REG - Chesnara PLC - Half-year Report <Origin Href="QuoteRef">CSN.L</Origin> - Part 2
31/08/2017 07:06
- Part 2: For the preceding part double click ID:nRSe3461Pa
range.
- Whilst maintaining the focus on protection, Scildon plan to increase the assets under management for pension business
and remain market leader in the small but growing unit linked market.
KPIs
Scildon - term assurance market share %
% 2013 2014 2015 2016 30 Jun 2017
Market share 10.9 5.0 6.6 5.9 7.4
Scildon - new business profit
£m 2013 2014 2015 2016 30 Jun 2017
New business profit/(loss) 0.9 (3.5) 0.1 2.0 1.7
BUSINESS REVIEW | acquire life and pensions businesses
On 5 April 2017 we completed the acquisition of Legal & General Nederland (subsequently renamed Scildon).
The completion of Scildon, which had an economic value of E237.5m at the point of acquisition, results in the group having
40% of its Economic Value in the Netherlands.
The deal was funded by a combination of debt, equity and existing cash resources.
This acquisition represents the ongoing delivery of our acquisition strategy in the Netherlands, following the purchase of
the Waard Group in 2015. We believe this deal leaves us with sufficient scale and presence to progress further value
adding deals in the Dutch market.
Highlights of Scildon acquisition:
- Completion purchase price of E161.2m
- Economic value of E237.5m at acquisition, representing a purchase price discount of 32%
- The impact of the acquisition, after taking account of the equity de-risk programme, is to increase the solvency
surplus of the group by £4.7m
- Integration plans progressing well, with equity de-risk programme completed
Acquisition of Scildon
About Scildon
E237.5m EcV 204% Solvency ratio 175,000 Policies E2.2bn AUM 149 Employees
- Scildon is a long established, award winning specialist insurer in the Netherlands.
- It has approximately 175,000 policies, predominantly individual protection and savings contracts and operates on a
stand alone basis.
- It is open to new business and sells protection, individual savings and group pensions contracts via a broker led
distribution model.
- Scildon is well-capitalised, with a solvency ratio of 204% at the point of acquisition. It applies the standard
formula with no transitional measures.
Impact on the group
Cash generation
- Cash generation is expected to emerge from the business post acquisition at levels which would more than cover
incremental funding costs thereby creating a net positive impact on group cash.
Value
- Scildon was purchased at a 32% discount to its economic value, resulting in a day 1 gain of £65.4m.
- This one off gain contributes materially to overall group EcV of £700.4m.
- The Netherlands now makes up 40% of group EcV.
Customer outcomes
- Continuity of Scildon's operating model will ensure existing high quality customer outcomes are not compromised.
Risk appetite
- The risks associated with Scildon align with the appetite of the Chesnara group following the equity de-risk
activity.
- Our integration plans include bringing Scildon within the group's risk management framework.
Policy numbers
- Additional policies of 175,000 results in the group now managing a policy base of over 1 million, of which 26% are in
the Netherlands.
Solvency
- The acquisition has given rise to an increase in the absolute level of group capital above its capital requirements,
after taking account of the planned equity de-risk programme.
- The group remains well capitalised, with a solvency ratio of 143%, with a surplus of £181.9m.
Capital
- The deal was financed through £66.7m of equity after costs, £49.0m of incremental debt and £21.9m of Chesnara's own
cash.
- Our group gearing ratio of 23.7% remains well within our risk appetite.
- Further equity raising capacity is expected to be available for future deals.
Post acquisition integration
A post acquisition integration plan is in the process of being delivered, and has progressed in line with expectations. In
particular:
- On 11 April 2017 the Scildon brand was launched, replacing the previous name of Legal and General Nederland.
- The acquisition business case assumed that the investment management strategy of Scildon would be aligned with the
existing Chesnara group, and consequently a number of indirect equity holdings were sold post acquisition, as planned.
This has resulted in a reduction in the level of market risk capital required to be held, thus improving the solvency
position of both Scildon and the group.
- The alignment of financial reporting processes has progressed as planned. Some further alignment of finance processes
will continue to be delivered over the course of the year.
- Our integration plans include aligning risk and governance processes of Scildon with the group framework. This has
progressed in line with plans, with further integration work expected to be delivered during the remainder of the year.
