B.A.T INDUSTRIES GROUP STRATEGY REVIEW SECRET tIATC0 (70'4FTDFI;Tl \I- - C ~TFGORY 1: NITN'I:E-507~ TOB.ACCO LITIGATION. BATCo document for Province of British Columbia 26 October 1999 Contents Pa2e Introducion 1 Executive Summan 2 3. Economic : Market Assumptions 6 B.A.T Industries' Objectives and Strateg~es 7 TobacCD and Other Commercial Activid~ 10 6. Bro%kr. %V;i.`a7.sw 7. BATCc- 8. BATCF 9. Souza C:-,;z 25 10. Financial Services 26 11. a-s!le S-= 34 1 -_. Allied Dunbz: 38 13. Farme7s Gmu-o 40 14. Associated Companies 42 Qr, CD CD CD Z:- N) CD 01 0- 92 S ~T(-r) CONTPDFN71.~L - (7.~TFCOR'v 17 ',IINNESOT-~ TOBACCO LITIGATION. BATCO document for Province of BritiSh Columbia 26 October 1999 Introduction 1 : -,as prev;ousk be,en a2r-_--` =1: 17. ord",r to satisrv snarehoiders. B.A.' primar,- objeczive s.-.ou.-z '-.e to ;.-ovicie an above ave-aae re=-. on in%es:men, in the -omoanv's sna--= :nro-_-s!.-i dividends and caniLai growz.~-. can. be sustained over the mec':'~.= zzzors: =Tn future. s=-.Eez,,- is to acnieve this Dv cc:-.:=z:-a-2nz on pursuing growth in Tobacco and Financ:al Services. building on tide world-wide strengths and es:ablishing 1---dership positions in selecte_c' proz:able 270Wth markets within these rwo s~_-ors. T-he purpose of the Stratezy Revic-.z is to assess the Group's current per:ormance and pros=:s over the medium to lcnger :---n in relation to the obi=::ives. -n ort-_- 10 lGendry any gaps betwe-en I'-.eSE. !-.C to 7=0mmend: T-he prorities f07 _zmor. 7!quired to achieve a more efTeczve imvie-nentation ol-- .S___.Z Str-Leales: Any new initiatives zo ~-::Lise on opportunities identified in orde: zo mf--! the objec-tives. o.- :o resoive any ouLstandins issues idenrif-let ;n this review. conclusions from this a:.- accepted. they will be in vuidelines which will be p7--sen-----' for approval at the next Board meea;nz. ou--unin- prionues for action in Operating Groups and in Centra.1 =ms or d.-Dart:ments responsible for im:).ern-:::ang s:)=,.ric recommendations. 1. The Guidelines should be 'n the Operating Group Plans for 1993-1997. These Plans will be discussed "by tnt CPC and presented to the Board in me us-,I way in Janua_-y/February. 1.6 Ahead of this, Operating Grou:~S will be asked to produce outline plans for discussion by the CPC in Ocobe7. in order that the sLrategits on whic- they a:-. based can be agr=d. 1.7 A consolida~on and review of mt-se previews will be presented to the Board in November. Q.-4 CD 29 :061:92 13 ATCr) CONFIDENTT ~L - C..kTE(-,0IY 1: NTI.'INESOT.-% TOBACCO LIT'IG-kT!O,;. BATCo document for Province of BritiSh Columbia 26 October 1999 Executive Surnmar:, B.A.T Industries' Objec:j,es and Strategies The primuy :2.- B.A.-I Inc-".1s'ne's is to provide share'nolders wit" ar. above-ave-aae re:urn or. ::.e .nveSIMCM th-,ough dividends and capital growth. B.A-T Indus-Lnes' s-L.-_:z;y is to achieve this above-averag! growth b, concentratina the Grou:~ S resources in Tobacco and Financial Servicis. The rationale for this strazezv ~s that Tobacco offers -rowth and a stronz cash flow while Financial Sc:%-ices offers opportunities for growth by investm.-nE in businesses which have *_'-d xtential for subsequent self-funded grov-th at above- avera=ae rates. Current assessments of marke, pros?ecLs suggest that it should be possible to provide above-average rc-.:-rs to shareholders at rates of Earnings Per Share (EPS) ,,rowth lower than th~- .*5~7c p.a. assu=d in previous years. and therefore the ob2ccdve has been zo 12% P.a. However, ta-kinz into a=,.nt the resuiLs for 1990 and 1991, there is a short-term requirement to achieve s- 7,-?lc recove--y in pror-iLs in 1992-93 in order to complete the restoration of con-,`idt:-.z-. in the vadidiry of the Group's strategy. There. is also a need to try to avoid variations in profits on the scale experience-,; since 1989. The previous plan show--,-' that the Group expected to achieve the EPS objective. although without much -~rovisiori to cover risks to profit. It also showed that there would be a growing amount of available resource and surplus ACT. Therefore in order to enhance the abL~zv to achieve the objective, the Group should consider investing in a sEratepc opportunity to take advantage of the ACT-position. L2 Criteria used in the Review i The main criteria azzins- which the Group's performance and prospects have been measured in this review '.-,ave been the qualitative requirements to: Ac.hie,,e a -a--ic' rtcoverv in profits in the shorter term; Establi5h and maintain leadership positions in Tobacco and Fin2Lnci--' Services over *.'-e medium to lonzer term-, Avoid excessive vulne-abilitv to external factors which could have a signincant e::e--: on pront perTormarice. The aim o reduce the G:oup's effective tax rate by increasing UK income and hence recoveries of AC-1 ~,as also been taken into account. 30,06:'92 R-~TCO (7(_)NF1DF.1:T1.\!_ - C kTE(-,ORY 1: NITNNESOT-~ TOBACCO LITIG-MON. BATCo document for Province of British Columbia 26 October 1999 Executive Summar, Tobacco conclusion from the of th! G.-oup's Tobacco businesses is t~ia: Lht7t appear to be good opporvur:~Lies for growth through increased marke, share in exusunz ma:.~::s and through inc=ed peietradon of the former monopoiV markets. Inital1v this is ex-)eced to be uircwt exports but. in the longer :---Tn. it 7 , W will be investment in manuiacturing ithin the markets concert.^ StTen2th in L-i~ernational Br-.nds will be the key to competidve capabiHty. 7rie ass-.;mnon ta: the market ;s capable of offerin., excellent returns still rama~ns valid. . ele- -.:z in the over.!! strategy for tobacco are programmes to i==C e,. I me. K rna:~e, share. maintain the growth in exports, strengthen the competitive position of InEernamonal Brands, invest for the medium term in new markets. imo-ove inL-a-Group co-operation in marketing and product sourcing, and improve management training and developmen:. 7here is also continuing empnasis or, disDosin2 of other commercial activities in order to focus the GrouD's available finanmal. ar;~~ :nana!zernen, resource on develot)inz the tobacco business. -iew of increase in down-trading. the priorities for action should include In an emphasis or, increasing productivity. Tiriere are also opportunities for shorl term ezrmin-s ~,rok-.h through proric trnprovemerit, concentrating on activit2es which are cur=ntly operating at low levels of profi:abiliry and whZare of a size to provide sianificant There should also be more emphasis on the technical upE-ading of products and processes, and opportunities for expanding Le.-_- expor-z should be pursued. _.,.4 In r-----nt v=s. volumes have declined sliEhtly in domestic markets. Tbe previous pl,z.i (excludi-rig Souza Cruz, which has an over-riding objective to improve proffiabiliry) projected a rerurn to domestic volume growth of 3.5% p.a. This m=ts the objective set out in this Strategy Review paper. 2.3.5 Recent export volume growtIn of about 207. p.a. has meant that the objective for export volume growth has been revise--' f~rom the 8.6% p.a. projecte-1 in the prv.-ious plan o 17.5 p.a. .6 The market or Inter-national Br-ands is expected to continue to grow at 65c o 77c E p.a. B.A.T Industries has been gaining market share and the objective is to cc.-.-dnue this by growing International Brands at 10% p.a. 1. :s noted th-, although B.A.T Industr - ies is the leading Tobacco group outside the US. it occu-oles only third position in the US domestic market and it is not considered feasible to gain leadership in this market, at least in the shor-L-term. Howeve-, it is believed that the Group does not need to achieve this in order to CD mLntain the erowth and strone cash fiow which the Group's strategy requires. CD Th,_,s. the aim. will be to be a leadina LIobal player rater than the ove-LI wor;d- X:b leadt- in Tobacco. 3 30 06i92 BATCO CONFIDENTLki- - C.ATEGORY 1: NTINNESOT.k TOB,-kCCO LITIGATIO'. BATCo document for Province of BritiSh Columbia 26 October 1999 Executive 5,,mm-'in 7 he current performance and prospects for Tobacco are that the G=-o is ma~dng good progress in exports growth and in laying the foundatic--; for becomin.: established in new markers. The disDanties in profitabih-.y have nar7owed somewhat. 7he US domestic marke, continues to rn.-:~-'- a disproportionately lazze contribution to the Group total, but this is Likely to lessen. c In total, the previous plan projected trading profit growth at 12.3 3 7c p.a. w--' --h is slightly below the financlal objective set out in this St:-a:egy Review pa7er or 1 :.5% p.a. 2.4 Financial Services The conclusion for Financial Se-victs is that the sector has the capa!-,--`-V to provide above-averrage, self-funded growth (although the previous assu.-7.-juons regarding the potential for profizs growth within this sector mav need to be reduced sLightly). 7 n-- short term objective is to regain credibilitv in Financial Services. T---z long term objective is to be the premier personal lines insurer in selected marke----. 3 For the existing Financial Services businesses, the operational strategies :--e to improve performancz as a base for future ex,,)ansion in the UK, t~.! US, Continental Europe and, longer term, in the Far East and the rest of the %world. The priorities for action are to: Seek means of maximising the value added by being part of B.A.T Industries in addition to self-generated benefits and economies: Improve profitability by particular emphasis on underwrit-17 and investment performance, and expense ratios: Continue to strengthen the competitive position of the bus:Lnesses particularly in their home markets, concentrating an enhancz-,g the st;-engEh of distribution and upgrading IT systems, and productivity both of the sales channels and in the back officzs. 2.4.4 The expansion strategy, to concentrate initally in the T--;K and US, and -":n in Continental Europe, has increased in priority since the previous plan. Mr.= are opportunities for the existing businesses and also for acquisitions and joint v=rures in these markets, to strengthen distribudon, take advantage of market restructurings, and enter faster growing markets. The priorities for action are to pursue the opportunities for growth throusth: CD expanded distnibution in the UK. throush an accuisition, tied az:.-.