REG - Legal & General Grp - L&G Full Year Results 2015 Part 3 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 2
15/03/2016 07:07
- Part 2: For the preceding part double click ID:nRSO0691Sa
own funds1 13.5 12.5
Economic capital requirement 5.9 5.5
Surplus 7.6 7.0
1-in-200 coverage ratio2 230% 229%
1. Eligible own funds do not include an accrual for the 2015 final dividend of £592m (2014: £496m) declared after the balance sheet date.
2. Coverage ratio is calculated on unrounded values.
Further explanation of the underlying methodology and assumptions is set out in the sections below.
(b) Methodology
Eligible own funds are defined to be the excess of the value of assets over the liabilities. Subordinated debt issued by
the group is considered to be part of available capital, rather than a liability, as it is subordinate to policyholder
claims.
Assets are valued at IFRS fair value with adjustments to remove intangibles, deferred acquisition costs and to value
reassurers' share of technical provisions on a basis consistent with the liabilities on the Economic Capital Balance Sheet.
The economic value of assets excluded from the IFRS Balance Sheet is also included.
Liabilities are valued on a best estimate market consistent basis, with the application of an Economic Matching Adjustment
for valuing annuity liabilities.
The Economic Capital Requirement is the amount of capital required to cover the 1-in-200 worst projected future outcome in
the year following the valuation, allowing for realistic management and policyholder actions and the impact of the stress
on the tax position of the group. This allows for diversification between the different firms within the group and between
the risks that they are exposed to.
The liabilities include a Recapitalisation Cost to allow for the cost of recapitalising the balance sheet following the
1-in-200 stress in order to maintain confidence that our future liabilities will be met. This is calculated using a cost of
capital that reflects the long term average rates at which it is expected that the group could raise debt and allowing for
diversification between all group entities.
All material insurance firms, including Legal & General Assurance Society, Legal & General Insurance, Legal & General
Pensions Management Company (PMC) (LGIM's insurance subsidiary) and Legal & General America (LGA) are incorporated into the
group's Economic Capital model assessment of required capital, assuming diversification of the risks between those firms.
Firms for which the capital requirements are less material, for example Legal & General Netherlands, are valued on the
Solvency II Standard Formula basis. Non-insurance firms are included using their current regulatory surplus, without
allowing for any diversification with the rest of the group.
Allowance is made within the Economic Capital Balance Sheet for the group's defined benefit pension scheme based upon the
scheme's funding basis, and allowance is made within the capital requirement by stressing the funding position using the
same economic capital basis as for the insurance firms.
The results and the model are unaudited but certain elements of the methodology, assumptions and processes have been
reviewed by PwC.
Capital and Investments
71
4.03 Group Economic Capital (continued)
(c) Assumptions
The calculation of the Economic Capital Balance Sheet and associated capital requirement requires a number of assumptions,
including:
(i) assumptions required to derive the present value of best estimate liability cash flows. Non market assumptions are
broadly the same as those used to derive the group's EEV disclosures. Future investment returns and discount rates are
based on market data where a deep and liquid market exists or using appropriate estimation techniques where this is not the
case. The risk-free rates used to discount liabilities are market swap rates, with a 12 basis point deduction to allow for
a credit risk adjustment. For annuities the liability discount rate includes an Economic Matching Adjustment;
(ii) assumptions regarding management actions and policyholder behaviour across the full range of scenarios. The only
management actions allowed for are those that have been approved by the Board and are in place at the balance sheet date;
(iii) assumptions regarding the volatility of the risks to which the group is exposed are used to calculate Economic
Capital Requirement. Assumptions have been set using a combination of historic market, demographic and operating experience
data. In areas where data is not considered robust, expert judgement has been used; and
(iv) assumptions on the dependencies between risks, which are calibrated using a combination of historic data and expert
judgement.
For annuities the liability discount rate includes an Economic Matching Adjustment. The Economic Matching Adjustment is
derived using the same approach as the Solvency II matching adjustment, but any constraints we consider economically
artificial, such as capping the yield on assets with a credit rating below BBB and any ineligibility of certain assets and
liabilities, have not been applied.
The other key assumption relating to the annuity business is the assumption of longevity. As for IFRS and EEV, Legal &
General models base mortality and future improvement of mortality separately. For our Economic Capital assessment we
believe it is appropriate to ensure that the balance sheet makes sufficient allowance to meet the 1 in 200 stress to
longevity over the run off of the liabilities rather than just over a 1 year timeframe as required by Solvency II.
(d) Analysis of change
The table below shows the movement (net of tax) during the financial year in the group's Economic Capital surplus.
