REG - Legal & General Grp - L&G Full Year Results 2015 Part 3 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 7
15/03/2016 07:07
- Part 7: For the preceding part double click ID:nRSO0691Sf
Insurance, Savings and LGR1 10,508 796 (709) 722 (444) 183
LGA 601 55 (45) (19) 13 -
Total covered business 11,109 851 (754) 703 (431) 183
5% 5%
10% 10% lower lower
lower lower 10% mortality mortality
As equity/ main- lower (UK (other
pub- property tenance lapse annu- busi-
lished values expenses rates ities) ness)
£m £m £m £m £m £m
Insurance, Savings and LGR1 10,508 (186) 116 95 (412) 65
LGA 601 - 13 (9) n/a 209
Total covered business 11,109 (186) 129 86 (412) 274
Effect on new business contribution for the year
1% 1% 1%
lower higher 1% 1% higher
As risk risk lower higher equity/
pub- discount discount interest interest property
lished rate rate rate rate yields
£m £m £m £m £m £m
Insurance, Savings and LGR1 445 67 (61) 50 (33) 21
LGA 84 6 (5) 2 (2) -
Total covered business 529 73 (66) 52 (35) 21
5% 5%
10% 10% lower lower
lower lower 10% mortality mortality
As equity/ main- lower (UK (other
pub- property tenance lapse annu- busi-
lished values expenses rates ities) ness)
£m £m £m £m £m £m
Insurance, Savings and LGR1 445 (7) 19 22 (37) 4
LGA 84 - 1 2 n/a 13
Total covered business 529 (7) 20 24 (37) 17
1. Includes LGC and workplace savings.
Opposite sensitivities are broadly symmetrical.
The above sensitivity analyses do not reflect management actions which could be taken to reduce the impacts. Sensitivity to changes in assumptions may not be linear, and as such, they should not be extrapolated to changes of a much larger order. A 2% higher risk discount rate would result in a £1,194m negative impact on UK embedded value and a £107m negative impact on UK new business contribution for the year.
European Embedded Value
94
5.06 Assumptions
UK assumptions
The assumed future pre-tax returns on fixed interest and RPI linked securities are set by reference to the portfolio yield
on the relevant backing assets held at market value at the end of the reporting period. The calculated return takes
account of derivatives and other credit instruments in the investment portfolio. Indicative yields on the portfolio,
excluding annuities within LGR, but after allowance for long term default risk, are shown below.
For LGR, separate returns are calculated for new and existing business. An indicative combined yield, after allowance for
long term default risk and the following additional assumptions, is also shown below. These additional assumptions are:
i. Where cash balances and debt securities are held at the reporting date in excess of, or below strategic investment
guidelines, then it is assumed that these cash balances or debt securities are immediately invested or disinvested at
current yields.
ii. Where interest rate swaps are used to reduce risk, it is assumed that these swaps will be sold before expiry and the
proceeds reinvested in corporate bonds with a redemption yield of 0.7% p.a. (0.7% p.a. at 31 December 2014) greater than
the swap rate at that time (i.e. the long-term credit rate).
iii. Where reinvestment or disinvestment is necessary to rebalance the asset portfolio in line with projected outgo, this
is also assumed to take place at the long-term credit rate above the swap rate at that time.
The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account of
the credit rating, outstanding term of the securities. The allowance for corporate securities expressed as a level rate
deduction from the expected returns for annuities was 22bps at 31 December 2015 (21bps at 31 December 2014).
UK covered business
i. Assets are valued at market value.
ii. Future bonus rates have been set at levels which would fully utilise the assets supporting the policyholders'
portion of the with-profits business in accordance with established practice. The proportion of profits derived from
with-profits business allocated to shareholders amounts to almost 10% throughout the projection.
iii. The value of in-force business reflects the cost, including administration expenses, of providing for benefit
enhancement or compensation in relation to certain products.
iv. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including
those for mortality, morbidity, persistency and maintenance expenses (excluding the development costs referred to below).
These are normally reviewed annually.
An allowance is made for future mortality improvement. For new business, mortality assumptions may be modified to take
certain scheme specific features into account.
v. Development costs relate to investment in strategic systems and development capability that are charged to the
covered business.
Overseas covered business
Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for
mortality, morbidity, persistency and maintenance expenses.
European Embedded Value
95
5.06 Assumptions (continued)
Economic assumptions
As at As at
2015 2014
% p.a. % p.a.
