Financial Services marketplace in the United Kingdom Sid Maheshwari Global Research Center

Financial Services marketplace in the United Kingdom

Sid Maheshwari

Global Research Center

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2

Contents – Financial Services marketplace in the UK

Contents Slide #

Banking 2

Insurance 17

Investment Banking 56

Asset Management 65

Audit and Consulting Market 79

Appendix 94

3

UK Banking Sector

4

UK Banking Sector

Contents Slide #

Banking sector assets 5

Largest players and cost-revenue performance 6

Trend in margins 7

Credit quality trend 8

Personal insolvency trends 9

Corporate loan growth 10

Loan book of select UK banks 12

Long-term trends in market share – mortgages, deposits and unsecured lending

13

Remortgages 14

Key trends and forecasts 15

Key issues 16

5

UK Banking Sector

• This segment covers various trends in the UK Banking sector. The segment starts with information on the UK banking sector assets along with the time-series growth pattern and gives an international comparison with the US and a few European and Asian Counterparts.

• The presentation then moves on to the player profiles and talks about “weaker” revenue performance expected in 2005. The revenues will be weak in comparison to 2004, primarily due to the declining margins. However, profits will remain stable due to prudent expense management.

• The focus then moves to credit quality, which would remain strong, in spite of a modest deterioration in 2005.

• Related to the above is the personal insolvency trend, which although a cause of concern is not likely to have any major impact on the credit quality.

• The presentation then moves to corporate loans, their key drivers and future expectations. This segment appears to be robust in spite of an anticipated modest decline.

• Analysis of loan books of select UK banks come next followed by the trends in the market share movements in mortgages, deposits and unsecured lending.

• This is followed by a further analysis of the mortgage market with special focus on remortgaging, which is one of the key driver of the market.

• The section ends with a summary of key trends and issues. The section also gives certain economic, regulatory, technological and marketing trends.

6

UK Banking – a jewel in the global banking arena and an attractive center for foreign banks

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

UK banks Foreign banks

UK Banking Sector Assets grew by 12% annual growth rate during 1999-2003

CAGR 12.1%

UK is the 3rd largest banking centre globally (2002 assets)

4,483 4,375

3,042

2525

974647 627

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

US

Japa

nUK

Germ

any

Fran

ce

Switz

erla

nd

I tal

y

$ bn End 2002

UK has highest average assets per bank and bank branch

7,825

2,853 2,591

1,011 814380 356

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

US

Japa

n

Germ

any

Fran

ce

I tal

y UK

Switz

erla

nd

# B

anks

0

10

20

30

40

50

60

70

80#

Bra

nch

es

(000)

Banks (LHS) Branches (RHS)

The UK is the third largest banking centre globally, being next only to the US and Japan. The sector has witnessed robust performance in the past 5 years with an average annual growth of 12% during 1999-2003.

A surprising fact about the UK banking sector is its low ranking in terms of no. of banks and no. of bank branches, which implies that the assets per bank or branch should be one of the highest in the UK among the global banking centres.

The contribution of foreign banks to the banking sector assets in the UK is higher than their domestic counterparts, which highlights the importance of the country as an international banking center.

Source: IFSL, GRC Analysis, FDIC

7

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

2002 2003 2004E 2005E 2006E

Alliance & Leicester Barclays Bank

HBOS HSBC (£m)

Lloyds TSB Royal Bank of Scotland

Sector total Domestic sector total

Global UK based players along with “local” players dominate the top 10 rankings in a landscape that is threatened by weaker revenue growth

Lower revenues in 2005

The UK banking sector may witness lower revenue growth in 2005, due to slower housing market and regulatory and competitive issues.

Revenues would also be impacted by a decline in net interest income (see next slide), due to declining margins (not compensated by higher expected volumes).

Higher costs in 2005 – tapering off expected in 2006

Costs are expected to increase by 5% as compared to revenue growth of 8% in 2005. Costs in 2004 were inflated due to compliance with the IFRS. This inflated level is likely to stay put in 2005 but not further.

After a strong domestic revenue growth of 13% in 2004, growth is likely to taper off to 9% in 2005 and 7% in 2006

-30%

-20%

-10%

0%

10%

20%

30%

40%

2002 2003 2004E 2005E 2006E

Alliance & Leicester Barclays Bank

HBOS HSBC (£m)

Lloyds TSB Royal Bank of Scotland UK sector total UK domestic sector total

Cost increase is expected to be less than revenue growth implying higher operating profits

1,034

806 791

651

450

316

120 86 66 57

0

200

400

600

800

1,000

1,200

HSB

CRBS

Barcl

ays Ban

k

HBO

S

Lloy

ds T

SB

Abbey

Nat

iona

l

Stan

dard

Cha

rter

ed

Allian

ce &

Lei

cest

er

Nor

ther

n Ban

k

Bradfo

rd &

Bin

gley

$ b

n

UK Top 10 banks by Assets (Dec 2003)

Source: CSFB, IFSL, BBA, Smith Barney, GRC Analysis

8

Declining margins will be an impediment in the long term growth story – margin improvement expected in 2006; revenues may suffer

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

2002 2003 2004E 2005E 2006E

Alliance & Leicester Barclays

Bradford & Bingley HSBC

HBOS Lloyds TSB Royal Bank of Scotland UK simple average

Net Interest Margins of UK Based Banks – declining but set to rebound in 2006

Net interest margins have declined for at least past 20 years and this trend is expected to continue in 2005. However, in the past this decline has been more than compensated by strong lending volumes and good growth in non-interest income. This may not be the case in 2005.

Going forward in 2005, the margins (excluding the impact of IFRS that would boost margins and bad debt provisions) would decline at a slower rate than 2004. This would happen due to the following counts:

•Reduction in funding pressure, as retail lending eases leading to better match between it and retail funding

•Higher return on free funds

•A more comfortable relationship between the level of wholesale funding costs and the base rate in the UK.

However, the lending margins may witness erosion due to softer loan demand, which the banks may offset by aggressive pricing.

In the credit card market, which saw some margin improvement in 2004 and early 2005 (as a result of significant increase in the UK credit card rates along with roll-off of some of 0% introductory offers), banks may have to rely more extensively on the fees as many special features offered on these cards may become “standard” features over the year.

Customer loans would increase at 9% in 2005 and 8% in 2006 (down from 12% in 2004). This would however not compensate the decline in margins. As a result revenues would suffer.

-20%

-10%

0%

10%

20%

30%

40%

2002 2003 2004E 2005E 2006E

Alliance & Leicester Barclays Bank Bradford & Bingley HBOS HSBC (£m) Lloyds TSB Royal Bank of Scotland UK sector total UK domestic sector total

A 9% growth in 2005 would not compensate the fall in margins – revenues likely to be negatively impacted

Source: CSFB, Smith Barney, GRC Analysis

9

Credit quality will remain strong in 2005, in spite of a modest deterioration

0

20

40

60

80

100

120

140

2002 2003 2004E 2005E 2006E

Alliance & Leicester Barclays Bank Bradford & Bingley HBOS HSBC Lloyds TSB Royal Bank of Scotland UK sector total UK domestic sector total

Credit quality will improve across all the key operational segments of the UK banks

Credit quality will remain strong, in spite of a modest deterioration, with aggregate bad debts increasing by 18%, about double the rate of loan growth at 9%. This will primarily be due to the lower level of releases and recoveries especially at the banks with large operations in Asia. Given below is the revenue outlook of key product/ geographic segments from where the UK banks derive their revenues:

• UK Household: This constitutes around 76% of the UK lending, out of which around 80% is mortgage lending, the rest being unsecured lending. It is expected that personal sector provisioning will increase at a faster rate than personal sector lending, in part reflecting the usual lag between strong loan growth and increased provisioning. However, this will not lead to any significant decline in underlying credit quality.

• UK Corporate: Credit quality will be “comfortable” in 2005, due to improved profitability and continued financial surplus.

• Ireland: Accelerating economic growth with declining unemployment will boost private sector earnings that would keep the bad debt charges as a proportion of loans at the comfortable level.

US: US corporate credit quality is expected to remain very good in 2005 with the possibility that gross new provisioning could fall relative to 2004, as most of the indicators of credit quality and economy are stable or improving.

Rest of the World: Credit quality in Asia and Hong Kong in particular is expected to remain good. No major threat is seen across other parts of the world.

In the context of credit quality the personal insolvency trends remain a concern (see next slide), although they are not likely to impact the market immediately.

Source: CSFB

10

Personal insolvency trends remain a concern although not a threat for credit quality

0

2000

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Q1

75

Q1

76

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00

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01

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Q1

04

UK

In

div

idu

al

Inso

lven

cie

s

Individual Insolvencies – 1975 – Q3 2004

Trend 1

Trend 2

The rapid increase in the personal insolvencies (mainly involving unsecured debt), at levels not seen since the recession of early 1990s, is a cause of concern. The impact of this trend on credit quality is unclear and currently not expected to be significant. Also, the impact of bankruptcy laws that came into effect in Apr 2004, on this trend is not clear.

This trend is also supported by a survey conducted by the “Bank of England” which noted that unsecured debts was considered to be a “burden” by almost 38% of the respondents in comparison to the household debt, which only 7% thought was a burden.

The concerns also get somewhat heightened considering that the strain is being felt in spite of the interest rates being at historically low levels.

Source: Smith Barney, Bank of England, GRC Analysis

Note: Graph above is approximate representation of actual data. The analysis is based on the “as is” situation till Q3-Q4 2005.

Mortgage

52%

Overdrafts

1%

Personal Loans7%

Credit Cards3%

Other Banks & Speciali

st Lenders

22%

Building Societie

s15%

Personal Lending

Unsecured Debt

Unsecured debt comprises of Personal Loans, Credit Cards and Authorized Overdrafts.

This segment has been facing a problem of increasing number of insolvencies as highlighted in the accompanying graph and below.

11

Corporate loan growth remains promising, driven by manufacturing and real estate to a lesser extent

Segmental loan growth (YoY) 1994-2005

Corporate Loan growth (YoY) 1994-2005

UK Loan Growth (YoY) 1991-2005

Total banking loans have been on the rise since the start of H2 2004. Corporate loans have shown a significant increase followed by credit cards and unsecured personal loans (UPLs) to a lesser extent. These have more than compensated the decline (although not substantial) in the mortgage lending.

Within the corporate loans strong growth is coming from manufacturing and construction with marginal contributions from the real estate segment.

It is worth noting that manufacturing loans started picking up since the start of year 2004, which were then added on to by the construction sector growth beginning in mid 2004.

Corporate loan growth forecasts remain promising, but declining to mid single digits by 2006 end.

Source: Smith Barney

12

Corporate loan growth by sub-segments

The graphs above show the sector contribution and growth in corporate lending. Lending to most categories of non-financial companies increased in January 2005.

•In addition to the robust loan growth recorded to the Real Estate sector in January 2005 (19.8%), lending to the Construction sector increased 13.2% year on year.

•Lending to the Wholesale & Retail Trade in 2004 was 10.1%, significantly higher than 5.6% in 2003. This sector started 2005 strongly with lending remaining robust at 11.2% in the year to January 2005.

•Lending to the Transport & Storage and Hotel & Restaurant sectors also remains buoyant, up 10% and 7% respectively in the year to January 2005.

•In contrast to the strong lending seen elsewhere, lending to the Agriculture & Fishing and Manufacturing sectors remains weak, recording loan growth of between 2%-3% in the same time period.

1 Other includes Mining & Quarrying, Electricity, gas & hot water supply, Public Admin & Defence, Education, Health & Social Work, Recreational, Personal & Community Services and Unclassified.

Source: BBA and Smith Barn analysis

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

FY 01 FY 02 FY 03 FY 04 5-J an

Agriculture & Fishing ManufacturingConstruction Wholesale & Retail TradeHotels & Restaurants Transport, Storage & Comm.Real Estate Other 1/ Unclassified Corporate Corporate (excl. financials)

Real Estate

39%

Transport,

Storage &

Comm.

4%

Other 1/

Unclassified

Corporate

21%

Agriculture

& Fishing

3%

Construction

6%

Hotels &

Restaurants

9%Manufacturi

ng

9%

Wholesale &

Retail Trade

9%

Corporate loan growth was robust in FY 04 – more than double the FY 03 growth Real Estate is the largest sector for Corporate Loans

Source: Bank of England Statistics, Smith Barney, CSFB

13

Loan book of select UK Banks – most banks are mortgage “heavy”

Abbey National

Corporate5%

Other Domest

ic10%

Other Person

al5%

Residential

Mortgages

80%

Alliance & LeicesterCorpora

te4%

Other Domest

ic0%Other

Personal

10%

Residential

Mortgages

86%

Bradford & Bingley

Corporate

9%

Residential

Mortgages

91%

HBoS

Residential

Mortgages, 61%

Other Persona

l, 7%

Other Domestic, 4%

Corporate, 28%

Lloyds TSBOverse

as5%

Corporate

19%

Other Domest

ic11%

Other Person

al15%

Residential

Mortgages

50%

Northern RockOther

Domestic

4%

Other Persona

l7%

Residential

Mortgages

89%

BarclaysOversea

s5%

Corporate

35%

Other Domest

ic3%

Other Persona

l14%

Residential

Mortgages

43%

Royal Bank of Scotland

Overseas

34%

Corporate

32%

Other Domest

ic5%

Other Persona

l10%

Residential

Mortgages

19%

Most of the top banks are heavy on residential mortgages, except Royal Bank of Scotland and Barclays. Lloyds TSB also has a little more than half of its loans in the residential mortgages, still much less than banks such as Abbey National, Alliance & Leicester and Bradford & Bingley.

Source: Smith Barney

14

Long-term trends in mortgages, deposits and unsecured lending market share

Banks share of mortgage lending in the UK

Banks share of unsecured lending in the UKBanks’ share of mortgage stock increased from 5% in 1980 — the year they effectively entered the market — to 68% in 2003.

Over the same time period, banks’ share of unsecured lending remained broadly unchanged between 70% and 80% (73.6% in 2Q04).

The banks’ share of M4 retail deposits increased sharply, from 41% in 1983 to 80% by 1997 and is currently stable at that level.

For both mortgages and deposits (not unsecured lending), the most significant changes relate to building society conversions - Abbey National (1989), C&G and N&P (1995), Bristol & West (1996), Alliance & Leicester, Northern Rock, Halifax and Woolwich (1997) and Bradford & Bingley (2000).

Note: Graphs above show approximations based on the actual data.

Source: Bank of England, Smith Barney, GRC Analysis

Q2 93 to Q2 04

Q2 93 to Q2 04

Banks share in retail deposits

15

Within the mortgages, re-mortgages remain the key driver

0%

10%

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30%

40%

50%

60%

70%

80%

90%

100%

Remortgages First time buyers Movers Buy to Let Other

Surge in remortgaging since 2000 contrasts with the decline in mortgages among the first time buyers

Remortgaging increased from 31% of gross lending in 2001 to 42% in August 2004.

•Over the same period, the percentage of gross lending by first-time buyers (FTB) fell from over 20% to 11%, mainly due to continuously rising house prices

•Of the £25 billion total mortgage lending in August 2004, £10.4 billion was remortgaging (42%), £2.7 billion FTBs (11%), £7.9 billion ‘movers1’ (32%), £1.6 billion ‘further advances’ (6%) and £0.7 billion ‘buy-to-let’ (3%)

Remortgaging at 15% of outstanding stock (of total mortgage loans) in August 2004, was down from the peak of 19% in Oct 2003. In August 2004, the ‘Churn’ rate (growth rate in mortgage market less remortgaging) of -4% showed that remortgaging was still growing faster than the new mortgage market.

Source: Smith Barney, Bank of England

16

Summary of key trends and forecasts

Economic Slowdown in the key markets

All the major economies in which the UK banks operate are expected to witness a modest slowdown in growth. For 2005, growth in the UK is estimated to be 2.8%, in Europe at 1.5%, in the US at 3.7% and in Hong Kong at 4.4%.

Soft-landing in UK housing market

UK housing market is forecasted to have a soft landing with average house prices falling about 5% in 2005 and net lending to be about £84bn. This should drive up mortgage balances by about 9% in 2005.

UK banks with Asian operations to witness

faster lending growth – margin erosion to slow

down

Average loan growth is forecasted to be around 9%, well spread across both retail and wholesale lending. Lending growth for the UK banks with US operations is also expected to be around this level. Banks with Asian exposure should continue to experience a faster rate of lending growth than this average in most of the countries, except Hong Kong, where lending growth may be only 5-6%.

Despite continuing pressure on lending margins, the pace of overall margin erosion in the UK will slow, reflecting a closer alignment between retail funding and retail lending, a stable relationship between LIBOR and the base rate and a higher average return on free funds.

Margins in the US are likely to come under slightly more pressure, due to the impact of rising short-term rates and a flattening yield curve.

Broadly stable margins are expected in Hong Kong due to reduced liquidity and higher liability spreads.

