Group Finance Director's Statement
The Group delivered a solid performance in 2009 which is a satisfying result against a difficult economic background, particularly during the first half of the year. In the second half strong sales performance, the success of expense management activities and recovering equity markets helped generate good earnings growth.
Philip Broadley Group Finance Director
The Group delivered a solid performance in 2009, which is particularly satisfying given the volatile market and weak operating conditions seen during the year, particularly during the first half. Our performance improved significantly in the second half of the year, when strong sales performance in the third and fourth quarters and recovering markets helped deliver good earnings growth. Across the Group as a whole, we have seen sales return to similar levels as in the first half of 2008. The decline in profitability in Europe and Nedbank was more than offset by the increase in profitability of the US Life business, following reserve strengthening and impairment losses in 2008.
IFRS adjusted operating profit (AOP) for 2009 of £1,170 million was £34 million higher than the comparable 2008 profit. Adjusted operating profit in the second half of 2009 was £636 million compared to £316 million for the second half of 2008. Adjusted operating profit earnings per share were 12.1p for 2009 compared to 14.9p for 2008. The AOP EPS for the second half of 2009 was 6.8p compared to 6.2p for the second half of 2008. In 2008 results had been significantly affected by the need to strengthen reserves in the US Life and Bermuda business: these businesses both made a profit in 2009. Bermuda is now treated as a non-core business and its profit is therefore excluded from the IFRS adjusted operating profit and the 2008 IFRS adjusted operating profit has been restated on the same basis.
In particular the performance of our LTS business showed the benefits of the geographic split of the business between Europe and Emerging Markets. While the profits from our Emerging Markets business were broadly evenly spread across the two halves of the year, both Nordic and Wealth Management showed significant improvements in the second half. Lower earnings on shareholder funds, increased levels of credit impairment in the banking businesses, and lower asset management profits in South Africa and the US restricted profits despite a creditable sales performance for the year overall.
Overview of 2009 Group results
|Group Highlights (£m)||2009||2008||% Change|
|Adjusted operating profit (IFRS basis)(pre-tax) *||1,170||1,136||3%|
|Adjusted operating earnings per share (IFRS basis) *||12.1||14.9||(19%)|
|Basic earnings per share||(7.8p)||8.6p||(191%)|
|(Loss)/profit after tax||(118)||683||(117%)|
|Life assurance sales - APE basis *||1,380||1,466||(6%)|
|Life assurance sales - PVNBP basis *||10,202||10,814||(6%)|
|Value of new business *||167||158||6%|
|Unit trust/mutual fund sales||7,567||6,600||15%|
|Adjusted Group MCEV (£bn)||9.0||6.2||45%|
|Adjusted Group MCEV per share||171.0p||117.6p||45%|
|Adjusted operating Group MCEV earnings (post-tax)||562||575||(2%)|
|Adjusted operating Group MCEV earnings per share||10.7p||11.0p||(3%)|
|Return on equity *||9.1%||11.3%|
|Return on Group MCEV||10.7%||7.8%|
|Net client cash flows (£bn)||(3.1)||(1.2)||(158%)|
|Funds under management (£bn)||285||265||8%|
* Treating Bermuda as a non-core business
Net client cash flows were £1.9 billion positive in LTS as a whole, although Group net client cash flows were negative £3.1 billion as a result of the net £4.5 billion outflow in US Asset Management, of which £4.1 billion occurred in the fourth quarter.
Adjusted Group MCEV per share for 2009 increased to 171.0p from 117.6p at the year end 2008, and from 143.8p for the first half of 2009. The increase in the adjusted Group MCEV per share over the period was largely driven by the substantial reduction over the period in corporate bond credit spreads in US Life, an increase in equity markets, positive exchange rate movements, operating earnings from covered business, and an amendment arising from an allocation of assets between covered and non-covered businesses at the beginning of the year. This was partially offset by a lower result in operations in Europe, and by an increase in the market value of listed debt and fair value of non-listed debt (where applicable). As anticipated, Wealth Management benefited from a tax gain in aggregate of £205 million following the changes made to the corporation tax treatment of dividends received from overseas subsidiaries by the Finance Act 2009. MCEV data still includes Bermuda as covered business for both 2008 and 2009.
