Topdanmark A/S annual report 2012 Reg.No. 78040017
Share profile The Topdanmark share is a value case not a growth case Focused strategy }} Danish player }} Stable insurance risks }} Low expense ratio }} Limited financial risk }} Efficient capital management }} Limited top line growth }} Profitable growth - in that order }} High net result }} Large share buy-back programme }} No protection against a take-over in the Articles of Association Read more about Topdanmark s equity story on www.topdanmark.com Share profile.
Topdanmark Annual Report 2012 5 March 2013 Announcement No. 03/2013 Key features of Annual Report 2012 Post-tax profit of DKK 1,823m (2011: DKK 1,023m) 78.2% increase Better than assumed result in Q1-Q3 2012 interim report Profit per share increase 91.0% to DKK 142.1 Combined ratio improved to 88.0% (2011: 90.3%) primarily due to lower weather-related claims Combined ratio excluding run-off profits improved to 90.3% (2011: 92.0%) Premiums increased 1.1% in non-life insurance and declined 4.3% in life insurance Investment return increased to DKK 1,336m (2011: DKK 652m) Result of life insurance increased to DKK 210m (2011: DKK 187m) Topdanmark bought back own shares of DKK 1,200m, which was in line with the buy-back assumed in the Q1-Q3 2012 interim report. Q4 2012 Post-tax profit increased to DKK 453m (Q4 2011: DKK 350m) Combined ratio improved to 88.2% (Q4 2011: 89.6%) Combined ratio excluding run-off profits was 91.7% (Q4 2011: 91.5%) Premiums increased 0.3% in non-life insurance and declined 21.7% in life insurance Investment return increased to DKK 343m (Q4 2011: DKK 233m). Profit forecast model for 2013 Assumed combined ratio for 2013 has been increased from around 91% to 91-92%, excluding run-off profits / losses due to reforms affecting the level of compensation for loss of earnings potential Assumed premium growth in non-life insurance continues at 1-2% Post-tax profit forecast model is DKK 1,050-1,150m, excluding run-off profits / losses, being DKK 95 profit per share. As this model is now in place, the DKK 500m from 2012 has been included in the share buy-back programme for 2013 Consequently, the share buy-back programme for 2013 is now DKK 2,000m including the DKK 500m transferred from the 2012 buy-back programme. The buy-back of DKK 2,000m represents a yield of 12.4%. In a webcast today Topdanmark's CEO, Christian Sagild, will present the financial highlights and comment on the forecast. A conference call will be held today at 15:30 (CET) when Christian Sagild, CEO, and Lars Thykier, CFO, will be available for questions based on the Annual Report and the webcast. The call will be conducted in English. In order to participate in the conference call, please phone: UK dial in number: +44 (0)20 7162 0125 US dial in number: +1 866 803 8344 quoting reference 929302 10-15 minutes before the conference asking the operator to connect you to the Topdanmark conference call or listen to the live transmission of the call. Please direct any queries to: Christian Sagild Chief Executive Officer Direct tel.: +45 4474 4450 Lars Thykier Chief Financial Officer Direct tel.: +45 4474 3714 Steffen Heegaard Group Communications and IR Director Direct tel.: +45 4474 4017, mobile: +45 4025 3524 Share buy-back In its Q1-Q3 2012 interim report Topdanmark announced that DKK 500m of the share buy-back programme had been postponed because it wanted to develop a new model for calculation of individual solvency in life insurance before the amount was paid out. Page 1 of 101
Contents Management s review 1 Key features of Annual report 3 Financial highlights 4 Profit of DKK 1,823m in 2012 4 Profit of DKK 453m in Q4 2012 5 Non-life insurance 11 Life insurance 13 Investment activities 16 Parent company etc. 16 Taxation 16 Prospects for 2013 19 Share buy-back 20 Share split 20 Value creation in Topdanmark 22 Risk management 25 Solvency 27 Capital model 28 Board of Directors and Articles of Association 29 Severance pay 29 Remuneration structure 30 Corporate Governance 30 CSR 30 Investor Relations 32 Annual General Meeting 32 Financial calendar 33 List of company announcements and trading reports 34 Board of Directors and Executive Board 39 Five-year summary - Group Annual financial statements - Group 40 Income statement 41 Statement of comprehensive income 42 Assets 43 Shareholders' equity and liabilities 44 Cash flow statement 45 Statement of changes in equity 46 Notes to the financial statements 79 Accounting policies 89 Annual financial statements - Parent company 97 Disclaimer 98 Statement by Management on the Annual Report Auditors' reports 99 Internal audit's reports 100 Independent auditor's reports 101 Group Structure Page 2 of 101
Financial highlights Q4 Q4 (DKKm) 2008 2009 2010 2011 2012 2011 2012 Premiums earned: Non-life insurance 8,952 8,665 8,548 8,668 8,759 2,201 2,209 Life insurance 3,980 3,208 3,395 3,303 3,161 968 757 12,932 11,873 11,943 11,971 11,920 3,169 2,966 Results: Non-life insurance 91 1,592 1,092 1,086 2,103 374 529 Life insurance (57) 292 384 187 210 69 46 Parent company etc. (58) (21) 31 76 22 13 18 Pre-tax profit / (loss) (24) 1,863 1,506 1,349 2,335 457 593 Tax (165) (417) (338) (326) (512) (106) (140) Profit / (loss) (189) 1,446 1,168 1,023 1,823 350 453 Run-off profits, net of reinsurance 506 214 204 148 201 41 77 Shareholders' equity of parent company at 1 January 3,716 3,243 4,465 4,900 4,915 4,738 5,489 Profit / (loss) (189) 1,446 1,168 1,023 1,823 350 453 Share buy-back (371) (376) (892) (1,159) (1,200) (186) (272) Share-based payments 77 150 159 150 177 12 46 Other movements in shareholders' equity 10 2 1 1 2 0 1 Shareholders' equity of parent company end of period 3,243 4,465 4,900 4,915 5,716 4,915 5,716 Deferred tax on security funds (348) (348) (348) (348) (348) (348) (348) Shareholders' equity of Group end of period 2,895 4,117 4,553 4,567 5,368 4,567 5,368 Capital base, parent company*) 3,645 4,868 5,305 5,319 6,122 5,319 6,122 Total assets, parent company 4,819 5,467 5,712 6,408 6,895 6,408 6,895 Total assets, Group 52,035 56,554 57,542 61,013 59,435 61,013 59,435 Provisions for insurance and investment contracts: Non-life insurance 13,685 14,478 15,139 16,228 16,251 16,228 16,251 Life insurance 24,938 28,882 31,166 30,618 32,553 30,618 32,553 Financial ratios (parent company) Post-tax profit / (loss) as a % of shareholders' equity (5.6) 36.6 24.1 21.1 33.9 7.2 8.0 Post-tax profit / (loss) per