Risk margin 3.1 3.3
Risk free rate1
- UK 2.4 2.2
- Europe 0.8 0.6
- US 2.3 2.2
Risk discount rate (net of tax)
- UK 5.5 5.5
- Europe 3.9 3.9
- US 5.4 5.5
Reinvestment rate (US) 5.1 5.0
Other UK business assumptions
Equity risk premium 3.3 3.3
Property risk premium 2.0 2.0
Investment return (excluding annuities in LGR )
- Fixed interest:
-Gilts & non gilts 2.0 - 2.7 1.7 - 2.4
- Equities 5.7 5.5
- Property 4.4 4.2
Long-term rate of return on non profit annuities in LGR 4.2 3.6
Inflation2
- Expenses/earnings 3.8 3.7
- Indexation 3.3 3.2
1. The risk free rate is the gross redemption yield on the 15 year gilt index. The Europe risk free rate is the 10 year ECB
AAA-rated Euro area central government bond par yield. The LGA risk free rate is the 10 year US Treasury effective yield.
2. The LGR inflation rate has been set with reference to a curve.
Tax
The profits on the covered business, except for the profits on the shareholder capital held outside the long- term fund,
are calculated on an after tax basis and are grossed up by the notional attributed tax rate for presentation in the income
statement. For the UK, the after tax basis assumes the annualised current rate of 20.25% and subsequent planned future
reductions in corporation tax to 18% from 1 April 2020. The tax rate used for grossing up is the long term corporate tax
rate in the territory concerned, which for the UK is 18% (31 December 2014: 20%). The profits on the shareholder capital
held outside the long-term fund are calculated before tax and therefore tax is calculated on an actual basis.
US, Netherlands and France covered business profits are also grossed up using the long term corporate tax rates of the
respective territories i.e. the US is 35% (31 December 2014: 35%), France is 34.43% (31 December 2014: 34.43%) and the
Netherlands is 25% (31 December 2014: 25%).
European Embedded Value
96
5.06 Assumptions (continued)
Stochastic calculations
The time value of options and guarantees is calculated using economic and non-economic assumptions consistent with those
used for the deterministic embedded value calculations.
A single model has been used for UK and international business, with different economic assumptions for each territory
reflecting the significant asset classes in each territory.
Government nominal interest rates are generated using a LIBOR Market Model projecting full yield curves at annual
intervals. The model provides a good fit to the initial yield curve.
The total annual returns on equities and property are calculated as the return on 1 year bonds plus an excess return. The
excess return is assumed to have a lognormal distribution. Corporate bonds are modelled separately by credit rating using
stochastic credit spreads over the risk free rates, transition matrices and default recovery rates. The real yield curve
model assumes that the real short rate follows a mean-reverting process subject to two normally distributed random shocks.
The significant asset classes are:
- UK with-profits business - equities, property and fixed rate bonds of various durations;
- UK annuity business - fixed rate and index-linked bonds of various durations; and
- International business - fixed rate bonds of various durations.
The risk discount rate is scenario dependent within the stochastic projection. It is calculated by applying the
deterministic risk margin to the risk free rate in each stochastic projection.
Sensitivity calculations
A number of sensitivities have been produced on alternative assumption sets to reflect the sensitivity of the embedded
value and the new business contribution to changes in key assumptions. Relevant details relating to each sensitivity are:
· 1% variation in discount rate - a one percentage point increase/decrease in the risk margin has been assumed in each
case (for example a 1% increase in the risk margin would result in a 4.1% risk margin).
· 1% variation in interest rate environment - a one percentage point increased/decreased parallel shift in the risk free
curve with consequential impacts on fixed asset market values, investment return assumptions, risk discount rate, including
consequential changes to valuation bases.
· 1% higher equity/property yields - a one percentage point increase in the assumed equity/property investment returns,
excluding any consequential changes, for example, to risk discount rates or valuation bases, has been assumed in each case
(for example a 1% increase in equity returns would increase assumed total equity returns from 3.3% to 4.3%).
· 10% lower equity/property market values - an immediate 10% reduction in equity and property asset values.
· 10% lower maintenance expenses, excluding any consequential changes, for example, to valuation expense bases or
potentially reviewable policy fees (for example a 10% decrease on a base assumption of £10 per annum would result in a £9
per annum expense assumption).
· 10% lower assumed persistency experience rates, excluding any consequential changes to valuation bases, incorporating
a 10% decrease in lapse, surrender and premium cessation assumptions (for example a 10% decrease on a base assumption of 7%
would result in a 6.3% lapse assumption).
· 5% lower mortality and morbidity rates, excluding any consequential changes to valuation bases but including assumed
product repricing action where appropriate (for example if base experienced mortality is 90% of a standard mortality table
then, for this sensitivity, the assumption is set to 85.5% of the standard table).
The sensitivities for covered business allow for any material changes to the cost of financial options and guarantees but
do not allow for any changes to reserving bases or capital requirements within the sensitivity calculation, unless
indicated otherwise above.
European Embedded Value
97
5.07 Methodology
Basis of preparation
The supplementary financial information has been prepared in accordance with the European Embedded Value (EEV) Principles
issued in May 2004 by the European Insurance CFO Forum.
