Annual Report and Accounts Looking forward

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1 Annual Report and Accounts 2004 Looking forward

2 Chairman s Statement Group Chief Executive s Review Financial Review Operational Review UK Life & Pensions Standard Life Bank Standard Life Healthcare Standard Life Investments Canada International Corporate Social Responsibility Board of Directors Report by the Directors Directors Responsibilities Corporate Governance Report of the Audit Committee Report of the Remuneration Committee Other Board Committees Independent Auditors Report Group Profit and Loss Account Balance Sheet Accounting Policies Notes on the Accounts Our achievements this year

3 Standard Life 2.6 million with profits members around the world Third party mandates have risen to more than 18bn 108bn assets under management 12,101 employees worldwide Major investments in training and technology

4 11.2% market share with Independent Financial Advisers Over 700 UK customer applications in one day Five Star Life and Pensions Provider of the Year * * Financial Adviser Service Awards 2004 Over 300 managers participated in our Leadership Development Programme Voted Company of the Year * * Money Marketing 1000 Broker Survey/IFA Awards

5 8.0% Total market share* 108bn Assets under management 1.4bn Total Insurance new business APE for 2004 Standard Life has been looking after its customers for 180 years, and currently over 7 million people rely on us for their financial needs. We have assets under management which are worth more than the combined market value of Shell, Reuters, Tesco, Cadbury Schweppes and Marks & Spencer. Our business operates within six key areas: UK Life & Pensions, Bank, Healthcare, Investments, Canada and International. *All market share data provided by ABI. The Standard Life Assurance Company 01

6 Chairman s Statement Our commitment to integrity, financial security and service to our customers remains paramount. Sir Brian Stewart Chairman 02 The Standard Life Assurance Company

7 Chairman s Statement Learning from the past, influencing the future Profitability is fundamental to the sustainability of the organisation and the long-term interests of our stakeholders. a comprehensive review of the available options. Our conviction is that this is the way to give members maximum value from their investment with the Company. Your Board reviews this conclusion regularly to ensure its continuing validity. The last year has been one of considerable achievement as we began the restructuring and repositioning of Standard Life to cope with new market and investment conditions. A year ago we acknowledged the need to respond to changes in our environment, and we promised that we would address those concerns urgently. During the last year we announced a Strategic Review of the business. It covered all parts of our operations and we moved decisively to implement the Review conclusions. The initial indications are that we are on track to achieve the objectives we set. Your Board is mindful of its duty towards members and in particular of the need to balance the interests of different generations of members. The Strategic Review concluded that members interests would be served best by demutualisation and flotation on the stock market. This view was formed after Profitability is fundamental to the sustainability of the organisation and the long-term interests of our stakeholders. In 2004 we implemented a restructuring programme as one of the necessary steps to becoming more efficient. In taking this action, which will help ensure the future financial health and stability of the Company, we have been careful to maintain the strong service culture from which much of the value of our brand derives. We made a commitment to improve our communications. We communicated promptly and fully on all the significant actions taken during the year. Our programme of member roadshows has been well received and will continue as part of our policy to keep all audiences informed. We will continue to enhance communications and report progress, in particular during this time of unprecedented change. The Standard Life Assurance Company 03

8 Chairman s Statement We have the strength and depth to grasp the commercial opportunities presented by the changing market conditions. Your Board has addressed the issue of directors remuneration and the need for close alignment between the rewards of our people and the interests of members. In this task, the Board s Remuneration Committee was assisted by an external firm of consultants and I am confident that the new long-term and shortterm incentive structures will address the concerns raised by members in recent years. With over 100 billion of funds under management, it is important that Standard Life takes a strong stance on issues of corporate social responsibility. We have restated our commitment to the community, to socially responsible investing and to the development of our people. The Corporate Social Responsibility section of this report goes into more detail on these subjects. Like many other companies we are adjusting to the changes in the regulatory environment and in accounting standards. Much time and resource is being invested to meet these challenges and Standard Life is making good progress in implementing the series of new financial, regulatory and accounting standards. We seek at all times to ensure your Board has the benefit of the appropriate individual and collective expertise. In that context, I am delighted that Kent Atkinson has joined the Board as a non-executive director. His extensive and diverse experience will undoubtedly prove a valuable addition. The appointment of Trevor Matthews as the new Chief Executive of the UK Life & Pensions business brings wideranging experience and extends the capabilities of the management team. The Board intends to appoint a new finance director to contribute to the process of developing Standard Life into a publicly quoted company and to further its development as an industry leader. I would like to thank members of the Board who have stood down this year for their valued contribution. Claude Garcia, President of Standard Life in Canada, left after a very successful career spanning more than 20 years with the Group. The Hon Roy McLaren retired as a non-executive director and David Lewis stepped down. I believe your Board is an outstanding team of high calibre executives and non-executives. Collectively they provide the leadership to drive forward successfully an organisation of the size and complexity of Standard Life. I would like in particular to record my thanks to the executive team for their continued efforts on behalf of the Company. The demands that are being made of them at this time are unusually heavy. I wish to thank our customers for their loyalty during a period of some turbulence. The enduring strength of the Company s brand is a core asset for us and has manifested itself in the continuing support we have received while we make the necessary adjustments. The Board is also conscious of the great effort by all Standard Life employees, who have continued to deliver an outstanding service standard despite the changes being implemented in the Company. 04 The Standard Life Assurance Company

