Irish Life Assurance plc. Financial Statements Year ended 31 December 2012

Transcription

1 Financial Statements Year ended 31 December 2012

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3 Contents Page Company Information 1 Operational and Financial Review 2 Risk Management 8 Directors' Report 17 Corporate Governance 19 Statement of Directors Responsibilities 22 Independent Auditor s Report 23 Financial Statements - Statement of Financial Position 24 - Income Statement 25 - Statement of Comprehensive Income 26 - Statement of Changes In Equity 27 - Statement of Cash Flows 29 - Notes forming part of the Financial Statements 30

4 Company Information Directors: Alan Cook (Chairman) Tom Barry (Independent Non-Executive) Brian Forrester (Independent Non-Executive) David McCarthy (Finance Director) Kevin Murphy (Chief Executive) Bernard Collins (Independent Non-Executive) (appointed on 20 April 2012) Cecil Hayes (Independent Non-Executive) (appointed on 31 July 2012) Annette Flynn (Independent Non-Executive) (appointed 7 January 2013) Pat Ryan (Independent Non-Executive) (resigned 29 June 2012) Secretary: Barry Walsh (appointed on 21 February 2012) Ciarán Long (resigned on 21 February 2012) Appointed Actuary: Dervla Tomlin Audit Committee: Cecil Hayes (Chairman) Tom Barry Annette Flynn Registered Office: Irish Life Centre Lower Abbey Street Dublin 1 Independent Auditor: KPMG, Chartered Accountants and Registered Auditor 1 Harbourmaster Place International Financial services Centre Dublin 1 Company Registration Number:

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6 Operating and Financial Review (Continued) Overview The market conditions for financial services companies in Ireland remain difficult. Although the economy has returned to modest growth on the back of solid export performance, domestic demand declined in 2012 but the pace of the decline slowed appreciably compared to The improving trend is expected to continue into 2013 with a return to modest positive growth in domestic expenditure in Unemployment remains high at 14.6%. On the positive side, yields on Irish sovereign bonds have fallen sharply in 2012 reflecting growing international confidence in the management of the macroeconomic situation and the austerity measures implemented. Reflecting this improvement in confidence, during the second half of the year Ireland made a successful return to the international capital markets with the NTMA issuing both Treasury Bills and long-term bonds. However, it is likely that any sustained recovery in Ireland will be dependent on a resolution of the wider Eurozone crisis. The Company The company is the largest life and pensions group in Ireland, servicing circa one million customers. The Irish Life brand is one of the best known and most recognised financial brands in Ireland. Its brand strength is based on broad distribution, product innovation and flexibility and strong investment performance. Irish Life Assurance ( ILA ), operates through two main divisions, Irish Life Retail ( Retail Life ) and Irish Life Corporate Business ( Corporate Life ). Irish Life Retail is focused on individual life assurance, pensions and investments and Irish Life Corporate Business is focused on life assurance and pension products for employers and affinity groups. ILA increased its market share to 29.6% in 2012 (2011: 27.6%). Irish Life Investment Managers ( ILIM ), a sister company of ILA, manages policyholder fund assets of 13.6bn on behalf of Irish Life Retail and Irish Life Corporate Business. Retail Life Retail Life provides life, pensions and investment products to personal and small business customers in Ireland. It is a market leader with a comprehensive product range spanning protection, pensions, investment and regular savings products. It has the largest and most diverse distribution network of any life assurance company in Ireland including the largest direct sales force. The division follows a multi-channel distribution strategy, with sales of its new business APE roughly evenly split between (i) independent brokers and independently regulated tied agents and (ii) tied agents in bank branches and its employed and self-employed sales force. Retail Life has bancassurance arrangements with four of Ireland s leading bank networks (AIB, Ulster Bank, EBS and permanent tsb). Three of these relationships are long-standing, while early in 2012 it secured a distribution agreement with AIB which will see Irish Life distribute its products through a nationwide retail banking network of 267 branches bringing to circa 450 the total number of bank branches through which Retail Life distributes its products. The AIB distribution of Retail Life products commenced in April 2012 and activity here is expected to increase further in Retail completed the transfer of a portfolio of the Quinn Life Direct policies in September 2012 which added approximately 100m to unit linked assets. Total sales on a present value of new business premiums ( PVNBP ) basis were 12% ahead of the same period in 2011 at 1,049m (2011: 934m). A significant increase of 27% in pension single premium sales to 572m (2011: 448m) was offset by a reduction of 8% in sales of investment bonds to 199m (2011: 217m). Retail new business earnings were lower despite the additional sales reflecting a very competitive market with significant price discounting and higher distributor costs in protection and pension products. Retail persistency experience improved in 2012 over 2011 and in the second half of 2012 aggregate experience was equal to the long term embedded value assumptions. Positive market returns in 2012 improved embedded value earnings significantly in comparison to Retail Life measures customer service using a customer service index based on a survey of a sample of customers. The customer service index score for the year of 81.3% was 1.4% ahead of the same period last year (2011: 79.9%). 3

7 Operating and Financial Review (Continued) Corporate Life Corporate Life sells pensions and risk products to employers and affinity groups in Ireland. Business is primarily distributed through pension consultants and brokers, including Cornmarket (a specialist affinity broker and a wholly owned subsidiary of the company s parent, Irish Life Group Limited). The key drivers of sales growth are employment and salary growth in the Irish economy, with the trend away from defined-benefit pension provision towards defined contribution also representing a major growth opportunity. On a PVNBP basis, sales were down by 8.8% to 759m (2011: 832m), principally due to a reduction in sales of Personal Retirement Bonds and no bulk annuity market activity in the year. The decline was somewhat offset by strong DC and risk sales. Total annuity sales (individual and bulk purchase) fell by 34% to 145m (2011: 219m) as the market for bulk purchase annuities stalled while trustees awaited the publication of the new funding standard for defined benefit pension schemes in order to determine their future strategies. The new standard was issued on 1 June In the light of the provisions in the standard, there is likely to be significant activity benefiting providers of savings and annuities including Irish Life. The customer service index score for the year in Corporate Life of 95.1% was 1.0% ahead of the same period last year (2011: 94.1%). Significant developments Prior to 29 June 2012, the company, through its parent Irish Life Group Limited, was part of the permanent tsb Group (formerly the Irish Life & Permanent Group). Under the Financial Measures Programme ( FMP ) agreed between the Government and the EU, IMF and ECB troika in November 2010, the Central Bank of Ireland completed a Prudential Capital Assessment Review and a Prudential Liquidity Assessment Review ( PCAR/PLAR ) of the permanent tsb Group in These exercises, which were completed in March 2011, determined that the permanent tsb Group required additional regulatory capital of 4.0bn. In July 2011, the Government contributed 2.7bn of the requirement and the balance of 1.3bn was to be raised from the sale of Irish Life. In late 2011, an extensive disposal process was undertaken to sell the Irish Life Group and this attracted significant interest from a broad range of potential purchasers. However, the very challenging market conditions, particularly the perceived worsening of the financial crisis and stability of the Eurozone, resulted in the sale process being suspended in November Following the suspension, the State committed to acquire the Irish Life Group from the permanent tsb Group for a consideration of 1.3bn to meet the PCAR/PLAR capital shortfall. On 29 June 2012, the Group s former parent, permanent tsb Group completed the sale of its 100% holding in the Group to the Minister for Finance for 1.3bn. The completion of this sale marked the legal separation of the businesses of permanent tsb bank and Irish Life Group. The Irish Life Group, post 29 June 2012, was 100% owned by the Minister for Finance on behalf of the Irish State. In advance of the sale, the operational separation of the life and banking businesses of the Group was substantially completed. In particular, a separate board and management team for the Irish Life Group was put in place. On 19 February 2013, the Group welcomed the announcement of an agreement between Great-West Lifeco of Canada and the Irish Government on the acquisition of the business by the Canadian company. Following the transaction the Irish Life name will be retained and the life and pensions operations of Great-West Lifeco s Irish subsidiary Canada Life (Ireland) Limited will be combined with the operations of Irish Life. The customers of both organisations will have continuity of products and customer services under Irish Life. Great-West Lifeco is one of the outstanding global players in the life and pensions business with 417 billion assets under administration and an AA rating from rating agencies Fitch and Standard & Poor s. Through Canada Life, Great-West Lifeco has a long association with Ireland stretching back over 100 years. Their financial strength and longstanding commitment to the Irish market makes them a wonderful fit for Irish Life. They will underpin the Group s position as the leading force in the life, pensions and investment management business in Ireland. The transaction will have no impact on the terms and conditions of policies held by Irish Life customers nor any change to the current business arrangements for Corporate and Institutional customers. The transaction, which is expected to close in July 2013, is subject to the necessary regulatory approvals. 4

8 Operating and Financial Review (Continued) Financial review Summary operating profit analysis ( m) IFRS Accounting Basis m m Investment contracts income Insurance contracts income Expected return on shareholder assets 8 13 Operating income Acquisition costs and other administrative expenses (279) (259) Changes in deferred acquisition costs (6) (8) Amortisation of purchased interest in long-term business (3) (3) Finance costs (10) (12) Operating expenses (298) (282) Operating profit Short term investment fluctuations 49 (26) Effect of economic assumption changes (16) (35) Other 6 (20) Profit before taxation Taxation (15) (2) Profit after taxation Profit after tax increased from 57m in 2011 to 113m in 2012 mainly due to positive short term investment fluctuations and economic variances, more than offsetting reduced operating profits. Operating profit The reduction in operating profit before tax from 140m for 2011 to 89m for 2012 is mainly due to lower insurance contracts income, and higher exceptional and corporate costs. In 2011 there was a one-off reserve release of 12m resulting from the repayment of a 100m loan facility secured on the VIF in Operating income Investment contracts income of 162m is 6m lower than 2011 due to the impact of negative persistency experience and also includes the impact of lower sales of tracker investment products through the bancassurance distribution channels. In 2011, strong margins were earned on Retail Life bond sales (through permanent tsb) which were not repeated in 2012 and allocation rates on single premium pension business written in 2012 increased. The decline was somewhat offset by the addition of the AIB distribution channel. Insurance contracts income of 217m is 24m lower than in The adverse variance was mainly due to a lower new business contribution and lower risk experience in Corporate Life (although still positive) and a one-off positive in 2011 for release of a closed to new business reserve not being repeated. Acquisition costs and other administrative expenses Costs of 279m are 8% ahead of 2011 ( 259m). This is mainly due to higher project and one-off costs. Baseline operational costs increased 5% in 2012 primarily due to new client costs in the third party administration business and a higher proportion of costs retained post separation. 5

9 Operating and Financial Review (Continued) Short term investment fluctuations Short term investment fluctuations in 2012 of 49m positive (2011: 26m negative) reflect positive excess unit returns on shareholder investment and insurance assets and lower investment financial options and guarantee (secure performance fund) costs as a result of strong fund performance on the back of recovery in investment markets and reduced volatilities since year end Effect of economic assumption changes The effect of economic assumption changes, was a negative 16m in 2012 compared to a negative 35m in 2011 as a result of a reduction in the sovereign default risk reserves and positive policyholder fund results being offset by an increase in financial options and guarantee costs as a result of interest rate falls and a revision of the risk discount rate basis from 1.3% to 0.75%. Other The 6m costs incurred in 2012 were mainly due to the project and one-off costs being offset somewhat against the 3m gain from the acquisition of 100m investment contracts from Quinn Life Direct. Included in 2011 is the value of in-force ( VIF ) loan financing costs of 18m which includes 4m for early repayment interest, 9m for amortisation of upfront interest and 5m for interest on the loan up to when it was repaid (in 2010, the Group sourced a 100m loan facility secured on the VIF and repaid this facility in May 2011). Capital The following table details the drivers of the capital generated by the company for the year ended 31 December The figures show the increase in the available capital as measured on the regulatory basis for ILA. It is the Group s policy to periodically transfer excess capital from the operating companies to the parent company for management at group level Expected inforce & New business strain Experience variances & Operating capital generated Operating capital generated investment return assumption changes m m m m m Total Operating Profit 143 (60) STIFs (42) Economic (28) Other Capital Flows (9) Total 143 (60) Operating capital generated The operating capital generated within the company fell from 144m in 2011 to 116m in This reduction was due to higher new business strain in 2012, lower exceptional positive risk experience after tax (2012: 15m, 2011: 21m), and a once-off reserve release after tax during 2011 of 10m which was not repeated in Short term investment fluctuations Short term investment fluctuations led to a positive capital generation of 1m in 2012, including a positive variance of 2m relating to property holdings. The negative in 2011 included a negative variance of 17m from directly held property assets, and reflects the impact of market falls in that period. Effect of economic assumption changes The effect of economic assumption changes principally reflecting the impact of interest rate and credit default reserve movements. There was a positive variance of 1m in 2012 compared to a negative 28m in The 2011 negative variance principally related to an increase in the reserves relating to investment guarantees as a result of lower interest rates. Other capital flows Other capital flows include strategic costs and movements in inadmissible assets. For 2011, other capital flows reflects the VIF loan financing costs. 6

10 Operating and Financial Review (Continued) Capital Management ILA has maintained a strong capital position throughout the financial and economic crises. The solvency ratio for ILA as at 31 December 2012, before any dividend requirement, was 2.0 times (31 December 2011: 1.9 times) the minimum EU capital requirement of 416m (31 December 2011: 402m). The Central Bank capital requirement is 1.5 times this minimum. Based on ILA s current risk exposures, ILA s target is to maintain a solvency ratio of 1.75 times the EU minimum. Solvency cover ( m) Minimum capital Regulatory capital Net worth Subordinated debt Inadmissible assets (90) (106) Capital available Solvency cover 2.0 times 1.9 times The company s capital is invested mainly in deposits, property (including owner occupied property) and debt securities. Outlook The company has proven to be extremely resilient during the economic crisis and has remained both profitable at an operating level and generated dividends as demonstrated by the table below: Year ended IFRS total profit before tax Dividends paid m m m The robust financial performance through the financial crisis reflects the low risk nature of the business and the conservative manner in which it is run. In particular, the company seeks to minimise policyholder guarantee exposure and the company follows a conservative investment strategy for shareholder assets. For life non-linked exposures, the duration of assets held closely matches the duration of the liability and the assets are principally held in high quality sovereign bonds. While economic conditions remain challenging both in Ireland and the Eurozone, the company is well-positioned to benefit from a stabilisation in the Eurozone and a recovery in the Irish economy. The markets for life assurance and pensions and investment products in Ireland are highly concentrated and the company continues to hold a leading position in these markets. As noted previously, on 19 February 2013, Great-West Lifeco, the parent company of Canada Life (Ireland), announced its intention to acquire the Group, subject to the necessary regulatory approvals. The acquisition by Great-West Lifeco will provide Irish Life with a parent with financial strength and stability. It will combine the businesses of Irish Life and Canada Life (Ireland) representing a transformational deal in the Irish market and it is expected that the combined business will continue to set the pace in the life and pensions industry in Ireland. 7

11 Risk Management The Board of Irish Life Group Limited (the parent company of the group) ( the Group ) is ultimately responsible for the governance and oversight of risk throughout the Group. The Board of Irish Life Assurance plc ( ILA ) ( the Board ) is responsible for risk management within the company with oversight and support provided by the Group. The Board adopts group policy or approves ILA-specific risk policy in relation to the types and level of risk that the company is permitted to assume in the implementation of the strategic and business plans of the Group. The effectiveness of risk governance in ILA is dependent on the strength of the corporate risk culture. Risk culture is supported by shared corporate values, a common approach to risk classification and management, clear lines of risk responsibility, and timely and transparent communication. Principal Risk Factors The principal risk factors encapsulating the material risks to the company are set out below. The company defines risk as unexpected future events leading to variability in performance and damage to earnings capacity, capital position, business reputation or cash flows; or any unexpected future event damaging the business ability to achieve its strategic, financial, or overall business objectives. Definition Appetite Risk Source Risk Management Insurance Risk The risk associated with the variability in cash flows caused by fluctuations in demographic and other risk factors such as rates of policyholder mortality, disability, morbidity inception, recovery, and persistency as well as expense rates. The company has an appetite for accepting insurance risks. The company expects that the acceptance of such insurance risks is value additive given its cumulative knowledge and understanding of the risks. The company recognises that policyholder lapse and expense risks are inherent in its business model and adheres to best management practices to control the risks within acceptable levels. The company s results and capital position depend to a significant extent on actual insurance risk experience versus the assumptions used in underwriting, product pricing and the estimation of liabilities for policy benefits and claims. Expected future rates of customer persistency are a key assumption in product pricing and the calculation of financial results. Adverse persistency experience in recent years has seen high levels (on a historical basis) of policy lapses in the company s in-force life assurance book. The company maintains underwriting standards which incorporate strict underwriting limits and risk assessment throughout the underwriting cycle from business acceptance to claims settlement. In addition, the level of risk cover retained on any individual policy issued by the company, or on any group of exposures, is restricted through the use of retention limits. Risk cover in excess of these limits is reinsured by the company. The company s adherence to internal underwriting and retention standards is subject to regular review with results reported periodically to senior management. The company actively monitors actual risk experience against its long-term insurance risk assumptions and refines product pricing and reserving assumptions in the light of this experience. This ensures that such assumptions reflect current demographic and economic developments. Current persistency assumptions reflect recent lapse experience by allowing for further adverse persistency over a number of years, reducing to the long-term assumptions thereafter. The projected improvement from recent experience is supported by significant commercial initiatives undertaken by the business in recent years which include changes to operational process and commission structures, designed to encourage increased persistency rates. Definition Appetite Market Risk The risk associated with changes in the level or volatility of balance sheet values (and revenue) due to market movements. Market risk includes the risk of adverse returns on all asset classes, including due to currency rate movements, and adverse movements in interest rates. The company has no appetite for market risk exposure, except where it arises as a consequence of core strategic activity. For example, the company will accept the risk to management fees, derived from the value of assets held in unit-linked policyholder 8

12 Risk Management (continued) funds, which will fluctuate due to market price movements. Risk Source The company has no appetite to offer investment guarantees on new products, and thereby expose the company to market risk, unless those guarantees can be statically hedged by purchasing replicating assets at outset and where any associated counterparty risks can be passed to policyholders. The company is affected by market price changes for securities, investment markets and foreign exchange rates. Revenues from many of the company s products and services depend on fees linked to the value of the assets under management, which can decline due to falling investment markets or currency exchange rate impacts on non-euro denominated asset values. Market risks also affect the cost of investment guarantees issued to policyholders. The market consistent cost of such investment guarantees is provided for within the balance sheet. However, in certain scenarios, including scenarios of adverse market returns, the costs could be higher. Interest rate risk is significant to the company s life assurance business, since the value of non-linked insurance reserves fluctuates with changes in medium to long term interest rates, and any such movements to the extent that they are not matched by changes in the backing assets, will lead to volatility in the shareholder equity. Risk Management The company is exposed to property risk via its investments in owner-occupied and non-owner occupied property. Non-owner occupied property exposures (investment properties) are significantly concentrated in property situated in Luxembourg. The company matches unit-linked policyholder liabilities with matching assets. In relation to interest rate risk, the company matches non-linked policyholder liabilities with assets whose sensitivity to interest rates is the same as, or similar to, that of the underlying liabilities. From the start of 2013 the company has sold equity futures contracts to partially hedge the exposure to equity market levels which arise from historic investment guarantees. Property investments of the company are managed by its investment manager a sister company within the Irish Life Group. Close management and monitoring of the letting and sales strategies for individual properties helps to manage the risks to property values. Definition Appetite Risk Source Credit Risk The risk arising from a counterpart s failure to meet the terms of any contract with the company or its failure to perform as agreed. The company also considers changes in the level or volatility of the market prices of assets and liabilities, due to fluctuations in the credit standing of the issuer, as a credit risk. The company accepts exposure to credit risk as an inherent part of its business activities, to the extent that the acceptance of the risk optimises its risk adjusted return. Credit risk arises from the company s relationships with counterparties to its financial transactions. Counterparty default can arise due to many different factors. Whilst collateral may be held against counterparty default, the collateral or security provided may prove inadequate to cover the obligations in the event of a default. Counterparty default risk for the company principally arises from fixed interest and cash assets within the shareholder equity and assets backing non-linked liabilities. These fixed interest assets are significantly invested in sovereign debt instruments. Credit risk on unit-linked assets is borne by the policyholder. However, where the company has issued a guarantee relating to counterparty default, the credit risk is transferred to the company. Risk Management The company is also exposed to credit risk from its reinsurers. The company is still liable for reinsured risks if the reinsurer does not meet its contractual obligations. Hence, a failure of a reinsurance counterparty would require the company to obtain replacement cover or to establish capital and reserves in respect of the previously reinsured business. The company manages credit risk exposures through a counterparty limit structure applicable at single counterparty, aggregate and average exposure levels utilising internal credit rating assessments and external credit rating agency ratings. The 9

13 Risk Management (continued) company requires collateral, where appropriate, for specific reinsurance arrangements and derivatives transactions. The company requires collateral for credit risk mitigation in respect of reinsurance treaties for its annuity business. A reinsurer withdrawal of assets from the collateral charged accounts must be authorised by ILA. Over the course of 2012, the continuing Eurozone economic crisis resulted in high volatility of spreads on fixed income securities and ratings actions for sovereign and non-sovereign counterparties alike. The company responded to the prevailing conditions; proactively managing counterparty exposures and diversification, and eliminating exposure to certain peripheral sovereigns no longer matching its credit risk appetite. Definition Appetite Risk Source Risk Management Liquidity Risk The risk that, though solvent, the company has insufficient liquid and other financial resources to meet its cash-flow and capital requirements, or can secure the required resources only at excessive cost. The company has no appetite for liquidity risk. Assets are invested so that the company can meet its liabilities as they fall due. Illiquid investments to optimise policyholder and company risk adjusted returns, are made only where the corresponding policyholder liabilities are also illiquid. Market downturns exacerbate asset liquidity by reducing the number of available investors, deflating market prices and limiting sources of funding. Only low probability / high impact risk events would be expected to significantly impact on the liquidity profile of the company. Such events might include, for example, market seizures affecting asset liquidity, or catastrophic levels of risk claims and payments. Illiquid assets of the company include property assets. In addition, for certain unitlinked property funds, policy terms and conditions allow the company to defer the policyholder right to encash their units for up to six months to allow time to sell the relevant property assets. Failure to sell within this time period, and if rental incomes from the properties are insufficient, may necessitate that the company provide temporary liquidity from shareholder funds. No such liquidity support is being provided at year-end 2012, but 8m of support was provided for a period during The Group does not anticipate any requirement to provide such liquidity support for the foreseeable future. The liquidity profile of the company s unit-linked liabilities is matched as closely as possible with that of the backing assets. The company has liquid resources significantly in excess of any anticipated requirements. Investment strategies for such excess liquid resources focus on investment quality and security with positions being actively monitored. Definition Appetite Risk Source Operational & Compliance Risk The risk associated with inadequate or failed internal processes, people and systems or from external events; and the risk of failure to meet legislation and regulation applicable to the company. The company recognises that operational and compliance risks are inherent in its business and cannot be fully eliminated. However, the company has no tolerance for regulatory compliance or legal breaches and co-operates fully with all regulatory requirements. The company recognises that compliance risks warrant particular attention in circumstances where the company is providing advice to customers. Processes - The company processes a high volume of complex transactions across a diverse product range adhering to a number of different regulatory requirements. The company s ability to maintain accurate records, provide high-quality customer service and develop profitable products, depends on the effectiveness of its internal or outsourced processes, systems and controls, including information technology and other business resilience systems. People - The company s ability to attract, retain and motivate key personnel is important for the effective management of the business. Talent management, succession planning and sound systems for staff learning and development are all necessary to ensure that the company retains talented personnel across key positions within the business. 10

