital requirements.Knowledge and experience - Chesnara has a strong Board and management team withan average of over 15 years' experience in managing life assurance business.The senior management team also has experience in the integration andmanagement of closed books within a highly regulated environment.Regulatory record - Chesnara has a strong focus on compliance and riskmanagement and it maintains a close relationship with CA's primary regulator,the FSA. All issues raised in its last formal FSA "Arrow" assessment in 2002were cleared in good time and, although there are some points that have beenraised as a result of themed reviews, we regard these as being of minorconsequence. The next formal Arrow assessment is scheduled for the secondquarter of 2005.Future development costs - As a consequence of outsourcing the back office toLiberata, future development costs are likely to be lower than as a stand aloneentity as, following migration, they will be incurred on a shared platform.This arrangement also offers the benefit of consultation with other platformusers in the definition of development requirements. Such developments areexpected to be funded out of emerging surplus and these, to a degree, areallowed for in calculating the value of the business. Some development costsmay, under the terms of the policies, be passed to policyholders and this willlimit the effect on shareholder returns.Structure of the BusinessChesnara operates from a single site and is based in Preston in Lancashire.Throughout 2004 it maintained a workforce of some 200 engaged in themaintenance and servicing of CA customer contracts and associated supportfunctions. Prior to the sale of KRS, the Group employed a further workforce ofsome 41 in Preston and a home-based sales force of around 35 in that operation.Following the demerger, CA re-established its plan to outsource the CA backoffice functions in order to reduce the significant cost inefficiencies thatwould arise with fixed and semi-fixed costs on a diminishing policy base. Thisresulted in the completion of an Insurance Administration Services Agreementwith Liberata, which took effect from 1 February 2005. As a result of this,some 184 people transferred to Liberata on that date under a TUPE arrangement.The agreement with Liberata, which runs for 10 years, provides Chesnara with adefined level of cost per policy, during the term, and mitigates a number ofrisks including: * the impact of increasing per policy costs which would affect both policy competitiveness and returns to shareholders * the failure to retain resource with key skills, knowledge and experience against a backdrop of reducing policy numbers and consequent headcount reductions * the inevitable disparity between maintaining key resource levels and funding necessary systems developments to meet ongoing business requirements (e.g. of a legal and regulatory nature) and the reducing income with which to support them. Chesnara now has just 14 employees and will concentrate on corporategovernance, fulfilment of regulatory responsibilities, management of theoutsourcing arrangement and the identification of development opportunitieswith a view to maximising the total return to shareholders.Legal and RegulatoryCA is regulated by the Financial Services Authority ("FSA"). As a result it issubject to both the general operation of the Financial Services and Markets Act2000 and the regulatory processes of the FSA. Whilst the weight of Conduct ofBusiness rules has reduced slightly following the substantial closure to newbusiness we are still subject to the full weight of prudential regulation. Thisfalls largely on the areas of solvency, capital adequacy and policyholderprotection and is the subject of progressive development to bring it in linewith the likely development of EU Directives and will, therefore, continue tobring challenges to Chesnara.Of particular note are the following: * the change to the Appointed Actuary regime where, as from 31 December 2004, the Board is required, inter alia, to take responsibility for proper provision for long-term insurance liabilities and for the adequacy of capital resources in relation to capital requirements. * the introduction of the Individual Capital Assessment ("ICA") regime, in accordance with Policy Statement 04/16 Integrated Prudential Sourcebook issued in July 2004, which the FSA will, in future, use to assess the financial strength of life companies. CA completed its ICA during the second half of 2004 and submitted it to the FSA. The Company expects to receive guidance on this from the FSA during 2005. As part of the regulatory process CA continues to be subject to a regime ofperiodic and themed reviews