REG - Legal & General Grp - L&G H1 2014 Results Part 3 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 2
29/10/2014 10:33
- Part 2: For the preceding part double click ID:nRSF3773Oa
With-profits surplus 0.7 0.7 0.8
Risk capital margin (0.1) (0.1) (0.1)
Surplus 0.6 0.6 0.7
Legal & General Assurance Society Limited is required to maintain a surplus in the with-profits part of the fund on a realistic basis (Peak 2). The risk capital margin is calculated based on the most onerous capital requirement calculated after performing five stresses specified by the PRA. The surplus includes the present value of future shareholder transfers of £0.3bn (H1 13: £0.3bn; FY 13: £0.3bn) as a liability in the calculation.
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77
4.02 Group Economic Capital
Economic capital is the amount of capital that the Board believes the Group needs to hold, over and above its liabilities,
in order to meet the Group's strategic objectives. This is not the same as regulatory capital which reflects regulatory
rules and constraints. The Group's objectives include being able to meet its liabilities as they fall due whilst
maintaining the confidence of its investors, rating agencies, customers and intermediaries that this will be the case.
Over the past few years Legal & General has invested considerable time and resource in developing a risk based capital
model that is used to calculate the Group's economic capital balance sheet and support the management of risk within the
Group. The Group continues to develop the economic capital model in light of developments in the Group's business model,
refinements in modelling and the analysis of experience, emerging market practice and feedback from independent reviewers.
The Group's economic capital position will reflect these changes as they are implemented.It is intended that this modelling
framework, suitably adjusted, should also meet the needs of the Solvency II regime, due to come in to force on 1 January
2016. Our Economic Capital model has not been reviewed by the Prudential Regulatory Authority ("PRA"), nor will it be.
The economic capital numbers presented here do not represent our view of the Solvency II outcome for the Group. Solvency
II has elements which are considered to be inconsistent with the Group's definition of economic capital, so there will be
differences between the two balance sheets.
The Group has been discussing progress on Solvency II with the PRA and in 2015 it will make a formal application for
approval of an internal model. As yet the Group's Solvency II internal model has not been reviewed or approved by the
PRA.
(a) Capital position
As at 31 December 2013 the Group had an economic capital surplus of £6.9bn, corresponding to an economic capital coverage ratio of 251%. The economic capital position is as follows:
At
31.12.13
£bn
Eligible own funds 11.4
Economic capital requirement 4.5
Surplus/ (deficit) 6.9
1-in-200 coverage ratio (%)1 251
1. Coverage ratio is calculated on unrounded values.
The figures that appear in this note are all pre-accrual for any dividend.
Further explanation of the underlying methodology and assumptions are 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 certain elements adjusted to move to an economic capital basis. 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 subsidiaries 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 the Group's 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 capital and
allows for diversification between all Group entities.
All material insurance subsidiaries, including Legal & General Assurance Society Limited, Legal & General Pensions
Management Limited and LGA operating subsidiaries are incorporated into the Group's economic capital model assessment of
required capital, assuming diversification of the risks between those subsidiaries.
Insurance subsidiaries for which the capital requirements are less material, for example LGF, LGN and Suffolk Life, are
valued on the Group's latest interpretation of the Solvency II Standard Formula basis. The business ceded to Legal &
General Pensions Limited, an internal Insurance Special Purpose Vehicle, has been valued on a "look through" basis and
capital requirements calculated as if the business was not internally reassured. Non-insurance subsidiaries are included
using their current regulatory surplus, without allowing for any diversification with the rest of the Group.
The allowance for the Group's defined benefit pension scheme in the base balance sheet is made on the scheme's funding
basis, and the allowance within the capital requirement is made by stressing the funding position using the same economic
capital basis as for the insurance subsidiaries.
The results and the model are unaudited but certain elements of the methodology, assumptions and processes have been
reviewed for the Group by PricewaterhouseCoopers LLP. As stated previously this model has not been reviewed by the PRA.
Capital and Investments
78
4.02 Group Economic Capital (continued)
(c) Assumptions
The calculation of the economic balance sheet and associated capital requirement requires a significant 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 10 basis point deduction to allow for
a 'credit risk 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 to are used to calculate the 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, judgement has been used; and
(iv) assumptions on the dependencies between risks, which are calibrated using a combination of historic data and expert
judgement.
As stated above, for annuities the liability discount rate includes an economic matching adjustment. This uses the same
approach as the Solvency II matching adjustment but any constraints the Group considers economically artificial, such as
capping the yield on assets with a credit rating below BBB and any ineligibility of certain assets, have not been applied.
The other key assumption relating to the annuity business is the modelling of stresses to longevity. As for IFRS and EEV,
the Group models base mortality and future improvements separately. For the Group's economic capital assessment, the Group
believes 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) Sensitivity analysis The following sensitivities are provided to give an indication of how the Group's economic capital surplus as at 31 December 2013 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 capital
capital coverage
surplus ratio
31.12.13 31.12.13
£bn %
Credit spread widens by 100bps with no change in long term default expectations (0.3) (8)
A 3 notch downgrade, e.g. AA- to A-, of 20% of the corporate bond portfolio backing annuity business, (0.5) (11)
with no change to the assumed spread sensitivity or long term default expectations
20% fall in equity market (0.3) (3)
40% fall in equity markets (0.6) (6)
15% fall in property markets (0.2) (4)
100bps increase in risk free rates (0.3) 1
100bps fall in risk free rates 0.1 -
1% reduction in annuitant base mortality (0.1) (3)
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79
4.02 Group Economic Capital (continued)
(e) Reconciliation of IFRS Shareholders' Equity to Economic Capital Eligible Own Funds
The table below gives a reconciliation of the Eligible own funds on an EC basis and the Group's IFRS shareholders' equity.