14 Risk Management (continued) Systems Consistent with its peers, the company s reliance on computer systems exposes it to potential risks including complete or partial systems failure. Even though system back-up, disaster recovery systems and contingency plans are in place, the company cannot guarantee that disruptions, interruptions, failures or security breaches will not occur. Such systems failures can lead to interruptions in customer service, data loss, internal and external reporting errors or delays, ineffective anti-fraud measures and subsequent damage to the company s reputation. Risk Management Compliance - Regulations impact on many aspects of the company s business; including capital adequacy, marketing and sales practices, advertising, licensing agents, terms of business and permitted investments. The company s legal and regulatory environment requires accurate interpretation of the rules and continued successful implementation, especially during periods of regulatory change. ILA, has been assessed as high impact by its prudential regulator, the Central Bank of Ireland, due to the company s size of operations in Ireland. Operational and compliance risk management is coordinated on a group-wide basis for the Irish Life Group. Within this framework, company-specific operational and compliance risks are managed by dedicated operational risk and compliance functions within ILA. Registers are maintained of each business division s top operational risks and regulatory requirements. Senior management within the company and across the Group receive regular reports on current divisional status regarding operational and compliance risks. Risk can arise where the company has an advisory relationship with the customer during the sales process. The company maintains clear sales procedures, utilising automated point-of-sale tools and focused staff training to guard against the inherent risks from this role. During 2012, the company entered into a new bancassurance distribution agreement with Allied Irish Banks plc. Under this agreement, the company s bancassurance partner follows a consistent sales process for the company products to that used internally by Irish Life. Furthermore, the company employs additional risk management, legal and compliance procedures to monitor sales practices within its bancassurance partners. Definition Appetite Risk Source Risk Management Commercial Risks The risks arising from changes in the company s business environment and from adverse or improper implementation of business decisions leading to a failure to manage business performance against objectives or to safeguard corporate reputation. A financially strong and profitable business is best placed to provide long-term, security for policyholder benefits, whilst also providing a return for the shareholder. The performance of the company is inherently exposed to commercial risks and it recognises that annual earnings will be volatile. The company has a low tolerance for any damage to its reputation, which is critical to achieving its business objectives. The business divisions of the company are based in, and derive their income from Ireland. In recent years Ireland has experienced significant job losses, weak consumer confidence, increased consumer debt burdens and a decline in income levels, property values and other asset values. Such macroeconomic conditions can impact on the market perception of the company and its financial strength via the effects on customer confidence, demand for the company s products and persistency rates for existing customers. The company operates in competitive financial markets. The company s new business volumes, persistency and results are dependent upon the strength of the "Irish Life" brand and reputation relative to its competitors. Material operational losses, adverse regulatory or legal actions, mis-selling scandals, customer mismanagement, fraud, failure to satisfy fiduciary responsibilities or any wider market concern over the company s financial stability have the ability to damage the company s brand and reputation and affect its competitive position. Managing commercial risks is the day-to-day responsibility of the company s management team. The impact on the results of the company is monitored at divisional and product level. Business strategy is set within the individual business units of the company with oversight and challenge from executive management and the Board. 11

15 Risk Management (continued) Risk management framework Risk taking is fundamental to a financial institution s business profile and hence prudent risk management, limitation and mitigation forms an integral part of the company s governance structure. As part of the wider Irish Life Group, the company operates a proactive Enterprise Risk Management ( ERM ) approach in the identification, assessment and management of risk. This framework underpins profitable and prudent risk taking by the company. The ERM framework is designed to ensure that all material risks are identified and managed and that business strategy across the company is implemented in full recognition of its risks. The Board is ultimately responsible for the governance and oversight of risk throughout the company and establishing the mechanisms and structures that control and manage the risk. The Board has delegated authority (but not overall responsibility) in respect of risk identification, assessment, measurement, monitoring and control for the company, to the Irish Life Group Limited Board Risk and Compliance Committee. The company s risk management framework is therefore integrated with the risk management framework of the wider group, which was established by: Identifying and reviewing the risks applicable across the Group, assessing each risk s materiality for the company, the Group and its business divisions, and selecting the risk treatments best placed to control risk exposures; Setting the company s risk appetite for the risks to which it is exposed, and developing relevant risk policies to embed such risk appetites and tolerances at an operational level within the business through dedicated internal controls; Establishing risk management and governance structures incorporating committees and corporate functions with appropriate terms of reference, mandates and composition to effectively monitor and limit the risks; and Reviewing and evaluating the group-wide risk framework and benchmarking against industry guidelines for risk governance. Risk identification, assessment and treatment Identification of risks within the company (both existing and emerging) is overseen by the Risk function. Significant input is provided by the business divisions, senior management, risk specialists and the specific risk committees of the company and the Group. Risk identification relies on both a bottom up process and a top down review of existing and emerging risks. Risk identification leverages the company s stress testing framework where scenario analysis can lead to the identification of emerging risks and previously unidentified risk concentrations. Assessment of identified risks utilises individual risk assessment frameworks at the divisional level, overlaid with a company and group risk materiality framework. Risks assessed as material for the company are ratified with senior management from across the company and the Group and are monitored regularly by the Board Risk and Compliance Committee. The company s risk materiality framework follows an iterative approach as represented in the chart below. 12

16 Risk Management (continued) The company applies three broad approaches to the treatment of its identified risks and any combination of treatments may be used for specific risks. 1. Capital may be held to ensure continued solvency in the event of a severe occurrence of the risk; 2. Risk management through controls; and 3. Risk mitigation by choosing not to take on the risk or fundamentally transferring the risk to a third party. The desired risk treatments for the company s material risks form the basis of the company s risk policies. Risk appetite, policy and controls The core objectives of the company s risk strategy are to: maintain the security of policyholder benefits; and protect and increase the value of shareholders investment These objectives are mutually aligned since policyholder interests are best served if the company continues to operate as a financially strong, profitable business. Equally, continued profitability can only be achieved if customers, financial advisors and other interested parties are satisfied as to the security of the company. The company maintains a position of financial strength, holding capital in excess of minimum regulatory capital requirements. The amount of excess capital is determined so as to be sufficient to absorb a medium sized risk event shock without breaching the regulatory minimum. This approach to internal capital management supports the company s target Insurer Financial Strength Rating from external credit rating agencies, which is a key driver of external market perceptions of its security. Risk appetite statements build on the company s internal capital targets, establishing core risk strategy across the business. Statements are developed through an iterative process of review, monitoring and update involving key functions of the company and the Group, with the Board responsible for approval of the risk appetite statement. The risk parameters encapsulated within risk appetite statement are closely aligned with the company s strategic and business plans, and address core objectives, such as solvency stability, capital usage, earnings stability, prudent liquidity management, prudent credit risk management and operational risk management. Risk appetite sets risk strategy and risk tolerance and is cascaded down into business level process and controls in relation to the type and level of risk that the company is permitted to assume. This is achieved through risk policies set or adopted by the Board, which stipulate the Board s expectations for risk management and reporting 13

17 Risk Management (continued) along with any applicable risk limits to be enforced. Business division risk processes and controls are established to enforce the specific risk policies approved for use by the Board. The Irish Life Group sets minimum standards for the internal risk control framework across all of its group entities. For the company, the different aspects of internal control captured in its internal control framework include the control environment, risk assessment, control activities, monitoring activities and control management information and communication. Responsibilities in relation to the company s internal risk control framework are established based on the three lines of defence risk model. 3rd Line of Defence Board Audit Committee Internal Audit Independent Assurance over Risk Governance The Board Board Risk & Compliance Committee MI 2nd Line of Defence Risk Oversight CEO 1st Line of Defence Risk Taker Management Oversight Functions (Risk, Compliance, Actuarial) Internal Audit The 1st line of defence is maintained by the risk taking functions of the company, i.e. the business units and core service providers making business decisions on a day-today basis. The 2nd line of defence corresponds to the oversight functions which control, monitor and report risks within the company and across the group risk governance structure and help define risk policy. The 3rd line of defence relates to independent assurance provided by the group s internal audit function. In relation to internal risk controls, the 1 st line of defence has primary responsibility for design and implementation of effective internal controls. The oversight functions in the 2 nd line of defence are responsible for oversight and monitoring of these internal controls and the risks they manage. Internal audit, as the 3 rd line of defence, carry out risk-based independent assessments of the internal risk control framework and the oversight provided by the 2 nd line of defence. Risk governance The functions and corporate bodies forming the group-wide risk governance structure are set out below. This structure is subject to on-going review and amendment by the Group Board. 14

18 Risk Management (continued) Board Risk & Compliance Committee Board Nomination Committee ILGL Board of Directors ILA Board Board Remuneration & Compensation Committee Board Audit Committee Board & Non-Executive Sub- Committees Irish Life Assurance Financial Risk Committee Group Operational Risk Committee Group Compliance Management Committee Executive Risk Committees Risk, Actuarial & Compliance Functions Group Internal Audit Control Functions The risk governance structure facilitates reporting and escalation of risk issues from the bottom up, and communication and guidance relating to risk policy and risk decisions from the top down. The Board Risk and Compliance Committee is comprised of group non-executive directors and has responsibility for oversight and advice to the Board on risk governance, the current risk exposures of the company and future risk strategy, including strategy for capital and liquidity management, the setting of compliance principles and policies and the embedding and maintenance throughout the company of a supportive culture in relation to the management of risk and compliance. The Board Risk and Compliance Committee supports the Board in carrying out its responsibilities for ensuring that risks are properly identified, reported, assessed and controlled, and that the company's strategy is consistent with risk appetite. The Board Risk and Compliance Committee is responsible for monitoring adherence to risk appetite statements. Where exposures exceed levels established in appetite statements, the Board Risk and Compliance Committee is responsible for developing appropriate responses. The Board Risk and Compliance Committee, in turn, delegates responsibility for initial monitoring and management of specific risks to executive committees accountable to it. The terms of reference for each committee, whose members include members of group senior management, are reviewed and approved regularly by the Board Risk and Compliance Committee. The Irish Life Assurance Financial Risk Committee ( FRC ) is responsible for the management of financial risks arising for Irish Life Assurance plc. The principal objectives of the FRC include monitoring financial risk exposures and recommending suitable risk policy (for all financial risks including insurance risks, market risk, credit risks, liquidity risk, capital-funding risk and concentration risks), monitoring the matching of assets and liabilities and reviewing new product development. The Group Operational Risk Committee provides oversight and monitoring of operational risk within the company and the Group. The Committee provides a forum for the prioritisation and review of the company s existing and emerging material operational risks and the design and monitoring of key risk indicators attaching to such risks. The Group Compliance Management Committee provides oversight and monitoring of compliance within the company and the Group, including recommendation of appropriate regulatory and compliance policies and standards and monitoring of the on-going state of compliance across the company and the Group. Executive risk committees and the Board Risk and Compliance Committee are supported by dedicated control functions established within the company and across the Group. The Risk function supports the Head of Risk in the development of risk appetite, development of risk policies, risk identification, risk monitoring / reporting and provision of risk advice to the business. The Risk function is operationally independent and separate from the business units of the company. The Risk function is comprised of two operational pillars: Financial Risk Management and Operational Risk Management. The Actuarial function provides actuarial services and advice to the company. Led by the Chief Actuary, the Actuarial function carries out the company s actuarial-based statutory duties, including the investigation of its 15

19 Risk Management (continued) financial condition, the valuation of its liabilities and the review of the sufficiency of premiums for new business. The Actuarial function monitors the solvency and capital of the company and supports the Risk function in determining the capital required to cover the nature and level of the risks to which the company is, or might be, exposed. The Compliance function is largely decentralised with individual compliance units embedded in business units of the company. Reporting to the Head of Compliance at group level, the Compliance Officers in each of the company s business units are responsible for the implementation of compliance arrangements within their divisions. The compliance function supports the Head of Compliance in identifying, assessing, monitoring and reporting the compliance and regulatory risks across the company and the Group, and carrying out compliance investigations as required. The Compliance function supports the business by providing independent advice in relation to regulatory developments and other compliance matters. Group Internal Audit operates in accordance with its Board Audit Committee approved charter. Its objective is to provide an effective, responsive and highly valued internal audit service that adds value to, and improves the Group s operations through risk-based, independent assessment of the adequacy, effectiveness and sustainability of the Group s governance, risk management and control processes; with the ultimate objective of providing an opinion on the control environment to the Board Audit Committee. All activities undertaken within, and on behalf of, the Company and the wider group are within the scope of Group Internal Audit. This includes the activities of other control functions. Group Internal Audit has unrestricted access at any time to all records, personnel, properties and information of the company and the wider group. Evolving risk management framework During 2012 the Irish Life Group was separated from a larger group under the parental ownership of Irish Life & Permanent plc. This necessitated the separation of risk governance structures and provided the Irish Life Group with the opportunity to review and augment its own framework. The suite of risk policies enforcing risk appetite at an operational level across the company and the Group have been broadened. In addition, the formal documentation providing clarity on specific roles and responsibilities of corporate bodies and functions within the risk governance framework have been refreshed. The resulting Enterprise Risk Management framework of the company and the Group is considered to be closely aligned with the emerging Solvency II requirements for risk management and systems of governance. The framework will continue to develop as new initiatives are bedded into business as usual and the final Solvency II requirements become clearer. The company and the Group continue to regularly review and evaluate their risk management and governance structures. 16

20 Directors Report The directors hereby present their report and audited financial statements of Irish Life Assurance plc (the Company ) for the year 31 December Principal activities The principal activities of the company are life assurance and pension business in Ireland. Results The company s profit after tax for December 2012 was 113m (December 2011: 57m). Dividends The directors authorised and paid dividends of 3.25 per share ( 65m) in declared for No dividends have been Review of the business and likely future developments A detailed review of the company s performance during the year and an indication of likely future developments are set out in the Operating and Financial Review. Information on the key performance indicators and principal risks and uncertainties in the business is provided and are outlined in the Risk Management section. Accounting Policies The financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ) adopted by the EU as set out in company accounting policies in Note 1, Basis of preparation and significant accounting policies to the financial statements. Corporate Governance The report on Corporate Governance, as outlined in the Corporate Governance section, forms part of the Directors Report. Directors and secretary The directors and secretary who served on the board are: Tom Barry Alan Cook Brian Forrester David McCarthy Kevin Murphy Pat Ryan Bernard Collins (appointed on 20 April 2012) Cecil Hayes (appointed on 31 July 2012) Annette Flynn (appointed 7 January 2013) Barry Walsh (Secretary) (appointed on 21 February 2012) Ciarán Long (Secretary) (resigned on 21 February 2012) Pat Ryan (resigned 29 June 2012) The directors and secretary were in place at the date of signing of the financial statements. 17

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22 Corporate Governance Corporate Governance Code for Credit Institutions and Insurance Undertakings In November 2010 the Central Bank of Ireland issued a Corporate Governance Code for Credit Institutions and Insurance Undertakings ( the CBI Code ). This CBI Code imposes minimum core standards upon all credit institutions and insurance undertakings with additional requirements upon entities which are designated as major institutions. Irish Life Assurance plc has been designated as a major institution under the CBI Code. The CBI Code applied to existing boards and directors with effect from 1 January 2011 with transitional provisions applying up to 31 December ILA submitted its first compliance statement in respect of 2011 to the Central Bank in June 2012 and reported no material deviations from the code for The 2012 Compliance Statement is due to be filed by May Role of the Board There is an effective board to lead and control the company. The board has reserved to itself for decision a formal schedule of matters pertaining to the company and its future direction, such as the company s commercial strategy, major acquisitions and disposals, board membership, appointment and removal of the Chief Executive and the Company Secretary, executive remuneration, trading and capital budgets and risk management policies. All strategic decisions are referred to the board. Documented rules on management authority levels and on matters to be notified to the board are in place, supported by an organisational structure with clearly defined authority levels and reporting responsibilities. The board currently comprises six non-executive and two executive directors. The board considers that its current size and structure to be appropriate to meet the requirements of the business. While there is no optimum number of non-executive and executive directors, membership of the board is kept continuously under review. The range of qualifications, skills and experience that the board members have is harnessed to the maximum possible effect in the deliberations of the board. The roles of the Chairman and the Chief Executive are separated and are clearly defined, set out in writing and agreed by the board. The board considers all the non-executive directors to be independent of management and free of any business or other relationship which would interfere with the exercise of their independent judgement. The board had eleven scheduled board meetings during 2012 and also met on other occasions as was necessary. Full board papers are sent to each director in sufficient time before board meetings and any further papers or information are readily available to all directors on request. The board papers, where practicable, include the minutes of all committee meetings which have been held since the previous board meeting and the chairman of each committee is available to report on the committee s proceedings at board meetings if appropriate. The board receives formal reports on compliance matters at each of its meetings. The board has a formal performance review process to assess how the board and its committees are performing. This process comprises a detailed and rigorous examination by directors of all aspects of board and committee performance. A report produced following the review identifies any measures which can enhance this performance and these are considered by the full board. In accordance with the terms of the CBI Code, this performance review process will be facilitated every three years by external consultants. The performance of each individual director is also assessed on an annual basis by the Chairman and is discussed with the Director concerned. The non-executive directors, evaluate the performance of the Chairman, taking into account the views of executive directors. The Chairman meets at least once a year with the non-executive directors without the executives present. Procedures are in place for directors, in furtherance of their duties, to take independent professional advice and training, if necessary, at the company s expense. The company has arranged directors and officers liability insurance cover in respect of legal action against its directors. Appropriate training is arranged for directors on first appointment and the Chairman also ensures that the directors continually update their skills and knowledge through appropriate seminars and presentations. The Company Secretary is responsible for advising the board through the Chairman on all governance matters. All directors have direct access to the Company Secretary. Any Director who has any material concern about the overall corporate governance of the company must report the concern without delay to the board in the first instance and if the concern is not satisfactorily addressed by the board within 5 business days, the director must 19

23 Corporate Governance (continued) promptly report the concern directly to the Central Bank advising of the background to the concern and any proposed remedial action. This is without prejudice to the director s ability to report directly to the Central Bank. Board Committees The board of Irish Life Group Limited established a number of committees on 3 rd October 2011, which operate within defined terms of reference. These committees are the Audit Committee, the Risk and Compliance Committee, the Remuneration and Compensation Committee and the Nomination Committee (together the Committees ). All of the committees are composed of non-executive directors, all of whom are considered by the board to be independent. Membership and chairmanship of each committee is reviewed annually. In October 2011, the Board of ILA resolved to rely on the committees of Irish Life Group Limited. Detailed terms of reference for each of the committees are available on request. In accordance with good corporate governance, the Chairman of the company is not a member of the Audit Committee. Audit Committee As at 31 December 2012, the Audit Committee comprised of Brian Forrester (Chairman), Tom Barry and Cecil Hayes. The Board ensures that the chairman of the committee has recent and relevant financial experience. The Audit Committee met seven times during 2012 all of which were scheduled. The Audit Committee provides a link between the board and the external auditors, is independent of the company s management and is responsible for making recommendations in respect of the appointment of external auditors and for reviewing the scope of the external audit. It also has responsibility for reviewing the company s annual report and financial statements, half-yearly accounts and the effectiveness of the company s internal control systems and risk management process. The committee monitors the company s internal audit, compliance and risk management procedures and considers issues raised and recommendations made by the external auditors and by the Group Internal Audit function. The committee meets at least annually with the external auditors in confidential session without management being present. The Audit Committee reviews the non-audit services provided by the external auditors based on the policy approved by the board in relation to the provision of such services. Other assurance services are services carried out by the auditors by virtue of their role as auditors and include assurance related work, regulatory returns and accounting advice. In line with best practice, the auditors do not provide services such as financial information system design and valuation work which could be considered to be inconsistent with the audit role. Risk and Compliance Committee As at 31 December 2012, the Risk and Compliance Committee comprised Tom Barry (Chairman), Brian Forrester, Alan Cook and Cecil Hayes. The Board ensures that the chairman of the committee has relevant risk management and / or compliance experience. The Risk and Compliance Committee met four times during the year, all of which were scheduled. The Risk and Compliance Committee has responsibility for oversight and advice to the board on risk governance, the current risk exposures of the company and future risk strategy, including strategy for capital and liquidity management, the setting of compliance policies and principles and the embedding and maintenance throughout the company of a supportive culture in relation to the management of risk and compliance. The Risk and Compliance Committee supports the board in carrying out its responsibilities for ensuring that risks are properly identified, reported, assessed and controlled, and that the company's strategy is consistent with it s risk appetite. The Risk and Compliance Committee is responsible for monitoring adherence to the company s risk appetite statement. Where exposures exceed levels established in the appetite statement, the Risk and Compliance Committee is responsible for developing appropriate responses. This is facilitated by the periodic review of a key risk indicators report calibrated to the risk appetite statement. 20

24 Corporate Governance (continued) The Risk and Compliance Committee, in turn, delegates responsibility for the monitoring and management of specific risks to committees accountable to it. These committees are the Life Assurance Financial Risk Committee, the Group Operational Risk Committee and the Group Compliance Management Committee. The terms of reference for each committee, whose members include members of senior management, are reviewed regularly by the Risk and Compliance Committee. Remuneration and Compensation Committee As at 31 December 2012, the Remuneration and Compensation Committee comprised Brian Forrester (Chairman), Alan Cook, Tom Barry and Bernard Collins. The Committee met five times during the year, all of which were scheduled. The responsibilities of the committee include the establishment of remuneration policies and procedures within the company based on best practice and any requirements which the Central Bank of Ireland or the Department of Finance may issue, ensuring that the institution s remuneration policies and procedures do not promote excessive risk taking and agreeing with the Board the framework or broad policy for the remuneration of the Chief Executive, the Chairman of the Board, Executive Directors, the Company Secretary and other senior executives reporting directly to the Chief Executive. Nomination Committee As at 31 December 2012, the Nomination committee comprised Alan Cook (Chairman), Tom Barry, Brian Forrester and Bernard Collins. The Committee met five times during 2012, all of which were scheduled. The committee is charged with responsibility for bringing recommendations to the board regarding the appointment of new directors. Decisions on board appointments are taken by the full Board. The committee uses external consultants to assist in identifying and considering candidates from a wide range of backgrounds in the context of a description of the role and capabilities required for a particular appointment. The committee keeps under review the leadership needs of the company, both executive and non-executive, with a view to ensuring the continued ability of the company to compete effectively in the marketplace. This committee is also responsible for reviewing the effectiveness of the board s operations, including the chairmanship and composition of board committees. The Nomination Committee reviews the size and composition of the board and satisfies itself that the current board size and composition is appropriate to the circumstances of the company and that the board had the necessary knowledge, skills, experience, expertise, competencies, professionalism, fitness, probity and integrity to carry out its duties. In 2012 the Committee commenced the selection and recruitment process for a new chief executive and made substantial progress. Subject to satisfactory performance, non-executive directors are typically expected to serve two three-year terms, although the board may extend an invitation to serve a further three-year term. 21

