REG - Chesnara PLC - Half-year Report <Origin Href="QuoteRef">CSN.L</Origin> - Part 2
31/08/2016 07:06
- Part 2: For the preceding part double click ID:nRSe4739Ia
policies sold in the period;
- Sales volumes are up on the same period in 2015; and
- The period has seen in increase in additional investments being made by existing policyholders.
Risks associated with this strategic objective
- The attractiveness of unit linked products can be influenced by economic conditions especially as some traditional
products offer guaranteed returns in uncertain times. That said Swedish investors tend not to adopt an "all or nothing
approach" to equity exposure and hence there will always be a certain level of unit linked demand.
- New business volumes are sensitive to the quality of service to the IFA and the end customer. Movestic continues to
score highly in internal and external service level assessments.
- New business remains relatively concentrated towards several large IFAs. This is inevitable to some extent but the fact
that Movestic continues to increase the breadth of IFA support reduces this concentration risk. Whilst Movestic has
further broadened its coverage of the IFA market, the fact remains that a large proportion of new business comes from two
large IFA firms thereby creating a level of concentration risk. Movestic continue to score highly when assessed by the
main IFA distributors across all elements including, fund range, sustainability and cost.
- The competitive market puts pressure on new sales margins. Movestic's margins have generally held up well although the
improved terms offered for the higher margin transfer business is evidence of the pressure on margins. Movestic has
redressed the margin balance by successfully focussing on achieving better terms in the fund operation, and by improving
sales mix towards the higher margin products.
CAPITAL MANAGEMENT - Solvency II
Managing the group and subsidiaries' capital positions appropriately is a critical part of ensuring we remain true to the
group's culture and values, which includes a clear focus on maintaining adequate financial resources. We are
well-capitalised at a group and subsidiary level under Solvency II. In applying Solvency II we have not used any elements
of the Long Term Guarantee Package, including transitional arrangements.
The group and its subsidiaries manage capital in accordance with their respective capital management policies, which are
based on the requirements of our regulators. These policies include the concept of a "management buffer", which is
incremental to the regulatory capital.
Chesnara group
Solvency 30 Jun 2016 £m 31 Dec 2015£m
Total assets less liabilities 403.4 401.6
Ring-fenced fund restriction (5.2) (4.8)
Proposed dividend (8.6) (15.6)
Own funds 389.6 381.1
Solvency capital requirement 263.4 260.6
Surplus own funds above solvency capital requirement 126.3 120.5
Solvency ratio (post dividend) 148% 146%
Capital requirement including "Management buffer" 289.7 286.7
Surplus above internal capital requirement (includes "management buffer") 99.9 94.5
Movement in assets less liabilities £m
31 Dec 2015 401.6
Expected in period 3.9
New Business 1.7
Operating variances 1.9
Operating assumptions (3.4)
Economic impact (6.5)
Non-operating variances (1.8)
Risk margin (7.9)
Taxation 6.1
Dividends (15.6)
Foreign exchange 23.4
30 Jun 2016 403.4
Movement in SCR £m
31 Dec 2015 260.6
Market risk (10.3)
Counterparty (0.4)
Life underwriting 3.9
Health underwriting 0.1
Operational risk 0.2
Diversification (0.5)
Loss absorbing capacity of deferred tax (1.2)
Capital requirement of other financial institutions 0.1
Forex impact 10.9
30 Jun 2016 263.4
Analysis
- Strong group solvency maintained with small increase in absolute level of surplus.
- Transitional arrangements have not been used.
- Solvency is stated after deducting interim dividend of £8.6m.
- Group own funds broadly in line with year end, with reduction in own funds in the UK being offset by growth in Swedish
and Dutch divisions.
- Capital requirements increased due to the weakening of sterling against the Swedish krona and the euro, off-set by a
reduction in investment related market risk capital requirements.
- The group solvency surplus shows only marginal difference in the impacts of a 25% equity and property stress and a 2%
reduction in the yield curve.
Sensitivities Own funds SCR Surplus Solvency ratio %
Base valuation 389.6 (263.3) 126.3 148%
25 % reduction in equity and property value (73.2) 41.5 (31.7) (5)%
2% reduction in yield curve (24.1) (5.9) (30.0) (12)%
UK
Solvency 30 Jun 2016£m 31 Dec 2015£m
Total assets less liabilities 198.4 203.0
Ring-fenced fund restriction (5.2) (4.8)
Proposed dividend (30.5) (30.5)
Own funds 162.8 167.7
Solvency capital requirement 118.4 123.8
Surplus own funds above solvency capital requirement 44.4 43.9
Solvency ratio (post dividend) 137% 135%
Capital requirement including "Management buffer" 142.1 148.5
Surplus above internal capital requirement (includes "management buffer") 20.7 19.1
Movement in assets less liabilities £m
31 Dec 2015 203.0
Expected in period 1.6
Operating variances 4.6
Operating assumptions (3.1)
Economic impact (3.3)
Non-operating variances (1.1)
Risk margin (5.3)
Taxation 2.0
30 Jun 2016 198.4
Movement in SCR £m
31 Dec 2015 123.8
Market risk (6.7)
Counterparty (0.3)
Life underwriting 1.9
Health underwriting (0.4)
Operational risk 0.2
Diversification 0.6
Loss absorbing capacity of deferred tax (0.7)
30 Jun 2016 118.4
Analysis
- Strong solvency maintained despite headwinds from falling bond yields.
