TIDMLGEN
RNS Number : 4570G
Legal & General Group Plc
04 March 2015
Capital and Investments 67
4.01 Group regulatory capital
(a) Insurance Group's Directive
(IGD)
The Group is required to measure and monitor its capital resources on
a regulatory basis and to comply with the minimum capital requirements
of regulators in each territory in which it operates. At a Group level,
Legal & General must comply with the requirements of the IGD. The table
below shows the estimated total Group capital resources, Group capital
resources requirement and the Group surplus.
At At
31.12.14 31.12.13
GBPbn GBPbn
Core tier 1 6.4 6.3
Innovative tier 1 0.6 0.6
Tier 2(1) 1.7 1.2
Deductions (1.0) (0.8)
Group capital resources 7.7 7.3
Group capital resources requirement(2) 3.8 3.3
IGD surplus 3.9 4.0
Group capital resources requirement
coverage ratio(3) 201% 221%
1. The Group issued GBP0.6bn subordinated notes constituting Lower Tier
2 Capital in June 2014.
2. Group capital resources requirement includes a With-profits Insurance
Capital Component (WPICC) of GBP0.4bn (2013: GBP0.2bn).
3. Coverage ratio is calculated on unrounded values.
A reconciliation of the capital and reserves attributable to the equity
holders of the Company on an IFRS basis to the Group capital resources
on an IGD basis is given below.
At At
31.12.14 31.12.13
GBPbn GBPbn
Capital and reserves attributable
to equity holders on an IFRS basis 6.0 5.6
Innovative tier 1 0.6 0.6
Tier 2 1.7 1.2
UK unallocated divisible surplus 0.7 1.1
Proposed dividends (0.5) (0.4)
Intangibles (0.4) (0.4)
Other regulatory adjustments(1) (0.4) (0.4)
Group capital resources 7.7 7.3
1. Other regulatory adjustments include differences between accounting
and regulatory bases.
The table below demonstrates how the Group's net cash generation
reconciles to the IGD capital surplus position.(1)
At
31.12.14
GBPbn
IGD surplus at 1 January 4.0
Net cash generation 1.1
Dividends (0.7)
New business capital deployed (0.4)
Existing business capital release 0.2
New subordinated debt issued 0.6
Additional pension deficit
repayments (0.2)
Interest rate and market impacts (0.3)
Other With-profits impacts (0.2)
Other variances and regulatory
adjustments (0.2)
IGD surplus at 31 December 3.9
1. All IGD amounts are estimated, unaudited and after accrual of the
final dividend of GBP496m in 2014 (2013: GBP408m).
Capital and Investments 68
4.01 Group regulatory capital (continued)
(b) IGD sensitivity analysis
The table below provides management estimates of the impact of changes
in market conditions on the IGD surplus.
Impact
on surplus
capital
2014
GBPbn
Sensitivity test
20% fall in equity
values (0.4)
40% fall in equity
values (1.0)
15% fall in property
values (0.2)
100bp increase in
interest rates 0.4
100bp decrease in
interest rates (0.6)
100bp increase in
credit spreads (0.1)
100bp decrease in
credit spreads 0.1
We have applied a consistent methodology to the IFRS sensitivity testing
in Note 2.19.
The above sensitivity analysis does not reflect management actions which
could be taken to reduce the impacts. In practice, the Group actively
manages its asset and liability positions to respond to market movements.
Additionally, the sensitivity tests are considered in isolation, although
in practice there is likely to be a correlation between the scenarios.
The impacts of these stresses are not linear therefore these results
should not be used to extrapolate the impact of a smaller or larger
stress. The results of these tests are indicative of the market conditions
prevailing at the balance sheet date. The results would be different
if performed at an alternative reporting date.
The interest rate sensitivity assumes a 100 basis point change in the
gross redemption yield on fixed interest securities together with a
100 basis point change in the real yields on variable securities. For
the UK long term funds, valuation interest rates are assumed to move
in line with market yields adjusted to allow for the impact of PRA regulations.
The interest rate sensitivities reflect the impact of the regulatory
restrictions on the reinvestment rate used to value the liabilities
of the long term business.
Modelling improvements have been made in the year, which more accurately
isolate the impacts of discrete assumptions changes. This, coupled with
the increase in the Group's annuity liabilities, has led to an increase
in the reported sensitivities to interest rates movements. Zero yield
floors have not been applied in the estimation of the stresses, despite
the low interest rate environment at the balance sheet date.
Capital and Investments 69
4.02 Group Economic Capital
Legal & General defines economic capital to be the amount of
capital that the Board believes the Group needs to hold, over and
above its liabilities, in order to meet its strategic objectives.
This is not the same as regulatory capital which reflects
regulatory rules and constraints. The Group's objectives include
being able to meet its liabilities as they fall due whilst
maintaining the confidence of our investors, rating agencies,
customers and intermediaries.
Legal & General has invested considerable time and resource
in developing a risk based capital model that is used to calculate
the Group's Economic Capital Balance Sheet and support the
management of risk within the Group. The Group continues to develop
the economic capital model in light of developments in the Group's
business model, refinements in modelling and the analysis of
experience, emerging market practice and feedback from independent
reviewers. The Group's economic capital position will reflect these
changes as they are implemented. It is intended that this modelling
framework, suitably adjusted for regulatory constraints, should
also meet the needs of the Solvency II regime, due to come in to
force on 1 January 2016. Our Economic Capital model has not been
reviewed by the Prudential Regulatory Authority (PRA), nor will it
be.
The economic capital numbers presented here do not represent our
view of the Solvency II outcome for the Group. Solvency II has
elements which are considered to be inconsistent with the Group's
definition of economic capital, so there will be differences
between the two balance sheets. Legal & General is engaged in
discussions with the PRA and in 2015 we will make a formal
application for approval of an internal model for use under
Solvency II. As yet our Solvency II internal model has not been
reviewed or approved by the PRA.
(a) Capital position
As at 31 December 2014 the Group had an economic capital surplus of
GBP7.0bn (2013: GBP6.9bn), corresponding to an economic capital coverage
ratio of 229% (2013: 251%). The economic capital position is as follows:
2014 2013
GBPbn GBPbn
Eligible own funds 12.5 11.4
Economic capital requirement 5.5 4.5
Surplus 7.0 6.9
1-in-200 coverage ratio(1) 229% 251%
1. Coverage ratio is calculated on
unrounded values.
Further explanation of the underlying methodology and assumptions are
set out in the sections below.
(b) Methodology
Eligible own funds are defined to be the excess of the value of
assets over the liabilities. Subordinated debt issued by the Group
is considered to be part of available capital, rather than a
liability, as it is subordinate to policyholder claims.
Assets are valued at IFRS fair value with adjustments to remove
intangibles, deferred acquisition costs and to value reassurers'
share of technical provisions on a basis consistent with the
liabilities on the Economic Capital Balance Sheet. The economic
value of assets excluded from the IFRS Balance Sheet (e.g. present
value of future with-profits transfers) is also included.
Liabilities are valued on a best estimate market consistent
basis, with the application of an Economic Matching Adjustment for
valuing annuity liabilities.
The Economic Capital Requirement is the amount of capital
required to cover the 1-in-200 worst projected future outcome in
the year following the valuation, allowing for realistic management
and policyholder actions and the impact of the stress on the tax
position of the Group. This allows for diversification between the
different firms within the Group and between the risks that they
are exposed to.
The liabilities include a Recapitalisation Cost to allow for the
cost of recapitalising the balance sheet following the 1-in-200
stress in order to maintain confidence that our future liabilities
will be met. This is calculated using a cost of capital that
reflects the long term average rates at which it is expected that
the Group could raise debt and allowing for diversification between
all Group entities.
All material insurance firms, including Legal & General
Assurance Society, Legal & General Insurance, Legal &
General Pensions Management Company (PMC) (LGIM's insurance
subsidiary) and Legal & General America (LGA) are incorporated
into the Group's Economic Capital model assessment of required
capital, assuming diversification of the risks between those
firms.
Firms for which the capital requirements are less material, for
example Legal & General France, Legal & General Netherlands
and Suffolk Life, are valued on the firm's latest interpretation of
the Solvency II Standard Formula basis. The business retained
within Legal & General Pensions Limited, an internal Insurance
Special Purpose Vehicle, has been valued on a "look through" basis
and capital requirements calculated as if the business was not
internally reassured. Non-insurance firms are included using their
current regulatory surplus, without allowing for any
diversification with the rest of the Group.
Allowance is made within the Economic Capital Balance Sheet for
the Group's defined benefit pension scheme based upon the scheme's
funding basis, and allowance is made within the capital requirement
by stressing the funding position using the same economic capital
basis as for the insurance firms.
The results and the model are unaudited but certain elements of
the methodology, assumptions and processes have been reviewed by
PwC.
Capital and Investments 70
4.02 Group Economic Capital (continued)
(c) Assumptions
The calculation of the Economic Capital Balance Sheet and
associated capital requirement requires a number of assumptions,
including:
(i) assumptions required to derive the present value of best
estimate liability cash flows. Non market assumptions are broadly
the same as those used to derive the Group's EEV disclosures.
Future investment returns and discount rates are based on market
data where a deep and liquid market exists or using appropriate
estimation techniques where this is not the case. The risk-free
rates used to discount liabilities are market swap rates, with a 10
basis point deduction to allow for a credit risk adjustment;
(ii) assumptions regarding management actions and policyholder
behaviour across the full range of scenarios. The only management
actions allowed for are those that have been approved by the Board
and are in place at the balance sheet date;
(iii) assumptions regarding the volatility of the risks to which
the Group is exposed to are used to calculate Economic Capital
Requirement. Assumptions have been set using a combination of
historic market, demographic and operating experience data. In
areas where data is not considered robust, expert judgement has
been used; and
(iv) assumptions on the dependencies between risks, which are
calibrated using a combination of historic data and expert
judgement.
For annuities the liability discount rate includes an Economic
Matching Adjustment. The Economic Matching Adjustment is derived
using the same approach as the Solvency II matching adjustment, but
any constraints we consider economically artificial, such as
capping the yield on assets with a credit rating below BBB and any
ineligibility of certain assets, have not been applied.
