The provision is the largest yet to be revealed in the life industry and reflects NU's exposure to a problem expected to cost the industry a total of pounds 10bn.
Annuity guarantees were for decades used to promote the sale of pension policies for the self-employed. They typically promised a saver an annual retirement income worth at least 12 per cent of the amount saved.
As long as long-term interest rates stayed in double figures - as they did for most of the past 30 years - insurers expected never to lose money on the guarantees.
But last year long-term interest rates plummeted to their lowest level since 1966, leaving a giant gap between what insurers had promised and what they could afford to fund. Many insurers are now reserving hundreds of millions of pounds to cover their exposure to the guarantees.
Richard Harvey, NU chief executive, disclosed the level of the provision for the first time yesterday, ending months of uncertainty over the scale of NU's exposure. He said the company had doubled the level of reserves after the fall in long-term interest rates last year.
"We have always reserved for guaranteed annuities - they are part of an overall business of offering guarantees within [NU]," he said.
The cost of the guarantees will be met from free reserves within the life fund of NU - 10 per cent owned by shareholders - slightly eroding the company's financial strength. NU's free asset ratio - the headline measure of financial strength - fell from 15 to 12.9 last year.
NU also said its shareholders, including 1.3 million policyholders who kept their shares when the insurer de-mutualised in 1997, will receive a 10 per cent rise in dividend to 12.8p a share.
The company turned in operating earnings up 11 per cent, boosted by a 6 per cent growth in new business worldwide. Mr Harvey said the company planned to raise general insurance premiums by 5 to 10 per cent in the coming year.
He added NU was on target to deliver pounds 30m a year in cost savings following its purchase of London & Edinburgh, the general insurer, last autumn.Reuse content