From its inception in 2000, Old Mutual Bermuda (OMB) sold over 51,000 policies, with an aggregate premium value of over $9 billion, through a bank distribution strategy. The business model addressed a key customer niche by providing investment products to international, non-US citizen and non US resident customers seeking a wide range of investment choices (multiple funds and fund families across a variety of international asset allocation portfolios, equity, bond, money market and fixed rate accounts), exposure to international economies and confidentiality through participation in a secure structure.

A significant attraction for customers was that assets are held in segregated accounts, with our trust participation model ensuring that all plans were issued in Bermuda and governed by applicable Bermuda law. Our core business competency remains meeting the needs of large financial institutions by providing innovative and competitive investment solutions through an open-architecture platform.

Generic own brand, private label and proprietary versions of products were customised to distributors' needs and sold through over 70 financial institutions, primarily large international banks. The business also served a range of private and institutional customers.

Following a change of Group strategy and a significant recapitalisation of the business in 2008, after completion of a strategic review in 2009, OMB was closed to new business on 18 March 2009 other than where contractually obliged to accept premium add-ons up to the first policy anniversary date.

Key markets and products

As a leading and innovative provider of investment products for international banks' high net worth and affluent customers, our product mix comprises three investment plans which currently have funds under management of $5.8bn:

• The Universal Investment Plan (UIP): an international investment plan which offers long-term growth potential with a variety of investment options including international equity, bond, hedge and money market funds, as well as fixed rate accounts. This plan also offers strategies to help protect and potentially grow the investment
• The Guaranteed Index Plan (GIP): an investment plan with index options that link returns to the values of the world's major indices, while guaranteeing a minimum of 105% of the amount invested. This plan gives investors full participation in any upside, subject to an annual cap
• The Guaranteed Rate Plan (GRP): an investment plan offering a fixed rate solution that allows control over maturity and flexibility of return. This plan enables investors to diversify by allocating into multiple guarantee periods.

Performance in 2009

Business transformed and delivering on run-off plan

* Stated on a start manager basis as USAM manages $1.1 billion of funds on behalf of Old Mutual Bermuda.

Overview

The business performed credibly against its core objectives, with all written policies passing their first anniversary date meaning that no further policyholder premiums have been permitted since August 2009.

Old Mutual Bermuda (OMB)'s core focus in 2009 was to retain the key staff necessary to execute the agreed run-off plan, reduce costs by half over a three-year period, improve operational efficiencies, strengthen the governance structure, manage capital and liquidity, significantly improve management information analytics and continue de-risking the in-force variable annuity book through a range of measures.

In 2009, management implemented a soft-close strategy to restrict fund choices and continued to improve hedge effectiveness by reducing basis fund mismatches. The business has been transformed with a significantly improved understanding of liabilities and associated management information systems developed, with robust financial metrics and a return to profitability.

Significant reductions in the cost base were delivered during 2009 (over 40% expense reduction year-on-year), with further savings and operational improvement initiatives targeted for 2010. Overall a leaner business operating model has been adopted, with ongoing cost efficiencies anticipated to drive down costs by a further 5-10% annually.

Aggregate surrender activity remains in line with expectations. Ultimately, surrender activity will determine the speed of run-off and the extent and timing of any associated capital, or cash, release. The business remains well capitalised and able to meet all its future obligations, with the knowledge that retention packages are in place for key employees needed to execute on the run-off plan.

IFRS results

Bermuda is now treated as a non-core business and its profit is therefore excluded from the Group's IFRS adjusted operating profit. The 2008 IFRS adjusted operating profit has been restated on the same basis.

IFRS pre-tax profit of $34 million for 2009 was significantly better than 2008 ($675 million IFRS pre-tax loss for 2008) benefiting from expense reductions, lower DAC expense (mainly due to reduced unlocking) and lower guarantee losses, primarily as a result of improved effectiveness of the hedging programme, favourable equity markets and currency movements, higher interest rates, lower volatility and improved fund basis development. The impact of selective releases of hedge positions instituted in the fourth quarter of 2009 was also beneficial in reducing guarantee losses in conjunction with reduced overall reserve requirements as a result of favourable markets.