by the FSA and of the development and maintenanceof an ongoing risk mitigation programme.In addition, we are undertaking preparatory work on the introduction ofInternational Financial Reporting Standards where we are required to report onthis basis in respect of our results for the six months ending 30 June 2005.Key DependenciesWe continue to rely on a number of key relationships for the successful andefficient conduct of our business:Reinsurance - CA has transferred part of its exposure to certain risks to otherinsurance companies through reinsurance arrangements. Under such arrangements,other insurers have assumed a portion of the losses and expenses associatedwith reported and unreported losses in exchange for a portion of the policypremiums.Outsourcing - CA has transferred most of its operational functions to Liberataunder an Insurance Administration Services Agreement referred to above. Havingundertaken appropriate due diligence on Liberata, CA is confident of itsability to undertake the transferred operations to agreed standards. Thecontract duration is 10 years and, during this time, CA will maintain a closerelationship with Liberata and monitor their financial and operationalperformance.Systems - While under the direct management of CA the business maintainedadequate operational systems and maintained, and regularly tested, a BusinessContinuity Plan. With the transfer of operations to Liberata the systems andthe continuity plan have been transferred to them. As part of the agreementChesnara will support Liberata's intention to migrate CA's mainframe systems totheir modern and flexible Amarta system. The related agreement also providesfor Liberata to manage the systems, including provision for businesscontinuity, required by the Chesnara governance team.Investment management - CA has outsourced the management of its own andpolicyholder investments, predominantly to Schroders and Hendersons. Ongoingmonitoring of their performance is maintained and is formally reviewed eachmonth by internal management and every quarter with the Investment Managers.Actuarial function - The Appointed Actuary regime ended on 31 December 2004. Inits place CA was required to appoint a Head of Actuarial Function and aWith-Profits Actuary. In order to maintain continuity and minimise the level offixed resource within Chesnara, CA have appointed their former AppointedActuary, Peter Wright of Tillinghast-Towers Perrin, to these new roles.Chesnara is now a small professional knowledge-based team which is resourced todeliver known requirements. As such it will, from time to time, requireexternal resource to facilitate new and/or unexpected developments. In themain, it aims to build on its existing relationships but will closely monitorthe availability, quality and cost of suitable alternatives.Operating ReviewBasis of AccountingThe Company reports primarily on the Modified Statutory Solvency Basis ("MSSB")and will continue to provide supplementary information on the Achieved Profit("AP") basis. While the AP method is value based and recognises profits as theyare earned over the lives of the underlying insurance policies, MSSB recognisesprofit on the basis used for regulatory reporting, modified principally by thedeferral of costs incurred in the acquisition of new business arising in thecurrent year (Deferred Acquisition Costs) and by the amortisation of costsdeferred from previous years. Adjustments are also made to certain long-termreserves which have been established for prudential reasons. As the Company wassubstantially closed to new business in August 2003 and reinsured its newbusiness to Friends Provident with effect from September 2002, there has been asignificant reduction in the amount of acquisition costs deferred into futureperiods. The significant related charges to profit continued through 2004 andthe remaining deferred costs of ‚£5.1m at 31 December 2004 are expected to bealmost wholly amortised by the end of 2005, so that, during 2006, there will nolonger be significant charges to profit arising from this modification.MSSB ResultThe following summarises information in the non-technical account, togetherwith headline statistics: Year ended 31 December 2004 2003 ‚£000 ‚£000 Operating profit/(loss) from continuing 2,536 (15,510)operations Operating profit from a discontinued 109 151operation ---------- ---------- 2,645 (15,359) Profit on disposal of a discontinued 1,948 -operation ---------- ---------- Profit/(loss) on ordinary activities 4,593 (15,359)before tax ---------- ----------New Business:- Policies arranged 2,339 36,941 ---------- ---------- - Life annual premium income (API) ‚£3.3m ‚£17.3m ---------- ---------- - Life single premium