Ecclesiastl.8fe Regulatory News (ELLA)

ECCLESIASTICAL INSURANCE GROUP PLC

ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 DECEMBER 2010

The Company has now approved its annual report and accounts for 2010.

This Annual Financial Report announcement contains the information required to comply with the Disclosure and Transparency Rules, and extracts of the Directors' Report forming part of the full financial statements.

The financial information set out below does not constitute the Company's statutory accounts for the year ended 31 December 2010. The annual report and accounts will be available from 28 April 2011 on the Company's website at www.ecclesiastical.com. Copies of the audited financial statements are also available from the registered office at Beaufort House, Brunswick Road, Gloucester GL1 1JZ.

A copy of the Company's statutory accounts for the year ended 31 December 2010 has been submitted to the National Storage Mechanism and will shortly be available for inspection at www.hemscott.com/nsm.do.

Directors' Report

Group Chief Executive's Review of Group Operations

The year overall

2010 has been a year of significant change, with the completion of several major initiatives designed to place Ecclesiastical in a stronger position for the years ahead. We feel pleased with progress and the growing sense of confidence within our business. Overall profitability was good but our underlying underwriting result (measured by the COR) reflected a number of large claims events and a return to a more normal number of larger claims after a more fortunate 2009.

Insurance premium rates remained at, or even below, 2009 levels. We are learning to live with this competitive pressure and are determined to maintain underwriting disciplines. Gross Written Premium for our underwriting businesses grew by 11% to £474 million, although excluding the effect of exchange rate movements and the one-off increase from our new relationship with Cornish Mutual the underlying figure was nearer 4%. Adding in brokerage, life business and other fee income, Group turnover increased to over £500 million for the first time in our history.

The environment served up more than its normal number of challenges with several earthquakes, storms and other events. For us the Queensland floods are expected to cost £2.5 million (including reinstatement premium) in 2010, and in combination the two UK freezes and the hailstorms in Melbourne and Perth cost in excess of £10 million. On top of this the Christchurch (New Zealand) earthquake in September was our largest ever gross loss at some £61 million and at the net (after reinsurance) level it, together with the Chilean and Haiti earthquakes and associated reinsurance reinstatements, cost £10.8 million. Australia and New Zealand continue to suffer in 2011 with severe natural disasters including the Brisbane floods in January, Cyclone Yasi hitting Queensland and another tragic earthquake in Christchurch in February. These claims are still developing and our current estimate of cost is £3.5 million. Through our London Market business we insure some risks in Japan. Aside from possible reinsurance reinstatement costs, it is currently expected that the Group's reinsurance programme will limit any financial exposure in excess of current retention limits.

Claims were not only affected by natural catastrophes, but the litigious world in which we live also produced ongoing challenge. Liability claims escalated as both frequency and cost increased, making UK motor and other liability insurance difficult. Even though our motor portfolio is small, it saw a £3.4 million underwriting loss. The recent EU ruling removing gender as a rating factor will impact a small number of our customers. We do not expect this to have a material impact on results.

The Group owns South Essex Insurance Brokers (SEIB) and has a 49% stake in Lycetts (up from 40% at the end of 2009). Economic conditions and continued low premium rates challenged many brokers but we were pleased that both businesses exceeded their targets. SEIB commission grew by some 3% and made a pre-tax profit contribution of £2 million. Lycetts grew similarly. First and foremost our brokers are independent high quality advisory businesses and our aim is that they are successful in their own right. We were pleased with the continued growth of the mutually strong relationship between SEIB, Ecclesiastical and the National Association of Funeral Directors (NAFD). Also encouraging was the acquisition, jointly with Lycetts of some larger new clients including Alnwick Castle. Both brokers represent opportunities for the Group in the years ahead.

The economic climate remained uncertain. The recovery in UK Gross Domestic Product was fragile and our customer base remained concerned about their income sources. On the other hand, accepting some volatility, the investment world has been more confident with stock markets recovering despite a dip at the half-year. This, coupled with continued excellent investment performance, produced returns on our financial investments of over 9%. Our credit ratings - from both Standard & Poor's and A.M. Best - remain strong at A- and A respectively.

Our pre-tax profit was £50 million - very much in line with our financial targets. On the basis of this and our strong 2009 results we were delighted to have made £19.25 million of grants to our charitable owners Allchurches Trust in 2010. Of this we regard £9.25 million as the underlying sustainable grant on which we plan to build in the years ahead. This helps them undertake more good work and their own giving has nearly doubled in the last seven years.