- Ongoing review with local management is underway to deliver process and value for money enhancements over the next two
years.
Acquisition outlook
The successful completion of the Scildon acquisition contributed positively to the acquisition outlook due to increased
scale and presence in the Netherlands, and we are well-positioned to take advantage of any future acquisition
opportunities.
From a UK perspective we have seen a gradual increase in closed book market activity which, in our view, is driven in part
by reduced uncertainty regarding Solvency II and regulatory developments.
The environment in which European life insurance companies operate continues to increase in complexity. In particular, in
May 2017 "IFRS 17 Insurance Contracts" was issued, which is a fundamental overhaul of the way in which insurance contracts
are accounted for under international accounting rules. We believe this contributes to the factors that exist that will
drive further consolidation, namely larger financial organisations wishing to re-focus on core activities and remove
operating complexities, and the desire to release capital or generate funds from potentially capital intensive life and
pension businesses.
Chesnara is a well-established life and pensions consolidator with a proven track record. This, together with a good
network of contacts in the adviser community, who understand the Chesnara acquisition model and are mindful of our track
record and good reputation with our regulators, ensures we are aware of most viable opportunities in the UK and Western
Europe.
Our financial foundations are strong, we have a proven and stringent acquisition assessment model, and we continue to have
strong support from shareholders and lending institutions to progress our acquisition strategy. In addition, our operating
model which consists of well established outsource arrangements plus efficient, modern in-house solutions, means we have
the flexibility to accommodate a wide range of potential target books. With all the above in mind, we are confident that
we are well positioned to continue the successful acquisition track record in the future.
CAPITAL MANAGEMENT | Solvency II
What is solvency and capital surplus?
- Solvency is a measure of how much the value of the company exceeds the level of capital it is required to hold.
- The value of the company is referred to as its "own funds" (OF) and this is measured in accordance with the rules of
the Solvency II regime.
- The capital requirement is again defined by Solvency II rules and the primary requirement is referred to as the
Solvency Capital Requirement (SCR).
- Solvency is expressed as either a ratio: OF/SCR% or as an absolute surplus OF less SCR
Solvency surplus to cash generation
Subject to ensuring other constraints are managed, surplus capital is a useful proxy measure for liquid resources available
to fund matters such as dividends, acquisitions or business investment. As such Chesnara defines cash generation as the
movement in surplus, above management buffers, during the period.
GROUP SOLVENCY AT 30 JUNE 2017
Group solvency remains strong and the impact of the Scildon acquisition, after taking into account the equity de-risking
programme, has had a positive impact. During the period all divisions have contributed positively to the absolute levels
of surplus capital available.
Solvency position
£m 30 Jun 2017 31 Dec 2016 31 Dec 2016(excl. LGN impact*)
Own funds (post dividend) 606 505 443
SCR 425 321 309
Buffer 42 32 31
Surplus 139 153 104
Solvency ratio % 143% 158% 144%
Analysis
- Surplus: The group remains well capitalised at 143%, equating to an absolute level of surplus own funds above SCR of
£181.9m. Removing the impact of the equity raise, which relates to the Scildon acquisition, the closing solvency surplus
has increased by £47.3m. Further detail on the solvency surplus movement has been provided in the table below.
- Dividends: The solvency position is stated after deducting £10.5m proposed dividend (31 December 2016: £19.0m).
- Own funds: Own funds have increased by £111.6m, before the impact of the interim dividend. This includes underlying
own funds growth across the divisions and holding company of £57.6m, coupled with a net increase in own funds of £54.0m
arising on completion of the Scildon acquisition, representing the difference between the purchase price of £137.6m and the
own funds acquired of £191.6m.
- SCR: The group's underlying SCR, before the impact of the Scildon acquisition, has reduced by £8.3m. The Scildon
acquisition has, as expected, resulted in a large increase in the group's SCR of £112.2m. This is made up of the
underlying Scildon SCR of £93.0m coupled with an increase in additional group SCR of £19.2m.