income (SPI) ‚£73.5m ‚£21.2m ---------- ---------- - Life annualised premium income (API + ‚£10.7m ‚£19.4m1/10 SPI) ---------- ---------- Policies in force at period end 208,000 255,000 ---------- ---------- Headcount (average FTE) 222 293The profit arising on the sale of a discontinued operation, KRS, is more fullydescribed in "Background" above.During March 2004, the residual pipeline of new business reinsured with FriendsProvident had been either issued or cancelled and this signalled the finalstage in CA's substantial closure to annual premium new business. Consequently,and as expected, the volume of such new issued business was minor compared with2003. As the terms of the reinsurance agreement with Friends Provident weresuch that this reinsured business was incurred at a loss in the life business,the new business strain arising from this source in the technical account has,accordingly, been stemmed. The results for 2003 also included a write-down, inthe non-technical account, of ‚£3.8m in respect of Group Relief Receivable aspart of the arrangements for the demerger of the life business from CAG.The results for both 2004 and 2003 were materially adversely affected bysignificant increases in provisions for redress and administration costs inconnection with mortgage endowment mis-selling claims. While these provisionswere increased by ‚£14.0m in 2003, a further ‚£16.6m was charged to the technicalaccount in 2004. The following sets out the background to the decisions by theBoard to increase the provisions during 2004.CA is required to write to its endowment policyholders at least every two yearsand, where appropriate, to appraise them of any potential shortfall in theexpected maturity value of their policy. During the first half of the year thecompany completed this endowment re-projection mailing programme, which beganin May 2003, whereby virtually all endowment policyholders received therequired mailing. During the early months of 2004 it became apparent that, witha background of heightened media coverage, an underlying increase in the levelof complaints was occurring. This media coverage was concentrated when theHouse of Commons Treasury Select Committee issued a report, "Restoringconfidence in long-term savings: Endowment mortgages," on 9 March 2004. Thisexperience led the Board to decide that it needed to strengthen the provisionfor redress on future mortgage endowment mis-selling claims by ‚£4.8m (‚£3.4m netof tax). Supplementary Listing Particulars relating to this were issued on 10May 2004.On the day that Chesnara plc was listed - 25 May 2004 - the FSA and the ABIissued new rules and guidance in respect of endowment re-projection mailings.These new rules also included an immediate change in the time-bar rules. Thereis now a requirement to give clear notification to policyholders of anindividual "cut-off" date by which they must complain (if they are minded to doso). If a policyholder does not submit a complaint by the cut-off date, thenthe company has the right to refuse to consider it, thus "time-barring" thecomplaint. The cut-off date is now stated in new-style, focussed reviewletters, which highlight potential shortfalls, and also in any other "keycommunications" with policyholders. A more immediate effect was that a numberof CA policyholders, who would have become time-barred in the second half of2004, have had the time period in which they have the right to complainextended. After a period during which Chesnara sought clarification andguidance on the new regime, the Board decided that these new rules were likelyto have a material effect on its results due to the temporary deferral ofexpected time-barring and the likelihood of an increased propensity to complaindue to the detailing of the cut-off date. Therefore it further strengthened theprovision for mortgage endowment mis-selling claims redress at 30 June 2004 by‚£11.75m (‚£8.2m net of tax) leading to total charges to pre-tax profit inrespect of increases in the provision for the six month period of ‚£16.6m (‚£11.6m net of tax). After strengthening, the provision amounted to ‚£20.5m at 30June 2004 and was ‚£14.8m at 31 December 2004. The experience in the second halfof the year was broadly in line with the assumptions underlying thestrengthened position at 30 June 2004. The Board continues to monitor theadequacy of the provision, particularly in the light of the customer responseto the ongoing mailing programme, which accords with the new regulatory rulesand guidance described above.Surplus arising on the run-off of the product portfolio emerged strongly duringthe year. The absence of further charges to profit in the second half of theyear in respect of strengthening