REG - Chesnara PLC - Final Results <Origin Href="QuoteRef">CSN.L</Origin> - Part 5

ChesnaraAnnouncement

31/03/2016 07:06

- Part 5: For the preceding part double click  ID:nRSe6231Td 

yields remain constant; and 
 
(iii)    10% decrease in the equity and property values.  This gives rise to a situation where, for example, a Managed Fund
unit liability with a 60% equity holding would reduce by 6% in value. 
 
Operating sensitivities 
 
(i)      10% decrease in maintenance expenses, giving rise to, for example, a base assumption of £20 per policy pa reducing
to £18 per policy pa; 
 
(ii)     10% decrease in persistency rates giving rise to, for example, a base assumption of 10% of policy base lapsing pa
reducing to 9% pa; 
 
(iii)    5% decrease in mortality/morbidity rates giving rise to, for example, a base assumption of 95% of the parameters
in a selected mortality/morbidity table reducing to 90.25% of the parameters in the same table, assuming no changes are
made to policyholder charges or any other management actions; and 
 
(iv)    the sensitivity to the reduction in the required capital to the statutory minimum shows the effect of reducing the
required capital to the minimum requirement prescribed by regulation. 
 
In each sensitivity calculation all other assumptions remain unchanged except where they are directly affected by the
revised economic conditions: for example, as stated, changes in interest rates will directly affect the reference rate. 
 
4    Earnings per share 
 
 Year ended 31 December                      
                               2015   2014   
                               p      p      
 Basic earnings per share                    
 Based on profit for the year  50.17  38.24  
 Diluted earnings per share                  
 Based on profit for the year  50.06  38.20  
 
 
5    Covered business 
 
The Group uses EEV methodology to value the bulk of its long-term business (the 'covered business'), which is written
primarily in the UK, Sweden and Netherlands, as follows: 
 
(i)   for the UK Business, the covered business of CA and S&P comprises the business's long-term business being those
individual life insurance, pensions and annuity contracts falling under the definition of long-term insurance business for
UK regulatory purposes. 
 
(ii)  for the Swedish Business (comprising the Movestic segment), the covered business comprises the business's long-term
pensions and savings unit-linked business.  Group life and sickness business, including waiver of premium and non-linked
individual life assurance policies are not included in the covered business: the result relating to this business is
established in accordance with IFRS principles and is included within 'other operational result' within the consolidated
summarised income statement. 
 
(iii) for the Dutch Business the covered business comprises the long-term insurance business of Waard Leven and Hollands
Welvaren.  The general insurance business within Waard Schade is not included in the covered business, with the result
relating to this business being established in accordance with IFRS principles and is included within 'other operating
result' within the EEV consolidated income statement. 
 
(iv) The operating expenses of the holding company, Chesnara plc, are allocated across the segments. 
 
Under EEV principles no distinction is made between insurance and investment contracts, as there is under IFRS, which
accords these classes of contracts different accounting treatments. 
 
6    Methodology 
 
(a) Embedded Value 
 
Overview 
 
Shareholders' equity comprises the embedded value of the covered business, together with the net equity of other Group
companies, including that of the holding company which is stated after writing down fully the carrying value of the covered
business. 
 
The embedded value of the covered business is the aggregate of the shareholder net worth ('SNW') and the present value of
future shareholder cash flows from in-force covered business (value of in-force business) less any deduction for (i) the
cost of guarantees within S&P, and (ii) the cost of required capital. It is stated after allowance has been made for
aggregate risks in the business. SNW comprises those amounts in the long-term businesses, which are either regarded as
required capital or which represent surplus assets within that business. 
 
New business 
 
CA, S&P and Waard Group 
 
Much of the covered business is in run-off and is therefore substantially closed to new business.  Accordingly, for these
segments, not all of those items related to new business values, which are recommended by the EEV guidelines, are reported
in this supplementary financial information. 
 
Movestic 
 
New business, in relation to the pensions and savings covered business is taken as all business where contracts are signed
and new premiums paid during the reporting period, for both new policies and premium increases on existing business, but
excluding standard renewals.  New business premium volumes as disclosed in "Enhance value through new business" on page 22
are not consistent with this definition, as they include non-covered business. 
 