Areas of major progress

Over the years it has been challenging to make a success of our Life business - especially manufacturing our own with-profit and non-profit products. Increased regulatory requirements, ever more detailed and complex technical actuarial standards and the relatively fragmented nature of our business led us reluctantly to conclude we could not continue without change. Two years ago we reviewed the strategic position. While we saw the need to continue giving our core customer group (the Church) excellent, genuine and empathetic advice we also saw that we did not need to manufacture our own products; indeed we saw that the advice element could be improved by offering choice across the whole market. The aim was and still is to build a first class advice business - initially serving our core market but ultimately developing into other affinity links emulating the excellent relationship we have with the NAFD. We were therefore delighted to find in Homeowners Friendly Society (trading as Engage Mutual) a partner with whom we could identify and one which would benefit from an increased scale with the addition of our funds. We were also concerned to do the best we could for staff affected by the changes. The deal concluded with Court Approval on 26 November and saw 16 people being transferred to Engage Mutual. Our newly focused advisory service and full IFA, Ecclesiastical Financial Advisory Services, has restructured its approach to giving advice around seminars and more targeted methods to the Church and associated customer groups. The future Retail Distribution Review will be a challenge but we believe we are well placed to deal with it. It was very pleasing to note record business with NAFD - over £13.5 million written premium.

Another decision taken over two years ago was that as Kevin Cannon who had led our very successful London Market underwriting agent, Ecclesiastical Underwriting Management Limited, reached retirement age we would try to find a buyer for the business. Over the years it has produced over 20% return on capital employed and while volatile as would be expected from the nature of the business, it has made a very positive contribution to our results over the longer term. In the event we did not find a suitable buyer and placed it into run-off. This was announced in September and the transition has started very smoothly. We applaud Kevin and all the staff for their contribution over the years and professional approach to this change.

In addition, the decision was taken to simplify our corporate structure and streamline aspects of administration. This led to the closing of several smaller companies and in particular the conversion of Ansvar UK to become a business division of Ecclesiastical with effect from 1 January 2011. Having two brands stands us in good stead - Ansvar has a different business focus and strong relationships with different brokers and customers. It makes business sense to retain an independent brand and we need to keep it separate to make sure we do not inhibit its ability to prosper. Nevertheless maintaining a full corporate structure is costly and an increasing regulatory challenge as governance needs become more and more resource-intensive. Changing Ansvar to a business division helps on these fronts as well as it benefiting from a higher credit rating. Court Approval was granted on 9 December 2010.

The fourth major initiative was our raising of an extra £40 million of capital by extending the non-cumulative irredeemable preference issue of Ecclesiastical Insurance Office plc (EIO) from £66 million to £106 million. Our capital base was strong - at year end 2009 total equity stood at £408.1 million and EIO, our principal insurance subsidiary, held 3.3 times its Enhanced Capital Requirement. That said, we see many business opportunities and we thought it sensible to take advantage of market conditions to raise additional capital to help us fund those opportunities and to strengthen our capital base. It was very encouraging to hear the positive reaction of investors as we talked about Ecclesiastical. The issue was oversubscribed with us having to scale it back. At the end of 2010 total equity reached £474.0 million reflecting this new money and retained earnings.

Key operations

Turning now to comment on each of our major businesses not yet mentioned:

Our UK and Ireland underwriting businesses, including Ansvar, made excellent progress. Gross written premiums grew from £314.7 million to £341.7 million. This reflected increased professionalism and confidence in the sales activity while maintaining and strengthening underwriting disciplines. We were delighted with the number of new customers and in particular with our relationship with Cornish Mutual which commenced in October 2009. The relationship with Cornish Mutual sees us reinsuring 100% of their insurance business, undertaking underwriting management and providing technical support, leaving them able to concentrate their resources on their customer relationships. The Cornish Mutual gross written premium for 2010 was £16.5 million.

Across the portfolio, retention remained high - well over 90% and our regular customer feedback remains highly supportive and positive. In particular, we are pleased at the new confidence in our business in Ireland, where we have recently agreed an accelerated investment programme to build on the solid foundations now in place. The market clearly now sees us as much more than a company serving the needs of the Church of Ireland alone. Key appointments to the main representative bodies within our core niches in Ireland has raised our business profile with customers increasingly seeing us as first choice.