9 Chairman s Statement As we look to the coming year, there are many factors that could affect our business plans and our journey to demutualisation and flotation. While the UK economy has enjoyed an extended period of relative stability, the life assurance industry has seen a series of changes in recent years, both in regulation and in industry structure, and there are likely to be more changes to come. Given the signs of recovery in equity markets and the major world economies, we are cautiously optimistic about conditions in our industry but we remain aware of the volatility in international oil prices and global political uncertainties that may yet destabilise equity market recovery. Our programme of member roadshows has been well received and will continue as part of our policy to keep all audiences informed. We will continue to enhance communications and report progress, in particular during this time of unprecedented change. We have the strength and depth to grasp the commercial opportunities presented by the changing market conditions. Our commitment to integrity, financial security and service to all of our customers remains paramount as we focus on enhancing the value of the Company on behalf of our stakeholders. The Standard Life Assurance Company 05

10 Group Chief Executive s Review Since we announced the Strategic Review we have introduced changes to make the Company more responsive to market conditions. Sandy Crombie Group Chief Executive 06 The Standard Life Assurance Company

11 Group Chief Executive s Review We are confident about building on the fundamental attributes that make Standard Life one of the most respected financial services groups in the UK. However, the business we did write was written on better terms. Other operational units have made good progress on increasing business volumes. Overall, the Group s total new business for the 2003/4 period showed modest improvement on the previous year (after adjusting for seasonality and the change of year end). Responding to a new environment The strategy being pursued in recent years in our UK Life & Pensions operation did not produce business of sufficient quality and profitability. Cost reductions proved necessary and this operation bore the brunt of job losses which last year totalled more than 2,200 across the Group. Since we announced the Strategic Review we have introduced changes to make the Company more responsive to market conditions, both in the UK and in our international operations. The benefits are already being felt but the full impact of these changes should become apparent in 2005 and later years will be a crucial year, both in trading performance and strategic terms, as we work towards the proposed demutualisation. While some of the decisions we made have been painful, we are confident about building on the fundamental attributes that make Standard Life one of the most respected financial services groups in the UK. Steps have been taken to ensure that the emphasis of the Group is on improved profitability. We took the decision to write less business in UK Life & Pensions last year. Cost reductions are not the complete response to profitability issues. Profitability in some UK Life & Pensions products has been affected by the terms on which customers advisers have been remunerated. Changes to commission terms were introduced and some product charges were increased. For different reasons, our healthcare operation incurred a loss during Product charges were increased to offset a worsening of claims experience in the early part of last year. We expect the full benefit of this repricing to flow through in In both operations, product innovation is a further part of the solution to issues of profitability. We have seen excellent performances from new products and services such as Healthcare Switch and our new Self Invested Personal Pension (SIPP), launched by UK Life & Pensions in December. The Standard Life Assurance Company 07

12 Group Chief Executive s Review Our 2005 plan is demanding and we are determined to meet and exceed our stretching targets. Our investment team has demonstrated an impressive performance track record that has supported sales of Standard Life s insurance products and the continued growth in third party assets under management. As we look to the coming year, we are increasingly confident that our strong investment offering in the retail and institutional markets will support continued growth across our product range. Our banking operation has critical mass, and we are focused on processing increased volumes through our existing infrastructure. New business is coming from savings and mortgage products, and from new products developed elsewhere in the Group for example from cash deposits held within the new SIPP product. Significant benefit will derive from Standard Life having a banking function at its core. The bulk of our Canadian business was transferred into a wholly-owned subsidiary over the 2004 year end. This provides greater flexibility in capitalising that business. We have a strong commitment to this market and our Canadian operation produced 12% of the Group s new business last year. We had an outstanding year in Germany, more than doubling sales. This represented 15% of Group new business. The German market was particularly buoyant in the run up to a change in the tax treatment of life assurance contracts. Although last year was exceptional, we anticipate Germany will make an increasingly important contribution to the Group. Finally, we took steps, including a very successful capital raising initiative, to ensure that our balance sheet remains secure. There has been considerable comment about our intentions to proceed towards demutualisation, and criticism about the Board s change of stance on this matter. Over the coming months, it is important that we make clear to members the reasons for this decision and the need for their support. Since 2000, when members voted to support the retention of our mutual status, there have been many significant changes in our circumstances. With profits products have declined markedly in popularity and the capital requirements of the Group have increased. We are a mutual company, but can no longer deliver some of the additional benefits from our mutual status that we once could. There is little likelihood of that changing. In such changed circumstances, the Board has recognised that it is no longer as valuable to members to retain our mutual status and, as a consequence, has changed its position. Having examined a number of options, we believe that demutualisation would maximise value for eligible members and enable us to distribute that value fairly. A flotation would give eligible members a greater degree of choice about the nature of their relationship with the Company by separating their interests as policyholders from their interests as shareholders. The proposed flotation can also raise additional capital to fund the Group s future growth. 08 The Standard Life Assurance Company