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30 Statement of Changes in Equity Year ended 31 December Attributable to owners of the company Capital Share Revaluation contribution Retained capital reserve reserve reserve Total m m m m m As at 1 January Profit for the year Other comprehensive income (net of tax): Revaluation losses (net of tax) - (3) - - (3) Actuarial loss on defined benefit pension schemes (net of tax) (19) (19) Total other comprehensive income - (3) - (19) (22) Total comprehensive income for the year ended 31 December (3) Transactions with owners, recorded directly in equity Contributions by and distributions to owners Release of share option / long term incentive plan reserve - - (3) 3 - Transfer between reserves Dividends paid (65) (65) Balance at 31 December

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32 Statement of Cash Flows Year ended 31 December 2012 Cash flows from operating activities Note m m Profit before taxation for the year Adjusted for: Depreciation and amortisation 9, Impairment of property and equipment and intangible assets - 1 Fair value losses on investment properties Realised and unrealised profits on financial assets excluding trading assets (2,439) 819 Interest on VIF loan - 9 Interest on subordinated liabilities 4 5 Retirement benefit charge Amortisation of purchased shareholder value of in-force business Increase in provision Amortisation of up front interest - 9 Gain on purchased interest in long term business 37 (3) - (Increase) / decrease in operating assets Other financial assets 679 1,049 Investment properties Reinsurance assets 15,16 (314) (107) Other assets (13) (30) Deferred acquisition costs Retirement benefit assets 13 - (11) Increase / (decrease) in operating liabilities Borrowings (28) (23) Derivative liabilities 35 (120) Insurance contract liabilities Investment contract liabilities 15 2,134 (1,915) Payables related to direct insurance contracts 31 (4) 8 Other liabilities and accruals (49) 43 Provisions 19 (2) (13) Deferred front-end fees 20 (10) (6) Retirement benefit liability 13 (13) (1) Net cash flows from operating activities before tax Tax refunded (paid) 36 (3) (7) Net cash flows from operating activities Cash flows from investing activities Purchase of property and equipment 9 (2) (8) Sale of property and equipment Purchase of intangible assets 10 (3) (3) Sale of intangible assets Investment of / (in) restricted cash (1) - Net cash flows from investing activities (1) (10) Cash flows from financing activities Interest paid on subordinated liabilities (4) (4) VIF loan - (100) VIF loan interest and charges - (9) Equity dividends paid (65) (143) Net cash flows from financing activities (69) (256) Increase / (decrease) in cash and cash equivalents 885 (13) Analysis of changes in cash and cash equivalents Cash and cash equivalents as at 1 January 3,755 3,768 Effect of exchange rate retranslation 3 - Net cash flow inflow / (outflow) 885 (13) Cash and cash equivalents as at 31 December 4,643 3,755 29

33 Note reference Note name Page Note 1 Basis of preparation and significant accounting policies 31 Note 2 Critical accounting judgements and estimates 38 Note 3 Cash and cash equivalents 40 Note 4 Debt securities 41 Note 5 Equity shares and units in unit trusts 42 Note 6 Derivative instruments 43 Note 7 Investment properties 45 Note 8 Investments in subsidiary undertakings 47 Note 9 Property and equipment 48 Note 10 Purchased interest in long-term business and other intangible fixed assets 50 Note 11 Other assets 51 Note 12 Deferred acquisition costs 52 Note 13 Retirement benefit obligations 53 Note 14 Loans and borrowings 56 Note 15 Investment contract liabilities 57 Note 16 Life insurance contracts 58 Note 17 Financial options and guarantees 61 Note 18 Other liabilities 62 Note 19 Provisions 63 Note 20 Deferred front end fees 64 Note 21 Deferred taxation 65 Note 22 Subordinated liabilities 66 Note 23 Shareholders' equity 67 Note 24 Analysis of equity and capital 68 Note 25 Financial risk management 70 Note 26 Fair value of financial instruments 76 Note 27 Measurement basis of financial assets and liabilities 81 Note 28 Current / non-current assets and liabilities 83 Note 29 Premiums on insurance contracts 84 Note 30 Investment return 85 Note 31 Claims on insurance contracts 86 Note 32 Expense analysis 87 Note 33 Interest on loans and borrowings 88 Note 34 Employment costs 89 Note 35 Share-based payments 89 Note 36 Taxation 90 Note 37 Business combinations 91 Note 38 Commitments and contingencies 92 Note 39 Assets held in parent undertaking 93 Note 40 Related parties 94 Note 41 Reporting currency and exchange rates 98 Note 42 Events after the reporting period 98 Note 43 Approval of statutory financial statements 98 30

34 1. Basis of preparation and significant accounting policies Introduction Irish Life Assurance plc (the "company") is a company domiciled in Ireland. The company s registered office address is Irish Life Centre, Lower Abbey Street, Dublin 1, Ireland. The principal activities of the company are the transaction of life assurance and pension business. On 29 June 2012, permanent tsb Group Holdings plc (formerly Irish Life & Permanent Group Holdings plc) completed the sale of its 100% holding in the company's parent Irish Life Group Limited ("the Group") to the Minister for Finance for 1.3bln. The completion of this sale also marked the legal separation of the businesses of permanent tsb and Irish Life. The two businesses are now fully independent with separate boards and management teams that operate independently of each other. The Group is now 100% owned by the Minister for Finance on behalf of the Irish State and has no Stock Exchange listing. On 19 February 2013, Great-West Lifeco, the parent company of Canada Life (Ireland), announced its intention to acquire the Group, subject to regulatory approvals. This transaction is expected to close over the coming months. Further details of this post balance sheet event are outlined in Note 42. Going Concern The time period that the Board of Directors have considered in evaluating the appropriateness of the going concern basis in preparing the financial statements for the period ended 31 December 2012 is a period of twelve months from the date of approval of these financial statements ( the period of assessment ). The financial statements have been prepared on a going concern basis. In making the assessment of the company's ability to continue as a going concern, the Board of Directors has taken into consideration the significant economic, political and market risks and uncertainties that currently impact Irish financial institutions and the company. The going concern assessment for the financial statements is supported by business plans which project that the company will continue to operate within regulatory capital guidelines for the foreseeable future. In particular for the company to take account of the current difficult economic circumstances and the current risk profile of the company, the company set a target capital ratio of 175% of the minimum requirement. The solvency cover for the company at the end of 31 December 2012, is 2 times the minimum requirement of 416m. The Board believes that the implementation of Solvency II will release an additional amount of regulatory capital due to the lower risk nature of the business undertaken by the company. In making its assessment of going concern the Board of Directors has also considered the following: - the period over which the Irish economy is expected to recover from the current Irish and European economic crisis; - the impact that current and further austerity measures will have on persistency and new business volumes; - the impact of any further adjustment to pensions legislation; and - the impact of the pending sale of the Group to Great-West Lifeco. The impact on the Group of its separation from its former ultimate parent, permanent tsb plc, continues to be monitored. In July 2012, following separation from permanent tsb plc, S&P regraded the company from BBB- to BBB+. This resulted in the Group being graded the same as the Irish sovereign. The Directors believe that the clarity that the Great-West Lifeco transaction will bring to the Group's corporate ownership will offer further financial strength and stability to the Group. The Board believes that it continues to be appropriate for the company's financial statements to be prepared on a going concern basis because following a review of the above risks and those outlined in the Risk Management Report, the Board expects that the company will continue to trade and exceed current regulatory capital requirements for the foreseeable future. Adoption of new accounting standards The International Financial Reportings Standards ("IFRSs'') adopted by the EU applied by the company in the preparation of these financial statements are those that were effective for accounting periods ending on or before 31 December Basis of preparation The financial statements have been prepared in accordance with IFRSs as issued by the International Accounting Standards Board ("IASB") and as adopted by the EU and these will form the basis of the company's financial statements in future periods. The company financial statements were authorised for issue by the Board of Directors of Irish Life Assurance plc on 23 April The basis of preparation and accounting policies applied in the preparation of the financial statements for the year ended 31 December 2012 are set out below. Comparative amounts Comparative IFRS financial information presented in these financial statements has been prepared on a consistent basis. Basis of measurement The financial statements have been prepared on the historical cost basis except that the following assets and liabilities are stated at their fair values: derivative financial instruments, trading financial instruments and other financial instruments designated at fair value through profit or loss, certain risks in hedged financial instruments and investment properties. Functional and presentational currency These financial statements are presented in euro, which is the company's functional currency. All financial information presented in euro has been rounded to the nearest million, except when otherwise indicated. 31

35 1. Basis of preparation and significant accounting policies (continued) Estimates and assumptions The preparation of the financial statements in conformity with IFRSs, as adopted by the EU, requires management to make judgements, estimates and assumptions that affect the application of accounting policies and reported amounts of assets, liabilities, income and expenses. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances and are reflected in the judgements made about the carrying amounts of assets and liabilities that are not objectively verifiable. Actual results may differ from the estimates made. Estimates and underlying assumptions are reviewed on an ongoing basis and where necessary are revised to reflect current conditions. The principal estimates and assumptions made by management relate to insurance liabilities, investment valuations and investment contract liabilities, interest rates, demographic and other factors. Judgements made by management that have a significant effect on the financial statements and estimates with a significant risk of material adjustment in the next year are discussed in Note 2, Critical accounting judgements and estimates. Significant accounting policies (i) Interests in subsidiary undertakings Interests in subsidiary undertakings are stated in the statement of financial position at cost, less amounts written off where an impairment in value is considered to have occurred. (ii) Business combinations Business combinations are accounted for using the acquisition method as at the acquisition date. The cost of acquisition is measured as the aggregate of the consideration transferred measured at acquisition date (date which control is transferred), fair value and the amount of noncontrolling interest in the acquiree. For each business combination the acquirer measures the non-controlling interest in the acquiree at either the fair value or at the proportionate share of the acquiree's identifiable net assets. Acquisition costs are expensed to the profit and loss as incurred. The assets and liabilities on a business combination are measured at their fair value at the acquisition date. (iii) Foreign currencies The financial statements are presented in euro. This is the functional currency of the company. Foreign currency transactions are translated into the functional currency of the company at the exchange rate prevailing at the date of the transaction. Monetary and non-monetary assets and liabilities denominated in foreign currency are translated at the exchange rates prevailing at the financial position date or at the exchange rate in a related forward foreign exchange contract where such a contract exists. Exchange movements are recognised in the income statement. (iv) Financial assets The company classifies its financial assets on initial recognition as held for trading ( HFT ), designated at fair value through profit and loss ( FVTPL ) or loans and receivables. All derivatives are classified as HFT unless they have been designated as hedges. Purchases and sales of financial assets are recognised on the trade date, being the date on which the company commits to purchase or sell the asset. Financial assets are initially recorded at fair value. The fair value of assets traded on an active market is based on current bid prices. In the absence of current bid prices, the company establishes a fair value using various valuation techniques. These include recent transactions in similar items, discounted cash flow projections, option pricing models and other valuation techniques used by market participants. Financial assets are derecognised when the right to receive cash flows from the financial assets has expired or the company has transferred substantially all the risks and rewards of ownership. All assets attributable to life assurance operations are carried at FVTPL to eliminate an inconsistency that would otherwise arise between the valuation of assets and liabilities. Debt securities Debt securities classified as FVTPL are measured at fair value and transaction costs are taken directly to the income statement. Realised and unrealised gains together with income earned on these assets are shown as investment return in the income statement. Equities and units in unit trusts Equities and units in unit trusts are classified as FVTPL. Realised and unrealised gains together with dividend income on equities are reported as investment return in the income statement. Dividends are recognised in the income statement when the company's right to receive payment is established. Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted on an active market and that the company has no intention of trading. Loans and receivables, subsequent to initial recognition, are held at amortised cost less allowance for incurred impairment losses. Income is recognised on an effective interest basis as interest receivable in the income statement. Cash and cash equivalents Cash and cash equivalents consist of cash at bank and in hand, deposits held at call with banks, deposits with credit institutions, and other liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of change in value. 32

36 1. Basis of preparation and significant accounting policies (continued) Significant accounting policies (continued) (v) Derivative instruments Derivative instruments are used in the company's life assurance operations and primarily comprise currency forward rate contracts, currency and interest rate swaps, futures contracts, forward rate agreements and options. All derivatives are classified as HFT unless they have been designated as hedges. All derivatives are held on the statement of financial position at fair value. Fair values are obtained from quoted prices prevailing in active markets, where available. Otherwise, valuation techniques including discounted cash flow analysis and option pricing models are used to value the instruments. Gains and losses arising on derivatives, which are measured at fair value, are recognised in investment return. Where derivatives are used as hedges, formal documentation is drawn up at inception of the hedge specifying the hedging strategy, the component transactions and the methodology that will be used to measure effectiveness. Monitoring of hedge effectiveness is carried out on an on going basis of the hedge relationship as to whether the hedging instrument is expected to be highly effective in offsetting the changes in the fair value or cash flows of the respective hedged items attributable to the hedged risk, and whether the actual results of each hedge are within a range of 80%-125%. All existing hedge relationships are fair value hedges. Movements in the fair value of derivative hedge positions together with the fair value movement in the hedged risk of the underlying financial instrument are reflected in the income statement. (vi) Sales and repurchase agreements (including stock borrowing and lending) Financial assets may be lent for a fee or sold subject to a commitment to repurchase them. Such assets are retained on the statement of financial position when substantially all the risks and rewards of ownership remain with the company. The liability to the counterparty is included separately on the statement of financial position as appropriate. Similarly, where financial assets are purchased with a commitment to resell, or where the company borrows financial assets but does not acquire the risks and rewards of ownership, the transactions are treated as collateralised loans, and the financial assets are not included in the statement of financial position. The difference between the sale and repurchase price is recognised in the income statement over the life of the agreements using the effective interest rate. Fees earned on stock lending are recognised in the income statement over the term of the lending agreement. Securities lent to counterparties are also retained on the statement of financial position. (vii) Financial liabilities Financial liabilities include loans and borrowings and subordinated debt issued. Such financial liabilities are recognised initially at fair value plus directly attributable transaction costs. These financial liabilities are carried at amortised cost calculated on an effective interest basis. Financial liabilities that are part of a hedging relationship are carried at amortised cost adjusted for changes in the fair value of the hedged risk. The change in the fair value of the hedged risk is recognised together with the movement in the fair value of the derivative positions hedging the liability in the income statement. Interest expense on an effective interest basis is recorded in the income statement as interest payable. Financial liabilities are derecognised when its contractual obligations are discharged, cancelled or expire. (viii) Product classification In accordance with IFRS 4 Insurance Contracts, the Group s life assurance products are classified for accounting purposes as either insurance contracts or investment contracts at inception of the contract. Insurance risk is defined as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur. Investment contracts are those contracts which carry no significant insurance risk. Insurance contracts are defined as those contracts which transfer significant insurance risk. The Group has a small closed book of insurance contracts which had discretionary participation features, all of these contracts also have significant insurance risk and are therefore classified as insurance contracts. (ix) Insurance contract liabilities In conjunction with the Appointed Actuary, the Board determines insurance contract liabilities. The liabilities include an assessment of the cost of any significant investment related future options and guarantees contained within the insurance contracts measured on a market consistent basis. Changes in the liabilities are included in the income statement. The liabilities are calculated in accordance with the valuation of liability regulations of the European Communities (Life Assurance) Framework Regulations, They include the provision for the increase in liabilities arising from the distribution of surplus as a result of the latest actuarial investigation and provisions required in respect of possible depreciation in asset values. (x) Liability adequacy tests The company performs liability adequacy tests on its insurance contract liabilities to ensure that the carrying amount of the liabilities is sufficient to cover estimated future cash flows. When performing the liability adequacy tests, the company discounts all contractual cash flows and compares this amount to the carrying value of the liability. Any deficiency is immediately charged to the income statement. 33

37 1. Basis of preparation and significant accounting policies (continued) Significant accounting policies (continued) (xi) Premium income and claims recognition on insurance contracts Premiums are recognised as revenue in the income statement. Single premiums on insurance contracts are recognised on the date the policy is effective. Regular premiums on insurance contracts are recognised on the date the payments are collected, or on the due date in the case of group contracts. Claims on insurance contracts are recognised as an expense in the income statement. Claims include payments arising due to death or serious illness, maturity and encashment payments, and regular annuity payments along with claims handling costs. Claims handling costs include internal and external costs incurred in connection with the negotiation and settlement of claims. Internal costs include all direct expenses of the claims department. Death and serious illness claims are recognised on the date of notification. Maturity and annuity payments are recognised when due for payment. All other claims are recognised when paid or payable, or if earlier, on the date the policy ceases to be included within the calculation of insurance contract liabilities. (xii) Acquisition costs on insurance contracts Acquisition costs comprise direct and indirect costs of obtaining and processing new business. Such costs are deferred as an explicit deferred acquisition cost asset, to the extent that they are expected to be recoverable out of future revenues to which they relate. Such costs are amortised through the income statement over the period in which the revenues on the related contracts are expected to be earned, at a rate commensurate with those revenues. Deferred acquisition costs are reviewed by category of business at the end of each financial year. Should the circumstances which justified the deferral of costs no longer apply, the deferred acquisition costs are written off, to the extent that they are believed to be irrecoverable. (xiii) Investment contract liabilities Investment contracts are measured at FVTPL to eliminate an inconsistency that would otherwise arise between the valuation of assets and liabilities. Unit-linked liabilities are valued with reference to the value of the underlying net asset value of the company's unitised investment funds at the financial position date. Non-linked investment contracts are measured based on the value of the liability to the policyholder at the financial position date. Deposits and withdrawals are accounted for directly in the statement of financial position as movements in the investment contract liabilities. (xiv) Revenue from investment contracts Fees charged in respect of investment contracts are recognised when the service is provided. Initial fees, which exceed the level of recurring fees are deferred and amortised over the anticipated period in which services will be provided. Fees charged for investment management services for institutional fund management activity are also recognised over the period of the service. Premiums and claims in respect of investment contracts are not included in the income statement but are reported as deposits to and withdrawals from investment contract liabilities in the statement of financial position. (xv) Acquisition costs on investment contracts Acquisition costs represent those costs directly associated with the acquisition of new investment management service contracts. Such costs are deferred as an explicit deferred acquisition cost asset, to the extent that they are expected to be recoverable out of future revenues to which they relate. Such costs are amortised through the income statement over the period in which the revenues on the related contracts are expected to be earned, at a rate commensurate with those revenues. Deferred acquisition costs are reviewed by category of business at the end of each financial period. Should the circumstances which justified the deferral of costs no longer apply, the deferred acquisition costs are written off, to the extent that they are believed to be irrecoverable. (xvi) Reinsurance The company cedes insurance premiums and risk in the normal course of business in order to limit the potential for loss. Outward reinsurance premiums are accounted for in the same period as related premiums for the business being reinsured. Reinsurance assets include amounts due from reinsurance companies in respect of paid and unpaid losses and ceded future life and investment policy benefits. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance is recorded gross in the statement of financial position. (xvii) Investment properties Investment properties consist of land and buildings which are held for long-term rental yields and capital growth. Investment properties are carried at fair value with changes in fair value included in the income statement within investment return. Valuations are undertaken at least annually by external chartered surveyors at open market value in accordance with IAS 40 Investment Property and with guidance set down by their relevant professional bodies. 34

38 1. Basis of preparation and significant accounting policies (continued) Significant accounting policies (continued) (xviii) Property and equipment Leasehold premises with initial lease terms of less than fifty years and all other equipment are stated at cost less accumulated depreciation and impairment losses. Depreciation is calculated to write off the costs of such assets to their residual value over their estimated useful lives, which are assessed annually by the Directors. Freehold premises and leasehold premises with initial lease terms in excess of fifty years are revalued at least annually by external valuers. The resulting increase / decrease in value is transferred to a revaluation reserve. The revalued premises, excluding the land element, are depreciated to their residual values over their estimated useful lives, which are assessed annually by the Directors. Subsequent costs are included in the asset s carrying amount, only when it is probable that increased future economic benefits associated with the item will flow to the company and the cost of the item can be measured reliably. Property and equipment is assessed for impairment where there is an indication of impairment. Where impairment exists, the carrying amount of the asset is reduced to its recoverable amount and the impairment loss recognised in the income statement. The depreciation charge for the asset is then adjusted to reflect the asset s revised carrying amount. The estimated useful lives for the current and comparative years are as follows: Freehold buildings Leasehold buildings Office equipment Fixtures and fittings Computer hardware Motor vehicles 50 years 50 years or term of lease if less than 50 years 5-15 years 5-15 years 3-10 years 5 years (xix) Leases Lessee Rentals payable under operating leases are charged to the income statement on a straight-line basis over the lease period. Assets held as finance leases are capitalised and included in property and equipment initially at fair value and subsequently at depreciated cost. Lessor Assets leased to customers are classified as operating leases if the lease agreements do not transfer substantially all the risks and rewards of ownership. The leased assets are included as investment properties. Lease income is recognised on a straight-line basis over the term of the lease. (xx) Intangible assets Software Computer software is carried at cost, less amortisation and provision for impairment, if any. The external costs and identifiable internal costs of acquiring and developing software are capitalised where it is probable that future economic benefits that exceed its cost will flow from its use over more than one year. Capitalised computer software is amortised over three to ten years. Software is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An asset's carrying value is written down immediately to its recoverable amount if the asset's carrying amount is greater than its estimated recoverable amount. The estimated recoverable amount is the higher of the asset's fair value less costs to sell or value in use. Purchased shareholders value of in-force ("VIF") business and other intangible assets The company has two business portfolios of long-term insurance and investment contracts, which were acquired from other companies. On acquisition of these contracts, the fair value of the portfolios, which are based on the net present value of the shareholders interest in the expected cash flows of the in-force business, are capitalised in the statement of financial position as an intangible asset. That part of the shareholders' interest which will be recognised as profit over the lifetime of the in-force policies is amortised and the discount unwound on a systematic basis over the anticipated life of the related contracts. The carrying value is assessed annually using current assumptions in order to determine whether any impairment has arisen compared to the amortised acquired value, based on assumptions made at the time of the acquisition. Other intangible assets Other intangible assets relate to the client portfolio acquired on the acquisitions of a brokerage and life insurance companies. All intangibles are subject to an impairment review at least annually and if events or changes in circumstances indicate that the carrying amount may not be recoverable it is written down through the income statement by the amount of any impairment loss identified in the year. Intangibles are amortised over periods of up to 20 years. 35

