REG - Chesnara PLC - Half Yearly Report <Origin Href="QuoteRef">CSN.L</Origin> - Part 3
28/08/2015 07:01
- Part 3: For the preceding part double click ID:nRSb3703Xb
£m £m £m
CA
Surplus arising in the period 9.7 19.1 43.8 1
Change in target capital requirement 2.1 (0.2) 2.7 1
S&P
Surplus arising in the period (0.3) 0.2 3.7 2
Change in target capital requirement 5.4 0.1 (0.8) 2
Decrease/(increase) in ring-fenced policyholder funds 2.0 (0.2) 1.5 2
UK 18.9 19.0 50.9
Movestic
Cash generation in the period 3.3 - - 3
Waard Group
Cash generation in the period - - - 4
Chesnara
Cash utilised by operations (6.9) (3.0) (8.3) 5
Total gross cash generation 15.3 16.0 42.6
Items affecting ability to distribute cash
Cash generated on acquisition of the Waard Group 39.9 - - 4
Synergistic effects of Part VII transfer - - 27.4 7
Restricted surplus in S&P WP fund 1.5 (0.4) 1.1 2
Net cash generation available for distribution 56.7 15.6 71.1 6
Items affecting the net cash available for distribution:
Note 1 - The CA segment has generated cash of £11.8m in the period, which is less than the £18.9m in the same period in
2014. This is principally due to a reduction in the surplus arising, driven by the same key items that affect the IFRS
profit, as analysed on below. As expected, our capital requirements continue to run off as our book runs off, which
further supports the ability to distribute cash out of the segment.
Note 2 - The S&P segment has reported cash generation of £7.1m. This is driven primarily through a reduction in the target
required capital in the period, as result of a reduction in the estimated regulatory capital requirement since the start of
the year. The regulatory surplus in the period has been slightly negative, and is lower than the reported IFRS surplus due
to the difference in accounting requirements for those products that contain options and guarantees.
Note 3 - Movestic's scale has now reached a level such that it is now generating cash, which amounted to £3.3m in the
period.
Note 4 - The Waard Group has generated immaterial levels of post-acquisition cash in the period due to the proximity of the
acquisition to the end of the period. The acquisition of the Waard Group has delivered a significant one off cash
generation item, amounting to £39.9m, driven by the strong levels of regulatory surplus in this group.
Note 5 - The Chesnara segment has reported an increase in cash utilisation compared with the same period in 2014, the
majority of which (£3.5m) represents a foreign currency translation loss arising on holding Euros prior to the completion
of the Waard Group acquisition, coupled with some additional one-off expenses, such as the cost of additional resources
required for final Solvency II preparations, deal costs associated with the Waard Group acquisition and loss of office
payments associated with the resignation of the previous CEO.
Note 6 - The net cash generation KPI is a useful indicator of the dividend paying capacity of the Group's regulated
subsidiaries. This is monitored closely by Management as cash generated by the Group's regulated subsidiaries is used by
the Chesnara Parent Company for corporate transactions such as the servicing of debt, payments of dividends and the funding
of future acquisitions. It should be noted that this KPI is quite distinct from the Group's Cash Flow Statement as
included in the Group's IFRS Financial Statements, which is intended to reflect the movement in cash held by Chesnara and
its subsidiaries but does not reflect that most of the subsidiary cash balances are held in regulated insurance funds and
are therefore not available for use by the Parent Company.
Note 7 - There have been no further synergistic effects arising from the Part VII transfer of the Protection Life business
into CA plc in the period. Subsequent to the end of the period notification was received that Protection Life has been
deauthorised. This will give rise to the balance of the synergistic impact of the Part VII, amounting to £3.5m. This will
be reported in the full year 2015 cash generation.
EEV EARNINGS £44.9M* SIX MONTHS ENDED 30 JUNE 2014: £47.3M
*excluding the positive impact of modelling adjustments of £5.9m
Summary
The first half of 2015 has seen a positive EEV result being reported for the Group, amounting to £44.9m (six months to 30
June 2014: £47.3m). The results are driven by three key areas:
- Solid operating profit of £15.2m (six months to 30 June 2014: £37.2m). Whilst the profit shows a reduction when
compared with the same period in 2014, the 2014 result was dominated by operating assumption changes in the CA segment,
primarily due to the £17.3m one off surplus arising from a change around how the assumptions for future bonus units that
are allocated to policyholders are determined. After taking account of this the operating profits are more aligned, as
would be expected.
- Positive investment market results of £15.9m (six months to 30 June 2014: £21.2m). Investment markets in the UK have
been relatively flat, resulting in a modest result for this territory. Swedish investment markets have performed more
positively, and despite a further reduction in the risk free rate in the period, taking Sweden into negative territory,
this is more than off-set by relatively strong equity markets, which have increased by 6.5% in the period.