Revenue performanceTotal revenue for the UK sector are expected to increase by about 8% and about 9% excluding the Asian banks, slightly faster than expenses, which are forecasted to rise by about 5% and about 6%, respectively.

Credit quality to remain strong in spite of a

modest deterioration

Credit quality will deteriorate modestly in 2005, with aggregate bad debts increasing by 18% that is much higher than aggregate loan growth of 9%. The recoveries at the banks with Asian exposure will be lower. There will also be a small increase in UK mortgage and consumer credit provisioning.

Corporate credit quality will remain very strong, reflecting the overall health of company balance sheets and the expected benign economic environment. The main risk would be that releases and recoveries of past provisions may decline more rapidly than the banking sector may be prepared for, leading to a sharper than forecast increase in net bad debt charges.

There may be some increases in retail provisioning, especially on unsecured lending, but this should not lead to any significant negative impact on credit quality. A survey by Bank of England into household indebtedness showed that, by the standards of the past decade, relatively few households are currently close to a stressed financial position. Among the findings from this survey are the facts that 95% of debt is owed by households, only 4% of which have any problems paying for their accommodation. Also, the proportion of households having problems meeting their unsecured debts is lower than a decade ago.

17

Key issues

• Apart from the issues and trends highlighted earlier in the presentation, the following issues are also deemed to be of high relevance to the UK banking sector.

Weaker outlook on the UK economy

Inflation is running higher than expected and may be fuelled further by the increasing oil prices which show no signs of abatement.

Unemployment is expected to increase which would add further downward pressure on the consumer spending.

Rate cuts are expected in 2005, which may lead to margin decline with no recovery in the loan volumes.

Consolidation - Basel II and IFRS

Basel II gives mortgage assets a favourable treatment. This may enthuse interest among larger European players to acquire certain mortgage “heavy” UK banks. At the same time the implementation of IFRS may put to backburner some larger deals in the banking sector, although small acquisitions may still be on the cards.

Weak house pricing data may benefit wholesale

funded banks

Mortgage approvals and house prices are expected to trend downwards in the first half of 2005, which will exert pressure on the players, especially considering the strong performance in H1 2004. Also, unsecured borrowing may continue to be low. This should relatively benefit wholesale funded banks such as HBoS, Northern Rock and Bradford & Bingley.

Bancassurance

The FSA has implemented more realistic reporting standards for the banks in the UK. These take into account various aspects of the IFRS and Basel II. This is expected to make the analysis and assessment of bancassurance trends easier. At the same time, bancassurance is expected to benefit from the “depolarisation” (see slide 27), which would lead to some consolidation in the distribution.

IFRS

Traditionally life insurance accounting (bancassurance) has been a major area of uncertainty for the UK banks. The impact due to IFRS is however, expected to be non-material for most UK banks. Restatements of the past results would lead to some concern at Barclays and to a lesser extent at Lloyds, HBoS and Northern Rock. HSBC, RBS, Alliance & Leicester and Bradford are not likely to be impacted.

Basel II

Favourable treatment of mortgages and less favourable treatment of emerging market exposure should be a benefit for UK banks. However, the relative benefit of mortgages could be offset by the treatment of securitization, as HBOS, Northern Rock and Bradford & Bingley already securitize mortgages.

Banks will have to do a careful planning to achieve the capital floor requirements, which limits capital release.

Excess capital benefits may be passed on to the customers in the form of competitive pricing, especially true with relatively large proportion of the mortgage market being controlled by the listed banks.

Bancassurance groups may not be allowed double counting of capital.

18

UK Insurance Industry

19

UK Life Insurance and Pensions

Contents Slide #

UK Insurance 19

UK life and pensions 22

Top 20 Life and Personal Pension players and market consolidation 23

Top 20 Other Pensions and Protection players and market consolidation

24

Top 20 Total Long-Term insurance players and market consolidation 25

Market share, positioning and distribution scenario 26

Review of year 2004 27

Expenses too high and increasing 29

Newly enacted solvency requirements 30

Depolarisation and its impact on the distribution landscape 31

Market share movements expected due to depolarisation 32

Further thoughts on Depolarisation 33

Distribution landscape – IFAs may contract significantly 34

Future product style-distribution landscape is “in” for some significant changes

35

Pension Funds 36

Regulatory changes in the pension fund laws 37

20

UK Insurance Industry

Other, GBP 12.5 bn

Property, GBP 8 bn

Motor, GBP 9.5 bn

I ncome Protection

and CI , GBP 2.5bn

Life I nsurance, GBP 29bn

Life Annuities, GBP 10bn

Pension Annuities, GBP 10bn

Group Pensions

(excl. Pension

Annuities), GBP 34bn

I ndividual Pensions, GBP 25bn

Facts about the UK insurance industry:

•The UK insurance industry is the largest in Europe;

−It is the third largest globally

−The industry employs around 348,000 people (end 2003), which is around one-third of the entire Financial Services jobs in the UK

−The industry accounts for around 17% of investment in the stock markets

−pays out almost £222 million per working day in pension and life insurance benefits and £74 million per working day in general insurance claims

There are 772 companies authorized to conduct insurance business in the UK, out of which 568 carry out General Insurance business only, 159 operate in long-term (life and pensions) business and 45 operate in both segments.

Consolidation – The industry is highly consolidated

−The largest ten motor insurers account for 82% of that business.

−The largest ten property insurers account for 84% of their market.

−The long-term insurance market is not so concentrated. The largest ten companies account for 72% of the market.

General Insurance1 Long-term insurance business

1 Excludes Lloyds

Source: Association of British Insurers, IFSL

21

UK Insurance IndustryLife and Pensions

22

UK Life and Pensions

• The section starts with the segmental and sub-segmental breakdown of the life and pensions industry along with an analysis of the trends witnessed in 2003.

• This is followed by sector rankings and market consolidation data.• The section then moves to life insurance positioning and distribution scenario, in which the top spots are

occupied by Standard Life, Skandia and AVIVA. Market share movements in wake of “depolarisation” are also highlighted with HBoS and Prudential emerging as clear winners.

• A review of 2004 market performance is carried out next, which reveals that sales were flat or down but certain signs of recovery were visible going forward in 2005.

• The section then analyses an important issue of higher expenses in the UK life insurance. The reasons for high cost base along with the possible solutions (outsourcing, greater use of IT and benevolence from the FSA).

• Solvency requirements and the proposed amendments to the tax laws for the life insurers are then explored (although not in great detail).

• Next follows a comprehensive analysis on the issue of “depolarisation”. Given is the impact of this phenomena on the future market share, distribution scenario and on the players as well as the customers. The underlying theme is that “depolarization” seems to be a strong “market gain” opportunity for many players such as Skandia and a market share loss to some such as Zurich Financial Services.

• The section ends with an analysis of pensions - the current state, time series movements, rate of return, regulatory changes & challenges and the future sector performance.

23

Life & Annuities

I ndividual Pensions

Other Pensions

I ncome Protection

0

20,000

40,000

60,000

80,000

100,000

120,000

1999 2000 2001 2002 2003

Net

Wri

tten

Pre

miu

ms G

BP

mn

Life & Annuities I ndividual Pensions

Other Pensions I ncome Protection

GBP 29.3 bn

GBP 24.6 bn

GBP 33.8 bn

GBP 2.5 bn

UK Life and Pensions

Market segmentation - Life and Annuities have declined continuously with other segments alternating the growth and decline pattern

0

50,000

100,000

150,000

1999 2000 2001 2002 2003Single Premium Regular Premium

0

10,000

20,000

30,000

1999 2000 2001 2002 2003Life & Annuities Individual PensionsOther Pensions Income Protection

020,000

40,00060,000

80,000100,000

1999 2000 2001 2002 2003Life & Annuities Individual PensionsOther Pensions Income Protection

Regular Premium

Single Premium

Segmentation by single/regular premiums

Net

Wri

tten P

rem

ium

s £

Mn

The UK Life and Pensions market amounts to £90 billion. Pensions account for two-third’s of the market with the Life and Annuities accounting for one-third. Income protection is miniscule at less than 3% of the total market.

The market is dominated by single premium products, which account for 71% of the market. Regular premiums account for the rest of the market.

Single premium products are dominated by pensions, although their share has been showing alternating cycle of growth and decline, with the market contracting significantly in 2001 and marginally in 2003. Market contraction has also been witnessed in the single premium life and annuity products in 2003.

Regular premium products market has been fairly stable since 2002 (after a decline in 2001). The decline was led by Life and Annuities.

Note:

Single Premium Investment Plan: An Investment Plan in which an Investor pays a single premium, with the option of paying further ad-hoc premiums as and when it suits the Investor. Regular Premium Investment Plan: An Investment Plan in which the Investor commits to pay regular premiums of a specific amount at a specific frequency (e.g. monthly or annually), and for a specific premium-paying term.

Source: Association of British Insurers, IFSL

NWP in 2003

24

Sector Rankings – Life and Personal Pensions

In life insurance business, HBOS, AVIVA and ALICO were the top three players. HBOS witnessed strongest market share gain in 2003. Top 5 companies accounted for 44.7% of the market, a decline of 371 basis points since 2002.

In personal pensions, AVIVA, Standard Life and Lloyds were the top three players. The top two players interchanged their ranking in 2003 from 2002. Top 5 players accounted for 57.5% of the market, up significantly from 51.5% since 2002.

Source: Association of British Insurers

2003 (2002) Life Business Rankings

1 (3) HBOS

2 (1) AVIVA plc

3 (2) ALICO

4 (5) Standard Life

5 (6) Legal & General

6 (4) Prudential

7 (8) Zurich Financial Services

8 (9) AXA

9 (7) Lloyds TSB Group

10 (10) Friends Provident

11 (11) Co-operative Insurance Society

12 (20) Skandia Insurance

13 (13) Abbey National

14 (21) Royal Bank Of Scotland

15 (18) St. James' Place Capital

16 (19) Royal London Mutual Insurance Society

17 (16) Resolution Group

18 (15) GE Insurance

19 (41) Munich Re

20 (12) HHG plc

2003 2002

Share of top 5 companies 44.69% 48.00%



Product share of the total market 42.01% 45.80%

2003 (2002) Personal Pensions

1 (2) AVIVA plc

2 (1) Standard Life


4 (4) HBOS

5 (5) AXA



8 (6) Prudential

9 (11) Lincoln Financial Group

10 (9) Aegon

11 (10) HHG plc



14 (18) Winterthur





19 (17) Sun Life Assurance Company of Canada

20 (26) Suffolk Life Annuities

2003 2002




Product share of total market 32.54% 35.44%

25

Sector Ranking – Other Pensions and Protection business

In “Other Pensions” business, Prudential, Aegon and AVIVA were the top three players. AVIVA witnessed strongest market share gain in 2003 among these players. Top 5 companies accounted for 68.6% of the market, a decline of 328 basis points since 2002.

In Protection and Other business, GE Insurance, UNUM and AVIVA were the top three players. AVIVA improved its ranking by one position. Top 5 players accounted for 63.5% of the market, up 374 basis points from 59.8% since 2002.


2003 (2002) Other Pensions Business

1 (1) Prudential

2 (3) Aegon

3 (7) AVIVA plc

4 (2) Standard Life



7 (6) HBOS

8 (8) Canada Life Ltd

9 (18) AXA

10 (31) Winterthur



13 (-) Royal London Mutual Insurance Society


15 (17) HHG plc


17 (33) Britannic Assurance

18 (13) St. James' Place Capital



2003 2002





2003 (2002) Protection and Other Business

1 (1) GE Insurance

2 (2) UNUM

3 (4) AVIVA plc

4 (3) Canada Life Ltd

5 (5) Swiss Reinsurance Company


7 (7) Swiss Life

8 (9) HHG plc




12 (14) Liverpool Victoria

13 (11) Munich Re



16 (16) Barclays

17 (19) ALICO


19 (17) Aegon

20 (22) HSBC

2003 2002





26

Sector Ranking – Total Long-term Business

Definitions1. Rankings are based on Net Written Premiums. 2. Life Business will include unit linked and non unit linked regular and single premium business, as well as collective life, insurance ISAs and life annuities.3. Personal Pension Business will include regular and single premiums GPPs, SIPPs FSAVCs, Pension Term Insurance, Pension Annuities , S32 Buyouts, Income Drawdown, Premium Waiver Benefits, and DSS Rebates.4. Other Pension Business will include occupational pensions, EPPs, SASSs, AVCs, TIPs, and Bulk Buyouts.5. Protection and Other Business will include Income Protection, Long Term Care, Stand Alone Critical Illness and any other long term business not included elsewhere.

Notes1. GE Insurance includes Financial Assurance, GE Frankona RE, GE Life Ltd, GE Pensions Ltd2. HBOS includes Clerical Medical and Halifax Life3. HHG plc includes London Life, NPI and Pearl4. Lloyds TSB Group includes Llyods TSB Life and Scottish Widows

Life Insurance

Personal Pensions

Other Pensions business

Protection and Other business

Total

HBOS AVIVA plc Prudential GE Insurance

AVIVA plc

AVIVA plc Standard Life

Aegon UNUM Standard Life

ALICO Lloyds TSB AVIVA plc AVIVA plc HBOS

Standard Life

HBOS Standard Life

Canada Life Ltd

Prudential

Legal & General

AXA Legal & General

Swiss Re Lloyds TSB

Top 5 market share

44.7% 57.5% 68.6% 63.5% 39.7%


Total Business 2003 (GBP Mn) 2002 (GBP Mn)

AVIVA plc 8,385 8,381

Standard Life 7,177 9,590

HBOS 6,093 6,049

Prudential 5,424 7,786

Lloyds TSB Group 4,825 4,693

Legal & General 4,216 4,167

AXA 3,675 3,442

Aegon 2,973 3,211

Zurich Financial Services 2,835 3,402

Friends Provident 2,565 2,542

ALICO 2,373 3,877

Royal London Mutual Insurance Society 1,552 1,724

Skandia Insurance 1,523 1,014

HHG plc 1,284 1,882

Winterthur 1,150 571

Abbey National 996 1,356

Co-operative Insurance Society 989 1,200

GE Insurance 970 1,613

Resolution Group 874 1,123

Canada Life 832 802

Total Market £68,207m £68,869m

Share of Top 5 companies 39.70% 46.54%



27

Life insurance market share, positioning and distribution scenario

Norwich Union, 12.4%

HBoS, 12.2%

Prudential, 7.0%

L&G, 6.9%

ZFS, 5.8%

AXA, 5.5%

Friends P, 5.0%

Skandia Life, 3.9%

Others, 14.2%

Scottish Equitable,

7.4%

Scottish Widows,

8.5%

Standard Life, 11.1%

Bra

nd

Pro

duct

Tech

nolo

gy

IFA S

erv

icing

Bro

ker C

onsu

ltants

Man

ag

em

ent

Expense

s

Acq

uisitio

n Fe

es

Com

missio

ns

Avera

ge

Standard Life 5 1 2 2 1 3 3 3 2.5

Skandia 7 6 3 1 7 1 6 4 4.4

Aviva 3 2 8 9 3 5 4 7 5.1

Legal & General 1 4 4 10 9 2 10 2 5.3

Friends Provident 6 3 1 4 5 8 9 6 5.3

Scot. Eq. 10 8 7 8 2 11 2 1 6.1

HBOS 9 5 9 7 8 6 1 NA 6.4

Scottish Widows 4 10 10 5 6 7 5 NA 6.7

Axa Sun Life 8 9 6 3 4 10 8 8 7

Prudential 2 7 5 11 10 9 11 5 7.5

ZFS 11 11 11 6 NA 4 7 NA 8.3

Life insurance market share in 2003 Positioning of life insurance companies (ranked 1 to 11)

Top three players are Norwich Union, HBoS and Standard Life each with more than 10% share of the market, a market in which products are getting increasingly commoditized.

The table above shows the rankings (1 to 11) of each insurer across eight parameters, considered important for long-term success. Standard Life stands out across most parameters except the brand where it ranks rather average at 5. Skandia is next, the ranking being dragged by poor opinion on the brand, products and broker consultants. AVIVA’s ranking is pulled down due to poor opinion on technology and IFA servicing.

The market share movements projected by 2008 are based (among other things) on the impact of depolarisation (covered in next few slides) on various companies. HBoS and Prudential are expected to be major beneficiaries of this phenomena. HBoS is expected to be the market leader by 2008.

HBoS12%

Standard Life12%

L&G8%

Scottish Equitable

7%

Friends P6%

Skandia Life6%

AXA Sun Life6%

ZFS4%

Others10%

Prudential8%

Scottish Widows

9%

Norwich Union12%

Forecasted Life insurance market share in 2008

Note: Scottish Widows is a part of Lloyds and Scottish Equitable a part of AEGON UK. Minor market share variations may be there from the ABI data due to difference of sources and classification.

Source; Money Management, Bear StearnsNote: The market share forecast to 2008 have been calculated as an outcome of depolarisation ONLY.