The other key assumption relating to the annuity business is the
assumption of longevity. As for IFRS and EEV, Legal & General
models base mortality and future improvement of mortality
separately. For our Economic Capital assessment we believe it is
appropriate to ensure that the balance sheet makes sufficient
allowance to meet the 1 in 200 stress to longevity over the run off
of the liabilities rather than just over a 1 year timeframe as
required by Solvency II.
(d) Analysis of change
The table below shows the movement (net of tax) during the financial
year in the Group's Economic Capital surplus.
Economic
Capital
surplus
Analysis of movement from 1 January to 31 December 2014 GBPbn
Economic solvency position as at 1 January
2014 6.9
Operating experience(1) 0.5
New business strain(2) -
Non-operating experience(3) (0.4)
Other capital movements:
Subordinated debt issuance 0.6
Dividends paid in the
period (0.6)
Economic solvency position as at 31 December 2014 7.0
1. Release of surplus generated by in-force business, model and assumption
changes.
2. New business written in 2014 is broadly neutral on surplus.
3. Non-operating experience: changes in asset mix across the Group
(with corresponding increase in Economic Capital Requirement), changes
in pension scheme deficit (following completion of the triennial valuation)
and other market movements.
Capital and Investments 71
4.02 Group Economic Capital (continued)
(e) Reconciliation of IFRS Shareholders' Equity to Economic Capital
Eligible Own Funds
The table below gives a reconciliation of the Eligible own funds on
an Economic Capital basis and the Group's IFRS shareholders' equity.
2014 2013
GBPbn GBPbn
IFRS shareholders' equity at 31 December 6.0 5.6
Remove DAC, goodwill and other intangible
assets and liabilities (2.0) (1.7)
Add subordinated debt treated as economic available capital(1) 2.4 1.9
Insurance contract valuation differences(2) 6.6 6.2
Add value of shareholder transfers 0.3 0.3
Increase in value of net deferred tax liabilities (resulting
from valuation differences) (0.6) (0.7)
Other 0.1 0.4
Adjustment - Basic own funds to Eligible own funds(3) (0.3) (0.6)
Eligible own funds at 31 December 12.5 11.4
1. Treated as available capital on the Economic Capital Balance Sheet
as the liabilities are subordinate to policyholder claims.
2. Differences in the measurement of liabilities between IFRS and Economic
Capital, offset by the inclusion of the recapitalisation cost.
3. Eligibility restrictions relating to the own funds of US captive
reassurers and the UK With-profits fund.
The figures that appear in this note are all pre-accrual for the final
dividend.
(f) Sensitivity analysis
The following sensitivities are provided to give an indication of how
the Group's economic capital surplus as at 31 December 2014 would have
changed in a variety of adverse events. These are all independent stresses
to a single risk. In practice the balance sheet is impacted by combinations
of stresses and the combined impact can be larger than adding together
the impacts of the same stresses in isolation. It is expected that,
particularly for market risks, adverse stresses will happen together.
Impact
on
Impact economic
on
net of capital
tax
capital coverage
surplus ratio
2014 2014
GBPbn %
Credit spread widens by 50bps (AAA-rated), 100bps (AA-rated),
150bps (A-rated), 200bps (BBB-rated), 250bps (BB-rated),
300bps (B-rated), 350bps (other rated) on Legal & General's
corporate bond holdings, with no change in the firm's long
term default expectations (0.7) (15)
A worsening in our expectation of future default and downgrade
to 125% times our assumed best estimate level (0.5) (21)
20% fall in equity
market (0.4) (4)
40% fall in equity
markets (0.7) (9)
15% fall in property
markets (0.2) (3)
100bps increase in
risk free rates - 9
100bps fall in risk
free rates 0.1 (10)
1% reduction in annuitant
base mortality (0.1) (2)
The above sensitivity analysis does not reflect management actions which
could be taken to reduce the impacts. In practice, the Group actively
manages its asset and liability positions to respond to market movements.
The impacts of these stresses are not linear therefore these results
should not be used to extrapolate the impact of a smaller or larger
stress. The results of these tests are indicative of the market conditions
prevailing at the balance sheet date. The results would be different
if performed at an alternative reporting date.
Capital and Investments 72
4.02 Group Economic Capital (continued)
(g) Analysis of Group Economic Capital Requirement
The table below shows a breakdown of the Group's Economic Capital Requirement
by risk type. The split is shown after the effects of diversification.
2014 2013
% %
Interest Rate 6 5
Equity 15 16
Credit(1) 44 44
Property(2) 4 8
Currency 3 (3)
Inflation (2) (1)
Total Market Risk(3) 70 69
Counterparty Risk 1 1
Life Mortality - 1
Life Longevity(4) 10 12
Life Lapse(5) 5 7
Life Catastrophe 3 4
Non-life underwriting 1 2
Health underwriting 1 -
Expense 1 1
Total Insurance Risk 21 27
Operational Risk(6) 7 4
Miscellaneous 1 (1)
Total Economic Capital Requirement 100 100
1. Credit risk is Legal & General's most significant exposure, arising
predominantly from the cGBP40bn portfolio of bonds backing the Group's
annuity business.
2. During 2014, the Group improved the modelling of its sale and leaseback
assets, resulting in a lower capital requirement.
3. The Group also has significant exposure to other market risks, primarily
due to the investment holdings within the shareholder funds but also
the risk to fee income from assets backing unit linked and with-profit
Savings businesses.
4. Longevity risk is Legal & General's most significant insurance risk
exposure, arising from the annuity book on which the majority of the
longevity risk is retained.
5. Lapse risk is also a significant risk, primarily through the risk
of mass lapse on investment management and savings businesses and the
risk of non-renewal on the Group's protection businesses.
6. During 2014, Legal & General has improved its operational risk scenario
analysis in response to internal and external feedback, which led to
a revised calibration.
(h) Solvency II
The Economic Capital results set out above do not reflect the
Solvency II regime. We anticipate that our Solvency II internal
model will be approved in 2015, ready for use on the Solvency II go
live date - 1 January 2016. We expect the final outcome on Solvency
II to result in a lower Group capital surplus and solvency ratio
than the Economic Capital basis.
Capital and Investments 73
4.03 Investment portfolio
Market Market
value value(1)
2014 2013
GBPm GBPm
Worldwide total assets 710,554 614,360
Client and policyholder
assets (638,117) (553,251)
Non-unit linked with-profits
assets (15,242) (17,391)
Investments to which shareholders are directly
exposed 57,195 43,718
1. Comparative has been restated following the adoption of IFRS 10,
further details are contained in Note 2.24.
Analysed by investment class:
Other
non profit Other
LGR insurance LGC shareholder
investments(1) investments investments investments Total Total
2014 2014 2014 2014 2014 2013
Note GBPm GBPm GBPm GBPm GBPm GBPm
Equities(2) 279 - 1,905 81 2,265 1,760
Bonds 4.05 40,737 2,546 1,620 908 45,811 35,697
Derivative assets(3) 3,827 14 98 1 3,940 2,307
Property 1,879 - 147 4 2,030 1,447
Cash (including cash
equivalents), loans
& receivables 652 368 1,339 659 3,018 2,331
Financial investments 47,374 2,928 5,109 1,653 57,064 43,542
Other assets(4) 118 - 13 - 131 176
Total investments 47,492 2,928 5,122 1,653 57,195 43,718
1. LGR investments includes all business written in LGPL, including
GBP0.6bn of non annuity assets held in LGPL.
2. Includes equity investment in CALA Group Limited.
3. Derivative assets are shown gross of derivative liabilities of GBP2.7bn
(2013: GBP1.4bn). Exposures arise from the use of derivatives for efficient
portfolio management, especially the use of interest rate swaps, inflation
swaps, credit default swaps and foreign exchange forward contracts for
asset and liability management.
4. Other assets include finance lease debtors.
Capital and Investments 74
4.04 Direct Investments(1)
(a) Analysed by asset
class
Direct(1) Traded(2) Direct(1) Traded(2)
Investments securities Total Investments securities Total
2014 2014 2014 2013 2013 2013
GBPm GBPm GBPm GBPm GBPm GBPm
Equities 318 1,947 2,265 202 1,558 1,760
Bonds 2,983 42,828 45,811 1,048 34,649 35,697
Derivative assets - 3,940 3,940 - 2,307 2,307
Property 2,030 - 2,030 1,447 - 1,447
Cash (including cash
equivalents), loans & receivables 241 2,777 3,018 6 2,325 2,331
Other assets 131 - 131 176 - 176
5,703 51,492 57,195 2,879 40,839 43,718
1. Direct Investments constitute an agreement with another party and
represent an exposure to untraded and often less liquid asset classes.
Direct Investments include physical assets, bilateral loans and private
equity but exclude hedge funds.
2. Traded securities are defined by exclusion. If an instrument is not
a Direct Investment, then it is classed as a traded security.
(b) Analysed by segment
LGR LGC LGA LGAS Total
2014 2014 2014 2014 2014
GBPm GBPm GBPm GBPm GBPm
Equities - 318 - - 318
Bonds 2,586 168 229 - 2,983
Property 1,879 147 - 4 2,030
Cash (including
cash
equivalents), loans
& receivables - 54 187 - 241
Other assets 118 13 - - 131
4,583 700 416 4 5,703
LGR LGC LGA LGAS Total
2013 2013 2013 2013 2013
GBPm GBPm GBPm GBPm GBPm
Equities - 202 - - 202
Bonds 997 - 51 - 1,048
Property 1,294 149 - 4 1,447
Cash (including
cash
equivalents), loans
& receivables - - 6 - 6
Other assets 176 - - - 176
2,467 351 57 4 2,879
(c) Movement in the year
Carrying Change Carrying
in
value market value
01.01.14 Additions Disposals value Other 31.12.14
GBPm GBPm GBPm GBPm GBPm GBPm
Equities 202 132 (31) 18 (3) 318
Bonds 1,048 1,629 (82) 202 186 2,983
Property 1,447 794 (256) 45 - 2,030
Cash (including cash
equivalents), loans & receivables 6 230 (1) 6 - 241
Other assets 176 13 - 2 (60) 131
2,879 2,798 (370) 273 123 5,703
Capital and Investments 75
4.05 Bond portfolio summary
(a) Analysed by sector
LGR LGR Total Total
2014 2014 2014 2014
Note GBPm % GBPm %
Sovereigns, Supras and
Sub-Sovereigns 4.05(b) 7,760 19 9,249 20
Banks:
- Tier 1 24 - 26 -
- Tier 2 and other subordinated 559 1 621 1
- Senior 1,667 4 2,221 5
Financial Services:
- Tier 1 - - - -
- Tier 2 and other subordinated 96 - 132 -
- Senior 946 2 1,138 3
Insurance:
- Tier 1 128 - 129 -
- Tier 2 and other subordinated 363 1 375 1
- Senior 624 2 704 2
Utilities 5,561 14 5,824 13
Consumer Services and
Goods & Health Care 4,126 10 4,726 10
Technology and Telecoms 2,548 6 2,836 6
Industrials & Oil and
Gas 4,306 11 4,928 11
Property 1,882 5 2,126 5
Asset backed securities:(1)
- Traditional 722 2 1,234 3
- Securitisations and
debentures 8,305 20 8,422 18
CDOs(2) 1,120 3 1,120 2
Total 40,737 100 45,811 100
1. Traditional asset backed securities are securities, often with variable
expected redemption profiles issued by Special Purpose Vehicles and
typically backed by pools of receivables from loans or personal credit.