- Dividend of £30.5m was paid to Chesnara on 20 July 2016.
- Own funds reduction driven by the net impact of economic variances arising from bond value appreciation, off-set by bond
yield assumption changes giving rise to an increase in insurance technical provisions, mainly in relation to S&P products
with embedded guaranteed returns.
- Capital requirements have decreased in the period and reflect the net impact of:
o Reduced equity and interest market risk related capital requirement.
o Increased life underwriting risk capital as a consequence of yield curve reduction.
- A 2% fall in the yield curve has a greater impact on the division's solvency ratio than a 25% equity and property
stress.
Sensitivities Own funds SCR Surplus Solvency ratio %
Base valuation 162.8 (118.4) 44.4 137%
25 % reduction in equity and property value (28.0) 15.4 (12.6) (7)%
2% reduction in yield curve (15.4) (3.3) (18.7) (16)%
Sweden
Solvency 30 Jun 2016£m 31 Dec 2015£m
Total assets less liabilities 160.8 149.8
Proposed dividend - -
Own funds 160.8 149.8
Solvency capital requirement 104.5 97.5
Surplus own funds above solvency capital requirement 56.3 52.3
Solvency ratio (post dividend) 154% 154%
Capital requirement including "Management buffer" 125.4 117.0
Surplus capital resources above "Management requirement" 35.4 32.8
Movement in assets less liabilities £m
31 Dec 2015 149.8
Expected in period 1.8
New business 1.7
Operating variances (0.7)
Operating assumptions (0.5)
Economic impact (2.3)
Non-operating variances (0.7)
Risk margin (2.7)
Taxation (0.2)
Exchange rates 14.6
30 Jun 2016 160.8
Movement in SCR £m
31 Dec 2015 97.5
Market risk (6.6)
Counterparty 0.7
Life underwriting 2.9
Health underwriting 0.6
Operational risk 0.1
Diversification (0.6)
Other sectors 0.1
Forex impact 9.8
30 Jun 2016 104.5
Analysis
- Strong solvency maintained with small increase in absolute level of surplus.
- Own funds increase predominantly driven by exchange rate gains, with the Swedish krona strengthening against sterling by
10% during the period. This has offset the negative impact of investment market returns during the period.
- Capital requirements have increased during the period and reflect the net impact of:
o Exchange rate driven SCR increase; off-set by;
o Equity-driven market risk SCR reduction due to falling equity markets in the period.
- Movestic displays most sensitivity to an equity stress scenario due to its high level of collective investment holdings.
Movement in SCR Own funds SCR Surplus Solvency ratio %
Base valuation 160.8 (104.5) 56.3 154%
25 % reduction in equity and property value (46.5) 20.6 (25.9) (16%)
2% reduction in yield curve (7.7) (0.5) (8.2) (9)%
Netherlands
Solvency 30 Jun 2016£m 31 Dec 2015£m
Total assets less liabilities 78.8 69.8
Proposed dividend - -
Own funds 78.8 69.8
Solvency capital requirement 13.5 11.7
Surplus own funds above solvency capital requirement 65.3 58.1
Solvency ratio (post dividend) 584% 597%
Capital requirement including "Management buffer" 23.6 20.4
Surplus capital resources above "Management requirement" 55.2 49.4
Movement in assets less liabilities £m
31 Dec 2015 69.6
Expected in period 0.5
Operating variances 0.7
Operating assumptions 0.2
Economic impact (0.8)
Non-operating variances 0.0
Risk margin 0.1
Taxation (0.3)
Forex impact 8.8
30 Jun 2016 78.8
Movement in SCR £m
Dec 2015 11.7
Market risk 1.7
Counterparty (0.5)
Life underwriting (0.3)
Health underwriting (0.0)
Operational risk 0.0
Diversification (0.4)
Loss absorbing capacity of deferred tax (0.0)
Forex impact 1.3
Jun 2016 13.5
Analysis
- Strong solvency maintained albeit reduced from the 2015 closing position due to a higher capital requirement.
- Own funds increase as a consequence of the euro strengthening against sterling in the period, offset by declining yield
curve driven investment returns.
- Capital requirements increased in the period due to the combined impact of foreign exchange rate movements and market
risk increases, arising from a slight shift in investment holdings, moving from cash into collective investment schemes.
- The Waard Group remains fairly insensitive to equity stress due to its underlying asset mix.
Movement in SCR Own funds SCR Surplus Solvency ratio %
Base valuation 78.8 (13.5) 65.3 582%
25 % reduction in equity and property value (1.1) 0.3 (0.8) 4%
2% reduction in yield curve (1.9) (1.4) (3.3) (66)%
FINANCIAL REVIEW
The key financial performance indicators below are used by management to assess how we have performed in delivering our
three strategic objectives and our core culture and values. The overriding feature of the results of the group in the
first half of 2016 is the investment market performance during the period, most notably falling government bond yields in
both the UK and Eurozone. In particular this has given rise to losses in the UK on our products with guarantees.
