Group Business Review

Group Finance Director's Review

Business Review: United States

US LIFE

Growth in assets delivers improved profits – up 25%
Our US life business’s adjusted operating profit of $174 million was 25% up on the $139 million achieved in 2003 as our strategy to manage growth in profitable product areas and to drive towards capital self-sufficiency in 2007 made good progress. The impact of the continued growth in scale of the business is shown by funds under management increasing by 30% to $17 billion during 2004.

Strong APE growth continues – up 29%
Total APE for 2004 was $501 million, an increase of 29% from $389 million in 2003, with the business reaping the benefits of successfully diversifying from fixed to equity-linked products during 2004, coupled with the maturing of the offshore and corporate channels. Total premiums exceeded $4 billion. OMNIA and Corporate channels continued to mature, with 44% growth of APE over 2003 ($41 million to $59 million). Life assurance sales grew by 25% from $85 million in 2003 to $106 million in 2004.

Managing product mix enhances margin to 23%
Over the past year the business has demonstrated its flexibility to seize new opportunities in changing market conditions by rapid product development. We succeeded in producing profitable equity index annuity and term life products, both of which achieved second place market share nationally for the period for our Managing General Agents channel. The average margin on new business after tax increased from 15% to 23% of APE and the value of new business after tax at $113 million increased by 92% on 2003, reflecting the positive movements in interest rates and changes in product mix.

Capital position strengthened
We continued to manage the capital position of our US life business carefully. In order to support our ratings, we decided to increase the target risk-based capital (RBC) ratio to 300%. Consequently, the capital base was strengthened by a one-off injection of $200 million (making a total of $300 million for the year). At the same time we repatriated to the USA a significant block of annuity business from Old Mutual Re (Ireland). This repatriation improved our Group solvency position, but had one-off negative impacts of $39 million on our consolidated embedded value and $43 million on the statutory profit before tax of Fidelity & Guaranty Life Insurance Company. The US life business continues to mature and is expected to begin releasing capital from 2007.

US ASSET MANAGEMENT

Adjusted operating profit up 22%
The Group’s US asset management business delivered adjusted operating profit of $163 million, an increase of 22% on 2003. The combination of increased client inflows and strong equity markets in the latter half of 2004 led to a 21% improvement in average asset levels to $165 billion for 2004. Management fees increased from $497 million in 2003 to $570 million in 2004, significantly improving adjusted operating profit. Strong performance fees, transaction fees and improved revenues from securities lending also contributed to the overall growth in revenue. Offsetting this improvement, expenses increased by 17%, as a result of costs associated with our retail initiative ($6 million) and increased variable compensation costs together with one-off expenses, including the cost of restructuring the Dwight Stable Value Fund ($7 million).

Funds under management up 20%
Funds under management increased 20% overall during 2004, from $154 billion at 31 December 2003 to $185 billion at 31 December 2004. Investment returns in the funds under management accounted for 12% of the increase, while net inflows of client assets, including $3.2 billion in cash collateral assets, contributed a total of $12.3 billion, or 8% of the increase for the year. 2004 marks the fourth consecutive year of net inflows of client assets to our member firms.

Strong fund performance
The inflows reflect the continuing strong investment performance achieved by our member firms. At 31 December 2004, 72% and 95% of assets were outperforming their benchmarks over three and five years respectively. Over the same periods, 61% and 73% of assets ranked in the first quartile of their peer group.

Retail initiative launched
In October, Old Mutual Capital launched the Old Mutual Advisor Funds, establishing the foundation for a full-scale retail distribution initiative. These funds utilise the diverse asset management capabilities of our affiliates to construct asset allocation mutual fund products tailored to different investor risk profiles. This initiative is targeted to increase our presence in the mutual fund market and is designed to give our affiliates access to a higher margin market, further diversifying revenue-generating sources for the Group.

Managing the portfolio
The US asset management group continually assesses its business position and ability to maintain product leadership. In line with this strategy, several adjustments were made to the manager group in 2004. We reached agreement with the principals of one of our remaining revenue-sharing firms, First Pacific Advisors, under which they have an option to acquire certain of the firm’s assets and liabilities with effect from October 2006. Its assets under management at 31 December 2004 were $8.4 billion (31 December 2003: $5.5 billion). At the end of 2004 we discontinued the operations of another member firm, Sirach Capital Management. The firm, predominantly a growth equity manager, had suffered steep asset declines since 2000. Funds under management at the beginning of 2004 were $1.6 billion, and management has taken the decision to return the remaining funds to clients. The resultant non-operating loss to the Group was $14 million, principally the write-off of goodwill.

In June 2004, Liberty Ridge Capital (LRC) (formerly Pilgrim Baxter & Associates) reached agreement with the Securities and Exchange Commission and the Office of the New York Attorney General to settle regulatory action against the firm. Total fines and penalties agreed were $90 million and have been disclosed as a non-operating loss. LRC has also committed to future fee reductions of $10 million. During 2004, all outstanding class action lawsuits filed against Old Mutual in relation to these activities were consolidated into a single lawsuit, along with all other cases against US parties alleging market timing and late trading violations. Proceedings in this case are at the preliminary stage. Following the resolution of regulatory matters and reflecting new company management, LRC underwent a firm-wide revitalisation, revising its product strategy, enhancing its investment processes and rebranding under its new name. Despite net outflows of $2.4 billion in 2004, funds under management remain robust, and management continues to focus on rebuilding the franchise.

Early in 2005, we created a strategic alliance with Copper Rock Capital Partners. This is a small cap growth firm, and the alliance is designed to supplement our capability in this product area.

Clients benefit from diversity and focus
Looking ahead, we are committed to derive business growth organically, leveraging off the diversity and styles of the individual firms. We are currently in negotiations to add a hedge fund capability and will continue to seek targeted investment opportunities in other areas to strengthen and broaden product capability.