Adjusted operating Group MCEV earnings per share for 2009 of 10.7p were 3% lower than the 2008 year end results. Adjusted MCEV operating earnings in US Life and Bermuda increased significantly, mainly resulting from higher expected returns in 2009 from the corporate bond portfolio. This was offset by lower operating earnings from the other long-term insurance businesses (in particular, Wealth Management) due to lower short-term swap rates, adverse operating assumption changes in relation to persistency and capitalisation of planned development and project expenditure, and lower earnings in both the asset management and banking businesses. These fell on a pre-tax basis from £97 million to £83 million, and from £575 million to £470 million respectively.
The ROEV of 10.7% has increased significantly from 2008 largely as a result of the lower opening MCEV for 2009.
Reconciliation of IFRS and AOP profits
The IFRS after tax result for 2009 was a loss of £118 million, compared to a profit of £683 million in 2008. This movement was largely driven by the impact of marking-to-market of Group debt, as the improvement in the external valuation of Group debt in 2009 negatively impacted profit after tax by £263 million for the year, reversing the positive impact of £503 million of marking-to-market our own debt instruments in 2008. The movement was also driven by the unusually high effective tax rate on the IFRS results. In accordance with our AOP policy, a charge relating to acquisition accounting of £443 million and negative short-term fluctuations in investment return of £316 million represent the other significant deductions from the adjusted operating profit (pre-tax) to arrive at the 2009 loss after tax. As usual at the year-end, we have reviewed our goodwill balances, and we have recognised a goodwill impairment (included within the acquisition accounting charge noted above) of £187 million in respect of Retail Europe business and £79 million in respect of Wealth Management which arose specifically in continental Europe. This impairment reflects a downgrading of our view of the value of these businesses since the time of acquisition given the changed economic circumstances in Europe and market readjustments. We continue to recognise goodwill of around £200 million for Retail Europe which we believe is supportable going forward, and the goodwill for the continental Europe part of Wealth Management has been written off. There was also a release of other provisions relating to long-standing litigation matters of £61 million.
Management Discussion and Analysis of Results for 2009
The principal businesses of the Group are the Long-Term Savings division, Nedbank, Mutual & Federal and US Asset Management. During the year, Old Mutual owned on average 55% of Nedbank and 74% of Mutual & Federal. At 31 December 2009, the market capitalisation of Nedbank was £5.2 billion and of Mutual & Federal was £610 million. Since 31 December 2009, Old Mutual has completed the purchase of the remaining minorities of Mutual & Federal.
The key financial metrics for the Long-Term Savings division are shown in the table below:
|2009||Emerging Markets||Nordic||Retail Europe||Wealth Management||US Life||Total|
|Life assurance sales (APE)||393||235||67||617||68||1,380|
|Value of new business||65||44||(5)||49||14||167|
|Unit trust/mutual fund sales||2,765||393||24||3,210||-||6,392|
|Adjusted operating profit (IFRS basis) (pre-tax)||446||62||22||106||49||685|
|Operating MCEV earnings (covered business) (post tax)||212||81||(44)||(4)||266||511|
|2008||Emerging Markets||Nordic||Retail Europe||Wealth Management||US Life||Total|
|Life assurance sales (APE)||362 *||213||91||664||136||1,466|
|Value of new business||61 *||32||10||67||(12)||158|
|Unit trust/mutual fund sales||2,708||262||47||2,561||-||5,578|
|Adjusted operating profit (IFRS basis) (pre-tax)||415||88||29||150||(230)||452|
|Operating MCEV earnings (covered business) (post tax)||343||149||14||229||(364)||371|
- * Includes Nedgroup Life sales. The comparative figures excluding Nedgroup Life are as follows: APE: £334m; PVNBP: £2,399m; VNB: £53m
LTS reported strong results with IFRS operating profits up 52%, margins improved, and there was strong growth in funds under management, with positive net client cash flows. Sales for the whole of LTS were down only 6% for the full year, but up 5% for the second half compared to the same period in 2008. Emerging Markets sales in the first half were strong relative to those of other parts of LTS reflecting the later entry of South Africa into recession. Wealth Management sales performance in the second half was particularly strong, as was Nordic with very good NCCF and funds under management. Sales in Europe accounted for 67% of the APE and 53% of the value of new business. US Life sales were as planned, and the turnaround in the US Life business, which has delivered a small AOP profit, as compared to a significant loss in 2008, led to the increase in IFRS operating profits.