New business premium volumes for the year are as follows: 
 
 Pensions and savings covered business31 December                  
                                                   2015£m  2014£m  
 New business premium income                       40.7    47.4    
 Regular premium increments                        14.2    15.8    
 Total new business premium income*                54.9    63.2    
 
 
*Basis: annualised premium plus 1/10 single premium translated into sterling at the 2015 average rate of SEK 12.8946 = £1
(2014: SEK 11.2989) = £1). 
 
The new business contribution has been assessed as at the end of the year, using opening assumptions. 
 
Value of in-force business 
 
The cash flows attributable to shareholders arising from in-force business are projected using best estimate assumptions
for each component of cash flow. 
 
The present value of the projected cash flows is established by using a discount rate which reflects the time value of
money and the risks associated with the cash flows which are not otherwise allowed for.  There is a deduction for the cost
of holding the required capital, as set out below. 
 
In respect of Movestic there are certain non-linear exposures of shareholder profit to asset returns arising from variable
administrative fees and variable investment fund rebates which are modelled deterministically rather than stochastically. 
 
Participating business 
 
For participating business within the S&P business the Group maintains the assets and liabilities in separate with-profits
funds.  In accordance with the Principles and Practices of Financial Management, in the first instance all benefits, which
in some cases include guaranteed minimum investment returns, are paid from policyholder assets within the fund.  The
participating business effectively operates as a smoothed unit-linked contract subject to minimum benefit guarantees.  The
with-profits funds contain assets which are attributable to shareholders as well as those attributable to policyholders. 
Assets attributable to shareholders can only be released from the fund subject to meeting prudent liabilities in respect of
minimum benefits and the frictional cost of this restriction has been allowed for in determining the value of the in-force
business. 
 
Fundamentally, the value of the with-profits in-force business is driven by the fund management charges levied on the
policyholder assets, subject to the effect of minimum benefit guarantees. 
 
Taxation 
 
The present value of the projected cash flows arising from in-force business takes into account all tax which is expected
to be paid under current legislation, including tax which would arise if surplus assets within the covered business were
eventually to be distributed.  All previously announced changes in corporation tax affecting future periods has been
allowed for, with the exception of the most recent reduction in corporation tax rates, announced by the Chancellor on 16
March 2016. 
 
The value of the in-force business has been calculated on an after-tax basis and is grossed up to the pre-tax level for
presentation in the income statement.  The amount used for the grossing up is the amount of shareholder tax, excluding
those payments made on behalf of policyholders, being policyholder tax in the UK businesses, corporation tax rate for the
Waard Group and yield tax in Movestic. 
 
Cost of capital 
 
The valuation approach used requires consideration of 'frictional' costs of holding shareholder capital: in particular, the
cost of tax on investment returns and the impact of investment management fees can reduce the face value of shareholder
funds.  For CA, the expenses relating to corporate governance functions eliminate any taxable investment return in
shareholder funds, while investment management fees are not material.  The cost of holding the required capital to support
the covered business (see Note 6(b)) is reflected as a deduction from the value of in-force business. 
 
Financial options and guarantees 
 
CA 
 
The principal financial options and guarantees in CA are (i) guaranteed annuity rates offered on some unit-linked pension
contracts and (ii) a guarantee offered under Timed Investment Funds that the unit price available at the selected maturity
date (or at death, if earlier) will be the highest price attained over the policy's life.  The cost of these options and
guarantees has been assessed, in principle, on a market-consistent basis, but, in practice, this has been carried out on
approximate bases, which are appropriate to the level of materiality of the results. 
 
S&P 
 
The principal financial options and guarantees in S&P are (i) minimum benefits payable on maturity or retirement for
participating business; (ii) the option to extend the term under the Personal Retirement Account contract on terms
potentially beneficial to the policyholder; (iii) the option to increase premiums under the Personal Retirement Account
contract on terms potentially beneficial to the policyholder; and (iv) certain insurability options offered. 
 
The cost of guaranteeing a minimum investment return on participating contracts, being the only material guarantee, has
been assessed on a market consistent basis.  This has involved the use of a stochastic asset model, which is designed to
establish a cost of guarantees which is consistent with prices in the market at the valuation date, for example the prices
of derivative instruments.  For the remaining options and guarantees the cost has been assessed on an approximate basis,
appropriate to the level of materiality of the results. 
 
Movestic 
 
In respect of Movestic, some contracts provide policyholders with an investment guarantee, whereby a minimum rate of return
is guaranteed for the first 5 years of the policy, at a rate of 3% per annum.  The value of the guarantee is ignored as it
is not material to the results. 
 