Sensitivities
Impact (£m) 1% fall in yields 10% fall in equity values
Own funds (16.7) (34.4)
SCR 4.9 (39.2)
Surplus (21.6) 4.8
Solvency surplus movement
£m
Group solvency 31 Dec 2016 - pre equity raise impact 134.6
CA 28.8
Movestic 15.0
Waard 5.3
Scildon 17.6
Chesnara / consol adj (5.9)
Scildon acquisition impact (8.0)
Exchange rates 5.0
Interim dividends (10.5)
Total surplus 30 Jun 2017 181.9
The table above provides some further analysis of how the solvency surplus has developed over the first half of the year.
To provide an end to end impact of the Scildon acquisition, the starting point reflects the solvency position of the group
at the start of the year before the impact of the equity that was raised in November 2016 to fund the acquisition.
- All divisions have contributed positively to the level of solvency surplus available.
- The table shows that the Scildon acquisition has reduced the solvency surplus available at a group level by £8.0m.
This was expected and does not include the impact of the equity de-risking, which was delivered post acquisition.
Adjusting for this, the "day 1" impact of the Scildon acquisition has resulted a small positive contribution to the overall
group solvency position by £4.7m.
- The overall closing surplus of £181.9m includes the impact of the £10.5m interim dividend, due to be paid in October
2017.
Managing the group and subsidiaries' capital positions appropriately is a critical part of ensuring we remain true to the
group's culture and values.
We are well capitalised at both a group and subsidiary level, and we have not used any elements of the long term guarantee
package.
Note: 31 Dec 2016 figures restated in the charts at 30 Jun 2017 exchange rates for comparison
UK
Analysis
- Surplus: £65m above regulatory requirements and £41m above board's capital management policy.
- Dividends: Dividend of £30m was paid to Chesnara in May 2017.
- Own funds: Positive growth driven by a transfer of £9m out of the with profit funds, a reduction in the with profit
cost of guarantees and an increase in the spread of swap yields over gilt yields and positive equity growth.
- SCR: Reduction of £8m driven by a reduction in spread risk due to investment portfolio changes and a reduction in
counterparty default risk owing to a change in the assumed likelihood of reinsurer default, offset by an increase in equity
risk due to equity growth.
Solvency position
£m 30 Jun 2017 31 Dec 2016
Own funds (post dividend) 187 166
SCR 122 130
Buffer 24 26
Surplus 41 11
Solvency ratio % 154% 128%
Sensitivities
Impact (£m) 1% fall in yields 10% fall in equity values
Own funds (6.9) (9.8)
SCR 2.1 (11.6)
Surplus (9.0) 1.8
SWEDEN
Analysis
- Surplus: £71m above regulatory requirements and £41m above board's capital management policy.
- Dividends: Dividend of £2.7m was paid to Chesnara in June 2017.
- Own funds: Growth largely driven by positive economic experience due to positive equity markets coupled with
positive operating experience on in force policies, offset by the negative impact of lowering the assumption for future
expected charge income on certain investment funds.
- SCR: Increase of £12m is largely due to increased market risk capital being held due to strong investment growth in
year increasing the risk on equities, corporate bonds and foreign currencies.
Solvency position
£m 30 Jun 2017 31 Dec 2016
Own funds (post dividend) 218 193
SCR 148 138
Buffer 30 27
Surplus 41 28
Solvency ratio % 148% 140%
Sensitivities
Impact (£m) 1% fall in yields 10% fall in equity values
Own funds (6.4) (22.5)
SCR 0.1 (21.8)
Surplus (6.5) (0.6)
NETHERLANDS - WAARD GROUP
Analysis
- Surplus: £49m above regulatory requirements and £38m above board's capital management policy.
- Dividends: A dividend of £32m was paid in April 2017 by the insurance companies within the division to the Dutch
holding company and then subsequently used to part-fund the acquisition of LGN.
- Own funds: Reduction driven by the dividend of £32m, offset by modest economic variances, positive operating
mortality experience and the positive impact of changing mortality assumptions in the modelling.
- SCR: Reduction of £2m over the period is primarily due to a fall in counterparty default risk from a reduction in
cash at bank following the £32m transfer to part-fund the acquisition of LGN.
Solvency position
£m 30 Jun 2017 31 Dec 2016
Own funds (post dividend) 59 89
SCR 11 12
Buffer 11 12
Surplus 38 64
Solvency ratio % 533% 712%
Sensitivities
Impact (£m) 1% fall in yields 10% fall in equity values
Own funds (0.5) (0.3)
SCR 0.4 (0.2)
Surplus (0.8) (0.1)
NETHERLANDS - SCILDON
Analysis
- Surplus: £119m above regulatory requirements and £34m above board's capital management policy.