Economic
Capital
surplus
2015
Analysis of movement from 1 January to 31 December 2015 £bn
Economic solvency position as at 1 January 2015 7.0
Operating experience expected release1 0.8
Operating experience new business 0.1
Other capital movements2 0.3
New Sterling subordinated debt issuance 0.6
Repayment of Euro subordinated debt (0.5)
Dividends paid in the period (0.7)
Economic solvency position as at 31 December 2015 7.6
1. Release of surplus generated by in-force business.
2. Other capital movements comprise model and assumption changes, changes in asset mix across the group (with corresponding increase in Economic Capital Requirement) and other market movements.
Capital and Investments
72
4.03 Group Economic Capital (continued)
(e) Reconciliation of IFRS Shareholders' equity to Economic Capital Eligible own funds
The table below gives a reconciliation of the group's IFRS Shareholders' equity to the Eligible own funds on an Economic Capital basis.
2015 2014
£bn £bn
IFRS Shareholders' equity at 31 December 6.4 6.0
Remove DAC, goodwill and other intangible assets and liabilities (2.0) (2.0)
Add subordinated debt treated as economic available capital1 2.5 2.4
Insurance contract valuation differences2 7.0 6.6
Add value of shareholder transfers 0.2 0.3
Increase in value of net deferred tax liabilities (resulting from valuation differences) (0.5) (0.6)
Other 0.2 0.1
Adjustment - Basic own funds to Eligible own funds3 (0.3) (0.3)
Eligible own funds at 31 December 13.5 12.5
1. Treated as available capital on the Economic Capital balance sheet as the liabilities are subordinate to policyholder claims. 2. Differences in the measurement of liabilities between IFRS and Economic Capital, offset by the inclusion of the recapitalisation cost.3. Eligibility restrictions relating to the own funds of US captive reassurers and the UK with-profits fund. The figures that appear in this note are all pre-accrual for the 2015 final dividend of £592m (2014:
£496m).
(f) Sensitivity analysis The following sensitivities are
provided to give an indication of how the group's
economic capital surplus as at 31 December 2015 would
have changed in a variety of adverse events. These are
all independent stresses to a single risk. In practice
the balance sheet is impacted by combinations of
stresses and the combined impact can be larger than
adding together the impacts of the same stresses in
isolation. It is expected that, particularly for market
risks, adverse stresses will happen together.
Impact on
Impact on economic
net of tax capital
capital coverage
surplus ratio
2015 2015
£bn %
Credit spreads widen by 100bps assuming an escalating (0.4) (8)
addition to ratings1,2
Credit spreads tighten by 100bps assuming an escalating 0.4 8
deduction to ratings1,2
A worsening in our expectation of future default and (0.3) (12)
downgrade to 115% of our assumed best estimate level
20% fall in equity markets (0.3) (4)
40% fall in equity markets (0.6) (6)
20% rise in equity markets 0.4 5
15% fall in property markets (0.2) (3)
100bps increase in risk free rates3 - 10
100bps fall in risk free rates 0.1 (9)
1% reduction in annuitant base mortality (0.1) (2)
1% increase in annuitant base mortality 0.1 2
1. All spread sensitivities apply to Legal & General's
corporate bond (and similar) holdings, with no change in
the firm's long term default expectations. 2. The stress
for AA bonds is twice that for AAA bonds, for A bonds it
is three times, for BBB four times and so on, such that
the weighted average spread stress for the portfolio is
100bps.3. A 100bps increase in risk free rates would
result in a significant reduction in Group own funds,
which would be offset by a similar reduction in group
ECR, resulting in net nil impact on surplus (when
rounded to nearest £0.1bn).
The above sensitivity analysis does not reflect
management actions which could be taken to reduce the
impacts. In practice, the group actively manages its
asset and liability positions to respond to market
movements. The impacts of these stresses are not linear
therefore these results should not be used to
extrapolate the impact of a smaller or larger stress.
The results of these tests are indicative of the market
conditions prevailing at the balance sheet date. The
results would be different if performed at an
alternative reporting date.
Capital and Investments
73
4.03 Group Economic Capital (continued)
(g) Analysis of Group Economic Capital Requirement
The table below shows a breakdown of the group's Economic Capital Requirement by risk
type. The split is shown after the effects of diversification.