IFRS PRE-TAX PROFIT £0.2m (Six months ended 30 June 2015: £30.4m)
IFRS TOTAL COMPREHENSIVE INCOME £15.7m (Six months ended 30 June 2015: £22.9m)
What is it?
The presentation of the results in accordance with International Financial Reporting Standards (IFRS) aims to recognise the
profit arising from the longer term insurance and investment contracts over the life of the policy.
Why is it important?
IFRS profit is an indicator of the value that has been generated within the long-term insurance funds of the divisions
within the group, and is a key measure used both internally and by our external stakeholders in assessing the performance
of the business. IFRS profit is an indicator of how we are performing against our stated strategic objective of
"maximising value from the existing business" and can also be impacted by one-off gains arising from delivering against our
stated objective of "acquiring life and pensions businesses".
Risks
The IFRS profit can be affected by a number of our principal risks and uncertainties as set out below. In particular,
volatility in equity markets and bond yields can result in volatility in the IFRS pre-tax profit.
Highlights
H1 2016 H1 2015
CA 14.2 13.9
S&P (13.9) 7.5
Movestic 3.6 3.4
Waard 2.0 -
Group & Consolidation adjustments (5.7) (10.7)
Profit on acquisition - 16.2
Taxation 0.2 (2.1)
Forex impact 15.3 (5.4)
Total profit before tax and exceptional items 15.6 22.8
- A Brexit-driven set of results.
- IFRS pre-tax profit of £0.2m is significantly lower than same period in prior year largely as a result of:
o Loss in S&P segment driven by falling government bond yields in the period;
o Comparative figures include a large one-off gain of £16.2m arising on acquisition of the Waard group.
- At a total comprehensive income level the group has reported positive exchange rate gains arising from a weakening
sterling against euro and Swedish Krona in the run up to, and post, the EU referendum result.
CASH GENERATION £13.6m (Six months ended 30 June 2015: £56.7m*)
What is it?
Net cash generation is a measure of how much distributable cash has been generated in the period. Cash generation is
driven by the change in amounts freely transferable from the operating businesses, taking into account board-approved
solvency buffers that are based on those imposed by our regulators. It follows that cash generation is not only influenced
by the level of surplus arising but also by the level of required solvency capital.
Why is it important?
Cash generation is a key measure, because it is the net cash flows to Chesnara from its life and pensions businesses which
support Chesnara's dividend-paying capacity and acquisition strategy. Cash generation can be a strong indicator of how we
are performing against our stated objective of "maximising value from the existing business". However, our cash generation
is always managed in the context of our stated value of maintaining strong solvency positions within the regulated entities
of the group.
Risks
The ability of the underlying regulated subsidiaries within the group to generate cash is affected by a number of our
principal risks and uncertainties as set out below. Whilst cash generation is a function of the regulatory surplus, as
opposed to the IFRS surplus, they are impacted by similar drivers, and therefore factors such as yields on fixed interest
securities and equity and property performance contribute significantly to the level of cash generation within the group.
Highlights
H1 2016
UK 1.5
Sweden 2.5
Netherlands 5.8
Other group activities 3.8
Total 13.6
- Positive cash contributions from all divisions drives total cash generation in the period that continues to support
our attractive dividend strategy.
- UK is at the lower end of the range, principally as a result of falling bond yields in the period.
- Movestic and Waard cash generation includes the benefit of positive foreign exchange gains.
* includes one-off cash generation of £39.9m arising on the acquisition of the Waard group.
ECONOMIC VALUE (ECV) £459.9m (31 December 2015: £453.4m)
What is it?
Economic value (EcV) has been introduced in the period by Chesnara as a replacement metric for European Embedded Value.
This has been introduced following the introduction of Solvency II at the start of 2016, with EcV being derived from
Solvency II own funds. Conceptually EcV is broadly similar to EEV in that both reflect a market-consistent assessment of
the value of existing insurance business, plus adjusted net asset value of the non-insurance business within the group.
Why is it important?
EcV aims to reflect the market-related value of in-force business and net assets of the non-insurance business and hence is
an important reference point by which to assess Chesnara's intrinsic value. A life and pensions group may typically be
characterised as trading at a discount or premium to its economic value. Analysis of EcV provides additional insight into
the development of the business over time.
The EcV development of the Chesnara group over time can be a strong indicator of how we have delivered to our strategic
objectives, in particular the value created from acquiring life and pensions businesses and enhancing our value through
writing profitable new business. It ignores the potential of new business to be written in the future (the franchise value
of our Swedish business) and the value of the company's ability to acquire further businesses.
Risks
The economic value of the group is affected by economic factors such as equity and property markets and yields on fixed
interest securities. In addition to this, whilst the other KPIs (which are all "performance measures") remain relatively
insensitive to exchange rate movements, the EcV position of the group can be materially affected by exchange rate
fluctuations. For example a 10.0% weakening of the Swedish krona and euro against sterling would reduce the EcV of the
group by 3.6% and 1.6% respectively, based on the composition of the group's EcV at 30 June 2016.