--y or CD CD joint venmre: Z3. r1 J 4 30 06192 B,%TCO CONFIDENTIAL - CATFGORY 1: NIINNESOT.,, TOB.NCCO LIT - --kTION. BATCo document for Province of BritiSh Columbia 26 October 1999 Executive Sum ar, organic growth and acquisition zo obtain leadership pcsiaons in US States wher! currently represer.:ec and selec,--,~ additionL Sm-, establishing a significant presen= in Continental Fur--->e t-ouah an acquisition or joint ven:urt. f An analysis of the current performance and prospects for the F-nanccial Services businesses shows that in the previous plan business turnover w;-s projected to increase at 10.947c p.a. and General Business mmover at 10.05o p.a. whic" should result in small market share gains. --ious plai proiected profi g-rowth (excluding Eaggle S= Gtneml The pre. Insurance which has a recovery objective) of 16.1% p.a. which siightly exceeds the objective set out in this Strategy Review paper of 10% p.a. real profit growth. (Using a different accounting convention it would be possible to increase the level of reported Life profiTs, but this could malke the reported profits slighzly more volatile and would have no impact on available cash.) Eag~e Star Gene.-al Insurance's contribution to the recove-y in 1992-93 and to lonser tenn profit -,rowth, and the steady progression in pronts from the Life businesses. are very impoi-4nt to the acnieve-nent of this plan. 2.4 The Amociates Ile Group's associates have wished to follow strategies involving --dons of dir diversification which differ from the rest of the Group. In genenal, these have tended to be relatively unsuccessful and have diminished the vLue to B.A.T Industries of the investment in the Associated company. Dividend y&iellds have also been lower than B.A.T Industries would wish and the degree of influence which could be exerted on this and on the overall strategy of the company conc---ned has been Liniited. 2. 5. It is recommended that B.A.T Industries should continue to seek to reduce its interests in the Associates' activities outside Tobacco and Financial Servicts, preferably exchanging these for an enhanc--4 share of the businesses of direct interest to the Grou:). Ln CD Zz. -10.;061 92 1-1 1 1 1 -rT7 C-. n Q F 1,nT Tn g CM Ll- - \ TION. BATCo document for Province of BritiSh Columbia 26 October 1999 Economic Assumptions Key macro-econom-1c assumptions that have been agreed by = Boart -.o.- use as backaround for this review are se, out in full in the Future Business Environment paper and are summarised below. Recovery in economic growth is expecLed to be hesitant in UK ant czndnental Europe and may be delayed until late 1992 or 1993. Recove-y is ex.:=- to be stronger and earlier in US. I he medium ten-n prospe--ts (to the mid 1990s) are for mode-ate rams of growth. JaDan and key Far East countries (including China) are likelv to remain the fastest growing economies. Pros=rs are also improving in many Latin American countnes. 7 here will be continuing problems in CIS, Eastern Europe. the Bal':Lns. Middle Fast. Africa and the Indian sub-continent. There appears to be a worid-,-,,~idee determination to moderate infla"-on levels, although this could take manv vears ir Latin America and the form.-- communist countries. '.6 Succes~ in controllinz inflation would be ex=md to lead to a gradual owering or real interest rates. Hence nominal i=nm-est rates are also expected gener--div to ease. However. in US the budget deficit problem could mean tha: intercs- rates may increase in the medium term. The US doUar is expected to strengthen agairist sterling, DIM and yer, compared with its average 1991 value. ,.8 Earnings per share for leading UK companies will grow only slowly i;-1 1992 and are expected to reach a gnowth rate in 1993 and beyond of about 7% p.z. '.9 Investment returns both from equities and from gilts are expected to be lower in the 1990s than the 1980s. -.10 ,,Iajor uncertainties are the timing and strength of the economic =ov,-:-%,, possibie problems in Germany in the wake of the re-unification and political instability in Central Europe and the CIS. 6 29/06i92 BATCO CONFIDFNTIAL - C.,kTF(-,ORY 1: NUNNESOT.-k TOB-\CCO LITIG-MON. BATCo document for Province of BritiSh Columbia 26 October 1999 .4. B.A.T Industries' Objectives and Strategies 4.1 Primary Objective 4. -7he primary objec=ve for 13.A.T lndus~rits is to provict sr1arcnc.:_-rs wim a:. above average re:urn on the invesurieni in ,he company throug.~ cividends a.7c canit.il ,rowth. 4.1.2 in order to have the capability to provide this, the Group n=dds to a:~.Iieve abo,.e average growth in earnings per share (EPS). This was previousl1v e.-z-oressed as a requirement to ac.~ievc sustained average growth in MIS of 15% p. a. In view o; the forecast reduc--4 on in growth rate of EPS for leading UK camp=' ts. 2, Z, in EPS for B.A.T Industries of 127o p.a. is ex=ted to be 5% p.a. ~dghcr than te ave-age, and to be equivalent to a real growth. rate of 8% p.a. Ms level of grow- ' is also considered :o'be more achieva 1, iz: .. t in.=sing he ri,k ~:.-ofile of Lt. Grout). 4. 1. 3 To some extent EPS is used here as a proxy for sus=ned cash gene-ratior., sir=- this is what is recuired to pay increasingly food divide-ids and to :--vest in value -7--ring opportunmes. 4,'_~ Therefore whilst EPS is the key objective frorn which the subsidiar,- objecz4ves will be derived. there wiil also be an emphasis on cash 2eneration. 4.2 Qualitative Objectives 4.2.1 It is believed that B.A.T Industries can achieve a level of perfonmznce that will satisfv shareholders over the long term through concentrating it: resource on Tobacco and Personal Financial Services and- Establishing a position of compedtive advantage in key ce'ements of the global Tobacco market, enabling the Group to earn high remms and achieve sienificant rates of volume -rowth throueh im-=ved markc- penetration; EstabLishing a leadership position in profitable growul markets in Personal Financial Services, concenazting firs: on ~hc 'L:~K and Nort, America but subsequently expanding elsewhere in Europe and, lonpr term, in the Far East and the Res-, of the World. 4. 2. There is also a requirement that the progression of profits should be reasonably smooth, therefore another important objective is that results shot:!C' have limircat vulne-abilitv to factors outside the control of the Group. 4.3 Short Term Objective 4.3.1 FoilowinR the downturn in profits in 1990, the-c is a short cc= objective to main:ain confidenoc in the validity of the Group's strategy by d!77,-,.szrating tha, Eazle SLa:'s profits are recovering more rapidl-~ than those of --'-e othe7 U K 7 30i06;'9-' 13%TCO (70NFTDF, NTT. kL - C.kTF(-,ORY 1: *,t IN, ESOTk TO B.xCC0 LITIGATION. Qn CD CD CD (_-4 BATCo document for Province of BritiSh Columbia 26 October 1999 B.A.T Industries' Objectives and Strategies Composites in 1992- and -.-at total profits -.= Finznc:1-:_* Services _;:-t L-owing s=21y in 1993. Criteria used in the Review The ke%, criteria against which the GouD's s=aiezies have been measured in this Review are to: Be established as a leading player in the global Tobacco mz_-ke,; Establish a leading position in profitable growth markets in Financial Services with the long term objective of becoming the pre--' er personal lines insurer in its selected markets: Avoid excessive vulnerability to factors outside the Group's control: Complete the recove-v of prof--,ts in Eagle Star. and restore profiz !zrowth momenrum in Allied Durb2-,. in 1993. -he aim to reduce the GrouD's effective tax rate by in-7 easing UK income ant hence ACT recoveries has aiso been taken into account. 4. B.A.T Industries' Strategies t .1 B.A.T Industry's strategy is to pursue grow h in Tobacco and Finan. ial Services v;ith particular emphasis on markets in the Nonh Atlantic region, but also seeking opp,ortunities to expand in the Far Ewt and Eastern Europe. 4-5.2 Tobacco sti1l has potential for growth as a result of the opportunities for increzsed market share in existing markets and for increased penetration of the former monopoly markets. It also has opportunities for short term ear. =igs growth through profit improvement. Whilst these opportunities may not be enough to support above average profit growth in the Tobacco business itself over the lonz term, the high returns available in this se-c-tor enable the businesses to supl)or-. overall Group profits growth at the =uired rat-, through provid;--z cash for investment in other activities. n -5.3 Maintaining long term above average EPS growth depe ds on finding investments which are themselves capable of self-funded growth at this rate. This %w a kev cr;,erion for choosing Financial Services. Other key criteria were th= The sector offers good opportunities for growth th:-ough direct expansion and through extension into new market segments. ne,.% geographical areas or complementaxy activities: B.A.T Industnies has the skills to add vaiue to the businesses: 301002 F3-\TCn (_0NF1r)F1;T1.\L - C.\TF(-.ORY 1: MINNESOT.x TOB.-\CCO LITIGATIC)N- U-1 CD CD BATCo document for Province Of BritiSh Columbia 26 October 1999 4. B..k.T Industries' Objectives and Rr7ategies The financial stren2ths o~ B.A.T IndusLhes will hellp, the F,==-_zT Services .ousinesses to ac~-,`.-,.,e their full potential. G-eographicaUN, the Group has world-wid: st:-engths in Tobacco. Over L~e v=--,. the Group has been inc.-easing the proportion of its profits derivet 11 ts --"ve!v stable parts of the world from whic. profi can be remitted :onzentrating expansion in these gtognaphical areas. The Financial Se-%-::zs s=.=gv was paidy designed -AiLh this aim in mind. zrsion is beim, concent:rated ----s, in No,-,h America and Europe where c2 n most easiiv build or. exisrin2 strenzths, but oDoorrunide-s are souz~u in L~e fastest ,rowin,, econor-~ies of the Far East as entry to those rnz:ka~s possible. --=-_.sed TJK' profits have the add-,' benefit of attracting a lower effec-_:ve :a-x b=use of the Group's ACT, position. 9 30 06 9_2 ~-r)NFTT)F1;T1 CATU1,ORY 1: NITNNESOT.~ TOBACCO LITIG-%-7:ON. ,::D 71 J (_-4 CC 13 ATCo document for Province of BritiSh Columbia 26 October 1999 Z. Tobacco and Other Cornmercial Activities Objectives F-inancial objectives for ti~~ Group's Tobacco activities over the n= ye-1--s are to achieve an averap 107~ p.a- increase in ne, turnover and a. 1--5% p.a. increase in =ading profits. 7here wii! also be an objective to achieve a -)7-:~-:Tessive ;nc-.e= in the ratio of trad:ng profits to ne, tmd; ng assets. 4.1-- The volume objectives. f07 the Toba:co businesses excluding Souza C.-,;:. will be to achieve overall growth of 7.5 % p.z. through: SL=dHy inc-t-asing marke: share in domesuic markets by in=--asing volumes by 3, -5 T, :).a.; 17.5% p.a. inc7tzse in 10% p.a. increase :n Init-national Brands: Beccmin2 estzbl.is.hed as a domestic produce.- in at le-,S: cie new marke, each yea:. The o*()ilec"-,.-e for Souza C--lz ;s to pmgress towards a p:-.c.