2015 2014
% %
Interest Rate 4 6
Equity 13 15
Property 6 4
Credit1 48 44
Currency - 3
Inflation 3 (2)
Total Market Risk2 74 70
Counterparty Risk 1 1
Life Mortality - -
Life Longevity3 4 10
Life Lapse 4 5
Life Catastrophe 4 3
Non-life underwriting 1 1
Health underwriting - 1
Expense 1 1
Total Insurance Risk 14 21
Operational Risk 7 7
Miscellaneous4 4 1
Total Economic Capital Requirement 100 100
1. Credit risk is Legal & General's most significant exposure, arising predominantly
from the c£40bn portfolio of bonds backing the group's annuity business.2. In
addition to credit risk the group also has significant exposure to other market
risks, primarily due to the investment holdings within the shareholder funds but also
the risk to fee income from assets backing unit linked and with-profits Savings
business.3. Longevity risk is Legal & General's most significant insurance risk
exposure, arising from the annuity book on which the majority of the longevity risk
is retained.4. Miscellaneous includes the ECR for the pension scheme and the sectoral
capital requirements for non-insurance regulated firms.
(h) Reconciliation from Economic Capital surplus to Solvency II surplus
The Economic Capital position does not reflect regulatory constraints. The regulatory
constraints imposed by the Solvency II regime result in a lower surplus. The table
below provides an analysis of the key differences between the two bases. The Solvency
II results are reported net of Transitional Measures on Technical Provisions.
2015
£bn
Economic Capital surplus as at 31 December 7.6
Different matching adjustment1 (1.4)
Risk margin vs Recapitalisation cost2 -
Longevity calibration3 (0.3)
Eligibility of Group own funds4 (0.5)
LGA on a D&A basis5 0.1
Solvency II surplus as at 31 December6 5.5
1. This is the difference between the Economic Matching Adjustment and the Solvency
II Matching Adjustment.2. The risk margin represents the amount a third party
insurance company would require to take on the obligations of a given insurance
company. It is equal to the cost of capital on the SCR necessary to support insurance
risks that cannot be hedged over the lifetime of the business. The recapitalisation
cost is an equivalent measure under economic capital, but represents the cost of
recapitalising the balance sheet following a stress event. It also removes elements
of its specification that are, in Legal & General's view, uneconomic. 3. Economic
Capital and Solvency II balance sheets use different calibrations for longevity
risk.4. Deductions for regulatory restrictions in respect of fungibility and
transferability restrictions. These do not apply to the Economic Capital balance
sheet.5. To ensure consistency of risk management across the group, L&G America
remains within the Internal Model for Economic Capital purposes.6. There are also
differences in the valuation of with-profits business and the group pension scheme
that have lower order impacts on the difference between the surpluses.
Capital and Investments
74
4.04 Investment portfolio
Market Market
value value
2015 2014
£m £m
Worldwide total assets 747,944 710,554
Client and policyholder assets (679,913) (638,117)
Non-unit linked with-profits assets (11,644) (15,242)
Investments to which shareholders are directly exposed 56,387 57,195
Analysed by investment class:
Other
non profit Other
LGR insurance LGC shareholder
investments investments investments1 investments Total Total
2015 2015 2015 2015 2015 2014
Note £m £m £m £m £m £m
Equities 149 - 1,987 116 2,252 2,265
Bonds 4.06 39,368 2,367 1,427 754 43,916 45,811
Derivative assets2 3,627 - 36 - 3,663 3,940
Property 2,157 - 186 4 2,347 2,030
Cash, cash equivalents, loans & receivables 1,053 534 1,988 593 4,168 3,018
Financial investments 46,354 2,901 5,624 1,467 56,346 57,064
Other assets - - 41 - 41 131
Total investments 46,354 2,901 5,665 1,467 56,387 57,195
1. Equity investments include CALA Group Limited and Peel Media Holdings Limited (MediaCityUK).
2. Derivative assets are shown gross of derivative liabilities of £2.7bn (2014: £2.7bn). Exposures arise from the use of derivatives for efficient portfolio management, especially the use of interest rate swaps, inflation swaps, credit default swaps and foreign exchange forward contracts for asset and liability management.
Capital and Investments
75
4.05 Direct Investments
(a) Analysed by asset class
Direct1 Traded2 Direct1 Traded2
Investments securities Total Investments securities Total
2015 2015 2015 2014 2014 2014
£m £m £m £m £m £m
Equities 432 1,820 2,252 318 1,947 2,265
Bonds 3,722 40,194 43,916 2,983 42,828 45,811
Derivative assets - 3,663 3,663 - 3,940 3,940
Property 2,347 - 2,347 2,030 - 2,030
Cash, cash equivalents, loans & receivables 425 3,743 4,168 241 2,777 3,018
Other assets 41 - 41 131 - 131
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