Waard Group 
 
The unit-linked business within Hollands Welvaren contains a minimum return to policyholders, of 20% of the premium.  As
this guarantee is substantially out of the money, it is ignored on materiality grounds. 
 
Allowance for risk 
 
Allowance for risk within the covered business is made by: 
 
(i)      setting required capital levels by reference to the assessment of capital needs made by the Directors of the
regulated entities within the respective businesses; 
 
(ii)     setting the risk discount rate, which is applied to the projected cash flows arising on the in-force business, at
a level which includes an appropriate risk margin (see Note 6(c)); and 
 
(iii)    explicit allowance for the cost of financial options and guarantees and, where appropriate, for reinsurer
default. 
 
Internal group company 
 
EEV Guidance requires that actual and expected profit or loss incurred by an internal group company on services provided to
the covered business should be included in allowances for expenses.  The covered business in Movestic is partially managed
by an internal group fund management company. Not all relevant future income and expenses of that company have been
included in the calculation of embedded value.  However, the effect is not considered to be material. 
 
Consolidation adjustments 
 
Consolidation adjustments have been made to: 
 
(i)      eliminate the investment in subsidiaries; 
 
(ii)     allocate group debt finance against the segment to which it refers; and 
 
(iii)    allocate corporate expenses as explained in Note 7(d). 
 
(b) Level of required capital 
 
The level of required capital of the covered business reflects the amount of capital that the Directors consider necessary
and appropriate to manage the respective businesses.  In forming their policy the Directors have regard to the minimum
statutory requirements and an internal assessment of the market, insurance and operational risks inherent in the underlying
products and business operations.  The capital requirement resulting from this assessment represents: 
 
(i)      for CA plc (comprising the CA and S&P segments), 162.5% of the long-term insurance capital requirement ('LTICR')
together with 100% of the resilience capital requirement ('RCR'), as determined by the regulations of the Prudential
Regulation Authority in the UK; 
 
(ii)     for Movestic, 150% of the regulatory solvency requirement as determined by the regulations of the
Finansinspektionen in Sweden. 
 
(iii)    for the Waard Group, 200% of the regulatory solvency requirements as determined by the regulations of De
Nederlandsche Bank in the Netherlands. 
 
The required level of regulatory capital is provided as follows: 
 
(i)      for the UK Business, by the retained surplus within the long-term business fund and by share capital and retained
earnings within the shareholder funds of the regulated entity; 
 
(ii)     for Movestic, by share capital and additional equity contributions from the parent company, net of the accumulated
deficit in the regulated entity, these components together comprising shareholder's equity; and 
 
(iii)    for the Waard Group, by the retained surplus and by share capital and retained earnings within the shareholder
funds of the regulated entities. 
 
(c) Discount rates 
 
The discount rates are a combination of the reference rate and a risk margin.  The reference rate reflects the time value
of money and the risk margin reflects any residual risks inherent in the covered business and makes allowance for the risk
that future experience will differ from that assumed.  In order to reduce the subjectivity when setting the discount rates,
the Group has decided to adopt a 'bottom up' market-consistent approach to allow explicitly for market risk. 
 
Using the market-consistent approach, each cash flow is valued at a discount rate consistent with that used in the capital
markets: in accordance with this, equity-based cash flows are discounted at an equity discount rate and bond-based cash
flows at a bond discount rate.  In practice a short-cut method known as the 'certainty equivalent' approach has been
adopted.  This method assumes that all cash flows earn the reference rate of return and are discounted at the reference
rate. 
 
In general, and consistent with the market's approach to valuing financial instruments for hedging purposes, the reference
rate is based on swap yields.  These have been taken as mid swap yields available in the market at the end of the reporting
period. 
 
Allowance also needs to be made for non-market risks.  For some of these risks, such as mortality and expense risk, it is
assumed that the shareholder can diversify away any uncertainty where the impact of variations in experience on future cash
flows is symmetrical.  For those risks that are assumed to be diversifiable, no adjustment has been made.  For any
remaining risks that are considered to be non-diversifiable risks, there is no risk premium observable in the market and,
therefore, a constant margin has been added to the risk margin. 
 