28

Review of 2004 – sales flat or down, pensions a problem but profitability showing signs of recovery

Year 2004 - a difficult year

Many challenges remain

• Year 2004 was a difficult year for the UK life insurers. Their business remained relatively flat due to the continuing problems in the endowment and with-profits markets, lack of government direction over pensions and protection, and lacklustre stock market performance. However, many players are upbeat with the market showing signs for bottomline recovery.

– The performance of the “single premium” market will be critical for the revival of the industry fortunes, as this market attracts more sophisticated and wealthier customers than the regular premium market. This seems to be the trend in the market, as witnessed in the first three quarters of 2004 - new regular premiums for individual life business remained fairly consistent at around £277 million for the first three quarters of 2004 with the corresponding single premium business increasing from £4.9 billion in the first quarter to £5.3 billion in the third quarter.

– Also suggestive of improving market sentiments is the fact that S&P downgraded only five British insurers in 2004 as compared to nine downgrades in the previous year. The five companies were Standard Life, Legal and General, Abbey National Life, Unum and National Provident.

– Some industry experts also believe that the years of cost-cutting and consolidation are finally going to deliver bottomline results in 2005 and beyond.

• Although the pressure has come off a little, life insurers are still facing many challenges. Profits continue to be squeezed, especially by the 1% cap on charges for stakeholder pensions. This may ease a bit due to the following factors:

– Improved pricing after the increase in the stakeholder cap on charges from 1% to 1.5% for the first ten years of the contract term.

– Benefits for the industry emanating from the Govt. decision to allow Market Value Adjustments to stakeholder pensions. However, this may make it difficult for the insurance industry to reach the new savers efficiently.

– Consolidation of individual pensions, post April 2006 when pension tax and regulation are simplified.

The room for manoeuvrability would still remain limited.

29

Review of 2004 – Partial recovery expected in 2005

Outsourcing would be a focus area to drive down

the costs

• In the past life insurers in the UK have been averse to outsource areas of business such as investment management. However, this is now becoming increasingly acceptable. Currently, the administration for six million to seven million policies is outsourced, out of a potential market of around 60 million.

Adviser commissions - an area of concern

• One area in particular that has suffered as a result of poor market conditions is adviser commissions. Many insurers thought that these were unsustainable if the profit margins were to be maintained. Thus, earlier in 2004, Standard Life, Norwich Union and Scottish Equitable announced reduction in the commission levels, with Standard Life imposing conditions, such as a minimum group size and premium level, for the sale to qualify for commission. Going forward, it is expected that more and more of the life insurers will focus on the products outside the stakeholder regime. This may help them reduce the cost of distributing the cheaper stakeholder products.

Protection market struggling but

improvement expected in the future

• Protection market has suffered due to a slowdown in the mortgage sales, which drive a large proportion of the “protection” sales. The market is estimated to have declined by 5-10% in 2004.

• Income protection market penetration remains low at around 11%, with sales slowly falling in the last few years.

• The worst performer has been Commercial Insurance where the insurance premiums have increased by around 50% in 2004 as a result of the withdrawal of reinsures from the guaranteed market. This has resulted in a decline in premium volume by 20%, which means there has been a huge fall in insurance cover levels.

• A few sections in the industry are however optimistic on the recover of the market in the long-term, driven by market regulation on IFAs (Jan 05), launch/re-launch of products by existing players and new entrants in 2004, which would continue in 2005. IFAs have been particularly interested in this market as their commissions in the traditional products such as pensions and investments have dried up.

Inheritance tax planning may be the savoir

• One of the area that could provide some relief for life insurers is inheritance tax planning. Property price increases mean that more and more people are finding their assets push them over the inheritance tax nil-rate band - £263,000 this tax year. The inheritance tax bill in the future can be mitigated by making use of whole-of-life policies.

The life insurance companies have faced a tough year 2004 in terms of regulatory changes. Protection products, which are aligned with general insurance became subject to new regulatory requirements from Jan 2005, which means that the regulatory headache would remain for most part of the current year.

Source: Various Investment Bank reports, General Factiva News

30

Expenses are too high and increasing – at 1.49% of assets – several times that of their asset management counterparts, at 0.43%. High cost base to limit growth

I ndustry

0%

20%

40%

60%

80%

100%

120%

1999 2000 2001 2002 2003

Pensions Life Annuities Other

1.43%

1.68% 1.73%

1.49%

0.0%

0.5%

1.0%

1.5%

2.0%

2000 2001 2002 2003

At 1.49%, expense ratio is far too high

Product Nature of expense ratio

Annuities Low

Protection Very high

With profits

Average

Pensions HighHigher expenses can partly be attributed to the changing product mix of the industry in which pensions and protection product’s share have been increasing

Other significant reasons (apart from product mix given above) for higher expenses are:

•Demutualized insurance companies are still not the best at managing the resources efficiently in a more competitive and accountable (to shareholders) environment – AVIVA, Scottish Amicable, Friends Provident.

•Long duration of policies (as long as 60 years) make technology advancements (that happen during the policy duration) costly to adopt – This is because old data needs to be transferred from “legacy system” onto a new platform.

• Consolidation does not do much good to reduce expenses either as different systems are not generally consolidated in many cases leading to higher fixed costs. Also, in many mergers the total cost synergies are often nullified by the costs of integration.

Why are expenses so high?•Greater use of information technology - Insurance is still a people-intensive industry with staff costs (wages, social security and pensions costs) account for roughly two-thirds of the industry’s non-commission expense base. A greater use of IT should act to reduce staff numbers and therefore costs.

•Reducing regulatory burden by FSA - The cost of complying with the large number of regulations is not insignificant. However, considering the recent scandals especially in the US, FSA is not expected to reduce the regulatory accountability anytime in the near future.

•Outsourcing – India seems to be the best destination, with strong English speaking workforce and staff costs at around 5% of those incurred at similar levels in the UK. Also, players with front-end operations in low-cost locations would benefit by incurring lower expenses (Pru & AVIVA)

How can the costs be cut?

•Increase in staff levels due to mortgage endowment mis-selling – additional staff will need to be recruited to analyse the increasing numbers of complaints.

•Commissions are not expected to decline in the future, in spite of the greater pressure on the charges

•Accounting costs are expected to increase as the insurers make preparations for changing FSA and EU regulations and for the advent of International Accounting Standards (see Note).

What may increase the costs further?

Note: Currently, the calculations of embedded values are carried out on a deterministic basis (a single scenario). However, under the draft statement of principles produced by the International Accounting Standards Board (IASB) on fair values, liabilities will be calculated using stochastic methods (multiple scenarios). JP Morgan expects this change to be enforced within five years; however, the IASB has acknowledged that the final accounting standard is unlikely to be issued in time for insurers to implement it by 2005, in line with EU requirements for the wholesale application of IAS by listed companies. The requirement to value liabilities using stochastic modelling will add additional complexity, and therefore additional costs. Source: JP Morgan, GRC Analysis

Prudential 1.15%

AEGON 1.42%

Lloyds 1.45%

Axa 1.45%

AVIVA 1.47%

Stan Life 1.54%

L&G 1.59%

HBOS 1.78%

Friends P 1.92%

Expense ratio is higher for Insurers with higher Protection (Friends Prov.) and Pensions business

31

Solvency requirements would strengthen the industry; Finance Bill clauses remain a cause of concern

• FSA’s new solvency requirements came into effect from January 2005, requiring firms to move to a risk-based approach to capital requirements.

– As per this requirement, the life insurers will need to ensure that they have the right level of controls and capital in place for the type of business they are undertaking.

– For some areas, this will mean increasing capital reserves; for others, where potential liabilities may be lower, less capital will be necessary. Reducing solvency requirements may become a key source competitive advantage.

– The costs are not expected to be significant, but these requirements may force a few smaller players to merge with their larger counterparts in an industry, which has already shrunk from 170 players two decades ago to around 70 today.

• The UK govt also announced its resolve to introduce changes in the taxation policy for the life insurance companies in the UK, which would increase the tax liability. However, due to continuous pressure from industry bodies, the amendments have been deferred as of now.

32

Depolarisation and its impact on the distribution landscape

Multi Tie Platform

Research

•Quotations

•Data

•Performance

•Funds Stats

•Policy Info

Service

•Compliance

•Valuations

•Policy Tracking

•Portfolio mgt.

•Asset allocation

•Wrap accounts

Processing

•E-commerce

•Straight-through

•E-underwriting

•Data Entry

•Online submission

•Multi-manager

IFAs realise economic benefits and relinquish independence Banks/Building Societies improve advice

from more choice Move to ongoing advisers from product sales

•Strong brands important •Product breadth or niche strength•Improve servicing to IFAs•Increase e-commerce capability•Enable online straight-thru processing•Higher commissions or profit shares•Efficiency of admin & expenses•Structure products to utilise technology

•Structure panels of 4-6 providers•Choose providers creating choice•Work with providers to develop platform•Provide wrap for insurer’s technology•Facilitate quote comparisons & research•Negotiate fair distribution of value chain•Reduce compliance and PI costs•Market multi-tie to distributors

42%34%

24%

IFA Multi-tied Tied

70%

30%

IFA Tied

Potential Future Landscape

Advisers

Current Distribution Landscape

Producers Distributors

Previous to Dec 1, 04, Advisers could offer either 'independent' or 'tied' advice. Independent advisers offer products from the whole of the market whilst 'tied' advisers are limited to the products of only one provider.

Following removal of the polarisation restrictions

(depolarisation) it will be possible for firms to offer

advice from the whole of the market, from a limited number

of providers, or a single provider. The FSA expects this

to result in more choice for consumers as firms that

previously only offered advice on the products of a single

provider will be able (if they wish) to expand their range of

products.

Source: Bear Stearns, GRC Analysis, FSA

Note: The “Future Distribution Landscape” is based on certain “Neutral assumptions” and may vary as per the variations in these assumptions or any significant unanticipated events impacting the macro-economic environment

33

Market share movements expected due to depolarisation



HBOS, 12.2% HBOS, 12.8%



Scottish Widows, 8.5%

Scottish Widows, 8.6%

Scottish Equitable, 7.4%

Scottish Equitable, 7.1%

Prudential, 7.0% Prudential, 8.4%

Legal & General, 6.9%

Legal & General, 7.8%

ZFS, 5.8%ZFS, 3.7%

AXA, 5.5% AXA, 5.4%

Friends Provident, 5.0%

Friends Provident, 6.3%

Skandia, 3.9%Skandia, 5.7%

Other, 14.2%Other, 10.9%

2003 2008

£8,600 million APE £10,400 million APE

•Norwich Union expected to loose market share by around 1%, as it may not be able to develop straight-through processing efficiently due to the large no. of legacy platforms yet to be integrated.

•HBOS expected to witness market share gain of 0.6%. The group is expected to benefit from cross selling opportunities from its product range, which is one of the best in the industry.

•Standard Life expected to increase market share by 0.8%, driven by superior servicing of advisers, technology and processing.

•Prudential will see a strong 1.4% market share improvement, fuelled by its relationship with Sesame, good development in progress on technology platforms, and improvement in service quality

•Highest improvement would be registered by Skandia, which is expected to gain 1.8% market share. This would be driven by the company’s strong reputation among IFAs, company products such as “flexible unit-linked savings solutions” and multi-manager products which are one of the best in class. The company would also benefit from its ownership of Bankhall, UKs largest provider of IFA support services

Source: Bear Stearns, Company Websites

Upward/Downward Arrow direction indicates upward/downward movement in market share. Double arrow indicates strong improvement/decline in market share

34

Depolarisation – further thoughts

The UK life insurance market is expected to witness consolidation as well as efficiency improvements as a result of depolarisation.

This phenomena is expected to bring landmark changes in the product-customer relationship and distribution (shown on previous two slides) leading to shifts in the market share of almost all the leading players in the industry. Various factors such as existing product portfolio especially in the context of cross-selling, the reputation of the company with respect to the IFAs, the ease/pace of integration of legacy systems, the service levels and the relationships/ownership of distributors would act as catalysts in yielding the positive/negative impact of depolarisation on the various companies.

Depolarisation would thus prove to be a huge competitive opportunity as multi-tied distribution would account for close to 34% of the total distribution share, with certain players emerging as “winners” due to the above mentioned factors.

Multi-Ties

•The major impact of depolarisation will be to create a new distribution channel, multi-tie panels (“multi-ties”). These panels may on average, comprise of four to six product manufacturers but may vary widely in their form. Some will comprise only waterfront providers, others will be “best-of-breed”, with one company for each product type and others will be panels for just one product type, e.g. a protection panel. (see Appendix)

Margin pressure•Depolarisation is likely to put pressure on the margins, as any efficiency benefits gained from concentration of distribution and production are likely to be shared between providers, consumers and distributors. This may lead to acquisition of distributors or IFA networks in the future.

Multi-tied to offer value add services

•Multi-ties will gradually evolve into entities that would offer extra services such as marketing or administration for payment options such as fee-charging or profit-sharing. Gradually, trail commissions over up-front commissions would come into picture as the industry moves to more level-based charging.

Impact of multi-tied distribution and building blocks for successful multi-tied networks

Source: Bear Stearns, GRC Analysis

35

Current and future distribution scenario

Standard Life, 15%

Norwich Union, 13%

Aviva, 10%

Prudential, 8%

Widows, 7%

Widows, 10%

HBoS, 7%

HBoS, 26%

Axa, 6%

Skandia, 6%Friends Pr, 5%

ZFS, 5%L&G, 5%

L&G, 12%

Other, 12%

Other, 41%

Scottish Equitable, 10%

0%

20%

40%

60%

80%

100%

120%

I FA Tied

Norwich Union, 13%

Norwich Union, 8%

HBoS, 8%HBoS, 25%

Standard Life, 15%

Scot Equitable, 10%

Prudential, 9% Prudential, 10%

L&G, 7% L&G, 8%

L&G, 9%

ZFS, 5%Axa, 6%

Friends Pr, 7%

Skandia, 7%

Others, 6% Others, 8%

Others, 43%

Norwich Union, 12%

HBoS, 10%

Standard Life, 15%

Widows, 7%Widows, 6%

Scot Equitable, 9%

Axa, 5%

Friends Pr, 7%

Skandia, 8%

0%

20%

40%

60%

80%

100%

120%

IFA Multi-tie Tied

70% 30% 42% 34% 24%2003 2008

Companies such as Norwich Union, HBos, Standard Life and Prudential are expected to have significant presence in the Multi-tie distribution by 2008 driven by factors discussed on Slide 28.

Multi-tie is expected to comprise around 34% of the entire distribution network by 2008. This is based on the assumption that IFAs would understand and appreciate the economic benefits of entering into the Multi-tie distribution, as most of the distribution share gain in the multi-tie is expected to come from IFAs (82% of Multi-tie) with Tied agents’ shift contributing the remaining 18%.

Distribution landscape – IFAs may contract significantly

Source: Bear Stearns

36

Future product style-distribution landscape is “in” for some significant changes

Note: EBC – Employee Benefits Consultant

Given alongside is a customer-product-distribution map. A key reason for the depolarisation is to increase access of insurance products for the low income consumers. These are expected to require only very simple products such as pure protection. Multi-tied agents would in all probability be used most with the “avg income” or “mass affluent” customers. Avg income customers are currently being served mainly by “single tied” agents. The higher income and higher net worth consumers are likely to continue preferring to be advised by whole-of-market IFAs.

The UK distribution landscape is segmented into multiple niche distributors catering for the differing needs of consumers. There is considerable overlap in the ownership of these channels. A number of banks own both tied and IFA channels and a number of networks own national, regional and specialist IFAs. The chart alongside depicts how the future distribution landscape in the UK may look.

Creation of a multi-tie channel would be a gradual process with defections from both the tied and IFA channels. Almost all the distribution stakeholders would be impacted except the employee benefit consultants and defined contribution pension specialists who primarily deal with group business.

Protection - Life

Protection - Health

Medium term savings

Long-term Savings

Annuities

Complexity

Traditional/Unit Linked

Distribution

Advice Level

Remuneration

Yes Possibility

Low Traditional

Low cost - single tied

Light Commission

Yes Yes Possibility

Possibility Possibility

Low-mid

Both-managed funds

Light touch - Multi tied

Increasing advice

Commission

Yes Yes Yes Yes Yes Mid-high

Both-some multi manager

More advice - multi-tied or IFA

Advice driven

Commission and Fees

Yes Yes Yes Yes Yes High Wrap style and multi-manager

Full advice - IFAs

Financial Advisory

Fees

Low Income

Avg. Income

Mass Affluent

High Net worth

Single Tie

Multi-tie IFA

Banks

Retailers

ProtectionSpecialists

MortgageBrokers

DC PensionSpecialists

Regional IFAs

Nationals/Network

EBCs

Moderate Earners

Mass Affluent

High Net Worth

Future distribution landscape

Source: Bear Stearns, Friends Provident, GRC Analysis

Future product style and distribution landscape

37

UK Pension Funds

UK Pension funds RoR returned to positive terrain in 2003

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1999 2001 2003

$ b

n

US J apan UK Canada Netherlands Other Europe Australia Switzerland Germany Other Pacific Basin Latin America Africa & M. East

$14,458 bn

$12,666 bn

$14,967 bnGlobal Pension Fund Assets

UK pensions fund industry is the 3rd largest and one of the most sophisticated globally. The industry is characterized by low dependence on the State pension. The long-term demographic profile is also more favourable than other counterparts in Europe.