provisions for mortgage endowment mis-sellingclaims helped the recovery of the full year pre-tax operating profit oncontinuing operations to ‚£2.5m, in contrast with a loss of ‚£6.5m on theequivalent position at the half-year. The impact of worse persistencyexperience on the Protection portfolio led to a lower emergence of surplus onbusiness which had not been reinsured with Friends Provident, but this wasoffset by the ability to release provisions against the segment of theportfolio reinsured with Friends Provident. The persistency experience on thissegment was also worse than expected, but, as explained above, this businesswas written at a loss to the life business. Consequently, the overall effect ofworse than expected persistency experience on the non-reinsured segment of theProtection portfolio was offset by the positive impact of worse than expectedpersistency experience on the reinsured segment of the portfolio.The amortisation of Deferred Acquisition Costs charged to the technical accountwas ‚£11.0m (2003: ‚£17.8m), which included an accelerated write-off of ‚£1.7m,following from worse than expected persistency experience in the amortisationprofile at the beginning of the year. Operating expenses for managing therun-off of the life portfolio continued to fall in 2004 in line with reducingpolicy numbers and were within planned levels. As indicated in "Structure ofthe Business" above, a significant proportion of these costs will now beincurred through a 10-year Insurance Administration Services Agreement withLiberata.Achieved Profit ResultSupplementary information on the Achieved Profit basis as produced in thefinancial statements on pages 72 to 79 is presented to provide alternativeinformation to that presented under MSSB. The Achieved Profit basis recognisesprofits as they are earned over the life of an insurance policy and assists inidentifying the value being generated by the life business. The resultdetermined under this method reflects the movement in the life businessembedded value. As the Group's life assurance operations are now substantiallyclosed to new business the principal underlying components of the achievedresult are the expected return from the business in force (being the yield atthe risk discount rate on the related policy cashflows as they fall intosurplus) together with (1) variances of actual experience from that assumed foreach component of the policy in-force cashflows and (2) the impact of resettingassumptions for each component of the prospective cashflows.The following is a summarised statement of our AP results: Year ended 31 December 2004 2003 ‚£'000 ‚£'000 Operating achieved loss before tax and (5,882) (44,745)exceptional items Investment return variances - Profit on sale of a discontinued operation 1,948 - - Trading result of discontinued operation 109 151 - Other 1,665 (1,212) Effect of economic assumption changes - Investment return (2,146) 3,855 - Risk discount rate 1,320 (2,533) ---------- ---------- Achieved loss before tax (2,986) (44,484) Tax 3,455 (1,899) ---------- ---------- Achieved profit /(loss) after tax 469 (46,383) ---------- ----------The achieved pre-tax loss for the year of ‚£3.0m has arisen largely as a resultof the strengthening, by ‚£16.6m, of provisions for redress and costs inconnection with mortgage endowment complaints more fully described in "MSSBResults" above. In addition, persistency experience over the year has differedbetween our two major product lines. On Endowment business there has beenconvergence of actual experience towards our underlying persistency assumptionsand we do not see the need to make any significant alterations to these.However, on Protection business, although there has, during the year, beenfavourable persistency experience of ‚£2.9m (‚£2.3m net of tax) against theunderlying assumptions relevant to the year, the expected convergence tolonger-term assumptions has failed to materialise at the expected rate. Inrecognition of this we are increasing the longer-term lapse assumptions and arealso extending the temporary lapse assumption, at a lower rate, for a furthersix months. The effect of these adjustments, which relate to expectedexperience after 31 December 2004, is to reduce the value In-force, and hencethe Achieved Profit result, by ‚£9.1m (‚£7.2m net of tax).Other items of significance impacting the AP result include: 1. an increase in the value in force of ‚£1.1m following a reduction of the risk discount rate used to discount future cashflows arising from the in-force portfolio, from 9.25% to 9.00%, in line with an easing down of longer-term risk-free market rates over 2004. This represents the rate at which the discounted policy-based