Business Review

LONG TERM SAVINGS: Old Mutual South Africa (OMSA) and Rest of Africa

Profits resilient as sales are under pressure in tough economic conditions

* H1 2008 restated on MCEV basis
** Life sales now exclude healthcare business
*** OMSA Unit trust/mutual fund sales include Marriott Income Specialists

Summary Review of Business Unit Results

Introduction

The SA economy entered a recession after contracting by an annualised rate of 6.4% in the first quarter. The slow down in the economic growth has led to cumulative reductions of 4.5% in short-term interest rates since December 2008. The South African economy is expected to shrink by about 2% this year.

The rand has managed to recover some of the ground lost in Q3 and Q4 of 2008 closing at R7.75 against the dollar and R12.74 against the pound at the end of Q2 mainly as a result of a narrowing trade deficit.

Although investment markets remain highly volatile, in line with international markets, local equity markets have rebounded strongly from the lows hit in February, with performance for the half year period to 30 June up 3%.

Net client cash flow

As announced in March 2009, OMIGSA experienced a large outflow from PIC as a result of the PIC performing a full review and redistribution of their equity portfolio, significantly increasing their number of managers. As a result of the PIC withdrawal, net client cash outflows were significantly greater than the prior period. In addition to the PIC outflow, there was a termination of a large Corporate segment client in Q1 this year, and the poor economic environment has led to higher numbers of members withdrawing from pension funds. In the Retail space, NCCF was ahead of prior year as a result of increase in inflows mainly in Unit Trusts, as well as lower asset values leading to lower maturity benefits. In OMIGSA our client cash flows have benefited from good non-life sales.

Life assurance sales

Lower equity markets have reduced the attractiveness of the equity-based products to the retail investor and this has particularly affected the single premium market. Lower asset values combined with increased volatility have made customers exercise greater caution before moving assets. This has been particularly evident in the Corporate segment where the conversion to a completed sale has taken longer. The assets that moved were predominantly invested in money market or cash-type funds, which tend to have very low margins. This has led to the overall lower life sales but higher money market Unit Trust sales as shown by the 11% (2% excluding Nedlife) decline in Life APE and the 13% increase in Unit Trust sales. OMSA has benefited from the wide diversity of product offerings leading to a modest overall increase in sales over 2008 when looking at both Life and Unit Trust sales together. Within the life sales, risk products were down by 30% (11% excluding Nedlife), with the Retail Mass segment sales increasing by 37% on the back of larger sales force and risk sales in the Retail Affluent segment fell by 41% (up by 8% excluding Nedlife).

Sales of recurring premium savings products declined 12% relative to prior year with a 20% decline in the Retail Affluent market as customers were reluctant to commit to long term savings products in light of the higher risk of job losses, lower disposable incomes as well as financial advisors adjusting to the new commission structures brought about by a change in the regulatory environment. In the Retail Mass segment recurring premium savings sales reduced by 9% mainly because of the increase in policy cancellations particularly where premiums are paid by debit order. Single premium savings products offering equity exposure also suffered. Our key non-equity offerings in the Retail Affluent segment, Investment Frontiers Fixed Bonds and annuities, were not as competitive as last year leading to a decline in overall sales compared to 2008. Annuity rates were improved at the end of April. We have launched a new bonus series for the Absolute Growth Portfolios to enhance the attractiveness of the product to Corporate customers.

Unit trust/mutual fund sales

There were signs of a slow down in money market fund sales late in Q2 as short term interest rates fell. We expect to see increased interest in exposure to other asset classes should this trend continue, supported by the modest recovery of equity markets in Q2. We are positioned to compete strongly, especially following the recent improvement in OMIGSA's relative equity investment performance in Q2.

Adjusted IFRS operating profit

In Q1 we reduced the rate of increase in cover on certain risk products in the Retail Mass segment to achieve better alignment between the cost of the benefit and the corresponding premium increase on the policies. The impact of this on the existing book has been a reduction in policy reserves leading to a significant contribution to life operating profit for the half year. Life profits also benefited from an increase in long bond yields during the half-year period leading to an increase in the interest assumption used to value life products from 7.5% at the beginning of the year to 9%. These positive factors were more than offset by:

• impact of lower equity levels on asset-based fees and investment variances,
• mortality and disability profits on Permanent Health Insurance and Group Life Assurance products,
• worse persistency experience as a result of the impact of the tough economic environment on our customers, and
• a small charge for share based payments this year compared to a large credit in the prior year.