Rate of return was negative from 2000-2002, due to deterioration in the equity markets. But, 2003 saw a turnaround, which continued in 2004 with the market environment improving significantly. Overall, during the period 1994-2003, the returns were 3.6%, only marginally below the 4% long-term (40 year) average annual return in the industry.

Challenges:

•Simplifying pension law and structures.

•Making the balance sheet treatment of pension funds in sponsoring companies’ accounts more transparent.

•Working toward the portability of pensions across the EU.

•Reviewing the rules of the annuity market to allow greater flexibility, particularly for more wealthy individuals, but at the same time, not eroding the guarantee of retirement income.

UK is the third largest market in terms of pension fund assets – a 10th of the global figure

Source: IFSL

38

Pensions growth expected to be 6-7%, mainly supported by pension reforms to be implemented in 2006

UK Life and Pensions Avg. Premiums Earned growth (2001-08) Sales and New business profits split by product (2004)

In the current scenario, the pension sales are constrained by inflexibility of withdrawal and product choice (after withdrawal) options:

•The money has to remain in the pension fund until retirement, and then

•The accumulated sum must be converted into an annuity by age 75, that limits the possibilities of inheritance.

This is however expected to change when the new pension laws come into force in April 2006. These laws will improve the flexibility and offer a push to the demand, which may lead to sales growth in the range of 6-7%.

Under the pension reforms called “Pension Simplification Rules”, the following changes are likely to be implemented:

•Annual limits for contributions into pension funds will largely be replaced by a lifetime limit of £1.5 million.

•The “inflexible” clause in the existing pension laws that makes it compulsory to annuitize the pensions by the age of 75, will be amended and give options of non-annuitization although the income earned under this option may be less.

•Another welcome move will be broadening of the investment options for Self-invested personal pensions (SIPPs) to include residential property and wines etc.

The introduction of the Lifetime and Annual limits is expected to lead to a new pattern of saving behaviour by the wealthy, which will lead to a rise in the single premium pension sales.

It is expected that a lot of individuals will choose to save outside their pension funds during the early part of their working life. Later in life, they will start pumping money into their pension fund, in order to get the tax relief on their savings (especially since 25% of the gross pension fund on retirement can be taken as a tax-free cash lump sum). The new contributions will occur through reasonably high margin large single premium contributions. The change may lead to a delay pension contributions to later in life, and reduce the regular premium savings, if people save elsewhere early on, and then exploit the flexibility to switch into pensions later in life. These transfers into pensions are expected to be encouraged by the relaxation of the other provisions. These new rules may create niche segment for insurers.

Source: Bernstein Research, Dept. of Work and Pensions

0%

10%

20%

30%

40%

50%

60%

WP Bonds Other Bonds Protection Annuities Pensions

39

UK Insurance IndustryGeneral Insurance

40

UK General Insurance

Contents Slide #

Top 20 Motor insurers and market consolidation 41

Top 20 Property insurers and market consolidation 42

Top 20 Accident and Health insurers and market consolidation 43

Top 20 Liability and Other insurers and market consolidation 44

Top 20 Total General Insurers and market consolidation 45

Market performance 1999-2003 46

Trend in average premium rates 47

Key issues in the Motor Insurance market 48

Distribution trends in the Motor Insurance market 51

Property Insurance market 52

Property Insurance market forecasts 53

Health Insurance market 54

Asbestos claims a long-term threat to profitability 55

41

UK General Insurance

• This section is somewhat constrained by the surprisingly “low” availability of well represented information from both the research firms, independent agencies as well as the general news firms in comparison to the immediate life insurance counterpart. As a result certain independent research reports from Datamonitor and Euromonitor have been used extensively, often combined with the specific information from select other sources.

• The section starts with the general insurance rankings across all the segments of the industry along with reporting of market consolidation. AVIVA remains the largest player almost 43% higher premiums than the second ranked Royal Bank of Scotland, which seems to have followed an inorganic market share acquisition strategy.

• The section moves to the motor insurance market with focus on the time series data on the evolution of the market since 1999. Both the premium performance as well as the underwriting performance are analysed, the latter moving in positive terrain since 2002.

• Premium rates are analysed next. These witnessed a decline in 2004, but a pick up is expected going forward.

• The focus moves to the key issues in the motor insurance market such as that of premium decline uninsured driving and capital adequacy.

• Next, the section analyses the distribution of motor insurance with clear trends showing increasing domination of direct channels.

• Finally, coming to the Property insurance, it is seen that the market growth has been modest at 4.5% average annual rate during 1999-2003. Forecasts are given along the expected market conditions in the future.

• Finally certain issues and trends in the health insurance are analysed. Asbestos, which many assume to be a “problem of the past” is viewed as a significant threat to the industry by the actuaries. Related claims are expected to be in the range of £8bn to 30bn in the next 30 years.

42

General Insurance Rankings – Motor Insurance

In Private Motor insurance business, RBS, AVIVA and Zurich Financial Services were the top three players. Zurich Financial and RBS witnessed market share gain in 2003, the gain in case of the latter being due to acquisition of Churchill Insurance. Top 5 companies accounted for 65.1% of the market, an increase of more than 5% points since 2002.

In Commercial Motor, AVIVA, Zurich Financial and Royal & Sun Alliance were the top three players. The top two players interchanged their ranking in 2003 from 2002. Top 5 players accounted for 76.2% of the market, down significantly from 79.8% since 2002.

2003 (2002) Private Motor Insurers

1 (2 & 3) RBS Group

2 (1) AVIVA



5 (4) Royal & SunAlliance

6 (7) Fortis Insurance Company

7 (9) Allianz Cornhill

8 (8) AXA

9 (12) Liverpool Victoria Friendly Society

10 (14) HBOS

11 (10) Groupama Insurance Group

12 (11) NFU Mutual

13 (18) Highway Insurance

14 (16) MMA Insurance

15 (13) Provident Insurance

16 (-) Zenith Insurance

17 (20) HSBC

18 (21) Sabre

19 (19) Allianz Corporate Ireland


2003 2002





2003 (2002) Commercial Motor Insurers

1 (1) AVIVA




5 (5) NFU Mutual

6 (6) AXA


8 (8) RBS Group

9 (11) Highway Insurance

10 (-) Brit Insurance Limited


12 (12) Westminster Motor Insurance Association

13 (18) Tradex

14 (16) HSBC

15 (14) St Paul International

16 (13) Allianz Corporate Ireland

17 (17) QBE International

18 (15) Ecclesiastical

19 (20) American Reinsurance

20 (25) Markerstudy Insurance Company

2003 2002





43

General insurance rankings – Household and Commercial Property

In Household insurance business, AVIVA, Royal & Sun Alliance and RBS were the top three players. The top three market rankings remained unchanged. Top 5 companies accounted for 69.6% of the market, an increase of more than 9% points since 2002.

In Commercial property, AVIVA, Royal & Sun Alliance and Zurich Financial were the top three players, unchanged from 2002. Top 5 players accounted for 79.3% of the market, up around 3% since 2002.

2003 (2002) Household (Domestic Property) Insurers

1 (1) AVIVA


3 (3 & 6) RBS Group


5 (5) Lloyds TSB


7 (9) AXA



10 (11) NFU Mutual


12 (14) Liverpool Victoria Friendly Society

13 (15) Hiscox


15 (17) Chubb Insurance Company of Europe

16 (19) National Housebuilding Council

17 (22) Bankers


19 (21) Albion

20 (38) New India

2003 2002





2003 (2002) Commercial Property Insurers

1 (1) AVIVA



4 (4) AXA


6 (7) RBS Group

7 (6) NFU Mutual

8 (10) Munich Re



11 (11) ACE Insurance S.A. - N.V.



14 (19) CNA


16 (9) GE Insurance

17 (20) American International Group



20 (12) Scor UK

2003 2002





44

General Insurance Rankings – Accident and Health Insurance

In Accident insurance, AVIVA, AXA and Pinnacle were the top three players. Rankings changed for AXA (3rd rank in 2002) and Pinnacle, the latter being more pronounced. Top 5 companies accounted for 63.1% of the market, an increase of more than 7% points since 2002.

Among health insurers, BUPA, AXA and AVIVA were the top three players, unchanged from 2002. Top 5 players accounted for 94.0% of the market, up by more than 2% since 2002.

2003 (2002) Accident Insurers

1 (1) AVIVA

2 (3) AXA

3 (7) Pinnacle


5 (5) Combined Insurance Company of America

6 (6) Lloyds TSB

7 (8) HBOS

8 (9) Stonebridge International Insurance


10 (12) London General






16 (18) RBS Group


18 (10) NFU Mutual

19 (22) ALICO

20 (23) Professional Travel

2003 2002





2003 (2002) Health Insurers

1 (1) BUPA

2 (2) AXA

3 (3) AVIVA

4 (4) Standard Life

5 (6 & 18) GE Insurance


7 (9) Exeter Friendly Society


9 (-) QBE International

10 (11) Albion

11 (15) CNA

12 (12) Personal


14 (14) Professional Travel

15 (-) BFC


17 (-) Alliance & Leicester

18 (19) Mitsui Sumitomo

19 (20) UIA (Insurance)

20 (-) China

2003 2002





45

General Insurance Rankings – Liability and Other Insurance

In Liability insurance, Zurich Financial, AVIVA and Royal & Sun Alliance (RSA) were the top three players. Rankings changed for AVIVA (3rd rank in 2002) and RSA (rank 2nd in 2002). Top 5 companies accounted for 61.0% of the market, marginal decline since 2002.

Among health insurers, RBS, Barclays and AVIVA were the top three players. RBS jumped the rankings due to inorganic activity. Top 5 players accounted for 44.0% of the market, up by more than 11% since 2002.

2003 (2002) Liability Insurers


2 (3) AVIVA


4 (4) AXA





9 (8) NFU Mutual


11 (11) RBS Group


13 (13) Hiscox




17 (12) The Underwriter Insurance Company Ltd

18 (22) Liberty Mutual

19 (26) International Insurance Of Hannover


2003 2002





2003 (2002) Other Insurance

1 (4,5,44) RBS Group

2 (2) Barclays

3 (1) AVIVA

4 (-) GE Insurance

5 (9) Munich Re



8 (18) AXA

9 (6) Swiss Re


11 (11) Pinnacle

12 (17) General & Cologne Re


14 (15) Lloyds TSB

15 (16) Domestic & General


17 (22) London General

18 (23) HBOS

19 (29) DAS Legal Expenses

20 (28) Motors Insurance Company

2003 2002





46

General Insurance Rankings – Total Sector

Ranking Summary

In the total industry, AVIVA was the largest player, with almost 43% higher premiums than the second ranked Royal Bank of Scotland. At the third position was Royal & Sun Alliance, which was ranked third with 38% less premiums than RBS.

Total Business Premiums 2003 (GBP Mn) 2002 (GBP Mn)

AVIVA 5,405 5,000

RBS Group 3,767 3,375

Royal & SunAlliance 2,726 3,209

Zurich Financial Services 2,547 2,350

AXA 2,392 2,215

Allianz Cornhill 1,352 1,182

BUPA 1,240 1,161

NFU Mutual 715 816

Co-operative Insurance Society

636 648

Lloyds TSB 588 532

GE Insurance 574 508

Fortis Insurance Company 521 478

Barclays 498 337

Legal & General 387 304

Munich Re 370 236

HBOS 360 293

Groupama Insurance Group 358 486

QBE International 346 318

Liverpool Victoria Friendly Society

340 279

Brit Insurance Limited 339 -




Total Net Written Premiums £30,015m £28,278m

Accident Health Liability Other

AVIVA BUPA ZFS RBS

AXA AXA AVIVA Barclays

Pinnacle AVIVA RSA AVIVA

AIG Standard Life AXA GE Insurance

CICA GE Insurance QBE International Munich Re

Private Motor Commercial Motor Household (Dom Prop)

Commercial Property

RBS Group AVIVA AVIVA AVIVA

AVIVA ZFS RSA RSA

ZFS RSA RBS Group ZFS

Co-op Ins Society Allianz Cornhill ZFS AXA

RSA NFU Mutual Lloyds TSB Allianz Cornhill

47

UK Motor Insurance sector performance improved in 2003

Private comprehensiv

e

Private non-comp.

Motorcycle

Commercial vehicle

Fleet

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1999 2000 2001 2002 2003

Gro

ss W

ritt

en

Pre

miu

ms G

BP

mn

Private comprehensive Private non-comp. Motorcycle

Commercial vehicle Fleet

Total

Private

= GBP

9.7 bn

Total

Commer

cial =

GBP 3.6

bn

Motor Insurance market in the UK – Private motor insurance accounts for a major chunk; commercial motor drove the market in 2003

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

200

4001999 2000 2001 2002 2003

GB

P M

n

Private motor Commercial motor Total motor

Commercial Motor insurance has been generating underwriting profit that has been more than nullified

by underwriting loss from Private motor Insurance

Market share of each segment has remained almost static during 1999-2003 time period. In the past decade there has been an increase in the cars covered under “Private Comprehensive” insurance. This trend has however flattened out since 2000. Overall the average annual market growth across various segments during 1999-2003 has been the following:

•Private Comprehensive – 9.9% with 2002-03 growth at 4.5%

•Private Non-Comprehensive – 11.6%, with 2002-03 growth at 3.3%

•Motorcycle – 4.6%, with 2002-03 growth at 3.4%

•Commercial Vehicles – 12.9%, with 2002-03 growth at 10.0%

•Fleet – 7.9%, with 2002-03 growth at 6.5%

Underwriting income, for most period has been negative (as is “common” in the industry). However, the industry seems to be returning to underwriting break-even, which is totally attributable to the underwriting profitability witnessed in the commercial vehicle insurance segment.

Source: Datamonitor, ABI

48

Average premium rates declined for private motor but are expected to rise again; Commercial motor premiums on the rise

400

500

600

700

800

900

1000

1999 2000 2001 2002 2003 2004

Comprehensive

Non-Comprehensive

Average premium rates are declining for private motor Private “Comprehensive” motor insurance rates witnessed their first quarterly fall for eight years in July 2004, falling by almost 3% on a comparable YoY basis.

Similarly, “non-comprehensive” rates also witnessed decline. Between October 2002 and October 2003, the average non-comprehensive premium rates fell by almost 1% to £904.10.

High competition in the “comprehensive insurance” marketplace was the key reason for the decline in the premium rates. Several competitors such as Esure and the Post Office set themselves market share targets in 2004, while players such as Nationwide promised to match any quote in the market. Combined, these pledges suppressed the average premium rates and continue to do so in the current time period.

On a more positive side, in spite of this decline in the premiums more and more competitors have declared their commitment to maintain the pricing discipline in the future so that they are able to achieve the underwriting profitability.

The average private motor premiums are expected to increase in the future due to higher costs of uninsured driving, costs of meeting FSA regulations and consolidation in the market

Commercial

Fleet

100

200

300

400

500

600

700

800

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

Avg

. P

oli

cy P

rem

ium

(G

BP

)

Average premium rates for commercial motor insurance

Source: Datamonitor, ABI

The average premium rates in the fleet sector rose marginally by 1% to £702. This sector has witnessed a rapid increase in the premium rates since 1999 due to high claims frequencies and historically poor levels of maintenance and risk management. Also, fleet mileages are generally higher than other motor lines, partly accounting for the fact that the average fleet premium is higher than any other product.

Commercial vehicle premium rates rose by 12.3% to £586 (average).

The situation is expected to improve in 2005, as a result of increasing competitive intensity and a more normalized premium rate environment.

49

Key Issues in the motor insurance market

Onset of Soft cycle – declining premiums are

posing a challenge to the insurers, although rates may go up due to FSA rules compliance along with higher costs from

uninsured driving

Past performance: In terms of the premiums, 2003 was a difficult year for the motor insurers due to declining premiums, which maintained the downward trend for most part of the 2004, although some insurers were able to push higher rates in the first half.

Current Scenario: In “private motor” insurance, rates came under pressure in 2004 due to aggressive market entrants coupled with brandassurers. Significant competitive pressure has come from players such as Esure and Admiral, who with their low cost bases and strong web-based sales programmes, have put significant pricing pressure on other players. Meanwhile, new entrants such as First Alternative, Virgin and the Post Office have also declared their resolve to follow an aggressive pricing strategy to capture the market share.