- Dividends: No dividends have been paid in the post acquisition period.
- Own funds: Increase since acquisition driven by positive economic experience, including the weakening of sterling
relative to the Euro, offset by the negative impact of a change in the assessment of persistency and mortality risk leading
to an increase in the risk margin.
- SCR: Reduction of £9m due to a substantial reduction in equity risk owing to a sale of equities in the division,
partially offset by an increase in spread risk and counterparty default risk following reinvestment of proceeds from the
equity sale.
Solvency position
£m 30 Jun 2017 31 Mar 2017
Own funds (post dividend) 205 192
SCR 85 94
Buffer 85 94
Surplus 34 3
Solvency ratio % 240% 204%
Sensitivities
Impact (£m) 1% fall in yields 10% fall in equity values
Own funds (4.6) (1.8)
SCR 1.7 (1.3)
Surplus (6.3) (0.5)
FINANCIAL REVIEW
The key performance indicators below are a reflection of how we have performed in delivering our three strategic objectives
and our core culture and values. The first half results of 2017 are dominated by the impact of the completion of the
acquisition of Scildon. Looking through this impact, all divisions have performed well across all financial metrics,
resulting in a closing EcV of over £700m.
Summary of each KPI:
IFRS
PRE-TAX PROFIT: £51.6M (30 Jun 2016: £0.2M)
TOTAL COMPREHENSIVE INCOME: £53.8M (30 Jun 2016: £15.7M)
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 in the Risk Management
section. In particular, volatility in equity markets and bond yields can result in volatility in the IFRS pre-tax profit,
and foreign currency fluctuations can affect total comprehensive income.
Highlights
£m 30 Jun 17 30 Jun 16
CA 8.4 14.3
S&P 14.7 (13.9)
Movestic 7.1 3.6
Waard 2.3 2.3
Scildon 7.0 -
Group & consol adj. (8.6) (6.1)
Profit on acquisition 20.7 -
Taxation (4.9) 0.2
Forex impact 7.1 15.3
Total 53.8 15.7
- Strong pre-tax results across all segments.
- IFRS pre-tax profit of £51.6m significantly ahead of prior year (2016: £0.2m). The underlying performance is
supported by a one off gain of £20.7m relating to the acquisition of Legal and General Nederland.
- All territories have delivered results ahead of 2016, supported by positive equity markets during the first half of
the year.
- Total comprehensive income includes a foreign exchange gain of £7.1m (2016: £15.3m) relating to sterling's
depreciation against both the euro and Swedish krona.
CASH GENERATION
GROUP CASH GENERATION £46.2M* (30 Jun 2016: £13.6M)
DIVISIONAL CASH GENERATION £54.8M (30 Jun 2016: £9.8M)
What is it?
Cash generation is a measure of how much distributable cash has been generated in the period. Cash generation is driven by
the change in solvency surplus in the period, taking into account board-approved capital management policies.
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 in the Risk Management section. 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
£m 30 Jun 2017
UK 30.4
Sweden 13.8
Netherlands 10.6
Divisional cash generation 54.8
Other group activities (2.2)
Group cash pre-Scildon acquisition 52.6
Impact of Scildon acquisition (6.4)
Total group cash generation 46.2
Divisional cash
- Significant cash contributions from all divisions in the first half of the year.
- UK cash generation underpins the result, with favourable movements in both own funds and capital requirements.
- Positive economic experience, primarily equity markets, have driven the growth in own funds and ultimately cash
generation in Sweden and the Netherlands.
Total cash generation
- At group level, the impact of the outflow of funds utilised in facilitating the purchase of Scildon, and the
addition of the associated capital requirement on completion, have resulted in a negative cash generation for the period.
* Includes the end to end impact of the Scildon acquisition
ECONOMIC VALUE (EcV)
£700.4M (30 Jun 2016: £459.9M)
What is it?
Economic value (EcV) was introduced in 2016 by Chesnara as a replacement metric for European Embedded Value. This was
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 Movestic and Scildon businesses) 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 3.1% and 3.6% respectively, based on the composition of the group's EcV at 30 June 2017.