13 Group Chief Executive s Review Last year proved to be a major turning point, ahead of a critical year for all of us connected with Standard Life. In 2004 we delivered on targets for cost savings and headcount reduction and for capital raising in the form of our heavily oversubscribed capital issue as part of repositioning the Group for profitable growth. At the same time we delivered and were recognised for great levels of customer service in each of our operating units. Our 2005 plan is equally demanding and we are determined to meet and exceed our stretching targets. We believe that demutualisation would maximise value for eligible members. Geographic Breakdown APE (Annual Premium Equivalent) Europe 19% (10%) UK 69% (78%) Canada 11% (11%) Asia 1% (1%) Life and pensions APE % months to 31 December (%) months to 15 November The Standard Life Assurance Company 09

14 Financial Review Funds under management exceeded 100 billion for the first time. John Hylands Group Finance Director 10 The Standard Life Assurance Company

15 Financial Review Creating stability for our future success Group Funds Under Management ( bn) Figures at 15 November 2004 Figure at 31 December The conclusions of the Strategic Review have a fundamental impact on the Group s future financial structure and operations. The ongoing implementation of the Review s findings and the announcement of the intention to demutualise and seek a public listing have resulted in a period of unprecedented change. In particular, the focus on profitability measures has increased, and preparations for the proposed flotation are ongoing against a backdrop of evolving financial reporting and regulatory solvency requirements. The Board also took a series of decisions regarding changes to the Company s bonus philosophy, including its approach to smoothing and to paying benefits of mutuality, the cessation of further reserving for the mortgage endowment promise and the time barring of complaints for mortgage endowment mis-selling. The Group has changed its financial year end from 15 November to 31 December, and consequently these accounts show the Group s results for the thirteen and a half month period ended 31 December In common with our competitors and to allow greater comparability with them the Group will now report on a calendar year basis. Another significant change in 2004 was the domestication of the Canadian non-participating business, which was previously written within the Canadian branch of The Standard Life Assurance Company. As from 31 December 2004, this business is now written through The Standard Life Assurance Company of Canada, a wholly-owned subsidiary of the parent company. Financial Reporting UK Generally Accepted Accounting Practice The Group s accounts are presented in accordance with UK Generally Accepted Accounting Practice, using the Modified Statutory Solvency Basis. On this basis, the valuation of liabilities is aligned to the regulatory peak basis used within the regulatory return submitted to the Financial Services Authority (FSA), subject to some modifications as specified in the Association of British Insurers Statement of Recommended Practice. We have changed our accounting policy in respect of the valuation of non-linked redeemable fixed income securities related to insurance business. These were previously valued at amortised cost, but are now valued using the mid-market value. This aligns more closely the asset valuation basis with developing techniques for valuing long-term liabilities. International Financial Reporting Standards From 2005 onwards, the application of International Financial Reporting Standards (IFRS) will be mandatory for the consolidated accounts of European Union (EU) listed companies. We intend to adopt IFRS in 2005 to comply with best practice. The International Accounting Standards Board (IASB) has now published the standards that will define IFRS reporting in 2005, including IFRS 4 Insurance. This is an interim standard enabling insurers to report under IFRS from The IASB is continuing to work on the development of a comprehensive standard for insurance accounting, although the timing of completion of this standard is uncertain. The IASB s existing standards have been endorsed by the EU for application from 2005 onwards. Consensus regarding the interpretation of the standards continues to develop within the industry and the accounting profession. In order to meet the new requirements, the Group established a project in 2003 to address the impact of IFRS. Despite continued uncertainty around the interpretation of certain standards the project is on track to deliver the production of IFRS financial statements for The Standard Life Assurance Company 11