Asset management operating profit was down 39% as a result of lower asset values due to lower investment markets, lower performance fees especially among funds with CPI (domestic South African inflation) based benchmarks and higher expenses. Expenses were higher, in part, because of a charge for share-based payments costs this year as the Group share price increased compared to a credit in 2008 when the share price reduced over the half year.

The LTIR was 17% lower after a 330bps decrease in the rate applied, reflecting lower investment returns on shareholder funds achieved in 2008 and the expectation of lower returns in 2009 combined with lower average investible asset balances.

Value of new business

The VNB was 5% lower than 2008 level (16% higher excluding Nedlife) despite the decline in new business volumes because of an increase in the new business margin. The margin increased because of a change in product mix (higher proportion of protection product sales) and reduced rate of future cover increases on certain protection products in Retail Mass.

Operating MCEV earnings

The operating Market Consistent Embedded Value (MCEV) earnings declined by 43% from the 2008 level, mainly due to lower expected existing business contribution resulting from a combination of a lower opening MCEV balance and a lower one-year swap rate at the start of 2009 compared to the start of 2008 (the expected existing business contribution under MCEV is derived with reference to the one-year forward swap rate applicable to the currency of the liabilities at the start of the reporting period) and the impact of worse termination experience particularly in the Retail segments as a result of the tough economic environment.

In December 2008 we reached agreement to sell our healthcare business to Lethimvula and on 1 June 2009 we sold our share of the Nedgroup Life and BOE Private Client joint-ventures to Nedbank. As a result we now exclude OM Healthcare from our life sales and embedded value (2008 sales and MCEV numbers have therefore been restated to exclude this). Profits for OM Healthcare and Nedbank joint ventures are included for the first five months to 1 June 2009.

Funds under management

Funds under management of R435 billion were down 8% on 31 December 2008 largely as a result of negative net client cash flow. After the period end, we completed the acquisition of 100% of ACSIS which will enable OMSA to gain access to a niche of private and retirement fund clients.

Our alternative asset class boutiques, OMIGPI and Alternative Investments, have shown resilience in performance in the volatile market. At an overall level our relative fund performance has improved over the short and medium term when measured against the benchmark funds and also improved over medium to long term when measured against peer funds as shown in a table below:

OMIGSA performance

Capital position

Old Mutual South Africa's life company capital position remains strong in spite of turbulent markets. The statutory capital cover has increased marginally to 3.9 times since December 2008.

At 30 June 2009, the statutory capital requirement reduced to R10.8 billion from 31 December 2008's figure of R11.2 billion as a result of a decision to hold more cash and reduce our exposure to equities.

Detailed Review of Business Unit Segments

* H1 2008 restated on MCEV basis

Total Retail Affluent Life APE is 28% lower than 2008 as a result of the challenging economic environment impacting negatively on consumer disposable income and volatile markets leaving many customers unwilling to make long-term savings commitments.

Life single premium sales are down 22% on 2008. Investment Frontiers is the main contributor to this drop, especially the Fixed Bond and market-linked funds. Annuity sales are down 12% from last year, because of less competitive annuity rates this year.

Recurring premium savings sales are 20% lower than 2008, with clients reluctant to commit to long-term savings products in the current economic environment. Recurring premium risk sales excluding Nedlife from 2008 sales are up 9% from last year. Greenlight sales have been boosted by the launch of the new Severe Illness Benefit in June and we expect this to continue.

Unit Trust sales are 10% up on 2008 driven by strong money market flows in the volatile investment markets with Old Mutual Money Market offering very competitive rates.

NCCF is positive, compared with negative flows in H1 2008. This is largely as a result of outflows, in particular surrenders and maturities, being lower than expected due to lower market levels for much of the year and a focus on business retention.

VNB is 79% (61% excluding Nedlife) lower than 2008 due to lower sales volumes while margin is lower because of a lower proportion of profitable life single premium products as well as higher new business strain on the back of lower sales.

