Note 14 - Notes to the Supplementary Financial Statements - Supplementary Financial Statements - Annual Report and Accounts 2006

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14. Significant Impacts

Corporate restructuring

On 31 December 2006, the non-linked non profit pensions and annuity business of Legal & General Assurance Society Limited (Society) was ceded to a new, wholly owned, reinsurance company, Legal & General Pensions Limited (LGP). The required capital and free surplus of LGP is included in the covered business.

LGP has been capitalised using £1.3bn of Society shareholder capital, £400m of this is represented by subordinated debt (£200m upper tier II, £200m lower tier II) and £900m by equity. The reinsurance was effected on arm’s length terms resulting in an initial regulatory loss in LGP. Further funds of £571m have been injected from Society’s LTF into LGP’s LTF by means of a contingent loan to cover this loss.

Prior to the capitalisation of LGP, the intra-group subordinated debt capital of £602m attributed to SRC was repaid to Group Plc and an equivalent amount was lent to Society shareholder capital on a subordinated basis (£301m upper tier II, £301m lower tier II).

Overall, the corporate restructuring has increased the embedded value by £171m. This arises from tax benefits totalling £322m, which include a reversal of the adverse impact of the 2005 UK tax changes. This is offset by an additional cost of solvency capital of £119m in LGP and other impacts of £32m which together total £151m. The EEV impact of the net tax benefits is reported within the tax section of the income statement. The impact of the higher cost of solvency capital and other impacts is reported below operating profit and grossed up for tax at 30%. The tax gross up of £65m is included in the tax charge. The additional cost of solvency capital in respect of new business transferred to LGP has reduced the contribution from new business by £19m.

Implementation of changes to FSA reporting and capital rules (Policy Statement 06/14)

In 2006, the FSA introduced a more realistic reserving framework for certain non profit business. As a result, there has been a reduction in the regulatory reserves required for term assurance business of £641m. The associated financial reinsurance previously in place to finance these reserves was terminated.

The impact of these changes has been to increase the EEV operating assumption changes by £64m, and contribution from new business by £33m, due to the resulting lower capital requirements.

Review of annuity investment policy

During 2006, Society undertook a review of its asset liability matching policy for annuity business. Property assets backing annuity liabilities were replaced with corporate bonds and Society entered into inflation swaps to mitigate negative inflation risk. As a result, a closer match between assets and liabilities was achieved. Additionally, the margin within the reserves to cover an interest rate mismatch was reviewed and reduced.

EEV operating profit has increased by £18m due to the reduction in the capital requirement. However, the EEV variation from longer term investment return is reduced by £27m due to the change in asset mix.