- Gain of £21.6m arising on the acquisition of the Waard Group. As expected, and in line with previous estimates, the
acquisition of the Waard Group has yielded a day-one gain, representing the excess of the EEV acquired over the purchase
consideration.
The results of the Waard Group are immaterial in the period, due to the proximity of the acquisition to the period end.
The following tables analyse the Group EEV earnings after-tax by source and by business segment:
Profit after tax movementSix months ended 30 June 2014 to six months ended 30 June 2015 (£m) £m
June 2014 47.3
Gain on acquisition of Waard Group 21.6
Tax 10.7
Waard Group 0.6
Movestic (0.1)
S&P (1.1)
Chesnara (4.6)
CA (29.5)
June 2015 44.9
Analysis of the EEV result in the year by business segment Unaudited Six months ended 30 June Year ended 31 December
2015 2014 2014
£m £m £m
CA 7.0 36.4 49.1
S&P 5.5 6.6 (14.2)
Movestic 17.3 17.5 27.5
Waard Group 0.6 - -
Chesnara (7.4) (2.8) (7.7)
Profit before tax and gain on acquisition 23.0 57.7 54.7
Gain on acquisition of the Waard Group 21.6 - -
Profit before tax 44.6 57.7 54.7
Tax 0.3 (10.4) (10.5)
Profit after tax 44.9 47.3 44.2
Analysis of the EEV result in the period by earnings source Unaudited Six months ended 30 June Year ended 31 December
2015 2014 2014
£m £m £m
New business contribution 2.6 6.2 9.7
Return from in-force business
Expected return 4.2 3.9 7.1
Experience variances 3.3 6.0 0.5
Operating assumption changes 4.8 17.1 11.0
Return on shareholder net worth 0.1 4.0 9.1
Operating profit of covered business 15.0 37.2 37.4
Variation from longer term investment return 13.6 25.8 32.0
Effect of economic assumption changes 2.3 (4.6) (7.4)
Profit on covered business before tax and gain on acquisition 30.9 58.4 62.0
Tax (1.2) (10.3) (12.2)
Profit on covered business after tax and before gain on acquisition 29.7 48.1 49.8
Gain on acquisition of the Waard Group 21.6 - -
Uncovered business and other group activities (7.9) (0.7) (7.3)
Tax on uncovered business 1.5 (0.1) 1.7
Profit after tax 44.9 47.3 44.2
Economic experience and assumption changes
The EEV results are sensitive to investment market conditions. Economic experience and assumption changes contributed a
profit of £15.9m in the first half of 2015 compared with a profit of £21.2m in the same period in 2014. Key economic
condition highlights are as follows:
- The FTSE All Share has increased by 1.1% during the first half of 2015, compared with a small reduction of 0.3% in the
same period in 2014.
- The Swedish OMX All Share has increased by 6.5% during the period, compared with a 6.0% increase in the same period
last year.
- 10 year UK gilt yields have increased by 0.3% in the year to date, compared with a decrease of 0.2% in the same period
in 2014.
These conditions have led to investment market surpluses emerging in the period, albeit at relatively modest levels
compared with prior periods.
The following table analyses the impact of investment market conditions by segment:
Unaudited Six months ended 30 June Year ended 31 December
2015 2014 2014
£m £m £m
CA 0.5 6.4 17.8
S&P 3.8 4.6 (11.7)
Movestic 11.6 10.2 18.5
Total 15.9 21.2 24.6
The CA and S&P segments have both reported modest economic experience and assumption changes in the period, driven by the
relatively flat investment markets in the period, as described above.
Movestic is sensitive to movements in equity markets, largely due to its core income stream being dependent upon management
charges generated from policyholders. These management charges are based on the level of funds under management, which are
primarily equity invested. Equity growth in Sweden of c6.5%, coupled with an increase in longer-duration Government bond
yields in the period having led to this positive contribution in the period.
New business contribution
The new business contribution relates primarily to the Movestic Pensions and Savings business. Movestic also writes Life
and Health policies, but due to its more short-term nature the Life and Health business is reported as uncovered business
and hence does not contribute to the new business result. Movestic has contributed £2.4m (six months to 30 June 2014:
£5.8m) of new business profits in the period, representing a significant reduction when compared with the same period in
2014. This reduction is due to a combination of a reduction in the overall volume of products being sold, coupled with a
reduction in margins on those products sold as a result of a change in the sales mix. The lower volumes have arisen from
the ongoing challenges in selling new contracts, with competitors continuing to offer high guaranteed returns to
policyholders, something that we perceive is unsustainable in light of the low interest rate environment in Sweden.