From 1 January 2016, the group is required to comply with the requirements established by the EU Solvency II Directive. The
Solvency II reporting framework incorporates a best estimate of cash flows in relation to insurance assets and liabilities
and consequently has replaced EEV reporting in the management information used internally to measure and monitor capital
resources. Therefore, from 2016 the group will no longer be reporting EEV information.
In accordance with the October 2015 CFO Forum guidance on Solvency II, the Group has not reflected Solvency II requirements
within the EEV results. Allowing for Solvency II could have had a significant impact on the EEV results, the impact of
which has not been quantified.
The supplementary financial information has been audited by PricewaterhouseCoopers LLP.
Covered business
The group uses EEV methodology to value individual and group life assurance, pensions and annuity business written in the
UK, Europe and the US. The UK covered business also includes non-insured self invested personal pension (SIPP) business.
The managed pension funds business has been excluded from covered business and is reported on an IFRS basis.
All other businesses are accounted for on the IFRS basis adopted in the primary financial statements.
There is no distinction made between insurance and investment contracts in our covered business as there is under IFRS.
European Embedded Value
98
5.07 Methodology (continued)
Description of methodology
The objective of EEV is to provide shareholders with realistic information on the financial position and current
performance of the group.
The methodology requires assets of an insurance company, as reported in the primary financial statements, to be attributed
between those supporting the covered business and the remainder. The method accounts for assets in the covered business on
an EEV basis and the remainder of the group's assets on the IFRS basis adopted in the primary financial statements.
The EEV methodology recognises profit from the covered business as the total of:
i. cash transfers during the relevant period from the covered business to the remainder of the group's assets; and
ii. the movement in the present value of future distributable profits to shareholders arising from the covered business
over the relevant reporting period.
Embedded value
Shareholders' equity on the EEV basis comprises the embedded value of the covered business plus the shareholders' equity of
other businesses, less the value included for purchased interests in long-term business.
The embedded value is the sum of the shareholder net worth (SNW) and the value of the in-force business (VIF). SNW is
defined as those amounts, within covered business (both within the long-term fund and held outside the long term fund but
used to support long term business), which are regarded either as required capital or which represent free surplus.
The VIF is the present value of future shareholder profits arising from the covered business, projected using best estimate
assumptions, less an appropriate deduction for the cost of holding the required level of capital and the time value of
financial options and guarantees (FOGs).
Service companies
All services relating to the UK covered business are charged on a cost recovery basis, with the exception of investment
management services provided to Legal & General Assurance Society Limited (Society). Profits arising on the provision of
these services are valued on a look-through basis.
As the EEV methodology incorporates the future capitalised cost of these internal investment management services, the
equivalent IFRS profits have been removed from the investment management (LGIM) segment and are instead included in the
results of the Insurance, Savings and LGR segments on an EEV basis.
The capitalised value of future profits emerging from internal investment management services are therefore included in the
embedded value and new business contribution calculations for the Insurance, Savings and LGR segments. However, the
historical profits which have emerged continue to be reported in the shareholders' equity of the LGIM segment on an IFRS
basis. Since the look-through into service companies includes only future profits and losses, current intra-group profits
or losses must be eliminated from the closing embedded value, and in order to reconcile the profits arising in the
financial period within each segment with the net assets on the opening and closing balance sheet, a transfer of IFRS
profits for the period from the UK SNW is deemed to occur.
New business
New business premiums reflect income arising from the sale of new contracts during the reporting period and any changes to
existing contracts, which were not anticipated at the outset of the contract.
In-force business comprises previously written single premium, annual premium, recurrent single premium contracts and
payments in relation to existing longevity insurance. The longevity insurance product comprises the exchange of a stream of
fixed leg payments for a stream of floating payments, with the value of the income stream being the difference between the
two legs. New business annual premiums have been excluded for longevity insurance due to the unpredictable deal flow from
this type of business.
New business contribution arising from the new business premiums written during the reporting period has been calculated on
the same economic and operating assumptions used in the embedded value at the end of the financial period. This has then
been rolled forward to the end of the financial period using the risk discount rate applicable at the end of the reporting
period.
The present value of future new business premiums (PVNBP) has been calculated and expressed at the point of sale. The PVNBP
is equivalent to total single premiums plus the discounted value of annual premiums expected to be received over the term
of the contracts using the same economic and operating assumptions used for the embedded value at the end of the financial
period. The discounted value of longevity insurance regular premiums and quota share reinsurance single premiums are
calculated on a net of reinsurance basis to enable a more representative margin figure.
The new business margin is defined as new business contribution at the end of the reporting period divided by the PVNBP.
The premium volumes and projection assumptions used to calculate the PVNBP are the same as those used to calculate new
business contribution.