39 1. Basis of preparation and significant accounting policies (continued) Significant accounting policies (continued) (xxi) Retirement benefit obligations The company has both defined benefit and defined contribution schemes. The net obligation in respect of the company's defined benefit scheme represents the present value of the obligation to employees in respect of service in the current or prior period less the fair value of the plan assets. The present value of the obligation is calculated annually by external actuaries using the projected unit method. The present value of the obligation is determined by discounting the estimated future cash flows. This discount rate is based on the market yield of high quality corporate bonds that have maturity dates approximating to the terms of the pension liability. The current and past service cost, the interest cost of the scheme liabilities and the expected return on scheme assets are recognised in the income statement in the period in which they are incurred. The company pays contractual contributions in respect of defined contribution plans. These contributions are recognised as employee expenses when the related employee service is received. (xxii) Termination payments Termination payments are recognised as an expense when the company is demonstrably committed to a formal plan to terminate employment before the normal retirement date. Termination payments for voluntary redundancies are recognised where an offer has been made by the company, it is probable that the offer will be accepted and the number of acceptances can be reliably estimated. (xxiii) Taxation Taxation comprises both current and deferred tax. Taxation is recognised in the income statement except where it relates to an item which is recognised directly in equity. Corporation tax payable is provided on taxable profits at current tax rates. Deferred tax is provided using the liabilitymethod on all temporary differences except those arising on goodwill not deductible for tax purposes, or where the temporary difference arose on the initial recognition of an asset or liability in a transaction which was not a business combination and which at the time of the transaction affects neither accounting profit nor taxable profit. Deferred tax assets are recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax liabilities and assets are offset only where there is both the legal right and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously. (xxiv) Other income and expense recognition Fees and commissions receivable and payable are recognised on an accruals basis. Expenses are recognised on an accruals basis. (xxv) Dividends Final dividends on ordinary shares are recognised in equity in the period in which they are approved by the company s shareholders. Interim dividends are recognised in equity in the period in which they are paid. (xxvi) Netting Assets, liabilities, income and expenses are shown net where there is a legal right to offset and there is an intention and an ability to settle on a net basis. Adoption of new accounting standards Standards and interpretations which was effective for annual periods beginning on or after 1 January 2012 and have been adopted in the current reporting period are detailed below: Title IFRS 7 Financial Instruments: Disclosures (Amendment) IAS 12 Income Taxes (amendment) IFRIC 14 Prepayments of a Minimum Funding Requirement (Amendment) Impact on company and financial statements IFRS 7 require additional disclosures on the risk exposures relating to transfers of financial assets and the affect they may have on the entity. The standard has an impact on stock lending disclosures in the following notes - equity shares and units in unit trusts, debt securities, and the maximum exposure in the financial risk management note. The amendment introduces an exemption to the existing principle for the measurement of deferred tax assets or liabilities arising on investment properties measured at fair value. It provides a presumption that investment property measured at fair value is recoverable through sale. This amendment did not result in a material impact on the financial statements of the company. This amendment to IFRIC 14 provides further guidance on assessing the recoverable amount of a net pension asset. The amendment permits an entity to treat the prepayment of a minimum funding requirement as an asset. This amendment did not result in a material impact on the financial statements of the company. 36

40 1. Basis of preparation and significant accounting policies (continued) Significant accounting policies (continued) The following new standards, amendments to standards and interpretations may be applicable to the company and once endorsed by the EU will be adopted in the financial statements. IFRS/IAS IAS 1: Presentation of items of Other Comprehensive Income - Amendments to IAS 1 (endorsed by the EU) Amendment This amendment requires entities to group together items on other comprehensive income based on whether they can be reclassified to the income statement. The amendment also preserves the existing option for profit and loss and other comprehensive income to be presented separately rather than a single continuous statement as was proposed in the exposure draft. This amendment will not result in a material impact on the financial statements of the company. Effective 01-Jul-12 IFRS 7 Financial instruments - The amendment to IFRS 7 require more disclosures focused on Disclosures - Offsetting quantitative information about recognised financial instruments Financial Assets and Financial that are offset in the statement of financial position, as well as Liabilities (endorsed by the EU) those recognised financial instruments that are subject to master and IAS 32 Financial netting, irrespective of whether they are offset. The amendment instruments - Presentation to IAS 32 is that the right to offset must not be contingent on a (amendment) (endorsed by the future event and must also be legally enforceable in the event of EU) a default, insolvency or bankruptcy. IFRS 7 amendment will not result in a material impact on the financial statements of the company. The company is currently assessing the impact of IAS 32 on the financial statements of the company. 01-Jan-13 (IFRS 7) 01-Jan-14 (IAS 32) IAS 19 Employee Benefits (revised) (endorsed by the EU) IAS 19 applies significant changes to the recognition and measurement of defined benefit pension expense and termination benefits. Additional disclosures are required for the characteristics of defined benefit plans, the amounts recognised in the financial statements and the risks arising from the defined benefit plan. Following an assessment of the impact on the company's financial statements, had the company adopted the change in the standard on the 2012 income statement, there would have been an additional charge of 0.4m, the Other Comprehensive Income would have seen an additional charge of 22m and shareholders funds would have been reduced by 82m in aggregate. 01-Jan-13 IAS 27 Separate Financial Statements (revised)* (endorsed by the EU) IAS 27 has been revised and now only deals with the provisions on separate financial statements. This revision will not result in a material impact on the financial statements of the company. 01-Jan-14 IFRS 9 Financial Instruments (amendment) (not yet endorsed by the EU) IFRS 9 will replace IAS 39 Financial instrument; Classification and Measurement and consists of Financial Assets; The multiple classification model for financial assets from IAS 39 is replaced with only two classification category's; amortised cost and fair value. IFRS 9 introduces a two step classification approach which involves the entity considering its business model and the contractual cash flows characteristics of the financial assets. The impact of IFRS 9 (amendment) on the financial statements of the company is currently being assessed. 01-Jan-15 IFRS 11 Joint arrangements (endorsed by the EU)* Replaces IAS 31 and SIC 13. The standard classifies joint arrangements as either joint operations or joint ventures. IFRS 11 focuses on the rights and obligations of the arrangement, rather than the legal form. Proportionate consolidation has been removed and the equity method is mandatory. IFRS 11 will not result in a material impact on the financial statements of the company. 01-Jan-14 IFRS 13 Fair value IFRS 13 defines fair value and explains how to measure fair 01-Jan-13 measurement (endorsed by the value under a three level hierarchy, based on type of inputs to EU) the valuation techniques used. The guidance also requires additional disclosures in relation to all assets and liabilities measured at fair value. The impact of IFRS 13 on the financial statements of the company is currently being assessed. *These two standards must be adopted at the same date. 37

41 2. Critical accounting judgements and estimates Critical accounting policies Management discussed and agreed with the Audit Committee the development, selection and disclosure of the company's critical accounting policies and estimates and the application of these policies and estimates. Critical accounting policies are those policies which are particularly significant in presenting the company's results of operations and include those that involve significant judgements and uncertainties, and potentially result in materially different results under different assumptions and conditions and are therefore particularly critical to an understanding of the company's financial statements. The Directors believe that the company's critical accounting policies are limited to those described below. (i) Liabilities in respect of insurance and investment contracts Insurance risk is defined as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur. Investment contracts are those contracts which carry no significant insurance risk. Insurance contracts are defined as those contracts which transfer significant insurance risk. Insurance Contracts: In conjunction with the Appointed Actuary, the Board determines insurance contract liabilities. The liabilities include an assessment of the cost of any significant investment related future options and guarantees contained within the insurance contracts measured on a market consistent basis. Changes in the liabilities are included in the income statement. The liabilities are calculated in accordance with the valuation of liability regulations of the European Communities (Life Insurance) Framework Regulations, They include the provision for the increase in liabilities arising from the distribution of surplus as a result of the latest actuarial investigation, and provisions required in respect of possible depreciation in asset values. Policyholder liabilities for non-linked insurance contracts are estimated by management. This requires management to make prudent estimates regarding the probability and the timing of the occurrence of the insured event; future investment returns, including an allowance for credit risk; and future expenses. The liability will therefore vary with movements in interest rates and with changes in the assumed future mortality and morbidity experience. Management follows industry guidelines in setting assumptions, using standard insurance risk tables amended to reflect the company's own experience and where appropriate makes allowance for expected insurance risk improvements or disimprovements. Reinsurance assets for non-linked insurance contracts require the company to estimate future cash flows from reinsurance contracts. The cash flows make assumptions regarding the probability and the timing of the occurrence of the reinsured event, future investment returns and future expenses. The asset will therefore vary with movements in interest rates and with future changes in actual experience. Management follows industry guidelines in setting assumptions using standard insurance risk tables amended to reflect the company's own experience and where appropriate makes allowance for expected insurance risk improvements or disimprovements. The company performs liability adequacy tests on its insurance contract liabilities to ensure that the carrying amount of the liabilities is sufficient to cover estimated future cash flows. When performing the liability adequacy tests, the company discounts all contractual cash flows and compares this amount to the carrying value of the liability. Any deficiency is immediately charged to the income statement. Investment Contracts: Investment contracts are accounted for as financial instruments under IAS 39 Financial Instruments: Recognition and Measurement and IAS 18 Revenue. They are measured at FVTPL to eliminate an inconsistency that would otherwise arise between the valuation of assets and liabilities. Investment contracts are primarily unit-linked contracts whose value is contractually linked to the fair value of the financial assets within the company's unitised investment funds. Initial fees earned and incremental costs (mainly commission) paid on sale of an investment contract are deferred and recognised over the expected life of the contract. The expected life of the contracts is estimated based on current experience and the term of the contracts and is reviewed at least annually. Changes to the expected life could affect the income and cost recognised and the value of the asset and liability in the financial statements. However, given that any changes to expected life will affect both costs and fees, the net impact is unlikely to be significant. Non-linked investment contracts are measured based on the value of the liability to the policyholder at the financial position date. Deposits and withdrawals are accounted for directly in the statement of financial position as movements in the investment contract liabilities. (ii) Deferred acquisition costs Acquisition costs for insurance contracts comprise direct and indirect costs of obtaining and processing new business. Acquisition costs for investment contracts represent those costs directly associated with the acquisition of new investment management service contracts. These costs are deferred as an explicit deferred acquisition cost asset, to the extent that they are expected to be recoverable out of future revenues to which they relate. These costs are amortised through the income statement over the period in which the revenues on the related contracts are expected to be earned, at a rate commensurate with those revenues. Deferred acquisition costs are reviewed by category of business at the end of each financial year. Should the circumstances which justified the deferral of costs no longer apply; the deferred acquisition costs are written off, to the extent that they are believed to be irrecoverable. 38

42 2. Critical accounting judgements and estimates (continued) (iii) Revenue and expense recognition Premiums earned in respect of insurance contracts are accounted for in the same period in which the liabilities arising from those premiums are established. Claims are accounted for when paid or payable, or if earlier on the date the policy ceases to be included within the calculation of insurance contract liabilities. Fees charged in respect of investment contract liabilities are recognised when the service is provided. Initial fees, which exceed the level of recurring fees are deferred and amortised over the anticipated period in which services will be provided. Premiums and claims on investment contracts are not included in the income statement but are reported as deposits to or withdrawals from investment contract liabilities. Fees and commissions receivable and payable are recognised on an accruals basis. Expenses are recognised on an accruals basis. (iv) Investment securities and derivatives The company classifies its financial assets on initial recognition as held for trading ( HFT ), designated at fair value through profit and loss ( FVTPL ) or loans and receivables. All derivatives are classified as HFT unless they have been designated as hedges. Purchases and sales of financial assets are recognised on the trade date, being the date on which the company commits to purchase or sell the asset. Financial assets are initially recorded at fair value. The fair value of assets traded on an active market is based on current bid prices. In the absence of current bid prices, the company establishes a fair value using various valuation techniques. These include recent transactions in similar items, discounted cash flow projections, option pricing models and other valuation techniques used by market participants. Financial assets are derecognised when the right to receive cash flows from the financial assets has expired or the company has transferred substantially all the risks and rewards of ownership. All assets attributable to life assurance operations are carried at FVTPL to eliminate an inconsistency that would otherwise arise between the valuation of assets and liabilities. Derivative instruments are used in the company's life assurance operations and primarily comprise currency forward rate contracts, currency and interest rate swaps, futures contracts, forward rate agreements and options. All derivatives are classified as HFT unless they have been designated as hedges. All derivatives are held on the statement of financial position at fair value. Fair values are obtained from quoted prices prevailing in active markets, where available. Otherwise, valuation techniques including discounted cash flow analysis and option pricing models are used to value the instruments. (v) Pension costs, other post-retirement benefits, and pension assumptions The company has both defined benefit and defined contribution schemes. The company's net obligation in respect of the defined benefit schemes is calculated separately for each scheme. The net obligation represents the present value of the obligation to employees in respect of service in the current or prior period less the fair value of the plan assets. The present value of the obligation is calculated annually by external actuaries using the projected unit method. The present value of the obligation is determined by discounting the estimated future cash flows. This discount rate is based on the market yield of high quality corporate bonds that have maturity dates approximating to the terms of the pension liability. The company pays contractual contributions in respect of defined contribution plans. These contributions are recognised as employee expenses when the related employee service is received. For defined benefit schemes, actuarial valuation of each of the scheme s obligations using the projected unit method and the fair valuation of each of the scheme s assets are performed annually in accordance with the requirements of IAS 19. The actuarial valuation is dependent upon a series of assumptions, the key ones being discount rates, expected rate of return on plan assets, salary increases, pension increases, rate of price inflation and mortality rates. The discount rate used to calculate the defined benefit scheme liabilities is based on the market yield at the financial position date of high quality bonds with a similar duration to that of the schemes liabilities. The returns on Irish and overseas equities are set relative to fixed interest returns by considering the long-term expected equity risk premium. The price inflation assumption reflects long-term expectations of both earnings and retail price inflation. Mortality estimates are based on standard industry and national mortality tables, adjusted where appropriate to reflect the company's own experience. The impact on the consolidated income statement and the consolidated statement of financial position could be materially different if a different set of assumptions was used. (vi) Valuation of property Investment property is held for capital appreciation and income and is let on a commercial basis to third parties. Investment property is carried at fair value as determined by independent valuers who have appropriate recognised professional qualifications and recent experience in the location and category of the property being valued. The valuers apply the Royal Institution of Chartered Surveyors ("RICS") guidance in determining the fair value of properties. The guidance set down by the RICS standards confirms that the definition of market value is consistent with that of fair value as defined within the accounting standards. Fair value takes into account recent occupancy and rental levels and are based on yields which are applied to arrive at the property valuation. 39

43 3. Cash and cash equivalents Note m m Cash at bank Deposits with credit institutions - Unit-linked deposits 3,895 3,041 - Shareholder / non-linked deposits ,649 3,763 Less bank overdraft 18 (6) (8) 4,643 3,755 40

44 4. Debt securities m m Designated at Fair Value Through Profit Loss ("FVTPL") 9,185 7,955 9,185 7,955 The carrying value of debt securities is analysed as follows: m m Government bonds 7,969 7,060 Bonds issued by public boards Bonds issued by credit institutions* 1, Other bonds ,185 7,955 Listed 8,462 7,456 Unlisted ,185 7,955 *Includes deposits which had a term greater than 12 months at date of inception. 6,669m (2011: 5,810m) of the above balance relates to debt securities held in unit-linked funds and 2,516m (2011: 2,145m) in nonlinked funds. Under a stock lending agreement, the company has transferred debt securities to third parties of 575m (2011: 551m), but has substantially retained all the risks and rewards associated with the transferred assets. Due to retention of substantially all the risks and rewards on these assets, the company continues to recognise these assets within debt securities. The risks associated with these securities are the same as those debt securities that are not included in the stock lending programme which are disclosed in Note 25, Financial Risk Management. In return, the company has accepted financial assets as collateral. The fair value of the segregated collateral that the company held externally with an agent amounted to 591m (2011: 576m). Segregated collateral consists of AA-rated OECD sovereign debt securities. In addition the external agent has provided an indemnity (at a charge) to make good any losses in excess of the segregated collateral should a counterparty default. The collateral is not included in the statement of financial position in accordance with IAS 39 as the company does not have the right to sell or re-pledge the sovereign debt securities provided as collateral. These transactions are conducted under terms that are usual and customary to standard stock lending agreements. 41

45 5. Equity shares and units in unit trusts m m Designated as FVTPL Listed 12,476 11,711 Unlisted ,559 11,817 Equity shares and units in unit trusts are all held in unit-linked funds. Note 26, Fair value of financial instruments, details the fair value hierarchy of these assets. Under a stock lending agreement, the company has transferred equity shares to third parties of 343m (2011: 468m), but has substantially retained all the risks and rewards associated with the transferred assets. Due to retention of substantially all the risks and rewards on these assets, the company continues to recognise these assets within equity shares. The risks associated with these securities are the same as those for equity securities that are not included in the stock lending programme which are disclosed in Note 25, Financial risk management. In return, the company has accepted financial assets as collateral. The fair value of the segregated collateral that the company held externally with an agent amounted to 363m (2011: 502m). Segregated collateral consists of AA-rated OECD sovereign debt securities. In addition the external agent has provided an indemnity (at a charge) to make good any losses in excess of the segregated collateral should a counterparty default. The collateral is not included in the statement of financial position in accordance with IAS 39 as the Group does not have the right to sell or re-pledge the sovereign debt securities provided as collateral. These transactions are conducted under terms that are usual and customary to standard stock lending agreements. 42

46 6. Derivative instruments Derivative instruments are used to match fixed rate or tracker bond liabilities arising on insurance or investment contracts and within the unitised investment funds which match unit-linked policyholder liabilities as part of the efficient portfolio management of these funds. Derivatives have also been purchased for Constant Proportion Portfolio Insurance ("CPPI") unitised investment funds. In turn, the CPPI counterparty has purchased a zero strike option from the life assurance business. In the case of derivatives entered into for the benefit of unit-linked policyholders all of the risks are borne by the policyholder. The life assurance business also has a fair value hedge to reduce interest rate exposure on a subordinated debt issue. All derivatives are carried at fair value. Derivatives not qualifying as fair value hedges are classified as trading in the note below. The movement in the valuation of derivative instruments is included in investment return. The derivatives used include: Currency forward rate contracts which are commitments to purchase and sell currencies, including undelivered spot transactions; Currency and interest rate swaps which are commitments to exchange one set of cash flows for another, for example, fixed interest rates for floating interest rates; Futures contracts which may be for currency, interest rates or equity indices and are contractual obligations to pay or receive an amount based on changes in exchange rates, interest rates or equity indices; Forward rate agreements which are contracts that give rise to a cash settlement at a future date for the difference between a contracted rate of interest and the interest rate at the date of settlement based on a notional principal amount; and Options which are contractual agreements under which the seller grants the purchaser the right but not the obligation to buy (a call option) or to sell (a put option) at a set date or during a set period a specific amount of a currency or a financial instrument at a specified price. Options may be traded on an exchange or negotiated between two parties. Further details on the risk management policies are set out in Note 25, Financial risk management. The fair value of derivative instruments is set out below: Fair value asset Fair value liability Fair value asset Fair value liability m m m m - Designated as fair value hedges Held for trading Total derivative instruments Further analysis of derivative instruments is included below: Contract / notional amount 2012 Fair value asset Fair value liability Contract / notional amount Fair value asset Fair value liability m m m m m m Designated as fair value hedges - Interest rate swap Held for trading - held in unitised / closed funds for the benefit of policyholders* 6, , zero strike option to return growth in unitised fund to CPPI counterparty held to match fixed rate and tracker bond liabilities , , Total derivative instruments 7, , * the company's Closed funds no longer held derivatives after July Derivatives held in unitised / closed funds for the benefit of unit-linked policyholders are as follows: Contract/ notional amount 2012 Fair value asset Fair value liability Contract/ notional amount Fair value asset Fair value liability m m m m m m CPPI Interest rate swaps Currency swaps 5, , Equity futures , ,

47 6. Derivative instruments (continued) Derivatives held to match fixed-rate and tracker bond liabilities are analysed as follows: Contract/ notional amount Fair value asset Fair value liability Contract/ notional amount Fair value asset Fair value liability m m m m m m Over-the-counter options

48 7. Investment properties m m As at 1 January 1,385 1,579 Additions from acquisitions Additions from subsequent expenditure 4 2 Disposals (88) (135) Fair value adjustments (107) (119) As at 31 December 1,205 1,385 Investment property is held for capital appreciation and income and is let on a commercial basis to third parties. Investment property is carried at fair value as determined by independent valuers who have appropriate recognised professional qualifications and recent experience in the location and category of the property being valued. The valuers apply the Royal Institution of Chartered Surveyors ("RICS") guidance in determining the fair value of properties.the guidance set down by the RICS standards confirms that the definition of market value is consistent with that of fair value as defined within the accounting standards. Fair values take into account recent occupancy and rental levels and are based on yields which are applied to arrive at the property valuation. The Irish commercial property market continues to see firm signs of prime property values reaching a floor with a stabilising in prime rents and yields. However, further slippage in rents and yields for secondary property continues to impact performance returns on an aggregate basis. Total property returns have been supported by a strong income return which is currently running at 10% per annum. While the market still faces significant issues including domestic, economic and occupier challenges, there is considerable international investment interest and activity. The Investment Property Databank ("IPD") provides a benchmark for the institutional commercial property investment market. The total IPD return for the Irish market for 2012 was positive 3.1% (2011: negative 2.4%). The UK property investment market experienced negative growth in The London market proved resilient in 2012 while other locations throughout the UK experienced weaker investment demand and valuation declines. This aligns to the negative 4.2% IPD capital growth figure for 2012 (2011: positive 1.2%). Rental income levels for 2012 are the same as 2011 (positive 6.8%) which offset the negative capital growth. The total IPD return for the UK was a positive 2.4% (2011: positive 8.1%). At 31 December ,194m (2011: 1,370m) of investment properties were held by unit-linked funds. This includes 39m (2011: 43m) geared property shareholder holdings. The yield spreads used in the independent valuations were as follows: 31 December December 2011 Sector ROI UK ROI UK Office Prime 6.19%-9.14% 5.02%-7.56% 6.00%-9.04% 4.25%-7.48% Suburban 7.95%-11.59% 7.38%-8.42% 7.95%-11.41% 6.10%-8.14% Provincial 7.50%-12.69% 6.34%-11.05% 7.48%-12.58% 6.10%-9.25% Industrial Prime 8.25%-11.62% 8.57% 7.95%-11.44% 7.97%-8.07% Secondary 8.23%-11.56% - 6.9%-11.50% - Retail Prime high street 5.50%-8.20% 5.00%-5.97% 5.74%-7.91% 4.63%-5.60% Secondary 6.50%-10.15% %-10.05% 4.76%-4.98% Shopping centre 7.84%-11.87% 9.96% 7.90%-11.58% 8.60% Retail warehousing 7.95%-10.71% 5.98%-6.78% 8.0%-11.0% 5.51%-6.45% Provincial 7.25%-10.33% 7.32%-7.68% 7.50%-10.33% 5.49%-5.83% Residential Residential properties are valued on a capital value per square foot rather than on basis of investment yield. Residential properties represent 1.4% (2011: 1.2%) of total investment property. Investment properties as at 31 December 2012 are analysed as follows: ROI UK Total m m m Residential Office Industrial Retail ,205 45