Experience variances
Unaudited Six months ended 30 June Year ended 31 December
2015 2014 2014
£m £m £m
CA 4.1 3.6 5.4
S&P 1.8 1.8 (4.8)
Movestic (3.0) 0.6 (0.1)
Waard Group 0.4 - -
Total 3.3 6.0 0.5
The CA and S&P segments have both reported positive experience variances of £4.1m and £1.8m respectively in the period,
which are both broadly in line with the same period in 2015. For both of these books the experience is made up of a number
of small items, with both including the positive impact of favourable lapse experience in the period.
Movestic has reported an experience loss of £3.0m in the period. This is predominantly driven by an expense overrun of
c£0.7m, a reduction driven by the impact of policyholders changing their investment allocations (c£1.0m) and an adverse
impact of c£1.0m driven by the 100% paid up rate for private pension policies, following legislation change in Sweden
resulting in there no longer being a tax benefit of investing in private pensions.
Operating assumption changes
Unaudited Six months ended 30 June Year ended 31 December
2015 2014 2014
£m £m £m
CA 0.4 24.1 20.8
S&P (1.0) (3.1) (4.6)
Movestic 5.4 (3.9) (5.2)
Waard Group - - -
Total 4.8 17.1 11.0
For the CA segment there were no significant operating assumption changes in the period. This compares with a significant
surplus arising from operating assumption changes in the same period in 2014, primarily due to a one off positive item of
£17.3m arising from a change around how the assumptions for future bonus units that are allocated to policyholders are
determined.
S&P has reported a strain of £1.0m in the period arising from operating assumption changes. This is primarily due to a
slight strengthening in lapse assumptions due to the recent "Pension Freedoms" rules.
During the period Movestic has reported profits of £5.4m arising from operating assumption changes. There are two key
drivers of this. Firstly, the impact of a change in assumptions on fee rebates arising, based on recent fee rebate
experience, has resulted in an EEV profit of c£9.0m in the period. This assumption change is based on a combination of fee
rebates emerging from the new SICAV structure coupled with renegotiated terms with some key fund managers. Off-setting
this is the impact of strengthening lapse assumptions for certain broker-generated blocks of business coupled with an
increase in expense assumptions to capture some expected future IT development costs.
Gain on acquisition of the Waard Group
The EEV result in the period has benefitted from a gain of £21.6m arising from the purchase of the Waard Group. This
represents the excess of the Embedded Value of the Waard Group at the point of acquisition over the consideration paid.
Uncovered business and other group activities
Unaudited Six months ended 30 June Year ended 31 December
2015 2014 2014
£m £m £m
Chesnara (7.5) (2.7) (7.7)
Movestic (0.6) 2.1 0.3
Waard Group 0.2 - -
Total (7.9) (0.6) (7.4)
The Chesnara segment of the uncovered business relates to Chesnara parent company costs, such as corporate governance and
business development, that are not attributable to the covered business. The increase in costs when compared with the same
period in 2014 largely relates to a one-off foreign exchange loss of £3.5m arising from holding Euros prior to purchasing
the Waard Group. In addition to this, some additional corporate costs have been incurred in the period. These include
costs associated with the Waard Group purchase, some loss of office costs arising in relation to the resignation of the
previous CEO and some additional resource costs to support the readiness for Solvency II.
Movestic has reported a small uncovered business loss of £0.6m, compared with a profit of £2.1m in the same period in 2014.
This reduction is driven by a reduction in profits of £1.1m in Movestic's associate, Modernac, coupled with a reduction of
£0.4m arising in the Life and Health segment, which is not modelled for EEV purposes.
EEV £441.2M 31 DECEMBER 2014: £417.2M
EEV movement 31 December 2014 to 30 June 2015(£m)
EEV actual December 2014 417.2
Net of tax profit arising in the period* 23.3
Exceptional surplus on acquisition 21.6
Effect of modelling adjustments 5.9
Foreign exchange reserve movement (11.7)
Dividend paid (15.1)
EEV actual June 2015 441.2
EEV movement 30 June 2014 to 31 December 2014 (£m)
EEV actual June 2014 400.3
Equity raise 34.6
Net of tax profit arising in the period (3.1)
Foreign exchange reserve movement (7.3)
Dividend paid (7.3)
EEV actual December 2014 417.2
EEV movement 31 December 2013 to 30 June 2014 (£m)
EEV actual December 2013 376.4
Net of tax profit arising in the period 47.3
Foreign exchange reserve movement (10.0)
Dividend paid (13.4)
EEV actual June 2014 400.3
* stated before exceptional items
Summary
The EEV of the Chesnara Group represents the present value of the estimated future profits of the Group plus an adjusted
net asset value. Movements between different periods are a function of the following components:
- Net of tax profit arising in the period, pre exceptional items;
- Exceptional items, such as:
- the impact of raising new equity;
- the surpluses arising on acquisitions; and
- modelling adjustments;
- Foreign exchange movements arising from retranslating the EEV of overseas subsidiaries into Sterling; and
- Dividends that are paid in the period.