(d) Analysis of profit 
 
The contribution to operating profit, which is identified at a level which reflects an assumed longer-term level of
investment return, arises from three sources: 
 
(i)      new business; 
 
(ii)     return from in-force business; and 
 
(iii)    return from shareholder net worth. 
 
Additional contributions to profit arise from: 
 
(i)      variances between the actual investment return in the year and the assumed long-term investment return; and 
 
(ii)     the effect of economic assumption changes. 
 
The contribution from new business represents the value recognised at the end of each year in respect of new business
written in that year, after allowing for the cost of acquiring the business, the cost of establishing the required
technical provisions and after making allowance for the cost of capital, calculated on opening assumptions. 
 
The return from in-force business is calculated using closing assumptions and comprises: 
 
(i)      the expected return, being the unwind of the discount rates over the year applied to establish the value of
in-force business at the beginning of the year; 
 
(ii)     variances between the actual experience over the year and the assumptions made to establish the value of business
in force at the beginning of the year; and 
 
(iii)    the net effect of changes in future assumptions, made prospectively at the end of the year, from those used in
establishing the value of business in force at the beginning of the year, other than changes in economic assumptions. 
 
The contribution from shareholder net worth comprises the actual investment return on residual assets in excess of the
required capital. 
 
(e) Assumption setting 
 
There is a requirement under EEV methodology to use best estimate demographic assumptions and to review these at least
annually with the economic assumptions being reviewed at each reporting date. The current practice is detailed below. 
 
Each year the demographic assumptions are reviewed as part of year-end processes and hence were reviewed in December 2015. 
 
The detailed projection assumptions, including mortality, morbidity, persistency and expenses reflect recent operating
experience. Allowance is made for future improvement in annuitant mortality based on experience and externally published
data.  Favourable changes in operating experience, particularly in relation to expenses and persistency, are not
anticipated until the improvement in experience has been observed.  Holding company expenses (for the Chesnara Group such
expenses relate largely to listed company functions) are allocated across the segments in proportion to the value before
tax of the in-force business.  Hence the expense assumptions used for the cash flow projections include the full cost of
servicing this business. 
 
The economic assumptions are reviewed and updated at each reporting date based on underlying investment conditions at the
reporting date.  The assumed discount rates and inflation rates are consistent with the investment return assumptions. 
 
In addition, the demographic assumptions used at 31 December 2015 are considered to be best estimate and, consequently, no
further adjustments are required.  In respect of the CA Business, the assumptions required in the calculation of the value
of the annuity rate guarantee on pension business have been set equal to best-estimate assumptions. 
 
(f)  Pension schemes 
 
In Movestic, where the Group participates in a combined defined benefit and defined contribution scheme, future
contributions to the scheme are reflected in the value of in-force business. 
 
(g) Financial reinsurance 
 
In respect of Movestic the Group uses financial reinsurance to manage the impact of its new business strain.  Whilst this
liability is valued at fair value within the IFRS financial statements, allowing for an option which provides the Group
with the right to settle the liability early on beneficial terms, when valuing the shareholder net worth within the EEV it
is considered more appropriate to assess this liability at a higher cost, reflecting the likelihood of the option not being
utilised. 
 
7    Assumptions 
 
(a) Investment Returns 
 
Investment returns are assumed to be equal to the reference rate, as covered in Note 6(c).  For linked business, the
aggregate return has been determined by the reference rate less an appropriate allowance for tax. 
 
The rates presented below are indicative spot rates: 
 
                                                                                           
 31 December                                                                               
                  CA*           S&P         Movestic    Waard Group  
                  2015   2014        2015   2014        2015         2014     2015   2014  
 5 year           1.60%  1.46%       1.60%  1.46%       0.68%        0.65%    0.33%  -     
 10 year          2.04%  1.88%       2.04%  1.88%       1.59%        1.27%    1.02%  -     
 15 year          2.22%  2.12%       2.22%  2.12%       2.04%        1.63%    1.45%  -     
 20 year          2.25%  2.26%       2.25%  2.26%       2.28%        1.82%    1.63%  -     
 25 year          2.21%  2.29%       2.21%  2.29%       2.28%        1.82%    1.66%  -     
 30 year          2.17%  2.30%       2.17%  2.30%       2.28%        1.82%    1.67%  -     
 Inflation - RPI  2.50%  2.60%       2.50%  2.60%       1.89%        1.42%    1.50%  -     
                                                                                           
 
 
*The PL segment is now reported within the CA segment, and as such a single rate of 1.90% is applied for all durations (31
December 2014: 1.80%). 
 
