Q&A: the embedded value bandwagon

You report on both an EEV and IFRS basis and these show very
different results. So, can you just talk me through the details here?

To understand our results you need to look at three different bases. You need
to look at embedded value, you need to look at IFRS and you need to look at
cash. Embedded value gives the long-term value of the business that we’re

On that basis profits are down 3%. Within that, the new business profit has
gone up a lot; we’ve increased new business and the profitability of that new
business. But that’s been offset by the fact that we have less money to invest
and our expectations of returns on investments have come down and, therefore,
the total profit is down by 3%.

IFRS suffers the new business strain – the cost of writing that new business
– and that’s a charge in the accounts. But that’s offset by the fact that the
business that we wrote in previous years is now beginning to generate more
surplus and that surplus has gone up in the year.

And then, importantly, we have a one-off basis change for the way we do
reserving and that’s generated a large profit in the year. Overall, that means
that the IFRS profit is up by 79%. The cash basis picks up the entire cost of
the new business, but also the entire benefit of the one offs and, therefore,
we’ve generated £340m of cash in the year. After financing and cost of the
dividend, that’s a modest outflow of £55m for the year.

Just to pick you up on one of those things you said there. Going back
to embedded value you said a 3% underlying drop in profits. But if you look at
the pre tax profit level it’s down by 34%. It’s a big number. Are you concerned
by that?

No. The difference between the underlying and the total profit is really the
outperformance or under performance of the investment markets in the year. Last
year, as you say, we had £312m profit and that reflected equity markets going
up. This year equity markets have gone up, but that’s been offset by the fact
that the capital value of bonds has gone down as interest rates have gone up
and, therefore, we only have a £7m profit on that this year.

So underlying profits under IFRS are up by 79%. What’s the picture

Yes, the underlying EPS is up strongly at 17.9p. With a dividend at 7.85p per
share that’s dividend cover of 2.3 times. Now, that includes the one off
reserving basis changes. So, if you strip those out, earnings per share is
11.7p, which is a dividend cover of 1.5 times. The effect of those on an IFRS
basis is £156m and on the cash basis is £274m.

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Fiona Westwood of Smith and Williamson.