£m
2016 Group EcV 602.6
EcV earnings 40.4
Acquisition 65.4
Dividends (19.0)
Forex gain 11.0
2017 Group EcV 700.4
- Economic value at the end of June exceeds £700m for the first time, having increased by £98m since the start of the
year.
- Strong underlying earnings achieved in the period of £40m.
- Total growth includes the gain delivered upon the acquisition of Scildon.
- Foreign exchange gains also contribute to the overall growth, offset by the payment of the final dividend in
relation to 2016.
- Pre tax EcV earnings of £105.8m in the first half of the year, driven by a combination of strong underlying economic
earnings supported by the substantial gain realised on the acquisition of Legal & General Nederland in April.
ECV EARNINGS NET OF TAX
£105.8M (30 Jun 2016: £(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 in the Risk Management section. 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.
£m 2017
Operating earnings 5.3
Economic earnings 37.0
Gain on acquisition 65.4
Other (1.9)
Total EcV earnings 105.8
- Pre tax EcV earnings of £105.8m in the first half of the year, driven by a combination of strong underlying economic
earnings supported by the substantial gain realised on the acquisition of LGN in April.
- Operating results were adversely affected by two non-recurring items. The expense assumptions now include the impact
of the LGN acquisition on group overheads and we have made provision to adopt a more attractive pricing strategy in
Movestic which has resulted in lower assumed fees on certain white label funds. Underlying operating profits include new
business profits of £7.1m and are in line with expectations.
- Economic earnings primarily driven by strong equity market performance across Europe in the period.
IFRS PRE-TAX PROFIT
£51.6M (30 Jun 2016: £0.2M)
IFRS TOTAL COMPREHENSIVE INCOME
£53.8M (30 Jun 2016: £15.7M)
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, despite some
period on period movements, the long term trend of material positive results indicates that the stable core continues to
deliver against these requirements.
(2) Variable element: The S&P component within the UK division can bring an element of short-term earnings volatility to
the group, with the results being particularly sensitive to investment market movements. Hence the split of the UK division
results showing S&P separately is shown below.
(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:
Unaudited Year
6 months ended ended
30 Jun 17 30 Jun 16 31 Dec 16
£m £m £m Note
CA 8.4 14.3 28.4 1
S&P 14.7 (13.9) 14.3 2
Movestic 7.1 3.6 8.7 3
Waard Group 2.3 2.3 6.2 4
Scildon 7.0 - - 5
Chesnara (6.6) (2.9) (9.7) 6
Consolidation adjustments (2.0) (3.2) (7.2) 7
Profit before tax and profit on acquisition 30.9 0.2 40.7
Profit on acquisition of Scildon 20.7 - - 5
Profit before tax 51.6 0.2 40.7
Tax (4.9) 0.2 (5.4)
Profit after tax 46.7 0.4 35.3
Foreign exchange 7.1 15.3 20.1 8
Total comprehensive income 53.8 15.7 55.4
Unaudited Year
6 months ended ended
30 Jun 17 30 Jun 16 31 Dec 16
£m £m £m Note
Operating profit 16.6 9.5 34.9 9
Economic profit 14.3 (9.3) 5.8 10
Profit before tax and profit on acquisition 30.9 0.2 40.7
Profit on acquisition of Scildon 20.7 - - 5
Profit before tax 51.6 0.2 40.7
Tax (4.9) 0.2 (5.4)
Profit after tax 46.7 0.4 35.3
Foreign exchange translation differences 7.1 15.3 20.1 8
Total comprehensive income 53.8 15.7 55.4
Note 1: The CA segment continues to deliver material and stable IFRS profits in line with plans. Prior year result
benefitted from significant increases in bond values.
Note 2: The S&P segment has reported an increase in profits on the prior year. Positive economic profits of c£12m arise
from the net impact of positive equity markets.
Note 3: Movestic has continued to generate strong results in the period, principally driven by strong growth in assets
under management and increased fund performance fee income generation.
Note 4: The Waard Group has reported a profit which is slightly improved from the prior year and in line with profit
generation expectations. The mortgage portfolio acquired in 2016 continues to generate favourable returns.