Securitisations are securities with fixed redemption profiles that are
issued by Special Purpose Vehicles and secured on revenues from specific
assets or operating companies and debentures are securities with fixed
redemption profiles issued by firms typically secured on property.
2. The underlying reference portfolio has had no reference entity defaults
in 2014. The CDOs are termed as super senior since default losses on
the reference portfolio have to exceed 27.5%, on average across the
reference portfolio, before the CDOs incur any default losses. Assuming
an average recovery rate of 30%, then over 39% of the reference names
would have to default before the CDOs incur any default losses. The
CDOs are valued using an external valuation which is based on observable
market inputs. This is then validated against the market valuation.
Capital and Investments 76
4.05 Bond portfolio summary (continued)
(a) Analysed by sector
(continued)
LGR LGR Total Total
2013 2013 2013 2013
Note GBPm % GBPm %
Sovereigns, Supras and Sub-Sovereigns 4.05(b) 4,772 16 6,502 18
Banks:
- Tier 1 100 - 105 -
- Tier 2 and other subordinated 637 2 698 2
- Senior 1,406 5 2,169 6
Financial Services:
- Tier 1 2 - 5 -
- Tier 2 and other subordinated 206 1 251 1
- Senior 800 3 1,041 3
Insurance:
- Tier 1 144 1 152 -
- Tier 2 and other subordinated 579 2 625 2
- Senior 481 2 552 2
Utilities 4,013 13 4,329 12
Consumer Services and
Goods & Health Care 3,128 10 3,716 10
Technology and Telecoms 1,995 7 2,333 7
Industrials & Oil and
Gas 3,074 10 3,626 10
Property 981 3 1,053 3
Asset backed securities:(1)
- Traditional 763 3 1,395 4
- Securitisations and
debentures 5,839 19 6,047 17
CDOs(2) 1,098 3 1,098 3
Total 30,018 100 35,697 100
1. Traditional asset backed securities are securities, often with variable
expected redemption profiles issued by Special Purpose Vehicles and
typically backed by pools of receivables from loans or personal credit.
Securitisations are securities with fixed redemption profiles that are
issued by Special Purpose Vehicles and secured on revenues from specific
assets or operating companies and debentures are securities with fixed
redemption profiles issued by firms typically secured on property.
2. The underlying reference portfolio has had no reference entity defaults
in 2013. The CDOs are termed as super senior since default losses on
the reference portfolio have to exceed 27.5%, on average across the
reference portfolio, before the CDOs incur any default losses. Assuming
an average recovery rate of 30%, then over 39% of the reference names
would have to default before the CDOs incur any default losses. The
CDO's are valued using an external valuation which is based on observable
market inputs. This is then validated against the market valuation.
Capital and Investments 77
4.05 Bond portfolio summary (continued)
(b) Analysed by domicile
The tables below are based on the legal domicile of the security:
LGR Total LGR Total
2014 2014 2013 2013
GBPm GBPm GBPm GBPm
Market value by region:
United Kingdom 20,055 21,021 13,099 14,178
USA 9,515 11,839 7,237 9,779
Netherlands 1,910 2,182 1,736 2,164
France 1,412 1,726 1,382 1,681
Germany 378 682 411 791
Greece - - - -
Ireland 276 303 234 271
Italy 301 429 636 786
Portugal 1 11 15 31
Spain 212 260 178 263
Russia 19 37 - 1
Rest of Europe 1,857 2,164 1,299 1,720
Brazil 139 157 83 86
Rest of World 3,542 3,880 2,610 2,848
CDOs 1,120 1,120 1,098 1,098
Total 40,737 45,811 30,018 35,697
Additional analysis of sovereign debt exposures
Sovereigns, Supras and Sub-Sovereigns
LGR Total LGR Total
2014 2014 2013 2013
GBPm GBPm GBPm GBPm
Market value by region:
United Kingdom 5,946 6,267 3,340 3,725
USA 536 772 282 664
Netherlands 5 153 10 194
France 1 138 90 220
Germany 204 417 212 472
Greece - - - -
Ireland - 8 - 7
Italy 2 96 236 323
Portugal - 9 - 16
Spain - 10 - 14
Russia 19 28 - 1
Rest of Europe 765 922 474 660
Brazil 55 64 11 13
Rest of World 227 365 117 193
Total 7,760 9,249 4,772 6,502
Capital and Investments 78
4.05 Bond portfolio summary (continued)
(c) Analysed by credit rating
LGR LGR Total Total
2014 2014 2014 2014
GBPm % GBPm %
AAA 1,936 5 3,4518
AA 10,357 25 11,190 24
A 13,231 33 14,420 31
BBB 10,360 25 11,441 25
BB or below 630 2 8532
Unrated: Bespoke CDOs(1) 994 2 9942
Other 3,229 8 3,4628
40,737 100 45,811 100
LGR LGR Total Total
2013 2013 2013 2013
GBPm % GBPm%
AAA 1,378 5 3,1449
AA 6,743 22 7,599 21
A 10,236 34 11,703 34
BBB 8,326 28 9,456 26
BB or below 603 2 8742
Unrated: Bespoke CDOs(1) 983 3 9833
Other 1,749 6 1,9385
30,018 100 35,697 100
1. The CDOs are termed as super senior since default losses have to
exceed 27.5%, on average across the reference portfolio, before the
CDOs incur any default losses. The underlying reference portfolio had
no reference entity defaults in 2013 or 2014. Losses are limited under
the terms of the CDOs to assets and collateral invested.
4.06 Value of policyholder assets held in Society and LGPL
2014 2013
GBPm GBPm
With-profits business 21,614 23,959
Non profit business 57,835 49,949
79,449 73,908
European Embedded Value 79
Group embedded value - summary
Covered business
==========================
LGAS Non-
UK overseas covered
business business LGA business Total
For the year ended 31 December GBPm GBPm GBPm GBPm GBPm
2014
At 1 January 2014
Value of in-force business
(VIF) 4,693 197 699 - 5,589
Shareholder net worth (SNW) 3,249 315 234 199 3,997
Embedded value at 1 January
2014 7,942 512 933 199 9,586
Exchange rate movements - (30) 44 (16) (2)
Operating profit/(loss) after
tax for the year 1,264 31 (68) 107 1,334
Non-operating profit/(loss)
after tax for the year 709 (11) (11) (5) 682
Profit/(loss) for the year 1,973 20 (79) 102 2,016
Intra-group distributions(1) (641) (30) (46) 717 -
Dividends to equity holders
of the Company - - - (580) (580)
Transfer to non-covered business(2) (26) - - 26 -
Other reserve movements including
pension deficit(3) 389 - (125) (309) (45)
Embedded value at 31 December
2014 9,637 472 727 139 10,975
Value of in-force business 6,118 147 518 - 6,783
Shareholder net worth 3,519 325 209 139 4,192
Embedded value per share (p)(4) 185
1. UK intra-group distributions primarily reflect a GBP675m dividend
paid from LGAS to Group, and dividends of EUR35m (2013: EUR16m) from
LGN and GBP5m from Nationwide Life (2013: GBP10m) paid to LGAS. Dividends
of $76m (2013: $69m) from LGA and EUR2m (2013: EUR2m) from LGF were
paid to Group.
2. The transfer to non-covered business represents the IFRS profits
arising in the year from the provisions of investment management services
by LGIM to the UK covered business, which have been included in the
operating profit of the covered business on the look through basis.
3. The other reserve movements primarily reflect the effect of reinsurance
arrangement transactions between UK and US covered business, pension
deficit movement, movement in the savings related share options scheme
and intragroup capital contribution.
4. The number of shares in issue at 31 December 2014 was 5,942,070,229
(31 December 2013: 5,917,066,636).
Further analysis of the LGAS and LGR covered business can be found in
Note 5.01.
European Embedded Value 80
Group embedded value - summary (continued)
Covered business
==========================
LGAS Non-
UK overseas covered
business business LGA business Total
For the year ended 31 December GBPm GBPm GBPm GBPm GBPm
2013
At 1 January 2013
Value of in-force business
(VIF) 4,402 146 735 - 5,283
Shareholder net worth (SNW) 3,178 296 239 (96) 3,617
Embedded value at 1 January
2013 7,580 442 974 (96) 8,900
Exchange rate movements - 9 (14) (10) (15)
Operating profit after tax
for the year 804 16 70 168 1,058
Non-operating profit/(loss)
for the year 222 60 (24) (17) 241
Profit for the year 1,026 76 46 151 1,299
Intra-group distributions(1) (602) (15) (44) 661 -
Dividends to equity holders
of the Company - - - (479) (479)
Transfer to non-covered business(2) (27) - - 27 -
Other reserve movements including
pension deficit(3) (35) - (29) (55) (119)
Embedded value at 31 December
2013 7,942 512 933 199 9,586
Value of in-force business 4,693 197 699 - 5,589
Shareholder net worth 3,249 315 234 199 3,997
Embedded value per share
(p)(4) 162
1. UK intra-group distributions reflect a GBP625m dividend paid from
LGAS to Group, and dividends of GBP10m paid to LGAS from subsidiaries
(primarily Nationwide Life). Dividends of EUR16m from LGN were also
paid to LGAS. Dividends of $69m from LGA and EUR2m from LGF were paid
to the group.