More detail behind each of these components for the six months to 30 June 2015 has been provided below. Tables for
comparative periods have been provided to provide additional context.
Net of tax profit
The EEV profit arising during the period has been analysed in more detail within the preceding section.
Exceptional surplus on acquisition
The purchase of the Waard Group on 19 May 2015 resulted in a day one increment to EEV of £21.6m. This represents the
excess of the Embedded Value of the Waard Group over the purchase price.
Equity raised for acquisition
During December 2014 equity of £34.6m was raised to finance the acquisition of the Waard Group. To mitigate the downside
risk of a strengthening Euro the capital raised was converted to Euros at the time of the capital raise.
Effect of modelling adjustments
Six months to 30 June 2015
During the six months to 30 June 2015 an adjustment of £5.9m has been reported relating to a tax error in the EEV model
which resulted in the tax charge in the EEV model being overstated at 31 December 2014. This has been corrected in the
period.
Six months to 31 December 2014 and six months to 30 June 2014
There were no modelling adjustments during these periods.
Foreign exchange reserve movements
The £11.7m foreign exchange reserve movement during the first half of 2015 has arisen as a result of a further weakening of
the Swedish Krona against Sterling by 7.5% since the end of 2014. This further adds to the weakening in the Swedish Krona
that was witnessed during 2014, albeit at a lower rate than was experienced in the prior year.
Dividends paid
Dividends of £15.1m were paid during the first half of 2015, being the final dividend from 2014.
Analysis of EEV
The information below provides some further analysis of the EEV of the Group, both in terms of the split between different
operating segments and also the split between the adjusted shareholder net worth and the value of the in-force (VIF)
business. The adjusted shareholder net worth represents the IFRS net worth of the Group, but adjusted for items that are
measured differently under EEV measurement rules and the VIF represents Management's best estimate of the present value of
the future profits that will arise out of each book of business.
EEV - Value in force (VIF) and adjusted shareholder net worth (SNW) (£m)
30 Jun 2015 31 Dec 2014 30 Jun 2014
VIF 264.5 243.7 279.3
SNW 176.7 173.5 121.0
Total EEV 441.2 417.2 400.3
Analysis of VIF at 30 June 2015
£m
Movestic 150.2
CA 88.1
S&P 15.3
Waard Group 10.9
Total 264.5
Analysis of EEV at 30 June 2015 - £441.2m
£m
Movestic 135.0
CA 164.1
S&P 59.8
Waard Group 73.3
Other Group Activities 9.0
Total 441.2
Highlights
- There is a good balance in EEV across the core business segments, with the UK businesses representing the majority
(51%) of the total EEV. The value in-force component is dominated by the Swedish business which represents 57% of the
total Group VIF.
- The Group EEV includes the addition in the period of Waard Group, representing £73.3m of EEV.
- There is a significant level of product diversification within the VIF. When adjusted to recognise the impact of the
S&P cost of guarantees which are predominantly pension contract related, 62.1% of the total product level value in-force
relates to pension contracts, 26.1% to protection business and 9.8% to endowments.
- "Other Group Activities" of £9.0m represents the Chesnara holding company balance sheet, stated after the elimination
of the carrying value of investments in Group companies.
Analysis of VIF by policy type
The tables below set out the value of in-force business by major product line at each period end. Analysis of the
composition of the VIF by business and major product category provides a useful insight into the commercial dynamics
underpinning the value of the Group.