(b) Actuarial assumptions 
 
The demographic assumptions used to determine the value of the in-force business have been set at levels commensurate with
the underlying operating experience identified in the periodic actuarial investigations. 
 
Certain products contain provisions that provide for the charges in respect of mortality risk to be reviewable.  In these
cases assumptions for future experience and charges are assumed to be linked and assumptions are only updated when
decisions have been made regarding product charges, so as not to capitalise any benefits that may not accrue to
shareholders. 
 
(c) Taxation 
 
Projected tax has been determined assuming current tax legislation and rates continue unaltered, except where future tax
rates or practices have been announced.  The tax rates for the UK business allow for changes in Corporation Tax as
announced by the Chancellor in his budget speech of 8 July 2015, so reflect a reduction from the current rate of 20% to 19%
from April 2017 and to 18% from April 2020. 
 
(d) Expenses 
 
The expense levels are based on internal expense analysis investigations and are appropriately allocated to the new
business and policy maintenance functions. 
 
For CA and S&P, these have been determined by reference to: 
 
(i)      the outsourcing agreements in place with our third-party business process administrators; 
 
(ii)     anticipated revisions to the terms of such agreements as they fall due for renewal; and 
 
(iii)    corporate governance costs relating to the covered business. 
 
For Movestic, these have been determined by reference to: 
 
(i)      an expense analysis in which all expenses were allocated to covered and uncovered business, with expenses for the
covered business being allocated to acquisition and maintenance activities; and 
 
(ii)     expense drivers, being, in relation to acquisition costs, the number of policies sold during the year and, in
relation to maintenance expenses, the average number of policies in force during the year. 
 
For the Waard Group, these have been determined by reference to: 
 
(i)      expenses of the covered business excluding those deemed to not relate to ongoing management of the covered
business; 
 
(ii)     consideration of a suitable allocation between fixed expenses and those that vary with business volumes; and 
 
(iii)    the agreement in place with Tadas as the Group's internal administration company for the Dutch covered business. 
 
Holding company expenses (for the Chesnara Group such expenses relate largely to listed company functions) are allocated
across the segments on a basis that reflects each segment's economic consumption of such costs. 
 
EEV Guidance requires that no allowance is made for future productivity improvements in expense assumptions.  For the UK
business, for expenses relating to policy administration this requirement is met.  As the UK company is essentially closed
to new business, those governance expenses which are not immediately variable can reasonably be expected to reduce through
management control in the future, though the timing and scale of such reductions is not fixed.  A prudent estimate of the
reductions has been allowed for within the expense assumptions. 
 
(e) Discount rate 
 
An explicit constant margin is added to the reference rate shown in (a) above to cover any remaining risks that are
considered to be non-market, non-diversifiable risks, as there is no risk premium observable in the market.  This margin,
which is 50 basis points for CA and S&P (as at 31 December 2014: 50 basis points) and 100 basis points for Movestic (as at
31 December 2014: 100 basis points) and 50 basis points for the Waard Group, gives due recognition to the relative
sensitivity of the value of in-force business to the discount rate for the different businesses, and to the fact that: 
 
a) For CA: 
 
(i)      the covered business is closed to new business; 
 
(ii)     there is no significant exposure in the with-profit business, which is wholly reinsured; 
 
(iii)    expense risk is limited as a result of the outsourcing of substantially all policy administration and related
functions to third-party business process administrators; and 
 
(iv)    for much of the life business the Group has the ability to vary risk charges made to policyholders. 
 
b) For S&P: 
 
(i)      the covered business is closed to new business; and 
 
(ii)     expense risk is limited as a result of the outsourcing of substantially all policy administration and related
functions to third-party business process administrators. 
 
c) For Movestic: 
 
(i)      the covered business remains open; 
 
(ii)     reinsurance is used to significantly reduce insurance risks; and 
 
(iii)    a number of the risks provide diversification benefits within the Chesnara Group, in relation to reinsurance
counterparties, market exposures and policyholder populations. 
 
d) For the Waard Group: 
 
(i)      the covered business is substantially closed to new business; 
 
(ii)     reinsurance is used to significantly reduce insurance risks; and 
 
(iii)    there are no material guarantees or other asymmetrical items within the cash flows. 
 
This information is provided by RNS
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