As a result, many promotional deals have been launched in the private car insurance such as Nationwide has launched their “Price Promise”, which promises to refund consumers who can find a cheaper quote elsewhere, and Norwich Union has offered two months’ free cover for motorists who have 4 years of no-claims discount.

Industry Outlook: Premium rates are expected to be flat across most lines of motor insurance market. There may be consolidation and exits among the players in the next 18 months. The premium rates decline is however not expected to be spread over a sustained long-term period of more than a couple of years.

Source: Datamonitor, General Factiva News

50

Uninsured driving leads to higher claims and costs

Uninsured Driving – significant costs in comparison to the

European counterparts

Background: One in twenty motorists in the UK lack insurance cover. In other words nearly 1.5 million vehicles in the UK are uninsured. These uninsured drivers cause significant loss to the insurance companies, which have compensated for this loss by increasing the annual average premiums of honest motorists by approximately £30 per policyholder. Existing legislation has proved absolutely ineffective at dealing with the problem.

Current Scenario: In August 2004, a government commissioned study into uninsured driving, called “Greenaway” report, was released. The Department of Transport has formulated a new approach to tackle this problem based on the recommendations of this report. Some of these recommendations (out of twenty in total) were – tighter restrictions on the time it takes insurers to upload policyholder details on the Motor Insurers’ Database (MID)1; the ability for courts to impose stiffer penalties; and new powers for police to seize and crush vehicles belonging to persistent offenders.

Industry Outlook: The first deadline for insurers was Jan 1, 2005. By this time, insurers were required to be 95% compliant in updating the MID with new or revised policyholder details within a 14 day time-span. It was found that on an average, the insurers were around 10% behind this target (during mid-2004), although consultations between insurers, the ABI and the Motor Insurers Bureau (MIB) were ongoing. A further recommendation for motor insurers was to develop products that incentivize younger motorists to gain driving experience in order to reduce future premiums. This got translated into the launch of schemes such as the Rapid Bonus scheme launched by Norwich Union (mentioned earlier).

Overall, the “Greenway” report recommendations will lead to a decline in the claims along with a rise in the product penetration due to uninsured drivers opting for the insurance cover.

Capital Adequacy – compliance with the new risk based rules enacted

by FSA for capital adequacy

Current Scenario: July 2004 saw the Financial Services Authority (FSA) publish its new risk-based rules for capital adequacy. All UK General insurers must be compliant with these stipulations by 31 December 2004. The non-life insurers are required to assess their own risk-based enhanced capital requirement and report this privately to the FSA. This is in addition to responsibilities to meet statutory solvency requirements based on existing EU directives.

Industry Outlook: The regulation would lead to higher costs of compliance, but would also bring in certain long-term improvements in the industry, especially the regulation is expected to lead to lesser no. of bankruptcies. It is also considered to be a natural extension of similar regulation across the banking and the investment banking community.

Source: Datamonitor, General Factiva News1The MID would be used as a key resource in improving detections and would also be accessible to the police.

51

Summary of key issues

Most of the investment income earned by the motor insurers is from short-term instruments with low risk profile such as gilts, government bonds and other fixed income securities. This makes the prevailing interest rate the single most important determinant of the investment income. According to the Bank of England, the interest rates are not expected to rise significantly in the near future. Thus, most of the motor insurers are not likely to have any significant increase in their investment income in the near future.

Technologically, there seems to be a high demand for claims management technological products.

Greenaway report recommendations, the EU approach to gender discrimination and CP190 capital adequacy requirements

Environmental

SocialLegislative

Political

Key issues facing the UK Motor Insurance

market

Technological

Congestion charging in urban areas along with govt. policy on transport and crime

Environmental sensitivity among consumers, Insurers’ corporate and social

responsibilities and Alternative fuel vehicles

Fraudulent claims, Uninsured driving and

motoring offences & driver behaviour

Claims processing technology, MID database access and Vehicle component technology

Source: Datamonitor, General Factiva News

Economic

Declining growth rate; benign interest rate outlook

52

Distribution of motor insurance – Direct channel becoming dominant in private motor; commercial motor dominated by brokers and intermediaries

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

1999 2000 2001 2002 2003

% m

ark

et

share

Total brokers and intermediaries National brokers

Chain brokers and telebrokers Other intermediaries

Company staff Tied agents

Banks / Building Socs. Direct

Utilities/ Retailers/ Affinity Groups Other

Direct insurers and affinity and retail players have eroded the private motor market share of brokers and intermediaries

The commercial motor channel is dominated by brokers and intermediaries although broker share has been declining

In Private motor

•Direct channel accounts for almost 40% of the business sold, growing marginally in 2003. This channel has sustained well in wake of the competition from other channels such as banks and building societies and brandassurers.

•Retail and Affinity groups are gaining market share at a fast pace and exerting pressure on the Direct Channel

•Banks and building societies have not been able to capture promising market share, as they have in the household insurance market. However, most of them see this segment as lucrative and are maintaining their focus on market share improvement.

•Brokers have been hit hard by other channels such as direct channels due to the ease and convenience they offer. A continuation of the current trend, would mean that direct channel will overtake brokers are the leading distribution channel for private motor insurance.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1999 2000 2001 2002 2003

Total brokers and intermediaries National brokers

Chain brokers and Telebrokers Other intermediaries

Company staff Tied agents

Banks/ Building Socs. Direct

Utilities/ Retailers/ Affinity Groups Other

In Commercial Motor

•The market share of national brokers has declined significantly from 80% in 1999 to 59% in 2003.

•Banks and building societies have had a minimal impact, in spite of focussed efforts from banks such as RBS and Lloyds TSB.

Source: Datamonitor

53

Property Insurance market has shown an impressive growth driven by rise in the UK house prices; AVIVA remains the largest player

4.93.8

2.6

2.5

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

1999 2000 2001 2002 2003

GB

P B

n

GBP 6.3bn

GBP 6.5bn

GBP 6.9bn

GBP 7.2bn

GBP 7.5bn

Domestic Commercial Total

CAGR = 4.5%

Property Insurance market sectors Market size and growth: The UK market for property insurance has grown by 4.2% over 2002 to reach a value of £7.5 billion (US$13.5 billion) in 2003. Over the five year review period, the market grew by 19.6%.

The largest sector was the domestic sector, which accounted for 65% of the total market in 2003, with a value of £4.9 billion.

The residential sector was the most dynamic sector registering growth of 28.2% over the review period.

Drivers: The main driving force behind the growth has been the dramatic rise in UK house prices over the review period, which has fuelled residential sector growth.

Commercial sector growth of around 6.5% during time period has been due to the increase in the price of policies in the commercial sector.

Concerns: In 2003, due to the Iraq war the major players have been forced to introduce measures, such as higher deductibles in order to cover themselves fully.

AVI VA, 23%

RSA, 21%

Others, 37%

Prudential, 4%

Direct Line, 5%

AXA UK, 10%

Top five players account for more than 60% of the market share

Other trends/ issues:

•Highly competitive market: The market for property insurance in the UK remains highly competitive. Around 810 insurance companies are authorized to carry on insurance business in the UK. Almost 600 of these can carry on general business only (such as motor, household and commercial insurance), 160 are authorized for long-term business only (such as life insurance and pensions) and 56 are composites (able to do both).

•Company Performance:

•Aviva Plc is in leading position in the UK property insurance market with a market share of 23%. Aviva Plc has benefited from the realignment of its insurance business over the last three years, through its strategy of concentrating on more stable personal and selected commercial lines and exiting the more volatile business.

•Royal and Sun Alliance, in second position, has benefited from the rising costs of insurance policies in the UK commercial sector.

•Axa, in strong position on this market, benefited from good growth in its Property & Casualty segment. Gross written premiums in the UK increased by 12.6% driven by strong rate increases, combined with limited effects of stricter underwriting.

Source: Euromonitor, General Factiva News, GRC Analysis, ABI

54

The market growth would be far from spectacular, although certain positives are in store for the industry

5.2 5.8

2.72.8

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

2003 2004 2005 2006 2007 2008

GB

P B

n

GBP 7.5bn

GBP7.9bn

GBP8.1bn

GBP8.3bn

GBP 8.5bn

Domestic Commercial Total

CAGR = 2.8%GBP

8.6bn

Property insurance growth not very attractiveMarket ForecastsThe market is forecast to increase by 13.3% during 2004-2008 period, to reach a value of £8.5 billion in 2008.

Domestic property insurance

The domestic sector is expected to remain the largest with a 67.5% market share equivalent to £5.8 billion in 2008.

The sector is expected to grow by 11.4% over the forecast period.

Commercial Property Insurance

The commercial market is expected to fare well in line with the expected stock market recovery, economic stability, and increased business confidence.

Growth drivers:

•Heightened uncertainty to drive the market: The market is set to grow as customers’ propensity to insure has increased in face of recent global events and heightened uncertainty of the future.

•New products and service improvement along with higher customer sophistication would also contribute to the growth.

Issues•Flooding and storm damage claims will be a major issue over the forecast period. This will be a challenge for insurers as these are difficult to forecast. Insurers will continue to cover for existing customers who live in areas where the Government will build or improve flood defences by 2008.

•Improving equity markets would improve insurer’s bottomline: Depressed equity markets and operating losses have impacted the industry’s financial strength, but this trend is set to reverse over the forecast period.

•Improved pricing discipline Improved pricing discipline has become more evident and the potential withdrawal of competitors from the general insurance market might create acquisition and accelerated organic growth opportunities.

Source: Euromonitor, General Factiva News, GRC Analysis, ABI

55

Health Insurance – market trends and issues

Market Trends

•Declining market: Private medical insurance market declined for seventh consecutive year. There were 82,000 fewer individual policyholders in 2003 compared to 1999. This was due to continuously increasing premiums that have suppressed demand. As a result fewer consumers are giving up their insurance cover and a some individuals are not taking it up.

•Opportunities to come from corporate sector: The strongest opportunities to increase subscriber numbers and grow premium income will remain in the corporate sector. Between 1999 and 2003 the number of corporate PMI subscribers rose by an average of 4.5% a year, which means that in 2003, almost 400,000 more people were covered by a group scheme. The drivers are:

•With cost control continuing to occupy the minds of UK businesses, issues such as absence management are being taken up very seriously.

•The providers of private medical insurance, healthcare cash plans and dental care insurance are increasingly keen to show how their products can assist in getting employees back to work quicker and thus reduce their costs

•Also, PMI, which earlier used to be a benefit reserved only for the “top-tier” employees is now being offered to junior staff members as well.

Market Size

•Marginal growth: The number of PMI policyholders in the UK rose marginally between 2002 and 2003. This was driven by a slight increase in the number of group policyholders, which offset the decline on the individual side1. The two reasons most frequently cited by consumers for not being interested in PMI are that it is "too expensive" and that they have "never really thought about it".

The mean premium of an individual PMI policy increased 47%, from £871 in 1999 to £1,280 in 2003.

Private medical insurance decline continues unabated – strongest opportunities to come from the corporate sector

Dental care and healthcare cash plans becoming more popular in the Group market

Increasing popularity: Dental care and healthcare cash plans are becoming more popular in the group market, as they offer a way to provide employees with some form of medical cover at a more affordable cost.

Cash plans in particular offer the benefit of covering many of the short-term illnesses that cause people to be off work and can be popular among large employers where the majority of staff is made up for manual or semi-skilled workers. Retail and manufacturing sectors tend to enjoy high take up rates.

Negative publicity of NHS Dental care: Difficulties associated with accessing NHS dental are well publicised with incidents such as “Carmarthen” receiving national coverage. This has provided food for thought for employers and ultimately increased the likelihood of them offering dental cover to their employees. Denplan, the leading provider in the market, reported record results for 2004, selling 215,000 plans in the last twelve months alone.

Source: General Factiva News, GRC Analysis, ABI

1Some policy holders with “individual cover” may have come under the group cover, and opted out of the former.

56

Asbestos claims expected to surge – total bill of £8bn- £20bn for UK insurers in the next 30 years

• Asbestos related claims are expected to surge in the coming decades and can make the British Insurers poorer by £8 bn to £20 billion, according to a study by the actuaries. British insures which cover the firms employees are likely to bear half of the costs.

• The study predicts as many as 200,000 new asbestos claims to come up in the next 30 years, shattering the popular perception that asbestos claims are a thing of the past.

• Britain seems to be mirroring the US, where the insurance companies have been bankrupted by the numerous claims of people who are not sick but believe they may, in the future.

• Although the asbestos related regulations have been tightened significantly over the past 30 years, the impact is likely to be felt over many more decades, due to the inherent nature of this mineral, which may cause illness long-time after the exposure (up to 40-50 years).

• The rising bill will also put pressure on: – The local authorities that have employed staff who worked with asbestos, – The companies which manufactured and installed the heat-proof material, and – The State compensation schemes that exist for people whose employers have gone bankrupt or cannot be traced.

• While the manufacture and use of asbestos has fallen in Western Europe and North America in recent decades, it has continued to expand in Asia and parts of eastern Europe. According to the study, urgent action is needed by the international community to help these countries deal with the inevitable "appalling" consequences of this activity.

Asbestos has been described as the biggest occupational health risk faced by workers in Britain. At least 3,500 people died in 2002-03 as a result of exposure to asbestos fibres, with the annual number of deaths expected to peak at 4,000 to 5,000 between 2011 and 2015.

Source: Factiva, The Guardian – from a report published by Actuaries in the UK

57

UK Investment Banking and Capital Markets

58


Contents Slide #

Investment banking – Contribution of product lines and geographies 59

Analysis of year 2004 and expectations for year 2005 60

UK’s position in Equity & Bond Markets and Cross Border trading 61

Exchange-Traded Derivatives market 62

OTC Derivatives market 63

Foreign Exchange Trading market 64

59

• London is the most important centre for investment banking globally along with New York.• The section starts with reporting of investment banking revenues across all major investment banking

categories in the UK along with certain trends/facts.• Going forward, the trends in equity issuance, bond issuance and M&A advisory are analysed using 2003

and 2004 performance data. Significant improvement can be seen in the equity issuance (169%) in 2004.• The section ends with an analysis of the derivatives markets, foreign exchange market and cross-border

trading in foreign equities.


60

UK Investment Banking: M&A’s an engine for growth

Corporate Fin. & Advisory Revenues in Europe (2003)

(100% = $11.4 bn)

Switzerland5%Eastern

Europe7%

Other1%

Spain7%

UK31%

Germany20%

I taly12%

France17%

0

10

20

30

40

50

60

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

$ b

n

Americas Europe Asia

Global Investment Banking : US is the main source of revenues

Note: Products include Equity, High Yield, High Grade & M&A, 2004 data represents first three quarters

2622

23

31

3739

50

57

42

34

41

34

•US was the primary source of investment banking revenues in the first three quarters of 2004 with 54% of the total revenues, followed by Europe with 28% share in the revenues.

•Investment banking had been the main engine for growth at many of Europe's financial institutions because of favourable conditions in bonds and an equity market upturn as economic conditions improved.

•UK was the main contributor of the Investment banking revenues in Europe with 27% market share.

•In the UK, the M&A Advisory function has been a main revenue earner consistently through the years.

•Though the revenues from M&A have decreased significantly over the past 3 years, there is likely to be more M&A activity in the coming years especially in the telecommunications, commercial banking and real estate sectors. Most of the M&A’s in the future will be cross-border.

0.71 0.66

1.57

3.28

1.80.170.68

0.3

1.27

0.47

0.14

0.18

0.31

0.62

0.63

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

1991 1994 1997 2000 2003

$ b

illi

on

M&A Equity Fixed income

UK Corporate Finance and Advisory: M&A the main revenue earner

1.01.01.61.6

2.42.4

5.25.2

3.03.0

Source: Freeman & Co. and International Financial Services, London.

61

Year 2004 was strong for Corporate finance and Advisory; further improvement expected in 2005, although oil prices may partly dampen the positive environment

(100% = $141.9 bn)

Spain, 2%

UK, 11%

Other, 23%

Belgium, 1%

France, 35%

Germany, 23%

Italy, 5%

Equity Issuance in Europe in 2003 and YTD Aug 31, 04

(100% = $127.3 bn)

UK, 22%

Other, 21%

Spain, 11%

Belgium, 6%

France, 13%

Germany, 19%

Italy, 8%

UK, 15%

Spain, 8%Switzerland,

4%

France, 13%

Others, 10%

Italy, 11%

Netherlands, 7%

Germany, 32%

Bond Issuance in Europe in 2003 and YTD Aug 31, 04

Switzerland, 4%

UK, 17%

Germany, 29%

Netherlands, 6%

Italy, 13%

Others, 10%

France, 13%

Spain, 8%

(100% = $87 bn)

Other, 22%

Norway, 5%

UK, 47%

Switzerland, 8%

Spain, 9%

France, 9%

(100% = $99.5 bn)

Switzerland, 10%

Other, 26%

UK, 31%

France, 5%

Spain, 22%

Netherlands, 6%

Announced M&As in Europe in 2003 and YTD Aug 31, 04

Equity Issuance

UK accounted for 11% of the European Equity issuance in 2003. However this jumped to 22% in eight months to Aug 31, 2004. Overall the equity issuance was robust in 2004, up substantially from the levels in 2003. Annualised YTD Aug 31, 04 figures would have meant a jump of 34% over 2003. On a similar basis, equity issuance in the UK is expected to have jumped by 169% in full year 2004.