share (DKK) (12.1) 92.2 77.2 74.4 142.1 26.0 36.4 Post-tax profit / (loss) per share, diluted (DKK) (12.1) 91.7 77.0 74.4 142.1 26.0 36.4 Net asset value per share (DKK) 207.1 288.1 338.6 368.7 461.2 368.7 461.2 Share buy-back per share (DKK) 23.4 23.8 58.8 84.3 93.6 13.8 21.8 Listed share price end of period 687 703 738 895 1,213 895 1,213 Average number of shares ('000) 15,640 15,688 15,131 13,741 12,828 13,448 12,461 Average number of shares, diluted ('000) 15,640 15,769 15,159 13,746 12,828 13,448 12,461 Number of shares end of period ('000) 15,663 15,496 14,472 13,332 12,394 13,332 12,394 Ratios non-life insurance (%) Gross loss ratio 64.6 73.1 75.5 78.2 70.0 72.1 69.7 Net reinsurance ratio 3.1 3.1 2.4 (3.6) 2.2 1.6 2.5 Claims trend 67.7 76.2 77.9 74.6 72.2 73.7 72.2 Gross expense ratio 14.7 14.9 15.4 15.7 15.8 15.9 16.0 Combined ratio 82.4 91.1 93.3 90.3 88.0 89.6 88.2 Operating ratio 80.4 90.1 92.7 89.6 87.8 89.3 88.1 Combined ratio excl. run-off profits 88.1 93.6 95.7 92.0 90.3 91.5 91.7 *) Shareholders' equity and loan capital Page 3 of 101
Profit of DKK 1,823m in 2012 Topdanmark s post-tax profit for 2012 increased 78.2% to DKK 1,823m (2011: DKK 1,023m). Profit per share increased 91.0% to DKK 142.1. for 2012 in the Q1-Q3 2012 interim report due to a combination of a better investment return and a better than assumed technical result in Q4 2012. This profit of DKK 1,823m was better than the DKK 1,550-1,650m assumed in the most recent profit forecast model Comparison between actual results and profit forecast model results Actual Forecast for 2012 Actual results for as in Q1-Q3 results for (DKKm) 2011 interim report 2012 Non-life insurance - Technical result 907 950 1,000 1,068 - Investment return after transfer to technical result etc. 179 820 870 1,036 Profit on non-life insurance 1,086 1,770 1,870 2,103 Life insurance 187 170 200 210 Parent company etc. 76 20 30 22 Pre-tax profit 1,349 1,960 2,100 2,335 Taxation (326) (410) (450) (512) Profit for the year 1,023 1,550 1,650 1,823 Pre-tax profit increased DKK 986m to DKK 2,335m from 2011 to 2012. The technical result increased DKK 161m to DKK 1,068m mostly due to lower weather-related claims and higher run-off profits. On the other hand, the technical result was adversely affected by the declining interest rates. The investment return increased DKK 857m to DKK 1,036m due to the generally positive financial markets for equities and credit products in 2012. Trend in pre-tax result (DKKm) 2011 2012 Non-life insurance - Technical result 907 1,068 - Investment return after transfer to technical result etc. 179 1,036 Profit on non-life insurance 1,086 2,103 Life insurance 187 210 Parent company etc. 76 22 Pre-tax profit 1,349 2,335 Profit on life insurance increased DKK 23m to DKK 210m due to, among other factors, a higher investment return. Profit of the parent company etc. declined DKK 54m to DKK 22m. This decline was due to a DKK 25m writedown of a property and particularly high earnings in Topdanmark Kapitalforvaltning in 2011. Profit of DKK 453m in Q4 2012 Post-tax profit increased to DKK 453m in Q4 2012 (Q4 2011: DKK 350m) which was somewhat better than assumed in the profit forecast model for 2012 in the Q1- Q3 2012 interim report (Q4 2012: DKK 180-280m). As described above, the improvement was due to a combination of a better investment return and a better than assumed technical result. Page 4 of 101
Pre-tax profit was DKK 593m in Q4 2012 (Q4 2011: DKK 457m). The technical result increased DKK 27m to DKK 263m due to lower weather-related claims and higher run-off profits. The investment return increased DKK 128m to DKK 266m. Profit on life insurance declined DKK 23m to DKK 46m primarily due to a slightly lower risk allowance, lower recognition as income from the shadow account of Life V and a lower return on Topdanmark Link. Profit of the parent company etc. increased DKK 5m to DKK 18m. Trend in pre-tax result Q4 Q4 (DKKm) 2011 2012 Non-life insurance - Technical result 236 263 - Investment return after transfer to technical result etc. 138 266 Profit on non-life insurance 374 529 Life insurance 69 46 Parent company etc. 13 18 Pre-tax profit 457 593 Non-life insurance Danish non-life insurance market Key features of the Danish non-life insurance market in 2012: Positive effect of price increases 1% growth in premiums Exceptionally low level of weather-related claims improved the combined ratio by around 1.5pp Lower average premium in motor insurance In spite of declining theft frequency for contents insurance policies, an increase in the average claim increased the overall claims trend Increase in claims level of policies covering loss of earnings potential due to a reform of early retirement pension Lower interest rates had a 1-2pp adverse effect on the combined ratio Overall, it is believed that the combined ratio for 2012 was around 92% excluding run-off profits Run-off profits had a positive effect on the combined ratio of around 3pp. The general price increases from most of the insurance companies in the Danish market in 2011 were replaced by more selective price increases in 2012. The price increases were mainly effected in house, contents, SME insurance and workers' compensation insurance. In 2012 a new house inspection scheme took effect providing new minimum conditions for change of ownership policies. Due to the new conditions the cover of the policy has been increased, and consequently the price of change of ownership policies has also been increased. Overall, the price increases are estimated to have had a 0.3-0.5% positive effect on gross premiums earned. Automatic price indexation in the personal and SME market was 1.9%, which is estimated to have an overall effect of around 1.4% for the entire market. Also in 2012 prices in the industrial market were under pressure. Including the effect of price increases growth in gross premiums earned is estimated to be around 1%. The level of rainstorm claims was lower than normal. This applies to both storm and rainstorm claims, which are the highest weather-related risks. The lower level of weatherrelated claims is estimated to have had a favourable effect on the combined ratio of around 1.5pp. Car sales moved towards relatively smaller and more roadworthy cars from 2011 to 2012, which contributed to a decline of around 0.8% in average premium, in spite of automatic indexation of 1.9%. The number of