Highlights
£m
31 Dec 2015 453.4
EcV Earnings (3.5)
Dividends (15.6)
Fx gain 25.6
30 Jun 2016 459.9
- Economic value at the end of June 2016 remains broadly in line with the start of the year.
- Negative EcV earnings in the period driven by investment markets, with the UK and Dutch businesses being impacted by
bond yield falls and the Swedish business adversely affected by the suppressed equity markets that have been witnessed in
the period.
- EcV benefited from large foreign exchange gains that were reported in the period as a result of sterling deprecation.
- The year end dividend of £15.6m was paid in May, thereby reducing EcV
ECV EARNINGS NET OF TAX £(3.5)m
What is it?
In recognition of the longer-term nature of the group's insurance and investment contracts, supplementary information is
presented that provides information on the economic value of our business.
The principal underlying components of the economic value result are:
- The expected return from existing business (being the effect of the unwind of the rates used to discount the value
in-force).
- Value added by the writing of new business.
- Variations in actual experience from that assumed in the opening valuation.
- The impact of restating assumptions underlying the determination of expected cash flows.
- The impact of acquisitions.
Why is it important?
By recognising the market-related value of in-force business (in-force value), a different perspective is provided in the
performance of the group and on the valuation of the business. Economic value earnings are an important KPI as they
provide a longer-term measure of the value generated during a period. The economic value earnings of the group can be a
strong indicator of how we have delivered against all three of our core strategic objectives. This includes new business
profits generated from writing profitable new business, economic value profit emergence from our existing businesses, and
the economic value impact of acquisitions.
Risks
The EcV earnings of the group can be affected by a number of factors, including those highlighted within our principal
risks and uncertainties as set out below. In addition to the factors that affect the IFRS pre-tax profit and cash
generation of the group, the EcV earnings can be more sensitive to other factors such as the expense base and persistency
assumptions. This is primarily due to the fact that assumption changes in EcV affect our long-term view of the future cash
flows arising from our books of business.
Highlights
£m
Operating earnings (0.1)
Economic earnings (5.5)
Other 2.1
Total EcV earnings (3.5)
- EcV loss of £3.5m in the period primarily driven by impact of economic items, predominantly falling bond yields in the
UK and Europe.
- The "other items" includes the net impact of risk margin movements and tax items. Included within this is the
positive impact of refining our deferred tax modelling amounting to £4.2m.
IFRS PRE-TAX PROFIT £0.2m (Six months ended 30 June 2015: £30.4m)
IFRS TOTAL COMPREHENSIVE INCOME £15.7m (Six months ended 30 June 2015: £22.9m)
Executive summary
The group IFRS results reflect the natural dynamics of the segments of the group, which can be characterised in three major
components:
(1) Stable core: At the heart of surplus, and hence cash generation, are the CA and Waard group segments. The requirements
of these books are to provide a predictable and stable platform for the financial model and dividend strategy. As closed
books, the key is to sustain this income source as effectively as possible. The IFRS results below show that the stable
core continues to deliver against these requirements.
(2) Variable element: The S&P component can bring an element of short-term earnings volatility to the group, with the
results being particularly sensitive to investment market movements.
(3) Growth operation: The long-term financial model of Movestic is based on growth, with levels of new business and
premiums from existing business being targeted to more than offset the impact of policy attrition, leading to a general
increase in assets under management and, hence, management fee income.
IFRS results
The financial dynamics of Chesnara, as described above, are reflected in the following IFRS results:
IFRS profit Unaudited 6 months ended Year ended Note
30 Jun 2016 30 Jun 2015 31 Dec 2015
£m £m £m
CA 14.2 13.9 23.9 1
S&P (13.9) 7.5 10.6 2
Movestic 3.6 3.4 6.7 3
Waard Group 2.0 - 0.9 4
Chesnara (2.9) (7.4) (9.5) 5
Consolidation adjustments (2.8) (3.2) (6.4) 6
Profit before tax and profit on acquisition 0.2 14.2 26.2
Profit arising on acquisition of the Waard group - 16.2 16.6 4
Profit before tax 0.2 30.4 42.8
Tax 0.2 (2.1) (3.0)
Profit after tax 0.4 28.3 39.8
Foreign exchange translations differences 15.3 (5.4) (0.2) 7
Total comprehensive income 15.7 22.9 39.6
Note 1: The CA segment has reported results for the period in line with the same period in 2015, despite the downward
pressure on results arising from falling bond yields in the period and relatively flat equity growth. Further insight is
provided in the CA segmental analysis below.
Note 2: The S&P segment has reported a loss for the first half of the year driven by the impact of falling bond yields in
the period causing a strain on the insurance provisions held for products that contain guaranteed returns. During the same
period in 2015 bond yields increased slightly. Further detail can be found below.
Note 3: The Movestic result has improved slightly when compared with the same period in 2015. This is principally driven
by an increase in the profits arising in the asset management business. Further analysis can be found on below.