- of S0.80joZck Without weakenine marke, share. Once this is achieved, the growth objec:ive xil.l then appiv. Cost objective: In order to achieve these volume objectives, the business wili eahance its global capability as a low-cost producer by increasing overall factory productivity by 5% p.a. Each factory wiU have its own productivity improvement target based on its current level of productivity, investment programme and re!adve costs of labour and capital. 5.'.- Leaf: Tbe:-. will also be an objec:ive to incrmse Leaf exports and to become established as a leading suppiier to the world market by the year 2000. 5. Other Commercial Activities: To focus the available financial and management resources. there will be an aim to reduce the involvement in othe: commercial activities except where these are directly supportive EO the tobacco business. The divestment of Hardee's from Imasco will be progressed, and the possibility of divestina Diversa and the ECE shopping centre investment in BATCF wiH be evaluate--4. Souza Crux will divest from Aracruz when a suitable opporruniy arises. The Market L7. Deveiopm.--us over the past v= have not suggested a need for any m, aior chanats in the key assumptions abouL Lhe Tobacco market. 10 301,'06i92 I-`I-r)rZV I- Vi%%F,~nT ~ TOn V7M LI-7 ~TMN. BATCo document for Province of BritiSh Columbia 26 October 1999 9. Tobacco and Other Co=ercial Activities 5. Nlediu.-., term growz:'. in c;-,ar=e --onsumpbon is expected to be limited -o about 1.0% p.a. with con=uing conu-aczon in North America (-3-3% p-a.) and Western Europe (-0.7% p.a.) be;1g offset by -rDWih in the developing countries. e.g. China (-3.5% p-z-)- 5.--.-- The expanding mar.'-!:s in the developing countries will continue to offer a gc~od potentai for volume growth but the greatest opportunities for the private sector companies will be in increased penetration of the former monopoly markets in the Far East, Europe (including Eastern Europe) and CIS. Investments in these markets are expec,--4 to be profitable but payback periods may be up to 10 years. International Filter Brands will continue to offer good prospects for profitable growth particularly in the short term, both through expanding exports and in domeszic markets. In the medium to longer term, there will be a need to have manufacturing businesses established in the former monopoly markets Where these are outside the Euro---,,-an 5.2-4 It is expected that consumers in many developing Tobacco markets will demand a hizhe.- quality produ--- and that L~ds should offer good opportunities for increased exports by high quaLy producers. 5.--.6 Hieher taxation and fur-dier restrictions on sales, marketing and consumer opporrunines to smoke are expected to be continuing features both in the developed world and, increasiLigly, in developing countries. However these pressures are expected to be manz-geable and do not change the general outlook for the Tobacco indus=.-. The Cipolione judgement is not expected to be a major reve.-se for the industrv, althoueh vroduct liabilirv liti,,ation a-ainst cizarette manufacm,-e-s will continue. 5.2.7 Ile world marke- will continue to be dominated by Philip Morris, B.A.T Industries, R-TR and Rothmans. with Philip Morris providing the strongest competition to B.A.T Industries for volume growth and market share. 5.2.8 The generally high level of profitability achieved by the leading tobacco companies is expected to continue. The US is ex=ted to remain the most profitable ma:ket, despite continuing volume declines, intensified competition and downtrading. Growth in profitability in this environment could be Iess strong than previously and will depend on success in growing market share, the main competitors needing to increase prices faster than inflation, careful management of the positioning of full revenue and VFM offerings, and continued productivity improvements. 5.2.9 Assuminz no major adverse developments in product liability litigation, the key uncertainties in the market assessments outlined above are as follows: Demand could be further depressed by an increase in anti-smo"King pressures and bv increased rates of excise: 30 i06- 92 9 T(-r) (-n%;7TT) I - C % TFr, OR 'Y' 1: M 11; N F 1,C)T % TnT3 -\ CCO LIT' r-, ATI ON. C-D Z:- BATCo document for Province of BritiSh Columbia 26 October 1999 Tobacco and Other Commercial ActiN it;E:~ De:nz--id could also be d-.::.-essez-1. espt--;2ilv in the develcoing coun=s, if the tx=-2~d wor'-`--xide economic -ecove-v is de!avec: As 7 consequence. t~e Valut-For-Money segment of the mark-., may incrz-ase more quick!-; than is c-.;7--znLly assumec; Exions to Eastern E~:rope and -o CIS are likely to be consr-z=.ed by economic and balance-of-paymen--s difficulties. The othe- maior unc---tainrv is a.7,; change 4-- competitors' strategies: PhMp Morris (P.14) requires substantial US price increases to runt co7morate strategies and fulfil :07o earnings growth expectations. In 1991, P.M significantly increased marketing spend, focusing in the US on additional ima2t advertsing and promotions for Marlboro and Vi7-=Inia Slims. This resulted ~n their US market share rising from 19 - 9 F~ in 1990 to 4 11. 1 % ir. 199 1. The proportion of the:.- business tha, was full revenue fe:--' from 88~, to 83%, but this is still much hizhe7 thar. -he industrv as a whole (80~-. to 75%), wid Brown & WiLliamscn (63 F, to 55 %.). PIM has also increased its investment and activities to grow the InLemational tobacco business. It aims to establish the leading brand in eac- market in which it operates. wherever that brand may be source-. Resources are focused sharply behind one or two priority brands in eac` market with the aim or secunng leadership. Regional priorities fo.- P-1111 are expected to continue to be Europe and the Far East. However pro;--table opportunities in sigmdficant markets in Latin America ant Az_; are likely to be exploitp--,. -M RJ. Reynolds (RJR) also requires substantial US price increases. KKR says that it is succeeding in refinancing the LBO, allowing RJR to be mor-- competitive and continue to meet LBO requirements, 21thouzi-. this is difficult to substantiate. RJR's market share feU ftom 31.2% Ln 1990 to 29.7% in 1991 (a volume decrease of 7.7%), and the,.'7 proportion of full revenue fell from 79% to 75%, which is almos: iden:ic--d to that of the market as a whole. Lik-- PM, RJR's investment ir. the International business accel-..-ated Intemarional volume growth in 1991. However, this was mainly achieved by large shipments to Russia at very low marzins (57c vs. 21 % for other International business). Without US fuil revenue trend CD imj,-ovemenLs, higher pricing or less discounting, RJR's US operating CD pro-,-a is unlikely to achieve the 1-2vels oristinally forecast bv KKR. This -ii! cause sianificant Pressure to 7educe media spend, to ds.-oun, VFM, (-14 r1,) 12 30iO6i92 -1- r' I I I -M R,, (-C-n I T71 (-, ~ 77- -- BATCo document for Province of BritiSh Columbia 26 October 1999 Tobacco and Other Commercial Activities less and to return to loa.`ing, ZO irn-J7:Vt zasi-, t'low. RJR are to maintain their strategy of focus-n=- on se!ccie~ key markets :r. Europe and the Far East ir. orce- to es-z)lish ~h=r pnonry internacont- brands, Camel and Salern. Rothmans International is expec--_` to become a more aggress-1-vt competitor, particularly in markets w~.ert its share is declining anc where mar-ins offer scope for value -fo r- mor. ey competition, e.g. 17. Europe and parts of the Far E--s:. In the US, LoriUard, American Tobacco and Liggett & Myers continue to follow cash and profit czt-misation strategies as they a:--- strongly dependent on tobacco profits. Loews has considered proposaLs to spin off Lorillard but is not ta~dnz ac"_on at the moment. Lodllard nearly 100% fuU revenue while Ligp= is more than 70% VFNI. Reemtsma and JT1 also pose threats in different re-~cnss and markets. Strategies Strategies and projects to achieve the Group's objec:ives will be agr.. arc zz- ordinated through the Tobacco Stratc-gy Re%iew Team (TSRT). 5.3.2 Intemational Brands: The TSRT wiU co-ordina:-- and monitor the programmes expand the sales of International Brands world-,xid!. 5.3.3 Within the overall plan for International Brands, diere will be specific objec-tives zc reduce the vulnerability in markets and marke, segments which are dependent o.- one brand by promoting an alternative (as an e=nDie using UKIB, increaSi7.; penetration of SE555 rn~kets by Benson & Hedges* and viL- versa) while s:iL Limiting the total portfoLio of brands to avoid dissipating efffort. 5.3.4 Smoking quality: Projects to enhance smoking quality will be pursued vigorousl, with the aim of achievine zTeater consumer satisfac:ion than is offered competitors' brands. 7here wili also be a policy that proposals for cost reduc--c,.. will only be accepted where it can be shown tha, these do not involve a redu.-"-c-. in smoking quality. 5.3.5 Brand valuation will be developed as a tool for monitoring the effectiveness c- the Group's strategies in enhancing the value of its br-ands and instituted in 1993. CD CD CZ) -.I. 13 30/06 9: 1-7 f r- r-nr,), 1: V11;1; FrnT k T08 ACCO LITTC- -%-'- ' BATCo document for Province of BritiSh Columbia 26 October 1999 Tobacco and Other Commercial Activities TABLE TI Tobacco Tradin2 Profits (Ern) 1990-1996 Growth Rates c-c D.:!. 1990 1991 1992 1994 1996 1991190 19%'9i Actual Actual BudgeE Man Plan B & 437 468 535 673 S:5 7. 1 % BATCc. 364 405 463 594 639 11. 3 51, BATCF 67 7" 8-' 99 i'l 14.9% Souza C--z 11 59 73 116 1 Imasco 1 68 76 78 86 96 il.8% OLhe: (6) (10) 3 8 Totai 941 10 7 f 12-1 1~73 19:6 TABLET2- Prof itabilitv 1991 Net Trading, Volume Sales Prorits Sales Prorits Margin (bas) (EM) (EM) LImBle L/mUle (17c) Brown WiLliarnson 85 BATCc. Z) 278 BATC-.- 40 Souza C.-.;z 136 Imasco 28 Note W BATUKH 28 BATCc:txcl.BATUKE) 250 1448 468 17.1 18,12 405 6.6 479 7/ 11.9 266 59 2.0 208 (b) 76(b) 18.7 323 110 11.5 1519 295 6.1 Note shar.- of net sales and mading profis 5.51 3:.: 1.46 in 1.91 15.;- 0.43 1- 6.82 -6~; 3.93 1.18 1~--, 21'061:92 '-(-n (-()NFTr)F:,;Tl \L -(-.~M-, OR Y 1: %11',": F SOT k TO B-~CCO LI-'- A TIO I. Ln CD C) CZ) BATCo document for Province of BritiSh Columbia 26 October 1999 Tobacco and Other Commerrial Activities 6 New markets: The New Business Development Team will contimie to evaluate -.ne potentiai for investing in new markets. concentrating on Central Europe. the CIS and the Far East. There will be a specific aim to prepare proposals and implem!ra investment in at lezst one major new mark-e, each y=. T'he TSRT will determme the organisation for managing new investment oppomuniucs in Emte-n Eurooe. 5-3.7 Management development and training: R=ognising the importance of recruitin,,, rmiiniriz and developing a sufficient cadre of managers with s-~~iis appropriate to the tobacco business, priority will be given to developing, agre!