Bond Issuance

UK accounts for 16-17% of the European bond issuance1.

Announced M&As

UK accounts for a third to half of the announced M&As in Europe. Annualising the YTD Aug 31, 04 figures, the announced M&As increased by 71.6% in Europe. The increase in the UK (calculated on annualised basis) is expected to have been much less at 13.2%.

Source: Thomson Financial Securities Data, Morgan Stanley, GRC Analysis

1Further information on the size of bond issuance is not available.

62

UK is a prime spot for Cross-border trading in foreign equities

14,173

21,352

2953

7165

1,0792,426

1,462

10,699

8,353

4,087

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Equity market Domestic debt securities

Am

ounts

outs

tandin

g,

$ b

illio

n

US Japan Germany UK Other

Global Equity and Bond Markets (Dec 2004): US leads the way

131 137

69

45

197

82

167 171

0

50

100

150

200

250

US UK J apan Germany

Equities Bonds

Relative size of Equity and Bond Markets

Value of domestic Equity and Bond Market as % of GDP, 2003

• UK has around 8% share in the global equity markets. The US market is the largest with around 45% market share.

• UK has the highest capitalization in relation to the GDP among the largest countries globally, at 137% in 2003. For bond markets this was 82%, much less than most other major markets such as US, Japan and Germany.

• London Stock Exchange, with 381 foreign companies listed is the most prime location for cross-border trading in foreign equities, with a 45% market share.

Source: World Federation of Exchanges, Bank of International Settlements

Cross-border trading in foreign equities (2003): LSE takes almost half the market

Switzerland, 1%

Other, 1%Germany, 3%

London, 45%

New York, 22%

Bermuda, 11%

Nasdaq, 11%

63

Exchange Traded Derivatives Markets – Since 1990, the turnover has increased by 19% on the UK based derivates exchanges

1,947 1,845

801

358178 236

2,913

2,167

1,015

507291

72 79 62

598

537861

357187

201278

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Kor

ea US

Ger

man

y

Fran

ce UK

Bra

zil

Japan

Sw

eden

Net

her

lands

Aust

ralia

Oth

ers

2002 2003

Annual number of contracts traded in millions

Source: International Financial Services, Bank of International Settlements

Exchange-traded Derivatives Turnover based on location

Millions of Contracts Traded Each Year

34 39 79 111157 136 174 209

150 118 131

619697 695

617

13 1725

3548 47

4857

5362 66

59

59 73

54

0

100

200

300

400

500

600

700

800

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

I PE Euronext LIFFE LME OM London/ EDX

Turnover of London-based Derivatives Exchanges

Source: Bank of England. Note: 1. 2004 data corresponds to first 8 months.2. Euronext LIFFE data prior to 2001 corresponds to LIFFE only. This inclusion is

responsible for the sudden surge in the contracts traded in 20013. EDX London was created in 2001.

• The number of contracts transacted through derivatives exchanges worldwide reached 8.18 billion in 2003. Annual turnover in the financial derivatives exchange was $874 trillion in 2003.

• Korea accounts for the bulk of trading on the exchanges with volumes accounting for 33% of the total. This is followed by the US, Germany, France and UK. Although the number of trades on UK exchanges is less than one quarter of US, the UK exchanges are heavily geared to serving international customers, whereas the US exchanges are predominantly domestic in orientation.

• There are four derivatives exchanges based in the UK namely, Euronext.liffe, London Metal Exchange (LME), International Petroleum Exchange (IPE) and EDX London which is backed by the London Stock Exchange and OM technology. The total turnover on these exchanges increased by 18.5% since 1990 to reach 506.9 million in 2003. The volumes are expected to have increased by 7% (annualising the 2004 eight months data). 2005 is expected to be a strong year as the markets conditions have improved further in comparison to 2004.

(1990-2003)CAGR IPE = 12.8%CAGR LME = 13.9%CAGR Total = 18.5%

64

UK the main centre for OTC Derivatives Markets with almost half the Global market share

OTC Market share in 2004 : UK the main centre for OTC Trading

Daily averages in April, in US $ billion (100% = $1,508 billion)

Belgium2%

Switzerland1%

J apan3%

Others10%

Netherlands1%

I taly3%

UK43%

US24%

Germany3%

France10%

63.548

79

59

29

43

16

36

7.5 9 4 5

0

20

40

60

80

100

2001 2004 2001 2004

Reporting dealers Other fin. institutions

Non-financial customers

UKWorld

Counterparties in OTC derivatives markets: World Vs UK (in % share of average daily turnover in April 04)

Swaps

Options

FRAs

Swaps

Options

0

100

200

300

400

500

600

700

1995 1998 2001 2004

Risk instrument in OTC derivatives markets in UK• International OTC derivatives trading has become more and more

concentrated in the UK and US during the past three years.

• UK is the leading centre in OTC derivatives market with 43% market share.

• Over a period of time, there is an increasing participation by other financial institutions, mainly because of greater use of derivatives instruments by commercial banks, insurance companies, mutual funds and hedge funds after the 2001 turbulence in the markets.

• Reporting dealers still hold more than half of the turnover in UK, though their share has dropped considerably over the past 3 years.

• Interest rates are the main instrument in the OTC derivatives market on the basis of turnover, notional amounts and gross market value. Derivatives based on foreign exchange also form an important sphere of activity.

Foreign exchange

Interest rate instruments

Source: Bank of England ,Bank of International Settlements

$ billion, Average daily turnover

65

UK the largest Foreign Exchange trading centre, well ahead of the US and Japan

17.9 15.7 19.2

6.99.1

8.37.1 6.2 5.24.8 5.5 4.9

18.832.3 31.1

32.5

31.231.3

0

20

40

60

80

100

1998 2001 2004

UK US J apan Singapore Germany Other

Daily Averages in April 2004

349 404 465606

44562130

59

137

151

208

209332

514

783

754

944

62

45

50

64

30

107

91

0

500

1000

1500

2000

1989 1992 1995 1998 2001 2004

$ b

illi

on

Spot transactions Outright forwards

Foreign exchange swaps Estimated gaps in reporting

Global Foreign Exchange Market Turnover

Source: Bank of International Settlements

• The UK is the largest global market for foreign exchange trading with around 32% market share, followed by US and Japan with 20% and 9% market shares respectively.

• World over, the foreign exchange trading has more than doubled since 1992. This growth is mainly because foreign exchange is being looked upon as an asset class, rather than for the only purpose of doing business cross border.

• There was a reduction in turnover during 1999 due to the introduction of Euro, which resulted in elimination of cross trading between the former Euro-area currencies.

• Traditional foreign exchange instruments account for nearly 92% of the global turnover in April, 2004.

• Daily Foreign exchange trading in London increased from $504 billion to $753 billion between April 2001 to April 2004.

Barclays

6%

RBS

5%

Goldman Sachs

7%

Merrill Lynch

5%CSFB / Credit

Suisse Group

6%

HSBC

8%

UBS

20%

Deutsche Bank

19%

J PMorgan

9%

Citigroup

15%

Largest OTC Dealers ( % share): Top three dealers account for more than a third of trading in 2003

Contribution to Global Foreign Exchange trading by Region (In %): UK a leader throughout

66

UK Investment Management

67


Contents Slide #

Growth, Fund Manager Rankings and Segmentation by Sources of Funds 68

Industry Profitability and Margins 69

Cross-country comparison – Small Size of UK Mutual Fund Industry 70

Retail asset allocation and Equity fund holdings in Mutual Funds 71

Mutual Fund Asset forecasts for select European Countries 72

Largest Managers of UK Mutual Funds 73

Retail Fund Inflows and performance of Hedge Funds 74

Hedge Funds as a proportion of Institutional Assets in select large markets 75

Market share of the UK in European Hedge Funds 76

Forecasted revenue performance and market growth of asset management products

77

Themes in 2005 78

68


• The section starts with a time series analysis of the funds under management in the UK. Leading fund manager rankings along with fund distribution facts and trends are given. Barclays was the largest fund manager followed by AVIVA and AMVESCAP as revealed by end 2002 data.

• The section then moves to the fund management revenue/ profitability benchmarks in the industry.• Focus then shifts to mutual funds, which meagre in comparison to pension funds and insurance funds,

strikingly opposite to the US, where they account for almost 38% of the total funds.• An analysis of retail assets of mutual funds is then carried out which reveals UK’s global lead in terms of

equity fund holdings in mutual funds.• Presented next are mutual fund forecasts for the UK and comparison with countries such a France, Spain

and Germany.• Retail fund manager rankings come next along with market share movement analysis of select players.• Thereafter, hedge funds and alternative investment products are analysed, which reveals another surprise

– hedge funds account for a very minor portion of the institutional assets in the UK.• The section ends with UK’s hedge fund position in Europe and globally along with issues and trends

expected in 2005.

69

UK Fund Management - Growth, Fund Manager Rankings and Segmentation by Sources

Rank CompanyTotal Funds Under

Management Value ($ bn)1 Barclays Global Investors 746

2 Aviva 3343 AMVESCAP1 3334 HSBC Group 3065 Prudential 2506 Legal & General Group 1877 Schroders 1408 Standard Life 1179 Lloyds TSB Group 11210 HBOS 10111 Eureko (F&C)2 9712 Friends Provident 9613 Royal & SunAlliance 6014 Hermes Pension Management 6015 Abbey National 43Source: Investment Management Association, Note: 1UK/US, 2 UK/Netherlands.

Leading Fund Managers based in the UK (end 2002)

Source: International Financial Services, London

Growth of Funds Under Management in UK

UK institutional funds

Overseas funds

UK private client funds

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

£ billion


The UK fund management industry managed over £2,800bn of funds at the end of 2003. This was up 6% on the previous year but still 7% lower than at the peak in 1999.

The recovery in 2003 was driven by rising stock markets and a flow of new investments. Between 2000 and 2002 the decline in the equity markets reduced commission income and fee levels, and made it more difficult to attract new funds. This followed a period of high growth in the 1990s during which funds more than doubled.

The institutional funds are the most important source of funds under management in the UK and accounted for 90% of the funds under management in 2003. Within them, insurance funds account for the major chunk followed by the pension funds. Unit trusts and Investment trusts account for a miniscule portion of the funds under management.

Mutual funds account for 11% of the funds under management.

Leading fund managers are Barclays, AVIVA, AMVESCAP and HSBC.

% Share of UK Funds

(100% = GBP 1.3 tr)

Pension

Funds

40%

Mutual

Funds

11%

I nsuran

ce

Compan

ies

49%

% Share of UK Funds (100% = GBP 1.3 tr)

I nsurance

Companies

39%

Retail Banks18%

Fund Manager

s12%

Investment

Banks19%

Other6%

Pension Fund

Managers

6%

Assets Managed in the UK by Manager Type Distribution of Funds

70

UK Fund Management Industry Profitability and key aspects

More than half of the UK Institutional funds are invested in equity. Thus institutional investors account for a higher percentage of shares at 53% than in most developed economies.

More than 90% of the overseas funds are from institutional clients. Overseas funds showed a strong growth almost doubling in the past eight years.

Private client funds account for 10% of the total funds (2003). The percentage of private client funds invested in UK equity is 15%, low in comparison to some other countries, partially offset by the absolute value of the share holdings. In terms of the value of these funds UK is ranked second after Switzerland in Europe.

The market is concentrated with top five fund managers accounting for 60% of the assets managed by the top 30 managers. Barclays Global is the largest registered UK fund manager followed by Aviva and Amvescap (see previous slide).

The industry employs more than 40,000 people (excluding retail stockbrokers). The employment situation stabilized in 2003 after declining in 2001 and 2002 and is expected to improve in 2004.

Funds managed in UK are larger than France and Germany combined, partially hidden due the large quantum of overseas funds which distort the fund management rankings.

Key aspects of the UK Fund Management Industry

Fund Management Industry Profitability

Fund Management Margins

23.7 24 24.3 24.6

17

19.918.7 18.7

6.7

4.15.6 5.9

0

5

10

15

20

25

30

2000 2001 2002 2003

Revenue/FUM

Costs/FUM

Profit/FUM

% of Funds under management (FUM)

15

20

25

30

35

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Margin as a % of revenue


71

A cross country comparison reveals the small size of UK mutual funds industry

Worldwide Total Net Assets of Mutual Funds in 2003 (Total = $15,000 billion)

338

172

32 9 3 2

1,104

479397 360

276 255

99 91 88

295

518

349256

12176

30 10 1 34

1,0511,148

0

200

400

600

800

1,000

1,200

Uni

ted

Sta

tes

Can

ada

Bra

zil

Mex

ico

Chi

le

Cos

ta R

ica

Arg

entin

a

Fran

ce

Luxe

mbo

urg

Italy

Uni

ted

Kin

gdom

Irela

nd

Ger

man

y

Spa

in

Bel

gium

Sw

itzer

land

Aus

tria

Res

t of E

urop

e

Aus

tralia

Japa

n

Hon

g K

ong

Kor

ea, R

ep. o

f

Taiw

an

Indi

a

New

Zea

land

Phi

lippi

nes

Sou

th A

frica

Res

t of W

orld

$ b

illio

n

Americas Europe Asia Pacific

$7,414 billion

Leading Markets Worldwide by Total Mutual Fund Assets in 2003

Europe, when considered as one unified market comprised of almost a third of the reported mutual funds assets or $4.6 trillion. The largest European markets are France followed by Luxembourg, Italy, the UK, Ireland and Germany. France and Luxembourg with assets of $1.1 billion each are the second and third largest markets globally.

Source: Investment Company Institute

72

UK leads globally in terms of equity fund holdings in mutual funds

Mutual Funds are country specific and not “European” in their coverage

This leads to differences in the products, as they are customized to local tax policies, products, infrastructure and customer demographics

In spite of significant lobbying, the evolution of a single fund range for entire Europe seems distant

Thus, the economies of asset management are determined by the interplay of “local” factors rather than those on a European scale.

European Asset Allocation continues to be defensive

Most of the European Markets except UK and Sweden have reduced their equity market penetration. UK leads globally among large markets, with equity fund holdings comprising 75.5% of the entire mutual fund asset base. Germany has almost half at 39.4% followed by France and Spain.

The customers are shifting back to Equity mutual funds after three years of preference for low-risk products. Nordic region is most buoyant in this shift-back, followed by the UK. Spain and France are witnessing moderate shifting whereas Germany and Italy continue to be stagnant.

Defensive asset allocation continues but gradual improvement expected

Mutual Funds are “local” in their value offerings

Retail Asset Allocation of Mutual Funds: Defensive assets still dominate

Source: Morgan Stanley, GRC Analysis Source: Morgan Stanley, GRC Analysis

26

47

2129 23

1228

10

11

8

11 23 6

16

3028

31

17

3931

22

75

31 27

5750

8

4612

27

0

10

20

30

40

50

60

70

80

90

100

Ge

rma

ny

Fra

nc

e

Ita

ly

Gre

at

Bri

tain

Sp

ain

Sw

itze

rla

nd

Ja

pa

n

US

A

(In

%)

Money Market Funds Balanced Funds Bond Funds Equity Funds

EUR Billion

Dec '03(Dec 02)

351(311)

612(539)

509(486)

337(296)

198(171)

263(260)

280(289)

5932(5133)

102

117

174

29

7

145

85

3421

93

128

192

21

-9

3117

5

-5

-50

0

50

100

150

200

1998 1999 2000 2001 2002 2003 2004Q1 2004Q2 2004Q3

US

ContinentalEurope & UK

US $ billion

Decelerating in 2004

Inflows into Equity Mutual Funds have decelerated significantly

Source: Investment Company Institute, Morgan Stanley, Investment Management Association, GRC Analysis

73

Mutual Funds growth (1999-2006F)

254 261236

195

241265

292321

0

100

200

300

400

500

1999 2000 2001 2002 2003 2004F 2005F 2006F

£ B

illio

n

0%

5%

10%

15%

20%

25%

30%

35%

Mutual funds Mutual funds/GDP

CAGR = 10%

Forecasts of Mutual Fund Assets (2006F) for Select European Countries – UK to grow at 10% average annual rate till 2006

UK

Spain Germany

France

Mutual Funds growth (1999-2006F)1,083

1,031973

909859

830740

569

0

200

400

600

800

1000

1200

1999 2000 2001 2002 2003 2004F 2005F 2006F

EU

RO

Bill

ion

-10%

0%

10%

20%

30%

40%

50%

60%

70%



392424 418

382

436

502

552596

0

100

200

300

400

500

600

1999 2000 2001 2002 2003 2004F 2005F 2006F

EU

RO

Bill

ion

0%

5%

10%

15%

20%

25%

30%

35%



204 206183 178 171

198220 237 256

0

100

200

300

400

500

1998 1999 2000 2001 2002 2003 2004F 2005F 2006F

EU

RO

Bill

ion

0%

10%

20%

30%

40%

50%


Source: ING Sector report on Retail Banking, July 2004

CAGR = 9%

CAGR = 11%

CAGR = 6%

74

Largest managers of UK retail funds – Fidelity remains #1

Company Nov-04 (£Bn)

Market Share Dec-04(£Bn)

Market Share Market share movement

Fidelity 24.8 9.3% 22.4 9.2% 0.1%

INVESCO Perpetual (part of AMVESCAP)

13.4 5.0% 11.7 4.8% 0.2%

Threadneedle 13.3 5.0% 12.5 5.1% -0.2%

Scottish Widows

12.6 4.7% 12.0 4.9% -0.2%

Legal & General

11.9 4.5% 10.9 4.5% 0.0%

Halifax 10.0 3.7% 8.4 3.5% 0.3%

Schroders 9.8 3.7% 9.3 3.8% -0.1%

M&G 9.8 3.7% 9.3 3.8% -0.2%

Henderson 9.4 3.5% 5.3 2.2% 1.3%

Mellon/Newton 7.0 2.6% 5.9 2.4% 0.2%

Gartmore 6.7 2.5% 6.6 2.7% -0.2%

Jupiter 6.7 2.5% 5.7 2.3% 0.2%

IF & C 6.5 2.4% 6.3 2.6% -0.1%

HSBC 5.9 2.2% 5.6 2.3% -0.1%

Morley 5.7 2.1% 5.0 2.0% 0.1%

SLTM 5.5 2.0% 6.0 2.5% -0.4%

New Star 5.4 2.0% 4.6 1.9% 0.1%

Others 103.7 38.7% 96.5 39.7% -0.9%

Total 267.8 100.0% 243.5 100.0%

Note: Includes Funds Under Management in FUM in unit trusts, OEICs, ISAs, and PEPs.