16 Financial Review This new approach changes the way firms have to calculate the financial resources they need to support future contractual and expected discretionary payments such as terminal bonuses. Financial Reporting Standard 27 Life Assurance The key performance drivers during the period were the maintenance of financial strength and the repositioning of the UK Life & Pensions business to achieve profitable growth. The main expected impacts of IFRS are as follows: Some investment-type business currently accounted for as insurance will be classified as financial instruments, which will reduce premium income and change the profit recognition profiles associated with that business; the accounting policy for with profits insurance business will change to a realistic basis; some investment vehicles previously treated as investments will be consolidated on a line by line basis, minority interests will thus also be reflected; the investment return in the profit and loss account will be subject to greater volatility; assets held to back liabilities under unit-linked contracts will no longer be shown on the face of the balance sheet but will be disclosed in the notes on the accounts; an increased proportion of financial instruments will be carried at fair value. European Embedded Value The Group is a member of the Chief Financial Officers Forum, which in 2004 published Principles and Guidance in respect of European Embedded Value (EEV) reporting. This basis of reporting has been developed to improve the presentation of shareholders interests in the long-term business. EEV reporting is being implemented by the Group as part of its preparation for the proposed demutualisation and listing. Regulatory developments The FSA implemented a new approach to the preparation of the regulatory returns which, for large with profits companies, requires the presentation of a realistic balance sheet for with profits business. Background During 2004, in response to the findings of the Report of the Equitable Life Inquiry, the Accounting Standards Board (ASB) was requested by the UK Government to initiate an urgent study into accounting for with profits business by life insurers, against the background of developments in the FSA s regulatory regime and IFRS. In July 2004, the ASB issued for comment Financial Reporting Exposure Draft 34, which proposed changes to with profits accounting and disclosures. Following a period of comment, the resulting Financial Reporting Standard (FRS) 27 was issued in December The main requirements of FRS 27 are as follows: For large UK with profits life assurance businesses falling within the scope of the FSA s realistic capital regime, liabilities to policyholders are required to be measured on the realistic basis; a capital position statement should be presented; the capital position statement should be supported by information on regulatory capital requirements or management s capital targets, the basis of determining regulatory capital, the sensitivity of liabilities and capital to changes in market variables and key assumptions, and the entity s capital management policies; information should be included on the assumptions used in the measurement of liabilities and the terms and conditions of options and guarantees relating to life assurance contracts. As part of the finalisation of FRS 27, leading members of the life assurance industry and the ABI gave certain undertakings to the ASB to enable it to defer implementation of FRS 27 for a year. The above requirements are therefore effective for financial statements relating to accounting periods ending on or after 23 December The Standard Life Assurance Company

17 Financial Review The undertakings given are included in the Memorandum of Understanding concerning FRS 27 (MoU). The following disclosures have been prepared in accordance with the MoU. Liability valuation assumptions The process for determining the discount rates used to calculate the long-term business provision comprises three stages: determining the current yield on the assets held after allowing for risk and tax, hypothecating the assets to various types of policy and determining the maximum discount rates from the hypothecated assets. For equity assets, the current earnings and dividends are considered and, if considered necessary, a deduction is made to reflect sustainability. Similarly, a deduction to the yields on property assets is made where considered necessary, to allow for the possibility of rental defaults and vacancies. For corporate bonds, a deduction is made for the risk of default. The yield for each category of asset is taken as the average adjusted yield weighted by the market value of each asset in that category. The future mortality assumptions are based on historical experience with an allowance for future mortality improvement in annuities. The Company s own mortality experience is regularly assessed and analysed, and the larger industry-wide investigations are also taken into account. A significant assumption is the rate at which future mortality is expected to improve for annuitants. The assumptions for future policy expense levels are determined from the Company s most recent annual expense analysis. No allowance has been made for potential expense improvement, and the costs of projects to improve expense efficiency have been ignored. The assumed future expense levels incorporate an annual inflation rate allowance of 3.5% for UK business derived from the expected Retail Price Index (RPI) and earnings inflation implied by current investment yields. Realistic liabilities The long-term business provision has been calculated on the Modified Statutory Solvency Basis. However the FSA requires companies with a large volume of UK with profits life assurance business to report those liabilities in their 2004 regulatory returns in accordance with the FSA s new realistic reporting regime. Standard Life will be reporting the realistic liabilities of the with profits business in its Canadian, German and Irish branches as well as its with profits business in the UK. The FSA s realistic reporting regime seeks to place a realistic and market consistent value on both assets and liabilities for with profits business. In particular the liabilities reflect discretionary benefits such as future bonuses as well as both the intrinsic value and the time value of options and guarantees and allow for possible future management actions. The assets include the value inherent in the existing policies. The realistic liabilities are based on the aggregate value of individual policy asset shares that reflect the actual premium, expense and charge history of each policy. Other components reflect policy related liabilities such as policy guarantees, options and future bonuses, which are calculated using a stochastic model that simulates future investment returns, asset mix and bonus strategies. The amount of those realistic liabilities is 37.2 billion compared to 36.7 billion in the long-term business provision. The amount of the realistic assets is 40.5 billion. The realistic assets exceed the realistic liabilities by 3.3 billion. The Standard Life Assurance Company 13