Note 4: The Waard group was purchased on 19 May 2015 and therefore did not contribute materially to underlying profits. A
one-off gain on acquisition of £16.6m was recognised in 2015, representing the excess of the net assets acquired over the
purchase price. Profit contribution in 2015 was in line with expectations.
Note 5: The Chesnara result represents holding company expenses. 2016 costs are lower than 2015 costs primarily due to a
one off foreign currency re-translation loss of £3.5m arising from holding euros prior to the completion of the Waard group
purchase.
Note 6: Consolidation adjustments relate to items such as the amortisation of intangible assets and remain broadly in line
with the same period last year.
Note 7: As a result of sterling weakening against both euro and the Swedish krona in the period the IFRS result includes a
large foreign exchange gain, off-setting the negative impact that falling bond yields have had on our results in the
period.
The IFRS results by business segment are analysed in more detail as follows:
CA
The key components of the IFRS result for CA for the period are as follows:
H1 2016£m H1 2015 £m Note
Product-based charges 7.6 8.3 8
Administration expenses (5.2) (4.8) 8
Experience variances 5.5 7.0 9
Assumption changes (0.7) (1.0) 10
Policyholder tax 3.8 2.8 11
Variation from investment return 9.6 0.4 12
Economic assumption changes (6.4) 1.2 12
Total 14.2 13.9
Note 8: Product-based deductions and administrative expenses have remained broadly in line period on period, as would be
expected. Charges have remained resilient to policy attrition.
Note 9: Positive experience variances in the period are largely driven by mortality surpluses with a smaller contribution
from positive lapse experience. A similar dynamic existed in 2015.
Note 10: No significant changes in assumptions have been made during the period.
Note 11: Policyholder tax represents the net impact of deductions taken from policyholders' funds to settle tax liabilities
arising from returns in unit-linked funds and any reserves held to settle such tax. Deductions from policyholders exceeded
the reduction in the reserve in the period as a result of favourable movements in fund values, underpinned by the increase
seen in gilts and UK equities. There was no such equivalent gilt growth in the same period in 2015, and equity performance
in that period was marginally adverse.
Note 12: variation from investment return and economic assumption changes should be considered together. Investment
returns in the period are largely as a result of bond yields having fallen significantly across all durations, with 10 year
gilt yields falling by 98 basis points. This has given rise to a large increase in the value of bonds that the segment is
invested in. However, as a result of falling bond yields in the period the assumption for the estimated future investment
return that was made at the start of the year has been reduced. This causes an increase in the value of our insurance
liabilities, thereby causing the strain seen above. No such dynamic existed in the prior year equivalent period.
S&P
The key components of the IFRS result for S&P for the period are as follows:
H1 2016£m H1 2015 £m Note
Product-based charges 7.0 7.2 1
Administration expenses (4.6) (4.6) 2
Experience variances (1.6) 0.1 3
Assumption changes (3.8) (0.3) 4
Policyholder tax 1.2 1.1 5
Variation from investment return 17.5 0.5 6
Economic assumption changes (29.6) 3.5
Total (13.9) 7.5
Note 1: Product-based deductions and administrative expenses have remained broadly in line period on period, as would be
expected. Product deductions have remained resilient to policy attrition.
Note 2: Slightly adverse experience in the period caused by marginally adverse mortality experience.
Note 3: The adverse assumption change in the period is driven by an increase in insurance provisions of £3.5m, attributable
to assuming a 1% cap on exit fees for those policyholders with pension products who are aged over 55.
Note 4: Policyholder tax represents the net impact of deductions taken from policyholders' funds to settle tax liabilities
arising from returns in unit-linked funds and any reserves held to settle such tax. The small positive contribution in the
period is primarily the consequence of higher tax deductions due to increases in fund values, supported by gilt value
appreciation and modest UK equity growth.
Note 5: Variation from investment returns and economic assumption changes should be considered in conjunction with each
other. During the period bond yields have fallen significantly across all durations, with 10 year gilt yields falling by
98 basis points and this has given rise to a large increase in the value of bonds that the segment is invested in.
However, falling bond yields have increase the value of our insurance liabilities, to a larger extent than the CA segment.
This is because the S&P segment has a number of policies that contain minimum guaranteed returns, and as future investments
returns reduce, this causes a strain on the segment's insurance liabilities because both the value and volume of product
guarantees increases.
Movestic
The key components of the IFRS result for Movestic for the period are as follows:
H1 2016£m H1 2015 £m Note
Pension and savings 2.1 2.9 6
Life and health 0.4 0.1 7
Movestic Kapital 1.5 0.1 8
Other (0.4) 0.3 9
Total 3.6 3.4
Note 6: The Pensions & Savings business continues to be the core source of IFRS profit in Movestic. The segment has
reported IFRS profits that are slightly lower than in the same period in 2015. The main driver of the reduction is that
the prior year included one off investment performance fees of £1.0m. In addition to this premium volumes are slightly
lower than in the prior year, and investment performance in the first six months was down on last year due to poor
performing equity markets in the period, with a knock on impact of slightly reduced asset management charges to
policyholders.