30 June 2015 (unaudited) Number of policies Value of in-force business
CA S&P Movestic Waard Total CA S&P Movestic Waard Total
000's 000's 000's 000's 000's £m £m £m £m £m
Endowment 27 3 11 4 45 17.7 3.7 9.3 0.7 31.4
Protection 165 4 - 55 224 71.2 2.3 - 10.2 83.7
Annuities 6 - - - 6 4.3 0.6 - - 4.9
Pensions 37 111 90 - 238 35.6 39.7 149.6 - 224.9
Other 2 10 - - 12 2.3 3.9 - - 6.2
Total at product level 237 128 101 59 525 131.1 50.2 158.9 10.9 351.1
Valuation adjustments:
Holding company expenses (7.3) (2.8) (8.8) - (18.9)
Other (12.8) (30.9) - - (43.7)
Cost of capital/frictional costs (3.6) (1.2) (0.1) - (4.9)
Value in-force pre-tax 107.4 15.3 150.0 10.9 283.6
Taxation (19.1) - - - (19.1)
Value in-force post-tax 88.3 15.3 150.0 10.9 264.5
-
30 June 2014 (unaudited) Number of policies Value of in-force business
CA S&P Movestic Total CA S&P Movestic Total
000's 000's 000's 000's £m £m £m £m
Endowment 31 4 11 46 22.2 3.4 8.2 33.8
Protection 179 4 - 183 79.6 3.5 - 83.1
Annuities 6 - - 6 5.7 1.0 - 6.7
Pensions 43 120 85 248 41.5 46.1 143.3 230.9
Other 3 11 - 14 4.1 5.1 - 9.2
Total at product level 262 139 96 497 153.1 59.1 151.5 363.7
Valuation adjustments:
Holding company expenses (6.4) (3.2) (8.3) (17.9)
Other (15.7) (16.8) - (32.5)
Cost of capital/frictional costs (4.5) (2.4) (0.1) (7.0)
Value in-force pre-tax 126.5 36.7 143.1 306.3
Taxation (27.0) - - (27.0)
Value in-force post-tax 99.5 36.7 143.1 279.3
31 December 2014 Number of policies Value of in-force business
CA S&P Movestic Total CA S&P Movestic Total
000's 000's 000's 000's £m £m £m £m
Endowment 29 3 10 42 19.0 4.1 8.3 31.4
Protection 172 4 - 176 69.0 2.4 - 71.4
Annuities 6 - - 6 4.6 0.6 - 5.2
Pensions 37 115 88 240 37.8 39.1 147.0 223.9
Other 2 10 - 12 2.2 4.2 - 6.4
Total at product level 246 132 98 476 132.6 50.4 155.3 338.3
Valuation adjustments:
Holding company expenses (7.8) (3.0) (9.1) (19.9)
Other (12.4) (34.6) - (47.0)
Cost of capital/frictional costs (3.9) (1.3) (0.1) (5.3)
Value in-force pre-tax 108.5 11.5 146.1 266.1
Taxation (22.4) - - (22.4)
Value in-force post-tax 86.1 11.5 146.1 243.7
The value-in-force represents the discounted value of the future surpluses arising from the insurance and investment
contracts in force at each respective period end. The future surpluses are calculated by using realistic assumptions for
each component of the cash flows.
Holding company expenses are apportioned across the segments pro-rata to the total product-based VIF.
Other' valuation adjustments in CA principally comprise expenses for managing policies which are not attributed at product
level. In S&P they represent the estimated cost of guarantees to with-profits policyholders.
Taxation in the value-in-force is modelled on a combined CA and S&P basis and, in the analysis above, is attributed wholly
to the CA segment.
financial management
"The Group's financial management framework is designed to provide security for all stakeholders, while meeting the
expectations of policyholders and shareholders."
The following table illustrates the aims, approach and outcomes from the financial management framework:
objectives
The Group's financial management framework is designed to provide security for all stakeholders, while meeting the
expectations of policyholders, shareholders and regulators. Accordingly we:
1. Maintain solvency targets
2. Meet the dividend expectations of shareholders
3. Optimise the gearing ratio to ensure an efficient capital base
4. Ensure there is sufficient liquidity to meet obligations to policyholders, debt financiers and creditors
5. Maintain the Group as a going concern.
HOW WE DELIVER TO OUR OBJECTIVES
In order to meet our obligations we employ and undertake a number of methods. These are centred on:
1. Monitor and control risk & solvency
2. Longer-term projections
3. Responsible investment management
OUTCOMES
Key outcomes from our financial management process, in terms of meeting our objectives are set out below:
1. SOLVENCY - Group Solvency Ratio of 271%
2. SHAREHOLDER RETURNS - 2015 TSR: Increased interim dividend. Share price remains broadly neutral. TSR for 2015, up
to 25 August, of 5.40%
3. CAPITAL STRUCTURE - Gearing ratio of 22.5% (This does not include the financial reinsurance that is held within the
Swedish business.)
