Where reporting responsibility for individual divisions within business units changes, the segmental analysis is reclassified accordingly.

Segment revenue

Segment assets

Capital expenditure

2 
  

Key management assumptions

2.1 

Credit impairment losses on loans and advances

2.2 

Fair value of derivatives

2.3 

Impairment of available-for-sale equity investments

The group determines that available-for-sale equity investments are impaired and recognised as such in the income statement, when there has been a significant or prolonged decline in the fair value below their cost. This determination of what is significant or prolonged requires judgement. In making this judgement, the group evaluates among other factors, the normal volatility in share prices. In addition, impairment may be appropriate when there is evidence of a deterioration in the financial health of the investee, industry and sector performance, changes in technology, and operational and financing cash flows.

Had the declines of financial instruments with fair values below cost been considered significant or prolonged, the group would suffer an additional loss of R24 million (2004: R7 million) in its financial statements, being the transfer of the negative revaluations within the available-for-sale reserve to the income statement.
 

2.4 

Securitisations and special purpose entities

The group sponsors the formation of special purpose entities (SPEs) primarily for the purpose of allowing clients to hold investments for asset securitisation transactions and for buying or selling credit protection. The group consolidates SPEs that it controls in terms of IFRS. As it can sometimes be difficult to determine whether the group controls an SPE, it makes judgements about its exposure to the risks and rewards, as well as its ability to make operational decisions for the SPE in question. In many instances, elements are present that, considered in isolation, indicate control or lack of control over a SPE, but when considered together make it difficult to reach a clear conclusion.

The group has consolidated SPEs with assets of R17 747 million (2004: R9 966 million) and profit of R10 million (2004: Rnil). The group has not consolidated SPEs with assets of R250 million (2004: Rnil) and no profit (2004: Rnil) as these entities were not considered to be controlled by the group.
 

2.5 

Held-to-maturity investments

2.6 

Income taxes

2.7 

Financial risk management

2.8

Long-term insurance contracts – process used to decide on assumptions, changes in assumptions and sensitivity analysis

The value of insurance liabilities is based on best estimate assumptions of future experience plus prescribed margins as required in terms of PGN 104, plus additional discretionary second tier margins determined by the statutory actuary.

The process of deriving the best estimate assumptions relating to future mortality, morbidity, medical, withdrawals, investment returns, maintenance expenses, expense inflation and tax are described below.

Mortality
An appropriate base table of standard mortality is chosen depending on the type of contract and class of business. Industry standard tables are used for smaller classes of business, while company specific tables are used for larger classes.

Investigations into mortality experience is performed annually. The period of investigation extends over the latest three full years for larger classes of business. Investigations relating to smaller classes usually extend over five years in order to gain sufficient credibility of the data.

The results of the investigation are used to set the valuation assumptions, which are taken as an adjustment to the respective standard table.

In setting the assumptions, provision is made for the expected increase in AIDS-related claims. In general, Actuarial Society of South Africa (ASSA) models are used to allow for AIDS-related claims. The practice differs by class of business, however for major classes of business, a basic allowance for AIDS-related deaths is included in the base mortality rates against which annual mortality investigations are conducted. A further discretionary margin is then held using the ASSA2000lite model.

For contracts insuring survivorship, an allowance is made for future mortality improvements based on trends identified in the data and in the continuous mortality investigations performed by independent actuarial bodies.

Morbidity
The incidence of disability claims is derived from industry experience studies, adjusted where appropriate for Liberty Life’s own experience. The same is true for the incidence of recovery from disability.

Medical
The incidence of medical claims is derived from the risk premium rates determined from annual investigations. This is adjusted where appropriate to allow for future expected experience.

Withdrawal
The withdrawal assumptions are based on the most recent withdrawal investigations taking into account past as well as expected future trends. The withdrawal rates are analysed by product type and policy duration. These withdrawal rates vary considerably by duration, policy term and company. Typically the rates are higher for risk type products versus investment type products, and are higher at early durations.

Investment return
Future investment returns are set for the main asset classes as follows:

• Gilt rate – Effective 10 year rate at the balance sheet date off the yield curve rounded to nearest 0,25 percentage point (2005: 7,5%);
• Equity rate – Gilt rate plus 2 percentage points as an adjustment for risk (2005: 9,5%);
• Property rate – Gilt rate plus 1 percentage point as an adjustment for risk (2005: 8,5%); and
• Cash rate – Gilt rate less 1,5 percentage points (2005: 6,0%).

The overall investment return for a block of business is based on the investment return assumption allowing for the current mix of assets supporting the liabilities.

The pre-taxation discount rate is set at the same rate. For the major classes of business the rate used is 9,0% per annum in 2005 (2004: 9,7% per annum). Where appropriate the investment return assumption will be adjusted to make allowance for investment expenses, taxation and the relevant prescribed margins as per PGN 104.

For annuity and guaranteed capital bond business, discount rates are set at the rate of return yielded by the assets matching the respective business, reduced by an allowance for investment expenses and the relevant prescribed margin.