2. The transfer to non-covered business represents the IFRS profits
arising in the year from the provisions of investment management services
by LGIM to the UK covered business, which have been included in the
operating profit of the covered business on the look through basis.
3. The other reserve movements reflect the pension deficit movement,
the movement of investment project costs from covered to non-covered
business and the effect of reinsurance arrangement transactions between
UK and US covered business.
4. The number of shares in issue at 31 December 2013 was 5,917,066,636.
Further analysis of the LGAS and LGR covered business can be found in
Note 5.01.
European Embedded Value 81
5.01 LGAS and LGR embedded value reconciliation
Shareholder net Total
worth
===========================
Free Required Value embedded
of
surplus capital Total in-force value
For the year ended 31 December GBPm GBPm GBPm GBPm GBPm
2014
At 1 January 2014 1,174 2,390 3,564 4,890 8,454
Exchange movement (1) (16) (17) (13) (30)
Operating profit/(loss) after
tax - UK business:
Contribution from new risks
after cost of capital
- New business contribution(1) (340) 343 3 607 610
- Intragroup transfer from
With-Profit to Non Profit
Fund - - - 80 80
- Expected return on VIF - - - 317 317
- Expected transfer from VIF
to SNW(2) 901 (213) 688 (688) -
- Expected return on SNW 55 116 171 - 171
======== ========= ====== ======== ========
Generation of embedded value 616 246 862 316 1,178
- Experience variances 175 (83) 92 (6) 86
- Operating assumption changes 171 (109) 62 (36) 26
- Development costs (26) - (26) - (26)
======== ========= ====== ======== ========
Variances 320 (192) 128 (42) 86
Operating profit after tax
- LGAS overseas 4 3 7 24 31
Operating profit after tax
- LGAS & LGR 940 57 997 298 1,295
Non-operating profit/(loss)
after tax - UK business:
- Economic variances (359) 219 (140) 851 711
- Other taxation impacts(3) (12) - (12) 10 (2)
Non-operating profit/(loss)
after tax - LGAS overseas 57 (7) 50 (61) (11)
Non-operating profit/(loss)
after tax - LGAS & LGR (314) 212 (102) 800 698
Profit for the year - LGAS
& LGR 626 269 895 1,098 1,993
Intra-group distributions(4) (671) - (671) - (671)
Transfer to non-covered business(5) (26) - (26) - (26)
Other reserve movements including
pension deficit(6) (125) 224 99 290 389
Embedded value at 31 December
2014 977 2,867 3,844 6,265 10,109
1. The UK free surplus reduction of GBP340m to finance new business
primarily reflects GBP343m additional required capital in relation to
new business.
2. The increase in UK free surplus of GBP901m from the expected transfer
from the in-force non profit business includes GBP688m of operational
cash generation and a GBP213m reduction in required capital. The GBP764m
operational cash generation from LGAS and LGR per Note 2.01 also includes
GBP29m dividend from LGN, GBP2m dividend from LGF and GBP44m primarily
reflecting profit from non-covered business.
3. Reflects the impact of the change in treatment in deferred tax to
align with IFRS by removing the effect of discounting.
4. Intra-group distributions primarily reflect GBP675m dividend paid
from LGAS to Group and dividend of EUR35m from LGN and GBP5m from Nationwide
to LGAS.
5. The transfer to non-covered business represents the IFRS profits
arising in the year from the provisions of investment management services
by LGIM to the UK covered business, which have been included in the
operating profit of the covered business on the look through basis.
6. The other reserve movements reflect the pension deficit movement,
the effect of reinsurance arrangement transactions between UK and US
covered business and intragroup capital contribution.
The value of in-force business of GBP6,265m is comprised of GBP5,925m
of non profit business and GBP340m of with-profits business.
European Embedded Value 82
5.01 LGAS and LGR embedded value reconciliation (continued)
Shareholder net worth Total
==========================
Free Required Value embedded
of
surplus capital Total in-force value
For the year ended 31 December GBPm GBPm GBPm GBPm GBPm
2013
At 1 January 2013 1,259 2,215 3,474 4,548 8,022
Exchange movement 3 3 6 3 9
Operating profit/(loss) after
tax - UK business:
Contribution from new risks
after cost of capital
- New business contribution(1) (324) 284 (40) 484 444
- Intragroup transfer from - - - - -
With-Profit to Non Profit
Fund
- Expected return on VIF - - - 266 266
- Expected transfer from VIF
to SNW(2) 869 (181) 688 (688) -
- Expected return on SNW 40 76 116 - 116
======== ========= ===== ======== ========
Generation of embedded value 585 179 764 62 826
- Experience variances 5 (9) (4) 14 10
- Operating assumption changes (24) 2 (22) 21 (1)
- Development costs (31) - (31) - (31)
======== ========= ===== ======== ========
Variances (50) (7) (57) 35 (22)
Operating profit after tax
- LGAS overseas 7 1 8 8 16
Operating profit after tax
- LGAS & LGR 542 173 715 105 820
Non-operating profit/(loss)
after tax - UK business:
- Economic variances 109 (8) 101 80 181
- Effect of tax rate changes
and other taxation impacts(3) - - - 41 41
Non-operating profit after
tax - LGAS overseas 20 - 20 40 60
Non-operating profit/(loss)
after tax - LGAS & LGR 129 (8) 121 161 282
Profit for the year - LGAS
& LGR 671 165 836 266 1,102
Intra-group distributions(4) (617) - (617) - (617)
Transfer to non-covered business(5) (27) - (27) - (27)
Other reserve movements including
pension deficit(6) (115) 7 (108) 73 (35)
Embedded value at 31 December
2013 1,174 2,390 3,564 4,890 8,454
1. The UK free surplus reduction of GBP324m to finance new business
includes GBP40m new business strain and GBP284m additional required
capital.
2. The increase in UK free surplus of GBP869m from the expected transfer
from the in-force covered business includes GBP688m of operational cash
generation and a GBP181m reduction in required capital. The GBP734m
operational cash from LGAS and LGR per Note 2.01 also includes GBP2m
and GBP14m remitted from LGF and LGN respectively, and GBP30m primarily
reflecting IFRS profit from non covered business.
3. Reflects the implementation of the UK planned future reductions in
corporation tax to 20% on 1 April 2015.
4. UK intra-group dividends reflect a GBP625m dividend paid from LGAS
to Group and dividends of GBP10m paid to LGAS from subsidiaries (primarily
Nationwide Life). Dividends of EUR16m from LGN were also paid to LGAS.
5. The transfer to non-covered business represents the IFRS profits
arising in the year from the provisions of investment management services
by LGIM to the UK covered business, which have been included in the
operating profit of the covered business on the look through basis.
6. The other reserve movements reflect the pension deficit movement,
the movement of investment project costs from covered to non-covered
business and the effect of reinsurance arrangement transactions between
UK and US covered business.
The value of in-force business of GBP4,890m is comprised of GBP4,454m
of non profit business and GBP436m of with-profits business.
European Embedded Value 83
5.02 Analysis of shareholders' equity
LGC
LGAS and group
and
LGR LGIM expenses LGA Total
As at 31 December 2014 GBPm GBPm GBPm GBPm GBPm
Analysed as:
IFRS basis shareholders'
equity(1) 847 541 3,770 870 6,028
Additional retained profit/(loss)
on an EEV basis 6,227 - (1,137) (143) 4,947
Shareholders' equity on
an EEV basis 7,074 541 2,633 727 10,975
Comprising:
Business reported on an
IFRS basis 484 541 (886) - 139
Business reported on an
EEV basis:
Shareholder net worth
- Free surplus(2) 90 887 161 1,138
- Required capital to
cover solvency margin 235 2,632 48 2,915
Value of in-force
- Value of in-force business(3) 6,870 529 7,399
- Cost of capital (605) (11) (616)
1. Shareholders' equity supporting the UK non profit LGAS and LGR businesses
is held within Legal & General Assurance Society Limited and Legal &
General Pensions Limited and is managed on a groupwide basis within
the LGC and group expenses segment.
2. Free surplus is the value of any capital and surplus allocated to,
but not required to support, the in-force covered business at the valuation
date.
3. Value of in-force business includes a deduction for the time value
of options and guarantees of GBP43m (2013: GBP23m).
Further analysis of shareholders' equity is included in Note 5.03.
LGC
LGAS and group
and
LGR LGIM expenses LGA Total
As at 31 December 2013 GBPm GBPm GBPm GBPm GBPm
Analysed as:
IFRS basis shareholders'
equity(1) 783 421 3,622 816 5,642
Additional retained profit/(loss)
on an EEV basis 4,830 - (1,003) 117 3,944
Shareholders' equity on
an EEV basis 5,613 421 2,619 933 9,586
Comprising:
Business reported on an
IFRS basis 408 421 (630) - 199
Business reported on an
EEV basis:
Shareholder net worth
- Free surplus(2) 67 1,107 192 1,366
- Required capital to
cover solvency margin 248 2,142 42 2,432
Value of in-force
- Value of in-force business(3) 5,398 711 6,109
- Cost of capital (508) (12) (520)
1. Shareholders' equity supporting the UK non profit LGAS and LGR businesses
is held within Legal & General Assurance Society Limited and Legal &
General Pensions Limited and is managed on a groupwide basis within
the LGC and group expenses segment.
2. Free surplus is the value of any capital and surplus allocated to,
but not required to support, the in-force covered business at the valuation
date.
3. Value of in-force business includes a deduction for the time value
of options and guarantees of GBP23m.
Further analysis of shareholders' equity is included in Note 5.03.