4. LIQUIDITY AND POLICYHOLDER RETURNS - Competitive fund performance Policyholders' realistic expectations maintained
5. MAINTAIN THE GROUP AS A GOING CONCERN - Group remains a going concern
How we Deliver our Financial Management Objectives:
1. Monitor & Control RISK & SoLVENCY
The Board sets internal solvency targets that are based on solvency requirements imposed by our regulators. The targets
are set with the intention of balancing the requirements of both our shareholders and policyholders.
i) a Pillar 1 calculation, which compares regulatory capital resource requirements, based on the characteristics of the
in-force life business, with an associated measure of capital as prescribed by regulation; and
ii) a Pillar 2 calculation which compares a risk-based assessment of solvency capital with an associated measure of
capital based on a realistic assessment of insurance liabilities; and
iii) the amount of required regulatory solvency capital is then determined by the method which gives rise to the lower
excess of regulatory capital over requirements.
These calculations are monitored regularly.
2. LONGER-TERM PROJECTIONS
Long term projections are performed covering, as a minimum:
i) Segmental earnings and surplus arising in the long-term insurance funds;
ii) Chesnara holding company cash flows;
iii) Regulatory solvency and capital resources and requirements; and
iv) European embedded value.
The projections are prepared for a base case, using latest board-approved assumptions, and for various individual and
multiple economic and non-economic sensitivities.
In addition:
Financial condition reports are prepared on an annual basis which includes assessments of the ability of the business to
withstand key adverse events, including increased rates of policy lapse, expense overruns and unfavourable market
conditions.
Reverse stress testing techniques are employed which assess events and circumstances which would cause the business to
become unviable. In this context, unviable is defined as the point at which the market loses confidence in the firm being
able to carry out its normal business activities.
3. RESPONSIBLE INVESTMENT Management
Investment management
We aim to promote customer retention by pursuing good relative investment performance across our UK, Swedish and Dutch
businesses.
We use third party investment managers in both the UK and Sweden. They are charged with operating within pre-determined
guidelines which are set having regard to the nature of the fund and to contractual obligations to policyholders. For the
with-profits funds these are also in accordance with the published Principles and Practices of Financial Management. In
Sweden a larger number of fund managers are used, which are subject to very stringent initial selection and ongoing
monitoring criteria.
A conservative approach to the investment of shareholders' funds is also adopted within the Group.
OUTCOMES FROM IMPLEMENTING OUR FINANCIAL MANAGEMENT OBJECTIVES
Key outcomes from our financial management process, in terms of meeting our objectives are set out below:
1. Solvency
The solvency and regulatory capital of the Group and its regulated subsidiaries is monitored regularly. Further detail of
the solvency positions of the Group and its regulated insurance companies has been summarised in the Business Review which
are analysed below.
2. Shareholder returns
The Board's primary aim is to provide an attractive dividend flow to its shareholders. Historically shareholder dividend
flows have been purely generated by CA plc, by way of the emergence of surplus in, and transfer of surplus from, its
long-term insurance funds to shareholder funds and by the return on shareholder net assets. Whilst CA plc remains the
principal cash generating subsidiary, especially following the Part VII transfer of Protection Life into it on 31 December
2014, 2015 has seen two changes to this dynamic. Firstly Movestic, whilst retaining a focus on targeted profitable growth,
has now reached a size where it is generating small levels of cash that are available to Chesnara. Secondly, the
acquisition of the Waard Group has introduced a second territory with a closed book focus, and there is a plan in place to
manage an orderly transfer of existing and future surplus to be available to Chesnara.
Dividend flows from cash generating subsidiaries to Chesnara are utilised in the first instance for the repayment and
servicing of debt, coupled with bearing central corporate governance costs which cannot be fairly attributed to the
long-term insurance funds, and which arise largely in connection with Chesnara's obligations as a listed company.
Returns to shareholders can be assessed by reference to many measures including the actual share price, the yields on the
shares and the comparison of total market capital to embedded value.
Throughout 2015, up to 25 August, the share price has remained broadly flat, being 339.3p per share at 1 January 2015 and
345.5p per share at 26 August 2015. The combined impact of the flat share price and the continuing attractive dividends
means shareholders have achieved good total shareholder return in the period.
3. Capital structure
The Group's UK operations are financed through a combination of retained earnings and debt finance. Surplus emerging from
the UK business is used to:
i) repay our debt obligations;
ii) support dividend distributions to shareholders; and
iii) continue to support our ongoing acquisition strategy.
The borrowings in place that part-finance the UK operations arose as follows:
- S&P, which was purchased in December 2010 for £63.5m, was accomplished by way of debt:equity financing broadly in a
ratio of 2:1.
- PL, which was acquired in November 2013 for £39.3m, was funded using a combination of debt and existing cash
resources.
- The process for raising the debt to fund the purchase of PL also gave rise to a restructuring of the existing
facilities that were initially arranged to fund the purchase of S&P. The result is that, at 30 June 2015 bank borrowings
amounted to £64.4m. This is a five year loan that has less than four years remaining.