18 Financial Review certain with profits unitised Trustee Investment Plan policies where, subject to specified conditions and limits, it is guaranteed that there will be no UPA when units are encashed; with profits bonds where it is guaranteed that no UPA will apply on regular withdrawals up to certain specified limits; with profits pensions policies where guaranteed minimum annuity rates apply at specified retirement dates if the policyholder chooses to apply the maturity proceeds to purchase an annuity with the Company; with profits policies where it is guaranteed that the annual interest rate credited will be at least 4%. Germany With profits policies where it is guaranteed that the unit price will not fall; Options and guarantees Life and pensions policies can contain financial options and guarantees that have the potential, depending on the behaviour of financial variables such as interest rates and equity returns, to increase the benefits paid to policyholders. The FSA s realistic reporting regime requires companies to use a market consistent stochastic model calculation or a fair value to determine the potential liabilities for such options and guarantees in with profits policies. Liabilities calculated in that manner have been included in the realistic liabilities stated above. The most significant are as follows: United Kingdom and Republic of Ireland With profits unitised life policies where, subject to specified conditions, it is guaranteed either that the unit price will rise at an annual rate of at least 3% a year or that the unit price will not fall, and, that there will be no unit price adjustment (UPA) at maturity; with profits unitised pensions policies where, subject to specified conditions, it is guaranteed either that the unit price will rise at an annual rate of at least 4% a year or that the unit price will not fall, and, that there will be no UPA at specified retirement dates; with profits pension annuity policies where changes in the level of the annuity are based on a rate of return declared by the Company but reductions in the level of the annuity are limited; conventional with profits policies where minimum surrender values and minimum paid-up values apply; with profits deferred annuity policies where, at maturity, annuity income can be converted to cash on guaranteed minimum terms; within the UK with profits business, single premium pension policies where a minimum pension is guaranteed; within the Irish with profits business, unitised life policies where it is guaranteed that there will be no UPA when units are encashed at the guaranteed surrender date. Canada With profits whole life policies where it is guaranteed that the interest on policy loans will not exceed 6%; conventional with profits policies where minimum surrender values and minimum paid-up values apply; with profits whole life policies where the lump sum death benefit can be converted into an annuity on guaranteed terms or retained by the Company whereupon the value accumulates at an annual interest rate of at least 2.5%; with profits unitised policies where, provided all premiums due have been paid, minimum surrender and maturity values apply; with profits unitised policies where it is guaranteed that there will be no UPA on claims on or after the surrender option date; with profits unitised policies where it is guaranteed that the premium required for a given level of benefit will not exceed a specified amount; with profits unitised deferred annuity policies where a minimum level of annuity is guaranteed at the selected retirement date. Other Within the UK linked business there are single premium policies where the maturity value is linked either to increases in the FTSE 100 Index or to increases in the UK RPI subject to minimum maturity values established when the policies commenced. The potential value of the minimum maturity values has been determined at fair value and included in the long-term business provision. Within the Company s UK, Canadian, Irish and German businesses there are financial guarantees and options that have not been valued in the long-term business provision at fair value or using a market-consistent stochastic model and have not been included in the realistic liabilities stated earlier. The most significant are stated below. 14 The Standard Life Assurance Company