Intra-group reinsurance arrangements are in place between the US and UK businesses, and it is expected that these
arrangements will be periodically extended to cover recent new business. LGA new business premiums and contribution reflect
the groupwide expected impact of LGA directly-written business.
European Embedded Value
99
5.07 Methodology (continued)
Projection assumptions
Cash flow projections are determined using best estimate assumptions for each component of cash flow and for each policy
group. Future economic and investment return assumptions are based on conditions at the end of the financial period. Future
investment returns are projected by one of two methods. The first method is based on an assumed investment return
attributed to assets at their market value. The second, which is used by LGA, where the investments of that subsidiary are
substantially all fixed interest, projects the cash flows from the current portfolio of assets and assumes an investment
return on reinvestment of surplus cash flows. The assumed discount and inflation rates are consistent with the investment
return assumptions.
Detailed projection assumptions including mortality, morbidity, persistency and expenses reflect recent operating
experience and are normally reviewed annually. Allowance is made for future improvements in annuitant mortality based on
experience and externally published data. Favourable changes in operating experience are not anticipated until the
improvement in experience has been observed.
All costs relating to the covered business, whether incurred in the covered business or elsewhere in the group, are
allocated to that business. The expense assumptions used for the cash flow projections therefore include the full cost of
servicing this business.
Tax
The projections take into account all tax which is expected to be paid, based on best estimate assumptions, applying
current legislation and practice together with known future changes.
Allowance for risk
Aggregate risks within the covered business are allowed for through the following principal mechanisms:
i. setting required capital levels with reference to both the group's internal risk based capital models, and an
assessment of the strength of regulatory reserves in the covered business;
ii. allowing explicitly for the time value of financial options and guarantees within the group's products; and
iii. setting risk discount rates by deriving a group level risk margin to be applied consistently to local risk free
rates.
Required capital and free surplus
Regulatory capital for the UK covered businesses is provided by assets backing the with-profits business or by the SNW. The
SNW comprises all shareholders' capital within Society, including those funds retained within the long-term fund
(collectively Society shareholder capital).
Society shareholder capital is either required to cover the EU solvency margin or is free surplus as its distribution to
shareholders is not restricted.
For UK with-profits business, the required capital is covered by the surplus within the with-profits part of the fund and
no effect is attributed to shareholders except for the burn-through cost, which is described later. This treatment is
consistent with the Principles and Practices of Financial Management for this part of the fund.
For UK non profit business, the required capital will be maintained at no less than the level of the EU minimum solvency
requirement. This level, together with the margins for adverse deviation in the regulatory reserves, is, in aggregate, in
excess of internal capital targets assessed in conjunction with the Individual Capital Assessment (ICA) and the
with-profits support account.
The initial strains relating to new non profit business, together with the related EU solvency margin, are supported by
releases from existing non profit business and the Society shareholder capital. As a consequence, the writing of new
business defers the release of capital to free surplus. The cost of holding required capital is defined as the difference
between the value of the required capital and the present value of future releases of that capital. For new business, the
cost of capital is taken as the difference in the value of that capital assuming it was available for release immediately
and the present value of the future releases of that capital. As the investment return, net of tax, on that capital is less
than the risk discount rate, there is a resulting cost of capital which is reflected in the value of new business.
For LGA, the Company Action Level (CAL) of capital has been treated as required capital for modelling purposes. The CAL is
the regulatory capital level at which the company would have to take prescribed action, such as submission of plans to the
state insurance regulator, but would be able to continue operating on the existing basis. The CAL is currently twice the
level of capital at which the regulator is permitted to take control of the business.
For LGN, required capital has been set at 104% of EU minimum solvency margin for all products without FOGs. For those
products with FOGs, capital of between 104% and 563% of the EU minimum solvency margin has been used. These capital
requirements have been scaled up by a factor of 1.042 at the total level to ensure the total requirement meets the 160%
Solvency I from the capital policy for the EEV, for the NBVA no scaling is applied. The level of capital has been
determined using risk based capital techniques.
The contribution from new business for our international businesses reflects an appropriate allowance for the cost of
holding the required capital.
European Embedded Value
100
5.07 Methodology (continued)
Financial options and guarantees
Under the EEV Principles an allowance for the time value of FOGs is required where a financial option exists which is
exercisable at the discretion of the policyholder. These types of option principally arise within the with-profits part of
the fund and their time value is recognised within the with-profits burn-through cost described below. Additional financial
options for non profit business exist only for a small amount of deferred annuity business where guaranteed early
retirement and cash commutation terms apply when the policyholders choose their actual retirement date.
Further financial guarantees exist for non profit business, in relation to index-linked annuities where capped or collared
restrictions apply. Due to the nature of these restrictions and the manner in which they vary depending on the prevailing
inflation conditions, they are also treated as FOGs and a
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