European Embedded Value 84
5.03 Segmental analysis of shareholders' equity
Covered Other Covered Other
business business business business
EEV IFRS EEV IFRS
basis basis Total basis basis Total
2014 2014 2014 2013 2013 2013
GBPm GBPm GBPm GBPm GBPm GBPm
LGAS
- LGAS UK Protection
and Savings 2,354 - 2,354 2,331 - 2,331
- LGAS overseas business 472 - 472 512 - 512
- General insurance and
other - 484 484 - 408 408
Total LGAS 2,826 484 3,310 2,843 408 3,251
LGR 3,764 - 3,764 2,362 - 2,362
LGIM - 541 541 - 421 421
LGC and group expenses 3,519 (886) 2,633 3,249 (630) 2,619
LGA 727 - 727 933 - 933
Total 10,836 139 10,975 9,387 199 9,586
5.04 Reconciliation of shareholder
net worth
UK UK
covered covered
business Total business Total
2014 2014 2013 2013
GBPm GBPm GBPm GBPm
SNW of long term operations
(IFRS basis) 4,693 5,889 4,291 5,443
Other assets (IFRS basis) - 139 - 199
Shareholders' equity on
the IFRS basis 4,693 6,028 4,291 5,642
Purchased interest in
long term business (46) (49) (52) (59)
Deferred acquisition costs/deferred
income liabilities (201) (1,255) (223) (1,129)
Deferred tax(1) (16) 444 (162) 232
Other(2) (911) (976) (605) (689)
Shareholder net worth
on the EEV basis 3,519 4,192 3,249 3,997
1. Deferred tax represents all tax which is expected to be paid under
current legislation.
2. Other primarily relates to the different treatment of annuities and
LGA Triple X securitisation between the EEV and IFRS basis.
European Embedded Value 85
5.05 Profit/(loss) for the
year
LGC
LGAS and group
and
LGR LGIM expenses LGA Total
For the year ended 31 December Note GBPm GBPm GBPm GBPm GBPm
2014
Business reported on an EEV
basis:
Contribution from new risks
after cost of capital:
- contribution from new business 5.06 760 90 850
- intra-group transfer from
With-Profit to Non Profit Fund 100 - 100
Contribution from in-force
business:
- expected return(1) 424 66 490
- experience variances (2) 21 (23) (2)
- operating assumption changes(3) 58 (241) (183)
Development costs (32) - (32)
Contribution from shareholder
net worth 7 184 3 194
Operating profit/(loss) on
covered business 1,338 - 184 (105) 1,417
Business reported on an IFRS
basis(4,5,6) 50 304 (190) - 164
Total operating profit/(loss) 1,388 304 (6) (105) 1,581
Economic variances(7) 893 (12) (74) (17) 790
Gains on non-controlling interests - - 7 - 7
Profit/(loss) before tax 2,281 292 (73) (122) 2,378
Tax (expense)/credit on profit from
ordinary activities (372) (63) 32 43 (360)
Other taxation impacts(8) (2) - - - (2)
Profit/(loss) for the year 1,907 229 (41) (79) 2,016
Operating profit attributable
to:
LGAS 377
LGR 1,011
p
Earnings per share
Based on profit attributable to equity
holders of the Company 34.07
Diluted earnings per share
Based on profit attributable to equity
holders of the Company 33.73
1. The expected return on in-force for LGAS and LGR is based on the
unwind of the risk discount rate on the opening, adjusted base value
of in-force (VIF). The opening base VIF of the UK LGAS and LGR business
was GBP4,693m in 2014 (GBP4,402m in 2013). This is adjusted for the
effects of opening model changes of GBP(30)m (2013: GBP27m) to give
an adjusted opening base VIF of GBP4,663m (2013: GBP4,429m). This is
then multiplied by the opening risk discount rate of 6.8% (2013: 6.0%)
and the result grossed up at the notional attributed tax rate of 20%
(2013: 20%) to give a return of GBP397m (2013: GBP331m). The same approach
has been applied for the LGAS overseas businesses.
2. LGAS and LGR variance primarily reflects UK cost of capital unwind
and favourable mortality experience for bulk annuities. LGA experience
variance primarily relates to adverse mortality experience within term
assurance and universal life products respectively.
3. LGAS and LGR operating assumption change primarily reflects mortality
assumptions changes for non-profit annuities. LGA operating assumption
change primarily incorporates an adjustment to our mortality assumptions
to reflect the changes in industry wide mortality tables (which were
issued in the second half of 2014).
4. LGAS and LGR non-covered business primarily reflects GI operating
profit of GBP59m (2013: GBP69m).
5. LGIM operating profit includes Retail Investments and excludes GBP32m
(2013: GBP34m) of profits arising from the provision of investment management
services at market referenced rates to the covered business on a look
through basis and as a consequence are included in the LGAS and LGR
covered business on an EEV basis.
6. LGC and group expenses non-covered business primarily reflects Group
debt costs and investment projects and expenses, partly offset by investment
returns from non-covered shareholder assets.
7. The LGAS and LGR positive variance has resulted from a number of
factors including lower risk discount rate, favourable default experience
and enhanced yield on annuity assets offset by a lower risk free rate.
LGC and group expenses primarily reflects lower equity return from shareholder
funds.
8. Other taxation impacts reflects the change in the treatment of deferred
tax on in-force business to align with IFRS by removing the effect of
discounting.
European Embedded Value 86
5.05 Profit/(loss) for the year (continued)
LGC
LGAS and group
and
LGR LGIM expenses LGA Total
For the year ended 31 December Note GBPm GBPm GBPm GBPm GBPm
2013
Business reported on an EEV
basis:
Contribution from new risks
after cost of capital:
- contribution from new business 5.06 544 107 651
- intra-group transfer from - - -
With-Profit to Non Profit Fund
Contribution from in-force
business:
- expected return(1) 358 68 426
- experience variances (2) 52 (23) 29
- operating assumption changes(3) (9) (52) (61)
Development costs (40) - (40)
Contribution from shareholder
net worth 5 113 7 125
Operating profit on covered
business 910 - 113 107 1,130
Business reported on an IFRS
basis(4,5,6) 47 270 (106) - 211
Total operating profit 957 270 7 107 1,341
Economic variances(7) 250 (6) 8 (37) 215
Gains on non-controlling interests - - 13 - 13
Profit before tax 1,207 264 28 70 1,569
Tax (expense)/credit on profit
from ordinary activities (251) (57) 21 (24) (311)
Effect of tax rate changes
and other taxation impacts(8) 41 - - - 41
Profit for the year 997 207 49 46 1,299
Operating profit attributable
to:
LGAS 360
LGR 597
p
Earnings per share
Based on profit attributable to equity
holders of the Company 21.91
Diluted earnings per share
Based on profit attributable to equity
holders of the Company 21.61
1. The expected return on in-force is based on the unwind of the risk
discount rate on the opening, adjusted base value of in-force (VIF).
The opening base VIF of the UK LGAS and LGR business was GBP4,402m in
2013. This is adjusted for the effects of opening model changes of GBP27m
to give an adjusted opening base VIF of GBP4,429m. This is then multiplied
by the opening risk discount rate of 6.0% and the result grossed up
at the notional attributed tax rate of 20% to give a return of GBP331m.
The same approach has been applied for the LGAS overseas businesses.
2. LGAS and LGR variance primarily reflects UK cost of capital unwind,
bulk purchase annuity data loading, fewer retail protection lapses and
better longevity experience. LGA experience variance primarily relates
to adverse persistency experience and mortality experience within term
assurance and universal life products respectively.
3. LGAS and LGR assumption changes primarily reflects mortality assumption
changes in LGR. LGA assumption changes primarily relate to improved
modelling of term business in the period after the end of the guaranteed
level premium period.
4. LGAS and LGR non-covered business primarily reflects GI operating
profit of GBP69m.
5. LGIM operating profit includes Retail Investments and excludes GBP34m
of profits arising from the provision of investment management services
at market referenced rates to the covered business on a look through
basis and as a consequence are included in the LGAS and LGR covered
business on an EEV basis.
6. LGC and group expenses non-covered business primarily reflects Group
debt costs and investment projects and expenses, partly offset by investment
returns from non-covered shareholder assets.
7. The LGAS and LGR positive variance has resulted from a number of
factors including equity market outperformance, favourable default experience,
actions to improve the yield on annuity assets and a lower risk margin
offset by a higher risk free rate. The higher risk free rate has contributed
to a negative variance in LGA.
8. Primarily reflects the implementation of the UK planned future reductions
in the corporation tax rate to 20% on 1 April 2015.
European Embedded Value 87
5.06 New business by product(1)
Present Contri-
value Capital- bution
of
Annual annual isation Single from
new
premiums premiums factor(2) premiums PVNBP business(3) Margin
For the year ended 31 December GBPm GBPm GBPm GBPm GBPm %
2014
UK Insurance 230 1,336 5.8 - 1,336 112 8.4
Overseas business 41 300 7.3 394 694 7 1.0
UK Savings 654 2,448 3.7 2,738 5,186 27 0.5
Total LGAS 925 4,084 4.4 3,132 7,216 146 2.0
LGR n/a - n/a 6,578 6,578 614 9.3
LGA 91 907 10.0 - 907 90 9.9
Total new business 1,016 4,991 4.9 9,710 14,701 850 5.8
Cost of capital 108
Contribution from new business
before cost of capital 958
1. Covered business only.
2. The capitalisation factor is the present value of annual premiums
divided by the amount of annual premiums.
3. The contribution from new business is defined as the present value
at the point of sale of assumed profits from new business written
in the period and then rolled forward to the end of the financial
period using the risk discount rate applicable at the end of the reporting
period.
Present Contri-
value Capital- bution
of
Annual annual isation Single from new
premiums premiums factor(2) premiums PVNBP business(3) Margin
For the year ended 31 December GBPm GBPm GBPm GBPm GBPm %
2013
UK Insurance 218 1,141 5.2 - 1,141 101 8.9
Overseas business 30 229 7.6 371 600 5 0.8
UK Savings 724 2,516 3.5 2,495 5,011 2 -
Total LGAS 972 3,886 4.0 2,866 6,752 108 1.6
LGR(4) n/a 939 n/a 4,089 5,028 436 8.7
LGA 99 926 9.4 - 926 107 11.6
Total new business 1,071 5,751 5.4 6,955 12,706 651 5.1
Cost of capital 72
Contribution from new business
before cost of capital 723
1. Covered business only.
2. The capitalisation factor is the present value of annual premiums
divided by the amount of annual premiums.