19 Financial Review Within the Canadian business there are linked policies where the maturity value is guaranteed to be no lower than 75% of the premiums, adjusted for withdrawals. The long-term business provision for these policies was 752 million at 31 December The cost of the guarantee has been calculated in accordance with local requirements and resulted in no provision being required. Within the Canadian business there is a block of savings products where premiums can be invested on both a linked and a non-linked basis. The non-linked investment options include term investment funds (TIFs) with various minimum interest rate guarantees depending upon the term selected and when the policy was effected. For some policies the Company guarantees that it will offer at least one TIF with an annual interest rate of at least 3%. Policyholders have the option to switch into TIFs some or all of their investments in the other investment options and can increase their premiums up to statutory limits. The long-term business provision for these policies was 54 million at 31 December 2004 and included a provision for the guarantee that was calculated in accordance with the local requirement at 3 million. Capital position The Company s capital supports its insurance business, both with profits and nonparticipating, in the UK and in branches in Canada, Ireland and Germany. Accordingly, the capital position is presented as a single column. In addition, through subsidiaries and joint ventures, insurance and other financial services are provided in the UK, Canada, Spain, India and China. Over 90% of the total available capital shown in the following analysis of capital is readily transferable across the Group. The Company s capital position as at 31 December 2004 was as follows: Fund for future appropriations 4,456 Adjustments onto regulatory basis Deferred acquisition costs (1,333) Other adjustments 326 Other qualifying capital Changes in market conditions and other variables have the potential to affect significantly the capital position. Poor investment returns would depress capital but the effect could be mitigated by changing the asset portfolio and by the level of bonuses declared. Future annuitant mortality could be significantly different from that assumed in the calculation of the liabilities. The interaction between the twin peaks under the FSA s new regulatory solvency regime and EU developments on solvency requirements could also have a significant impact on the future capital position. As a mutual organisation, the Company has limited opportunities for external funding and its capital management policies support its capital objectives of providing an appropriate degree of financial security to its customers and support to the development of its business. m (1,007) Subordinated members accounts 548 Subordinated loans 971 Implicit item 500 2,019 Total available capital to meet regulatory requirements 5,468 Regulatory capital resources requirement 2,513 Worldwide APE ( bn) Life and pensions APE + 10% of investment sales months to 15 November months to 31 December The Standard Life Assurance Company 15

20 Financial Review There are formal processes for identifying and assessing risks that could affect the capital position and they are described in the Corporate Governance section of this Report. Evolution of prudential regulation As discussed above, the FSA now requires large with profits companies to assess solvency on two bases regulatory and realistic. The realistic basis has been developed to address the objective of making with profits business more transparent. New rules on group capital requirements, stemming from the Insurance Groups Directive and the Financial Groups Directive will have the effect, amongst other things, of reducing the capital credit available to the Group from subordinated debt issued by a subsidiary and held within the Group. Standard Life has factored this change into its capital planning. The basis of regulatory reporting applicable at 31 December 2004 is different from the transitional approach to realistic reporting which the industry adopted last year. This means that the figures now being reported for realistic assets and liabilities are not directly comparable with those in the previous year s realistic balance sheet. Performance As a mutual company, our aim is to meet our members long-term financial needs, by paying competitive with profits returns and maintaining appropriate financial strength. The Strategic Review concluded that the Group will become increasingly capital constrained in the years ahead and will therefore require access to further external capital. The aim to demutualise and seek a listing is currently seen as the best option to address this requirement. It would also mean that members receive maximum return from their membership of Standard Life, in part through the shares they receive on flotation and in part through the amounts paid as their policies mature. The key performance drivers during the period were the maintenance of financial strength and the repositioning of the UK Life & Pensions business to achieve profitable growth. Results Group new business was broadly in line with that of the previous year. The increased focus on profitability led to a downturn in certain UK Life & Pensions sales. This was partly offset by strong performance overseas and in our banking, healthcare and investment businesses, demonstrating the strength of the Group s diversified operations. Group funds under management exceeded 100 billion for the first time. As at 31 December 2004, the Fund for Future Appropriations, representing the excess of assets over liabilities, amounted to 4,456 million (15 November 2003 restated 4,280 million). The increase reflects the effect of improved investment market conditions offset by the impact of new business strain, the cost of bonuses and changes to the assumptions underlying the long-term business provision, as disclosed in notes 17 and 18 to the accounts. Over the period, the investment return on the UK with profits fund was 11.8%. The effect of investment conditions over the last few years has meant that, as for most other insurers, bonus rates have reduced. A reduction of over 100 million of annualised recurring expenditure has been achieved within UK Life & Pensions. In addition to this, we have introduced revised commission and product terms across a range of products, restructured the UK sales division and launched new products such as the SIPP. Each of these initiatives is designed to improve the Group s effectiveness and profitability. Preparation for the proposed demutualisation The Group s preparations for the proposed demutualisation are continuing against the backdrop of unprecedented change in financial reporting. A finance programme has been established, working closely with the demutualisation programme to ensure key issues are identified and actioned. The finance programme includes projects relating to IFRS, EEV, financial controls, change of year end, capital allocation, internal reporting and preparation for demutualisation. During the period, the Group incurred costs of 17 million in relation to the finance and demutualisation programmes. Capital raising In November 2004 the Company raised the equivalent of 550 million in euros and sterling, in the form of Hybrid Tier 1 Mutual Assurance Capital Securities. The very positive investor response to this issue enabled the Company to increase the transaction size by 150 million whilst at the same time achieving more attractive pricing than was originally envisaged. Recent activity includes the third tranche in the ongoing programme of successful Standard Life Bank mortgage asset securitsation, which was once again oversubscribed and which raised 1.25 billion. Subsequent to the year end, a fourth such issue raised a further 1.25 billion. Derivatives The Group recognises the importance of effective risk management systems and, as explained within the Corporate Governance statement, has an established framework for achieving this. It is the Group s policy to permit the use of derivatives to manage risk and facilitate efficient portfolio management. Derivatives are not used for speculative purposes. The Group Technical Risk Committee monitors the use of derivatives and receives regular reports explaining the nature and extent of the Group s derivative exposures. Treasury management Our central Group Treasury function has responsibility for mitigating liquidity, interest rate and foreign exchange risks across the Group and for arranging external financing. Outlook The Group has come through a challenging period during which changes were made to ensure the maintenance of financial strength and readiness for the challenges that lie ahead is a year in which much work will be undertaken to continue our preparations for the proposed demutualisation and listing. Throughout this process, we will be committed to maintaining our focus on maximising the value we can provide for members. 16 The Standard Life Assurance Company