-"ig and implementing improved procedures to provide the human r=urces nectisary to implement the strategies which have been agreed. In order to raise standards of recruitment and promotion, candidate sp=ncations will be 'bench against efficient companies, e.g. Proctor & Gamble for Marketing. 3 Leaf: A project w-M be set up at the Centre to deEerrrurie by the end of 1993 wriat additional action needs to be taken to achieve in.-mased exports and to establis, the Group as a leading supplier of Leaf to the world market by the ve.,-- 2000. -.9 Productivity: The. -e wUl be continuing emphasis on the n=d to achieve improved efficiency, cost recuction and improved asset prc>duc:ziviry. Product sourcing will be reviewed to ensure that each market is se-ved in the most econorruc wav possible and that production is rationalised, expanding the most productive p.L-its and closing the smaller, less efficient facilities. ~r.3. 10 There wiU be specific tar;ets for improving the output of cigareues per man hour and for reducing the level of overheads. Priority will also be given to formulating and implementing planned programmes for replacing outdated machinery. 5.3. 11 Regulation: In opposing increased regulation, priority will be given to attempting to maintain as much freedom as possible to promote brands and brand itnazes through advertising and sponsorship. ~~.3. 12 Excise: A project will be set up to incr=e the priority given to eszabLish-~7g a dialogue with governments an excise in 1993. 13 Trade marks: A project wdl be set up to review how trade marks are handled across the Group from the Legal and Marketing viewpoints, with as7eed recommendations to be implemented in 1993. Z.4 Current Performance/Prospects i.4.1 Table T1 shows the actual (1989/90191) and forecast (1992194196) contributions to CD the Group's Tobacco trading profits, Table T`- shows the profitabilirv in 199 1. and CD Table T3 shows volumes and market shares in the major domestics markets. 7he ZN kev features from these tables are: NJ 30 i06 92 P kT(7n rn1;FTDF1;71AL - (7.kTF(-.ORY 1: NTINNESOT.~ TOBACCO LITIGATION- 13 ATCO document for Province of BritiSh Columbia 26 October 1999 Tobacco and Other Commercial Activities TABLE T3 Domestic Tobacco Volu mes and Mar ket Shares 1991-1996 1991 1992 1994 1996 1996i 91 Actual Budget Plan Plan C.A.G.R.% Domestic Volumes (bn) B&W 5- 58 60 61 1.4% BATCo 3 7 248 21 6 8 4 .5 To BATCF 1,7*'.Ge=ar-.y 26 26 'Z 7 19 0 17,; F-.Ge=arv 2 3 4 17.9% Souza Cn-,- 13 1 128 133 '9 M-~Sco 24' 25 2.3 21 6) % Total Domestic 4-45 477 495 523 2.8% [Exc'-ud'--.7 Souza C.-uz 324' 349 362 38-' [Mem o: [Total Export 108 1214 142 163 8.6,7o] NLarket Share (major markets,% USA 11.1% W.Germnany 2) 0. 6 % E.Ger,-,.z:-,y 10.9% Brazil 83.6% Al--c-lanz 52.67o Venezue'-- 66.0% ChUe 97.0% Aus=ha 25.6% Pak:isar. 56.2% India 71.3 11.811. 13.0 5,c 14.2 Tr, 20.4% 21.3% 22.5% 12.4% 16.35. 19.4% 82. 0% 82.0% 82.0% 49.2% 48.5 % 4 8.9 9rc 69.6% 70.0 5r. 70.557. 96.9% 96.8% 96.7% 29.0% 29.97. 31.0% 55.0% 55.0% 55.8 9r. 72.4% 71.417o 71.0% 16 30/06,92 BATCO CONMENTIAL C.%TECORY 1: MINNESOTA TOBACCO LITIGATION. U-1 CD CD CD -r-. N) BATCo document for Province of BritiSh Columbia 26 October 1999 Tobacm and Otber Commercial Activitie~i The contribution from Brown & Wiffiamson. which is of criri=: impor-ance to To'bac--o profits, remains at about 43% of the tou' Tobac::o trading profits thrOLghOUE the plan period. The growth in profits from Brown & WiWamson depends on the ability to continue to increase dornestc prices faster than inflation in an increasinvy compe--itive market place. Brown & Williarnson's ability to achieve the profit growth objeczive depends on accelerating export profits; BATCo's ability to achieve the profit growth objective will deDelid c:,. improving the margins of its non-BATUKE business- All comDanies except BATCF improved the ratios of sales and trading profi:s per miUe in 199 1. BAT CF's ability to achieve the profit growt objectve also depends on acce;eratin- export profits: Souza Cruz inC7=ed its margin in 1.991 and its objecdve is acce,e-ate the improvement in profitability; Domestic volumes (excluding Souza Cruz) art projected to grow a: 3.5% p.a. which meets the objective, while export volumes art projected to grow at 8.6% p.a. which falls well short of :he obit-,ctive: rD CrI 17 30:06i9Z TI NT(70 rr)NFTDF.NTI ~L - (-.%TF(-,ORY 1: NIINNESOT.k TOBACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 6. Brown & WIlLiamson US Domestic Tobacco Volumes and Market Shares 1990-91 1990 1991 Domestic Volumes (bn) 294.37 285.92 Nfarke! Share % 1990 1991 Brown & Williamson 10.16 10.37 Philip Morns 39-85 41.09 R.J. Revnolds 31.2C 29.66 Loriilar~ LL 7.0: 6.67 American Tobacco 7.70 8.04 --ert &. Myers 4.0,4 4.14 ~~ e. 0.02- 0.03 Market Share (major segments;F, Menthol 2 6.2 7 Slims 7.29 Value For Nionev 20.16 Of which: Low price branded 13.05 Plainiprivate label 3.40 Fxtra. low price Z.65 Low price 25s 1.0: Lov.- price 30s 0.0Z Source: Nie~sen 25.87 7.25 25.42 12.99 5.43 6.27 0.72 0.02 is % change (2.8-I)FO % Full Revenue 1990 1991 63% 55 F,, 887, 83% 7 9 5c 75 % 99 98 FO 6 9 5-c 59% 33% 29% 83 % 78 To 30 06,92 BATCO CONFTDFNTI.kL - CATFGORY 1: NIINNFI-OT k TOB.-\CCO LIT'.r-kTION. CD U-4 BATCo document for Province of BritiSh Columbia 26 October 1999 Brown &- Williamson 6.1 Brown & Williamson is responsib;t the manazement and deveiopmen. of B.A.T. Industries' tobacco interests in -ne USA and for promoting and managing the sales of US International Brands orld-wide through exports and throug- hcense-es within and outside the grOLD. 6. Its financial objective is to incr= nL-ig profit at 7.55c p.a. The previous pla:~ projected trading profit growth at 12.0% p.a. This was achieved by assuming tha- the overall domestic marzmri would rise from 31.8% in 1991 to 34.71%, in 1996 based on an assumption that prices wouid rise faster than inflation and that there would be continuing improvements in manufac-urim, and administrative efficiency. This objective has been reduced to on.- which is considered more achievable in z-7 incr--asing!y competitive market. Z . 6.3 The 1992 budget for Brown & Williamson shows that 80% of the pro,"a: contribution before common costs is de-;ved ftom the US domestic market whic'. ac.counts for 58.2 billion out of 106 bE,'cn sales for the company as a whole. 6.4 Within the domestic marke,, 72% of -'-e brand contribution is forecast to corne from 25.8 billion sales of full-revenue products, including 62.9% from 20.9 bdlion. of Kool sales. This compares 28 % of contribution from 32.3 billion of Value-for-Nionev (VFNI) brands. This is :he first year that VFM sales are forecas: to exceed those of full-revenue products. 6.5 The US cigarette market is forecast to reduce by 3.27. p.a. from 1991 to 1996. with a reduction of 8.7% p.a. in fuU-=venue brands bein., offset in part by an 8.6% p.a. increase in VFM brands. 6.6 Brown & Williamson are expecting to lose market share in full-revenue brands overall, down from 5.851, in 1991 to 3.5% by 1996. Ful.l-revenue brand volumes are forecast to reduce by 12.7% p.a. between 1991 and 1996. Volumes of Koo! reduce slightly faster at 12.9 % p.a., wUe those of Capri remain static. 6.7 Brown & Williamson are expecting to gain market share in VFM, up from 5.35c in 1991 to 10.7% in 1996. VFM sales are forecast to increase by 11.5% p.a. led by Raleigh Extra (growing at 20% p.a.) and GPC (growing at 10.6% p.a.) back---4 by continuing growth in Viceroy (growing at 6.5% p.a.). 6.8 The other key assumptions for Brown & Williamson are that exports will grow more rapidly than the industry, at 11.2% p.a., from 39.6 billion units in 1991 to 67.4 billion units in 1996, and that margins (contribution/sales) improve frorn 30.0% in 1991 to 31.1% in 1996. Interna6onal volume is forecast to excte~ domestic volume for the first time in 1-^95. 6.9 Phorifies for action will be to: C-D 19 30106/92 R \7(-o rr)NFTT-1PNT7 ~1 - C kTF(-,nrZY i: ,7i,;\r-,,nT Tn,3-\(-(-n LIT] r, Tn,. BATCo document for Province of BritiSh Columbia 26 October 1999 6. Brown & Williamson 6.9., Max-im'se the proftabiliz-y of Koc: a:~z nain-Ln share of ~7-- ftii' rever,--z menthol seamenE: 6.9.: Ke--:: Richland mde-mark- viabie while minimisi;nz cost of d---iicare4~ resou.-:=: 6.9.2 Grow VFM in order to increase mazke, share from 5.3% in 1991 to I I % by 1997 and also incre2se proflLs: 6.9.3 Accelerate international growth. The previous plan showers USM increasing at 41% p.a., expor-z at 10% p.a.. and iniernadona~i margins improving by 0.27. of sales p.a.; 6.9. Reducz the level of antimpaton., bu,;'n-T of Brown & Wii-'amson's produc:s by I billion in 1903, 6.9.5 Reduct remms from the trade: 6.9.6 Impro,--- expense effliciency by 7e~duc;--r :ommon cosLs to 7. 2 F, of sales by 19'27-, 6.9.7 Upgrade the skills and capabil.ities of humai resources and ensure appropnate organisational. sz-ucrures for domes:ic and international. CZ) CD (-14 .0 30 06192 13 ATCO CONFIDFNTIAL - CATEGORY 1: NTINNESOT.-~ TOBACCO LITT~GATION. BATCo document for Province of BritiSh Columbia 26 October 1999 -%TC.). B . 7-.a scccnt most irrmortant ccntribuior to the G.Oup's Tobacco profits is BATCO.. con"_~_-=ng 37.7% of Tobaczo trading profits in 1991. In addition. it is also an im-acr-Ln: conmbutor to Grou-i cash flow. T growth of 5.1 % p.a. and improving margins over BACJ. is forecasting volume the De-`od 1991-1996 based on continuing expansion in exports, a reversal of s.-la:-e losses in some key domestic markets (e.g. Australia and Malaysia) and continui:nz progress on productivity improvements. including manufacturing rationalisaaon and :he :7,pansion of Southampton. 7.3 T-he 199: budge, shows the proportion of trading profit from BATUKE risizz to 31 7c of ule total and remaining above 3017o for the plan years. a compound g-C';--:h - I n m:z o. i-.75, P.a. Overall tradi g profit is for=zsr to grow at 118% p.a. 7, 7;-.-- sccce for lifting profits growth above this level is dependent on radiCal =st re=-czon. expansion of leaf exports and new business through e--por-,s to new rr.a:k-e:s and investment in joint ventures. 7. P'o"a-es, for acdon will be :c: -aiise or co-ordinate the marke:ing Cena iniuatives and Support for the key UK and US International Brands, and accelerate their growth ftm 12.9 % of world IFB (excluding domestic markets) to 17.5 % by l9c:7 7. 5. Evaluate the visual, physical and smoking quality of BATCZ).'s products for comparison with the competition; 7.5.3 Continue to assist B.A.T. Industries to develop business oppommities in new geographic markets; 7. 