Operating & Financial Review

Investment performance

The investment contribution during 2006 was £115.1m (2005: £90.9m). The return on average cash and investment balances of £2.3 billion (2005: £1.5 billion) was 4.8% (2005: 5.4%). The increase in cash and investments was driven by strong organic cash flows from profitable trading, the increase in capital following the £200 million of new equity to support the Bermudian business and the replacement of letters of credit with subordinated debt.

Investment performance

The equity portfolio produced a good return of 15.1% (2005: 26.6%). Global economic growth was steady during 2006 which was supportive of equities with global corporate earnings growth at around 15%. Equity pricing was also buoyed by mergers and acquisitions activity. In June advantage was taken of the second quarter equity market correction to start to build up the Group’s equity exposure, which had been diluted by the additional capital for Bermuda.

By comparison the performance of our bond portfolios was weak with a return on short dated sterling bonds of 2.5% (2005: 5.3%) and 3.8% (2005: 1.6%) on short dated US dollar bonds. Rising oil prices in the first part of the year and generally solid economic growth increased inflationary pressures during 2006 keeping most central banks on a monetary tightening bias. The US Federal Reserve continued to raise interest rates until August, the European Central Bank increased interest rates throughout the year and the Monetary Policy Committee in the UK surprised the markets by tightening policy in August, a move they consolidated by a further rise in November. This background was not positive for the short end of bond markets, as it caused yields to rise, and therefore prices to fall.

Due to rising interest rates cash returns have been relatively attractive. To balance the equity volatility in our capital assets cash has been an asset class of choice for us in recent years. In addition, in its start up phase Amlin Bermuda held significant levels of cash. Cash returned 4.7% for the period (2005: 4.8%),

Expenses

Total expenses, including underwriting, non- underwriting and finance costs, increased by 37% during the year to £345.9 million. Expenses include the translation differences of non monetary assets and liabilities. The impact of this in the year was to increase expenses by £27.9 million (2005: reduce expenses by £26.2 million). After removing these exchange differences the net increase in expenses was £39.8 million. £25.2 million was an increase in acquisition costs, reflecting the growth in premium earned in the year. Much of the balance relates to the operational expenses of the Bermuda business, with £4.1 million incurred in the year.

Taxation

The effective tax rate of the Group for the year was 21.9% (2005: 24.9%). The main reason for the low rate in 2006 is that the Amlin Bermuda result is not subject to current UK tax. This alone reduces the effective tax rate by 8.5%. We believe that Amlin Bermuda is exempt from the Controlled Foreign Corporation tax provisions of the UK tax regime. On this basis the Group will pay tax to the UK tax authorities only when distributions are made back to its UK holding companies. Recognitionof this future tax charge has been made by settingup a deferred tax provision for 9% of Amlin Bermuda’s profits.

The other factor reducing the effective tax rate is continued use of unprovided capital losses which have been offset against equity gains. This pushes down the effective tax rate by 1.1% (2005: 3.8%). This effect will not repeat in the future as all capital losses brought forward have now been utilised.

© Copyright Amlin 2006