reported incidents of car damage declined 9% from 2011 to 2012. In contents insurance recent years' trend of declining claims frequency but increasing average claims continued into 2012. Efforts by the police to get closer to the public seem to have helped reduce the number of thefts. On the other hand, the size of average claims increased due to, among other factors, more organised burglary behaviour and an increase in the value of theft attracting items. Overall, it is believed that the claims trend in contents insurance has increased in 2012. At the end of 2012, the Danish Parliament adopted a reform of the rules for early retirement pension taking effect on 1 January 2013. As there is a relation between workers' compensation, motor liability, illness / accident insurance claims and the reform, the reform will have financial consequences for the size of the compensation. Generally, the public subsidy to people in flex-jobs will decline, meaning that a larger share of the loss incurred by a claimant in a flex-job needs to be covered by the Page 5 of 101
insurance policy. Furthermore, the reform provides that temporary annuities in workers' compensation will be paid for a longer period than today which, other things being equal, will have an adverse effect on the claims. The Danish National Board of Industrial Injuries has estimated that Danish workers' compensation insurance companies alone will incur a retrospective loss of about DKK 250m on the private companies, while in the future the annual claims will increase around DKK 90m, representing about 2% of premiums earned on workers' compensation insurance policies. Additionally, there will be an increase in expenses on other policies covering loss of earnings potential. As provisions for outstanding claims are discounted to present value, lower interest rates will increase the payments on claims. Interest rates were lower in 2012 than in 2011 which, depending on the composition of the portfolio, increased the combined ratio by 1-2pp. It is estimated that the overall combined ratio, excluding any run-off profits / losses, was around 92% for the entire market in 2012. However, there are significant differences between the combined ratios of the individual companies. The run-off profits are estimated to have had a favourable effect of around 3pp on the combined ratio. The run-off profits, which are estimated to be slightly higher than normally, are typically in long-tail lines such as workers' compensation, accident and motor liability. Result of non-life insurance in Topdanmark Premiums earned Premiums earned increased 1.1% to DKK 8,759m in 2012, which was slightly lower than the assumed premium growth of 1-2% (as in the Q1-Q3 2011 interim report). The growth in premiums was affected by a run-off profit in a captive, administered by Topdanmark, releasing a premium bonus of DKK 19m. Premium bonuses are deducted from premiums earned. Premiums earned benefitted from automatic price indexation of 1.9pp with an effect of around 1.4pp on total premiums. On the other hand, premiums earned were only marginally impacted by extraordinary price increases. In 2012 Topdanmark increased market pressure on the personal segment, the SME segment and farms which improved its competitive situation. For example, the customer exchange ratio in the personal segment gradually improved during the year due to, among other factors, an increase in the retention percentage. The improved customer exchange ratio was not reflected in premiums earned in 2012 but is expected to have a favourable effect on premium growth in 2013. Typically, profitability for major businesses does not meet Topdanmark's return requirements, leading to a loss of some major unprofitable customers in 2012. Claims trend The claims trend improved to 72.2% in 2012 (2011: 74.6%) This 2.4pp improvement was mostly due to a decline in weather-related claims to DKK 48m net of reinsurance (2011: DKK 285m net of reinsurance), representing a 2.7pp improvement of the claims trend at group level. Topdanmark assumes DKK 170m net of reinsurance as a normal level of weather-related claims. Weather-related claims were DKK 122m lower than this level in 2012, corresponding to a 1.4pp effect on the claims trend. Run-off profits net of reinsurance were DKK 201m in 2012 (2011: DKK 148m). As compared to 2011 run-off profits had a 0.6pp positive effect on the claims trend. Run-off profits in workers' compensation insurance represented DKK 148m of run-off profits in 2012. Fire claims net of reinsurance declined DKK 32m, corresponding to a 0.4pp improvement of the claims trend. The improvement was mainly due to a favourable claims trend in the personal segment. The interest rate curve used to discount the provisions for outstanding claims was lower in 2012 than the previous year, which impacted the claims trend adversely by 1.6pp. The reform on the rules on early retirement pension increased the claims level for those policies covering loss of earnings potential, with a 0.4pp adverse effect on the claims trend. Page 6 of 101
Expense ratio The expense ratio increased marginally to 15.8% (2011: 15.7%). Combined ratio Overall expenses on claims, reinsurance, sales and administration as a percentage of gross premiums earned (combined ratio) improved to 88.0% (2011: 90.3%). Excluding run-off profits the combined ratio improved to 90.3% (2011: 92.0%). Weather-related claims of the year had an effect on the combined ratio, which was 1.4pp lower than the normal effect. Accordingly, the underlying combined ratio was 91.7% (2011: 90.7%) excluding run-off profits. Page 7 of 101