Note 7: The Life and Health business has generated a slightly higher profit when compared with the same period in 2015.
Underlying profits are broadly in line over each period, with 2016 reporting the benefits of a profit on commission from
Modernac, the reinsurance company that Movestic owns 49% of, amounting to £0.5m.
Note 8: Movestic Kapital is the Swedish division's internal investment management business. Developing this operation has
been a significant area of management focus, with the increase in contribution from this aspect of the division arising
from increases in performance fees arising from general growth in the operation.
Note 9: The "Other" component includes: the results of Movestic's associated company, Modernac; investment income and fair
value adjustments on the financial reinsurance that Movestic uses to fund the writing of new Pensions & Savings business.
There have been no significant fluctuations in the profit contributions that these aspects of the business create.
Waard group
The Waard group has reported a profit of £2.0m in the period, slightly up on the profit of £0.9m that was reported in the
latter half of 2015, post Chesnara acquisition. Profits principally arise from mortality surpluses arising from the Waard
group's term assurance policies.
CASH GENERATION £13.6m (Six months to 30 June 2015: £56.7m)
Cash in the business is generated from increases in the group's surplus funds. Surplus funds represent the excess of
assets held over management's internal capital needs, as laid down in each division's and the group management policy.
These are based on regulatory capital requirements, with the inclusion of additional "management buffers". The first six
months of 2016 is the first period that our cash generation metric has been calculated with reference to Solvency II based
capital management policies. Comparatives as reported applied our previous Solvency I based capital policies.
Highlights
- Cash has continued to be generated across the group, with cash generation in the period of £13.6m continuing to be of
a magnitude that would support our previous levels of dividend.
- Cash generation in the prior period benefitted from a one-off positive contribution of £39.9m, arising on the
acquisition of the Waard group.
- UK cash continues to be generated despite being hampered by the impact of falling bond yields, which has had an
overall negative impact on both own funds and required levels of capital.
- The Swedish and Dutch divisions have reported positive cash development in the period. A contributing factor of this
is the positive Swedish krona and euro exchange gains witnessed.
- Other group activities reflects the impact of consolidation routines, specifically movements in capital requirements
determined at a group level.
Cash generation for period ended 30 June 2016 (£m) Group UK Sweden Netherlands Other group activities
Increase/(decrease) in own funds 17.0 (5.0) 10.9 9.0 2.1
Decrease/(increase) in management's internal capital requirement (3.4) 6.5 (8.4) (3.2) 1.7
Cash generation 13.6 1.5 2.5 5.8 3.8
Impact of moving from Solvency I to Solvency II on cash reporting:
- The "day 1" transitional impact on our cash reporting of moving from Solvency I to Solvency II is complex and has
various dynamics at play:
- At a divisional level the transition to Solvency II had a modestly positive impact on collective absolute levels of
surplus within our divisions, and hence absolute cash potential.
- At a group level incremental solvency capital is required to be held over and above that held in our divisions. This
is required to cover the group's exposure to foreign currency fluctuations, driven by our operations in Sweden and the
Netherlands, and this offsets the positive capital benefit of having diversified operations. As a result the absolute
level of day one surplus at a group level is lower under Solvency II, as reported on page 23 of the 2015 Annual Report &
Accounts.
- In the medium term this constraint will not impact cash distribution expectations.
- In the longer term the constraint can be reduced through management actions such as currency hedging. In addition, the
process of distributing cash from the non-UK divisions to Chesnara, as is assumed to be the case in the long-term, will
reduce the absolute value of the group level capital required to cover this foreign exchange exposure.
ECV EARNINGS £(3.5)m *
Economic value earnings are negative for the first six months of the year, driven by the negative impact of falling bond
yields in the period.
Analysis of the EcV result in the period by earnings source:
6m to 30 Jun 2016£m
Expected movement in period 4.3
New business 4.0
Operating variances 3.2
Operating assumption changes (8.5)
Other operating variances (3.2)
Total operating earnings (0.2)
Economic experience variances 34.2
Economic assumption variances (39.7)
Total economic earnings (5.5)
Other non-operating variances (1.2)
Risk margin movement (2.9)
Tax 6.3
Total EcV earnings (3.5)
Analysis of the EEV result in the year by business segment
6m to 30 Jun 2016£m Note
UK (5.5) 1
Sweden (3.8) 2
Netherlands 0.6 3
Group and group adjustments (1.1) 4
EcV earnings before tax (9.8)
Tax 6.3 5
EcV earnings after tax (3.5)
* This is the first period that EcV earnings have been reported. Consequently comparative information has not been
presented.
Economic conditions: As with our previously reported EEV metric, the EcV result is sensitive to investment market
conditions. Key investment market conditions in the period are as follows:
- The FTSE All share index has increased by 2.1%;
- The Swedish OMX all share index has decreased by 6.8%; and
- 10 year UK gilt yields have fallen from 2.01% to 1.03%.
Note 1 - UK: Operating earnings of £1.6m in the UK business are largely in line with expectations. Economic losses of
£3.3m have been reported in the period, driven by the impact of falling bond yields on the business, largely through
increases in reserves held for policies with guarantees. The risk margin within the UK business has increased by £2.7m in
the period, largely owing to the impact of falling bond yields on the level at which the risk margin is discounted.