3. The contribution from new business is defined as the present value
at the point of sale of assumed profits from new business written in
the period and then rolled forward to the end of the financial period
using the risk discount rate applicable at the end of the reporting
period.
4. LGR includes present value of annual premiums for longevity insurance
on a net of reinsurance basis to enable a more representative margin
figure. The gross of reinsurance longevity insurance annual premium
is GBP270m. The LGR PVNBP contribution from new business and margin
are also inclusive of longevity insurance.
European Embedded Value 88
5.07 Sensitivities
In accordance with the guidance issued by the European Insurance CFO
Forum in October 2005 the table below shows the effect of alternative
assumptions on the long term embedded value and new business contribution.
Effect on embedded value as
at 31 December 2014
1% 1% 1%
lower higher 1% 1% higher
As risk risk lower higher equity/
pub- discount discount interest interest property
lished rate rate rate rate yields
GBPm GBPm GBPm GBPm GBPm GBPm
LGAS and LGR(1) 10,109 855 (724) 628 (488) 175
LGA 727 103 (85) 22 (21) -
Total covered business 10,836 958 (809) 650 (509) 175
5% 5%
10% 10% lower lower
lower lower 10% mortality mortality
As equity/ main- lower (UK (other
pub- property tenance lapse annu- busi-
lished values expenses rates ities) ness)
GBPm GBPm GBPm GBPm GBPm GBPm
LGAS and LGR(1) 10,109 (302) 158 82 (428) 71
LGA 727 - 12 (2) n/a 168
Total covered business 10,836 (302) 170 80 (428) 239
Effect on new business contribution
for the year
1% 1% 1%
lower higher 1% 1% higher
As risk risk lower higher equity/
pub- discount discount interest interest property
lished rate rate rate rate yields
GBPm GBPm GBPm GBPm GBPm GBPm
LGAS and LGR(1) 760 117 (96) 38 (29) 26
LGA 90 14 (11) 5 (5) -
Total covered business 850 131 (107) 43 (34) 26
5% 5%
10% 10% lower lower
lower lower 10% mortality mortality
As equity/ main- lower (UK (other
pub- property tenance lapse annu- busi-
lished values expenses rates ities) ness)
GBPm GBPm GBPm GBPm GBPm GBPm
LGAS and LGR(1) 760 (7) 30 20 (97) 10
LGA 90 - 1 4 n/a 16
Total covered business 850 (7) 31 24 (97) 26
1. Includes LGC.
Opposite sensitivities
are broadly symmetrical.
The above sensitivity analyses do not reflect management actions which
could be taken to reduce the impacts. Sensitivity to changes in assumptions
may not be linear, and as such, they should not be extrapolated to changes
of a much larger order. A 2% higher risk discount rate would result
in a GBP1,281m negative impact on UK embedded value and a GBP168m negative
impact on UK new business contribution for the year.
European Embedded Value 89
5.08 Assumptions
UK assumptions
The assumed future pre-tax returns on fixed interest and RPI
linked securities are set by reference to the portfolio yield on
the relevant backing assets held at market value at the end of the
reporting period. The calculated return takes account of
derivatives and other credit instruments in the investment
portfolio. Indicative yields on the portfolio, excluding annuities
within LGR, but after allowance for long term default risk, are
shown below.
For LGR, separate returns are calculated for new and existing
business. An indicative combined yield, after allowance for long
term default risk and the following additional assumptions, is also
shown below. These additional assumptions are:
i. Where cash balances and debt securities are held at the
reporting date in excess of, or below strategic investment
guidelines, then it is assumed that these cash balances or debt
securities are immediately invested or disinvested at current
yields.
ii. Where interest rate swaps are used to reduce risk, it is
assumed that these swaps will be sold before expiry and the
proceeds reinvested in corporate bonds with a redemption yield of
0.70% p.a. (0.70% p.a. at 31 December 2013) greater than the swap
rate at that time (i.e. the long term credit rate).
iii. Where reinvestment or disinvestment is necessary to
rebalance the asset portfolio in line with projected outgo, this is
also assumed to take place at the long term credit rate above the
swap rate at that time.
The returns on fixed and index-linked securities are calculated
net of an allowance for default risk which takes account of the
credit rating, outstanding term of the securities. The allowance
for corporate securities expressed as a level rate deduction from
the expected returns for annuities was 21bps at 31 December 2014
(27bps at 31 December 2013).
UK covered business
i. Assets are valued at market value.
ii. Future bonus rates have been set at levels which would fully
utilise the assets supporting the policyholders' portion of the
with-profits business in accordance with established practice. The
proportion of profits derived from with-profits business allocated
to shareholders amounts to almost 10% throughout the
projection.
iii. The value of in-force business reflects the cost, including
administration expenses, of providing for benefit enhancement or
compensation in relation to certain products.
iv. Other actuarial assumptions have been set at levels
commensurate with recent operating experience, including those for
mortality, morbidity, persistency and maintenance expenses
(excluding the development costs referred to below). These are
normally reviewed annually.
An allowance is made for future mortality improvement. For new
business, mortality assumptions may be modified to take certain
scheme specific features into account.
v. Development costs relate to investment in strategic systems
and development capability that are charged to the covered
business. Projects charged to the non-covered business are included
within Group investment projects in LGC and group expenses.
Overseas covered business
vi. Other actuarial assumptions have been set at levels
commensurate with recent operating experience, including those for
mortality, morbidity, persistency and maintenance expenses.
European Embedded Value 90
5.08 Assumptions (continued)
Economic assumptions
As at As at As at
2014 2013 2012
% p.a. % p.a. % p.a.
Risk margin 3.3 3.4 3.7
Risk free rate(1)
- UK 2.2 3.4 2.3
- Europe 0.6 2.2 1.7
- US 2.2 3.1 1.8
Risk discount rate (net of tax)
- UK 5.5 6.8 6.0
- Europe 3.9 5.6 5.4
- US 5.5 6.5 5.5
Reinvestment
rate (US) 5.0 5.8 4.3
Other UK business assumptions
Equity risk
premium 3.3 3.3 3.3
Property risk
premium 2.0 2.0 2.0
Investment return (excluding annuities
in LGR )
- Fixed interest:
-Gilts & non 1.7 - 2.4 2.2 - 3.6 1.9 - 2.9
gilts
- Equities 5.5 6.7 5.6
- Property 4.2 5.4 4.3
Long-term rate
of return on
non profit annuities
in LGR 3.6 4.6 4.3
Inflation(2)
- Expenses/earnings 3.7 4.1 3.4
- Indexation 3.2 3.6 2.9
1. The risk free rate is the gross redemption yield on the 15
year gilt index. The Europe risk free rate is the 10 year ECB
AAA-rated Euro area central government bond par yield. The LGA risk
free rate is the 10 year US Treasury effective yield.
2. The LGR inflation rate has been set with reference to a
curve.
Tax
vii. The profits on the covered business, except for the profits
on the Society shareholder capital held outside the long term fund,
are calculated on an after tax basis and are grossed up by the
notional attributed tax rate for presentation in the income
statement. For the UK, the after tax basis assumes the annualised
current tax rate of 21.5% and the subsequent enacted future
reduction in corporation tax to 20% from 1 April 2015. The tax rate
used for grossing up is the long term corporate tax rate in the
territory concerned, which for the UK is 20% (31 December 2013:
20%) after taking into account the expected further rate reduction
to 20% by 1 April 2015. The profits on the Society shareholder
capital held outside the long term fund are calculated before tax
and therefore tax is calculated on an actual basis.
US, Netherlands and France covered business profits are also
grossed up using the long term corporate tax rates of the
respective territories i.e. US is 35% (31 December 2013: 35%),
France is 34.43% (31 December 2013: 34.43%) and Netherlands is 25%
(31 December 2013: 25%).
European Embedded Value 91
5.08 Assumptions (continued)
Stochastic calculations
viii. The time value of options and guarantees is calculated
using economic and non-economic assumptions consistent with those
used for the deterministic embedded value calculations.
A single model has been used for UK and international business,
with different economic assumptions for each territory reflecting
the significant asset classes in each territory.
Government nominal interest rates are generated using a LIBOR
Market Model projecting full yield curves at annual intervals. The
model provides a good fit to the initial yield curve.
The total annual returns on equities and property are calculated
as the return on 1 year bonds plus an excess return. The excess
return is assumed to have a lognormal distribution. Corporate bonds
are modelled separately by credit rating using stochastic credit
spreads over the risk free rates, transition matrices and default
recovery rates. The real yield curve model assumes that the real
short rate follows a mean-reverting process subject to two normally
distributed random shocks.
The significant asset classes are:
- UK with-profits business - equities, property and fixed rate
bonds of various durations;
- UK annuity business - fixed rate and index-linked bonds of
various durations; and
- International business - fixed rate bonds of various
durations.
The risk discount rate is scenario dependent within the
stochastic projection. It is calculated by applying the
deterministic risk margin to the risk free rate in each stochastic
projection.
European Embedded Value 92
5.08 Assumptions (continued)
Sensitivity calculations
ix. A number of sensitivities have been produced on alternative
assumption sets to reflect the sensitivity of the embedded value
and the new business contribution to changes in key assumptions.
Relevant details relating to each sensitivity are:
-- 1% variation in discount rate - a one percentage point
increase/decrease in the risk margin has been assumed in each case
(for example a 1% increase in the risk margin would result in a
4.3% risk margin).
-- 1% variation in interest rate environment - a one percentage
point increased/decreased parallel shift in the risk free curve
with consequential impacts on fixed asset market values, investment
return assumptions, risk discount rate, including consequential
changes to valuation bases.
-- 1% higher equity/property yields - a one percentage point
increase in the assumed equity/property investment returns,
excluding any consequential changes, for example, to risk discount
rates or valuation bases, has been assumed in each case (for
example a 1% increase in equity returns would increase assumed
total equity returns from 5.5% to 6.5%).
-- 10% lower equity/property market values - an immediate 10%
reduction in equity and property asset values.
-- 10% lower maintenance expenses, excluding any consequential
changes, for example, to valuation expense bases or potentially
reviewable policy fees (for example a 10% decrease on a base
assumption of GBP10 per annum would result in a GBP9 per annum
expense assumption).