Financial highlights Non-life insurance Q4 Q4 (DKKm) 2011 2012 2011 2012 Gross premiums earned 2,201 2,209 8,668 8,759 Technical interest 7 2 65 20 Claims incurred (1,587) (1,541) (6,773) (6,131) Expenses (351) (353) (1,365) (1,388) Net reinsurance (35) (54) 312 (193) Technical profit 236 263 907 1,068 Investment return after transfer to technical result 130 260 123 1,015 Other items 8 6 55 20 Profit on non-life insurance 374 529 1,086 2,103 Run-off profits, net of reinsurance 41 77 148 201 Gross loss ratio (%) 72.1 69.7 78.2 70.0 Net reinsurance ratio (%) 1.6 2.5 (3.6) 2.2 Claims trend (%) 73.7 72.2 74.6 72.2 Gross expense ratio (%) 15.9 16.0 15.7 15.8 Combined ratio (%) 89.6 88.2 90.3 88.0 Operating ratio (%) 89.3 88.1 89.6 87.8 Combined ratio excl. run-off profits (%) 91.5 91.7 92.0 90.3 Developments in Q4 Premiums earned in Q4 2012 increased 0.3% to DKK 2,209m. This moderate premium growth was due to the DKK 19m payment of bonus in a captive, referred to previously, corresponding to an adverse effect of 0.8pp on premium growth. The claims trend improved 1.5pp to 72.2% in Q4 2012 (Q4 2011: 73.7%) due to a lower level of weather-related claims (2.9pp) and higher run-off profits (1.6pp). On the other hand, the lower interest rates had a 1.1pp adverse effect on the claims trend. Furthermore, a worse claims trend in fire had a 0.9pp adverse effect on Topdanmark's claims trend. Finally, the reform referred to in The Danish non-life insurance market increased payments on claims. The size of these extra costs is very uncertain, but it has been decided to recognise extra claims of DKK 35m, which had a 1.6pp adverse effect on the claims trend in Q4 2012. The expense ratio increased to 16.0% in Q4 2012 (Q4 2011: 15.9%). The combined ratio improved to 88.2% in Q4 2012 (Q4 2011: 89.6%). Excluding run-off profits it was 91.7% (Q4 2011: 91.5%). Page 8 of 101
Segment reporting Personal The Personal segment sells policies for individual households in Denmark. Premiums earned increased 0.2% to DKK 4,767m in 2012 reflecting growth in house and contents insurance while there was a decline in motor insurance. Furthermore, premiums were affected by a decline in premiums earned in illness / accident insurance (I/A). The growth in premiums was 0.3% negative in Q4. Adjusted for I/A, premium growth was 0.5% in 2012 and 0.8% in Q4. Topdanmark's competitive situation improved gradually in 2012. Sales through Topdanmark's own sales channels increased 6.4%. Topdanmark has changed its decentralised sales organisation from insurance outlets to larger sales centres and has expanded its sales team. The new sales organisation was in place at the end of 2012. Premiums earned on motor insurance declined 2.4% in 2012 due to, among other things, a lower average premium because increasingly smaller and more roadworthy cars are sold. The claims trend improved 1.2pp to 73.2% primarily due to an improved claims trend for weather-related claims. Run-off profits were DKK 31m in 2012 (2011: DKK 23m) which had a 0.2pp positive effect on the claims trend as compared to 2011. The run-off result in 2012 was a combination of a loss on I/A and profits on, among others, accident and motor liability insurance. The expense ratio increased to 16.2% from 15.8% due to the strengthening of distribution efficiency in the personal segment, see Distribution power. The combined ratio improved to 89.4% from 90.2%. Excluding run-off it improved to 90.1% from 90.7%. Page 9 of 101
Personal Q4 Q4 (DKKm) 2011 2012 2011 2012 Gross premiums earned 1,210 1,206 4,756 4,767 Technical interest 5 1 33 10 Claims incurred (903) (855) (3,762) (3,464) Expenses (197) (201) (753) (774) Net reinsurance 0 (40) 226 (24) Technical result 114 111 501 514 Run-off profits / (losses), net of reinsurance 14 (5) 23 31 Gross loss ratio (%) 74.6 70.9 79.1 72.7 Net reinsurance ratio (%) (0.0) 3.3 (4.7) 0.5 Claims trend (%) 74.6 74.2 74.4 73.2 Gross expense ratio (%) 16.3 16.6 15.8 16.2 Combined ratio (%) 90.9 90.9 90.2 89.4 Operating ratio (%) 90.6 90.8 89.5 89.2 Combined ratio excl. run-off (%) 92.1 90.5 90.7 90.1 SME and Industrial The SME and Industrial segment offers policies for Danish-based SME, agricultural and industrial businesses. Premiums earned increased 2.0% to DKK 4,011m in 2012 and in Q4 they increased 0.9%. The growth in premiums was impacted by severe competition in workers' compensation insurance and a premium bonus of DKK 19m on a captive scheme a premium bonus which was deducted from premiums earned. Generally, the loss of customers was lower except for workers' compensation insurance due to, among other factors, a new servicing concept. SME and Industrial saw a 2.6% increase in motor insurance customers which more than offset the decline in these customers in the personal segment. The claims trend improved 3.7pp to 71.2% primarily due to a favourable agricultural claims trend caused by, among other factors, a low level of weather-related claims. In Q4 fire claims net of reinsurance were DKK 21m higher than the level of Q4 2011, which had a 0.5pp adverse effect on the claims trend. Run-off profits increased to DKK 170m in 2012 (2011: DKK 125m) giving a 1.1pp positive impact on the claims trend. This run-off profit related mainly to workers' compensation insurance. The expense ratio declined 0.3pp to 15.3%. The combined ratio improved to 86.5% in 2012 (2011: 90.5%). Excluding run-off profits it declined to 90.8% (2011: 93.7%). Page 10 of 101
SME and Industrial Q4 Q4 (DKKm) 2011 2012 2011 2012 Gross premiums earned 997 1,006 3,934 4,011 Technical interest 2 1 31 11 Claims incurred (689) (688) (3,034) (2,686) Expenses (155) (152) (614) (615) Net reinsurance (35) (14) 86 (169) Technical result 120 152 403 552 Run-off profits, net of reinsurance 27 82 125 170 Gross loss ratio (%) 69.2 68.4 77.1 67.0 Net reinsurance ratio (%) 3.5 1.4 (2.2) 4.2 Claims trend (%) 72.7 69.8 74.9 71.2 Gross expense ratio (%) 15.5 15.1 15.6 15.3 Combined ratio (%) 88.2 85.0 90.5 86.5 Operating ratio (%) 88.0 84.9 89.8 86.3 Combined ratio excl. run-off (%) 90.9 93.1 93.7 90.8 Life insurance Danish life and pension market In 2012 the Danish life and pension market was characterised as follows: Reduction in deductibility of term life premiums Pension return tax increased from 15.0% to 15.3% It is believed that the level of overall payments into regular premiums was relatively unchanged. It is believed that overall pension payments into regular premiums were relatively unchanged in 2012. Result of life insurance in Topdanmark The result from life insurance was a profit of DKK 210m in 2012 (2011: DKK 187m) mainly due to an improved investment return. The deductibility of payments into term life premiums and terminable annuities was reduced from an annual DKK 100,000 to DKK 50,000 with effect from 1 January 2012. This lowering of the deductibility ceiling reduced the savings of term life insurance. On the other hand, there was an increased demand for annuities for which there is full deductibility. With effect from 1 January 2012 the tax rate for pension returns was increased from 15.0% to 15.3%. Profit on life insurance activities comprises the sum of the profits generated by Life I and Life V plus the investment return of Life Holding. These profits were calculated in accordance with the stated policy on the calculation of profit for the life insurance companies: see www.topdanmark.com Investor Business Life insurance Policy for the calculation of profit in life insurance. Result of life insurance 2011 2012 (DKKm) Life I Life V Group Life I Life V Group Investment return 63 41 105 73 56 129 Risk allowance 117 61 178 105 60 165 Transferred, shadow account (112) (2) (114) (116) (2) (117) Other 18 34 Profit on life insurance 187 210 Shadow account end of period 112 2 114 233 4 236 Page 11 of 101