Note 2 - Sweden: The Swedish division has reported a small operating loss in the period, largely driven by the net impact
of profits on new business written of £4.0m being offset by adverse operating assumption changes of £5.3m caused by expense
assumption strengthening in the period and a reduction in expected performed fees. A small economic loss of £1.4m has been
reported, predominantly as a result of marginally negative equity returns in the period. The risk margin held for the
Swedish division has increased by £1.3m in the period.
Note 3 - Netherlands: The Dutch division has not reported significant movements in its economic value in the period. This
is largely because the division's value is not particularly sensitive to investment market movements.
Note 4 - Group: A small loss has been reported in the group component. This largely relates to costs incurred in the
period.
Note 5 - Tax: The business is reporting a tax credit of £6.3m in the period. This is driven by a combination of deferred
tax on the loss in the period in the UK, coupled with a modelling adjustment for deferred tax when compared with the
opening period.
ECV £459.9m (31 December 2015: £453.4m)
The economic value of Chesnara represents the present value of future profits of the existing insurance business, plus the
adjusted net asset value of the non-insurance business within the group. EcV is an important reference point by which to
assess Chesnara's intrinsic value.
Value movement 1 January 2016 to 30 June 2016
£m
EEV 31 Dec 2015 455.2
Adj to EcV (1.8)
EcV 31 Dec 2015 453.4
EcV earnings (3.5)
Dividends (15.6)
Fx gain 25.6
EcV 30 Jun 2016 459.9
EEV adj: The opening EcV of the group is £1.8m lower than our previously reported EEV. As expected, the two reporting
metrics provide a consistent view of the value of the group.
EcV earnings: Negative EcV earnings in the period driven by investment markets. In particular, the UK and Dutch
businesses have been impacted by bond yield falls and the Swedish business has been adversely affected by the suppressed
equity markets that have been witnessed in the period.
Dividends: Under EcV, dividends are recognised in the period in which they are paid. Dividends of £15.6m were paid during
the first half of 2016, being the final dividend from 2015.
FX gain: The EcV of the group benefited from large foreign exchange gains that were reported in the period as a result of
sterling deprecation.
EcV to Solvency II
£m
Economic value 459.9
Risk margin (37.6)
Contract boundaries (18.9)
Own fund restrictions (5.2)
Dividends (8.6)
Group SII own funds 389.6
Our reported EcV is based on a Solvency II assessment of the value of the business, but adjusted for certain items where it
is deemed that Solvency II does not reflect the commercial value of the business. The above waterfall shows the key
difference between EcV and SII, with explanations for each item below.
Risk margin: Solvency II rules require a significant 'risk margin' which is held on the Solvency II balance sheet as a
liability, and this is considered to be materially above a realistic cost. We therefore reduce this margin for risk for EcV
valuation purposes from being based on a 6% cost of capital to a 3% cost of capital.
Contract boundaries: Solvency II rules do not allow for the recognition of future cash flows on certain in-force
contracts, despite the high probability of receipt. We therefore make an adjustment to reflect the realistic value of the
cash flows under EcV.
Ring-fenced fund restrictions: Solvency II rules require a restriction to be placed on the value of certain ring-fenced
funds. These restrictions are reversed for EcV valuation purposes as they are deemed to be temporary in nature.
Dividends: The proposed interim dividend of £8.6m is recognised for SII regulatory reporting purposes. It is not
recognised within EcV until it is actual paid.
EcV by segment at 30 June 2016
£m
UK 230.3
Movestic 183.1
Waard 81.1
Other group activities (34.6)
Group SII Own funds 459.9
The above table shows that the EcV of the group is diversified across its different markets. In particular, the EcV of the
UK and Swedish operations are of similar sizes, showing that we are well-balanced and not over-exposed to one particular
geographic market.
Replacement of EEV
During the period we have replaced the previous group valuation metric, European Embedded Value, with a new metric,
economic value (EcV). This has been introduced to align our valuation metric with Solvency II, with EcV being derived from
the Solvency II balance sheet.
As expected, the new valuation metric gives a broadly similar value of the Chesnara plc group. At 31 December 2015 our
previously reported EEV was £455.2m, compared with an opening EcV of £453.4m.
Our Embedded Value figures have historically been subject to an external audit opinion addressed to the Directors of
Chesnara plc. This reflected the significance of the Embedded Value figures and was consistent with industry best
practice.
The Economic Value figures are at this stage not subject to audit opinion other than to the extent the general audit
opinion of the Financial Statements considers their consistency with the Financial Statements.
External audit requirements regarding Solvency II disclosures remain to be finalised. The expectation is that the Solvency
II figures will be subject to external audit from the 2016 year end and as such given the Economic Value figures are
derived from the Solvency II balance sheet we expect to extend an audit opinion to the Economic Value disclosures in our
full year Report and Accounts.
RISK MANAGEMENT
Managing risk is a key part of our business model. We achieve this by understanding the current and emerging risks to the
business, mitigating them where appropriate and ensuring they are appropriately monitored and managed at all times.