21 Operational Review UK Life & Pensions Standard Life Bank Standard Life Healthcare Standard Life Investments Canada International We have an important part to play in people s lives. We re making ours a leading role. The Standard Life Assurance Company 17

22 Operational Review UK Life & Pensions 939m Annual UK new business (in APE) 8.0% Overall UK market share* 11.2% Market share with IFAs* UK Life & Pensions This has been a year of repositioning for our UK Life & Pensions business. As we refocus the business on those markets best able to create real value for the Group as a whole, many important decisions have been taken that will stand us in good stead, and there is much still to do to capitalise on all the opportunities in such a rapidly changing market. Share of Total UK Market (APE %) Throughout this period of change, the excellence of our overall service offering was maintained and received recognition in the Financial Adviser Service Awards where we received a five star award for the ninth year running. We appointed a new chief executive, Trevor Matthews, in July He followed through on the conclusions of the Strategic Review, and under his leadership important changes in practices, training and technology were implemented that have been well received by the market and put us in a strong position for The needs of today's customers are constantly changing. Through a combination of innovation on products and pricing, Standard Life is endeavouring to meet these evolving needs and help customers achieve their financial goals. Our broad life and pensions product offering benefits from the addition of components from other parts of the Group, as in our SIPP product, launched in December It is a wrap product, allowing investors a very wide range of assets through a single administrator even though their underlying investments could be with multiple providers. Standard Life s banking, pensions and investment expertise can all be brought to bear for the benefit of the customer. This new product is backed up by Standard Life s excellent customer service and technology. We are responding to demand from customers and advisers for greater product flexibility. Our SIPP customers benefit from the availability of a drawdown facility to meet their changing circumstances over the long-term. Also, our sigma range of popular funds from leading fund managers is now available across all our investment products months to 15 November months to 31 December * Fourth quarter figures, source: ABI 18 The Standard Life Assurance Company

23 A new chief executive, Trevor Matthews, has implemented important changes in practices, training and technology that have been well received by the market. Over 700 UK customer applications in one day Pension Provider of the Year* The new SIPP product is backed up by Standard Life s excellent customer service and technology. We want to retain our position as a leading pensions provider and build a greater presence in other profitable market segments. Our strength in group pensions was rewarded when we secured some significant schemes. We developed a state-of-the-art online underwriting and processing capability to allow us to re-enter the protection market in January 2005 with a competitive product. The new light touch Sandler sales process along with the new depolarisation rules that came into force in December will significantly change the way financial products are sold. Independent Financial Advisers (IFAs) will remain our primary distribution channel, but we are exploring opportunities to enter into multitied arrangements with a number of banks, building societies and distribution networks. Distribution costs will continue to be under pressure and throughout the year we launched initiatives to help IFAs work more efficiently. Our award-winning website allows them to improve their effectiveness and the service they can provide to customers with real-time quotes and online product servicing. We continue to contribute to the public debate on the development of the long-term savings industry. At this time there is a high degree of focus on retirement provision. We are wholly supportive of the Pension Commission s approach to pensions reform as outlined in Adair Turner s recent report. Calls for companies to improve their pension provision for employees and debate about the future of the state pension have brought our sector to the fore. We have recognised deficiencies in the present system for many years and are delighted to be given the opportunity to put forward our ideas for change to government ministers and advisers which we believe will help pensioners enjoy a happy retirement both today and in the future. Through a combination of innovation on products and pricing, Standard Life is endeavouring to meet evolving needs and help customers achieve their financial goals. * Bankhall Achievement Awards 2004 The Standard Life Assurance Company 19

