REG - Legal & General Grp - L&G FY 2014 results part 3 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 7

Legal & GeneralAnnouncement

04/03/2015 07:12

- Part 7: For the preceding part double click  ID:nRSD4570Gf 

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                                                                                                    
                                           93 
 
5.09 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. 
 
The supplementary financial information has been reviewed by PricewaterhouseCoopers LLP and prepared with assistance from
our consulting actuary Milliman in the USA. 
 
Changes to accounting policy - IASB consolidation project 
 
On 1 January 2014 the application of IFRS 10, 'Consolidated Financial Statements' became compulsory for entities reporting
in the EU. 
 
IFRS 10, 'Consolidated Financial Statements' defines the principal of control and establishes control as the basis for
determining which entities are consolidated in the consolidated financial statements. This states that an investor controls
an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the
ability to affect those returns through its power over the investee. The application of IFRS 10 has resulted in the Group
consolidating a small number of investment vehicles which were not previously consolidated which impacted the gain
attributable to non-controlling interest. 
 
As a result, the prior year disclosure in the Group embedded value summary and Note 5.05 have been restated to reflect the
adoption by the Group of IFRS 10, 'Consolidated Financial Statements'. The effect on amounts previously reported at 31
December 2013 is shown below. Embedded value at 31 December 2013 remains unaffected by the adoption. 
 
                                                                          2013   
                                                                          £m     
                                                                                 
                                                                                 
 Profit for the year as previously reported (after tax)            1,289  
 Gains on non-controlling interests                                
 IFRS 10 'Consolidated Financial Statements' amendment             10     
                                                                                 
                                                                                 
 Revised profit for the year (after tax)                                  1,299  
                                                                                 
                                                                                 
                                                                                 
 
 
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                                                                                                    
                                           94 
 
5.09 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 Pensions Limited (LGPL) and to Legal & General Assurance Society Limited
(LGAS). 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 LGAS 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 LGAS 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, regular premium, recurrent single premium contracts and
payments in relation to existing longevity insurance. 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 regular 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 is 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                                                                                                    
                                           95 
 
5.09 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 LGAS and LGR 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
and the excess assets in LGPL (collectively Society shareholder capital). 
 
Society shareholder capital is either required to cover 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 339% 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. 
 
For LGF, 100% of EU minimum solvency margin has been used for EV modelling purposes for all products both with and without
FOGs. 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                                                                                                    
                                           96 
 
5.09 Methodology (continued) 
 
Financial options and guarantees 
 
Under the EEV Principles an allowance for 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 time value cost recognised accordingly. 
 
The time value of FOGs has been calculated stochastically using a large number of real world economic scenarios derived
from assumptions consistent with the deterministic EEV assumptions and allowing for appropriate management actions where
applicable. The management action primarily relates to the setting of bonus rates. Future regular and terminal bonuses on
participating business within the projections are set in a manner consistent with expected future returns available on
assets deemed to back the policies within the stochastic scenarios. 
 
In recognising the residual value of any projected surplus assets within the with-profits part of the fund in the
deterministic projection, it is assumed that terminal bonuses are increased to exhaust all of the assets in the part of the
fund over the future lifetime of the in-force with-profits policies. However, under stochastic modelling, there may be some
extreme economic scenarios when the total projected assets within the with-profits part of the fund are insufficient to pay
all projected policyholder claims and associated costs. The average additional shareholder cost arising from this shortfall
has been included in the time value cost of financial options and guarantees and is referred to as the with-profits
burn-through cost. 
 
Economic scenarios have been used to assess the time value of the financial guarantees for non profit business by using the
inflation rate generated in each scenario. The inflation rate used to project index-linked annuities will be constrained in
certain real world scenarios, for example, where negative inflation occurs but the annuity payments do not reduce below
pre-existing levels. The time value cost of FOGs allows for the projected average cost of these constrained payments for
the index-linked annuities. It also allows for the small additional cost of the guaranteed early retirement and cash
commutation terms for the minority of deferred annuity business where such guarantees have been written. 
 
LGA FOGs relate to guaranteed minimum crediting rates and surrender values on a range of contracts, as well as impacts on
no-lapse guarantees (NLG). The guaranteed surrender value of the contract is based on the accumulated value of the contract
including accrued interest. The crediting rates are discretionary but related to the accounting income for the amortising
bond portfo