Expenses
An expense analysis is performed on the actual expenses incurred in the calendar year preceding the balance sheet date. The expenses are split between acquisition, maintenance and non-recurring expenses. The individual annual maintenance cost per policy, which forms the base for future projections, are as follows:

Expense inflation
The inflation rate is set at 3,5 percentage points lower than the gilt rate investment return assumption prevailing at the balance sheet date, resulting in a best estimate expense inflation of 4,0% at 31 December 2005.

Taxation
Future taxation and taxation relief are allowed for at the rates and on the bases applicable to Section 29A of the Income Tax Act at the balance sheet date. Each company's current tax position is taken into account, and the taxation rates, consistent with that position and the likely future changes in that position are allowed for. In respect of capital gains taxation (CGT), taxation is allowed for at the full CGT rate. Provision is made for CGT on unrealised gains/(losses), at the valuation date, at the full undiscounted value.

Correlations
No correlations between assumptions are allowed for.

Contribution increases
In the valuation of the liabilities, voluntary premium increases that give rise to expected profits are not allowed for. However, compulsory increases and increases that give rise to expected losses are allowed for. This is consistent with requirements of PGN 104.

Embedded investment derivative assumptions
The assumptions used to value embedded investment derivatives, in respect of policyholder contracts, are set in accordance with PGN 110. The expected investment return assumptions are set to be consistent with the Financial Soundness Valuations, while also taking account of the yield curve at the valuation date. Both implied market volatility and historical volatility are taken into account when setting volatility assumptions. Correlations between asset classes are set based on historical evidence.

Changes in assumptions
Modelling and other changes were made to the valuation to realign valuation assumptions with expected future experience. These changes resulted in a net increase in policyholders’ liabilities of R14 million in 2005.

The primary items were:

• a reduction in the inflation gap from 4,0 percentage points to 3,5 percentage points, increasing the liability by R131 million;
• setting up a liability in anticipation of the move from a real world model to a market consistent model for the calculation of the liabilities in respect of minimum investment guarantees, increasing the liability by R340 million;
• an adjustment to policyholders’ liabilities in respect of prepaid commission, which was previously recognised as a current asset. This resulted in a decrease of the policyholders’ liability in respect of insurance contracts of R1 013 million (2004: R1 096 million). The basis change is offset by a reduction in the current asset;
• a change in the economic valuation assumptions to re-align the economic assumptions with expected future experience, resulting in an increase of R653 million. It should be noted that the majority of this change is offset by a corresponding change in the value of the relevant matching assets;
• the demographic experience assumptions were adjusted to reflect expected future experience, amounting to a decrease in the liability of R37 million; and
• the balance of other modelling changes amounted to a decrease in liability of R60 million.

In addition, an allowance has been made for the adjustment to early termination values in terms of the Statement of Intent.

On 12 December 2005 a Statement of Intent was agreed between the Minister of Finance and the long-term insurance industry. In terms of the statement, minimum standards will be implemented on early termination values of retirement annuity contracts, as well as certain other contracts. Full provision has been made for the cost of these adjustments. The following adjustments amounting to R359 million are included as a basis change in the liabilities under insurance contracts:

• an amount of R172 million in respect of the retrospective cost over the period 1 January 2001 to 31 December 2005.
• an amount of R187 million in respect of the prospective cost of the adjustment to termination values and rates on in-force policies.

Sensitivity analysis
Shown in the table below are the sensitivities of the value of insurance liabilities disclosed in this note to various changes in assumptions used in the estimation of the insurance liabilities. Each value is shown with only the indicated assumption being changed and holding all other assumptions constant. In practice, this is unlikely to occur, and changes in some of the assumptions may be correlated.

It should be noted that the sensitivities ignore any changes in matched assets. This is particularly relevant to the sensitivity changes in future investment returns.

3 

Cash and balances with banks

 4

Short-term negotiable securities

5

Derivative instruments

5.1 

Fair values

5.2 

Notional amount

5.3

Derivative assets and liabilities

Click to enlarge

5.4 

Use and measurement of derivative instruments

In the normal course of business, the group enters into a variety of derivative transactions for both trading and hedging purposes. Derivative financial instruments are entered into for trading purposes and for hedging foreign exchange and interest rate exposures. Derivative instruments used by the group in both trading and hedging activities include swaps, options, forwards, futures, and other similar types of instruments based on foreign exchange rates, interest rates, credit risk and the prices of commodities and equities.

The risks associated with derivative instruments are monitored in the same manner as for the underlying instruments. Risks are also measured across the product range in order to take into account possible correlations.

The fair value of all derivatives is recognised on the balance sheet and is only netted to the extent that a legal right of set-off exists and there is an intention to settle on a net basis.