The APE margin of 12% for the year held up well relative to the comparative period (2008: 11%) despite the lower sales, and given the greater focus on product pricing. The PVNBP margin has also remained steady.
Further discussion on the drivers for the movements within the individual units of LTS, namely Emerging Markets, Nordic, Retail Europe, Wealth Management and US Life is given in the Business Review which follows.
Shareholder allocation and long-term investment return
The AOP result includes the long-term investment return (LTIR) result. The most significant portion of this return arises in the Emerging Markets unit, and in 2009 we have separated the return into those assets supporting OMLAC(SA)'s Capital Adequacy Requirement (CAR) and the excess shareholder assets. OMLAC(SA) is our principal legal entity in the South African part of the Emerging Markets Business Unit. The analysis of the investment return for this business is shown in the table below:
|31 December 2009
as currently reported
|31 December 2008
|31 December 2008
as previously reported
|Other operating segments||91||108||0|
In 2009, the OMLAC(SA) LTIR fell from £133 million to £126 million and reflects a lower expected return of 13.3% (2008: 16.6%) combined with a lower average asset base. In 2010, the LTIR rate for OMLAC(SA) and M&F is 9.4% reflecting the expected asset mix of 25% equities and 75% cash. OMLAC(SA)'s investible asset base at the year end was £1.2 billion, with £1 billion being the assets supporting their capital requirement. The LTIR rates for the European business units reflect the shift towards a higher proportion of cash investment. The LTIR rates for the other businesses have not changed materially in 2009, and are expected to remain stable in 2010.
The South African rand strengthened this year by 14% against sterling and the US dollar strengthened against sterling by 15% on an average basis over the year. This had the effect of improving randdenominated and dollar earnings whilst decreasing the sterling value of dollar-denominated debt at the year-end rates.
Return on Equity
Return on Equity for the Group declined to 9.1% in 2009 from 11.3% in 2008, primarily due to the lower profits from Nedbank, a return to a normalised tax rate and lower European profits, partially offset by improvements in US earnings.
Funds under management and net client cash flow
Funds under management at 31 December 2009 were £285 billion compared to £265 billion at the end of 2008. During 2009, Old Mutual delivered robust investment performance in challenging markets. Group net client cash flows were negative £3.1 billion, as a result of the net £4.5 billion outflow (net of Group transfers) in US Asset Management, although net client cash flows were £1.9 billion positive in LTS as a whole. We produced positive flows of £4.0 billion in our Wealth Management, Nordic and Retail Europe businesses combined, offset by outflows of £1.6 billion in our Emerging Markets business and £0.5 billion in our US Life business. The USAM negative net client cash flow was a result of outflows from several of our US Asset Management affiliates.
The overall FUM and NCCF result is pleasing, considering the challenges of delivering on absolute investment performance in the extremely volatile markets of the past two years. While over the course of 2009, the FTSE-100, the JSE Africa All Share Index and S&P 500 all grew more than 15%, within the period there has been significant fluctuation in many asset classes. The US and South African equity portfolios showed the greatest volatility. Given the movement in monthly funds under management during the period, there were adverse impacts on both management fees and performance fees in the first half of 2009, and these reversed in the second half of 2009. Our large fixed income assets under management performed well. Investment performance in South Africa improved on prior years. Benchmark performance of the US Asset Management business was mixed, with 'quant' underperforming and 'credit' out-performing.