-- 10% lower assumed persistency experience rates, excluding any
consequential changes to valuation bases, incorporating a 10%
decrease in lapse, surrender and premium cessation assumptions (for
example a 10% decrease on a base assumption of 7% would result in a
6.3% lapse assumption).
-- 5% lower mortality and morbidity rates, excluding any
consequential changes to valuation bases but including assumed
product repricing action where appropriate (for example if base
experienced mortality is 90% of a standard mortality table then,
for this sensitivity, the assumption is set to 85.5% of the
standard table).
The sensitivities for covered business allow for any material
changes to the cost of financial options and guarantees but do not
allow for any changes to reserving bases or capital requirements
within the sensitivity calculation, unless indicated otherwise
above.
European Embedded Value 93
5.09 Methodology
Basis of preparation
The supplementary financial information has been prepared in
accordance with the European Embedded Value (EEV) Principles issued
in May 2004 by the European Insurance CFO Forum.
The supplementary financial information has been reviewed by
PricewaterhouseCoopers LLP and prepared with assistance from our
consulting actuary Milliman in the USA.
Changes to accounting policy - IASB consolidation project
On 1 January 2014 the application of IFRS 10, 'Consolidated
Financial Statements' became compulsory for entities reporting in
the EU.
IFRS 10, 'Consolidated Financial Statements' defines the
principal of control and establishes control as the basis for
determining which entities are consolidated in the consolidated
financial statements. This states that an investor controls an
investee when it is exposed, or has rights, to variable returns
from its involvement with the investee and has the ability to
affect those returns through its power over the investee. The
application of IFRS 10 has resulted in the Group consolidating a
small number of investment vehicles which were not previously
consolidated which impacted the gain attributable to
non-controlling interest.
As a result, the prior year disclosure in the Group embedded
value summary and Note 5.05 have been restated to reflect the
adoption by the Group of IFRS 10, 'Consolidated Financial
Statements'. The effect on amounts previously reported at 31
December 2013 is shown below. Embedded value at 31 December 2013
remains unaffected by the adoption.
2013
GBPm
Profit for the year as previously
reported (after tax) 1,289
Gains on non-controlling interests
IFRS 10 'Consolidated Financial
Statements' amendment 10
Revised profit for the
year (after tax) 1,299
Covered business
The Group uses EEV methodology to value individual and group
life assurance, pensions and annuity business written in the UK,
Europe and the US. The UK covered business also includes
non-insured self invested personal pension (SIPP) business.
The managed pension funds business has been excluded from
covered business and is reported on an IFRS basis.
All other businesses are accounted for on the IFRS basis adopted
in the primary financial statements.
There is no distinction made between insurance and investment
contracts in our covered business as there is under IFRS.
European Embedded Value 94
5.09 Methodology (continued)
Description of methodology
The objective of EEV is to provide shareholders with realistic
information on the financial position and current performance of
the Group.
The methodology requires assets of an insurance company, as
reported in the primary financial statements, to be attributed
between those supporting the covered business and the remainder.
The method accounts for assets in the covered business on an EEV
basis and the remainder of the Group's assets on the IFRS basis
adopted in the primary financial statements.
The EEV methodology recognises profit from the covered business
as the total of:
i. cash transfers during the relevant period from the covered
business to the remainder of the Group's assets; and
ii. the movement in the present value of future distributable
profits to shareholders arising from the covered business over the
relevant reporting period.
Embedded value
Shareholders' equity on the EEV basis comprises the embedded
value of the covered business plus the shareholders' equity of
other businesses, less the value included for purchased interests
in long term business.
The embedded value is the sum of the shareholder net worth (SNW)
and the value of the in-force business (VIF). SNW is defined as
those amounts, within covered business (both within the long term
fund and held outside the long term fund but used to support long
term business), which are regarded either as required capital or
which represent free surplus.
The VIF is the present value of future shareholder profits
arising from the covered business, projected using best estimate
assumptions, less an appropriate deduction for the cost of holding
the required level of capital and the time value of financial
options and guarantees (FOGs).
Service companies
All services relating to the UK covered business are charged on
a cost recovery basis, with the exception of investment management
services provided to Legal & General Pensions Limited (LGPL)
and to Legal & General Assurance Society Limited (LGAS).
Profits arising on the provision of these services are valued on a
look through basis.
As the EEV methodology incorporates the future capitalised cost
of these internal investment management services, the equivalent
IFRS profits have been removed from the investment management
(LGIM) segment and are instead included in the results of the LGAS
and LGR segments on an EEV basis.
The capitalised value of future profits emerging from internal
investment management services are therefore included in the
embedded value and new business contribution calculations for the
LGAS and LGR segments. However, the historical profits which have
emerged continue to be reported in the shareholders' equity of the
LGIM segment on an IFRS basis. Since the look through into service
companies includes only future profits and losses, current
intra-group profits or losses must be eliminated from the closing
embedded value and in order to reconcile the profits arising in the
financial period within each segment with the net assets on the
opening and closing balance sheet, a transfer of IFRS profits for
the period from the UK SNW is deemed to occur.
New business
New business premiums reflect income arising from the sale of
new contracts during the reporting period and any changes to
existing contracts, which were not anticipated at the outset of the
contract.
In-force business comprises previously written single premium,
regular premium, recurrent single premium contracts and payments in
relation to existing longevity insurance. Longevity insurance
product comprises the exchange of a stream of fixed leg payments
for a stream of floating payments, with the value of the income
stream being the difference between the two legs. New business
annual premiums have been excluded for longevity insurance due to
the unpredictable deal flow from this type of business.
New business contribution arising from the new business premiums
written during the reporting period has been calculated on the same
economic and operating assumptions used in the embedded value at
the end of the financial period. This has then been rolled forward
to the end of the financial period using the risk discount rate
applicable at the end of the reporting period.
The present value of future new business premiums (PVNBP) has
been calculated and expressed at the point of sale. The PVNBP is
equivalent to total single premiums plus the discounted value of
regular premiums expected to be received over the term of the
contracts using the same economic and operating assumptions used
for the embedded value at the end of the financial period. The
discounted value of longevity insurance regular premiums is
calculated on a net of reinsurance basis to enable a more
representative margin figure.
The new business margin is defined as new business contribution
at the end of the reporting period divided by the PVNBP. The
premium volumes and projection assumptions used to calculate the
PVNBP are the same as those used to calculate new business
contribution.
Intra-group reinsurance arrangements are in place between the US
and UK businesses, and it is expected that these arrangements will
be periodically extended to cover recent new business. LGA new
business premiums and contribution reflect the groupwide expected
impact of LGA directly-written business.
European Embedded Value 95
5.09 Methodology (continued)
Projection assumptions
Cash flow projections are determined using best estimate
assumptions for each component of cash flow and for each policy
group. Future economic and investment return assumptions are based
on conditions at the end of the financial period. Future investment
returns are projected by one of two methods. The first method is
based on an assumed investment return attributed to assets at their
market value. The second, which is used by LGA, where the
investments of that subsidiary are substantially all fixed
interest, projects the cash flows from the current portfolio of
assets and assumes an investment return on reinvestment of surplus
cash flows. The assumed discount and inflation rates are consistent
with the investment return assumptions.
Detailed projection assumptions including mortality, morbidity,
persistency and expenses reflect recent operating experience and
are normally reviewed annually. Allowance is made for future
improvements in annuitant mortality based on experience and
externally published data. Favourable changes in operating
experience are not anticipated until the improvement in experience
has been observed.
All costs relating to the covered business, whether incurred in
the covered business or elsewhere in the Group, are allocated to
that business. The expense assumptions used for the cash flow
projections therefore include the full cost of servicing this
business.
Tax
The projections take into account all tax which is expected to
be paid, based on best estimate assumptions, applying current
legislation and practice together with known future changes.
Allowance for risk
Aggregate risks within the covered business are allowed for
through the following principal mechanisms:
i. setting required capital levels with reference to both the
Group's internal risk based capital models, and an assessment of
the strength of regulatory reserves in the covered business;
ii. allowing explicitly for the time value of financial options
and guarantees within the Group's products; and
iii. setting risk discount rates by deriving a Group level risk
margin to be applied consistently to local risk free rates.
Required capital and free surplus
Regulatory capital for the UK LGAS and LGR businesses is
provided by assets backing the with-profits business or by the SNW.
The SNW comprises all shareholders' capital within Society,
including those funds retained within the long term fund and the
excess assets in LGPL (collectively Society shareholder
capital).
Society shareholder capital is either required to cover EU
solvency margin or is free surplus as its distribution to
shareholders is not restricted.
For UK with-profits business, the required capital is covered by
the surplus within the with-profits part of the fund and no effect
is attributed to shareholders except for the burn-through cost,
which is described later. This treatment is consistent with the
Principles and Practices of Financial Management for this part of
the fund.
For UK non profit business, the required capital will be
maintained at no less than the level of the EU minimum solvency
requirement. This level, together with the margins for adverse
deviation in the regulatory reserves, is, in aggregate, in excess
of internal capital targets assessed in conjunction with the
Individual Capital Assessment (ICA) and the with-profits support
account.
The initial strains relating to new non profit business,
together with the related EU solvency margin, are supported by
releases from existing non profit business and the Society
shareholder capital. As a consequence, the writing of new business
defers the release of capital to free surplus. The cost of holding
required capital is defined as the difference between the value of
the required capital and the present value of future releases of
that capital. For new business, the cost of capital is taken as the
difference in the value of that capital assuming it was available
for release immediately and the present value of the future
releases of that capital. As the investment return, net of tax, on
that capital is less than the risk discount rate, there is a
resulting cost of capital which is reflected in the value of new
business.
For LGA, the Company Action Level (CAL) of capital has been
treated as required capital for modelling purposes. The CAL is the
regulatory capital level at which the company would have to take
prescribed action, such as submission of plans to the State
insurance regulator, but would be able to continue operating on the
existing basis. The CAL is currently twice the level of capital at
which the regulator is permitted to take control of the
business.
For LGN, required capital has been set at 104% of EU minimum
solvency margin for all products without FOGs. For those products
with FOGs, capital of between 104% and 339% of the EU minimum
solvency margin has been used. These capital requirements have been
scaled up by a factor of 1.042 at the total level to ensure the
total requirement meets the 160% Solvency I from the capital policy
for the EEV, for the NBVA no scaling is applied. The level of
capital has been determined using risk based capital
techniques.