Most of the customers are spread across Life I, Life V and Topdanmark Link. Policies written since 1 July 1994 with guaranteed pension benefits of 2.5%, 1.5% and 0.5% are placed in Life I which is also the company for new customers with guaranteed benefits. Schemes written before 1 July 1994 with guaranteed pension benefits of 4.5% are placed in Life V. Unit-linked schemes are written by Topdanmark Link. The return on funds owned by customers, before pension return tax, was 6.0% in Life I and 12.0% in Life V. The investment return on shareholders' equity increased from DKK 105m in 2011 to DKK 129m in 2012 representing 5.2% in Life I and 5.8% in Life V. The investment return on shareholders' equity is different from that on customers' funds due to different investment strategies and separate portfolios for each; for example, at present shareholders' equity does not invest in equities nor does it use instruments to hedge the guaranteed benefits. The risk allowance was DKK 165m in 2012 (2011: DKK 178m). The insurance technical result before bonus of Life I and Life V was not sufficient to fully include in income a risk allowance in all the contribution groups. Therefore DKK 117m was transferred to the shadow account which totalled DKK 236m at the end of 2012. The amount in the shadow account will be recognised as income in line with profits being generated in those contribution groups which have made transfers to the shadow account. "Other" comprises primarily the investment return of Life Holding of DKK 14m and the result from Topdanmark Link of DKK 11m. The improvement of DKK 16m to DKK 34m was mainly due to a DKK 16m improvement in Topdanmark Link. Trend in premiums Gross premiums declined 4.3% to DKK 3,161m in 2012 (2011: DKK 3,303m). Regular premiums declined 6.7% to DKK 2,157m in 2012 as per the forecast set out in the Q1-Q3 2012 interim report. Single premiums increased 1.4% to DKK 1,004m in 2012 (2011: DKK 991m). There was an overall increase of 5.8% in premiums in unit-linked pension schemes. Regular premiums increased 9.9% to DKK 572m and single premiums 2.7% to DKK 685m. The share of new business written by unitlinked savings increased to DKK 60.6% in 2012 (2011: 52.6%). Sources of gross premiums Q4 Q4 (DKKm) 2011 2012 2011 2012 Individual schemes 141 132 348 330 Corporate schemes 245 201 1,035 855 Group life 36 37 409 399 Unit-linked schemes 140 169 520 572 Regular premiums 562 539 2,312 2,157 Individual schemes 15 8 55 57 Corporate schemes 93 68 268 262 Unit-linked schemes 297 143 667 685 Single premiums 406 218 991 1,004 Gross premiums 968 757 3,303 3,161 Page 12 of 101
Developments in Q4 2012 The decline in profit to DKK 46m in Q4 2012 (Q4 2011: DKK 69m) was primarily due to a slightly lower risk allowance, lower recognition as income from the shadow account of Life V and a lower return on Topdanmark Link. Overall premiums declined 21.7% to DKK 757m in Q4 due to a 46.2% decline in single premiums to DKK 218m while regular premiums declined 4.1% to DKK 539m. Result of life insurance Q4 Q4 2011 2012 (DKKm) Life I Life V Group Life I Life V Group Investment return 17 11 28 11 13 25 Risk allowance 27 14 42 22 15 37 Transferred, shadow account (27) 7 (19) (27) (0) (28) Other 19 12 Profit on life insurance 69 46 Rate of interest on policyholders savings in 2012 and 2013 On 1 July 2012 the rate of interest on policyholders' savings was reduced in Life I and Life V. In Life I it was reduced from 2.25% to 1.8% before pension return tax and in Life V from 4.35% to 2.0% before pension return tax. Due to the improvement in the investment return the rate of interest on policyholders' savings has been increased with effect from 1 January 2013. In the interest rate group writing new business in Life I, the rate of interest on policyholders' savings was increased from 1.8% to 2.0% before pension return tax and in all of the interest rate groups of Life V from 2.0% to 4.35% before pension return tax. These rates may be subject to change if the development in the financial markets is different from expectations. Loss participation scheme Loss participation is a temporary measure introduced in periods where the market value of the customers' assets is lower than the sum of their savings and only serves a purpose when customers who want to leave the scheme prematurely need to have their surrender value calculated correctly. Should customers choose to leave their schemes prematurely, the loss participation is taken into account in the calculation of the surrender value of their policies in order to ensure that those customers who leave do not take with them funds owned by those who stay. Loss participation only applies to with-profits products and it is not deductible in the event of retirement, death and disability. Due to the development in the financial markets with a decline in equity prices and declining interest rates, Life I had to introduce loss participation in 2012. The loss participation scheme is calculated and adjusted once a month and was 0.8% on 5 March 2013 in interest rate group 2 in Life I. There are no loss participation schemes in the other interest rate groups of Life I. As long as the loss participation scheme is in force, the risk allowance will be transferred from the interest rate group concerned to the shadow account from where it will be brought into income when the scheme has been removed. Loss participation has at no time been introduced in Life V. Investment activities Topdanmark Group excluding life insurance The investment return in the Topdanmark Group excluding life insurance was DKK 1,336m in 2012 including a revaluation of provisions and income from associated companies but before the transfer to the technical result (2011: DKK 652m). It is Topdanmark's policy to accept a certain level of financial risk, given its strong liquid position and stable, high earnings from insurance operations. Topdanmark has invested in, among others, equities, properties and CDOs in order to improve the average investment return. The return in Q4 2012 and in 2012 on the most significant classes of assets is disclosed in the following table: Page 13 of 101