5. Develop new export markets in the Far East (mainly Thailand, Korea and Indo-China), Cena-al and Eastern Europe, and in South Americz-: 7.5. Develop, in conjunction with B.A.T Industries, a programme to expand leaf exports into a significant new business: 7.5.6 Close factories in markets served by more than one factory, and invest in existing factories to achieve economies of scale, modernisation cost effectiveness and cost reduction; 7. -5. - Achieve turnaround in Australia, Malaysia. Argentina. Venezuela and West Africa. 7.5.S Improve management development, training and selection. 21 30/06 92 BATCO CONFIDENTTAL - CATEGORY 1: NITN.NESOT.-k TOBACCO LITIGATION. CD L-4 (-IJ CD BATCo document for Province of British Columbia 26 October 1999 7. BATCo- R---s! com:)inez rate of of Benson & Htdzes. SE 55~z- Barcla-, a::d Ken: f7om current projeczd p.Z. to 10F~ U1 CD CD CD 22 301,'06i92 BATCO, CONFIIDENTI.~L - C.~,TEGORY 1: MINNESOTA TOBACCO LITIGATION. BATCo document for Province of British Columbia 26 October 1999 8. BATCF 8.1 BATCF's domestic marke, stra:ezy is airn-c' at gaining market share. Important ellements of this strategy are to: de!av as far as possible HB's market share decline. to concenzate adve-asing resources on the in,.e77.adonal brands Lucky Strike, Benson & Hedzes and Pall Mall: extend the position in the mild and ulLra-mild segments by giving Luckv Strike Lzhts substantial support and by launching an Internationai Light Brand (Barclav af-Ywt) naLion-wide. 8.1 Its Financ-al obi ective is to inc-ease trading :)r.- Fit at 12.5 % p. a. The previous plLn projected trading profit growth at 11.2% p.a. The objective could be achieved by accelerating export profit wth. 8.- BATCF is forecaszina a volume incr=e of 2.5% p.a. from 1991 to 1996. Domestic saies grow at 2.776 p.a., international at 4.017c p.a. and special business re-urris to 1991 leveis after peaking in 1992. 8.4 Kav assumodons underlying the plan are tha: gains in market share from Luck-y Strille (0.7% to 2.5%) and PaE Mall (1.2~: 2.77.) will ffiet a continuing decrease in iM (10.7% to 9.4%). Market Share 17c - West Germariv Dec Dec Dec Dec Dec Oct 1986 1987 1988 1989 1990 1991 BATCF 23.3 22.8 21.9 21.3 21.0 21.0 Reemtsma 25.7 25.1 24.2 23.2 23.7 23.9 Brinkmann 11.3 11.0 10.3 9.7 9.0 8.5 Philip Morris 24.6 26.3 28.8 31.1 R.8 32.7 R.J. Revnolds 10.1 9.8 9. Z 8.5 7.8 7.6 .Nlark-et Share Unified Ger=nv 1991 1992 1996 BATCF 19.3 19.3 22.0 8.5 Over the five years to 1996, Net Tumover is forecast to increase by 6.67o p.a. and Trading Profits by 11.2% p.a., with maqins improving from 15.9% to 19.617c, r:D larp-eiv due to the increase in fixed costs bellng far lower than the general price increase rate as cost cutting steps are takei. The profitability of exports is sianificand%, lower than that of domestic sales. (--4 23 30/06192 BATCO CONFIDENTIAL - CATEGORY 1: TOBACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 8. BATCF 8.6 Priori= for ac::on wiii be: S.6.1 Aczciemting pi-.c-- in(t7t,-=~ and reverse the ad,-e-se share trend in West Germany, increasing zornestic rna:ket share by 0.5 percenuge points -).a.: 8.6.2 Review cost strucrare and ag7-- plans for cost reduciion so that the cost o~ zoods sold inc.--zses no faster than inflation; 8.6.3 Improving profit-ability of export and special business by increasing the mar,gin or exports by 0.2 percentage points p.a. and that of sp=;al busmess by 0.3 ne-centa2e Doints p..,.. and expand in East Germany: 8.6.4 Conside7 options for outside sourcing and a-gree appropriate ac::ion; S. 5. 5 Revie%~ opors and agree sz7,-:--zy for Diversa: 8.6.6 R~!,.,iew options and agm! acton on the ECE shopping ccnire invest.-nenc. CZ) 24 30,'06. 92 BATCO CONFIDFNTIAL - C.-xTEGORY 1:MINNESOTA TOBACCO LITIGATION. BATCo document for Province of British Columbia 26 October 1999 9. Souza Cruz 9." c:)iec--~ve for Souza Cruz is to inc-.=e 11:L proEzabiiiry. ILs strategy is to ac"ie,. -z this by concentrating on tobacco and tobacco reiated ~~duc:s. a;7.--d a, modernising JMP1e7nC:'.UMZ an LnVeszmen: poucy and incmasing produz-.on capac-.-y and impiernenmig, a prz~duc"virv and cost reduc".ori 9-1 Tne `--anc;al obiec--;ve is to s:-o,.v L-adinz :~rofa Z: 20F~ P.a. from S300m in 1993. 9.3 The -'1-=asc for Souza Cruz shows dornestic ziaarene volumes increasinz ftLm 13'-.-- billion in 1991 to 138.6 billion in 1996 (0.9% p.a.), while marke, share just above 80176. Export cigarene volumes are forecast to increase from 5.1 bunion in 1991 to 14.5 billion in 1996 p.a.). At the same time. le--f e;,,:>o.--s increase from 46.900 tons to 78.XO tons (10.7,7G p.a.). 9-1 The -,~anrung assumption in the previous pian to cigarete price increases is that ccnsumers' prices will be kept szabi.- at the level of US SO.68/pack. This is cur-~.-7::.'v bein" exce-,ded and :he plan should be o progms to SO.80/pack without w e ~-~k e.-. inz Lh estren2th of the rnarke, share. 9.z Oth;!7 issues are the nee-,' to =mplee the aar---` divestment of the non-[obacco act%--.':::-, and to uograde the smoLnz qualiiv z:,.c the manufacturim, facilities so that *-'-.z company can main= iLs domestic mar"-.-: position and can also sup r, an po sion of cizarete expons. tal&g advantage of the low producrion costs in Br-.Z-. 9.6 Pnor."-es for action will be: 9.6.: Increase exports of cigarettes. consolidating traditional markets in South America and strengthening the position in Levant and Poland: 9.6.: Increase exports of leaf: 9.6.--- Improve the production facHities to improve quality and inc--ase produc:ivity-, 9. 6. Improve the smoking quality to be superior to tha-, of com-)e--'--'v.- brands: 9. 6. f Double marke, shaze in International Brands. focusing on Lucky SL-ike; 9.6.6 Complete the rationalisabon of the nori-robacco activities. 9.6.- Agree plans to talke advantaze of re!a.-adon of tax rules for dividends 2 :Z 30.,'06;92 BATCO CC,'- FID ENTI.~ L - C.%TECORY 1: MINN E -50T.-k TO BACCO LITIG -kT, 0 N. (ZD (-14 BATCo document for Province of British Columbia 26 October 1999 10. Financial Services 10- Objectives ic.,. The shon te-n objective f07 B.A.T Industries is to regain c-.---`biiicy as a manager of financial services businesses sufflcieri, to p-e-miE exploitation or marke: 6 evelopments in the longer term. This obj=:ive is to bu,-Id on the ex-isting streng-ths in Life Assurance. Pensions and Investment, General Irisuran= and associated businesses, including Trust Banicing, in the UK and North Arnerica. In particular, Eagle Star's recovers, is critical to the regaining of 1 C. 1.2 The long term objective for B.A.T Indusinies is to be the prtrnier personal hnes insurer in its selected markets. ic. Personal lines includes small cornmerc-'al business and does not e:-zlude other compatible services providing thaE they are proatable and he;p to secure marke: position or differentiation. Premier means: being one of the top 3 in zerms of profitabilicy-. being in a lezdership position in terms of goW -,.zrke, s-,ar: in the stiected markets in order to aclueve economies of scale ant zo be able to influence kev external variables; outperforming the competition in te-Tns of growth in market share. quality and range of service and distribution, and inrovation. 'C.'. Fiowinz f7om the B.A.T Industries' objectives, the objectives for te Financi2i Services Operating Groups are: Allied Dunbar is to be the premier life assurance company in the UK, Eagle Star is to be the prernier composite in5UrZr.= company in its selected markets: Farmers is to be the premier personal lines insurance company in the us. 1 C. T-he rimncial objective for the Group's existing Financial Services activities (excluding Eaggle Star General Insurance) over the five years ftm 1991 is to achieve an average 10% p.a. real growth in profits. Eagle Star General Insurance L- - has a recovery objective to obtain a base for future growth. C. -.7 7-he growth objective for Life Assurance is to gain market share on an annual premium equivalent basis. -ne growth objective for General insurance is to grow good aualizy. personal lines premium income. with a balance between premium and number of policies, in order to build long term marke, share. The obJective C7 commercial business is that it should be profitable. 26 30/06i9z 3-%TCO CONFIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATION CD CD BATCo document for Province of BritiSh Columbia 26 October 1999 I 10. F-mancial Services 1, is also an Obiec-_ive to ensure that the Firianci;3d Services bus' " 2:2 valued in the share price whUe minimising the volatility of The Nfarket lc_:., General Insurance - UK - The underwridng loss ratios for the first qua:-,.-r of 1992 show an improvement over 1990 and 1991, partly due to t: absence of serious storm darnaze. but also due to an improvement in pre.,:uum ra:zs. 13. Forecasts for loss raEios are for further r=ove-v being susmintd _-_cuz~ 199]. The sharp rise in prtmium rates will be refliected in high leve;s of prenuum growth in the shot-, term. Over the medium to longer term growth rates are e:,--,ec:ed to be sli2hdy hizher than GDP reflecting growth in rezi wealth, d;spcsabi-. income and assets. Improvement in unde-wridn,, levels will be suppiemented b% an 1r.:7-__5e in the overall level of inveszrnent income including capital gains. C.:. - The maior sensitivir; is the rate of GDP growth with a risk t~_-i a further pos-,poneme-ii in recovery could lead to f_,rther Mortgage Indernm-cy losses, more recession-relared claims (some fraudulent), resistance to price incz---ses and some incidence of under-insurance. 1 C. Jc There will also be many opporunities in this market. It is ex=:ed to be in a state of flux as a result of the weakness of the composites, mutuals and buildina societies in solvency terms. Conditions are ripe for a reszjctu-.ing or rationaliution. Continental European insurers are expected to be in a strong posirion to take advantage of this, and are already buying market share in some sectors of the UK market. i 0. General I=rance - US - Non-Hfe insurance results in the US are -expected to show a similar trend to that in the UK The rate of recove-v in the underwritinz results is expected to be relatively slow. However, US profiE margins are expected to recover to around their historical average, whereas UK margins could remain lower than they have been historically. IC,.:.- Investment income is likely to be reduced with low interest rates and asset values which may be depressed if interest rates begin to climb again. 10.:_3 The control of the US insurance industrv is likelv to remain in the '--znds of State rather than Fede-al regulators, and regulation could become inc-.."_.sLr:z!y political. IC.