49 7. Investment properties (continued) Investment properties as at 31 December 2011 are analysed as follows: ROI UK Total m m m Residential Office Industrial Retail ,385 The acquisition of certain investment properties on behalf of unit-linked policyholders is funded by borrowings. These borrowings (including accrued interest), which have recourse only to the specific property which they were used to acquire, amounted to 438m at 31 December 2012 (2011: 458m). The 2012 borrowings represents the gross amount borrowed and therefore before a 75m writedown to cater for the nonrecourse nature of this finance (please refer to Note 14, Loans and borrowings for more detail). As a result of the decrease in the values of investment properties held in unit-linked funds for the benefit of policyholders, there is one breach of loan-to-value terms attached to specific borrowings for a UK retail property. The group continues to fulfil all of its repayment obligations for such borrowings. There were no payment arrears at 31 December 2012 (2011: nil) on loan balances of 61m (2011: 57m). At 31 December 2012 there were a number of breaches of loan-to-value terms and payment defaults relating to non-recourse loans from third party banks secured on residential property included in unit trusts held by unit-linked funds for the benefit of policyholders. There were payment arrears of 2.8m (2011: 1.6m) on loan balances of 10m (2011: 11.3m). Property held under long leasehold interest at 31 December 2012 was 48m (2011: 51m). There are no contingent rents on these properties. 46

50 8. Investments in subsidiary undertakings m m As at 1 January Additions - - Permanent diminution of value (0.4) (0.3) As at 31 December Subsidiary undertakings are shown above at cost less amounts written off, if appropriate, for any permanent diminution of value. Principal subsidiary undertakings Incorporated in Nature of business % Holding Irish Life of North America U.S.A. Holding Company 100 The company is availing of the exemption under Section 16 (3)(a) of the Companies Act 1986 to provide a full list of subsidiaries as an annex to the annual return to the Companies Registration Office. 47

51 9. Property and equipment 2012 Land and buildings Motor vehicles Fixtures and Fittings Office and computer equipment Total m m m m m Cost or valuation As at 1 January Additions Valuation (4) (4) Disposals and adjustments 1 - (4) (27) (58) (89) Reclassification from intangible assets (note 10) (1) (1) As at 31 December Depreciation As at 1 January Provided in the year Valuation (1) (1) Disposals and adjustments 1 - (4) (26) (56) (86) Impairment As at 31 December Net book value as at 31 December For the year ended 31 December m (2011: nil) of disposals and adjustments relates to equipment with net book value of nil and no longer in use Land and buildings Motor vehicles Fixtures and Fittings Office and computer equipment Total m m m m m Cost or valuation As at 1 January Additions Valuation (6) (6) Disposals - (4) - - (4) Impairment As at 31 December Depreciation As at 1 January Provided in the year Valuation (1) (1) Disposals - (3) - - (3) As at 31 December Net book value as at 31 December

52 9. Property and equipment (continued) Land and buildings were revalued in December Valuations were carried out by registered, independent appraisers having an appropriate recognised professional qualification and recent experience in the location and category of the property being valued. Values take into account recent market transactions for similar properties. Valuations have used yields ranging from 7.2% to 8.5% (2011: 6.98% to 8.2%), depending on the property size and location. In relation to the larger head office buildings in 2012 vacant periods of 2 to 2.5 years (2011: 2 to 2.5 years) have been applied. The net book value of land and buildings include the following: m m Buildings - freehold Land The historic cost of land and buildings is 41m (2011: 41m). 49

53 10. Purchased interest in long-term business and other intangible fixed assets m m (a) Purchased interest in long term business (b) Other intangible fixed assets (a) Purchased interest in long-term business Cost Amortisation Net Book Value Cost Amortisation Net Book Value m m m m m m As at 1 January 59 (35) (32) 27 Additions (note 38) Charge of income in the year - (3) (3) - (3) (3) As at 31 December 62 (38) (35) 24 The above table is further analysed reflecting the businesses from which the portfolio transfers were made: Progressive Quinn Total Progressive Total Life Life Life m m m m m Cost As at 1 January Additions As at 31 December Amortisation As at 1 January (35) - (35) (32) (32) Charge of income in the year (3) - (3) (3) (3) As at 31 December (38) - (38) (35) (35) Net book value as at 31 December Purchased interest in long-term business from the portfolio transfer of business are written off on a straight line basis with estimated useful economic life as follows: Progressive Life Quinn Life Direct 20 years 8.25 years The addition of 3m of purchased interest in long term business is the value associated with the 4,000 insurance policies the company purchased from Quinn Life in September This is being amortised over 8.25 years. For further details refer to Note 37, Business Combinations. (b) Other intangible fixed assets Software Software m m Cost As at 1 January Additions 3 3 Disposals and adjustments 1 (18) - Reclassification 1 - As at 31 December Amortisation As at 1 January Amortisation for the year 3 4 Disposals and adjustments 1 (16) - As at 31 December Net book value as at 31 December For the year ended 31 December m (2011: nil) of disposals and adjustments relates to software with net book value of nil and no longer in use. 50

54 11. Other assets Amounts falling due within one year m m Debtors arising out of direct insurance operations: Policyholders Intermediaries 1 2 Debtors arising out of direct insurance operations Amounts due from group companies 6 1 Other debtors: Investment trading balances 19 6 Other debtors Prepayments - 4 Other debtors

55 12. Deferred acquisition costs 2012 Insurance Investment Total m m m As at 1 January Arising in the year Charge to income arising in the year (35) (37) (72) As at 31 December * Insurance Investment Total m m m As at 1 January Arising in the year Charge to income arising in the year (35) (35) (70) As at 31 December * * Includes 34m (2011: 38m) relating to deferred acquisition costs paid to another group company. 52

56 13. Retirement benefit obligations Defined benefit schemes The company operates an Irish defined benefit pension scheme which is now closed to new members and a hybrid scheme with a defined benefit element. Both schemes are funded by the payment of contributions into separately administered trust funds. The benefits paid from the defined benefit schemes are based on percentages of the employees' final pensionable pay for each year of credited service. The pension costs and provisions are assessed in accordance with the advice of independent qualified actuaries. Valuations are carried out every three years by independent actuarial consultants. The actuarial reports are available for inspection by members of the scheme and are not available for public inspection. The company's defined benefit pension scheme has been revalued within the timeframe set out by regulatory guidelines with the earliest valuation date being 30 September The key financial assumptions used are: % % Actuarial assumptions at the statement of financial position date Discount rate Expected rate of return on plan assets 1 N/A 5.00 Salary increases Pension increases Rate of price inflation From 1 January 2013 the company is adopting the revised IAS 19 accounting standard. This new standard replaces the expected rate of retun on plan assets with an interest income element that is based on the discount rate. As a consequence no expected rate of return has been set for 2013 at the statement of financial position date. 2 Salary increase assumption is 2% for the next three years and 3% thereafter. In addition to the salary inflation assumption above an assumed salary scale is also allowed for. The main post retirement mortality assumptions used at 31 December 2012 were 103% PNM(F)L00-1 with Central Statistics Office ("CSO") improvements from 2006 for active/deferred members and pensioners (2011: 103% PNM(F)L00-1 with CSO improvements from 2006 for active/deferred members and pensioners). On this basis the life expectancies underlying the value of the schemes' liabilities at 31 December 2012 and 31 December 2011 were the following: Years Years Retiring today age 65 Males Females Retiring in 15 years' time aged 65 Males Females Amounts recognised in the income statement in respect of these defined benefit schemes are: m m Current service cost Past service cost - 2 Interest cost Expected return on scheme assets (37) (42) Changes due to curtailments / settlements - (3) This charge has been included in administrative expenses. The actual return on scheme assets in 2012 was 90m (2011: 18m)

57 13. Retirement benefit obligations (continued) The actual return is calculated as follows: m m Expected return on plan assets Actuarial gain / (loss) on plan assets 53 (24) The expected return on assets is determined by calculating a total return estimate based on weighted average estimated returns for each asset class. Asset class returns are estimated using current and projected economic and market factors such as inflation, credit spreads and equity risk premiums. The expected rates of return for equities and property set at 31 December 2011 were calculated by allowing for a risk premium over prevailing long-dated bond yields. The equity rate allowed for a long dated yield of 3.70% together with an equity risk premium of 3.30%, giving a total of 7.00%. For property, a risk premium 1.00% lower than for equities was adopted. The expected rate of return on bonds reflected the prevailing yield on the specific portfolio of nominal and inflation linked long-dated bonds. The overall expected rate of return on assets was reduced by 0.6% to reflect the impact of the annual pension levy. The effect of the major categories of plan assets on the overall expected rate of return on assets is set out in the table overleaf detailing the long-term rate of return expected for each class of asset. The movements in the present value of defined benefit obligations in the year are: m m Benefit obligation as at 1 January (714) (674) Current service cost (17) (16) Interest cost (36) (35) Past service cost - (2) Actuarial gain / (loss) - experience adjustments assumption changes (90) (23) Curtailments - 3 Contributions by plan participants (3) (3) Benefits paid Transfer In (2) - Benefit obligation as at 31 December (828) (714) The movement in the fair value of defined benefit assets in the year are: m m Fair value of plan assets as at 1 January Expected return on plan assets Employer contribution Contributions by plan participants 3 3 Actuarial gain / (loss) 53 (24) Benefits paid (19) (21) Transfer In 2 - Fair value of plan assets as at 31 December The pension assets and liabilities recognised on the statement of financial position are as follows: m m m m m Benefit obligation as at 31 December (828) (714) (674) (618) (648) Fair value of plan assets as at 31 December Net asset / (obligation) (3) (66) During the period, the company, utilising various inputs, adopted the discount rate recommended by its external actuarial consultants for the purposes of the computation of the defined benefit liabilities. As a result, the estimation methodology used in calculating this discount rate for 2012 was refined from that used in the previous year. The refinement significantly extended the bond data included in the population from which the discount rate is derived and the approach used to extrapolate the available bond data was extended to more closely match the duration of the pension scheme obligations. As a result of the refined methodology adopted, the discount rate which would have been derived as 3.60%, increased to 4.25%. The effect of this change at the statement of financial position date was to reduce the present value of scheme liabilities from 965m to 828m based on the discount rate of 4.25% adopted. 54

58 13. Retirement benefit obligations (continued) The experience adjustments arising on plan liabilities and plan assets are as follows: Actuarial (gains) / losses - arising on benefit obligation ( m) (19) - arising on benefit obligation (% plan liabilities) (3) Actuarial gains / (losses) - arising on plan assets ( m) 53 (24) 5 42 (291) - arising on plan assets (% of plan assets) 6 (3) 1 6 (50) The movement in the present value of the net defined benefit assets / (obligations) in the year are: m m Net post retirement benefit asset as at 1 January Expense recognised in income statement (16) (8) Contributions paid Actuarial (losses) recognised in other comprehensive income (22) (32) Net post retirement benefit (liability) / asset as at 31 December (3) 22 Net post retirement benefit assets - 40 Net post retirement benefit liabilities (3) (18) Net post retirement benefit (liability) / asset (3) 22 The following tables set out, on a combined basis for all schemes, the fair value of the assets held by the schemes together with the long-term rate of return expected for each class of asset for the company Long-term Fair Plan rate of return Fair Plan value assets expected* value assets m % % m % Equities Bonds Property Other Fair value of plan assets as at 31 December *The long-term rate of return expected at 31 December 2011 for each of the asset classes above has been reduced by 0.6% to reflect the impact of the pension levy. An annual stamp duty levy of 0.6% (the "Pension Levy") of the market value of assets under management in Irish pension funds was put in place by the Irish Finance (No. 2) Act The levy will apply in each of the calendar years 2011 to 2014 inclusive, based on the value of the assets on 30 of June each year. The levy payment for 2012 amounting to 4.3m (2011: 4.2m), has been reflected as a reduction in the value of scheme assets and the levy has been incorporated into the expected return on scheme assets for No agreement has yet been reached as to who will ultimately bear the cost of this levy and the accounting will be updated to reflect the final decision once it is taken. The company is expected to pay contributions of approximately 12m to the pension schemes in If the discount rate was 0.25% lower than the assumption made at 31 December 2012 then the present value of defined benefit obligations would increase by approximately 51m, all of which would be included as unrecognised actuarial losses. A similar effect would arise if the rate of increase in salaries and pensions was to rise by 0.25% over the assumptions used at 31 December If the expectation of life post retirement increased by one year, then the present value of defined benefit obligations would increase by approximately 19m. 55

59 14. Loans and borrowings m m Unit-linked The acquisition of certain investment properties on behalf of unit-linked policyholders is funded by borrowings. These borrowings (including accrued interest), which have recourse only to specific property which they were used to acquire, amounted to 363m at 31 December 2012 (2011: 458m). The 2012 borrowings represents the value of borrowings after a 75m writedown to cater for the nonrecourse nature of this finance (please refer to Note 7, Investment properties for more details). 56

60 15. Investment contract liabilities The value of the investment options and guarantees shown in the tables below are calculated using a stochastic model Gross Reinsurance Net m m m Unit-linked liabilities 24,045 (38) 24,007 Non-linked and guaranteed tracker liabilities Investment financial options and guarantees As at 31 December 24,287 (38) 24, Gross Reinsurance Net m m m Unit-linked liabilities 21,863 (39) 21,824 Non-linked and guaranteed tracker liabilities Investment financial options and guarantees As at 31 December 22,153 (39) 22,114 The change in liabilities during the year ended 31 December 2012 is analysed as follows: 2012 Gross Reinsurance Net m m m As at 1 January 22,153 (39) 22,114 Premiums 3,297 (1) 3,296 Claims (3,709) 6 (3,703) Fees deducted (137) - (137) Change in investment contract liabilities 2,683 (4) 2,679 As at 31 December 24,287 (38) 24,249 The change in liabilities during the year ended 31 December 2011 is analysed as follows: 2011 Gross Reinsurance Net m m m As at 1 January 24,067 (57) 24,010 Premiums 2,692 (1) 2,691 Claims (4,173) 15 (4,158) Fees deducted (144) - (144) Exchange movements Change in investment contract liabilities (289) 4 (285) As at 31 December 22,153 (39) 22,114 The company is exposed to interest rate risk in relation to non-linked investment contracts and in relation to the capital protection guarantee element of certain unit-linked tracker products, to the extent that the value of the assets held in respect of these liabilities will not move in line with the value of the liabilities. It is the company's policy to mitigate this risk by holding appropriate fixed interest and cash assets. The following tables set out the undiscounted expected cash flows for the assets and liabilities by maturity date band. The tables exclude unit-linked liabilities and their matching assets. Not more than 1 year Over 1 year but less than 5 years Total 31 December 2012 m m m Investment contract liabilities Backing fixed interest and cash assets Gap 2 (1) 1 31 December 2011 Investment contract liabilities Backing fixed interest and cash assets Gap

61 16. Life insurance contracts (A) Analysis of insurance contract liabilities The company reflects insurance contract liabilities incurred as a result of its business operations Gross Reinsurance Net m m m Unit-linked liabilities Non-linked liabilities - without discretionary participation features 4,627 (2,331) 2,296 - with discretionary participation features* As at 31 December 5,119 (2,331) 2,788 *During 2012 the remaining with-profits liabilities within the company were converted to non-profit, non-linked liabilities Gross Reinsurance Net m m m Unit-linked liabilities Non-linked liabilities features 3,966 (2,015) 1,951 - with discretionary participation features As at 31 December 4,484 (2,015) 2,469 The change in liabilities during the year ended 31 December 2012 is analysed as follows: 2012 Gross Reinsurance Net m m m As at 1 January 4,484 (2,015) 2,469 Premiums 640 (167) 473 Claims (497) 220 (277) liabilities 76 (46) 30 Return credited to policyholders Fees deducted (250) 36 (214) Change in economic assumptions 551 (311) 240 Change in operating assumptions 52 (48) 4 Exchange differences 1-1 Other 5-5 As at 31 December 5,119 (2,331) 2,788 The change in liabilities during the year ended 31 December 2011 is analysed as follows: 2011 Gross Reinsurance Net m m m As at 1 January 4,238 (1,901) 2,337 Premiums 701 (135) 566 Claims (504) 187 (317) liabilities 83 (50) 33 Return credited to policyholders (20) - (20) Fees deducted (297) 64 (233) Change in economic assumptions 271 (163) 108 Change in operating assumptions 7 (17) (10) Exchange differences 1-1 Other 4-4 As at 31 December 4,484 (2,015) 2,469 58

62 16. Life insurance contracts (continued) The company is exposed to interest rate risk in relation to the non-linked insurance contract liabilities, to the extent that the value of the assets held in repect of these liabilities does not move in line with the value of the liabilities. It is the company's policy to mitigate this risk by holding appropriate fixed interest and cash assets. The following tables set out the undiscounted expected cash flows for the assets and liabilities by maturity date band. The tables exclude unit-linked liabilities and their matching assets. Not more than Over 1 year Over 5 years Over 10 years Over 20 years Total 1 year but less than 5 years but less than 10 years but less than 20 years 31 December 2012 m m m m m m Insurance contract liabilities , ,181 Backing fixed interest and cash assets ,045 3,380 Gap (44) December 2011 Insurance contract liabilities ,933 Backing fixed interest and cash assets ,216 3,211 Gap (374) At 31 December 2011, in addition to fixed interest and cash assets the company held 5m of equity assets and 2m of property assets in respect of insurance contract liabilities with discretionary participation features. Those assets were liquidated during 2012 when the liabilities were converted to non-profit, non-linked liabilities. (B) Assumptions The liabilities for insurance contracts are calculated in accordance with insurance regulations in force in Ireland. Liabilities for unit-linked insurance contracts include amounts reflecting the value of the underlying funds in which the policy is invested. Liabilities are calculated using a gross premium valuation method. In calculating the appropriate liability for non-linked insurance liabilities it is necessary to make assumptions on a range of items. The assumptions which have the most significant impact on the measurement liabilities are: - Interest rates - Mortality and morbidity - Expenses The interest rates used to discount the liabilities are based on the gross redemption yields of the assets deemed to back the liabilities. Regular premium business Single premium business % to 3.18% 0.06% to 2.69% % to 3.72% 0.29% to 5.22% Mortality and morbidity assumptions are based on the standard industry published tables amended to reflect the company's experience. Actual experience relative to the assumptions is monitored regularly by management. Annual investigations are carried out to review the experience over the previous three to five years, in order to assess the continued suitability of the key assumptions. For contracts insuring survivorship, an allowance is made for future mortality improvements based on trends identified in the data and in the continuous mortality investigations performed by independent actuarial bodies. Lives assured - Non-linked - Linked Annuities - Males - Females - Future mortality rates to improve on medium cohorts basis with minimum improvement of Disability rates - Inception: Males - Inception: Females - Termination Serious illness rates - Smokers - Non-smokers %-85% AM / AF00 select 100% AM / AF00 ultimate 104% PNMA00 104% PNFA % p.a. 80%-320% CMIR (12) 160%-640% CMIR (12) 45%-230% CIDA rates 147% - 174% of IC94 with 3% p.a. future deterioration 100% - 136% of IC94 with 3% p.a. future deterioration %-90% AM / AF00 select 100% AM / AF00 ultimate 104% PNMA00 104% PNFA % p.a. 80%-320% CMIR (12) 160%-640% CMIR (12) 45%-230% CIDA rates 163% of IC94 with 3% p.a. future deterioration 100% of IC94 with 3% p.a. future deterioration Expense assumptions are based on the current year expenses and size of book. Expense inflation assumption is 3% (2011: 3%). 59

63 16. Life insurance contracts (continued) (C) Changes in assumptions The principal changes in assumptions since 31 December 2011 were: - Interest rates used were changed to reflect the actual market interest rates at 31 December This increased liabilities by 246m after allowing for reinsurance. This is offset by returns on matching assets, reflecting the company's policy of matching assets and liabilities where possible. - Annuity mortality improvements assumptions were changed to reflect expected future mortality levels. This increased liabilities by 11m after allowing for reinsurance. - Mortality and serious illness assumptions were changed to reflect expected future experience. This reduced liabilities by 4m after allowing for reinsurance. - Expense assumptions were changed to reflect current and projected costs. This reduced liabilities by 3m after allowing for reinsurance. The principal changes in assumptions for the year ended 31 December 2011 were: - Interest rates used were changed to reflect the actual market interest rates at 31 December This increased liabilities by 112m after allowing for reinsurance. This is offset by returns on matching assets, reflecting the company's policy of matching assets and liabilities where possible. - The benefit inflation assumption was reduced to reflect a fall in inflation which reduced liabilities by 4m after allowing for reinsurance. This is offset by returns on matching assets, reflecting the company's policy of matching assets and liabilities where possible. - Expense assumptions were changed to reflect current unit costs. This reduced liabilities by 17m after allowing for reinsurance. - Annuitant mortality assumptions were changed to reflect expected future mortality levels. This increased liabilities by 7m after allowing for reinsurance. (D) Sensitivities The following indicates the sensitivities of insurance liabilities to changes in the assumptions at 31 December 2012: A 1% decrease in interest rates would increase liabilities by 276m after allowing for reinsurance. The company's policy, as described above, is to invest in fixed interest assets with a similar exposure to interest rates as the liabilities. Therefore the change in the value of the liabilities would be matched by a similar change in the value of the assets; A 1% increase in interest rates would reduce liabilities by 226m after allowing for reinsurance. The companys policy, as described above, is to invest in fixed interest assets with a similar exposure to interest rates as the liabilities. Therefore the change in value of the liabilities would be matched by a similar change in the value of the assets; A 10% decrease in maintenance expenses would decrease liabilities by 10m after allowing for reinsurance; and A 5% decrease in both mortality and morbidity rates would decrease liabilities by 11m after allowing for reinsurance. This amount includes an 18m increase in liabilities for annuities due to a fall in mortality rates. The above are based on a change in one assumption while holding all other assumptions constant. In practice this is unlikely to occur and changes in assumptions may be correlated. Changes in interest rates would be linked to equivalent changes in the value of the assets backing the insurance reserves. Changes to insurance contract liabilities and the value of the backing assets will also have an impact on the tax charge, which is not reflected in the figures above. 60