Our international underwriting businesses in Canada, Australia and New Zealand all progressed well. In Canada our reputation is now fully secured as a focused specialist with a clear set of values. The Canadian business continues to grow profitably at a respectable 12% in 2010 building on the growth we have seen since the operation was repositioned in 2004/2006. Having established a solid market reputation through hiring skilled professionals and a refocus on core segments; we have now become first choice for faith and independent schools, with other segments following fast. Targeting the best risks and working closely with the customer and broker, has given us a 96% business retention and profitable new business growth.

Ansvar Australia has been subject to more change. In particular we appointed a new CEO, Andrew Moon, on 1 August. We send our grateful thanks to his predecessor John Peberdy for all he achieved with Ansvar over 37 years. The businesses remained profitable despite the impact of weather events previously mentioned. The Australian operation is now moving to reduce its dependency on personal lines and increase the growth in its core commercial segments of faith, heritage, care, education and not-for-profit. A number of personnel changes and the increased clarity around these specialist activities have established a strong foundation for the next stage of business development.

Finally, although we have already described our broking businesses, it would be remiss not to report with sadness the untimely death of Bob Pluck at SEIB. We wish his family heartfelt condolences.

Further progress on other fronts

During the year we continued to take steps to improve our expense ratio and manage our expense base down. This is vital in order to remain competitive. A combination of process improvement, performance management and simplification have helped move us forward. The general business expense ratio progressed from 19% in 2007 to a high point of 20% in 2008, reducing to 19% for 2009 and 17% for 2010. We live in a highly competitive world and our current aim is that this moves rapidly downwards.

Alongside process improvement has to be a more focused use of modern technology and we were pleased in 2010 to see increased use of the Web - particularly in the UK to help brokers transact more effectively with us. We were delighted that some 65% of UK Charity and Care Home new business was written this way. At the same time we have completed the roll-out of our Customer Relationship Management system and transferred this to Australia as well.

Two key disciplines for us are our underwriting and claims. We continued to improve our capabilities in both during 2010. In particular for underwriting we completed a pricing best practice review, we restructured the UK team to align better with our strategy, we launched an underwriting academy and we improved our risk appetite policy requirements. We believe we are relatively strong in this area but the need for continuous improvement is high. For claims our customer feedback everywhere remained highly positive and the attitude of our claims specialists is excellent.

Another major area illustrating the professional manner in which Ecclesiastical is run is our approach to risk, capital and solvency management. We strengthened our approach to Enterprise Risk Management with the appointment of a new Risk Manager, and embedded our system of local Risk Champions. As mentioned under the Governance section, we inaugurated a Group Risk Committee which includes a combination of Non-executive and Executive Directors. We were pleased to be invited into the Financial Services Authority's Internal Model Approval Process and feel well placed to deal with Solvency II. However, the change involved with Solvency II cannot be underestimated. We have a strong team working on this who continually stay abreast of developments and assess the impact on our governance, reporting and capital position.

InvestmentsWe have already discussed our Life business so this is the moment to comment on another great success, that of our investment management business, Ecclesiastical Investment Management (EIM). Again two years ago we took a number of decisions; we changed its name to Ecclesiastical Investment Management (from Allchurches Investment Management), we put ourselves on a number of fund sales platforms and we started to market it more confidently. We have had superb investment performance with our key fund managers being recognised by the City. In 2010, net new funds topped £110 million (up from £34 million last year). We were delighted with awards from Lipper and others. We made substantial progress with preparations to launch a special charity investment vehicle, as we see the market for ethical third party fund management is well aligned to our target customer base.

Turning to the performance of our own funds, as mentioned in the introduction market conditions remained turbulent and uncertain. Our policy has always been to take a long term view based on assessing the fundamentals and this again stood us in good stead. Performance was good and our funds showed a total return in excess of 9% (2009: 9.9%). Our equity portfolio (including holdings of Ecclesiastical OEICs) returned close to 14%, compared with a rise in the FTSE 100 of 9%.

Our people and what we stand for

We firmly believe that people are at the heart of our business - if our people are energetic and focused we can deliver an exceptional customer experience and excellent relationships; these coupled with deep-seated expertise lead to a truly successful business. In 2010 we improved our collective vision, giving the whole organisation impetus around clear objectives focused on customers, business partners, staff and of course our charitable owners Allchurches Trust. We were keen to make sure that our purpose was recognised - and is as much about how we conduct business as what we aim to achieve. A sense of integrity, honesty and always being on our customers' side is at the heart of what we are all about.