Note 5: The Scildon result represents profit generation for the three months from the date of acquisition and is broadly in
line with expectations. The profit arising from the acquisition represents the difference between the value of the net
assets acquired (post acquisition accounting fair value adjustments) and the purchase consideration paid. Scildon's IFRS
reserving basis, whilst technically compliant, does not align to the Chesnara reserving approach. Scildon's current book
reserving approach creates a level of volatility which is greater than commercial reality. In light of this, we plan to
align Scildon's IFRS reserving policy during the second half of 2017. We do not anticipate that this change in reserving
methodology will materially alter the reported profit arising on acquisition.
Note 6: The Chesnara result represents holding company expenses. The year to date loss includes a foreign currency
re-translation loss of c£1.8m in respect of the euro denominated loan facility taken out in the year, to part fund the
Scildon acquisition. The result also reflects increased financing costs of c£0.8m due to the higher level of bank debt
carried in the period.
Note 7: Consolidation adjustments relate to items such as the amortisation of intangible assets. The current year figures
reflect the introduction of adjustments relating to the Scildon acquisition.
Note 8: As a result of sterling weakening against both the euro and Swedish krona in the period the IFRS result includes a
large foreign exchange gain.
Note 9: The operating result demonstrates the strength and stability of the underlying business, driving the generation of
profit. Product based income and favourable movements in operating experience, offset by assumption changes, specifically
expenses, have supported performance in the UK. Strong fund performance growth contributes to the Movestic operating
result, whilst the Waard result continues to benefit from the investment in its mortgage portfolio. The introduction of
Scildon as a source of profit generation adds further strength to the underlying business model.
Note 10: Economic profit represents the components of the earnings that are directly driven by movements in economic
variables, e.g. the impact of yield movements on the cost of guarantees reserves. During 2017 the economic profit is
generally driven by the net impact of positive equity markets, offset by falling bond yields in the year.
Note: Movestic, Waard Group and Scildon economic surplus is not readily determinable. While there is an element of movement
due to economic conditions, they are immaterial in comparison to non-economic items, therefore all surplus is treated as
derived from operating activities.
GROUP CASH GENERATION £46.2M
(30 Jun 2016: £13.6M)
DIVISIONAL CASH GENERATION £54.8M
(30 Jun 2016: £9.8M)
The three territories have generated £54.8m cash in the period, with all four businesses making positive contributions to
the cash generation.
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 in the capital management policies across the group. These are
based on regulatory capital requirements, with the inclusion of additional "management buffers".
HIGHLIGHTS
GROUP
- Before taking into account the impact of the acquisition of Scildon, cash has been generated across the group, with
total cash generation in the period of £52.6m. As highlighted in the divisional commentary below, this includes the
positive impact of some non-recurring management actions in the period amounting to £16.0m.
- Other group activities also reflected the residual group expenses and the impact of consolidation routines,
specifically movements in capital requirements determined at a group level.
- From a capital requirement perspective, this is driven by movements in required capital at a Chesnara holding
company level coupled with consolidation adjustments. At a Chesnara holding company level capital is principally required
to be held for the currency risk associated with the Movestic, Scildon and Waard Group surplus assets.
- The end to end impact of the acquisition of Legal & General Nederland is to reduce surplus cash by £6.4m. This was
in line with expectations. The £6.4m cash reduction consists of an increase in own funds of £116.2m (£62.1m of equity
raised and deal costs; £191.6m of own funds acquired; less purchase price of £137.6m) offset by an increase in capital
requirement of £122.6m (£88.4m of capital required in Scildon itself, including management group buffer, plus additional
capital at group level of £34.3m). The £88.4m of capital required for Scildon includes the positive impact of the equity
de-risk in the period, which amounted to £12.7m.
UK
- The UK continues to generate significant levels of cash to support the dividend payment.
- Own funds growth is the main driver of cash generation in the UK, which has benefitted from a reduction in the cost
of guarantees.
- There has also been a reduction in required capital due to changes in investment portfolio and reduced counterparty
default risk.
- Cash generation includes the benefit of a £9.0m release of previously trapped surplus from the with profit funds.
SWEDEN
- Sweden had a positive cash generation in the period of £13.8m primarily due to own funds growth.
- Own funds have benefitted from growth in equity markets during the period.
- Growth in equity has also had an adverse impact on the level of capital the business is required to hold, driving
the increase in management capital requirement.