64 17. Financial options and guarantees The main options and guarantees for which financial options and guarantees ( FOG ) costs have been determined are: (a) Investment guarantees on certain unit-linked funds, where the unit returns to policyholders are smoothed subject to a minimum guaranteed return (in the majority of cases the minimum guaranteed change in unit price is 0%, usually representing a minimum return of the original premium). An additional management charge is levied on policyholders investing in these funds, compared to similar unit-linked funds without this investment guarantee. This extra charge is allowed for in calculating the FOG cost. (b) Guaranteed annuity rates on a small number of products. (c) Return of premium death guarantees on certain unit-linked single premium products. The cost of these FOGs are calculated using stochastic models. There are two elements to the cost: - - The time value, which is required where a financial option exists which is exercisable at the discretion of the policyholder. The time value of an option reflects the additional value inherent in the option due to the potential for the option to increase in value prior to its expiry date, usually due to movements in the market value of assets; and The intrinsic value, which is the value based on market conditions at the date of the valuation. Where a FOG relates to a contract classed as an investment contract, the investment contract liability includes both the time value and the intrinsic value. Where a FOG relates to a contract classed as an insurance contract, allowance is made for the intrinsic and time value of FOGs in the insurance contract liabilities using the statutory reserving basis. The main asset classes relating to products with options and guarantees are European and International equities, property, and government bonds of various durations. The Deloitte's TSM Streamline model is used to derive the cost of FOGs. The model is calibrated to the European swap curve plus a fixed margin of 0.75% (31 December 2011, swap curve plus a fixed margin of 1.3%). If the fixed margin was left at 1.3% at 31 December 2012, the cost of the FOGs reflected in the Investment Contract Liabilities would have been 12m lower. The equity volatility rate used in the model is calibrated to the market implied equity volatility rate at 31 December Ten years of historical weekly data are used to derive the correlation between the returns on different asset classes. The model uses the difference between two inverse Gaussian distributions to model the returns on each asset class. This allows the model to produce fat-tailed distributions, and provides a good fit to historical asset return distributions. The statistics relating to the model used are set out in the following table: As at 31 December Year return 20-Year return Mean 1 StDev 2 Mean 1 StDev 2 European assets (Euro) Bonds 2.3% 3.6% 2.9% 7.9% Equities, Property 2.3% 21.1% 2.9% 24.7% UK assets (Sterling) Bonds 1.9% 3.0% 3.1% 6.6% Equities 1.9% 21.7% 3.1% 24.1% As at 31 December Year return 20-Year return Mean 1 StDev 2 Mean 1 StDev 2 European assets (Euro) Bonds 3.7% 4.0% 4.1% 8.9% Equities, Property 3.7% 23.8% 4.1% 27.7% UK assets (Sterling) Bonds 2.1% 2.6% 3.1% 5.8% Equities 2.1% 23.3% 3.1% 25.4% The risk-neutral nature of the model means that all asset classes have the same expected return. No value is added by investing in riskier assets with a higher expected rate of return. The means quoted above reflect this. Standard deviations are calculated by accumulating a unit investment for n years in each simulation, taking the natural logarithm of the result, calculating the variance of this statistic, dividing by n and taking the square root. The results are comparable to implied volatilities quoted in investment markets. 61

65 18. Other liabilities Note m m Amounts falling due within one year PAYE and social insurance Other taxation 4 4 Investment trading balances 1 18 Other creditors Premiums on deposit Bank overdraft Amounts due to reinsurers Commissions payable Loan interest payable Rent prepaid 9 11 Life assurance premium levy 2 1 Amounts due to group companies 9 12 Corporation tax Total other liabilities There were no amounts falling due after one year in 2012 or

66 19. Provisions 2012 Staff restructuring costs Other Total m m m As at 1 January Provisions made during the year Provisions used during the year (2) - (2) As at 31 December Staff restructuring costs Other Total m m m As at 1 January Provisions made during the year Provisions used during the year (9) (4) (13) As at 31 December Staff restructuring costs Staff restructuring costs include provisions for employees on career breaks, voluntary severance schemes and voluntary early retirement. During 2011 a provision was made of 10m, this was partially utilised in 2011 with the remainder fully utilised in This provision was recognised in Administration Expenses in The 2011 Life Group restructuring schemes included programmes in the Retail Life business which had 65 employees exiting the business. 61 employees had exited by the end of 2011, with the remaining four exiting in the first quarter of Other The other provision is in relation to outstanding settlements on policyholder claims. The policyholder claims are expected to be addressed during

67 20. Deferred front end fees m m As at 1 January Arising in the year 6 11 Credit to income arising in the year (16) (17) As at 31 December

68 21. Deferred taxation m m Deferred tax liability as at 1 January Recognised in income 5 4 Recognised in equity (3) (4) Deferred tax liability as at 31 December Deferred taxation comprises: Property and equipment - (1) Investment property capital allowances 5 5 Deferred acquisition costs 2 2 Investment contract liabilities - (1) Undistributed life business surpluses Retirement benefits - 3 Other temporary differences (1)

69 22. Subordinated liabilities Undated Issued by Irish Life Assurance plc m m 200m 5.25% step-up perpetual capital notes The terms and conditions of this subordinated liability are as follows: 200m step-up perpetual capital notes. The interest rate is fixed at 5.25% for 10 years until 8 February 2017 ('the first reset date'). On the first reset date the interest rate becomes Euribor +2.03%. The note is callable in whole at the first reset date and each coupon payment date thereafter. The notes may also be redeemed if they no longer qualify as eligible regulatory capital. 66

70 23. Shareholders' equity Share capital Share capital is the funds raised as a result of a share issue and comprises the ordinary shares of the company. As detailed in the following table, the company has only one class of share in issue. Number of shares Share capital Share capital m m Ordinary shares of 125 cent each 20,000, The number of ordinary 125 cent fully paid-up shares is as follows: As at 1 January 1 1 Movement during year - - As at 31 December 1 1 Revaluation reserve The revaluation reserve comprises the unrealised gain or loss, net of tax on the revaluation of owner occupied properties. This is a nondistributable reserve. Retained earnings The company retained earnings include distributable and non-distributable earnings. 67

71 24. Analysis of equity and capital Capital management The company is regulated by the Central Bank of Ireland ("Central Bank") which sets and monitors regulatory capital requirements in respect of the company's operations. The company provides an annual return to the Central Bank under the European Communities (Life Assurance) Framework Regulations, A similar abbreviated return is submitted quarterly. The company s policy is to manage the capital base so as to meet all regulatory requirements while maintaining investor, creditor and market confidence and ensuring that there is adequate capital to support future growth in the business. In addition, the relationship between the level and composition of regulatory capital and the shareholders return on capital is monitored to ensure that there is an appropriate balance between equity and debt capital within the overall regulatory capital held. The regulatory capital requirements of the company is determined according to the European Communities (Life Assurance) Framework Regulations 1994 modified by the EU directive 2002/83/EC. The regulations set down the approach to be used to value the assets and liabilities and the calculation of the required solvency margin m m Total shareholders funds attributable to life assurance Adjustments to valuation of assets and liabilities to regulatory basis (68) (103) Subordinated liabilities Other assets available to cover solvency margin - 4 Regulatory capital before available dividend Proposed dividend (50) (65) Regulatory capital within after available dividend Held within the long-term business fund Held outside the long-term business fund Proposed dividend (50) (65) The amount of surplus declared from long-term business fund to shareholder fund was 51.0m (2011: 20.5m), the amount of surplus declared as bonuses for policyholder was 4.2m (2011: 1.1m). The surplus in the long-term business fund was 516.3m (2011: 441.8m). The solvency cover, before accounting for any available dividends, is 2.0 times (2011: 1.9 times before dividend, 1.8 times after dividend) the minimum requirement of 416m (2011: 402m). The directors consider this to be a conservative level of capital to manage the business having regard for the basis of calculating liabilities and the insurance and operational risks inherent in the underlying products. At 31 December 2012 the company had sufficient capital on a stand-alone basis and therefore no capital injections were expected to be needed in the future. Transfers of capital out of the company are subject to the company continuing to meet the regulatory capital requirements. Shareholder capital is principally invested in cash, debt securities and property. In November 2008 a stop-loss reinsurance treaty in relation to new business was signed with Swiss Re and the effect on regulatory assets is analysed below: m m Effect on regulatory assets Analysis of effect on regulatory assets: New business strain Expected return (55) (51) Experience variance The accounting treatment in the financial statements of this stop-loss reassurance treaty is not to show either the contingent asset or contingent liability on the statement of financial position as they offset each other but the reassurance fee of 4.1m (2011: 3.9m) for this treaty is accounted for in the income statement. 68

72 24. Analysis of equity and capital (continued) In 2010 Irish Life Assurance plc raised loan capital of 100m secured on the in-force book of business. The table below shows the early repayment of the loan, including interest and penalty charges, in The table below analyses the change in regulatory capital of ILA (net of tax) m m Regulatory capital within as at 1 January Capital generated from existing business - Expected return Experience variances Operating assumption changes (4) 16 New business strain (60) (57) Expected investment return 4 8 Short-term investment fluctuations - Direct shareholder property short-term investment fluctuations Other short-term investment fluctuations (1) (70) Effect of economic assumption changes 1 (28) VIF loan capital movements and costs - (115) Other (4) (18) Change in inadmissible assets Dividends paid (65) (143) Regulatory capital as at 31 December before available dividend Proposed dividend (50) (65) Regulatory capital as at 31 December after available dividend Best estimate assumptions are used to analyse the various components of the capital movements which are explained as follows: Capital generated on existing business which has three components: - Expected return: the capital which would arise if the existing business behaved in line with the begin year best estimate assumptions; - Experience variances: the capital arising because actual experience in the year differs from the begin year best estimate on mortality, morbidity, persistency, expenses and non-linked matching; and - Operating assumption changes: the effect on capital of changes to regulatory liability demographic and expense assumptions. These assumptions are reviewed regularly and are changed where appropriate in light of either current or expected experience. New business strain: when a life assurance contract is written significant acquisition costs are normally incurred up-front, these costs are then recovered through future charges. This up-front payment gives rise to a reduction in capital. Expected investment return: capital generated by the expected investment earnings on the net assets attributable to shareholders using the equity and property investment return begin year best estimate assumptions applicable at the start of the financial year. The expected investment earnings allow for interest payable on subordinated debt and the fee payable in relation to the stop-loss reassurance treaty. Short-term investment fluctuations: this is the effect on capital of the difference between the actual investment return achieved and the long-term investment return assumed for both policyholder and shareholder assets and includes impairments. Effect of economic assumption changes: this is the impact on capital of changes in economic assumptions excluding changes in nonlinked regulatory liability interest assumptions. 69

73 25. Financial risk management The company risk identification and assessment process has identified the following risks as being material to the operations of the Market risk Liquidity risk Credit risk Insurance risk Operational risk The company s approach to management of these risks is set out in the following pages. Risk management framework The Board of Directors approves overall policy in relation to the types and levels of risk that the company is permitted to assume in the implementation of its strategic and business plans. The Board Risk and Compliance Committee has responsibility for oversight and advice to the board on risk governance, the current risk exposures of the company and future risk strategy, including strategy for capital and liquidity management, and the embedding and maintenance throughout the company of a supportive culture in relation to the management of risk. The Board Risk and Compliance Committee supports the board in carrying out its responsibilities for ensuring that risks are properly identified, reported, assessed and controlled, and that the company's strategy is consistent with risk appetite. The Board Risk and Compliance Committee is responsible for monitoring adherence to risk appetite statements. Where exposures exceed levels established in appetite statements, the Board Risk and Compliance Committee is responsible for developing appropriate responses. The Board Risk and Compliance Committee, in turn, delegates responsibility for the monitoring and management of specific risks to committees accountable to it. These committees are the Irish Life Assurance Financial Risk Committee, the Group Operational Risk Committee and the Group Compliance Management Committee. The terms of reference for each committee, whose members include members of Group senior management, are reviewed regularly by the Board Risk and Compliance Committee. A. Market Risk (excluding credit risk) The company's investment and asset-liability management policies set out the principles in respect of the management of market risk. They are determined by the Irish Life Assurance plc ('ILA') board and are designed to ensure that investment activity is carried out in a prudent and controlled manner, consistent with risk appetite. They are subject to annual review and approval by the Board Risk and Compliance Committee with subsequent adoption by the ILA board. The policies take into account the differing requirements and risk profiles of different classes of policyholder funds, whether the investments are in respect of guaranteed or non-guaranteed business and the solvency and financial strength requirements of the life companies. Adherence to the policy is monitored by the Life Assurance Financial Risk Committee. The table below show a split of the assets of the company. The associated market risks are discussed in the following paragraphs. Unit-linked Company Exposure* Total Unit-linked Company Exposure* Total m m m m m m Cash and cash equivalents 3,555 1,094 4,649 2,599 1,164 3,763 Debt securities 6,669 2,516 9,185 5,810 2,145 7,955 Equities and units in unit trusts 12,559-12,559 11, ,817 Derivative assets Reinsurance asset 38 2,394 2, ,079 2,118 Investment properties 1, ,205 1, ,385 Other assets ,607 6,643 31,250 22,399 6,181 28,580 *The Company exposure column includes assets held within unit-linked cash funds where the company has provided a credit risk guarantee to policyholders (see section C. Credit Risk below). It does not include Company exposure to unit-linked funds with an investment guarantee (see note A(ii) below) or seed capital in unit-linked funds (see note A(iii) below). A(i) Unit-linked assets The company holds matching unit-linked assets in respect of the unit-linked liabilities, which comprise 91% (2011: 92%) of the company s long-term insurance and investment contracts net of reinsurance liabilities. Policyholders primarily bear the investment risk, with changes in the underlying investments being matched by changes in the underlying contract liabilities. The underlying assets in the unit-linked funds are subject to credit and market risks. Dependent on the specific fund, market risks include the effect of changes in interest rate, equity prices, foreign exchange rates and property values. Investment value changes are matched by changes in the unit-linked liabilities. Accordingly, in the absence of any issued investment guarantee, the company is not directly exposed to significant financial risk, although the policyholders' benefits will vary as a consequence. However, reduction of the capital value of unit-linked funds (e.g. as a result of a fall in market value of equities, property or fixed-interest assets) represents an indirect risk to the company as it will reduce the future annual investment management charges to be earned from the unit-linked business. 70

74 25. Financial risk management (continued) A. Market Risk (excluding credit risk) [continued] A(ii) Investment guarantees The company is directly exposed to market risks where investment guarantees have been issued to the unit-linked policyholder. The additional risk reflects the variation in the cost of the guarantee in line with the market performance of the guaranteed unit-linked funds. These investment guarantees are described further in Note 17. Financial options and guarantees. A(iii) Equity / property price risk Equity / property risk is defined as the risk to company earnings and capital associated with changes in the level or volatility of the market price of equities and property. The company's direct investments in equities and property include the investment properties noted in the table above, as well as owner-occupied property assets which are classified as property and equipment in the statement of financial position and in other assets in the above table. In addition, the company may provide seed capital for certain unit-linked funds. At 31 December 2012 the company held 29m (31 December 2011: 30m) in unit-linked equity and geared property funds and the company is directly exposed to price movements of the underlying assets. A(iv) Inflation risk The company is exposed to inflation risk in respect of insurance contract liabilities where the benefit is linked to a price inflation index. It is the company's policy to mitigate this risk by purchasing inflation-linked fixed interest assets. Perfect matching of assets with the underlying contract liabilities is not always possible. The investment opportunities for inflation-linked assets may be limited or may result in undesirable consequences regarding the matching of asset liquidity or term structures with underlying contract liabilities. In addition, product features such as benefit inflation caps may further contribute to imperfections between asset and liability matching. A(v) Derivative risk The company purchases derivative assets only as part of efficient portfolio management or in order to reduce risk. Derivatives usage is controlled via the application of the Irish Life Derivatives Policy which is subject to annual review and approval by the Board Risk and Compliance Committee with subsequent adoption by the ILA Board. All investment in derivatives is within the parameters set down by statutory requirements. There is periodic reporting of derivative positions to the Irish Life Assurance Financial Risk Committee. The derivative asset of 31m held within the non-linked assets as a Company exposure relates to an interest rate swap agreement which ILA purchased in order to hedge its interest rate risk relating to required coupon payments on its 200m nominal subordinate debt. The derivative has the effect of converting the required fixed rate coupon payment to a variable rate. A(vi) Interest rate risk The company is exposed to interest rate risk in relation to the non-linked insurance and investment contract liabilities, to the extent that the value of the assets held in respect of these liabilities does not move in line with the value of the liabilities. It is the company's policy to mitigate this risk by holding appropriate fixed interest and cash assets. This mitigation policy is monitored on a regular basis by the Life Assurance Financial Risk Committee. This risk is discussed further in Note 15. Investment contract liabilities, and Note 16. Life insurance contracts. A(vii) Currency risk The Group s life assurance liabilities are primarily denominated in euro and it is company policy to match the currency exposure of the liabilities and the underlying assets. However, the company is indirectly exposed to market movements in exchange rates via their potential effect on the capital value of unit-linked funds (as denominated in euro) and any possible reduction in the future annual investment management charges to be earned from such unit-linked business. B. Liquidity risk Amounts under unit-linked contracts are generally repayable on demand. Irish Life Investment Managers manage the associated assets to ensure there is sufficient liquidity to meet policyholder liabilities as they fall due. The main asset class with reduced liquidity within the unit-linked portfolio are property assets. For certain property linked funds there is the ability to defer encashments for up to six months to allow time to sell properties. If properties cannot be sold within this period then the company may have to provide liquidity for these funds. No such liquidity support was required at 31 December 2012 or 31 December The liquidity position of the property linked funds is monitored on a regular basis by the Irish Life Assurance Financial Risk Committee. The liquidity risk for non-linked liabilities is managed through purchasing assets which provide regular cash-flows that are utilised to meet expected liability outflows. Exact cash-flow matching is not targeted as the nature of certain liabilities mean that the interest rate exposures are best matched by holding assets with a longer duration than the best estimate of the liability cash-flows. Note 15. Investment contract liabilities and Note 16. Life insurance contracts, show profile of the expected liability cash-flows and the expected cash-flows from the backing assets. The company's policy is to hold assets that are listed in deep, publicly quoted markets (predominantly fixed interest assets such as government bonds) in respect of non-linked liabilities. This policy reduces any residual liquidity risk. In addition, the company holds a significant portion of its capital in deposits, which provides an additional source of liquidity under extreme scenarios. 71

75 25. Financial risk management (continued) C. Credit risk Credit risk is approved and managed in line with a set of clearly defined policy statements, which have been approved by the Board Risk and Compliance Committee and adopted by the Board. There are three principal sources of credit risk for the company: Debt securities: The company is exposed to credit risk to third parties where the company holds debt securities (including sovereign debt). The company has set individual counterparty limits for all investments in debt securities as well as aggregate concentration limits. Cash and cash equivalents (including Deposits with credit institutions): The company is exposed to credit risk where it places nonlinked assets on deposit with credit institutions. In addition, the company is exposed to credit risk in relation to 392m (2011: 472m) of deposits held within unit-linked funds where the company has provided a credit risk guarantee. The company has set individual counterparty limits for deposits with credit institutions as well as aggregate concentration limits. Reinsurance counterparty risk: The company is exposed to credit risk from its reinsurers since it remains liable for reinsured risks in the event that the reinsurer fails to meet its contractual obligations. Hence, in the event of a reinsurance counterparty failure, the company is at risk of financial loss from any increased cost of replacement reinsurance cover or funding costs for repatriated insurance liabilities. The company uses only reinsurers meeting minimum reinsurer financial strength ratings. New reinsurance treaty selection is subject to approval from the Irish Life Financial Risk Committee who regularly monitor reinsurer financial strength ratings and the effectiveness of reinsurance programmes. Reinsurance counterparty risk is managed through the company s reinsurance strategy. The reinsurance strategy is established by the Irish Life Financial Risk Committee, approved by the Board Risk and Compliance Committee and adopted by the Irish Life Assurance plc Board. Maximum exposure to credit risk net of collateral held: As at 31 December 2012 Aaa Aa A Baa Ba Unrated Total Company Exposure Cash and cash equivalents ,094 Debt securities 891 1, ,516 Reinsurance assets* Total shareholder 891 1,896 1, ,436 * Net of 1,568m of collateral held in charged accounts in relation to annuity reinsurance contracts. As at 31 December 2011 Aaa Aa A Baa Ba Unrated Total Company Exposure Cash and cash equivalents ,164 Debt securities 1, ,145 Reinsurance assets* Total shareholder 1,735 1, ,971 * Net of 1,417m of collateral held in charged accounts in relation to annuity reinsurance contracts. The following table discloses, by country, the company's exposure to sovereign and corporate debt. Credit Ratings Sovereign debt Corporate debt Sovereign debt Corporate debt m m m m Country* Ireland Ba Ba Germany Aaa Aaa France Aa Aaa 1, Italy Baa A Spain Baa A Austria Aaa Aaa Finland Aaa Aaa Netherlands Aaa Aaa United Kingdom Aaa Aaa Other Worldwide Countries Total 2, , * This table excludes 119m of loans to a subsidiary company secured on a property. In 2011 there was an additional Company exposure to corporate debt of 55m invested in a corporate debt unit trust which was classified in the Statement of financial position as equity. 72