-'.9 General Insurance - Europe - Growth prospects in Europe diffcr by coun=v depending on the economic growth rates. penet:ration of insurance cover and re2ulations cove-ina both national markets and the implementation of the Single Market. T-here are expected to be some markets which will have much bette- growth prc5?ecs than the UK. 2 7 30,'06;92 5-\TCO CONFIDENTIAL - CATEGORY 1: MINNESOT.x TOBACCO LITIGATION. Q;7 BATCo document for Province of BritiSh Columbia 26 October 1999 10. Finaz:ial Services 10. --., 0 Cenerai Imrance - Far Fast - This region is still considered :c have the tt_-: zro,-= :)otentiai. with high rates of GDP growth combined wii.~ a lov, c-_=tn: rauo premiums to GD?. There are cur-rently some hign barriers to en'r; these zn- expecmd to fall with deregulation. !3.:. 1 Life A--smrance - T'he main influences on the rate of growth of Life assur-.::.:-- :)r=,-.-.=s and savinas products ,ene-aliv are the leve; and rate of -owta in ell incor,=: the propensity to save; demographics and related institutional chang:s and r:f~rms in the rvulatorv frameworks: In North Ame-ica and Weste.-n, Europe, total personai savings shc--,'-- be boosted as the post-wa-,, baby-bcorn gene:=cn move LnLo the:-- hi2h-earning and hizh-saving middle-age. This influence is pa:-dcul_--.- marked in the USA, Canada. Spain. Portup-1. Italy, Franc: anz Gre-_z: Gove-nmenis. es=ially in Europe. will continue to try to provision for old ap from socal securi-y to pn%,a-,2 pens::::~ arrangements: Reforms will continue to take place in the main financ-al sen-c-n- markets. This will lead to more open structures. the breakna-u-) cartels, widenim, access to markets and the breakine-down of b=_-z-_ between markets; The EC proposals for a Single Market for financial services wiL. "--.z implemented progressively even though the single market goal wU be achieved in its entirety by the target date of end- 1992. 10.Z. On assumptions, the Life assurance and savings markets can generally expec:_~ to experience rapid premium growth through the 1990s. T"he fastest of grzwth are likely to be found in the relativeiv smaU and unde-develm.=' mark= in Southern Europe, Eastern/Central Europe and Latin America but s=rz -Tow,- can also be expected in the Far East. g - 10.2. 13 In the more mature markets of North America and Northern Europe. the above factcn will also favour strong growth. However, the forecasts for declL--'-z intlar:cn rates and modest real growth in EPS, dividends and stock market leveis. make ze re-occurrence of the boom conditions of the mid-to-late-80s unLikelv. 10. L 11 -' Corrve--bon is expected to intensify as oLhrr institutions and espe-cially banks Ln buii~~7 societies become more aczive in sellinz investment products. CD 10.2. 1-5 The 7.~blicity being given to low surrender values could lead to pressure on CD 'cz,~ins: and hence on caoital recuirements and levels of profir-ability. 28 30, 06 9: BATCO C~-.-'-TDFNTI.%L - C.NTFGORY 1: MINNESOTA TOBACCO LITIGAT:()N. BATCo document for Province of BritiSh Columbia 26 October 1999 10. Financiai ServicE!s 10.116 in se!lin~, will be on.- of the deerminanLs of success and ccm.::an;e!~ nav -i=d to develop new ch=nels of distribution in order to remain corn-,et-nn.e. 10. 2. 17 insurance will remain an oppor--.-Lty for growth with companies also be--cm~ing mana22~s of health facilities in az effort to control costs, particularly in te USA. aithou.- it is not yet proven that :t is possible to exploit this opportunity prof-',:z~iv. 10.2.18 Ou'na: opportunities, parziculaily for sing': premium business, are for capturing and maturing Life policies. 10.3 Scratqies 10.3.1 Tnt key operational strategies for the existing Financial Services businesses ~n gene-al te=s are set out below: Profitability - Improve proCnabilicy in all existing businesses by particular emphasis on unde:--~--idng and investment performance and expense ratios: Risk - I'Mariaze the risk exposures of the businesses to increase the quaiin- of the business written and reduce underiving profit volatility; Competitive position - Continue to strengthen the competitive position of the businesses particularly in their home markets, concentrating on enhancing the strength of dis-1--ibution and upgrading IT systems, and improving productivity both of the sales channels and in the back officts: Market share - Grow ma:'.---, share in profitable, high quality segments of selected markets; Influence - Use market strerig-.,-~s to influence kev variables; Public relatioms and regulation - Contribute to the improvement of the public relations of the insurance industry, ensure the highest standards of Compliance, and influence the development of a "level playing field"; Management development and training - Recruit, remin and develoo a suff-icient. cadre of managers to implement the strategies; LM Cohesion - Seek means of max~-nising the value added by being part of Z) B.A.T Industries in addition to seff-gencrated benefits and economics. 29 30/061`92 BATCO CONFIDFNTIAL - CATEGORY 1: NTINNESOTA T013ACCO LITIG.-\TION. BATCo document for Province of BritiSh Columbia 26 October 1999 to. Financial Services TABLE F1 Financial Services Profits (Ern) 1990-1996 19% 1991 1992 1994 1996 1991196 Actual Actual Forecast Plan Plan C.A.G. I. EAGT'F STAR Non-Life Smoothed Cap. Apprec. 60 46 100 96 183 Underwriting Loss ('66) (543) ("34) (119) (95) Other 138 131 118 138 Total Non-Life (16:) (359) (3) 9f 226 Life -5 62 8: 110 1". 9 Total Eagle Star (115-, (304) 59 1-77 336 Al UED DUNBAR 118 121 13*7 202 279 18.2% FAR-NrFRS Non-Life 29 280 316 401 564 15.0 5C Life 70 79 88 128 170 16.6% TIvL-kSC0 (Group share) z: 5; 741 99 119 16.7% OTEFER - (1) (1) (1) 2 - TOTAL 373 230 673 1006 1470 44.9% Memo: TotnI Fxcl'2 ES Non-Life ~;3.- 589 676 911 1244 16.117,o Memo: N,on-Life 86 (79) 313 496 790 Life 23 3 255 287 412 559 17.0ro TMASCO & Other z: 54 73 98 121 17.5~,*o TOTAL 373 230 673 1006 1470 44.9% (Note: continuing business only) 30 30 iW92 BATCO CONFIDENTIAL - C.-%TECORY 1: MIN-NESOT.-k TOBACCO LITIGATIO,,;. C:) C~ _Z~x L,_j BATCo document for Province of BritiSh COIUMbia 26 October 1999 10. FiLaac;ai Service:E I C. 7.-,~ expansion strategv is to concer=tt inidaily in the UK and US. Condr.-_,; E--,.-:-:,e is also c; considerable longer tenn interest as is the Far East but the :mpac. is likely to be made in the UK and US. A1tzrn-,-_,.e o:)-:u77unitim to b.- examined (which are not MLVJZIIV exclusive) are: The possibie acquisition of a UK composae (especi:32-y in respec: of personai Lines) to achieve economies of scaie or expense ra6onalisation: The -ossible accuisidor, of an insurance mutual (wi-Lich is Likely to inclute Life but which may be a composite) also to achieve econorTues of s---'e: I he --ossible acquisition of a majo,- building society to add d;stribu~or, stren-m. T-his could require management input from Canada Trust-, The --,s-- of Eazie Star and/or Allie4d Dunbar equity in &-i acquisition to r-,=7.1se ACT bene~=, The :.ossible aca'uisition of smajlJsingle State US personal lines insuren to im-irove Farmers' marke, position in se!e,cted Sates where i: cur-,-n tiv operates. and selected prospective States; T-he ?ossibdity of establishing a Farmers' qW of business in the UK using Farmers' expertise, Eagle Star's knowledge of the marke: and Alhe~d Dunbar's recruitment capability; The opportunities available in Europe resulting from growth in demand, developments in the various markets and the Insurance Mrecdves; The roie of BAT in the restructuring of the UK Financial Services mark-:,. The possible closer co-operation bmween Eagle Star Life and Allied Dunba:, in the UK and in Europe. 10.4 Curnat Perfor=nce /Prospects 10.-,.l Tabie F1 shows the actual (1990/91) and forecast (1992/94/96) contributions to profits from t~e main Financial Services activities. The key features of this ar--: Excluding Eazle Star General Insurance. profit grc%k-zh is project-ed to exc----; the obiective over the plan period: The importance of the turnaround in Eagle S= Non-Life and the underwri~ng result: 31 30/06,'92 BATCO CONFIDENTIAL CATEGORY 1: MINNESOTA TOBACCO LITIGATION. C-D Z-11. r\j BATCo document for Province of BritiSh Columbia 26 October 1999 10. Financial Services TABLE r- Financial Serices Turno,er and Premium income (Ern) 199(~-1996 1990 1991 1992 1994 1996 1991196 Actual Actual Forecast Plan Plan C.A.G. '7- Total Turnover Genemi busmess 3009 3 19 -1 3 36: 4107 5091 9.8% Ufe business 2-' 11 2- 6 --- : 2 4 8 --, 31-43 4417 10.951. Financial Services T'over 5420 -982-6 5845 7350 9SO8 10 .3 % Inciuding Farmers' Exc"=ps: General business 6206 6787, 73;-z9 8914 10931 10.0% Life business 2111 2-63: 2 -' R- 3 3243 4-117 10.9% T'over incl'-. Exchaages 8617 9419 9872 12 157 IS343 10.3% General Business Personal: Eazle S= UK 6'-., 680 E 890 1235 12.9% Faz-,ners' Ex changes 3:30 36:3 3910 4603 551~2 8.7% Total Pe-sonal 3851 4-3,08 4-56-5 5493 6757 9.497. Commercial: Eazle Star UK 497 509 546 659 791 9.2% Farmers' Exchanzes 417 465 660 841 1085 18.5% Total Commercial 914 974 12-06 1500 1876 14.0% RAASCO 898 886 920 1029 1175 5.8% Eazle Star Non-UK&Othe- 553 619 698 892 1123 12.6 % General Business T'over 6206 6787 7389 8914 10931 ~0.0,70 Life Busimess Sin--le Prerrdum Income: Ezzle Stw- 5-'-' 56-i 3, -- S 464 703 4.5 % Allied Dunbar 434 537 - 3 -1 498 627 3.2% Farmers 2 3 3 3 3 - Total Sinz-'e 9-19 110-1 76S 965 1333 3.8% Rene,A-abie: Eazle Star 329 331 673 989 21.0% Allied Dunbar 743 783 897, 1128 1479 13.5 % Farmers 135 19~ 2-14 263 332- lt.2% Total Re-newable 12~7 J.Z~9 1 f: -; 3 2064 2800 15.6% Uniz Trusts ec. 175 169 '.-57 214 28-1 11.091, Life Business Turnover 2411 2632 1,183 32-43 4417 10.917C 30/06i92 BATCO CONFIDENTI.AL - C.XTFGORY 1: MINNESOTA TOBACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 10, Financial Services The resurned uvward trend in F==s' profits which were depressed 1990 bv adverse exchanLe r,-:--s: The steady growth in profits -cm the L;fe businesses. 10-1.1- A different rneEhod of accounting for L:.'e profits. such as the Accruals Method would result in a one-off ste:) increase ,r, =,or-,ed tr-ading profits of about f:150m Ln 1992. The increase would be as a result of reco-lising, profits on contrac:s eariie- in their life. The main disadvanta-p is that the reported profits could be more volatile as they would morr closely r-.dror underlying business performance and would also be affected bv chanzes L-. bases and assumptions such as tax rez;rmes. However, the results for 1990 ar..,-: '1991 and the forecast for 1992 do ncE show any inc.-eased volatility if restated. 0. Table F'-' shows that acrual (1990191) Lid forecast (1992/94/96) turnover of the Financ-'al Se-vic,es activities. 7he key fe=.-zs of this anaiysis are: The Gene-al business rdrnove7 ;s forecas-, to increase at 10% p.a. with the fastest arowth rates ir. Far7.-.