The purchase of Movestic was financed by internal cash resources. On an ongoing basis the Movestic business is financed by
an external financial reinsurance arrangement. Historically Movestic has also required capital contributions from Chesnara
to support its initial growth phase and to ensure it remained appropriately capitalised. Movestic has, during 2015,
reached a size where it is starting to now generate cash.
The recent acquisition of the Waard Group was funded primarily through an equity raise in December 2014, although it was
part funded by existing cash resources. The Waard Group, as a well-capitalised closed book of business will generate cash
for the benefit of our shareholders through a combination of the orderly transfer of existing surplus in the funds coupled
with the emergence of future surplus.
With respect to future acquisitions the Group seeks to finance these through a suitable mix of debt, existing cash
resources, and equity, within the constraints imposed by the operation of regulatory rules over the level of debt finance
which may be borne by Insurance Groups without breaching solvency requirements.
Other factors which may place a demand on capital resources in the future include the costs of unavoidable large scale
systems developments such as those which may be involved with changing regulatory requirements. To the extent that ongoing
administration of the UK life businesses is performed within the terms of its third-party outsourcing agreements, the Group
is sheltered, to a degree, from these development costs as they are likely to be on a shared basis.
4. Liquidity and policyholder returns
Key aspects of policyholder fund performance in respect of the UK, Swedish and Dutch businesses are set out in the Business
Review.
The current profile and mix of investment asset holdings between fixed-interest securities and cash deposits is such that
realisations to meet obligations to third parties and to support dividend distributions can be made in an orderly and
efficient way.
5. Maintain the Group as a going concern
The Group's cash position, together with the return on financial assets in the parent company, supports the ability to
trade in the short term. Accordingly, the underlying solvency position of the Group's subsidiaries under the Solvency I
regime, and their ongoing ability to generate surpluses following the implementation of Solvency II, which support cash
transfers to shareholders' funds, is critical to the ongoing ability of the Group to continue trading and to meet its
obligations as they fall due.
The information set out below indicates a strong solvency position as at 30 June 2015 under Solvency I, as measured at both
the individual regulated life company levels in the UK, Sweden and the Netherlands, and at the Group level, and that we do
not expect the implementation of Solvency II to adversely impact our solvency position across the Group.
In addition, in respect of the UK business, the financial condition report and reverse stress testing assessments indicate
that it is able to withstand the impact of adverse scenarios, including the effect of significant investment market falls,
while the business's outsourcing arrangements protect it from significant expense overruns.
The Group is well capitalised, and has a healthy level of cash reserves to be able to meet its debt obligations as they
fall due. The Group does not rely on the renewal or extension of bank facilities to continue trading - indeed, as
indicated, its day to day operations are cash generative. The Group does, however, rely on cash flow from the maturity or
sale of fixed interest securities which match certain obligations to policyholders, which brings with it the risk of bond
default. In order to manage this risk we ensure that our bond portfolio is actively monitored and well diversified. Other
significant counterparty default risk relates to our principal reassurers. We monitor their financial position and are
satisfied that any associated credit default risk is low. It is noteworthy that we have negligible exposure to
Euro-denominated sovereign debt.
In light of the above, our expectation is that the Group will continue to generate surplus in its insurance subsidiaries
sufficient to meet its debt obligations as they fall due. The Directors therefore confirm that the IFRS Financial
Statements have been prepared on the Going Concern basis.
RISK management
Risk management processes
Overlaying all the day-to-day and development activity we undertake is a focused risk management culture and regime.
In the UK, Swedish and Dutch businesses we maintain processes for identifying, evaluating and managing the most significant
risks faced by the Group, which are regularly reviewed by the Group Audit & Risk Committee. Our risk processes have regard
to the significance of risks, the likelihood of their occurrence and take account of existing controls and the cost of
mitigating them. The processes are designed to manage rather than eliminate risk and, as such, provide reasonable, but not
absolute, assurance against loss.
At the subsidiary level in the UK businesses we maintain, in accordance with the regulatory requirements of the PRA and
FCA, a risk and responsibility regime. Accordingly, the identification, assessment and control of risk are firmly embedded
within the organisation and the procedures for the monitoring and updating of risk are robust. As part of this we have a
Risk Committee in CA plc, which comprises solely of Non-executive Directors. This Committee receives quarterly updates of
the key risk registers, as maintained by the senior management, for review and challenge. The Committee reports directly
to the CA plc Board which also reviews reports from the compliance and internal audit functions. The Chesnara plc Group
risk register is updated on a quarterly basis for any material changes in the CA plc risk register, which is then presented
to the Chesnara Audit & Risk Committee. The key risk registers have been designed to complement the production of
Individual Capital Assessments, which we are required to submit to the PRA on request and maintain on an ongoing basis. We
categorise all risks against the following relevant categories - insurance, market, credit, liquidity, operational and
Group - and identify potential exposures and the necessary capital requirements accordingly.