We continued building our open culture and encouraged everyone to take a greater interest in how the business was progressing through regular webcasts and open meetings. We responded to the findings of our first entry into the Sunday Times Best Place to Work programme with new training initiatives, leadership development and reviewing our approach to wellbeing. In particular we implemented a new set of leadership competencies and assessed our top 50 people against this new framework. This has led to a more active approach to talent management and personal development.

A further major training development was the bringing to fruition of our sales academy. This started in 2009 and the first 'graduates' were honoured in May 2010. This is a systematic appraisal of sales skills and a clear development programme. At the end of this, candidates are externally assessed. We have seen substantial improvements in sales results for those who have been through the academy. This academy was our second - after the risk survey one launched a few years ago - and close on its heels have been similar programmes in underwriting and claims.

Given the values that underpin Ecclesiastical, it is not surprising that we can also report substantial progress with our community programme and our environmental policies. These are reported in more depth in the Corporate Responsibility Report on pages 18 to 21 of the report and accounts of Ecclesiastical Insurance Office plc, but we should note here the substantial efforts of our people in raising nearly £200,000 and giving over 2,000 hours of volunteer time to charities across the Group.

GovernanceAs the Chairman has already reported, we have continued to make sure our governance approach matches rapidly changing best practice. In particular, although we were not legally required to apply the new UK Corporate Governance Code, we have voluntarily agreed to meet it both in spirit and in deed.

As well as this, we set up a new Board committee - the Group Risk Committee and we re-focused and increased the remit of the Remuneration Committee. We would like to acknowledge the support and effort of all our Non-Executive Directors in this regard.

Major staff changes

We would again pay tribute to John Peberdy, who retired mid-year after 37 years' service with Ansvar in Australia and New Zealand. John worked untiringly for the business and the local community. Closer to home, Graham Shearn retired in April, having made a major contribution to the senior leadership of the Group; we will miss his deep expertise and thoughtful approach to our business. Another major change saw Richard Mander move on. Richard made substantial contributions as Director of HR over some years. We wish these and all who have retired or left our business well.

AwardsIn 2010 we won awards across all areas of our business. We have already mentioned the investment awards from Lipper, but we also won Best Ethical Investment Provider at the 2010 Investment Life & Pensions Moneyfacts Awards for the second year running. Robin Hepworth was also named Fund Manager of the Year. We were named Voluntary, Care & Education Underwriting Team of the Year in the Underwriting Services Awards organised by Post Magazine. We also won Most Effective B2B Campaign from the Financial Services Forum for investment marketing. We were also shortlisted or runner-up in a long list of awards including the British Insurance Awards, Risk Management Awards and Marketing Effectiveness Awards.

Outlook and conclusion

So we have come through 2010 stronger than ever before. It has not been a straightforward year, but one in which we have handled many natural catastrophes, helped many customers through difficult personal challenges and made a real difference through our attitude to the communities we serve. As well, we have come through stronger in terms of the shape of our business, our people and our finances. We have had a challenging start to 2011 that has included more natural disasters overseas, continued bad weather in the UK and no upward trend within the rating environment. However, we are confident that we can continue to build on the foundations and recognise with deep appreciation the vital efforts all our staff make. We look forward to reporting further substantial progress next year as we move into celebrating our 125th Anniversary.

Michael Tripp, Group Chief Executive

Principal activity

The principal activity of the Company is that of an investment holding company. Its principal subsidiary is Ecclesiastical Insurance Office plc (EIO). That company heads a group which operates principally as a provider of general and long-term insurance.

Ownership

At 21 April 2011 the entire equity capital of the Company was owned by Allchurches Trust Limited.

Dividends

The directors do not recommend the payment of a dividend for the year ended 31 December 2010 (2009: £nil).

Charitable and political donations

Charitable donations paid and provided for by the Group in the year amounted to £20.6 million (2009: £9.8 million).

During the last ten years, a total of £87.5 million (2009: £71.2 million) has been provided by Group companies for church and charitable purposes.

It is the Group's policy not to make political donations.

Employees

The Group recognises the importance of employee communication and aims to keep employees informed about its affairs through the use of briefing groups, Group newsletters and the publication of financial reports. Regular meetings are held between management and other employees and discussion encouraged. It is the Group's policy to give full consideration to applications for employment by disabled persons. Appropriate training is arranged for disabled persons, including retraining for alternative work of employees who become disabled, to promote their career development within the organisation.