Swaps are transactions in which two parties exchange cash flows on a specified notional amount for a predetermined period. The major types of swap transactions undertaken by the group are as follows:

• Interest rate swap contracts generally entail the contractual exchange of fixed and floating rate interest payments in a single currency, based on a notional amount and an interest reference rate.
• Cross currency interest rate swaps involve the exchange of interest payments based on two different currency principal balances and interest reference rates and generally also entail exchange of principal amounts at the start and/or end of the contract.
• Credit default swaps are the most common form of credit derivative, under which the party buying protection makes one or more payments to the party selling protection during the life of the swap in exchange for an undertaking by the seller to make a payment to the buyer following a credit event, as defined in the contract, with respect to a third party.
• Total return swaps are contracts in which one party (the total return payer) transfers the economic risks and rewards associated with an underlying asset to another counterparty (the total return receiver). The transfer of risk and reward is effected by way of an exchange of cash flows that mirror changes in the value of the underlying asset and any income derived therefrom.

Options are contractual agreements under which the seller (writer) grants the purchaser the right, but not the obligation, either to buy (call option) or to sell (put option) by or at a set date, a specified amount of a financial instrument or commodity at a predetermined price. The seller receives a premium from the purchaser for this right. Options may be traded over-the-counter (OTC) or on a regulated exchange.

Forwards and futures are contractual obligations to buy or sell financial instruments or commodities on a future date at a specified price. Forward contracts are tailor-made agreements that are transacted between counterparties in the OTC market, whereas futures are standardised contracts transacted on regulated exchanges.
 

5.5 

Derivatives held for trading

5.5.1 

Foreign exchange derivatives

Foreign exchange derivatives are used to hedge foreign currency risks on behalf of customers and for the group's own positions. Foreign exchange derivatives primarily consist of forward exchange contracts, foreign exchange futures, and foreign exchange options.
 

5.5.2 

Interest rate derivatives

5.5.3 

Commodity derivatives

5.5.4 

Credit derivatives

5.5.5 

Equity derivatives

5.6 

Derivatives held for hedging

5.6.1 

Derivatives designated as fair value hedges

5.6.2 

Derivatives designated as cash flow hedges

5.6.3 

Derivatives designated as fair value portfolio hedges

5.6.4 

Derivatives designated as hedges of net investments in subsidiaries

6

Trading assets

7 

Investments

7.1 

Investment securities held in banking operations

Redemption value
Dated investment securities had a redemption value at 31 December 2005 of R13 156 million (2004: R14 122 million).

Investment registers
Registers of investment securities are available for inspection by members, or their authorised agents, at the registered offices of the company and its subsidiaries.

Directors’ valuation
The directors’ valuation of unlisted investments is equal to the carrying value. All unlisted investments were valued at 31 December 2005.
 

7.2

Investments held by insurance operations

7.3

Financial instruments

¹Instruments in this category comprise loans secured against policyholder contracts. The maturity profile is not determinable as the holder has the option to settle at any time prior to the policy maturity date.
 
²As allowed on adoption of IFRS, assets have been reclassified as held at fair value through profit or loss with effect from 1 January 2005.
 

7.4

Investment properties

8

Loans and advances

8.1

Loans and advances net of impairment

Segmental analysis – geographic area
The following table sets out the distribution of the group’s loans and advances by geographic area where the loans are recorded. The geographic spread of loans and advances within the various regions of South Africa closely follows the demographic and economic activities within the country.

8.2

Instalment finance

8.3

Credit impairments for loans and advances

9 

Current and deferred taxation

10 

Other assets

11

Interest in associates and joint ventures

12

Goodwill and other intangible assets

12.1

Goodwill

Impairment testing
For the purposes of impairment testing, the goodwill is allocated to the smallest cash generating unit. The cash generating units are defined as the corporate entities listed above. The goodwill is tested annually for impairment and in the majority of cases the impairment is tested using the value in use as the recoverable amount.

The largest impairment incurred was that of Capital Alliance Holdings Limited (CAHL). The goodwill arose from the residual cost of CAHL over its embedded value. All the cash flows from the entity’s cash generating units have been taken into account in calculating the embedded value. As there are no further cash flows to attribute to the goodwill it is impaired in full.

12.2

Other intangible assets

13

Property and equipment

13.1

Summary

13.2

Movement

13.3

Valuation

14

Share capital

14.1

Authorised

14.2

Issued

14.3

Unissued shares

14.4

Interest of directors in service at 31 December 2005 in the capital of the company

15

Trading liabilities

16 

Deposit and current accounts

Deposit and current accounts were increased by fair value adjustments of R436 million (2004: R575 million) relating to deposit and current accounts which were subject to specific hedging relationships and were therefore only fair valued for the risk subject to hedging.

Maturity analysis
The maturity analysis is based on the remaining periods to contractual maturity from year end.

17

Current and deferred taxation

17.1

Deferred tax analysis

17.2

Deferred tax reconciliation

18

Other liabilities

18.1

Summary

18.2

Provision for post-retirement benefits

19

Policyholders’ liabilities

19.1

Policyholders’ liabilities under insurance contracts

19.2

Policyholders’ liabilities under investment contracts 

20

Subordinated bonds

21 

Empowerment reserve

22 

Contingent liabilities and capital commitments

22.1

Contingent liabilities

22.2

Capital commitments

22.3

Financial assets pledged

22.4

Operating lease commitments

23 

Supplementary income statement information

23.1

Interest income

23.2

Interest expense

23.3

Non–interest revenue