24 Operational Review Standard Life Bank 9.1m Profit before tax 29,500 New mortgage completions 10.2bn Mortgages under management Standard Life Bank In 2004 Standard Life Bank continued on a path of profitable growth, after breaking into profit in Standard Life Bank Mortgages Under Management ( bn) 10.2 Mortgages under management passed the 10 billion milestone for the first time and ended 2004 at 10.2 billion, while gross mortgage lending for the period increased to 4.6 billion from 3.7 billion. Profit before tax for the 13.5 month period was 9.1 million (12 months to 15 November 2003: 4.6 million). The upturn in the interest rate cycle led to a slowing market for Standard Life Bank and by the autumn, the overall mortgage market was over 20% down on the peak of the previous year. It is a testament to our cost control disciplines, strong customer service and an innovative product base that we have increased the profits of this operation, and succeeded in maintaining our market share. Many of our customers are now using the Freestyle mortgage as a financial planning tool, reflecting the ever-increasing need for straightforward solutions to the complex savings and investment issues they face. The flexible features of Freestyle, such as the ability to overpay or draw down extra cash, have been used by 64% of our customers at least once during the lifetime of their mortgage. Our investment in user-friendly technology has further enhanced our customers' experience of doing business with Standard Life The Bank's business is now at the stage where building scale is an important strategic objective. The impressive growth to date has been achieved alongside substantial improvements in efficiency: the Bank currently operates with 18% fewer staff than when the mortgage book was half its current size. Thanks to efficient telephone and internet-based processes, we avoid the need for a costly branch network Figures at 15 November 2004 Figure at 31 December 20 The Standard Life Assurance Company

25 Despite the rapid growth of our operations, business quality remains very high. The average indexed loan-to-value ratio of our mortgage book fell from 46.3% to 44.7%. Arrears (customers three or more monthly payments down) were 0.12% at 31 December, about a sixth of the industry average 1. The success of our customer proposition is largely due to the expertise of our people whose professionalism is a source of great pride. The success of our customer proposition rests largely on the expertise of our people whose professionalism is a source of great pride. The quality of our customer service was recognised in November 2004 with a five star service award from the Financial Adviser magazine for the sixth year running. The Bank continues to maintain a diverse funding base, with 40% of our funding coming from retail deposits, 30% from wholesale sources and 30% from our securitisation programme, at 31 December. Our high-quality mortgage book continues to be a cornerstone of our successful ongoing securitisation programme. Our latest securitisation saw heavy demand and the offering was oversubscribed. Our investment in user-friendly technology has further enhanced our customers experience of doing business with us. The quality of our customer service was recognised in November 2004 with a five star service award* Cost control disciplines, strong customer service and an innovative product base mean that we increased the profits of this operation, and succeeded in maintaining our market share. The Bank s business is now at the stage where building scale is an important strategic objective. 64% of Freestyle customers used its flexible features 2004 will be remembered in the industry for the introduction of statutory mortgage regulation. Both our people and our systems were well prepared for the 1 November launch. The Bank has embraced the regulatory framework around the FSA s Treating Customers Fairly principle and our customers are better informed. This has been a year of change, success and solid performance. Plans are now in place to continue on the same path in the year ahead. 1 Council of Mortgage Lenders data for H show arrears (three or more monthly payments down) standing at 0.80%. * Financial Adviser magazine The Standard Life Assurance Company 21

26 Operational Review Standard Life Healthcare 23m In-force premium increase 98% Customer satisfaction for claims 33m New business premiums for 2004 Standard Life Healthcare Annual premium income in the 2004 period was increased by nearly 12% compared to the twelve months to November 2003 but early in the year we experienced an increase in claims. We took decisive management action on pricing and underwriting and reduced our cost base in the course of the year. These management actions began to take effect in the second period of the year and had the effect of reducing first half losses of 4m to 2.1m for the latter 7.5 month period. We expect the improving trend to continue. Our focus on customer service will enable Standard Life Healthcare to be a leading player in We received many awards in 2004 recognising our products, performance and service, including the accolade Health Insurance Company of the Year for the fourth year running. Standard Life Healthcare New Business Premiums ( m) Intermediaries remain a vital source of new business and our e-policy servicing now enables them to amend membership and policy details online. This not only reduces paperwork but also minimises the scope for errors. Our new Individual Switch service is proving popular. Private medical insurance customers with other insurers can now move to Standard Life Healthcare safe in the knowledge that existing health conditions will be covered. Customers also receive a no claims discount based on claims experience with their previous providers. The service is particularly appealing to customers with a good health history, which ensures that our business retains a good balance of risk months to 15 November months to 31 December 22 The Standard Life Assurance Company

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