At
31.12.13
£bn
IFRS shareholders' equity at 31 December 2013 5.6
Remove DAC, goodwill and other intangible assets and liabilities (1.7)
Add subordinated debt treated as economic available capital 1.9
Insurance contract valuation differences 6.2
Add value of shareholder transfers 0.3
Increase in value of net deferred tax liabilities (resulting from valuation differences) (0.7)
Other 0.4
Adjustment - Basic own funds to Eligible own funds (0.6)
Eligible own funds at 31 December 2013 11.4
The figures that appear in this note are all pre-accrual for any dividend.
(f) 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.
At
31.12.13
%
Interest Rate 5
Equity 16
Credit 44
Property 8
Currency (3)
Inflation (1)
Total Market Risk 69
Counterparty Risk 1
Life Mortality & Life Catastrophe 5
Life Longevity 12
Life Lapse 7
Non-life underwriting 2
Health underwriting -
Total Insurance Risk 26
Operational Risk 4
Total Economic Capital Requirement 100
- Credit risk is the Group's most significant exposure, predominantly arising from
corporate bond exposure backing the Group's annuity portfolio.- The Group also has
significant exposure to other market risks, predominantly due to the investment
holdings within the shareholder funds but also the risk to fee income from assets
backing unit linked and with-profit Savings businesses.- Longevity risk is the
Group's most significant insurance risk exposure, again arising from the annuity book
on which the majority of the longevity risk is retained.- Lapse risk arises through
the risk of mass lapse on investment management and savings businesses and the risk
of non-renewal on the Group's protection businesses.
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80
4.02 Group Economic Capital (continued)
(g) Solvency II
As indicated above, the economic capital results set out above do not reflect the Solvency II regime. They have been
derived using the same modelling framework that the Group intends to use for Solvency II. The Solvency II internal model
has not, as yet, been reviewed or approved by the PRA. The Group intends to submit its internal model to the PRA in 2015 to
gain approval to use the model from Solvency II go live on 1 January 2016. The Group expects the final outcome on Solvency
II to result in a lower Group solvency ratio than the economic capital coverage ratio shown above.
(h) Half-Year 2014 surplus
The economic capital surplus as at 30 June 2014 has increased from 31 December 2013 to a surplus of £7.6bn (FY 13: £6.9bn)
and coverage ratio of 261% (FY 13: 251%), with the increase in surplus supported by the raising of £0.6bn of subordinated
debt in June 2014.
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81
4.03 Investment portfolio
Market Market Market
value value1 value1
At At At
30.06.14 30.06.13 31.12.13
£m £m £m
Worldwide assets under management 467,176 440,152 452,260
Client and policyholder assets (401,874) (380,388) (391,151)
Non-unit linked with-profits assets2 (17,061) (17,906) (17,391)
Investments to which shareholders are directly exposed 48,241 41,858 43,718
1. Comparatives have been restated following the adoption of IFRS 10.
2. Includes assets backing participating business in LGF of £2,378m (H1 13: £2,434m; FY 13: £2,347m).
Analysed by investment class:
Other
non profit Other
LGR insurance LGC shareholder
investments1 investments investments investments Total Total Total
At At At At At At At
30.06.14 30.06.14 30.06.14 30.06.14 30.06.14 30.06.13 31.12.13
Note £m £m £m £m £m £m £m
Equities2 84 - 1,592 9 1,685 1,507 1,760
Bonds 4.05 34,062 2,401 1,538 1,241 39,242 34,647 35,697
Derivative assets3 2,184 28 125 - 2,337 2,314 2,307
Property 1,692 - 324 4 2,020 1,065 1,447
Cash (including cash
equivalents), loans & receivables 582 252 1,602 366 2,802 2,184 2,331
Financial investments 38,604 2,681 5,181 1,620 48,086 41,717 43,542
Other assets4 155 - - - 155 141 176
Total investments 38,759 2,681 5,181 1,620 48,241 41,858 43,718
1. LGR Investments includes all business written in LGPL and excludes with-profits non-participating business.
2. Includes equity investment in CALA Group Limited.
3. Derivative assets are shown gross of derivative liabilities. 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.
4. Other assets include finance lease debtors and properties under construction.
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82
4.04 Direct Investments1
(a) Analysed by asset class
Direct1 Traded2 Direct1 Traded2
Investments securities Total Investments securities Total
At At At At At At
30.06.14 30.06.14 30.06.14 31.12.13 31.12.13 31.12.13
£m £m £m £m £m £m
Equities 298 1,387 1,685 202 1,558 1,760
Bonds 2,036 37,206 39,242 1,048 34,649 35,697
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