76 25. Financial risk management (continued) C(i) Reinsurance The company cedes insurance and investment risk to a number of reinsurance companies. There are three main categories of reinsurance assets as set out below. The assets held in a charged account are in respect of reinsurance treaties for annuity business, where all withdrawals from the charged account have to be authorised by ILA. Assets are managed in accordance with a mandate which matches the assets and liabilities. Assets where credit risk is borne by the policyholders relate to unit-linked investment contracts where the policy documents specify that the return to the policyholder is based on the return from the reinsurance companies. Reinsurance counterparty risk is managed through the company's reinsurance strategy. The reinsurance strategy is established by the Irish Life Financial Risk Committee, approved by the Board Risk and Compliance Committee and adopted by the Irish Life Assurance plc board. The company regularly reviews the financial security of its reinsurance counterparties. strength rating varies by the category of business to be reinsured. The required minimum reinsurer financial Since 2002 the company has entered into a number of reinsurance arrangements to reduce its exposure to longevity risk on its annuity business, including reinsuring a portion of its existing book in From 2002 to 2009 the reinsurance also transferred the investment risk on the backing assets to the reinsurance counterparty and as such a significant transfer of assets to the reinsurers took place. The associated credit risk to these reinsurers was mitigated by requiring the reinsurers to post the assets to charged accounts, from which ILA can restrict withdrawals by the reinsurers. These collateral accounts are regularly valued and compared to the liabilities, and the accounts are topped up or may be reduced by the reinsurers upon agreement by ILA. The following tables show an analysis of the company's credit exposure relating to reinsurance assets m m Reinsurance assets where credit risk is mitigated through collateral held in charged accounts 1,542 1,443 Reinsurance assets where credit risk is borne by policyholders Other reinsurance assets where credit risk is borne by the company Total Reinsurance assets 2,432 2,118 The reinsurance assets, where credit risk is borne by the company and not mitigated through collateral arrangements, are broken down by credit rating of the counterparty as follows: m m Aa A Total Reinsurance assets where credit risk is borne by the company D. Insurance risk Insurance risk is the risk associated with the variability in liability cash flows caused by fluctuations in policyholder claims under insured events. Insurance risk also includes the risk from changes in policyholder lapse and expense rates. The theory of probability is applied to the pricing and provisioning for a portfolio of insurance contracts. The principal risks are that the frequency of claims or the severity of claims is greater than expected. Insurance events are random by their nature and the actual number and size of events during any one year may vary from those estimated using established statistical techniques. The company manages its insurance risk through strict application of underwriting standards (which includes strict underwriting and retention limits for new business), regular monitoring of insurance risk experience against that assumed in pricing and provisioning models and approval procedures for new products and reinsurance arrangements that are enshrined in Board-approved risk policies. The assumptions used to place a value on the liabilities of insurance contracts and the sensitivity of these assumptions to a range of factors is set out in Note 16. Life insurance contracts. Insurance risk falls into three main categories: - Mortality and Morbidity risks on life assurance contracts; - Longevity risks on annuity contracts; and - Morbidity risks on income protection contracts. D(i) Life Assurance contracts These are contracts where the benefit is payable on death or serious illness. The benefit may be a lump sum or in the case of serious illness an annual income stream which may be fixed or escalate at a fixed rate or in line with a relevant index. Insurance risks associated with life insurance contracts include the risk of epidemics, accidents and changes in lifestyle such as smoking habits and stress-related diseases. 73

77 25. Financial risk management (continued) D(i) Life Assurance contracts (continued) Life assurance contracts may be unit-linked or non-linked. For unit-linked contracts the company charges for the insured risk on a monthly basis and has the right to alter these charges based on its risk experience. In this way the company can limit its exposure. Nonlinked business may be group business or individual contracts. Group business is normally written for a maximum of a three-year term and the insurance risk may be repriced at the end of each term. For individual business written for a fixed term there are no mitigating terms and conditions which reduce the insurance risk. Individual business risk is managed through the inclusion of medical selection in the underwriting criteria and through reinsurance of the risk. The sum-at-risk amounts net of reinsurance are as follows: m m Unit-linked contracts 7,677 8,604 Non-linked contracts - Individual 15,118 15,980 - Group 31,943 35,170 The calculation of the insurance contract liabilities allows for the discounted expected cost of the sum at risk amounts shown above using mortality and morbidity assumptions and interest rate assumptions as shown in Note 16(b), Life insurance contracts. D(ii) Annuity contracts These are contracts where the policyholder, in return for a single premium paid at the start of the contract, purchases an annual income stream for the remainder of his or her life. Annuities may be level, escalate at a fixed rate or in line with a relevant index. Payments are often guaranteed for a minimum term regardless of survival. Annuities may also continue after death, in full or in part, to a surviving partner. The main insurance risk associated with this product is longevity risk and in particular that improvements in medical science and social conditions would increase longevity. In recognition of this risk, in 2002 the company decided to reinsure 57% of the in force portfolio of annuity contracts. All new annuity business written between 2002 and 2009 was 100% reinsured. Under the reinsurance treaties, longevity risk is borne by the reinsurance companies. Assets are held by the reinsurance companies in charged accounts, all withdrawals from which have to be authorised by ILA. Assets are managed in accordance with a mandate which matches the asset and liabilities. Since 2009 the longevity risk on new annuity business is 85% reinsured, with 15% retained by ILA. The backing assets are held by ILA and are not transferred to the reinsurance company. The reserves held for annuity contracts are as follows: m m Gross 2,929 2,584 Reinsurer s share (1,543) (1,440) 1,386 1,144 D(iii) Income Protection contracts Income protection contracts pay benefits to policyholders who are incapacitated and hence unable to work due to illness or accident. A claimant's capacity to work is assessed at various times during the claims management cycle from claim acceptance through to termination. Assistance may be offered to claimants to help the policyholder return to full or part time work. The reserves held for income protection are as follows: m m Gross Reinsurer s share (27) (21) E. Operational risk Operational risk throughout the company is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The company operates an industry best practice operational risk framework which includes the measurement and monitoring of both operational and regulatory risk. The aim of this framework is to help focus management attention on the subset of operational risks which are material at each level of the organisation (either in terms of financial impact, or more broadly because of reputational or regulatory impacts). 74

78 25. Financial risk management (continued) E. Operational risk (continued) Central management, and each of the business units within the company, identify the material operational risks to which they are exposed. The identification process is based on a detailed review of business activities, supplemented by reference to external industry information. Each business unit has a designated operational risk manager who is responsible for coordinating operational risk management within that business unit. The local management team of each business unit is responsible for reviewing and authorising the register of the main operational risks for each business unit on an annual basis. The company operational risk framework utilises the business unit operational risk registers to identify the company s material operational risks. Materiality is determined through a quantitative and qualitative assessment of each risk by reference to its likelihood of incidence and potential impact. These material operational risks are regularly reported to the Group Operational Risk Committee and the Board Risk and Compliance Committee. The Group Operational Risk Committee is responsible for steering progress on the measurement and mitigation of these risks. Key risk indicators are used to carry out this monitoring process. A sub-register of significant operational risks at business unit level is also maintained by the company. Each of the business units (or group function as appropriate) manages and monitors these operational risks to company requirements. The company applies the formal, documented Operational Risk Policy which has been approved by the Board Risk and Compliance Committee and adopted by the Board. E(i) Operational risk recording The company operates an industry best practice risk and event recording database. The database is managed by the Group Operational Risk function and records all operational risk (including risks arising from changes in regulation and regulatory compliance issues) events and near misses across the Group. Significant risk events and their associated impact are considered by the Group Operational Risk Committee. The operational risk database generates risk reports for review at Group Operational Risk Committee meetings. Database reports support quantitative and qualitative analysis of operational risk loss events and near misses by ILA's individual business units. F. Impairment of financial assets The company's policy on valuing financial assets is outlined in Note 26. Fair value of financial instruments. As outlined in that note the company carries all financial assets at fair value, which is defined as the amount for which the asset could be exchanged in an arms length transaction between knowledgeable and willing parties. This approach means that the carrying value reflects the market view of any impairment which should be applied to the asset's value. In light of this approach the company does not apply any further impairment adjustments to the carrying value of its financial assets. G. Sensitivity Analysis The table below shows the impact on the pre-tax profits and on the company equity from a number of scenarios. The impact on the company equity includes an allowance for tax. The results are based on a change in one assumption while holding all other assumptions constant. In practice this is unlikely to occur and changes in assumptions may be correlated. The sensitivity shown for a change in mortality and morbidity rates assumes a permanent change in experience in all future years. The future impact of this is capitalised through an increase in the insurance contract liabilities and thus is immediately recognised within the income statement. Impact on profit before tax Impact on total equity Sensitivity test m m 10% decrease in property values 10% decrease in equity values 10% fall in renewal expenses 1% fall in interest rates Permanent 5% decrease in mortality & morbidity rates* (23) (23) (12) (11) 10 9 (16) (14) *The impact on profit includes a loss of 18m relating to annuity contracts where a permanent reduction in assumed future mortality rates will lead to an increase in the value of insurance contract liabilities. 75

79 26. Fair value of financial instruments The company's accounting policy on valuation of financial instruments is described in Note 1, Basis of preparation and significant accounting policies. The fair value of a financial instrument is defined as the amount for which an asset could be exchanged, or a liability settled, in an arms length transaction between knowledgeable and willing parties. Where possible, the company calculates fair value using observable market prices. Where market prices are not available, fair values are determined using valuation methodologies as outlined below. These techniques are subjective in nature and involve assumptions which are based upon management's view of market conditions at the period end which may not necessarily be indicative of any subsequent fair value. Furthermore, minor changes in the assumptions used could have a significant impact on the resulting estimated fair values and as a result, readers of these financial statements are advised to use caution when using this data to evaluate the company's financial position. The fair value of financial instruments held by the company is set out below: Carrying amount Fair value Carrying amount Fair value m m m m Financial assets: Cash and cash equivalents (note 3) 4,649 4,649 3,763 3,763 Debt securities (note 4) 9,185 9,185 7,955 7,955 Equity shares and units in unit trusts (note 5) 12,559 12,559 11,817 11,817 Derivative assets (note 6) Amounts due from group companies (note 11) Financial liabilities: Loans and borrowings (note 14) Derivative liabilities (note 6) Investment contract liabilities (note 15) 24,287 24,287 22,153 22,153 Subordinated liabilities (note 22) Amounts due to group companies (note 18) The volatility in financial markets and the liquidity that is evident in these markets creates a difficulty in determining the fair value of certain assets and laibilities. The valuation methodologies for calculating the fair value of financial instruments are set out below. Cash and cash equivalents The fair value of these financial instruments is equal to their carrying value due to these instruments being repayable on demand and short-term in nature. Debt securities at fair value through profit or loss ('FVTPL') The fair values of debt securities in an active market are based on quoted market prices. Debt securities in inactive markets are determined using broker valuations and / or valuation techniques such as discounted cash flow models which are subject to internal management review. Such models incorporate inputs such as current interest rate, credit spreads and forward foreign exchange rates. The bulk of debt securities are sourced from quoted market prices. Management review the source of the market prices, the liquidity of the security, the credit risk and recent market history to assess the reasonableness of the valuations. The significant categories of debt securities where fair value valuations are not obtained using quoted market prices are as follows: (a) (b) (c) (d) (e) Zero coupon bonds amounted to 602m (2011: 372m). As at 31 December 2012, 482m (2011: 372m) of such bonds are classified as level 2 in the fair value hierarchy below. Valuations are determined by a discounted cash flow model produced by a third party system. Model inputs include bond cash flows, interest rates and term to maturity, all of which are market observable data. 120m (2011: nil) of these bonds are classified as level 3 as the price is obtained from the counterparty who uses both observable and unobservable inputs in their pricing models. French government strip bonds amounted to 787m (2011: 642m). As at 31 December 2012, such bonds are classified as level 2 in the fair value hierarchy below. Valuations are obtained from a third party broker who extracts the valuation from their proprietary model. Model inputs include bond cash flow, interest rates and credit spreads which are market observable data. Housing finance agency inflation-linked bond amounted to 56m (2011: 44m). As at 31 December 2012, these transferred from level 2 classification to level 3 due to the assessment of the reduction in the liquidity of these bonds during the year. Valuations are obtained from a third party broker market maker. European investment bank inflation-linked notes amounted to 514m (2011: 453m). As at 31 December 2012, these notes are classified as level 3 in the fair value hierarchy below. Valuations are obtained from an external broker using a valuation technique incorporating significant inputs, some of which are market unobservable data. Such inputs include a discount to reflect the lack of liquidity in the market for these instruments. Sovereign amortising bonds amounted to 54m (2011: nil). As at 31 December 2012, these bonds are classified as level 2 in the fair value heirarchy below. Valuations are obtained from an external broker using a valuation technique that incorporates the price of new issues of these bonds and the yield spread on Government bonds. 76

80 26. Fair Value of financial instruments (continued) Equity shares and units in unit trusts The fair value of quoted equities are based on quoted market prices sourced from external pricing services where securities are traded on a recognised exchange. Equity investments valued using quoted market prices totalled 12,215m (2011: 11,431m) out of a total balance of 12,559m (2011: 11,817m). The net asset value ("NAV") based on the best approximation of the underlying fair value of the investments of the unit trusts and funds, as reported by the investment managers has been used as the basis for determining the fair value of the company's interest in units trusts and funds. Therefore units in unlisted unit trusts and unlisted investment funds are valued using the latest price or valuation issued by unit trust and fund managers. Each unit trust price is reviewed by management to assess the reasonableness of the price. Management considers the illiquidity and pricing basis of any underlying assets, any restrictions on redemptions put in place by the unit trust and fund managers and evidence of trading taking place at the issued price. If appropriate the latest price or valuation issued by the unit trust and fund managers is adjusted to reflect the illiquidity or latest valuations of underlying assets. The significant categories of equity shares and units in unit trusts where fair value valuations are not obtained using quoted market prices are as follows: (a) (b) (c) Units in unit trusts that are not priced or traded on a daily basis amounted to 171m (2011: 113m). As at 31 December 2012, these units are classified as level 2 in the fair value hierarchy below since the units are priced and traded by the investment manager on a monthly basis. Units held in a property unit trust amounted to 108m (2011: 189m). As at 31 December 2012 and 2011, these units are classified as level 2 in the fair value hierarchy below since the units are priced and traded by the investment manager on a monthly basis. Unlisted shares held in private companies amounted to 6m (2011: 21m). As at 31 December 2012, these shares were classified as level 3 in the fair value hierarchy below. These valuations are prepared internally using the most recently available financial information for the companies, which are market unobservable data. Derivative assets and liabilities The fair values for derivatives traded in active markets are obtained from prevailing quoted prices. Active markets would include all exchange traded equity, currency and commodity futures, quoted on recognised futures and derivative exchanges. Derivatives in inactive markets are determined using broker valuations and / or valuation techniques such as discounted cash flow models which are subject to internal management review. Such models incorporate inputs such as current interest rate, time to maturity and forward foreign exchange rates. Observable prices model inputs are usually available in the market for exchange-traded derivatives (primarily options) and simple over the counter derivatives such as interest rate swaps. The significant categories of derivatives where fair value valuations are not obtained using quoted market prices are as follows: (a) Derivative instruments relating to CPPI products amounted to 481m (2011: 700m). As at 31 December 2012, 469m (2011: 688m) of these instruments was classified as level 2 in the fair value hierarchy below. Valuations are obtained from a third party broker who extracts the valuation from their proprietary model. This uses a standard option pricing model comprising Monte-Carlo simulation and discounted cash flows. Significant inputs include the Pensions Consensus Fund ('PCF') value, the risk free rate and cash returns. 12m (2011: 12m), being the option element of CPPI, was classified as level 3 as valuations are obtained from third party brokers who uses non-observable inputs to determine the price. (b) (c) (d) Options used in tracker products amounted to 37m (2011: 26m). As at 31 December 2012, these options are classified as level 3 in the fair value hierarchy below. These options are valued by a third party broker based on a valuation model incorporating proprietary inputs, some of which are not market observable data. Currency forward assets amounted to 18m (2011: 30m) and currency forward liabilities amounted to 19m (2011: 29m). As at 31 December 2012, these forwards are classified as level 2 in the fair value hierarchy below. Market rates used to price the forwards are received from a third party provider daily. Interest rate swap liabilities amounted to 3m (2011: 4m). As at 31 December 2012, these instruments were classified as level 2 in the fair value hierarchy below. These are valued using deposit futures rates and the Euro swap curve both of which are market observable. Loans and Borrowings The fair value of loans and borrowings has been assessed as approximating their carrying value. For non-recourse loans and borrowings with a Loan to Value ("LTV") of greater than 100% the carrying value has been set equal to the collateral value of the property on which these loans are secured. For non-recourse loans and borrowings with a Loan to Value ("LTV") of less than 100% the company considers that the carrying value approximates fair value given the average maturity profile of this portfolio of loans. Fair value measurements recognised in the statement of financial position In accordance with IFRS 7, Financial Instruments: Disclosures, the company has adopted the fair value hierarchy classification of financial instruments. This requires the company to classify its financial instruments held at fair value according to a hierarchy based on the significance of the inputs used to arrive at the overall fair value of these instruments. The three levels of the fair value hierarchy as defined by the accounting standard are outlined below: Level 1: fair value measurements derived from quoted market prices (unadjusted) in active markets for identical assets or liabilities. Level 2: fair value measurements derived from inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly (i.e. as prices) or indirectly (i.e. derived from prices). Level 3: fair value measurements derived from valuation techniques that include inputs for the asset and liability that are based on unobservable market data. 77

81 26. Fair Value of financial instruments (continued) This fair value hierarchy has been applied to all of the financial instruments that are measured at fair value in the statement of financial position. Categorisation of these financial instruments according to the fair value hierarchy is included below as at year end: 31 December 2012 Valuation Valuation Quoted techniques using techniques using market observable unobservable prices market data market data Level 1 Level 2 Level 3 Total Financial instruments measured at fair value m m m m Financial assets Debt securities At fair value through profit and loss ("FVTPL")(note 4) 7,023 1, ,185 Equity shares and units in unit trusts (note 5) 12, ,559 Derivative assets Financial liabilities Derivative liabilities Investment contract liabilities * (note 15) - 24,287-24, December 2011 Valuation Valuation Quoted techniques using techniques using market observable unobservable prices market data market data Level 1 Level 2 Level 3 Total Financial instruments measured at fair value m m m m Financial assets Debt securities At fair value through profit and loss ("FVTPL")(note 4) 6,257 1, ,955 Equity shares and units in unit trusts (note 5) 11, ,817 Derivative assets Financial liabilities Derivative liabilities Investment contract liabilities * (note 15) - 22,153-22,153 * Investment contract liabilities are backed by assets attributable to the life operations including assets which are carried at FVTPL which are measured at quoted market prices and valuation techniques using observable market data. Reconciliation of level 3 fair value measurements of financial assets 31 December 2012 Debt Equity shares securities and units in Derivative at FVTPL unit trusts assets Total m m m m Opening balance Total gains or losses - in profit or loss - Investment return 63 (9) Other comprehensive income Transfers into level Transfers out of level Sales (15) (8) (7) (30) Purchases Total gains or losses for the year included in profit or loss for assets held at the end the reporting period. - Investment return

82 26. Fair Value of financial instruments (continued) 31 December 2011 Debt Equity shares securities and units in Derivative at FVTPL unit trusts assets Total m m m m Opening balance Total gains or losses - in profit or loss - Investment return 88 (6) (32) 50 Sales (87) (5) (2) (94) Purchases Total gains or losses for the year included in profit or loss for assets held at the end the reporting year. - Investment return 71 (11) (22) 38 Sensitivity analysis of level 3 fair value measurements (non unit-linked funds) Financial instruments classified as level 3 amounting to 82m (2011: 41m) of a total balance of 745m (2011: 512m) include debt securities and equities which are not held within unit-linked funds in respect of the company's life operations. Debt securities at fair value through profit or loss (FVTPL) For European investment bank inflation-linked notes not held within unit-linked funds of 36m (2011: 31m) and Housing Finance Agency notes of 46m (2011: nil) not held within unit-linked funds, the fair value of such notes are sensitive to changes in the underlying assumptions (inflation expectations, nominal yields and credit spreads). The following table shows the sensitivity of the fair value of these notes to a +1% / -1% movement in the assumptions respectively as at period end: 2012 Reflected in income statement Favourable Unfavourable change change m m Debt securities at FVTPL - Inflation expectations 10 (8) - Nominal yields 8 (7) - Credit spreads 8 (7) 2011 Reflected in income statement Favourable Unfavourable change change m m Debt securities at FVTPL - Inflation expectations 8 (6) - Nominal yields 6 (5) - Credit spreads 6 (5) Sensitivity analysis of level 3 fair value measurements (unit-linked funds) Financial instruments classified as level 3 include 663m (2011: 471m) of a total balance of 745m (2011: 512m) include debt securities, equity shares and units in unit trust and derivative assets, which are held within unit-linked funds in respect of the company's life operations. For unit-linked funds, any fair value changes in unit-linked assets are matched by changes in unit-linked liabilities. Debt securities at fair value through profit or loss (FVTPL) For European investment bank inflation-linked notes held within the unit-linked funds of 478m (2011: 422m) and Housing Finance Agency notes of 10m (2011: nil) held within the unit-linked funds the valuations were obtained from the external broker who is the principal market maker for these instruments. Inputs included discounts for lack of liquidity in the market. All other inputs to the valuation are market observable. Hence the fair value of such notes is sensitive to changes in the underlying assumptions (inflation expectations, nominal yields and credit spreads). The details of the sensitivity are set out below. As these are unit-linked assets there is no impact on the income statement for the overall company for a change in the underlying assumptions A 1% favourable /unfavourable move in the inflation expectations would have a valuation effect of 165m / ( 121m) (2011: 146m / ( 107m)) on unit-linked assets and liabilities and no impact on shareholder values. A 1% favourable /unfavourable move in credit spreads would have a valuation effect of 135m / ( 102m) (2011: 119m / ( 90m)) on unit-linked assets and liabilities and no impact on shareholder values. A 1% favourable /unfavourable move in nominal yields would have a valuation effect of 135m / ( 102m) (2011: 119m / ( 90m)) on unit-linked assets and liabilities and no impact on shareholder values. 79

83 26. Fair Value of financial instruments (continued) Equity shares and units in unit trusts The equity shares classified as level 3 include 6m (2011: 11m) that consist of a number of unquoted companies held in unit-linked wrapper funds. Valuations were based on the most recently available financial information for these companies and possible alternative assumptions would not have had a material impact on the valuations. Derivative assets Derivatives of 37m (2011: 26m) in respect of options used in tracker products and 12m (2011: 12m) being the option element of CPPI were classified in level 3. The valuations were obtained from a third party broker who values the options using a model with proprietary inputs. The brokers provide regular valuations throughout the year. Historically trades have been executed at values very close to the most recent valuation quote. Therefore the directors do not believe that alternative assumptions give a reasonable alternative valuation, although future equity growth would impact the value of the derivatives. 80

84 27. Measurement basis of financial assets and liabilities The table below analyses the carrying amounts of the financial assets and liabilities by accounting treatment and by statement of financial position classification At fair value through profit or loss Derivatives Loans and Fair value designated Held Designated receivables / adjustment on Investment as fair value for upon initial payables hedged assets contract hedges trading recognition amortised cost and liabilities** liabilities *** Total m m m m m m m Financial assets: Cash and cash equivalents (note 3) - - 4, ,649 Debt securities (note 4) - - 9, ,185 Equity shares and units in unit trusts (note 5) , ,559 Derivative Assets* (note 6) Total financial assets , ,964 Financial liabilities: Loans and borrowings (note 14) Derivative liabilities (note 6) Investment contract liabilities*** (note 15) ,287 24,287 Subordinated liabilities (note 22) Total financial liabilities ,287 25,026 81