MCEV results

The post-tax loss on the MCEV operating earnings of $29 million for 2009 was significantly better than the prior year mainly due to the large negative assumption changes made in 2008 for the GMAB strengthening and lower interest rates. Surrender development also led to persistency experience variances.

Reserves

Of total insurance liabilities of $6,741 million (2008: $7,018 million), $4,688 million (2008: $3,934 million) is held in the separate account, relating to Variable Annuity investments, where risk is borne by policyholders. The remaining reserves amount to $2,053 million (2008: $3,084 million). Of this, $763 million (2008: $1,428 million) is in respect of GMAB/GMDB liabilities on the Variable Annuity business, and $1,290 million (2008: $1,656 million) for policyholder liabilities which are supported by the fixed income portfolio (these liabilities include deferred and fixed indexed annuity business as well as Variable Annuity fixed interest investments). These non-separate account reserves represent the discounted future expected account balance needed to meet policy obligations. OMB reserves are calculated on a policy-by-policy basis and are updated frequently and verified independently through both internal and external actuarial review, as well as subject to internal and external audit, as part of the normal statutory audit.

New fund mappings developed in 2009 better allocated exposures to Asian and other emerging markets (which require higher levels of reserving given their inherent higher volatility), thereby improving the accuracy of the reserves. OMB maintains a very significant surplus to its minimum capital requirement, and no further cash or capital injections are anticipated.

Investment Portfolio

No defaults were recorded in the year, with reported impairments of $20 million (2008: $56 million) for 2009. The net unrealised loss position improved to $29 million as at 31 December 2009 ($277 million as at 31 December 2008) as spreads continued to narrow across key sectors.

The book value of the portfolio fell from $1.3 billion at the end of 2008 to $1.0 billion at the end of 2009, primarily to meet surrenders and withdrawals. The fixed income portfolio remains at an A2 average quality, with an improvement to 95% investment grade compared to 2008 of 93%.

As at 31 December 2009, the book value, fair value and unrealised loss of the investment portfolio with a market value to book value ratio of 80% or less was $71 million, $50 million and $21 million respectively (compared to $521 million, $324 million and $197 million, respectively, at 31 December 2008).

Management of Hedging

The hedge policy originally adopted by OMB focused on hedging the underlying economic risk of the guarantees. Generally this strategy reduces the income statement exposure but can result in substantial cash flow movements as the realised changes in value of the underlying derivatives are offset by an unrealised movement reflected in the reserves. In a falling market this will result in large cash inflows while, in a rising market, there will be cash outflows. During most of 2009, hedges were applied to a core number of components (interest rates, foreign exchange, equity markets), with an average hedge effectiveness of 95-96% achieved in the period to September 2009.

Given the improvement in the capital position of the Group, combined with management's improved understanding and management systems for tracking the underlying risks, a process of selective and progressive release of the hedge position commenced in the fourth quarter of 2009. This has been subject to strict oversight and is operated within risk parameters agreed with the Group Risk and Capital Committee. The control systems in place mean that the reinstatement of effective hedges could be made very quickly if required. The new approach continues to manage the underlying economics, but is more dynamic in nature, striking a balance between the potential changes in the income statement, cash flow movements and the transactional costs. Where considered appropriate, the level of hedging activity may be adjusted, subject to a strict stop-loss policy.

The OMB hedge team evaluates the hedging strategy on a continuing basis, with any proposed changes to the strategy subject to strict oversight. A stop-loss protection protocol, and daily management and reporting of Value at Risk cash and profit & loss are used by the Group to monitor business exposures.

Priorities for 2010

With the business transformed in 2009, the key priorities for 2010 are to:

• Further improve expense and operational efficiencies delivered in 2009, maintaining cost discipline and focus to deliver further planned expense reductions
• Manage capital and liquidity effectively
• Further embed risk management into key business decision making processes
• Continue to de-risk the in-force variable annuity book, appropriately executing a dynamic hedging program on key risks
• Implement conservation efforts to better retain profitable non-guaranteed assets.

Outlook

OMB aims to continue to aggressively execute against its run-off strategy, whilst maintaining high levels of customer service through continued operational and service improvements. A return to more normal market conditions will further underpin the continued recovery in profitability, although the business expects increased volatility in earnings in the medium term, particularly as the peak of the crystallisation of guarantees approaches in 2012 and then 2017.