Key actuarial and MCEV developments in 2009
Old Mutual reports its supplementary embedded value information in accordance with the Market Consistent Embedded Value Principles (the 'Principles') issued in June 2008 by the CFO Forum and updated in October 2009 to reflect the inclusion of a liquidity premium. The risk-free reference rate to be applied under MCEV should include both the swap yield curve appropriate to the currency of the cash flows and a liquidity premium where appropriate. The CFO Forum is performing further work to develop more detailed application guidance. The Principles have been fully complied with for all businesses at 31 December 2009.
For the US Life business and OMLAC(SA)'s Retail Affluent Immediate Annuity business we considered the currency, credit quality and duration of our actual corporate bond portfolios, together with a wide range of liquidity market data and literature, and derived adjusted risk-free reference rates at 31 December 2009. It is the Directors' view that a significant proportion of corporate bond spreads at 31 December 2009 is attributable to a liquidity premium rather than credit and default risk and that returns in excess of swap rates can be earned on our portfolios, rather than entire corporate bond spreads being lost to worsening default experience. Liquidity premiums of 100 basis points for the US Life business (31 December 2008: 300 basis points; 30 June 2009: 175 basis points) and 50 basis points for OMLAC(SA)'s Retail Affluent Immediate Annuity business (31 December 2008: zero allowance; 30 June 2009: 50 basis points) were added to swap rates used for setting investment return and discounting assumptions. We believe that the differences between market yields on our US Life and OMLAC(SA)'s Retail Affluent bond portfolios and the adjusted risk-free reference rates still provide adequate implied margins for defaults. No liquidity adjustment is applied for other regions.
When the liquidity premium adjustment was calibrated and introduced for US Life business at 31 December 2008, similar research was not yet concluded for South Africa to estimate the quantum of the liquidity premiums inherent in South African corporate bond spreads. In addition, the impact of a liquidity premium adjustment on US Life business was far more material than for OMLAC(SA)'s Retail Affluent Immediate Annuity business as the concentration of investments in the corporate bond market is far greater and the widening of corporate bond spreads has been more pronounced in the US compared to other regions. Hence the application of a liquidity premium adjustment was initially focused on the US and an adjustment was only introduced for OMLAC(SA) at 30 June 2009 for consistency in methodology.
The recovery of global equity markets together with the contraction of corporate bond spreads, whilst partly offset by the reduction in the liquidity premium adjustment for US Life, were the main factors driving positive economic variances of £1.0 billion for 2009. In addition there was also a strong contribution from foreign exchange movements mainly caused by strong rand appreciation against sterling.
Adverse persistency was experienced across a number of operations and the organisational restructure led to negative expense variances, although this was partly offset by positive mortality variances across all operations.
Persistency assumptions were strengthened, partly to allow for temporary worsening in persistency, and planned development and project expenditure has been capitalised in the value of in-force (VIF). This was partly offset by positive mortality assumption changes, in particular because of a weakening of mortality assumptions in OMSA's Retail Mass business following positi0ve experience for assured lives.
The MCEV of Wealth Management was boosted by the removal of dividend tax in the International business.
Following the purchase of the minority interests in respect of Mutual & Federal on 8 February 2010 in exchange for 147 million Old Mutual plc shares, Mutual & Federal has been delisted and will be incorporated in the adjusted Group MCEV at its IFRS equity amount from 2010 onwards. If the transaction had completed on 31 December 2009, it would have diluted the 2009 adjusted Group MCEV per share by approximately 6p.