Chesnara adopts the "three lines of defence" model across the group taking into account size, nature and complexity, with a
single set of risk and governance principles applying consistently across the business, underpinned by board-approved group
and divisional governance maps and risk policies.
PRINCIPAL RISKS AND UNCERTAINTIES
Risks and uncertainties are assessed by reference to the extent to which they threaten, or potentially threaten, the
ability of the group to meet its core strategic objectives. These currently centre on the intention of the group to treat
customers fairly and maintain an attractive dividend profile.
There are a number of potential risks and uncertainties which could have a material impact on performance over the
remaining months of the financial year causing material fluctuation in actual results from those expected.
Recent events such as the European Union referendum result has triggered an increase in economic uncertainty and the latest
round of FCA consultations have increased the range of potential outcomes faced by the UK division.
The directors, however, do not consider that the principal risks and uncertainties have changed materially since
publication of the annual report for the year ended 31 December 2015.
A detailed explanation of the risks faced by Chesnara and how they are mitigated can be found on pages 36 to 39 of the
annual report. These risks are summarised in the table below.
RISK IMPACT
Adverse mortality/ morbidity/ longevity experience In the event that actual mortality or morbidity rates are worse than from the assumptions underlying product pricing and subsequent reserving, less profit will accrue to the group.
Adverse persistency experience If persistency rates are significantly lower than those assumed in product pricing and subsequent reserving, this will lead to reduced group profitability in the medium to long-term.
Expense overruns and unsustainable unit cost growth For the closed UK and Dutch businesses, the group is exposed to the impact of fixed and semi-fixed expenses, in conjunction with a diminishing policy base, on profitability. For the Swedish open life and pensions business, the group is exposed to the
impact of expense levels varying adversely from those assumed in product pricing.
Significant and prolonged equity market falls A significant part of the group's income and, therefore, overall profitability derives from fees received in respect of the management of policyholder and investor funds. Fee levels are generally proportional to the value of funds under management and, as
the managed investment funds overall comprise a significant equity content, the group is exposed to the impact of significant and prolonged equity market falls, which may lead to policyholders switching to lower-margin, fixed-interest funds.
Adverse exchange rate movements against sterling Exposure to sterling:Swedish krona and sterling:euro exchange rate movements arises from actual planned cash flows between Chesnara and its overseas subsidiaries and from the impact on reported IFRS, EcV and SII results which are expressed in sterling.
Counterparty failure The group carries significant inherent risk of counterparty failure in respect of:- its fixed interest security portfolio;- cash deposits; and- payments due from reinsurers.
Adverse movements in yields on fixed interest securities The group maintains portfolios of fixed interest securities (i) in order to match its insurance contract liabilities, in terms of yield and cash flow characteristics, and (ii) as an integral part of the investment funds it manages on behalf of
policyholders and investors. It is exposed to mismatch losses arising from a failure to match its insurance contract liabilities or from the fact that sharp and discrete fixed interest yield movements may not be associated fully and immediately with
corresponding changes in actuarial valuation interest rates.
Failure of outsourced service providers to fulfil contractual obligations The group's UK life and pensions businesses are heavily dependent on outsourced service providers to fulfil a significant number of their core functions. In the event of failure by any of the service providers to fulfil their contractual obligations, in
whole or in part, to the requisite standards specified in the contracts, the group may suffer losses, poor customer outcomes, or reputational damage as its functions degrade.
Key man dependency The nature of the group is such that it relies on a number of key individuals who have particular knowledge, experience and know how. The group is, accordingly, exposed to the sudden loss of the services of these individuals.
Adverse regulatory and legal changes The group operates in jurisdictions which are currently subject to significant change arising from regulatory and legal requirements. These may either be of a local nature, or of a wider nature, following from EU-based regulation and law. Significant
issues which have arisen and where there is currently uncertainty as to their full impact on the group include:i) the FCA's review of legacy business; ii) the changes in pensions legislation in April 2015; andiii) HM Treasury's review of exit
charges on pensions business.
Inconsistent regulation across territories Chesnara currently operates in three regulatory domains and is therefore exposed to inconsistent application of regulatory standards across divisions, such as the imposition of higher capital buffers over and above regulatory minimums. Potential
consequences of this risk for Chesnara constraining the efficient and fluid use of capital within the group, or creating a non-level playing field with respect to future deal assessments.
Availability of future acquisitions Chesnara's inorganic growth strategy is dependent on the availability of attractive future acquisition opportunities. Hence, the business is exposed to the risk of a reduction in the availability of available acquisition opportunities in Chesnara's
current target markets, for example arising as a result of a change in competition in the consolidation market or from regulatory change influencing the extent of life company strategic restructuring.
Defective acquisition due diligence Through the execution of acquisitions, Chesnara is exposed to the risk of erosion of value or financial losses arising from risks inherent within businesses or funds acquired which are not adequately priced for or mitigated within the transaction.
Cyber fraud Cyber fraud is a growing risk affecting all companies, particularly in the financial sector.This risk
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