--:s' commercial business (18.5% p.a.): The Life business turnover ~s fomcast, to increase at 10.9% p.a. witli-. the fastest growth rates in rtnewable pre-nium income which is g,:-ieraUy higher quality. mor-- profitable business. Lr7 C) CD 33 30/06,'92 BATCO CONFIDENTIAL - CATEGORY 1: NIINNESOT.-k TOBACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 F-i-,!e S-tar Objec:ive -iective for agie S- is to be :h: pr.-mier compos"..- msu=t con-man'l Tn~ c~ i~: sc::c:zd mark=. I L 1.2 The =-Im are selected b v: - product - personal lines and small commercial. Lcp comme-cal is continued onlv where it is clearly profitable and suroor-s the Mar. focus or where exi[ing would destroy value; geography - resource will be direc:ed to those mar*,-z:.s whe-e Eazit S:ar occupies. or has the potential to occupy, a preatit.- position. ar.C will be withdrawn from markets where this is rot considered feasible. 3 In or_`,:- to ouroerform comDe6tion Eaaie Star has the objec:ive of bein- a low cos: produ=r and of having excellent manazernent information s-"stems. 11.2 L-K Gtneral Insurance I i. I i The =-=-' Long terrm strategic aim for Eaggle SL'--'s UK Genemd Lasurance is tc improve its market ranking such that it becomes the principal challenger to Sun Allian-c-c for market leadership. However the prime objective currently is to restore prof;~ilirv in as short a time frame as possible. FuLl advantage will be taken cf t~'_ h, , 7 -et conditions in 1991 to achieve maximum increases ar" _ _.enIng mark - rating to se-pient the business portfolio towards those areas offering the best returns. This will position the business better to take advantage of more favourable growt.'-. cond:-_:ons when the insurance cycle improves. 11.2.: The fina cial objective is to incre--se profit as a per=ntage of net premium. income from a minimum of 3 % to 5 To' by the end of the plan period. The previous pian ac-neved 3% by 1994 and 5% by 1996. 11.2.3 The current position of the operation is that it is a major player in the UK Nor- L"'- market. with a good reputation with both intermediaries and the insuring public. The principal businesses comprise Personal Lines which is orzanised by chann't.; (Direct, Corporate Financial Institutions, and Intermediary), and Commercial. Eagle Star is currently number 6 in terms of world-wide and UK non-life pre-rutim income. However within the UK personal 1Lnes market it is numbe: 3 for Property and number I for Motor. 1989 World-wide Non-Life Premiums of British Companies (:Em) Eagle Cornmercial General Guardian Royal Sun ToW CD Star Union Accident Royal Alliance Exchange 15 :4.9 3 LOO.: 2004.0 3675. 265C--' N"I.,kc: sha", 5.81: 9. 4 % 11.7% 7.6 T, 13-91: 9. look_ BATCO CO%FIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATIO'.. BATCo document for Province of British Columbia 26 October 1999 Eagle Star Gene 7 ne 1992-1996 Plan projects Eagle Star's UK -zd Insurance nt, w`:-en premium growth to be about 13% p.a., with mos', of the increase arising -1-orn :-,-:2 mcreas,es. In 1992 the personal lines policy count is budgeted to fail bu, -.ttn rises ny about 9% p.a. to 1996. In commercial lines. the policy court is 20~: lower 1 ~96 than it was in 199 1. 11.:.5 7he Plan assurnes that Eagle Star's UK underwriting margin will im-pro~e progressively from -411,c' in 1991, to -18% in 1992 to -317. in 1996. Hcwvier the latest view (as expressed in the firs', quarter QPR) is that the 1992 mar~-~. will be worse than bud,,e, due to continuins financial insurance business where 199'-~ domestic properzy price movements and repossession rates may be wo-,-s-- Lhar. budEeted. 11.16 7rie strategic priorities for Eagle Star's UK General Insurance business ar-- -o: Incre= customer foc--,s through the channel sDe--.".- br-,r.:'-. arzanisation: develop marketing partnerships with key distributors using =~-noicgv as a linkilIg factor: Exit lines of business that are not core and re-unde-,X-,.:-- -"!! k2y accounts of Motor, Household and Nfortgage Indemmiry; Accelerate the benefit of networking in the Intermediary charin:;: Review methods of handling business and structures, to ensum ~h.- most efficient use of resources; Manage the reduction of staff to ensure that quality staff a:-- =Lned and create opportunities for younger staff; Build customer service and operational excellence into business proce=s. 1.:. 7 The Direct channel is the fastest growing distribution channel in the UK Personal Lines marke, with increasing numbers of competitors. By 1996 it is ex-pected that this channel will contml 20% of the market. Eagle Star's objective is to be a profitable direct insurer with a significant presence. Its strategy is to have levels below the standard account that achieve a satisfactory whilst maintaining a competitive edge, and to emphasise higher risk customers :o achiv.-e higher average premiums and higher profitability. The number of pciicies is pianned to double to 700,000 by 1994, which is expected to be about 10F. marke, C= share of this channel. T"his will increase Easile Star's market rankine -,.-orn 6th o BATCO CONFIDFNTI.~L - CATEGORY 1: MINNESOT.-% TOBACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 11. Eagle Star 11.2.S In the short. te-n the market conditions for Property insurance through Corporate Financial Institutions (e.gg. Building Societies) are unlike;v to be favourabie for real growth. 'rhe pno--'~:y for 1992-1994 is to take full advantage of the harder market conditions to restore the channel to profitability. Where rates ar~ unsatisfactory the business will be exited. 11.2.9 In 1992 a signi'ficam hardening, of the Motor and Property rates is expeec=d in the Intermediary channel which will he!p to restore profitability in the underwriting accounts. ThroughouE the period of the plan, distribution is expected to become more tied. 71"he Eaggle Star plan assumes that the AA is the only distributor with which it has prefer=' insurer status. The AA is expected to continue to provide nearly a quarzer of Intermediary business, but Irim-mediar; business a-, a whole falls 1-Tom over half of total personal business to about 4091c. 11.2. 10 The short term strategic objecz_ive for the Commercial business is to re-um it to profitability in as shot-, a time frame as possible. The remedial action reauired in ratinz and re-underwriting is likelly to be more stringent than compentors as market leve; inc---ises will. be insufficient to restore profitability within an ac=;table time frame. It has b=n assumed that this will reduc-_ the total number of poUcies by 207~ over the Plan Mriod. 7he most significant business losses are ace;y to be ~.i Fire a~d Product Liability. T-he long- term strategy for this business must be re%iewed in the ~izht of the suD he core personal lines business. . port it gives tot 11.3 Overseas General 11.3.1 A new overall strategy for Overseas General Insurance business is beinz Eag fornnulated by gle Star in line with its objective of being a premier player in its selected markets. It is likely that the early years of the plan will see further rationalisarion where profit potential or sn-ategic positioning is low. 11.4 UK Life 11.4.1 'ne stated long term objective for Eagle Star's UK Life operation is to grow market share significantly to become one of the leading UK Life offices, while 7. cominuin- to achieve an acc---imble return. The overriding priority of this Plan is to achieve and maintain a strong UK base. 11.4.2 The financial objectives are to increase the embedded value by 17% p.a. and premium income by 1091,, p.a. real. The current capital position has imposed a constraint on the growth of sales. The 1991 Plan was built upon the basis that capital needed to support statutory new business strain would not exc=d the U-1 amount of strain released from the existing portfolio, which was approximate!% E100m p.a.. and the projected statutory solvency ratio was projected to increase from 2.517, in 1991 to 3.5% by 1996. This plan showed embedded values increasinz at about 14'7c p.a. BATCO CONFIDENTIAL - CATEGORY 1: MIN, ESOTA TOBACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 11. Eazle Star I i -13 The maicr strategies of the Plan ar-- :o fr=z-- expenses at 1991 levels, change proc--c-. mz to less "capital hungry" products. ex:t high strain and loss-maldna prod--= Lines. continue to invest in IT systenis and reduce bonus declarations. 11-1.4 The current prospects are that the 1991 Plan projected growth in EagJe Star Life's total. revenue premiums of 15% p.a. in the UK and 27% p.a. in the oversels businesses. which exceed the financial objectives set out in 11.4.2. This Plan results in the UY, annual premium ma:',-C, sham rising from 1.6% in 1991 to 3.4% in 1996, while the single premium marke, share rises slightly from 2.5% to 2.6%. The number of policies sold rises from 116k in 1991 to 244k in 1996, while the num'-~er of renewals rises from 5021, to 1.24m. Ezzie Star's d=endence on the rFA marke, is projected to decrease from 381% in 1990 :o 527. in 1996 for new annual premium business, and from 9317, to 51% for single premium business. Eagle Sta:-'s new annual premium sales through mega- ties (AA and Bristol & West) are assume~d to incrmse between 1990 and 1~96 from 8 % to 211 %. 11. 6 The strategic priorities are: Wid-Lin the UK Individuai, business, to achieve significant gains in market share in the retirement benefits market (with marke, shares of individual, group and executive pensions rising from 1 %/2% in 1992 to 2%/4% in 1996 and prenuums growing at 35.5% p.a.); To achieve significant gains in market share in the protection market (market share rising from 1.3% in 1992 to 2.8% in 1996 and premiums growing at 34% p.a.); To sustain marke, position in the elderly marke, by creating targeted products; To develop a modular approach to produc, development; Within the UK Group business, to continue to re instruEe Eagle S= Liie as a major pensions office by developing the Group Pensions Money Purchase and Executive Pensions rn~kets (Grout) and Executive Pensions are projected to gr ., ow at 28.417o p.a.); To switch the sales force to sell low capital strain products and improve the productivity and expense ratios of the sales force (expenses as a percentage of premiums is projected to fall from 20.3% in 1991 to 10.517. in 1996, and the overall distribution allowance is targeted to fall from 220 of LauLro in 1992 to 180 9, in 1997). CD CD BATCO CONFIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 12. AlLed Dunbar 12.1 The objective for A.L:i--` Dunba: is to be the premier life assurance company in --n-z UK. 1'.-, - - Its rimancial objectives are to azhieve a reL inc.--ue of 10% p.a. in earnings :~er share by growing sa:es and managing expenses and to grow embedded value a-, 20% ::.a_ The pre%~ous plan ac!ueved these objectives. 