The Group considers a number of key performance indicators in the assessment of its people strategy. In addition to numeric measures, such as staff turnover and absenteeism, the Group pays particular attention to the outcome of its annual staff satisfaction surveys, and has developed measures for assessing the success of its leadership and succession planning programmes.

Policy on payment of creditors

It is the Group's policy to pay creditors promptly and fully, in accordance with the terms of their contracts. The Group has not adopted any particular external code. The number of days' purchases represented by the amounts due to trade creditors of the Group at 31 December 2010, was 30 days (2009: 23 days).

Principal risks and uncertainties

The principal risks and uncertainties, together with details of the financial risk management objectives and policies of the Group and Company, are disclosed in notes 3 and 4 to the financial statements and are set out later in this announcement.

Group restructure

As part of the Company's strategy to streamline the Group, during the year a number of Group entities were dissolved and similar businesses were consolidated. The Group also ceased writing new business through its London Market underwriting agent and disposed of most of its life business to a third party, the Homeowners Friendly Society (trading as Engage Mutual).

Going concern

A review of the Group's business activities is provided within this Directors' Report. The additional notes on Insurance and Financial Risk in this announcement disclose the Group's principal risks and uncertainties, including exposures to insurance and financial risk and the Group's objectives for managing capital. The Group has considerable financial resources and, as a consequence, the Directors believe the Group is well-placed to manage its business risks successfully and continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the annual report and accounts.

Directors' Responsibilities

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 is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the Company'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.

Directors' Responsibility Statement

The following statement is extracted from page 13 of the 2010 annual report and accounts, and is repeated here for the purposes of the Disclosure and Transparency Rules. The statement relates solely to the Company's 2010 annual report and accounts and is not connected to the extracted information set out in this announcement. The names and functions of the Directors making the responsibility statement are set out page 3 of the full annual report and accounts.

The directors confirm to the best of their knowledge:

CONSOLIDATED INCOME STATEMENT

For the year ended 31 December 2010

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the year ended 31 December 2010

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

For the year ended 31 December 2010

The equalisation reserve is not distributable and must be kept in compliance with the insurance companies' reserves regulations.

The revaluation reserve represents cumulative net fair value gains on owner occupied property.

The translation reserve arises on consolidation of the Group's foreign operations.

Retained earnings of the Group includes a specific non-distributable reserve of a subsidiary amounting to £4,200,000 (2009: £4,200,000).

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

At 31 December 2010

CONSOLIDATION STATEMENT OF CASH FLOWS

For the year ended 31 December 2010

NOTES TO THIS ANNUAL FINANCIAL REPORT ANNOUNCEMENT OF RESULTS

For the year ended 31 December 2010

1 Accounting policies

The company has prepared this announcement of its consolidated results using the same accounting policies and methods of computation as the full financial statements for the year ended 31 December 2010 as prepared under International Financial Reporting Standards (IFRS) as adopted for use in the EU.

2 General Information

Whilst the financial information included in this announcement has been prepared in accordance with the recognition and measurement criteria of International Financial Reporting Standards (IFRS), this announcement does not itself contain sufficient information to comply with IFRS. Full financial statements that comply with IFRS were approved by the Board of Directors on 21 April 2011.

The financial information set out above does not constitute the company's statutory accounts for the years ended 31 December 2010 or 2009, but is derived from those accounts. Statutory accounts for 2009 have been delivered to the Registrar of Companies and those for 2010 will be delivered following the company's annual general meeting. The auditors have reported on those accounts; their reports were unqualified, did not draw attention to any matters by way of emphasis without qualifying their report and did not contain statements under sections 498(2) and 498(3) of the Companies Act 2006.

This announcement was approved at a meeting of the Board of Directors held on 21 April 2011.

Ecclesiastical Insurance Group plc is a subsidiary of Allchurches Trust Limited which is a private company limited by guarantee.

The ordinary shares of Ecclesiastical Insurance Group plc are not listed.

Copies of the audited financial statements are available from the registered office at Beaufort House, Brunswick Road, Gloucester GL1 1JZ.

The following information is included in this announcement in compliance with the Disclosure and Transparency Rules and has been extracted from the full financial statements for 2010.