Investment return Portfolio 31 Dec 2011 2012 (DKKbn) Return Q4 2011 Return Q4 2012 Return 2011 Return 2012 (DKKm) % (DKKm) % (DKKm) % (DKKm) % Danish equities 0.3 0.4 8 1.5 (13) (3.6) (55) (14.1) 44 12.9 Foreign equities 0.8 0.7 31 3.7 28 3.3 (56) (6.8) 112 15.1 Government and mortgage bonds 12.7 11.4 48 0.4 140 1.2 277 2.2 525 4.4 Credit bonds 0.5 0.6 (7) (0.8) 28 5.2 6 1.0 98 21.2 CDOs 0.7 0.8 58 8.5 85 11.8 173 26.0 305 51.6 Properties 1.4 1.4 33 2.5 (7) (0.5) 100 7.7 33 2.4 Assets related to I/A 1.8 2.1 58 3.3 56 2.8 143 8.5 192 10.1 Money market etc. 2.9 2.3 (1) (0.1) (12) (0.3) 26 0.9 7 0.2 Subordinated loan capital (1.2) (1.2) (17) (1.4) (15) (1.4) (52) (5.3) (63) (5.4) Interest-bearing debt (2.7) (0.4) (8) (0.2) (2) (0.2) (27) (1.0) (11) (0.6) 17.2 18.2 204 1.2 289 1.6 534 3.1 1,241 6.9 Asset management 29 54 118 95 Total investment return 233 343 652 1,336 Transferred return technical provisions Discounting (65) (49) (323) (217) Technical interest (7) (2) (65) (20) The exposure in foreign equities and credit bonds have been adjusted by the use of derivatives. The return percentages are calculated as the ratio between the return on financial instruments and the size of the exposure of the underlying asset. The return on government and mortgage bonds and assets related to I/A (illness/accident) includes revaluations of claims provisions. From 2012 the return related to I/A has been calculated before pension return tax whereas in 2011 it was calculated after pension return tax. The comparatives for 2011 have been restated. The investment return after the transfer to the technical result was DKK 1,099m, which generated an exceptionally large deviation from the expected return given Topdanmark's current risk profile. This high deviation should be viewed in the light of the highly positive investment year 2012 when the returns on both equities and bonds were high. Furthermore, Topdanmark's relatively high exposure in credit products, including CLOs, contributed to a significant excess return. Danish mortgage bonds, in which Topdanmark's exposure is high, performed well in 2012. Also a fortunate positioning in European government bonds, primarily from the core countries, contributed to the excess return. Finally, a change in the discount curve used by Danish insurance companies to value liabilities (see below) generated a gain of DKK 76m. Generally, the difference between the interest rate exposure of assets and liabilities has been relatively small. Therefore, given the expected development in general interest rates, the positioning has only contributed modestly to the excess return. The equity portfolios are well diversified with no large individual positions. The composition of the portfolios is based on OMXCCAP for Danish equities (representing around 30% of the portfolio at 31 December 2012) and MSCI World in the original currency for foreign equities. The Group's investments have no significant concentration of credit risk except for AAA-rated Danish mortgage bonds which are considered to be particularly safe assets according to the Danish Financial Business Act. Since 31 October 2008, Danish insurance companies and pension funds have calculated the value of provisions by using a discount rate representing the combined weighting of the swap rate and the option-adjusted Danish mortgage credit rate. With effect from June 2012, the curve has been adjusted as convergence towards a fixed forward interest rate of 4.2% has been incorporated from the 20-year point. Therefore, the revaluation of longtail provisions is less sensitive to changes in the market rate for long-term assets. The post-tax equity exposure was DKK 682m (pre-tax: DKK 909m) excluding associated companies but including the impact of derivatives. Page 14 of 101
Most of the portfolio comprises high-quality mortgage bonds, which ensures consistency between the investment return and the discount rate. The class of government and mortgage bonds comprises primarily Danish mortgage bonds and revaluation of technical provisions. In addition, there are government bonds mainly from European core countries, covered bonds and derivatives. Covered bonds are AAA-rated mortgage bonds where the size of the loan may not exceed 70% of the value of the security. If the value of the security declines so much that the requirement is not fulfilled, the issuer will provide further security. Credit bonds with a rating lower than BBB (DKK 209m) comprise senior secured bank loans and high yield bonds, part of which are convertible, and subordinated bank capital issued by EU banks. Credit bonds with a rating of BBB and A (DKK 344m) are ordinary and convertible corporate bonds, annuity policies and subordinated bank capital issued by EU banks. Credit bonds with a rating higher than A (DKK 11m) are corporate bonds. The underlying assets of CDOs are mostly senior secured bank loans while the remainder are primarily CDOs with investment grade investments as the underlying assets. The maturity of the CDO investments is dependent on any changes in the payments made by the underlying assets which in turn are dependent on changes in the general economy and, therefore, it is not possible to outline the maturity distribution for the portfolio. The property portfolio comprises mainly owner-occupied property (DKK 861m), rental property (DKK 367m), rental office property (DKK 68m) and property rented for hotel use (DKK 96m). The tenancies for the residential and hotel properties are subject to a short termination notice. Re-letting of the residential properties is not considered to be a problem, but any re-letting of the hotels could be affected by the state of the market and local conditions. In this connection Topdanmark has chosen to write down a property by DKK 25m. The office property is rented under contracts with no option to terminate prior to 2015. Over 99% of the property portfolio is currently let. The properties are valued in accordance with the rules of the DFSA i.e. at market value taking into account the level of rent and the terms of the tenancy agreements. The class of "Assets related to IA" (illness / accident) comprises the investments in Topdanmark Livsforsikring corresponding to the size of the illness / accident provisions. "Money market etc." comprises primarily money market deposits and intra-group balances but also the result of currency positions. "Subordinated loan capital" comprises hybrid capital issued by the parent company and subordinated loans issued by Topdanmark Forsikring. "Interest-bearing debt" comprises other debt. CDOs Returns and portfolios Group excl. life insurance (DKKm) Q4 11 Q4 12 2011 2012 Return AAA and AA 2 6 5 13 Lower than AA 57 79 168 292 Total return 59 85 173 305 Interest 37 26 119 134 Revaluations 22 59 54 171 Total return 59 85 173 305 Book value 31 December AAA and AA 100 99 Lower than AA 592 719 Total book value 692 818 Page 15 of 101