The anticipated expected existing business contributions (or expected 'unwind' of the MCEV) at the 'reference rate' of £262 million as well as 'in excess of the reference rate' of £189 million for the twelve months following the year ended 31 December 2009 are provided to assist users of the MCEV supplementary information in forecasting operating MCEV earnings. Note that the exchange rates that are used for such disclosure are the same rates that are used to translate current year earnings for comparability purposes. Therefore the ultimate expected existing business contribution for the financial year ending 31 December 2010 may differ from these results.
Lapses and Surrenders
We continue to monitor and manage actively the lapse and surrender behaviour of customers and specific agents. The pattern of surrenders in the US during 2009 was more volatile than in 2008 in the fixed annuity book, similar to industry-wide trends, and terminations were above assumption levels for the first half of 2009. A moderation through the second half brought about by an active lapse and surrender management programme had the effect of reducing fixed annuity termination rates close to assumption levels. Termination experience for life products was below assumed levels and fixed annuity experience improved during the course of the year.
Emerging Markets saw some indications of deteriorating persistency in certain regular premium Retail Mass products given the economic conditions in the first half of 2009, which led to increased unemployment. Lapse and surrender management programmes in the unit are well established, but we have nevertheless strengthened operating assumptions for our Emerging Markets unit, partially short-term, and this reduced MCEV by £83 million.
The experience in Wealth Management, particularly in the UK and International businesses, reflected anxiety around equity-based investments although this stabilised in the second quarter and onwards for the rest of 2009. However, given the changes in the operating model of the UK business and the migration to the platform business from the older product lines, we have also made a negative operating assumption change of £81 million in respect of persistency.
Elsewhere in LTS, trends were generally in line with assumptions.
Surrenders in Bermuda occurred mainly on the non-guaranteed book as asset values recovered. Conservation activity here focused on managingcash flow and profitability, and efforts in this regard are likely to develop further in 2010 in a way that is consistent with maximising long-term value for the Group.
Overall the financial circumstances of our customer base remain the key driver of lapse and surrender behaviour. For example, rising unemployment in a number of markets has led to what we believe to be a temporary deterioration in persistency, which should revert back to long-term assumptions as economic conditions improve.
Capital, liquidity, leverage and dividends
The Group's regulatory capital surplus, calculated under the EU Financial Groups Directive, at 31 December 2009 was £1.5 billion (31 December 2008: £0.7 billion; 30 June 2009 £1.0 billion). This represents a coverage ratio of 135%, compared to 121% at 31 December 2008 and 128% at 30 June 2009. The increase since 31 December 2008 comprises the statutory earnings in the period, rand strength and a Nedbank Tier 2 capital raising offset by modest rises in statutory bank capital requirements in South Africa. There was a positive £0.1 billion movement in FGD arising from management actions including the disposal of Australia, closure of Bermuda to new business, and a change in the investment mix of Emerging Markets' shareholder funds held to back the Capital Adequacy Requirement. The Group FGD surplus was reduced by £42 million compared to 2008, as US Life is now included at 200% of local capital required rather than 150% as in prior periods.
Our Group capital is structured in the following way:
|Other Tier 1 Equity||611||11||573||13|
|Tier 1 Capital||4,829||84||3,621||83|
|Deductions from total capital||(1,597)||(28)||(1,724)||(39)|
Tier 1 includes £174m of the hybrid debt capital reported for accounting purposes as Minority Interests and Tier 2 includes £338 million of capital hybrid debt, which is reported as Group Preference Shares.
The Solvency II Directive was approved by the European Union in November 2009, and is scheduled to come into effect in October 2012. The Group is actively participating in the industry consultations, such as the Quantative Impacts Studies, which are taking place to develop the more detailed implementation measures which the European Union will agree over the next two years.
The Solvency II Directive is intended to align the regulatory capital regime for insurers more closely with the economic risk view of the business. However, it also changes the qualifying criteria for regulatory capital in response to the market events of the past couple of years, and in addition, has considerable implications on the governance structures and operating models for EU insurance businesses. Although the Solvency II Directive applies to EU insurers only, it applies to the Group's businesses globally; furthermore we expect other jurisdictions, notably South Africa, to implement equivalent regimes shortly afterwards.