cashflows unwind within the AP result and, besides a lower in-force base, leads to a reduction in expected return compared to 2003. The Board believe that it is appropriate that this rate, which is higher than the average rate used by the Life Business peer group, is conservatively set; 2. an increase of ‚£3.0m in the value-in-force following the revision of assumptions relating to the operating costs of maintaining the in-force portfolio. These have been adjusted to reflect changes in the nature and timing of projected costs in accordance with the specific terms of the Insurance Administration Services Agreement with Liberata. The overall net-of-tax achieved result is a small profit of ‚£0.5m, afterrecognising a net credit in respect of taxation of ‚£3.5m. There has been a lossof symmetry between the pre-tax operating loss and the effective rate of taxcredit which results from how changes in assumptions and business mix affectthe pattern of expected future taxationThe net-of-tax achieved profit represents the movement on embedded value beforedividend distributions.Embedded ValueThe embedded value, set out in Note 8 to Achieved Profit - SupplementaryInformation in the financial statements which follow, comprises: 31 December 31 December 2004 2003 ‚£000 ‚£000 Share capital 4,228 4,228 Demerger reserve 36,272 36,272 Capital redemption reserve 50 - Retained earnings 13,537 8,395 Undistributed surplus 4,382 5,329 ---------- ---------- Net asset value 58,469 54,224 Value in-force (after cost of capital) 84,594 98,521 ---------- ---------- Embedded Value 143,063 152,745 ========== ==========The embedded value at 31 December 2004, which represents the value of theGroup's net assets attributable to shareholders, together with an estimate ofthe net present value of profits attributable to shareholders from the policiesin-force, is stated after providing total dividends of ‚£10.15m in respect ofthe year then ended. No dividend was payable in respect of the year ended 31December 2003.The table below sets out the components of the in-force value by major productlines at each period end: 31 December 31 December 2004 2003 000 000 Number of policies - Endowments 78 94 - Protection 99 129 - Other 31 32 ---------- ---------- Total 208 255 ========== ========== 31 December 31 December 2004 2003 ‚£000 ‚£000 Value in-force - Endowments 49.3 52.4 - Protection 45.0 70.3 - Other 3.3 4.7 Total value in-force at product line 97.6 127.4level Valuation adjustments 3.0 (7.4) Cost of capital (4.4) (4.4) Total in-force value (pre tax) 96.2 115.6 Tax (11.6) (17.1) ----------- ----------- Total in-force value (post tax) 84.6 98.5 ========== ==========The value in-force represents the discounted value of the future expectedsurpluses arising from the policies in-force at each respective period end. Thefuture surpluses are calculated by using realistic assumptions for eachcomponent of the cash flow.Certain factors affecting the value in-force are not calculated at product linelevel and these are shown as "valuation adjustments". As at 31 December 2004,the calculation methodology was changed, as a consequence of the InsuranceAdministration Services Agreement with Liberata, such that a provision to covercompany operating expenses, which had previously been treated as a valuationadjustment, was taken up within the product line level calculations. The amountreallocated amounted to approximately ‚£10m, so that, on a like-for-likecomparison with the position at 31 December 2003, the total value in-force atproduct line level at 31 December 2004 would have been some ‚£10m higher and thevaluation adjustments would have been correspondingly lower by some ‚£10m. Thecalculation at 31 December 2003 has not been restated to take account of thischange in methodology.Apart from the impact of this methodology change and from the naturalrealisation of the value in-force into surplus, the value in-force attributedto the Protection product line reflects the effect of actual persistencyexperience, together with the effect of an increase in underlying lapseassumptions.Policyholder Funds Investment ReturnThe Managed Fund, which represents a highly significant proportion ofpolicyholder funds under management, returned 4.1% over the year. Theunderlying performance was compromised due to the necessity, in the first halfof the year, to move the unit pricing basis from that of an expanding fund toone of a contracting fund, as one would expect in a substantially closed bookscenario. The effect of this was to depress the unit price of this fund byapproximately 4.5%, which largely explains its underperformance when comparedto the average of 8.7% achieved by the ABI Life Balanced Managed Funds