85 27. Measurement basis of financial assets and liabilities (continued) 2011 At fair value through profit or loss Derivatives Loans and Fair value designated Held Designated receivables / adjustment on Investment as fair value for upon initial amortised hedged assets contract hedges trading recognition cost and liabilities** liabilities *** Total m m m m m m m Financial assets: Cash and cash equivalents (note 3) - - 3, ,763 Debt securities (note 4) - - 7, ,955 Equity shares and units in unit trusts (note 5) , ,817 Derivative Assets* (note 6) Total financial assets , ,326 Financial liabilities: Loans and borrowings (note 14) Derivative liabilities (note 6) Investment contract liabilities*** (note 15) ,153 22,153 Subordinated liabilities (note 22) Total financial liabilities ,153 22,946 * The 540m reported in the held-for-trading assets category (2011: 766m) are assets held for the benefit of policyholders and to match tracker bond liabilities. ** Financial assets and liabilities that are part of a hedging relationship are carried at amortised cost adjusted for changes in the fair value of the hedged risk. *** Investment contract liabilities are backed by assets attributable to the life operations including assets which are carried at FVTPL. 82

86 28. Current / non-current assets and liabilities The following tables provide an analysis of certain asset and liability line items that include amounts expected to be recovered or settled no more than twelve months after the financial position date (current) and more than twelve months after the financial position date (non-current) Current Non-current Total Current Non-current Total m m m m m m Assets Cash and cash equivalents (note 3) 4, ,649 3, ,763 Debt securities (note 4) 256 8,929 9, ,590 7,955 Investment properties (note 7) 27 1,178 1,205-1,385 1,385 Derivative assets (note 6) Other assets (note 11) Liabilities Loans and borrowings (note 14) Derivative liabilities (note 6) Subordinated liabilities (note 22) Other liabilities (note 18) The maturity profiles of investment contract liabilities and insurance contract liabilities are disclosed in Note 16, Investment contract liabilities, and Note 17, Life insurance contracts. 83

87 29. Premiums on insurance contracts m m Analysed by class of business: Individual premiums Recurring Single Premiums under group contracts Recurring Single Analysed by type of contract: Unit-linked contracts Non-linked contracts Analysed by geographic area: Ireland

88 30. Investment return Financial assets designated at FVTPL m m Equity shares Dividends Fair value and exchange gains/(losses) * 1,414 (1,082) 1,739 (756) Debt securities Interest Fair value and exchange gains * 1, , Exchange losses on debt securities / equity shares - (6) Total investment return on financial assets designated at FVTPL 3,016 (252) Derivatives designated as held-for-trading ("HFT") Expenses (1) (1) Fair value and exchange (losses)/gains (11) 16 (12) 15 Property market / deposits with credit institutions Income from investment properties Interest Fair value losses on investment property (107) (119) Other fair value and exchange gains Total investment return 3,109 (147) Total investment return Income from investment properties Dividends Interest Income from derivatives (1) (1) Fair value and exchange gains/(losses) * 2,332 (938) Total investment return 3,109 (147) *In 2012 exchange gains/(losses) have been categorised separately within equity shares and debt securities asset classes. 85

89 31. Claims on insurance contracts m m Claims paid Change in outstanding claims (4) Reinsurance Claims paid (226) (176) Change in outstanding claims 6 (11) (220) (187) Net claims on insurance contracts Analysed by type of claim: Death and disability benefit Maturities Encashments and commutations: Individual policies Group policies 12 6 Annuities Net claims on insurance contracts

90 32. Expense analysis (A) Acquisition costs and other administrative expenses m m Acquisition expenses Acquisition commission Changes in deferred acquisition costs - Insurance (4) (3) Changes in deferred acquisition costs - Investment Renewal expenses Renewal commission Acquisition costs and other administrative expenses Depreciation 7 10 Amortisation of other intangible assets 3 4 Amortisation of purchased interest in long-term business Acquisition costs and other administrative expenses are after charging the following: Operating lease rentals - land and buildings The following represent the fees included in the Income Statement for services provided by the Group auditors (excluding VAT) to the company: m m - Audit of financial statements Other assurance services Tax advisory services Other non-audit services (B) Investment expenses m m Expenses relating to investment properties Other investment expenses Investment property expenses include 4m (2011: 4m) in respect of vacant properties. 87

91 33. Interest on loans and borrowings m m Interest payable Interest on subordinated debt 4 5 Interest on unit-linked borrowed funds Interest on other borrowed funds Interest on other borrowed funds for 2012 includes nil (2011: 18m) interest on the loan secured on the value of the in-force book of business. This includes interest up to the date of repayment of the loan of nil (2011: 5m), amortisation of an upfront fee on the loan of nil (2011: 9m) and early repayment interest of nil (2011: 4m). 88

92 34. Employment costs m m Staff costs (including executive directors) for the year were: Wages and salaries* Social insurance Pension costs - Payments to defined contribution pension schemes Charge incurred in respect of defined benefit pension schemes (note 13) Contributions to PRSA schemes Charged to income statement * Including commission paid to sales staff * Wages and salaries exclude restructuring costs of Nil (2011: 11m) incurred during the year. Average number of staff (including executive directors) employed during the year: Ireland 432 1,334 Life assurance staff numbers include direct sales staff whose contracts had been seconded to the banking subsidiary of the company's ultimate former parent (to enable them to sell both life and banking products) and Bancassurance staff who had contracts of employment directly with the banking subsidiary but are under the control of Life Assurance management. All staff costs relating to these staff are reimbursed by the life assurance company and are included above. On 1 December 2011, in preparation for the separation of the company from its former parent, permanent tsb plc, these employees formerly redeployed to the company. Life assurance costs also include group human resources and group IT costs which are partly recovered by charge-outs to the company's ultimate former parent's banking subsidiary. On 1 December 2011 staff in the Retail division of the company, transferred into Irish Life Financial Services Limited ("ILFS") under Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). From 1 December 2011 the management and operations of the Retail division of the company were outsourced to ILFS under a services agreement. 35. Share based payments The company participated in the share option scheme operated by its former ultimate parent permanent tsb, prior to its separation on 29 June On the date of separation all outstanding permanent tsb group holding plc share options granted to company employees either lapsed or were forefeited. The number of share options allocated to company employees at the end of 2011 which subsequently lapsed or were forefited was 1,062,984. The company does not operate a share option scheme. 89

93 36. Taxation (A) Analysis of taxation charge Taxation charged to income statement m m Current taxation Charge for current year 11 3 Adjustments for prior periods (1) (5) 10 (2) Deferred taxation Origination and reversal of differences 6 6 Adjustment for prior periods (1) (2) Taxation charged to income statement 15 2 (B) Reconciliation of standard to effective tax rate m m Operating Profit Tax calculated at standard ROI corporation tax rate of 12.5% 16 7 Adjustment to tax charge in respect of previous years (2) (7) Different basis of tax for ROI life assurance (1) 1 Tax related to policyholder 1 1 Non-deductible expenses (C) Tax effects of each component of other comprehensive income 2012 Gross Tax Net m m m Revaluation of property (3) - (3) Actuarial (losses)/gains on defined benefit pension schemes (22) 3 (19) (25) 3 (22) 2011 Gross Tax Net m m m Revaluation of property (4) - (4) Actuarial (losses)/gains on defined benefit pension schemes (32) 4 (28) (36) 4 (32) 90

94 37. Business combinations Following an application to the High Court, on 16 September 2012 (date of acquisition) Irish life Assurance plc was granted permission to acquire 100% interest in the assets associated with c. 4,000 investment policies from Quinn Life Direct Limited ('QLDL'). The acquisition is consistent with ILA's policy to focus on the Irish life and investment market and further enhances ILA's customer base. This acquisition of primarily unit-linked investment policies was for a consideration of nil but at the acquisition date ILA assumed the responsibility for all the liabilities associated with the policies, which, at the date of acquisition, was estimated to be 100m or 3.2m lower than the fair value of the assets acquired. Consistent with IFRS 3, Business Combinations, this 3.2m has been capitalised as an intangible (see Note 10, Purchased interest in long-term business and other intangible fixed assets) and is being amortised over 8.25 years which represents the pattern in which the asset s future economic benefits are expected to be consumed. The assets and liabilities of QLDL acquired during 2012 have been fully integrated within the Group's life assurance segment and it is therefore impractical to separately assess the impact of the acquisitions on the results of the Group apart from the forementioned amortisation of the purchased interest in long term business. Acquisition related costs, which are estimated to be 1.75m, are recoverable from QLDL's parent, Quinn Financial Services Holding Limited ("QFS"). These expenses are being held on the Statement of Financial Position as a receivable at 31 December Identifiable assets acquired and liabilities assumed at the date of acquisition Total m Assets Notes Cash and cash equivalents 3 8 Debt securities 4 7 Equity shares and unit in unit trusts 5 - Equities 38 - Exchange traded funds 50 Purchased interest in long-term business 10 3 Liabilities Investment contract liabilities 15 (103) Fair value of identifiable net assets* 3 Consideration - Gain recognised in income statement at date of acquisition** 3 *This amount has been recognised in the Statement of Financial Position as described in Note 10 (Purchased interest in long-term business and other intangible fixed assets) **This amount has been recognised in "Fees, commission, and other income" in the Income Statement 91

95 38. Commitments and contingencies (A) Commitments The company has entered into capital commitments in respect of venture capital funds of 4m (2011: 6m). The company has notified its intention to redeem units in an external property fund of 5m (2011: 6m). The company has committed 1.4m (2011: 1.9m) to refurbish or develop investment properties in its portfolio. (B) Contingencies In the course of conducting insurance and investment business the company receives liability claims, and becomes involved in actual or threatened related litigation. In the opinion of the Board, adequate provisions have been established for such claims. Based on legal advice, the Board does not believe that any such litigation will have a material effect on the company s profit or loss and its financial position. In 2009 Irish Life Assurance (ILA) was notified by the Central Bank of Ireland that it was commencing an investigation into the background to certain deposits placed by ILA with Anglo Irish Bank in 2008 when ILA was part of the IL&P Group. While there were no developments of note in respect of this matter in 2012 from ILA s perspective, the company s understanding is that the investigation remains open. The company has provided rental guarantees to certain property funds whereby the company would be liable for rent due to these funds in the event of the properties being vacant. Other than those lease commitments provided for as detailed in Note 19, Provisions, the company does not believe that any further liability will have a material effect on its profit or loss and financial position. Early in 2012 it was agreed between specific tenants and the owners of an investment property which the company receives a rental revenue stream to appoint an arbitrator. The arbitrator is to examine whether the tenants petition to apply back dated downward rent reviews should be awarded. The arbitrator was agreed and appointed by both sides by the end of A date for the arbitration process was not agreed by year end. Where an outcome from the arbitration process favours the tenants petition; this would give rise to a liability for the company. However, as the existence of the obligating event is in dispute and the outcome is unknown and cannot be reliably measured, the company has disclosed this as a contingent liability. Due to the sensitive nature of this arbitration the company is not in a position to disclose the value of this contingent liability. (C) Operating lease commitments The company leases various offices under non-cancellable operating leases. The future aggregate minimum lease payments under these leases are as follows: m m Less than 1 year 2 2 Greater than 1 year and less than 5 years 7 9 Greater than 5 years These leases typically run for a period of twenty five years, with an option to renew the lease after that date. Lease payments may be increased every five years to reflect market rentals. None of these leases include contingent rentals. 92

96 39. Assets held in parent undertaking At 31 December 2011, Irish Life Assurance plc held 4.2m ordinary shares in Permanent tsb Group Holdings plc (formerly Irish Life & Permanent Group Holdings plc) representing 0.01% of the issued share capital. On 29 June 2012, Permanent tsb Group Holdings plc completed the sale of its 100% holding in the company's parent Irish Life Group Limited to the Minister for Finance for 1.3bn. The completion of this sale also marked the legal separation of the businesses of permanent tsb bank and Irish Life. The two businesses are now fully independent with separate boards and management teams and they operate independently of each other. The Irish Life Group is now 100% owned by the Minister for Finance on behalf of the Irish State and has no Stock Exchange listing. 93

97 40. Related parties The company has a related party relationship with its directors and senior management, subsidiaries and the company's pension schemes. During the period, the company had a related party relationship with its former ultimate parent, permanent tsb plc (formerly Irish Life and Permanent plc) and its affiliates until 29 June 2012 when it was acquired by the Minister for Finance. The company has a related party relationship with the Irish government and continues to have a related party relationship with permanent tsb plc due to having the Irish government as a shared parent. (A) Directors shareholdings The company participated in the share option scheme operated by its former ultimate parent, permanent tsb plc, prior to its separation on 29 June On the date of separation all outstanding permanent tsb Group Holding plc share options granted to company employees either lapsed or were forefeited. The number of share options allocated to company employees at the end of 2011 which subsequenetly lapsed or were forefited was 1,062,984. The company does not operate a share option scheme. (B) Transactions with directors and key management personnel Non-executive directors as at 31 December 2012 comprise of: Alan Cook (Chairman) Tom Barry Bernard Collins (appointed 20 April 2012) Brian Forrester Cecil Hayes (appointed 31 July 2012) Key management personnel include executive directors and company senior management and as at 31 December 2012 comprise of: Kevin Murphy David McCarthy David Harney Gerry Hassett Carol Pemberton Dervla Tomlin Chief Executive Finance Director Chief Executive Irish Life Corporate Business Chief Executive Irish Life Retail Head of Human Resources Head of Risk and Compliance and Chief Actuary In preparation for the separation of the company from its former parent, the company's key management personnel changed in Bill Hannan, former Head of Risk and Compliance and Tony Hession, former Head of Human Resources and Organisational Development ceased to be designated as key management personnel on 29 February Pat Ryan also resigned his position on the board on 29 June Carol Pemberton, Head of Human Resources and Dervla Tomlin, Head of Risk and Compliance and Chief Actuary were designated as key management personnel on 1 March Non-executive directors are compensated by way of fees only. The compensation of executive directors and other company key management comprises salary and other benefits together with pension benefits. Total compensation to key management personnel and non-executive directors for the year is as follows: '000 '000 Fees (payable to non-executive directors)* Salary and other benefits 2,471 2,620 Pension benefits defined benefit defined contributions - 30 Equity-settled benefits ,990 2,805 *Alan Cook did not receive any fees from the company in The increase in directors fees is due to an increase in the number of directors employed during the year. Number of key management personnel at year end is as follows: Non-executive directors 5 4 Executive directors and senior management For key management who are members of a defined benefit scheme, the pension benefit included above is the increase in transfer value during the 12 month period to 31 December For defined contribution schemes it is the contributions made by the company to the scheme. 94

98 40. Related parties (continued) In the normal course of its business the company had balances and transactions with key management personnel as follows: '000 '000 As at year end Life assurance 3,019 3,504 Pension policies 3,940 2,586 Transactions during the year Life assurance and pension premiums Life assurance and pension claims (259) (245) Life policies represent values for investment contracts (including pension policies) and sum assured for protection products. In addition some policies carry serious illness insurance cover. At 31 December 2012 total serious illness cover amounted to 1,241,430 (2011: 1,373,935). In the normal course of it's business, the key management personnel of the company had balances and transactions as part of its related party relationship with it's former parent, permanent tsb plc (up to date of seperation on 29 June 2012), as follows: June '000 '000 As at period end Loans Unsecured credit card balances and overdrafts 1 4 Deposits Transactions during the period Loan advances - 33 Loan repayments Interest on loans 8 9 Interest on deposits (33) (33) The loans are granted on normal commercial terms and conditions with the exception of certain house loans where executive directors and senior management may avail of subsidised loans on the same terms as other eligible management of permanent tsb plc. All of the loans are secured. All interest and principal due at the statement of financial position date on both loans and unsecured credit card balances and overdrafts has been repaid on schedule. Loans by ultimate parent entity to directors Loans are analysed individually as follows: Balance 1 Jan December 2011 Principal Balance 31 Maximum Repaid Dec Interest Paid Balance '000 '000 '000 David McCarthy ¹ 136 (136) - (1) (136) - (1) The loan to David McCarthy was secured on a residential investment property and was repaid in full in As at 31 December 2012, the total interest outstanding and the total provisions on loans by the directors / former directors was nil (2011: nil). (C) Transactions with the group companies In the normal course of business, Irish Life Investment Managers Limited ("ILIM"), acting as the company's investment manager, provides the following services, which are subject to the normal investment processes and procedures, to/on behalf of the company: (i) Manages the unit linked funds and non linked funds of the company, including providing investment advice to the company. (ii) Investment management services to the company's pension schemes. - Fees earned under these arrangements during the year were 2.1m (2011: 1.9m). (iii) Administers the investment only policies which are on the company's books. ILIM charge fees for acting as the company's investment manager for such services as described above. The amount charged for 2012 amounted to 35m (2011: 35m). In addition ILIM earns income from the stocklending arrangements as outlined in Note 4 and 5. 95

99 40. Related parties (continued) During the year the company paid 1.3m (2011: 1m) to Irish Progressive Services International Limited for administration services provided on funds under management. From 1 December 2011 the management and operations of the Retail division of the company were outsourced to ILFS under a services agreement. Fees totalling 105m were paid by the company to ILFS during 2012 (2011: 9m). The company has an arrangement to pay commissions to Cornmarket for selling ILA's products. Commission of 12m (2011: 16m) was charged during the year. At 31 December 2012, commission owed to Cornmarket amounted to 4m (2011: 7m). The related DAC balance included in the accounts is 34m (2011: 38m). In 2010 the company purchased an investment property through a special purpose vehicle ("SPV") which is owned by the company. This transaction had been recognised as an onerous contract and was subject to arbitration, which resulted in a loss being recognised on the purchase (see Note 19, Provisions and Note 30, Investment return). The company issued a loan of 119m to the SPV. At 31 December 2012, the loan balance was 119m (2011: 119m). Accrued interest on this loan for the year ended 31 December amounted to 10.4m (2011: 5.3m). The company has issued loan stock to Vestone Limited which is the parent company of Cornmarket. At 31 December 2012 the loan stock amounted to 2.4m (2011: 8m). Interest charged on this loan amounted to 0.2m (2011: 0.5m). At 31 December 2012 the company held intercompany debtor balances with Irish Progressive Services International Limited of 1.4m (2011: 1.5m). This balance included payroll charges and a number of service costs provided by the company for financial and IT services, human resource management, risk management and facilities management functions. The company also held an intercompany debtor balance with Irish Life Limited of 4.1m (2011: nil). At 31 December 2012 the company held intercompany creditor balances with Irish Life Financial Services of 6.9m (2011: 3.2m) and Irish Life Investment Managers Limited of 2.0m (2011: 8.3m). Irish Government and Government related entities The company has applied the amended IAS 24 Related Party Disclosures, that exempts an entity from the related party disclosure requirements in respect of the Government and Government related entities unless transactions are individually significant or collectively significant. In the normal course of business the company has entered into transactions with the Government and Government related entities involving deposits, senior debt, commercial paper and dated subordinated debt. The following are transactions between the company and the Government and Government related entities that are collectively significant. The company holds securities issued by the Government and Government related entities of 1,578m (2011: 1,383m). The increase reflects new bonds purchased during These numbers include the securities of the financial institutions listed in the table below. Included in the investment property portfolio are properties for which the Office of Public Works ("OPW"), on behalf of Government departments, is a tenant. These property investments are held in unit-linked funds. The total annual unit-linked rental income earned from these leases is 12m (2011: 12m) out of a total annual rental income of 147m (2011: 146m). Some other investment properties may include tenants who are agencies financed by the Government. In 2010, the company acquired 17 million B shares in National Asset Management Agency Investment Limited ("NAMAIL") resulting in the company holding 17% of the total ordinary share capital of NAMAIL. In 2012, NAMAIL paid a dividend of 1.2m to the company (2011: 1.7m). In September 2012, the company disposed of its shareholding in NAMAIL. The following table summarises the balances (including policyholder and shareholder funds) between the company and these financial institutions: Debt securities assets Derivative assets Deposits with credit institutions Loans and borrowings m m m m Irish Bank Resolution Corporation 31 December December EBS Limited (formerly Educational Building Society) 31 December December Permanent tsb plc 31 December December

100 40. Related parties (continued) Allied Irish Bank plc Bank of Ireland 31 December December December December (D) Transactions with permanent tsb plc Permanent tsb plc, the company's former parent, has a commission agreement with its former associated company, Allianz. Under this agreement, commission is paid for general insurance business written with Allianz through permanent tsb. Commission earned during 2012 was 5m (2011: 7m). The loans advanced by permanent tsb to the company of 286m (2011: 367m) are on behalf of unit-linked policyholders and are secured on a non-recourse basis on properties held within the unit-linked funds invested in by those policyholders. As part of the separation agreement, the company agreed to provide a defined list of services to permanent tsb plc for a defined period on a cost recovery basis. These services were principally IT and HR related. For 2012, permanent tsb plc was charged 14m for the provision of these services. The company has a long-term distribution agreement with permanent tsb plc, under the agreement the bank exclusively offers Irish life products to its customers as a tied agent. All transactions with permanent tsb plc are priced on an arms length basis. (D) Transactions with AIB Bank plc In April 2012, the company signed a long-term distribution agreement with Allied Irish Bank plc ("AIB"), under the agreement the bank exclusively offers Irish Life products to its customers as a tied agent. All transactions with AIB are priced on an arms length basis. 97

101 41. Reporting currency and exchange rates The company's financial statements are presented in millions of euro. The following table shows the average and closing rates used by the company for 2012 and Closing exchange rate / Stg Average exchange rate / Stg Closing exchange rate / US$ Average exchange rate / US$ Events after the reporting period On 19 February 2013, the company welcomed the announcement of an agreement between Great-West Lifeco of Canada and the Irish Government on the acquisition of the business by the Canadian company. Following the transaction the Irish Life name will be retained and the life and pensions operations of Great-West Lifeco s Irish subsidiary Canada Life (Ireland) will be combined with the operations of Irish Life. The customers of both organisations will have continuity of products and customer services under Irish Life. Great-West Lifeco is one of the outstanding global players in the life and pensions business with 417 billion assets under administration and an AA rating. Through Canada Life, Great-West Lifeco has a long association with Ireland stretching back over 100 years. Their financial strength and longstanding commitment to the Irish market makes them a wonderful fit for Irish Life. They will underpin the company's position as the leading force in the life, pensions and investment management business in Ireland. The transaction will have no impact on the terms and conditions of policies held by Irish Life customers nor any change to the current business arrangements for Corporate and Institutional customers. The transaction is expected to close by the end of July 2013 and is subject to regulatory approvals. 43. Approval of statutory financial statements The company financial statements were authorised and approved by the Board on 23 April