Our subsidiary businesses continue to have strong local statutory capital cover.
We remain committed to supporting the US Life capital ratio at a level above 300% RBC. In February 2009, $225 million of cash was injected into the US Life business. Since then, the improvement in performance has meant that the Group has not been required to provide any net additional capital to the US Life businesses. This compares favourably with our previous guidance where we stated the business could require between $200-300 million. The development for 2010 capital needs in US Life depends upon a wide range of factors including our statutory earnings, market movements, ratings migration and the implementation of possible changes to both US GAAP and NAIC accounting rules which are currently under consideration. Such developments may result in a release of statutory capital requirements in due course. Given the capital position of the business and our expected level of IFRS impairments for 2010 of $55 million, we do not anticipate a capital injection into the business during 2010.
Liquidity and Cash Flow
As a Group we concentrate on maintaining effective dialogue and strong commercial relationships with our banks and fixed income investors. In 2009 we have successfully extended two existing bank facilities of £250 million, have put in place an additional three-year bank facility of $200 million, and in October 2009, we successfully placed a £500 million seven-year 7.125% fixed rate senior bond.
At 31 December 2009, the Group holding company had total liquidity headroom of £1.2 billion (2008: £0.6 billion), comprising cash of £0.4 billion and undrawn facilities of £0.8 billion.
In addition to the cash and available resources referred to above at the holding company level, each of the individual businesses also maintains liquidity to support its normal trading operations.
The Group generated £434 million of free surplus in the year (2008: £83 million), of which £249 million (2008: (£158) million) was generated from covered business, and £551 million (2008: £308 million) was generated by the LTS division. Bermuda continues to be included as covered business for both 2008 and 2009.
|At 31 December 2009||At H1 2009||At 31 December 2008|
|Mutual & Federal||172%||141%||104%|
|Nedbank *||Core Tier 1: 9.9% Tier 1: 11.5% Total: 14.9%||Core Tier 1: 8.6% Tier 1: 10.0% Total: 13.2%||Core Tier 1: 8.2% Tier 1: 9.6% Total: 12.4%|
- * This includes unappropriated profits.
Our reported net debt at 31 December 2009 was 0.4% up on the 2008 year-end position at £2,273 million, but was £102 million lower than at 30 June 2009. This represented senior debt leverage of 1.8% compared to 5.4% in 2008 and total debt leverage was 20.1% in 2009, compared to 26.7% in 2008. At 31 December 2009, our gross debt on an IFRS basis was £2,842 million, and at market value it was £2,526 million.
During the year, the business units contributed £529 million of inflows which were offset by £339 million of operational expenses and organic investment including the $225 million of capital injected into US Life in the first quarter. During the period, cash of £41 million was also used to exit the AA TEDA transaction and £80 million was paid in respect of the settlement of certain long-standing litigation matters.
The movement in the net debt position is shown below:
|Opening net debt||(2,263)||(2,420)|
|Inflows from businesses||529||822|
|Outflows to businesses and expenses||(339)||(440)|
|Debt and equity movements|
Ordinary dividends paid
|Other non-cash movements||(202)||298|
|Closing net debt||(2,273)||(2,263)|
|Net decrease/(increase) in debt||(10)||157|
The Board has carefully considered the position in respect of a final ordinary dividend for 2009, and is recommending the payment of a final 2009 dividend of 1.5p per share (or its equivalent in other currencies). The Company is offering, for the first time, a scrip dividend alternative for eligible shareholders. The dividend timetable is set out opposite.