In the Swedish business, at the Movestic subsidiary level, there is full compliance with the regulatory requirement in that
its Board and Managing Director have responsibility for ensuring that the management of the organisation is characterised
by sound internal control, which is responsive to internal and external risks and changes in them. The Board has
responsibility for ensuring that there is an internal control risk function, which is charged with (i) ensuring that there
is information which provides a comprehensive and objective representation of the risks within the organisation and (ii)
proposing changes in processes and documentation regarding risk management. These obligations are evidenced by regular
compliance, internal audit, general risk and financial risk reports to the Movestic Board. The latter is supplemented by
quarterly returns to the Swedish regulator, Finansinspektionen, which set out estimated capital requirements in respect of
insurance, market, credit, liquidity, currency and operational risks.
The Dutch businesses has in place a risk management framework in accordance with guidance issued by the local regulators
(DNB for prudential supervision and AFM for financial conduct supervision). Appropriate to the size of the businesses, the
Audit Committee and the Risk Committee comprise all members of the Board of Directors and the Supervisory Board
respectively. The Risk & Compliance function performs Quarterly Risk Reviews with the risk owners, which include the
identification and response to newly emerging risks. To stay abreast with market developments, the company's Risk and
Compliance function also engages external professional support when conducting these Risk reviews. The risks identified
and corresponding mitigating internal control measures are centrally registered and appropriate monitoring and reminding is
ensured by the Risk & Compliance function.
Risk management processes are enhanced by stress and scenario testing, which evaluates the impact on the Group of certain
adverse events occurring separately or in combination. There is a strong correlation between these adverse events and the
risks identified in 'principal risks and uncertainties' below. The outcome of this testing provides context against which
the Group can assess whether any changes to its risk management processes are required.
Group and subsidiary auditors regularly report to management on identified control weaknesses together with suggested
improvements.
These risk management processes are continuing to be refined, in particular through the implementation of the Governance
Maps across the Divisions, the appointment of a Chief Risk Officer which will bring further expertise to this field, and
the implementation of the various risk management aspects of Solvency II. In particular our Group-wide risk management
processes are being enhanced in a uniform and consistent manner, embracing:
- articulation of risk appetite statements, following from documented strategic objectives;
- formulation and monitoring of associated risk metrics;
- risk identification and assessment;
- calculation of risk-based capital; and
- the embedding of risk management processes so that they are at the forefront of, and underpin, strategic and
operating decisions.
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
maintain an attractive dividend policy.
The specific principal risks and uncertainties subsisting within the Group are determined by the fact that:
i) the Group's core operations centre on the run-off of closed life and pensions businesses in the UK and the
Netherlands;
ii) notwithstanding this, the Group has a material segment, which comprises an open life and pensions business; and
iii) these businesses are subject to local regulation, which significantly influences the amount of capital which they
are required to retain and which may otherwise constrain the conduct of business.
The following table identifies the principal risks and uncertainties, together with a description of their actual or
potential impact and of the way in which the Group seeks to control these risks. These have been updated to reflect the
risks of the Waard Group, and it is worth noting that our Group-wide principal risks and uncertainties have remained
materially unchanged as a result of this update since those reported in the 2014 Annual Report & Accounts.
PRINCIPAL RISKS AND UNCERTAINTIES
Risk Impact Control
Adverse mortality / morbidity / longevity experience To the extent that actual mortality or morbidity rates vary from the assumptions underlying product pricing, so more or less profit will accrue to the Group. - Effective underwriting techniques and reinsurance programmes.- Option on certain contracts to vary premium rates in the light of actual experience.- Partial risk diversification in that the Group has a portfolio of annuity contracts where the benefits cease on death.
Adverse persistency experience Persistency rates significantly lower than those assumed will lead to reduced Group profitability in the medium to long-term. - Active investment management to ensure competitive policyholder investment funds.- Outsourcer service levels ensure strong customer service standards.- Customer retention processes.- Close monitoring of persistency levels across all groups of business.
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 - For the UK businesses, the Group pursues a strategy of outsourcing functions with charging structures such that the policy administration cost is sensitive to book run off to the fullest extent possible.- The Swedish operations assume growth through new business such that the general unit cost trend is positive.- The Dutch business pursues a low cost-base strategy using a designated service company. The cost base is supported by service income from third party customers.- For all three divisions, the Group maintains a strict regime of budgetary control.
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.
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