- Cash generation includes a one off benefit of enhancing our modelling for commission clawbacks amounting to £7.0m.
NETHERLANDS - WAARD GROUP
- The Waard Group has continued the solid cash generation witnessed in the prior year with positive underlying
movements in both own funds and capital requirements.
- Movement in own funds was driven by mortality experience and assumption changes.
- Fall in counterparty default risk underpins the reduction in the capital requirement.
NETHERLANDS - SCILDON
- Scildon has reported positive cash generation of £3.2m in the three months since the acquisition of the business.
- Positive economic experience, including euro exchange gains against sterling, support increase in own funds.
30 June 2017 (£m) Movement in own funds Movement in management's capital requirement Forex impact Cash generated
UK 20.7 9.7 - 30.4
Sweden 24.4 (11.3) 0.7 13.8
Netherlands Waard Group 3.6 3.5 0.3 7.4
Scildon 7.2 (4.9) 0.9 3.2
Divisional cash 55.9 (3.0) 1.9 54.8
Other group activities (8.7) 6.5 - (2.2)
Group cash pre- Scildon acquisition 47.2 3.5 1.9 52.6
Impact of Scildon acquisition 116.2 (122.6) - (6.4)
Total group cash 163.4 (119.1) 1.9 46.2
EcV EARNINGS
£105.8M
(30 Jun 2016: £(3.5)M)
Driven by generally beneficial investment markets in the first half of the year, with sterling depreciation and volatile
yet growing equity markets, the group has reported significant underlying EcV earnings, reflecting the resilience and
diversity of the business. This performance and the acquisition of Legal & General Nederland have delivered comprehensive
EcV earnings for the period.
Analysis of the EcV result in the period by earnings source:
30 Jun 2017 £m 30 Jun 2016 £m 31 Dec 2016£m Note
Expected movement in period 11.7 4.3 6.0
New business 7.1 4.0 11.9
Operating variances 4.4 3.2 22.7
Operating assumption changes (17.9) (8.5) 0.6 2
Other operating variances - (3.2) (7.3)
Total operating earnings 5.3 (0.2) 33.9
Economic experience variances 29.0 34.2 77.9 1
Economic assumption changes 7.6 (39.7) (38.3)
Total economic earnings 36.6 (5.5) 39.6
Other non-operating variances 5.0 (4.1) (3.0)
Gain on acquisition 65.4 - -
Tax (6.5) 6.3 2.0
Total EcV earnings 105.8 (3.5) 72.5
Analysis of the EcV result in the year by business segment:
30 Jun 2017£m 30 Jun 2016£m 31 Dec 2016£m Note
UK 26.2 (5.5) 42.2 3
Sweden 15.8 (3.8) 30.8 4
Netherlands 14.8 0.6 5.9 5
Gain on acquisition 65.4 - -
Group and group adjustments (9.9) (1.1) (8.4) 6
EcV earnings before tax 112.3 (9.8) 70.5
Tax (6.5) 6.3 2.0 7
EcV earnings after tax 105.8 (3.5) 72.5
Note 1 - 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 3.3%;
- The Swedish OMX all share index has increased by 7.2%; and
- 10 year UK gilt yields remain at 1.28%.
Note 2 - Operating assumptions: Provision has been made to adopt a slightly more attractive pricing strategy on certain
white label funds in Movestic should the business model benefit from such a change and the expense assumptions now include
the impact of the LGN acquisition on group overheads.
Note 3 - UK: The UK reported strong pre tax earnings of £26.2m for the period. The result was mainly driven by Economic
profits of £15.9m which was the result of positive equity market growth.
Note 4 - Sweden: The Swedish division has also reported a strong EcV movement in the year. Operating earnings were
underpinned by strong new business performance, which generated positive earnings of £6.5m owing to transfer in volumes and
increased average policy premiums. These new business earnings are offset by the negative effect of assuming a more
attractive pricing strategy on certain white label funds. An economic profit of £13.9m was also reported, driven by
improving equity markets in the first half of the year.
Note 5 - Netherlands: The Dutch division has reported earnings of £14.8m in the period. This is primarily all economic
earnings within the newly acquired Scildon supported investment returns.
Note 6 - Group: A loss has been reported in the group component. This is includes the impact of a foreign exchange loss
incurred in relation to a Euro denominated loan taken out for the LGN acquisition, increased loan financing costs and also
underlying group level expenses and consolidation activities.