Financing It is expected that Solvency II will require a minimum level of solvency capital in insurance holding companies corresponding to the solvency requirements of the underlying group companies. When Solvency II has taken effect, the capital base of the parent company will be sufficient to finance the investments in the group companies. In accordance with the relevant rules Topdanmark is only allowed to use, for solvency cover, a small portion of the tier 2 capital issued as solvency resources in relation to Solvency II. As a consequence, some of the planned distribution of dividend from the insurance group to the holding company needs to be postponed until the rules are changed. In the meantime, the parent company Topdanmark continues to have some loan financing via intergroup accounts with the insurance group or in the money market. Parent company etc. The parent company Topdanmark A/S does not perform any independent activities. The result of the parent company etc. includes the results of subsidiaries excluding insurance business (primarily Topdanmark Kapitalforvaltning, the asset management company) and financing costs. Profit declined to DKK 22m in 2012 (2011: DKK 76m) due to the DKK 25m write-down of a property and particularly high earnings in Topdanmark Kapitalforvaltning in 2011. Topdanmark Kapitalforvaltning manages the Group's financial assets and liabilities and its result is dependent on the investment performance. Taxation The tax charge was DKK 512m on a pre-tax profit of DKK 2,335m corresponding to an effective tax rate of 21.9% (2011: 24.2%). The deviation from the nominal tax rate of 25% was primarily due to Topdanmark's utilisation of an uncapitalised equity loss carried forward and adjustment of previous years. Mostly all of the tax charge is paid in Denmark: www.topdanmark.com About Topdanmark CSR Society Social accounting. Prospects for 2013 Expected trend in Danish non-life insurance market It is expected that in 2013 the Danish non-life insurance market will be characterised as follows: Continued low economic growth Most of the insurance companies have completed their general price increases 1-2% growth in premiums Increase in claims level of policies covering loss of earnings potential due to a reform of the early retirement pension Continued disciplined market The level of weather-related claims was exceptionally low in 2012. If the level of weather-related claims is normal in 2013, the combined ratio will deteriorate around 1.5pp from the 2012 level Overall, excluding any run-off profits / losses, the combined ratio is expected to be around 95% Run-off profits for 2013 are expected to be lower than in 2012. 2013 is expected to be affected by continued low economic growth. It is expected that BNP growth in the Danish economy will be around 1%. It is believed that most of the insurance companies in the Danish market have completed their general price increases. A number of those companies with a high combined ratio are expected to continue to implement selective price increases. In the personal and SME markets automatic price indexation, allowing for claims inflation, is 1.8% (though 5.6% for workers' compensation insurance) which, in turn, is estimated to have an effect of around 1.3% on the overall market. As in 2012, the average premium in motor insurance is expected to decline in 2013, primarily due to the sale of new cars, to a greater extent than previously, being smaller and cheaper cars, i.e. cars with a lower average insurance premium than bigger and more expensive cars. In addition, generally the claims trend in motor insurance has declined in recent years. Prices in the industrial market are expected to be under pressure also in 2013 due to competition from, among others, foreign insurance companies. Overall growth in gross premiums earned is estimated to be 1-2%. The reform of the rules for early retirement pension, see Danish non-life insurance market, will also in the future Page 16 of 101
increase claims paid on policies covering loss of earnings potential. A continued disciplined market is expected in Denmark. All of the six largest insurance companies, representing a market share of 71%, are quoted on the stock exchange or owned by a quoted company. Additionally, the low interest rates will continue to influence the companies to ensure profitability of their primary operations. The claims trend was affected by low storm and rainstorm claims in 2012. If the level of weather-related claims is normal in 2013, the claims trend will deteriorate around 1.5pp from the 2012 level. Assuming a normal level of large-scale claims, it is expected that the combined ratio for the market, excluding any run-off profits / losses, will be around 95% in 2013. Run-off profits improved the combined ratio by around 3pp in 2012 which is estimated to be higher than the normal level. A more normal level of run-off profits is expected in 2013. Expected trend in Danish life and pension market It is expected that in 2013 the life and pension market will be characterised by: Tax reform Increased need for pension saving Movement from with-profits to unit-linked schemes Decline in regular premiums New rules for calculation of individual solvency. Due to the tax reform, which took effect on 1 January 2013, the deductibility of payments into capital pension schemes has been removed. Furthermore, the opportunity has been given to prepay the tax on capital pension schemes which otherwise should be paid when the capital pension is paid out. The tax will be 37.3% in 2013 and 2014 while