Fidelity remains the largest player

At the end of November 2004, Fidelity was the largest by Fund Under Management (FUM), with £24.8 billion of assets or 9.3% market share. The 11% increase in FUM for the year to November was marginally above that of the overall industry at 10%, and market share edging up by 0.1%.

AMVECAP moved up two positions

Of the independent UK listed asset managers, AMVESCAP (under the INVESCO Perpetual brand in the UK) saw its FUM increase by 15% to £13.4 billion, and market share rise by 0.2% to 5.0%. This gain in market share has helped AMVESCAP move up to the second place, from fourth place at year-end 2003. The Group has overtaken both Threadneedle and Scottish Widows over these 11 months. INVESCO has been benefiting from strong investment performance.

Henderson change misleading

The large change in FUM at Henderson, up by 78% is somewhat misleading. This increase was boosted by institutional money, previously managed internally on a segregated basis for insurance and pension clients being switched into funds.

75

UK retail fund flows still weak despite positive returns from the equity markets; hedge fund returns would stage a recovery in 2005

Note: OEICS – Open-End Investment Companies. OEICS are a hybrid between closed-end, investment trusts and open-end investment vehicles. OEICS share investment trusts’ ability to leverage themselves and, like investment trusts, investors are offered shares in OEICS, whereas they are offered units in unit trusts. But OEICS are open-end vehicles where the number of shares in issue expands and contracts in line with demand and whose price precisely reflects the net asset value of the total portfolio.

ISAs - Individual Savings Accounts. A new form of low cost, tax-free savings scheme that introduced in the UK from April 1999. ISAs can include shares, life insurance policies and cash.

Total Net Retail Inflows of UK Unit Trusts, OEICS and ISAs

UK retail funds in 2004 were disappointing in spite of the fact that equity markets saw the second consecutive year of positive returns. It appears that retail investors’ confidence in the equity market has yet to fully recover after the three-year bear market. For the 11 months to Nov 04, UK retail funds saw net inflows of £4.2 billion, which was 42% lower than the £7.2 billion of net inflows over the same period in 2003. 2004 had a strong start, with net inflows in the first four months up by 24% year-on-year to £2.8 billion. The inflows were then hit particularly badly during the months of May to August when the industry had net inflows of only £0.4 billion. This could not be attributed purely to the seasonal factors since it was 88% down on the same months in 2003, when net inflows reached £3.2 billion. There was a modest pick-up in the period from September to November, but the size of the net inflows were much smaller yoy.

Hedge fund returns are found to move with the S&P 500 although the quantum of movement is much lesser for the former. Thus, the returns are expected to improve in 2005 from the 8.4% return witnessed in 2004. However, the all time high of 19.4% achieved in 2003, will in all probability not be realized for the next many years.

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

1999 2000 2001 2002 2003 2004 2005

Van Global Hedge Fund IndexS&P 500Lehman Brothers Aggregate Bond Index

Hedge Fund returns mirror

S&P 500 returns

S&P Scenarios

Hedge fund returns declined in 2004

2003 growth not sustainable.

Hedge Fund Returns declined in 2004.

S&P 500 expected to improve in 2005.

76

Hedge Funds remain a small proportion of institutional assets globally… even smaller in the UK

Source: Greenwich Associates , GRC Analysis

Private Equity Hedge Funds Real Estate

Number of Investors

Allocation of Investors

Number of Investors


Number of Investors


United States 392 5.1% 227 5.9% 422 5.7% Corporate DB Plans 166 5.5% 73 3.9% 185 4.0%

Public DB Plans 87 5.0% 23 2.0% 125 6.3% Endowments and Foundations 139 11.0% 131 15.5% 112 6.8%

Canada 40 4.9% 30 3.2% 99 6.7%

United Kingdom 69 2.5% 34 4.5% 308 7.6%

Continental Europe 81 2.5% 89 2.5% 161 8.9%Germany- All Investors 46 2.3% 27 1.9% 125 7.1%

Japan 13 1.8% 120 8.1% 28 2.0%

1.3%1.0%

0.2%0.1%

1.0%1.0%

NA1.0%

NA1.0%

1.2%0.9%

Allocation to Hedge Funds

Even among current hedge fund investors, hedge fund allocation remains a small proportion of total asset investments Hedge Fund Allocation remains a small percentage of total

assets. In most of the countries/regions hedge fund allocation was around 1% of the total assets. UK seems to be an exception, with the assets allocated to hedge funds being 0.1% of the total assets.

Even among the existing hedge fund investors, the allocation remained a small proportion. Highest was recorded for Japan at 8.1% followed by the US at 5.9%, the UK at 4.5%, Canada at 3.2%, Continental Europe at 2.5% and Germany at 1.9%.

Overall, it is expected that the Institutional/Individual investments in alternative investments would increase significantly in the future driven by improved comfort, higher dissemination of knowledge and consistent above average returns at a lower risk.

Continental Europe

Continental Europe

47%

47%

27%

27%

36%

38%

14%

13%

7%

8%

28%

24%

27%

28%

30%

34%

28%

27%

60%

60%

70%

67%

48%

50%

11%

11%

26%

24%

27%

25%

9%

8%

2%

15%

15%

8%

8%

9%

10%

7%

7%

8%

8%

7%

5%

1%

2%

7%

7%

8%

6%

3%

2%

12%

9%

19%

14%

11%

9%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

2003

2002

2003

2002

2003

2002

2003

2002

2003

2002

2003

2002

Domestic Equities Fixed Income

International Equities Alternative Investments

USUS

UKUK

CanadaCanada

GermanyGermany

JapanJapan

Alternative Investments are a small proportion of Total Asset Investments. Within alternative investments allocation to hedge funds is the lowest in UK

77

UK hedge funds account for an increasing proportion of the European hedge fund assets

61

11923

61

0

20

40

60

80

100

120

140

160

180

200

2002 2003

$ b

n a

ss

ets

Other Europe UK

UK’s Share of European Based Hedge Funds

(100% = 563 single manager funds)

Ireland, 12

UK, 394

Others, 9

Germany, 8

Spain, 6Italy, 5

Netherlands, 5USA, 29

Finland, 12

Sweden, 18

Switzerland, 36

France, 39

Almost 70% of European single-manager hedge funds are managed from London; 5% from the US (End 2002)

Why UK?• World financial centre• Favourable regulatory environment - full weight of the

regulatory regime not applied when the manager only delivers products and services to non-retail investors.

• Favourable personal tax laws of non-UK domiciled hedge fund managers1

• Fiscal rules allow UK-based hedge fund managers to manage funds domiciled in offshore zero-tax jurisdictions without bringing them into the UK tax net.

• Location in a strategic time zone, travel and communications hub for Europe, access to manpower with strong financial skills

Why UK?• World financial centre• Favourable regulatory environment - full weight of the

regulatory regime not applied when the manager only delivers products and services to non-retail investors.

• Favourable personal tax laws of non-UK domiciled hedge fund managers1

• Fiscal rules allow UK-based hedge fund managers to manage funds domiciled in offshore zero-tax jurisdictions without bringing them into the UK tax net.

• Location in a strategic time zone, travel and communications hub for Europe, access to manpower with strong financial skills

• Europe accounts for 12% to 15% of the Global hedge fund assets. However, almost half of the hedge funds are sourced from Europe mostly from offshore private banks and family offices, with the main market being Swiss offshore private banks. Most of the “sourced” assets are invested in the US funds

• Private Client hedge funds are beginning to decelerate after a spectacular run, but institutional demand remains robust. The institutional clients are directly approaching the multi-strategy hedge fund firms.

• Single-manager hedge funds managed from France, Switzerland and Sweden are steadily increasing.

• As shown in the pie-chart, almost 70% of single manager hedge funds globally are managed from London

Europe accounts for 12-15% of the market, but is a source of almost half of the global assets

Source: Morgan Stanley, IFSL, GRC Analysis

78

Alternative investments are expected to show the highest revenue margins and market growth rate in the future

BB

AA

CC

200 bp

Projected market growth in Asset Management products (2004-2006)

Source: Boston Consulting Group, Morgan Stanley

79

Themes in 2005

Consolidation

Consolidation is expected to be an important theme in the asset management industry in 2005. Year 2004 saw a few M&As such as the merger between ISIS and F&C and the acquisition of Baring Asset Management by Massachusetts Mutual.

M&A has been much slower to pick up in the UK market, with only a handful of acquisition completed over the last two years. However, the following factors would improve them going further in 2005:

• the improved market outlook

• the legal settlement with the FSA (in relation to the split cap issue) by a large number of firms, which would act as a catalyst for consolidation. Potential acquirers were earlier deterred by these companies facing unknown liabilities in the shape of fines and compensation, including the risk of legal action by investors.

• Consolidation would also be aided by the low cost of debt at the moment.

Retail funds may recover due to improving

investor confidence in the UK

The UK retail fund management industry has yet to see the recovery in fund flows witnessed in the US during 2004. Going forward in 2005, retail funds are expected to recover due to improved market conditions coupled with the fact that many fund groups may step up the marketing effort.

Investment Performance has been good and

improving

The investment performance has been improving - In the UK, AMVESCAP continues to generate strong investment performance. However, AMVESCAP’s all-important US mutual fund business still lags it rivals. Schroders too has seen its investment performance statistics improve significantly since 2000 and should also be well-placed to attract new retail business.

Hedge fund returns have suffered due to low

market volatility

Market volatility (with the exception of commodity markets) in 2004 has been uncharacteristically low by the standard of recent years. This lack of volatility has served to limit the opportunity for many hedge fund strategies to generate strong returns. Many hedge fund strategies are designed to benefit from volatile price movement over a relatively short space of time. Without this volatility, many hedge fund strategies may find it difficult to outperform traditional asset managers by the margins that would justify the higher management fees.

80

UK Audit and Consulting Market

81

Contents

Contents Slide #

Consulting Market – UK 81

Consulting Market – UK versus rest of Europe 82

FSI Consulting 84

FSI – Key business issues 85

Consulting – Leading Players 86

The Audit Market – FTSE Survey Results/Jan05 87

The Audit Market – Key trends 88

The Audit Market – Players 89

FSI Audit Market – GRC Analysis 90

82

Consulting Market - UK

Nordic Region5%

Switzerland3%

Eastern Europe3%

Rest of Europe5%

Netherlands4%

I taly4%

UK30%

Germany28%

France12%

Spain6%

Source: FEACO Survey, 2003

UK MC Market Summary, 2003

2001 2002 2003

Market Size (In £billion) 12,900 13,600 14,800

Growth Rate (%) 18.0 % 1.0 % 13.0 %

Management Consulting Firms

12,000 13,400 13,400

Management Consultants 45,000 50,000 52,000

UK is the largest individual market for consulting with a total turnover of €14.8 billion followed by Germany with €13.13 billion and France takes the third place with €5.6 billion.

FSI accounted for 10.8% of the total UK MC market in 2003 which implies a market size of £1,598.4 billion.

• According to the 2003 FEACO (the association for management consultants in Europe) consulting market survey :

– Due to higher growth rates during the last three years the UK has become the largest market for management consulting in Europe with a total turnover of €14.8 billion and a share of 31.2%.

– Traditionally, the UK marked is more internationalised than the continental European countries, with a client behaviour similar to the US market.

The European MC-Market Composition , 2003: UK has largest share in the pie

83

Consulting Market – UK versus rest of Europe

Country TotalTurnover2003 (In£billion)

Market sharein Europe

AverageGrowthrate2003

MC as a % ofGDP

NumberofMCfirms

NumberOfconsultants

TurnoverPerConsultant(In £billion)

Austria 600 1,3 % 2.00 % 0.20 % 3,000 10,000 60,000

Belgium 640 1.3 % – 4.50 % 0.18 % 650 4,000 160,000

France 5,600 11.8 % – 10.00 % 0.28 % 5,600 32,000 175,000

Germany 13,130 27.6 % 1.00 % 0.44 % 14,000 67,000 195,000

Greece 205 0.4 % 15.00 % 0.12 % 150 1,800 115,000

Hungary 215 0.5 % – 2.00 % 0.38 % 420 3,500 60,000

Italy 2,000 4.2 % – 2.50 % 0.15 % 3,200 25,000 80,000

Netherlands 1,950 4.1 % – 3.00 % 0.35 % 3,700 10,500 185,000

Norway 500 1.1 % – 13.00 % 0.25 % 600 4,000 125,000

Poland 240 0.5 % 3.00 % 0.15 % 1,100 5,000 48,000

Portugal 370 0.8 % – 5.00 % 0.26 % 750 6,000 60,000

Romania 95 0.2 % 14.00 % 0.23 % 250 1,900 50,000

Russia 698 1.5 % 60.00 % 0.04 % 1,100 15,000 47,000

Slovenia 72 0.2 % 13.00 % 0.33 % 700 1,200 60,000

Spain 2,600 5.5 % 6.00 % 0.31 % 350 38,000 70,000

Sweden 825 1.7 % – 12.00 % 0.25 % 650 4,000 205,000

Switzerland 1,200 2.5 % – 8.50 % 0.31 % 650 5,400 220,000

UK 14,800 31.2 % 13.00 % 0.96 % 3,400 52,000 280,000

Rest ofEurope

635 1.3 % n.a. n.a. 12,100 15,000 42,000

Eastern Europe

1,470 3.1 % 14.00 % n.a. 3,500 27,700 53,000

Nordic Region 2,300 4.8 % 11.60 % 0.24 % 2.300 14,500 160,000

Key Figures of Selected European MC-Markets, 2003

Source: FEACO Survey, 2003

• The United Kingdom and Germany are the largest markets for management consulting services in Europe.

• In terms of the number of management consultants Germany is at the top, followed by the UK and Spain.

• In terms of the proportion of consulting revenues to the Gross Domestic Product, the consulting industry has the highest importance in the UK at 0.96 % followed by Germany and Hungary.

84

Consulting Market – UK versus rest of Europe

9.9%

1.0%

8.7%

11.3%

4.6%

2.3%

21.8%

0.3%

15.1%

Insurance 7%

Banking 5%

2.2%

0.4%1.4% Chemicals

Consumer Goods

Automotive

Aerospace & Defense

Transportation

Comm/ Media/ Enter-tainment

Wholesale & Retail

Banking

Insurance

Personal- & Business Services

Healthcare & Pharmaceuticals

Non-Profit & Government

European Union

Other

Operations Management,

18.8%

I T, 23.7%

Outsourcing, 36.2%

Corporate Strategy and

Services , 12.0%

Human Resources

Management, 9.3%

Source: FEACO Survey, 2003, 2002, 2001

Composition by Client Industry, 2003: Non-profit & Government is the largest client industry

Largest Consulting service lines, 2003

Year Total MC Market

(£billion)

% of MC spend from

FSI

FSI MC Market

(£billion)

2001 12,900 13.5% 1,741.5

2002 13,570 16.3% 2,212

2003 14,800 10.8% 1,598.4

• According to FEACO, the vast majority of market growth in 2003 came from transformational outsourcing.