Principal Risks and Uncertainties - Insurance Risk

The risk under any one insurance contract is the possibility that the insured event occurs and the uncertainty of the amount of the resulting claim. By the very nature of an insurance contract, this risk is unpredictable and difficult to quantify with certainty.

The principal risk that the Group faces under its insurance contracts is that the actual claims and benefit payments exceed the carrying amount of the insurance liabilities, which may occur if the frequency or severity of claims and benefits are greater than estimated. Insurance events are unpredictable and the actual level of claims and benefits may vary from year to year from the estimates established using statistical techniques.

Factors that typically aggravate insurance risk include lack of risk diversification in terms of type and amount of risk, geographical spread and type of customer covered.

Experience shows that the larger and more diversified the portfolio of similar insurance contracts, the smaller the relative variability about the expected outcome will be. The Group's insurance underwriting strategy aims to diversify the type of insurance risks accepted in order to reduce the variability of the expected outcome.

General business risks

General insurance business classes written include property and liability. Property cover mainly compensates the policyholder for damage suffered to their properties or for the value of property lost. Property may also include cover for pecuniary loss through the inability to use damaged insured commercial properties. Liability insurance contracts protect policyholders from the liability to compensate injured employees (employers' liability) and third parties (public liability). Motor policies provide both property and liability cover for the insured. Injury, death or incapacity as a result of an unforeseen event is covered by the accident class of business.

In all operations pricing controls are in place, underpinned by sound statistical analysis and market expertise and appropriate external consultant advice. The Group manages risks to limit severity through its underwriting strategy, a comprehensive reinsurance programme and proactive claims handling. Net retention limits are in place and the Group arranges catastrophe reinsurance cover to protect against aggregations of losses.

Frequency and severity of claims

Property classes

For property insurance contracts, including the property element of motor contracts, the number of claims made can be affected by weather events, changes in climate and crime rates. Individual claims can vary in amount since the property insured is diverse in both size and nature. The cost of repairing property varies according to the extent of damage, cost of materials and labour charges.

Climate change may give rise to more frequent and severe extreme weather events, such as river flooding, hurricanes and drought, and their consequences, for example, subsidence claims.

The maximum claim payable is limited to the sum insured. The Group has the right to re-price the risk on renewal. It also has the ability to impose deductibles, reject fraudulent claims and pursue third parties for payment of some or all costs. These contracts are underwritten on a reinstatement basis or repair and renovation basis as appropriate. Costs of rebuilding properties, of replacement or indemnity for contents and time taken to restart operations for business interruption are the key factors that influence the level of claims. Individual large claims are more likely to arise from fire, storm or flood damage. The greatest likelihood of an aggregation of claims arises from weather or recession related events.

Liability classes

For liability insurance contracts, including the liability element of motor contracts, the frequency and severity of claims can be affected by several factors. The most significant are the increasing level of awards for damages suffered, the courts move to periodic payments awards and the increase in the number of cases that were latent for a long period of time. Inflation, from these and other sources, is a significant factor due to the long period typically required to settle these claims.

The Group has the right to re-price the risk on renewal. It also has the ability to impose deductibles, reject fraudulent claims and pursue third parties for payment of some or all costs. The severity of bodily injury claims is highly influenced by the value of loss of earnings and the future cost of care.

Concentrations of risk

The underwriting strategy is designed to ensure that the underwritten risks are well diversified in terms of type and amount of risk and geographical spread. The Group protects its gross underwriting exposure through the use of a comprehensive programme of reinsurance. The concentration of insurance risk for the financial year before and after reinsurance by territory in relation to the type of risk accepted is summarised below, with reference to written premiums:

Sources of uncertainty in the estimation of future claim payments

Property classes

The property classes, including property damage under motor contracts, give rise to a variety of different types of claims including fire, business interruption, weather damage, subsidence, accidental damage to insured vehicles and theft. There can be variability in both the number of claims in each period and the size of those claims. If a weather event happens near the end of the financial year, then the uncertainty about ultimate claims cost in the financial statements is much higher because there is insufficient time for adequate data to be received to assess the final cost of claims.

Claims payment, on average, occurs within a year of the event that gives rise to the claim. However, there is variability around this average with larger claims typically taking longer to settle.

Subsidence claims are difficult to predict because the damage is often not apparent for some time. Changes in soil moisture conditions can give rise to changes in claim volumes over time. The ultimate settlements can be small or large with a greater risk of a settled claim being re-opened at a later date.