For LGF, 100% of EU minimum solvency margin has been used for EV
modelling purposes for all products both with and without FOGs. The
level of capital has been determined using risk based capital
techniques.
The contribution from new business for our international
businesses reflects an appropriate allowance for the cost of
holding the required capital.
European Embedded Value 96
5.09 Methodology (continued)
Financial options and guarantees
Under the EEV Principles an allowance for time value of FOGs is
required where a financial option exists which is exercisable at
the discretion of the policyholder. These types of option
principally arise within the with-profits part of the fund and
their time value is recognised within the with-profits burn-through
cost described below. Additional financial options for non profit
business exist only for a small amount of deferred annuity business
where guaranteed early retirement and cash commutation terms apply
when the policyholders choose their actual retirement date.
Further financial guarantees exist for non profit business, in
relation to index-linked annuities where capped or collared
restrictions apply. Due to the nature of these restrictions and the
manner in which they vary depending on the prevailing inflation
conditions, they are also treated as FOGs and a time value cost
recognised accordingly.
The time value of FOGs has been calculated stochastically using
a large number of real world economic scenarios derived from
assumptions consistent with the deterministic EEV assumptions and
allowing for appropriate management actions where applicable. The
management action primarily relates to the setting of bonus rates.
Future regular and terminal bonuses on participating business
within the projections are set in a manner consistent with expected
future returns available on assets deemed to back the policies
within the stochastic scenarios.
In recognising the residual value of any projected surplus
assets within the with-profits part of the fund in the
deterministic projection, it is assumed that terminal bonuses are
increased to exhaust all of the assets in the part of the fund over
the future lifetime of the in-force with-profits policies. However,
under stochastic modelling, there may be some extreme economic
scenarios when the total projected assets within the with-profits
part of the fund are insufficient to pay all projected policyholder
claims and associated costs. The average additional shareholder
cost arising from this shortfall has been included in the time
value cost of financial options and guarantees and is referred to
as the with-profits burn-through cost.
Economic scenarios have been used to assess the time value of
the financial guarantees for non profit business by using the
inflation rate generated in each scenario. The inflation rate used
to project index-linked annuities will be constrained in certain
real world scenarios, for example, where negative inflation occurs
but the annuity payments do not reduce below pre-existing levels.
The time value cost of FOGs allows for the projected average cost
of these constrained payments for the index-linked annuities. It
also allows for the small additional cost of the guaranteed early
retirement and cash commutation terms for the minority of deferred
annuity business where such guarantees have been written.
LGA FOGs relate to guaranteed minimum crediting rates and
surrender values on a range of contracts, as well as impacts on
no-lapse guarantees (NLG). The guaranteed surrender value of the
contract is based on the accumulated value of the contract
including accrued interest. The crediting rates are discretionary
but related to the accounting income for the amortising bond
portfolio. The majority of the guaranteed minimum crediting rates
are between 3% and 4%. The assets backing these contracts are
invested in US Dollar denominated fixed interest securities.
LGN separately provides for two types of guarantees: interest
rate guarantees and maturity guarantees. Certain contracts provide
an interest rate guarantee where there is a minimum crediting rate
based on the higher of 1-year Euribor and the policy guarantee
rate. This guarantee applies on a monthly basis. Certain other
linked contracts provide a guaranteed minimum value at maturity
where the maturity amount is the higher of the fund value and a
guarantee amount. The fund values for both these contracts are
invested in Euro denominated fixed interest securities.
For LGF, FOGs which have been separately provided for relate to
guaranteed minimum crediting rates and surrender values on a range
of contracts. The guaranteed surrender value of the contract is the
accumulated value of the contract including accrued bonuses. The
bonuses are based on the accounting income for the amortising bond
portfolios plus income and releases from realised gains on any
equity type investments. Policy liabilities equal guaranteed
surrender values. In general, the guaranteed annual bonus rates are
between 0% and 4.5%.
Risk free rate
The risk free rate is set to reflect both the pattern of the
emerging profits under EEV and the relevant duration of the
liabilities where backing assets reflect this assumption (e.g.
equity returns). For the UK, it is set by reference to the gross
redemption yield on the 15 year gilt index. For LGA, the risk free
rate is the 10 year US Treasury effective yield, while the 10 year
ECB AAA-rated Euro area central government bond par yield is used
for LGN and LGF.
European Embedded Value 97
5.09 Methodology (continued)
Risk discount rate
The risk discount rate (RDR) is a combination of the risk free
rate and a risk margin, which reflects the residual risks inherent
in the Group's covered businesses, after taking account of
prudential margins in the statutory provisions, the required
capital and the specific allowance for FOGs.
The risk margin has been determined based on an assessment of
the Group's weighted average cost of capital (WACC). This
assessment incorporates a beta for the Group, which measures the
correlation of movements in the Group's share price to movements in
a relevant index. Beta values therefore allow for the market's
assessment of the risks inherent in the business relative to other
companies in the chosen index.
The WACC is derived from the Group's cost of equity and debt,
and the proportion of equity to debt in the Group's capital
structure measured using market values. Each of these three
parameters is forward looking, although informed by historic
information and appropriate judgements where necessary. The cost of
equity is calculated as the risk free rate plus the equity risk
premium for the chosen index multiplied by the Company's beta.
Forward-looking or adjusted betas make allowance for the observed
tendency for betas to revert to 1 and therefore a weighted average
of the historic beta and 1 tends to be a better estimate of the
Company's beta for the future period. We have computed the WACC
using an arithmetical average of forward-looking betas against the
FTSE 100 index.
The cost of debt used in the WACC calculations takes account of
the actual locked-in rates for our senior and subordinated long
term debt. All debt interest attracts tax relief at a rate of 20.1%
(2013: 20.1%).
Whilst the WACC approach is a relatively simple and transparent
calculation to apply, subjectivity remains within a number of the
assumptions. Management believes that the chosen margin, together
with the levels of required capital, the inherent strength of the
Group's regulatory reserves and the explicit deduction for the cost
of options and guarantees, is appropriate to reflect the risks
within the covered business.
Analysis of profit
Operating profit is identified at a level which reflects an
assumed longer term level of investment return.
The contribution to operating profit in a period is attributed
to four sources:
i. new business;
ii. the management of in-force business;
iii. development costs; and
iv. return on shareholder net worth.
Further profit contributions arise from actual investment return
differing from the assumed long term investment return (investment
return variances), and from the effect of economic assumption
changes. These are shown below operating profit.
The contribution from new business represents the value
recognised at the end of each period from new business written in
that period, after allowing for the actual cost of acquiring the
business and of establishing the required technical provisions and
reserves and after making allowance for the cost of capital. New
business contributions are calculated using closing
assumptions.
The contribution from in-force business is calculated using
opening assumptions and comprises:
i. expected return - the discount earned from the value of
business in-force at the start of the year;
ii. experience variances - the variance in the actual experience
over the reporting period from that assumed in the value of
business in-force as at the start of the year; and
iii. operating assumption changes - the effects of changes in
future assumptions, other than changes in economic assumptions from
those used in valuing the business at the start of the year. These
changes are made prospectively from the end of the period.
Development costs relate to investment in strategic systems and
development capability.
The contribution from shareholder net worth comprises the
increase in embedded value based on assumptions at the start of the
year in respect of the expected investment return on the Society
shareholder capital.
Further profit contributions arise from investment return
variances and the effect of economic assumption changes.
Economic variances represent:
i. the effect of actual investment performance and changes to
investment policy on SNW and VIF business from that assumed at the
beginning of the period; and
ii. the effect of changes in economic variables on SNW and VIF
business from that assumed at the beginning of the period, which
are beyond the control of management, including associated changes
to valuation bases to the extent that they are reflected in revised
assumptions.
European Embedded Value 98
Proforma 99
On 28 November 2014, the Group announced changes to its organisational
structure effective from 1 January 2015. In terms of changes to the
Group's segmental results, the only change is the move of the workplace
savings business from the LGAS Savings division into LGIM. The proforma
shown below restates the LGAS Savings and LGIM segmental information
for the prior periods to reflect these changes. To reiterate, no other
segmental changes have been made to the Group's results following this
announcement.
FY 2014 FY 2013
====================================== ======================================
Reported Adjusted Reported Adjusted Reported Adjusted Reported Adjusted
Savings Savings LGIM LGIM Savings Savings LGIM LGIM
GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm
Operational cash
generation 140 127 262 275 164 152 239 251
New business strain (43) (14) (29) (58) (22) (36)
Net cash generation 97 113 262 246 106 130 239 215
Experience variances (10) (7) (3) (27) (13) (14)
Changes in valuation
assumptions 8 3 5 11 2 9
Non-cash items and
other (20) (22) 2 (22) (29) 7
International and
other (1) (1) - - - -
Operating profit
after tax 74 86 262 250 68 90 239 217
Tax expense 16 19 74 71 21 28 65 58
Operating profit
before tax 90 105 336 321 89 118 304 275
Investment variance (19) (24) (12) (7) (55) (47) (6) (14)
Profit before tax 71 81 324 314 34 71 298 261
HY 2014 HY 2013
====================================== ======================================
Reported Adjusted Reported Adjusted Reported Adjusted Reported Adjusted
Savings Savings LGIM LGIM Savings Savings LGIM LGIM
GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm
Operational cash
generation 71 64 125 132 82 76 119 125
New business strain (23) (8) (15) (31) (14) (17)
Net cash generation 48 56 125 117 51 62 119 108
Experience variances (6) (3) (3) (5) (3) (2)
Changes in valuation
assumptions (1) - (1) 11 (1) 12
Non-cash items and
other (6) (10) 4 (22) (12) (10)
International and
other - - - (1) (1) -
Operating profit
after tax 35 43 125 117 34 45 119 108
Tax expense 9 11 34 32 11 14 33 30
Operating profit
before tax 44 54 159 149 45 59 152 138
Investment variance (18) (18) (5) (5) (35) (27) (2) (10)
Profit before tax 26 36 154 144 10 32 150 128
This information is provided by RNS
The company news service from the London Stock Exchange
END
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