The Board intends to pursue a dividend policy consistent with our strategy, and having regard to overall capital requirements, liquidity and profitability, and targeting dividend cover of at least 2.5 times IFRS AOP earnings over time.
|Timetable for the final dividend|
|Currency conversion date||5 May 2010|
|Currency equivalents and scrip calculation price announced||6 May 2010|
|Last day to trade cum div for shareholders on the registers in Malawi, Namibia, South Africa and Zimbabwe||7 May 2010|
|Ex-dividend date for shareholders on the registers in Malawi, Namibia, South Africa and Zimbabwe||10 May 2010|
|Last day to trade cum div for shareholders on the UK Register||11 May 2010|
|Ex-dividend date for shareholders on the UK Register||12 May 2010|
|Record date for the dividend||14 May 2010 (Close of business)|
|Payment date and date of issue of shares under the scrip dividend alternative||25 June 2010|
Share certificates and date of issue of shares under the scrip dividend alternative on the South African register may not be dematerialised or rematerialised between 10 May 2010 and 14 May 2010, both days inclusive. Further details of the scrip dividend alternative are contained in the separate shareholder circular.
US Life bond portfolio performance
The cash characteristics of the US Life business are very different from that of the equivalent period of 2008. We consider that the unusual market conditions have validated our decision to hold a higher than usual cash weighting in the US Life Investment portfolio. In the second half of 2009, we began to make selective purchases of new bonds. We currently hold around $0.8 billion of cash and other short-term holdings in the portfolio. The profile for maturities from the bond portfolio and new premium inflow, gives us considerable flexibility when considering actions to mitigate against having to realise losses on corporate bonds. The portfolio is well matched with assets (including cash and short-term holdings) of 5.6 years of average duration compared to 5.8 years of liabilities.
On the US Life $15.3 billion fixed income security portfolio, the unrealised loss was $0.5 billion at the end 2009, and has continued to improve to below $0.2 billion at the end of February 2010. This compares to $1.6 billion at 30 June 2009 and $2.3 billion at 31 December 2008. All of the above amounts are stated net of the impact of reclassification of certain securities permitted by the amendment of IAS 39, the unrealised loss on which amounted to $45 million at 31 December 2009, $283 million at 30 June 2009 and $387 million at 31 December 2008.
Of the portfolio, 50% is rated 'A' and above, 42% is rated 'BBB' or below and 8% is not rated. The ten largest holdings account for $1.3 billion (8.1%) of the portfolio (31 December 2008: $1.1 billion and 6.1%) with an average holding of $128 million (2008: $107 million). The portfolio continues to have approximately 15.7% in residential and commercial mortgage-backed securities, with approximately 5% in preferred stock and hybrid instruments.
There have been a small number of defaults in the portfolio in the year amounting to $14 million. Total impairments amounted to $389 million in 2009 compared to $711 million in 2008. The valuation of the bonds held in the portfolio has benefited from the ongoing equity recapitalisations, mainly of financial companies. As a result, we have taken advantage of the opportunity to harvest gains so as to improve the underlying features of the bond portfolio further. The running yield of the portfolio is 5.82% (including cash and other invested assets).
Bermuda is in run-off and consequently is treated as a non-core entity from 2009. The effect of this isto remove its result from our AOP disclosures, but to account for the interest on the loan notes to the Group as a cost for AOP purposes of approximately £40 million annually. It continues to be consolidated for the purposes of IFRS reporting. The AOP EPS for 2008 has also been restated from 12.2p to 14.9p.
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 and the stabilisation of the hedge effectiveness, combined with management's improved understanding and management systems for tracking the underlying risks, a process of selective and progressive release of the external hedge position commenced in the fourth quarter of 2009, with strict oversight and within risk parameters agreed with the Group Risk and Capital Committee. By 31 December 2009, the majority of the equity market hedges had been released. The release of the hedges is subject to a stop-loss protocol, and controls are in place to ensure that effective hedges can be reinstated quickly if required.
The business remains well capitalised and able to meet all its future obligations. Surrender behaviour that is influenced by underlying fund performance will determine the speed at which the Bermudan book of business runs off over time, and the extent and timing of any capital and cash release.