sector.Apart from the impact on policyholders' policy values, this underperformancehas also led to an increase in the overall cost of mortgage endowmentcomplaints redress and has led to a reduction of value-in-force, as futurecharges, based on fund values, have been reduced. The fund, however, benefitedfrom the improving markets and outperformed the sector average in the last twoquarters of 2004.Returns to ShareholdersReturns to shareholders are underpinned by the emergence of surplus in andtransfer of surplus from the long-term insurance fund to shareholder funds andby the return on shareholder net assets representing shareholder net equity.The surplus arises from the realisation of value in-force, which effectivelyunwinds at the risk discount rate used to discount the underlying cash flows:at 31 December 2004 this rate was reset at 9.0% (31 December 2003: 9.25%). Thereturn on shareholder net assets is determined by the Group's investmentpolicy. Shareholder funds bear central Group governance costs which cannot befairly attributed to the long-term insurance fund and which arise largely inconnection with the status of Chesnara plc as a listed company.No dividend was paid to the Group's holding company in respect of 2003, inorder to ensure a robust opening position for 2004 in the light of theprospective demerger. The Listing Particulars issued in connection with thesubsequent demerger and listing on the London Stock Exchange stated thatChesnara was targeting a dividend in respect of the year ended 31 December2004, subject to no unforeseen circumstances, of approximately ‚£10m. In theevent, despite a number of negative influences which had arisen at thehalf-year position, the strong continuing emergence of surplus from theunderlying policy base, together with a strong regulatory solvency position,has enabled the Board to meet the stated target, with aggregate dividendsproposed of ‚£10.15m for the year ended 31 December 2004.The dividend target and distribution is set within the context of the Board'spolicy of maintaining capital resources available at 150% of capital resourcerequirements within the Group's life insurance operation.The Board's continuing primary aim is to provide a stable and progressivedividend flow to shareholders within the context of the emergence of surplus inthe life business. As the Chesnara plc shares have only been listed since theend of May 2004, it is too early to discern meaningful trends in share priceperformance. However, for the greater part of 2004, the shares traded at animplied yield of between 11.5% and 12.0%, bearing in mind the dividendintention stated in the Listing Particulars. There has been a well publicisedconsolidation of that part of the life industry which focuses on the run-off ofclosed policy portfolios. Sentiment relating to this activity appears tounderpin a recent strengthening of the Company's share price, such that, in theearly part of 2005, the implied yield reduced to approximately 10%.Financial ReviewSolvency and Regulatory CapitalCapital Requirements CoverThe regulatory capital of life insurance companies in the UK is calculated byreference to FSA prudential regulations and has received significant publicityover the past year, much of it relating to "with-profits" companies. The rulesare designed to ensure that companies have sufficient assets to meet theirliabilities in specified adverse circumstances. As such, there is a restrictionon the full transfer of surplus from the long-term business fund toshareholders fund and on the full distribution of reserves from the Lifecompany, CA to Chesnara. In practice, CA has historically aimed to maintain asolvency margin of admissible assets over actuarially determined liabilities topolicyholders at 150% of the required regulatory minimum margin. CA'swith-profits funds (comprising ‚£59.8m of long-term liabilities to policyholdersat 31 December 2004 (2003: ‚£59.8m)) are wholly reinsured, and, therefore, as apredominantly linked office, the area of regulation dealing with with-profitsfunds is not expected to be onerous.In spite of significant increases in the mortgage endowment complaints redressprovision in the first half of 2004, CA remains in a strong solvency position,as illustrated by the following regulatory capital resource and requirementsinformation:Countrywide Assured plc 31 December 1 January 2004 2004 ‚£m ‚£m Available capital resources (CR) 57.9 49.3 ---------- ---------- Long-term insurance capital requirement 27.9 31.0(LTICR) Resilience capital requirement (RCR) 2.6 0.5 ---------- ---------- Total capital resources requirement 30.5 31.5(CRR) ---------- ---------- Target capital requirement cover 44.4 47.0 ---------- ----------