Liability classes

The settlement value of claims arising under public and employers' liability and the liability element of motor contracts is particularly difficult to predict. There is uncertainty as to whether any payments will be made and, if they are, the amount and timing of the payments. Key factors driving the high levels of uncertainty include the late notification of possible claim events and the legal process.

Late notification of possible claims necessitates the holding of provisions for incurred claims that may only emerge some years into the future. In particular the effect of inflation over such a long period can be considerable and is uncertain. A lack of comparable past experience makes it difficult to quantify the number of claims and, for certain types of claims, the amounts for which they will ultimately settle. The legal and legislative framework continues to develop which has a consequent impact on the uncertainty as to the length of the claims settlement process and the ultimate settlement amounts.

Claims that may arise from the liability portfolios include damage to property, physical injury, disease and psychological trauma. The Group has a different exposure profile to most other commercial lines insurance companies as it has lower exposure to industrial risks, where uncertainty is higher. Therefore, claims for industrial diseases are less common for the Group than injury claims such as slips, trips and back injuries.

Claims payment, on average, occurs about three years after the event that gives rise to the claim. However, there is significant variability around this average.

Note 30 in the full financial statements presents the development of the estimate of ultimate claim cost for public and employers' liability claims occurring in a given year. This gives an indication of the accuracy of the estimation technique for incurred claims.

Sources of uncertainty

The ultimate settlement cost of incurred general insurance claims is inherently uncertain. Such uncertainty includes:

Prudence in the provisions for outstanding claims

The group has taken into account the uncertain nature of claims reporting and settlement when provisioning for outstanding claims.

Provisions for latent claims

The public and employers' liability classes can give rise to very late reported claims, which are often referred to as latent claims. These can vary in nature and are difficult to predict. They typically emerge slowly over many years. The group has taken a prudent approach to reflect this uncertainty and believes that it holds adequate reserves for latent claims that may result from exposure periods up to the reporting date.

Long term business fund

The Group disposed of all of the products of the With-profit fund and the non funeral plan products of the Non-profit fund during the current year (hereafter referred to as "the disposed business"). The Group's long term business activity is now focussed on providing Whole of Life products to support the funeral planning products that are made available by business partners such as the National Association of Funeral Directors (NAFD).

Frequency and severity of claims

The group provides a range of life insurance products, which are summarised in the table below:

The retained funeral plan business is subject to variability in the frequency and severity of claims, however this does not provide significant insurance risk to the Group as the reserves held at any point in time for each policy are very close to the benefit that would be paid at that point in time.

Long term business insurance risks in the prior year, relating to the disposed business

The remainder of this section relates to prior year disclosure of insurance risks of that part of the long term business that has been disposed of during the current year.

Long term insurance contracts

For contracts where death is the insured risk, the most significant factors that could increase the overall frequency of claims are epidemics or widespread changes in lifestyle resulting in more or fewer claims than expected. For contracts where survival is the insured risk, the most significant factor is continued improvement in medical science and social conditions that would increase longevity.

For non-profit contracts with fixed and guaranteed benefits and fixed future premiums, there are no mitigating terms and conditions that reduce the insurance risk accepted.

The Group manages these risks through its underwriting strategy and reinsurance arrangements. Industry standard tables are used to price products. No allowance is made for the Group's own claims experience as it is not statistically significant. The Group's exposure is limited by reinsurance arrangements that restrict exposure on a single risk. Both yearly renewable term and original terms reinsurance arrangements are used.

Both pension and life annuities in payment provide a defined income stream to the policyholder which is commonly contingent on survival. The primary risks on these contracts are the level of future investment returns on the assets backing the liability and the longevity of the policyholders. The investment risk has been largely mitigated by holding fixed interest assets of a similar term to the expected longevity profile. The longevity risk is retained by the Group and directly impacts shareholders' equity.

Both with-profit life and pensions assurance products provide a combination of guaranteed and discretionary benefits for policyholders. The principal risks associated with these contracts are interest rate and equity price risk. In the first instance these risks are borne by the unallocated divisible surplus, which is available for allocation to policyholders as discretionary benefits.

The non-profit fund bears any difference between future administration expenses and the specified fees charged to the with-profit fund. The reserves in the non-profit fund for with-profit life and pension contracts reflect a shortfall between the forecast fees receivable and forecast expenses.

Insurance risk for contracts disclosed in this note is also affected by the policyholders' right to pay reduced or no future premiums, or to terminate the contract completely. As a result, the amount of insurance risk is also subject to policyholder behaviour. The Group has considered the impact of policyholders' behaviour in the calculation of these liabilities.