Group restructuring, corporate disposals and acquisitions and related party transactions
The Group continues to simplify its structure and reduce its spread of business to focus on areas of key competence and competitive strength, and drive operational improvements. As discussed in the Group Chief Executive's Report, we have announced a programme of corporate restructuring designed to simplify the Group and realise value for shareholders. A number of operations have been identified for potential exit. We expect proceeds from disposals and from retained earnings will be deployed to reduce debt as part of the Group Capital Management Programme. Within each business and in particular in the Wealth Management division of LTS, reorganisations and efficiency programmes are being launched, with a target of reducing costs by £100 million across the Group by the end of 2012. In aggregate, these will result in expected 2010 charges to AOP of around £50 million. While the restructuring programme is put into effect, we will be able to assess the impact on Group Head Office resources required and the progress made from iCRaFT and other risk management improvements. Head Office costs for 2009 were £65 million, and following the implementation of iCRaFT and the completion of the restructuring, we anticipate that we can maintain underlying Group Head Office costs at less than £60 million per annum.
During 2009, the Group launched an offer for remaining minorities of Mutual & Federal. This transaction closed on February 2010 with the issue of 147 million ordinary shares to the minority shareholders. We also successfully completed the acquisition of a 100% share in ACSIS, a South African asset management firm, in August. Disposals in 2009 were of the Chilean and Australian businesses, and the withdrawal from the AA TEDA acquisition in China in the first half of 2009, and Bankhall in the UK in October 2009. Following the disposal to Nedbank of several Old Mutual joint ventures, Old Mutual has sold the shares received from Nedbank in accordance with regulatory approved processes. During February 2010, Nedbank received final regulatory approvals to acquire 100% of the ordinary and preference shares in Imperial Bank.
Tax and non-controlling interests
The effective tax rate on adjusted operating profits of 25% has returned to within its normal anticipated range, from 8% in the comparative period. Factors increasing the 2009 AOP tax rate compared to 2008 include a reduced proportion of profits being earned on low-taxed dividends and capital profits, partially offset by prior year adjustments and lower secondary tax on companies (STC) costs on reduced dividends. We anticipate a similar rate for 2010. Furthermore, the 2008 rate was anomalously low due to the unprecedented market conditions, the recognition of previously unrecognised deferred tax assets and a release of provisions following agreement of various issues with tax authorities.
The IFRS effective tax rate for 2009 was anomalously high at 148% reflecting policyholder contribution, losses carried forward not recognised and non-deductible goodwill.
Risks and uncertainties
There are a number of potential risks and uncertainties that could have a material impact on the Group's performance and that could cause actual results to differ materially from expected and historical results.
Continued volatility in world economic conditions creates uncertainty in equity markets, currency fluctuations, credit spreads, corporate bond defaults and rating agency actions both on investments owned by the Group and the Group underlying entities. Unemployment conditions continue to deteriorate and could adversely affect termination experience in respect of the life insurance business that could result in realising losses on illiquid assets, particularly in the case of US Life, although this is likely to be less than in 2008 and 2009. Credit losses in South Africa's banking system are subject to uncertainty and volatility.
Economic uncertainty has contributed to reduced consumer confidence. This has changed product preferences to lower-risk investment products and affected termination experience in respect of existing and new business. These may have an impact on earnings and present both risks and opportunities for the Group.
The Group is continually monitoring these uncertainties and taking appropriate actions wherever feasible. The Group continues to meet Group and individual entity capital requirements and day-to-day liquidity needs.
The implementation of the new operating model will present challenges, yet reduce risk across the Group. The Group continues to strengthen and embed its risk management framework, whereby we actively monitor and manage risk through the three-lines-of-defence at both a business unit and Group level, where risks exceeding pre-determined thresholds are escalated to management and risk officers, who are responsible for the appropriate mitigating action. Each business regularly reviews its overall business risk exposure against risk appetite set in conjunction with Group Head Office. Further detail on risk management is provided in the Group Risk Report.
Group Finance Director
11 March 2010