Note 7 - Tax: The business is reporting a tax expense of £6.5m in the period. This is driven by a combination of current
tax on the profit in the period and movements in deferred tax relating to group level activities.
EcV
£700.4M
(30 Jun 2016: £459.9M)
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 Jan 2017 to 30 Jun 2017:
£m
2016 Group EcV 602.6
EcV earnings 40.4
Acquisition 65.4
Dividends (19.0)
Forex gain 11.0
2017 Group EcV 700.4
EcV earnings: Strong EcV earnings have been reported in the year to date, a result of strong operating profits and
positive economic profits, driven by the equity market growth.
Acquisition: In April 2017 the group successfully completed the purchase of LGN, delivering an underlying £65m economic
value gain on acquisition upon day one. This is reflected in the group closing EcV at the end of June.
Dividends: Under EcV, dividends are recognised in the period in which they are paid. Dividends of £19.0m were paid during
the 2017, being the final dividend from 2016.
FX gain: The EcV of the group benefited from foreign exchange gains that were reported in the period as a result of
sterling deprecation against both the euro and Swedish krona.
EcV by segment at 30 Jun 2017
£m
UK 231.5
Sweden 242.7
Netherlands 277.5
Other group activities (51.3)
The above table shows that the EcV of the group is diversified across its different markets, demonstrating that we are
well-balanced and not over-exposed to one particular geographic market.
EcV to Solvency II:
£m
2017 Group EcV 700.4
Risk margin (53.9)
Contract boundaries (16.5)
Own funds restrictions (13.1)
Dividends (10.5)
SII own funds 606.5
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 table 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 £10.5m is recognised for SII regulatory reporting purposes. It is not
recognised within EcV until it is actually paid.
Replacement of EEV:
During 2016 we 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 for 2016 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.
The annual external audit requirements cover Solvency II disclosures and as such given the Economic Value figures are
derived from the Solvency II balance sheet the Economic Value figures benefit from a degree of external audit comfort.
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.
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.
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 geopolitical events, such as the European Union referendum result, have triggered an increase in economic
uncertainty.
Completion of the acquisition of Scildon during the first half of the year has not materially changed the nature of the
risks facing the organisation. It has in some cases impacted the sensitivity of the key financial metrics to those risks.
The 'Capital Management: Solvency II' section provides further information on the sensitivities.
A detailed explanation of the risks faced by Chesnara and how they are mitigated can be found on pages 39 to 41 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 vary from the assumptions underlying product pricing and subsequent reserving, more or less profit will accrue to the group.
Adverse persistency experience If persistency is significantly lower than that assumed in product pricing and subsequent reserving, this will lead to reduced group profitability in the medium to long-term. The business is exposed to losses arising from "mass lapse" events (i.e. a large
number of customers terminating their contracts early within a short period of time). This risk is most prevalent for parts of the business such as Movestic, where retention is to a degree dependent on Broker relationships.
Expense overruns and unsustainable unit cost growth For the closed UK and Dutch businesses, the group is exposed to the impact on profitability of fixed and semi-fixed expenses with the potential to increase per policy administration costs as the book runs off and the costs remain fixed. For the open life
and pensions businesses (Movestic and Scildon), the group is exposed to the impact of expense levels varying adversely from those assumed in product pricing.
Significant and prolonged reduction in the market value of asset holdings A significant part of the company'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
any material fall in their value will impact on future income. In addition, for with profits products with guarantees, a sustained fall in the market value of assets can increase the cost of meeting the guaranteed benefits.The most material risk is equity
risk, as overall investment funds comprise a significant equity content. However, material market risks also exist if there is a sustained fall in the value of fixed interest holdings, a fall in the value of property holdings and exchange rate risk in
respect of overseas investments held by policyholders.Income levels may also reduce if policyholders switch from equity based funds to lower margin, fixed interest funds, as a consequence of a material fall in the market value of equities.
Adverse exchange rate movements against Sterling Exposure to adverse sterling:swedish krona and sterling:euro exchange rate movements (Sterling appreciating) arises from cash flows between Chesnara and its overseas subsidiaries and from the impact on reported IFRS and EcV results which are expressed in
sterling.
Financial 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.
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