* H1 2008 restated on MCEV basis

Sales are up 11% over the equivalent period in 2008, as a result of the larger sales force. This is achieved in spite of continued challenges on retention at early policy durations, especially relating to savings business.

The VNB and APE margin have increased from last year due to a favourable shift in product mix towards more profitable risk products and improved profitability of savings products.

Net client cash flow remains strong as a result of growth in life sales.

* Excluding Healthcare sales  
** H1 2008 restated on MCEV basis

Total Corporate life sales (APE) are 9% higher than in 2008, driven by higher recurring premium sales. Risk business has had a better start to the year than in 2008 with a large scheme secured in January 2009. Single premium sales are at a similar level to 2008 despite the turbulence in investment markets.

Despite total sales being 9% higher than in 2008, VNB is 7% lower. This is mainly due to a lower proportion of high margin annuity business in this year's sales compared to the corresponding period last year. A significant proportion of the savings flows have been into very low margin cash products compared to smoothed bonus products last year with the anticipation that this cash will move into the smoothed bonus products later this year. We have a strong sales pipeline, a new bonus series has been launched for the Absolute Growth Portfolios and we expect flows into that product to improve as the year progresses.

Net client cash flows are lower than in H1 of 2008. The termination of a large client (R1.47 billion) took place in February this year. Apart from this, other terminations have been at significantly lower levels than 2008. The worsening economic conditions are leading to higher rates of member withdrawal, impacting net client cash flow negatively.

* H1 restated on MCEV basis

Net client cash flows (excluding the PIC) slightly improved from 2008, a result of good non-life sales and lower outflows given sensitivities to markets and a good response to the conservative positioning of Marriott Income Specialists boutique.

As announced at our prelims presentation in March 2009, OMIGSA experienced a large outflow from PIC as a result of the PIC performing a full review and redistribution of their equity portfolio, significantly increasing their number of managers. While we lost significant assets, we were pleased to be awarded a portion of the re-configured portfolio, evidence of their confidence in our capabilities.

As our boutique structure has bedded down, there has been increased stability in our teams. We have set strong foundations in place over the past two years and are slowly seeing improving levels of acceptance and confidence in individual boutique investment philosophies and processes. The merger of the OMIGSA Fixed Income and Futuregrowth teams has proceeded smoothly, with the new combined team operating a single cohesive investment process.

The South Africa equity market (JSE All Share Index) has risen slightly off February lows, with a year to date performance of 3%. The past six months has been extremely volatile, with market sentiment oscillating between pessimism and flight to 'safe haven' sectors of gold and cash (particularly in January and February), and improved sentiment leading to rising markets from March onwards, particularly in sectors which had been heavily sold off between October and February. Compelling valuations in late 2008 in the non-gold Resources area, as well as some industrials, meant that a number of OMIGSA Boutiques were overweight in these areas early in the year. This significantly affected performance in January and February, but we saw a strong turnaround from March onwards.

Futuregrowth (now merged with the OMIGSA Fixed Income boutique) continues to deliver good performance across its fund range. SYmmETRY performance has also improved with its Balanced and Defensive CIS funds well positioned relative to peer group. Our alternative asset class boutiques, OMIGPI and Alternative Investments, have shown resilience in performance in this time of market volatility, helping to diversify investor returns. Shorter term performance in the majority of our equity boutiques has improved substantially from the end February 2009 onwards.

Rest of Africa

Despite similar challenging markets in Namibia, particularly in the retail sector, sales were ahead of prior year mainly due to strong performance from institutional business. Recurring premium sales continued to show an improving trend to the end of June 2009, with Retail Mass and the Broker Distribution channels delivering a solid sales performance.

The total life sales (on APE basis) were up 6%. Life single premium sales were 38% lower as a result of the tough economic environment. This was offset by a 32% improvement in the recurring premiums sales, driven mainly by strong sales in the Retail Mass segment as a result of the growth in the sales force.

Unit Trust sales continued to improve significantly, with total sales for the six months to 30 June 2009 ending up 59% on the comparative period last year. This is mainly due to strong Money Market sales as investors consider Money Market as a safer option given the volatile equity markets.