12.3 The s-,mte-_v to acn~ievc this objective is to focus on the sale of unit Linket~ pro[ec'on, pensions and investment produczs to individuals and small business ~r. the L7K. 12.4 The current position is that ALLied Dunba: is the leading unit lirik----4 office in UY, L-ciividual Life and Pensions market. It has the lar,,est direc: sales force, 2-n innov--'ve product range, good investment performance, a strong reputation :or clien: se-vice and effeczive use of technology. Taking unit linked and with prol4ts business together Allied Dunbar is number 6 in terms of new annual pre-nium equiv--':nt (annual :)Lis 10% single) income. Life Amrance Companies (ranked on IM Annual Preniium Equivalent (APE) lncome~ Rank C-mpany Annual Single A=u2d ~ Expenses Expenses Premiums PrL~ums 10% Sin2le APE I ?~.dendal 339.0 921.0 431.1 593.5 1.38 2 S:andard Life 304.0 910.0 395.0 351.1 0.89 3 7quitable Life 258.2 577.8 316.0 97.9 0.31 4 Sorwich Union 176.0 1022.0 27/8.2 382.6 1.38 5 L&gal & General 210.5 463.4 256.8 334.8 1.30 6 Mlied. Dunbar 198.0 395.0 237.5 276.5 1.16 [13 Eagle Star 72.0 462.0 118.2 136.7 1.16) 12.5 This oositioriin.- .,,-as reflected in strong growth in production and prorrs thmuz~out the 1980s. However the scve-~rv of the recession continuin- from 1990. top management changes, and competidon particularly for top sales advi=s, made 1991 a very difficult year and 1992 is continuing the same trend. Sales (expressed in Gross Initial Commissions, GIC) fell by 37- in 1990 and then by 10% in 1991. Growth in financial surplus fell from above 20% p.a. in the 1980s to 19% in 1990 and 15% in 1991. Althoueh the business is still ve--y p'rofi=ie, the gro,.;,-th in financial surplus cannot achieve projected -arcs without a s1'-,ni"=r turnaround in new business from current levels. 12.6 Curr--- projections show Allied Dunbar achieving sales growt;~. measured by GIC. 1017. in 1992 and then 15 % p.a. for the rest of the plan period. (The GIC meas---: is becominz less useful over time as a proxy for a volume measure rela:---i 38 30/06.9'- BATCO CO' CATEGORY 1: MINNESOT.-k TOBACCO LITIGATION. Ln CD LN BATCo document for Province of BritiSh Columbia 26 October 1999 12. Allied Dunbar to proft:abilir.. and should probably be replaced by A-PE). Whilst real rates of -,rowth are forecast for the marke,, these will be lowe7 than those planned by Allied Dunba:. This thererare implies an increzise in market share in a MarKe' where competition for boLh disL-ibuLion and clients wil: be fiercz. Earnings pe: share ar-- ex?ected to grow at 15 -5 p.a. throughout the Plal period. 1 Z.7 Critical assumptions in relation ,a achievement of this pe:-.or-.nance are that: 12.7.1 P-oduction, expenses and surplus are base on c,-,r7--nt business ac"-vities, and do not include any impact w:-.ich might arise from a s-,ategic alliance: 117.2- The stock market rises as forecast and that -.e implementation of the new stock market comourer svstem, TAURUS. is not delaved: 12.7. 3 Lapses return to more normal and acceptabie :--veis in 1992. S In resoonse to the challen-es of 1990 and 199 1, the strategic priorities will be a: 12. 8. I~ Anticipate and exjioi,. additional rzzziketing opportunities. differendatin-, Allied Dunbar from its compe--~iors, and develop hiz]- quality products and services which meet cons=ners' reanl needs; 12.8.2 Develop the key distribution channel, the D;---, Sales Force, which is the main strenLth of Allied Dunbar, as a quaL--, operation and inc7ease its size; 12.8.3 Generate a new stream of profits through rnk:or strategic alliances; 12.8-1 Build the business with the Independent Financial Ad"iser sector (the 1991 Plan projected 1015. g7owth in 1992 and '~5% in 1993); 12.8.5 Manage expenses activelly and eliminate was:-- (the 1991 Plan proiected actual expense loading as a percentage of design expense loading falling from 119% in 1991 to 100% in 1996): 12.8.6 Support the Spanish subsidiary; 12.8.7 Invest in the key support functions: imvestmeni management: information technology; administration; h"nan resources; financial management; management of corporate funds: and controls. U-1 CD X~- f") CO 39 30/06/'92 BATCO CO";FTDENTIAL - CATEGORY 1: MINNESOT.~ TC3ACCO LITIGATION. BATCo document for Province of BritiSh Columbia 26 October 1999 U. Farmers Group 13.1 ::armers' mission is to be recognised as pre-nie: insurance company in Amenca. by being the best insurance compar;y ;n terms of the aim take of all its zonsumenc,,es, though not ne=ssarily the biFz-!s: company. I The current position is that it is one of the -cp zhree insurers in 15 of the 29 staLes ~n which it competes for Personal Auto and Hcr-,eowne:s business, and seeks to be ~n the tou three in each State in which it operaes. 13.3 The primarv rm=cial objective is to achieve a steady increase in ne, income of at I p.a. from the management of th Tv and Casualtv businesses and 15 F.; e Prooe .rorn ownership of Life Insuranc2 subsidi-a-'es. 'De previous plan ac~--;eved this objective. 13.4 T-he operating objectives are to: I 13.4.1 Safeguard the financial stability of com:)anies; 13. 4. Increase earn inzs systematically for the azency force. empiove--s and management companies. and inc.-.=.- dividends~ to B.A.T Lnd-.=ies: 13.4.3 Increase policies in force and maike, share: 13.4.4 Provide policyholders with the bes: possible protection and service at the least possible cost; 13.4.5 Improve continually resource utilisation, particularly that of s-aff-, 13.4.6 Utilise information technology to maintain competitive advantage and increase the effe---tiveness and efln-mency of business operations. 13.5 One of the risks facing Farmers is its concentration in California and Texas. Tlerefore. while pursuing organic growth within its existing business. Farmers should also seek to expand into new states. aiming to achieve market positions similar to those achieved for the existing busmesses. 13.6 The Farmers base-case proj=tions show that pre-ruum growth in the Exchanges is expected to be 11.9% p.a., with rate levels increasing between 5% and 6% annually. Management Company net income is expected to rise by 11. 1 F. p.a. Life subsidiar; revenues increase by 13.4% p.z. and net income by 15.45c' p.a. 13.7 The focus -,oals which are the strategic priorities will be to: 13.7.1 Improve the surplus to premium ratio from 33.37a to 40'F:- by 1997. and ultimately to 5017.; 40 -'0/06,'92 B CONF10 ENTLk L - CATEGORY 1: NI IN NESOTA TOBACCO LIT -,(,- ATION. LM CD C:) CD Zl- BATCo document for Province of BritiSh Columbia 26 October 1999 Farmers Group 13.7.2 Re~duce controllable Exchar~ze ex-,)e:,,se, with *-I-',.- exDe:-.se rado to fall frorri 34% to 28% within th= to five years-, 13.7.3 Assist Age-its to increase their aver-age policin-in-lorce leve;s in order to increase their commission incor-ne and to enable them to provide fuLly professional servim to policyholders. The target is for Agents to have a minimum of 3,000 poficies-i n- force five ye-,-s of their appointment; 13.7.4 Reduce the rado of employee to Agents, from. more than one to 0.75, through advances in computer technology ant improved productivity during the pen , od of the plan; 13.7.7 Incr--ase the Life Companies' contributions to the Management Company's ean-dn,,s at a faster rate than P-opern- and Casuaiiv's contributions. U-I 41 30/06i92 SATCO COI;FTDEI;TI.\L - CATECORY 1: NTINNF-SOT.A TOBACCO LITIGATION. BATCO document for Province of BritiSh Columbia 26 October 1999 14. kssociated Companies 1--. --a most impor-2-rit of the Group's associated companies art %L=-;z (which is ~zzlt with under Br3ril), rrC in India (which is included in the BATCo plan), and `rasco in Canada. Imasco and ITC have a rellativeiv large propor-don of other outside Tobacco and Financial Sernces. I-,.- --ere is a confLic- of interest between B.A.T Industries and the other shareholders wno ~,ene-allv wish the companies to pursue diversification s-cam-pes outside the :r2in strategic tl=st of the Group. and there is a continuing problem in aggreeng z=ropriate levels of dividend payments. are continuing objjecdves to dispose of the investment in A:-,c.-uz and to =a-Licrure the share holding in fTC in a way which wiLl inc-.-ise control over the iobac~:o business. For Imasco, the main elements of the current per-formazc.- and prospects can be s--,rnmar'sed as follows: I Imperial Tobacco accounte-~ for 45.7% of consoddaLed earnings from operations in 1991. Tbe main issue facing it 's the continuing decline in the Canadian tobacco industry in the face of increasing levels of taxation and smugggling over the US border. Howeve:, Imperial Tobacco is the market leader in the Canadian cizarete marke% allowing continued profits growth desvite progressive volume reductions; Hardee's and FFi*A, operating in the US Fast Food marke,, contributed 5.4 % of earnings from operations. Profits were down 36 % on 1990, which was itself 39 % down on 1999. The company is in an industry sector which is under considerable pressure and has suffer= badly from the acquisition of Roy Rogers; Shoppers Drug contributed 10.2176 of earnings from operations. It is the market leader with about 27% share of drug store sales. Sales and earnings growth will depend on the timin-g of economic recovery in Canada; I The Fmancial Services businesses (CT Fu=cial, Irna o Enterprises, Genstar Development and F-Lasco) contributed 38.6% of earnings from operations in 1991, but profits were about 3% down on 1990, which was itself about 15% down on 1989. Planned profit (Z) improvements in 1992 are mainly due to assumed lower loan loss CD provisions. Beyond that, profit growth comes from rigorous cost CD control and a reversal of the d=li.e in market share of retail de:msits: .12 3010632 r-,"', 7Tr)FN;Tr k r - C kTF(-,Opy L N117NNESOT.-k TOB.-\CCO LMG -MON. BATCO document for Province of BritiSh Columbia 26 October 1999 11. kssoc'=ed Compardes 7 h=- 3 also a small Tobac--o retaiiing chain. UCS. azzounrina fo- 0. 2 F~ of e=inss in 199 1. 1-1 . 5 P.-c=-ts for ac::cri will be: i-1 .5. BrinE :ne stntegies for Imasco in Une with those of B.A.T A-,ree oians for divestment of Hardee's; Agree a timetable and mechanism for Imasco to read--= the;-- sha:t hold:--,T, in CT Financial to 65%; Inves-4eate the implications for B.A.T Industries of its -!f:-:ive sha:.- hold;ns in CT Financial beina reduced from 40% to 26 I - agrecment between Imasco and B.A.T Indus=-es on how the Reac., procttds from the sale of Hardee's and 35% of CT F;--ancial will 43 30/0619Z BATCO CC--=TDENTTAL - CATEGORY 1: NTTNNESOT.~ TOBACCO LITIGATON. BATCo document for Province of BritiSh Columbia 26 October 1999