Group life yearly renewable contracts

These contracts are mainly issued to employers to insure their commitments to their employees in terms of their pension fund and other employee benefit plans. The risk is affected by the nature of the industry in which the employer operates, in addition to the factors noted above.

The Group's disposed business has a higher than average concentration of risk in the clergy, but otherwise there is no bias to any particular industry. It is believed that the mortality and morbidity of the clergy does not depart significantly from experience for the United Kingdom population as a whole.

Prior to the disposal, reinsurance arrangements were in place to mitigate the Group's exposure to these risks. The net exposure for any one risk is limited.

Sources of uncertainty in the estimation of future benefit payments and premium receipts

Long term insurance contracts

Uncertainty in the estimation of future benefit payments and premium receipts for long term insurance contracts arises from the unpredictability of long term changes in overall levels of mortality and the variability in policyholder behaviour.

The Group uses appropriate base tables of standard industry mortality according to the type of contract being written. For contracts that insure survival, an adjustment is made for future mortality improvements based on trends identified in the mortality investigations performed by independent actuarial bodies.

Group life yearly renewable contracts

There is no need to estimate mortality rates or morbidity rates for future years because these contracts have short duration. However, for incurred disability income claims, it is necessary to estimate the length of the term over which payments will continue to be made. It has been assumed that payments continue for the remaining term of the policy with no allowance for either mortality or recovery.

Options and guarantees

All material financial options and guarantees are in the with-profit fund and the cost of meeting them is covered by the unallocated divisible surplus. These options and guarantees have the potential, depending on the behaviours of financial variables such as interest rates and equity returns, to increase the value of benefits paid to policyholders.

Further details of the material options and guarantees are given below, including the variables that determine the amount payable and the potential effect of adverse changes in market conditions. In line with the measurement of the with-profit policyholder liabilities, a deterministic methodology has been used to measure the options and guarantees and so they are not measured at fair value or using a market-consistent asset model.

With-profit maturity and surrender value guarantees

Substantially all of the conventional with-profit policies have minimum guaranteed benefits on maturity consisting of the sums assured plus previously declared regular bonuses. In addition, a small proportion of endowment policyholders have minimum guaranteed benefits on surrender after a certain time, consisting of a fixed proportion of the sums assured plus previously declared regular bonuses. The main variable that determines the amount payable under the guarantees is the level of regular bonuses added to the policy.

The difference between the guaranteed benefits and the value of the assets deemed to be allocated to the policies (their asset share) at maturity or at the point of surrender, represents the net cost of the guarantees. There will be no maturities in 2011 (2009: £1.8 million net cost expected for 2010), and no surrenders (2009: £0.2 million net cost expected for 2010). The discounted value of these amounts is included within the with-profit policyholder liabilities for the relevant policies.

The cost of the guarantees is most affected by a fall in equity returns and if returns were 10% lower than anticipated, the above costs would be £nil (2009: increase to £2.3 million) and £nil (2009: increase to £0.3 million) respectively.

No market value reduction (MVR) guarantees

For the with-profit bond and the deposit administration group pension contracts, there are circumstances when it is guaranteed that no MVR will apply in determining benefits, ie:

The cost of the guarantee is determined by the relationship between the total benefits on the contract and the total asset share when applied to the amount of the withdrawal. If withdrawals were made on all contracts up to the maximum level for the no MVR guarantee, then the total cost in 2011 will be £nil (2009: £0.2 million expected for 2010). This is allowed for in determining the liabilities for the contracts.

The cost of the guarantee is most affected by a fall in equity returns, and if returns were 10% lower than anticipated, the cost would be £nil (2009: increase to £0.4 million).

Principal Risks and Uncertainties - Financial Risk

The Group is exposed to financial risk through its financial assets, financial liabilities, reinsurance assets and insurance liabilities. In particular the key financial risk is that the proceeds from its financial assets are not sufficient to fund the obligations arising from its insurance and investment contracts. The most important components of financial risk are interest rate risk, credit risk, currency risk and equity price risk.

There has been no change from the prior period in the nature of financial risks that the Group is exposed to. Where noted below, the disposal of part of the Group's life business during the current year has reduced exposure to certain risks. The Group's management and measurement of financial risks is informed by either stochastic modelling or stress testing techniques.

Categories of financial instruments