• Management consulting, and the IT sectors actually shrank by about 9%.

• Broad financial recovery, particularly in the financial services sector is responsible for some of this growth coupled with release of pent up demand.

• The growth of the public sector spend to 22% of the total fees (2002: 13%) earned by member firms was also a significant contributor.

•The continuing decline in the strategy area over a number of years means that clients are looking for delivery as never before, coupled with downward pressure on margins.•Services areas which gained importance are outsourcing and the public sector.•Public sector demand comes from a UK government which currently has committed to a major growth in the public sector with the stated intention of a major improvement in public services across the board.•In the public sector large-scale projects (National Health Service) continued to be let. However there has been a tendency to move away from the large IT projects in the public sector on the grounds that experience shows an indifferent success record

85

However, this focus will shift toward expansion into new European countries. Expansion into Central and Eastern Europe is attractive to, for example, French, German or global banks that aim to work in the expanded European Union (EU).

• Price- and service-based competitive differentiation: Few financial service providers (FSPs) can, or will, derive a competitive advantage from product offerings. Despite mergers, there is an increasing trend from economies of scale toward economies of access — that is, providing customers with choices, advice and access based on their needs and preferences. There is less emphasis on vertical integration and more on an FSP's core competency focus (that is, what differentiates it from its competitors, creates revenue and is difficult for others to duplicate). FSPs will increase their use of partnerships and alliances to deliver other services and products.

233 237 252 257 275 284 293

230 235248 255 254 262 271

146 148158 162

167172

178

0

100

200

300

400

500

600

700

800

2002 2003 2004 2005 2006 2007 2008

Banking I nsurance (other than health) Securities

FSI Consulting

Source: Gartner Global Industry Forecast – Jan 2005

Note: Extracted from Gartner, not for distribution externally to ensure copyright

CAGR = 3.3%

FSI UK IT Consulting Spend Forecasts in US$ Mn

According to Gartner, IT consulting spend in Financial services in the UK was worth US$658 million in 2003 and will reach US$788 million by 2008.

Gartner forecasts the following are key trends to watch in 2005 for the Financial Services Segment:

• The shift toward international operations in Europe: Mergers and acquisitions have tended to focus on building scale in the home market (for example, U.K. banks acquiring each other, or French banks merging with French insurers).

86

FSI – Key business issues

Compliance Issues

Enforced compliance with new regulations, like Basel II, the Sarbanes-Oxley Act and International Accounting Standards, will stretch business unit and internal IT resources to their limits. Spending will be divided between infrastructure (to enable the integration of more systems and data), specific applications (like new credit risk engines), and training and reporting. Regulation is a trigger, rather than a driver, for IT. Integrated risk management solutions will drive a lower cost of capital through increased customer retention, reduced working capital and improved credit ratings. Governance and reporting capabilities will improve in the process.

Competition

Increased competition for customers among financial institutions will drive an increased focus on providing a superior customer experience to retain customer loyalty. Investment is likely to fall into two categories:

•Multichannel integration — that is, being able to carry out transactions over many channels (pervasive), being able to switch between channels in the middle of a transaction (persistent) and receiving the same answer despite which channel is used.

•Improved service — which could mean self-service (for example, through automated kiosks and automated teller machines), an assisted-service (for example, using staff to reduce queues) or a personal service (for example, remote access to product specialists).

Business Process Outsourcing

(BPO)

Business process outsourcing (BPO) will grow in the back office and middle office (and a little in the front office) as FSPs move from vertically integrated companies into extended enterprises. Expensive in-house solutions will become less attractive (except, perhaps, in the front office). At the same time, the emergence of the Internet has facilitated the increased adoption of shared services from BPO providers.

•The impact of offshore outsourcing in BPO (for example, from Wipro's Spectramind and Infosys's Progeon) has been even greater. Offshoring allows companies to take advantage of less expensive labour costs and, in some cases, improved service quality.

•The Internet in general, and Web services in particular, will enable quicker and easier interaction between the FSP, BPO provider and customer. Services can be provided remotely and, via XML, SOAP, WSDL and so on, with tighter coupling than before.

•In addition, BPM tools will facilitate BPO. At first, BPM may be used internally to separate business rules and workflow logic from applications, but this has the added benefit of making it much easier for someone else to run an application. A services oriented architecture achieves a similar objective by separating a service from the channel it is delivered through or the data that it accesses. This also makes it easier to isolate a service and run it through BPO.

Note: Extracted from Gartner, not for distribution externally to ensure copyright

87

Consulting – Leading Players

1,377

1,1401,085

845

524 518

360 330 306 288 282 270 266 249 242

0

200

400

600

800

1000

1200

1400

1600

IBM/ P

wC

Accen

ture

Logi

ca/ C

MG

Del

oitte

Touc

he T

ohm

atsu

Cap

Gemin

i E&Y

McK

inse

yCS

C

Fujit

su

BDO S

toy

Hay

war

dHP

EDS

Schl

umbe

rger

Sem

a

PA Con

sulti

ng

ATOS

KPMG O

rigin

Wat

son

Wya

tt

Source: Kennedy

Revenues of Key Players FY 2002 (in USD Millions))

88

The Audit Market – FTSE Survey Results/Jan05

20 17 21

4346.937.8

77.7

106.1

69.7 71.7

143.6

71.7

0

20

40

60

80

100

120

140

160

Deloitte Ernst & Young KPMG PwC

Clients (own + shared) Audit fees Other fees

Auditor fees - FTSE-250

Auditor No of clients Total fees (‘000)

Baker Tilly 1 £1,100

BDO Stoy Hayward 2 £1,100

D&T 50 £50,185

E&Y 31 £56,831

Hacker Young 2 £1,097

KPMG 51 £54,276

PwC 73 £106,047

RSM Robson Rhodes 1 £358

Total 211 £270,994

D&T18.6%

PwC39.7%

Other0.4%

E&Y18.6%

KPMG22.7%

Source: The Annual Audit Fees Survey FTSE - 100

Big 4 Fees – FTSE 100 (£m) Total Auditor Fees – FTSE – 350 (£m)

• The Audit market for the year 2003 was £350 million, with PwC having the largest share of almost 40%.

• The big four firms share the entire market among them.

• PwC is the leader in Audit market in terms of both audit fees and non audit fees.

89

The Audit Market – Key trends

Expansion Expected

• In June 2004, the Accountancy Age Top 50 league table noted the end of a year of contraction in the industry.

• It stated that UK's biggest firms are preparing to expand over the next 12 months, with 80% saying they expect to increase professional headcount and over half looking to take on more partners in the next 12 months.

Auditor Liability cap ruled out

• The UK government has ruled out placing a cap on auditors' liability, despite heavy lobbying from the UK's four largest accountancy firms that claim a limit is essential to maintaining a thriving audit market.

• The blow to the firms, which have argued that the current system of unlimited liability makes it more likely that another firm will collapse, following the failure of Andersen's in the wake of the Enron scandal.

High Compliance Costs

• A survey conducted in early 2004 by Handy Soft and Marketing UK revealed that European companies face a staggering 35% rise in audit costs to comply with the Sarbanes-Oxley Act's requirements.

• The survey found that an extra E370 million would be earned annually by accounting firms in additional audit fees from such companies by 2005.

• The average cost increase for each company would be E1.35 million.

90

Leading accounting firms and associations in the UK - fee data, 2003

Source: International Accounting Survey

The Audit Market – Players

91

FSI Audit Market – GRC Analysis

Sector US SIC codes No. of Companies listed by Onesource in the UK (UK Business Browser)

No. of Companies with Auditor and Audit fees details in Onesource

Commercial Banks •6021 - National commercial banks•6712 - Bank holding companies•6081 - Branches and agencies of foreign banks

•6029 - Commercial banks•6011 - Federal Reserve banks•6082 - Foreign trade and international banks•6022- State commercial banks

409 267

Consumer Financial Services •6061- Federal credit unions •6062- State credit unions•6091- Non deposit trust facilities•6099-Functions related to deposit banking•6111- Federal & fed-sponsored credit agencies

•6141- Personal credit institutions•6153- Short-term business credit•6159- Business credit institutions•6163-Loan brokers•6162- Mortgage bankers and correspondents

4699 1779

Life Insurance •6311- Life insurance 826 490

Health & Accident Insurance •6321-Accident and health insurance•6324-Hospital and medical service plans

102 62

Property & Casualty Insurance •6399-Insurance carriers•6324-Hospital and medical service plans

848 324

Investment Services •6211-Security brokers and dealers•6221-Commodity contracts brokers, dealers•6231-Security and commodity exchanges•6289-Security and commodity services•6282-Investment advice

2390 1666

Methodology:

1. Identify list of companies under specific FSI market sectors as below from Onesource.

2. Identify the Audit and Non Audit fees reported by Onesource as well as current Auditor.

Source: OneSource

92


Sector Audit Fees in £’ 000*

Non Audit Fees in £’ 000*

Audit & Non-Audit Fees (£’ 000)and No. of clients

Deloitte &Touche E&Y PwC KPMG

Commercial banks 73,765 148,193 Audit Fees: 12,822Non-Audit: 15,619Clients: 46

Audit Fees: 5,012Non-Audit: 2,078Clients: 23



Consumer Financial Services

34,086 23,727 Audit Fees: 5,162Non-Audit: 2,759Clients: 237

Audit Fees: 309Non-Audit: 98Clients: 174

Audit Fees: 1,967Non-Audit: 833Clients: 261

Audit Fees: 613Non-Audit:154Clients: 301

Life Insurance 27,777 21,694 Audit Fees: 709Non-Audit: 468Clients: 33




Property & Casualty Insurance

13,458 11,279 Audit Fees: 263Non-Audit: 219Clients: 46




Accident & Health Insurance

9.672 7915 Audit Fees: 340Non-Audit: 125Clients: 6




Investment Services 58,249 42,697 Audit Fees: 11,113Non-Audit: 5,790Clients: 206




Audit Total: 30,409Non-Audit Total: 24,980



Audit Total: 27,159Non-Audit Total:21,655

TOTAL FSI 217,007 255,505 Audit Share (%): 14%

Non-Audit Share (%): 10%

Audit Share (%): 8%


Audit Share (%): 9%


Audit Share (%): 13%


* Numbers are as reported/available on Onesource

93


30,409

16,74118,791

27,51924,980

9,23811,312

21,655

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Deloitte&Touche E&Y PwC KPMG

Audit Fees (GBP 000) Non-Audit Fees (GBP 000)

0

5,000

10,000

15,000

20,000

25,000

30,000


Commercial Banks Consumer Financial Services

Life Insurance Health & Accident Insurance

Property & Casualty Insurance Investment Services

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000


Commercial Banks Consumer Financial Services

Life I nsurance Health & Accident I nsurance

Property & Casualty I nsurance I nvestment Services

14%

8%9%

13%

4%4%

9%10%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Deloitte &Touche

E&Y PwC KPMG

Audit Non-Audit

Audit & Non-Audit Fees – Big 4 (Total FSI) £’000 Audit & Non-Audit Market Shares (%) (Total FSI) by Fees – Big 4

Non-Audit Fees - Big 4 (By FSI Sector) in £’000Audit Fees - Big 4 (By FSI Sector) in £’000

30,409

16,74118,791

27,519

24,980

9,23811,312

21,655

94

Appendix

95

Appendix – Structures for multi-tie panels

• The industry is currently discussing various possible structures for multi-tie panels, with the most often mentioned being waterfront providers, best-of-breed, product specific, product fill-in, tied-multi and hybrid panels. It is expected that banks and other tied channels to favour the best-of-breed and product fill-in panels, effectively retaining their exclusivity but adding increased product choice. IFAs will be reluctant to restrict their product choice and hence are more likely to tie to a panel of waterfront providers or tie just for certain product types. Distributors’ selection criteria for insurers being discussed fit into six broad categories:

– Political, i.e. are they too big to ignore?– Commercial, i.e. do they pay sufficient commissions?– Product, i.e. do they have a suitable product range?– Service, i.e. efficient platforms, sufficient agents?– Brand, i.e. how powerful is the brand to consumers/advisers?– Financial strength, i.e. how strong and robust is the balance sheet?

• For IFAs, the economic benefits of joining a multi-tie panel must outweigh the potential cost of losing independent status. This will not necessarily be easy given the emotional attachment to independence. The economic benefits will arise from increased commissions and other methods of profit redistribution, technology efficiency and higher premium volumes. The restriction in product range may not be as significant as they think because, realistically, IFAs will already deal with a fairly narrow range of providers within each product class. The larger IFAs and networks are clearly in an easier position to show the economic benefits of a multi-tie over a whole-of-market option. It is expected that over time small IFAs will be encouraged to join larger IFAs or, most likely, the networks with leading multi-tie options. Larger IFAs and networks will also be able to easily operate with both a multi-tie option (possibly even more than one multi-tie option) and a whole-of-market operation. Given below are further detail on the different structures as possibilities for multi-tie panels.

– Waterfront The waterfront model is likely to consist of maybe four to six providers that can cover all major product types. These panels are therefore likely to be permutations of Norwich Union, Standard Life, Prudential (once it reintroduces missing products), Legal & General, Scottish Widows and Clerical Medical. There is some concern that given the reluctance of these companies to offer increased commissions within a panel that the networks and larger IFAs may create two panels. The second panel would effectively act as a lower-tier panel, comprising other providers who are more prepared to offer higher commissions. This model, would be difficult to operate as it is expected that individual advisers would choose to stick to one status. While technically it may be possible under the new rules for an individual to be an IFA, and tied to different panels, disclosing this status at the first client contact, in practical terms it is believed that this would be very difficult in view of the compliance and regulatory hurdles. The main problem seen with this model is that the product ranges of these companies would be too similar, making it difficult to provide niche solutions. So, the solution may well be the hybrid model.

– Hybrid The hybrid model that will be most favoured by advisers is to have two to three waterfront players and then a further two or three players that are more specialised in their product offering. For example, Norwich Union and Standard Life might be the waterfront providers to which the panel may add some of the following providers:

• Prudential for its with-profits savings and annuities.• Friends Provident for protection and pensions.• Skandia for unit-linked multi-manager products.• Scottish Equitable for group pensions expertise.

– This model should provide sufficient choice to satisfy the requirements of most existing IFAs.

96

Appendix – Structures for multi-tie panels cont’d…

– Product-Specific: The product-specific model effectively offers a multi-tie panel for each of the major product areas, i.e. protection, pensions, life and savings. The consolidation of life insurers over the past few years has meant that a panel of five providers for each of these product types is likely to cover the majority of the market. Some players would make it onto every panel but there would be limited choice restriction, i.e. effectively the majority of the market would be offered by this model, providing little efficiency to the adviser and, ultimately, the consumer. However, there may be few benefits from this model. For instance, it is unlikely to be very efficient to run a number of panels, and once again there may be compliance and status disclosure issues. A number of networks and national IFAs already have protection panels in place after term assurance was effectively depolarised by the FSA in December 2000. This model makes increasing sense as many companies have now moved to electronic underwriting and hence the technology to achieve strong efficiency gains is in place. Restricting choice can also be beneficial to advisers since they are less likely to be caught out by changes in policy terms. With critical illness cover, for instance, the cover varies dramatically between providers and hence by limiting the range of providers, advisers find it easier to recognise the relative value of quotes for consumers. The operation of protection panels gives some insight into the way forward in developing full multi-tie panels. However, a successful multi-tie may go much further than existing panels with much greater efficiency gains and servicing enhancements than seen so far. It is also important to recognise that it is clearly much simpler to achieve straight-through processing and electronic underwriting for commodity products such as pure protection. Fully-automated systems are likely to remain a holy grail for insurers for complex products such as group pensions for large corporates. It is also expected insurers to be under greater pressure to pass on efficiency gains to both distributors and consumers.

– Best-of-breed: The best-of-breed model is essentially being tied to different providers for different products. This model is likely to be adopted by the banking channels as it will increase the choice given to customers yet not require significant upgrades to technology and expertise. Consequently, it can be viewed as an interim step and over the longer term one may expect these companies to move towards a more comprehensive model.

– Product Fill-In: The product fill-in model is similar to the best-of-breed model and is likely to be adopted by those banks that already have strong insurance operations or tied agreements to add to their existing offering. The banks will in effect focus on their core competencies and use other providers to add the niche products. The banks that fit into this category include: Lloyds-Scottish Widows, HBOS-Halifax Life, RBoS-Norwich Union and Barclays-Legal & General.

– Tied-Multi The tied-multi model, which had been discussed by some larger IFAs, involved the IFA being exclusively tied to a panel of providers. The providers would pay the IFAs an initial fee to access the panel. The insurers had been reluctant to pay for access given concerns over the quality of these IFAs. After the announcement by the FSA that no company should pay for access to a panel, this model appears unworkable in the present circumstances.

Documents

Financial Services marketplace in the United Kingdom Sid Maheshwari Global Research Center