normally 40%. It is believed that most of the payments previously made into capital pension schemes will be paid into annuity schemes with full deductibility in the future. Due to the increase in life expectancy and expected lower investment returns pension customers will need larger savings. The trend towards customers moving their pension savings from with-profits to unit-linked schemes is expected to continue. For example, more pension fund companies are offering their customers a grant or a share of unallocated resources if they choose to move their pension schemes from with-profits to unit-linked schemes. Due to the tax reform overall payments into regular premiums are expected to decline in 2013. The growth in premiums is expected to follow wage increases in the future. The DFSA has announced that in 2013 it will prepare new rules for the calculation of individual solvency: Individual solvency requirement. Topdanmark's profit forecast model for 2013 Traditionally Topdanmark does not publish actual profit forecasts but instead the expected level of results if a number of assumptions of the return in the financial markets are met. As the return in the financial markets changes on a daily basis, Topdanmark's profit forecast model will already deviate from actual expectations by the time it is published. Therefore set out in Risk scenarios is additional information on how changes in the assumptions underlying the profit forecast model will affect the results. As can be seen, the investment return forecast model is not based on a specific estimate of the expected investment return for the rest of the year but solely on a long-term standard assumption of the return. Non-life insurance In the interim report for Q1-Q3 2012 Topdanmark expected, for 2013, premium growth of 1-2% and a combined ratio of 91%, excluding any run-off profits / losses, based on the following assumptions: Premium growth in personal lines is expected to be higher than the assumed 1-2% overall premium growth for Topdanmark. Correspondingly, premium growth in the SME and industrial segment is expected to be lower than 1-2% Topdanmark has increased market pressure in the personal segment, SME businesses and farms. This helped to gradually improve the customer exchange ratio in the personal segment during 2012 and is assumed to have a favourable effect on premiums earned in 2013 Page 17 of 101
Topdanmark has no wish to participate in unprofitable competition, which is mostly seen in the market of major industrial businesses. Topdanmark's return requirements are expected to generate some loss of large businesses In order to improve the quality of its customer portfolio Topdanmark is implementing profitability promoting initiatives for less profitable customers, which is also expected to generate some loss of customers: Activities associated with pricing. A normal year for weather-related claims of DKK 170m, broken down by quarter: Q1: DKK 50m Q2: DKK 25m Q3: DKK 45m Q4: DKK 50m A level of interest rates corresponding to the interest rate curve on 2 November 2012 An expense ratio of 16%. Since the most recent profit forecast model was published in the interim report for Q1-Q3 2012, the reform of early retirement pension, referred to above, has increased payments on claims by around 0.4pp. Therefore the assumed combined ratio, excluding run-off profits / losses, has been increased from around 91% to 91-92%. The assumed growth in premiums continues to be 1-2%. Overall the pre-tax result of non-life insurance is assumed to be DKK 960-1,060m. Life insurance Due to the tax reform limiting deductibility of term life premiums and the opportunity to prepay the tax on capital pension schemes, Topdanmark assumes a decline in regular premiums of around 5% in 2013. In the profit forecast model for 2013 it is assumed that the investment return will be sufficiently high to include in income an allowance for risk of DKK 160-170m and around DKK 140m from the shadow account. Consequently, the balance of the shadow account including interest will be around DKK 105m at the end of 2013. Assuming that interest rates do not change and the total return for 2013 exceeds 4.1% and 6.3% respectively, the shadow account relating to interest rate group 1 (shadow account: DKK 150m) and interest rate group 2 (shadow account: DKK 53m) will be recognised as income in 2013. The DFSA has announced that the rules for calculation of individual solvency requirement will be changed with effect from 1 January 2014 and that concept of shadow account will be removed at the same time. It is not clear how the shadow account will be removed. One possibility is that the amount of the shadow account balance that could reasonably be expected to be recognised as income in keeping with the relevant rules will be posted to shareholders' equity on 1 January 2014. In such a scenario it is assessed that Topdanmark will have to write down DKK 30-40m of the remainder of the shadow account at 31 December 2013, after which the balance of the shadow account will be DKK 65-75m. The results are highly sensitive to fluctuations in the investment return. The risk allowance and shadow account are not finally calculated until the preparation of the 2013 Annual Report. Overall, pre-tax profit on life insurance is assumed to be DKK 390-420m. Parent company The profit forecast model for the parent company including subsidiaries outside of the insurance group shows a pre-tax profit of DKK 30-40m. Taxation Given a corporation tax rate of 25%, the tax charge is expected to be DKK 330-370m. The Danish Government has introduced a bill for reducing corporation tax, probably from 25% to 22%. It has also introduced a bill for increasing the payroll tax (tax on payroll costs in the financial sector) offsetting the reduction in corporation tax. Total Group profit The overall post-tax profit forecast model is assumed to be DKK 1,050-1,150m in 2013 representing a profit per share of DKK 95. This profit forecast model is subject to an annual 7.0% return on equities and unchanged foreign exchange rates from the level on 22 February 2013. Furthermore it is assumed that the return on interest-bearing assets hedging the discounted provisions is just sufficient to cover discounting and revaluation of the provisions, while the return on the remaining interest-bearing assets will be 2.48% (risk-free interest rate plus 2.0pp). Page 18 of 101