Insurer Old Mutual believes its Bermuda life insurance unit can recover to profitability after it cost the group more than half a billion dollars last year.

The London-listed insurance and banking giant said it recognised a total loss of $508 million in 2008 for Old Mutual Bermuda (OMB), which writes non-US life insurance and annuities.

OMB's hefty losses came about through products which guaranteed investment returns even as financial markets crashed. OMB failed to hedge its risks effectively.

The unit's performance impacted the results of Old Mutual, which has operations in the US, Europe and South Africa, and which yesterday reported a post-tax operating profit of $901 million, down from $1.29 billion in 2007.

Old Mutual pumped $582 million into the Bermuda unit to ensure that it maintained more than the minimum capital requirement of the Bermuda Monetary Authority.

Sweeping changes were introduced to OMB, which included putting group treasurer Don Hope in charge of the Bermuda operation.

Old Mutual's US Life division, of which the Bermuda unit is part, recorded impairments of $237 million in its fixed income portfolio in the fourth quarter, raising the full-year total to $768 million.

That included losses of $78 million on the failure of Washington Mutual, $50 million on the collapse of Lehman brothers, $98 million on three foreign financial institutions which were not identified and $151 million on preferred stock in Freddie Mac and Fannie Mae.

US Life's funds under management ended the year at $20.7 billion, down 14 percent from the opening position primarily due to a 21 percent decrease in the market value of the funds. OMB's funds under management fell just three percent to $5.8 billion.

"The rapid deterioration combined with volatility in global financial markets, most notably in the fourth quarter, gave rise to an extremely difficult operating environment, while we faced a number of specific issues in our US Life business," chief executive Julian Roberts said in yesterday's preliminary annual earnings statement.

The guaranteed returns were offered to policyholders by OMB through a product called the Universal Guarantee Option (UGO), which gave investors who chose it a guarantee that their investments would rise by five percent per annum, or by 20 percent over ten years.

"The turbulent economic conditions and failure to fully hedge certain risks, coupled with hedge ineffectiveness, meant that the cost of providing the guarantees increased substantially in 2008," Old Mutual stated.

"This resulted in swift and decisive action in the second half, including senior management changes, the withdrawal of the UGO, strengthening of governance and risk management practices, the adoption of more conservative assumptions, implementation of improved fund mapping and the launch of the 'Accelerated UGO' offer."

The accelerated UGO offer, which closed in late November, offered clients the chance to have their accounts topped up to 85 percent of the original investment. The offer included all guarantees and fees associated with them being terminated.

Around 14 percent of policyholders took up the offer, which resulted in a cash payout of $94.5 million and reserves of $133.4 million released for OMB.

Old Mutual said it planned to further restructure OMB to improve governance and risk management. It is also moving to increased its hedge effectiveness, which improved to 92 percent in the fourth quarter, compared to 75 percent for the full year 2008, the company said.

OMB will face challenges as it aims to "rebuild its position as a leading distribution platform", the company said. "However a return to more normal market conditions and the launch of a range of hedgeable new products will underpin a good recovery in profitability."