REG - Legal & General Grp - L&G H1 2014 Results Part 3 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 8
29/10/2014 10:33
- Part 8: For the preceding part double click ID:nRSF3773Og
adoption.
30.06.13 31.12.13
£m £m
Profit for the period as previously reported 783 1,289
Gains on non-controlling interest
IFRS 10 'Consolidated Financial Statements' amendment 2 10
Revised profit for the period (after tax) 785 1,299
Covered business
The Group uses EEV methodology to value individual and group life assurance, pensions and annuity business written in the
UK, Continental 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
108
5.08 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
(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 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
109
5.08 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 100% of EU minimum solvency margin for all products without FOGs. For those
products with FOGs, capital of between 100% and 425% of the EU minimum solvency margin has been used. At total level a
check is made to ensure the total requirement meets the 160% Solvency I (both EEV and NBVA) from the capital policy. 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
110
5.08 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 portfolio. The majority of the guaranteed minimum crediting rates are between 3% and 4%. The assets backing these
contracts are invested in US Dollar denominated fixed interest securities.
LGN separately provides for two types of guarantees: interest rate guarantees and maturity guarantees. Certain contracts
provide an interest rate guarantee where there is a minimum crediting rate based on the higher of 1-year Euribor and the
policy guarantee rate. This guarantee applies on a monthly basis. Certain other linked contracts provide a guaranteed
minimum value at maturity where the maturity amount is the higher of the fund value and a guarantee amount. The fund values
for both these contracts are invested in Euro denominated fixed interest securities.
For LGF, FOGs which have been separately provided for relate to guaranteed minimum crediting rates and surrender values on
a range of contracts. The guaranteed surrender value of the contract is the accumulated value of the contract including
accrued bonuses. The bonuses are based on the accounting income for the amortising bond portfolios plus income and releases
from realised gains on any equity type investments. Policy liabilities equal guaranteed surrender values. In general, the
guaranteed annual bonus rates are between 0% and 4.5%.
Risk free rate
The risk free rate is set to reflect both the pattern of the emerging profits under EEV and the relevant duration of the
liabilities where backing assets reflect this assumption (e.g. equity returns). For the UK, it is set by reference to the
gross redemption yield on the 15 year gilt index. For LGA, the risk free rate is the 10 year US Treasury effective yield,
while the 10 year ECB AAA-rated Euro area central government bond par yield is used for LGN and LGF.
European Embedded Value
111
5.08 Methodology (continued)
Risk discount rate
The risk discount rate (RDR) is a combination of the risk free rate and a risk margin, which reflects the residual risks
inherent in the Group's covered businesses, after taking account of prudential margins in the statutory provisions, the
required capital and the specific allowance for FOGs.
The risk margin has been determined based on an assessment of the Group's weighted average cost of capital (WACC). This
assessment incorporates a beta for the Group, which measures the correlation of movements in the Group's share price to
movements in a relevant index. Beta values therefore allow for the market's assessment of the risks inherent in the
business relative to other companies in the chosen index.
The WACC is derived from the Group's cost of equity and debt, and the proportion of equity to debt in the Group's capital
structure measured using market values. Each of these three parameters is forward looking, although informed by historic
information and appropriate judgements where necessary. The cost of equity is calculated as the risk free rate plus the
equity risk premium for the chosen index multiplied by the Company's beta. Forward-looking or adjusted betas make allowance
for the observed tendency for betas to revert to 1 and therefore a weighted average of the historic beta and 1 tends to be
a better estimate of the Company's beta for the future period. We have computed the WACC using an arithmetical average of
forward-looking betas against the FTSE 100 index.
The cost of debt used in the WACC calculations takes account of the actual locked-in rates for our senior and subordinated
long term debt. All debt interest attracts tax relief at a rate of 20.1%.
Whilst the WACC approach is a relatively simple and transparent calculation to apply, subjectivity remains within a number
of the assumptions. Management believes that the chosen margin, together with the levels of required capital, the inherent
strength of the Group's regulatory reserves and the explicit deduction for the cost of options and guarantees, is
appropriate to reflect the risks within the covered business.
Analysis of profit
Operating profit is identified at a level which reflects an assumed longer term level of investment return.
The contribution to operating profit in a period is attributed to four sources:
i. new business;
ii. the management of in-force business;
iii. development costs; and
iv. return on shareholder net worth.
Further profit contributions arise from actual investment return differing from the assumed long term investment return
(investment return variances), and from the effect of economic assumption changes.
The contribution from new business represents the value recognised at the end of each period from new business written in
that period, after allowing for the actual cost of acquiring the business and of establishing the required technical
provisions and reserves and after making allowance for the cost of capital. New business contributions are calculated using
closing assumptions.
The contribution from in-force business is calculated using opening assumptions and comprises:
i. expected return - the discount earned from the value of business in-force at the start of the year;
ii. experience variances - the variance in the actual experience over the reporting period from that assumed in the value
of business in-force as at the start of the year; and
iii. operating assumption changes - the effects of changes in future assumptions, other than changes in economic
assumptions from those used in valuing the business at the start of the year. These changes are made prospectively from the
end of the period.
Development costs relate to investment in strategic systems and development capability.
The contribution from shareholder net worth comprises the increase in embedded value based on assumptions at the start of
the year in respect of the expected investment return on the Society shareholder capital.
Further profit contributions arise from investment return variances and the effect of economic assumption changes.
Economic variances represent:
i. the effect of actual investment performance and changes to investment policy on SNW and VIF business from that
assumed at the beginning of the period; and
ii. the effect of changes in economic variables on SNW and VIF business from that assumed at the beginning of the
period, which are beyond the control of management, including associated changes to valuation bases to the extent that they
are reflected in revised assumptions.
European Embedded Value
112
Independent review report to Legal & General Group Plc - EEV
Report on the supplementary interim financial information
Our conclusion
We have reviewed the supplementary interim financial information, defined below, in the interim management report of Legal
& General Group Plc for the six months ended 30 June 2014. Based on our review, nothing has come to our attention that
causes us to believe that the supplementary interim financial information is not prepared, in all material respects, in
accordance with the EEV basis set out in Note 5.08.
This conclusion is to be read in the context of what we say in the remainder of this report.
What we have reviewed
The supplementary interim financial information, which is prepared by Legal & General Group Plc, comprises:
· the Group embedded value summary as at 30 June 2014; and
· the explanatory notes to the supplementary interim financial information.
As disclosed in Note 5.08 the supplementary interim financial information has been prepared on the European Embedded Value
("EEV") basis.
What a review of supplementary interim financial information involves
We conducted our review in accordance with International Standard on Review Engagements (UK and Ireland) 2410, 'Review of
Interim Financial Information Performed by the Independent Auditor of the Entity' issued by the Auditing Practices Board
for use in the United Kingdom. A review of supplementary interim financial information consists of making enquiries,
primarily of persons responsible for financial and accounting matters, and applying analytical and other review
procedures.
A review is substantially less in scope than an audit conducted in accordance with International Standards on Auditing (UK
and Ireland) and, consequently, does not enable us to obtain assurance that we would become aware of all significant
matters that might be identified in an audit. Accordingly, we do not express an audit opinion.
We have read the other information contained in the interim management report and considered whether it contains any
apparent misstatements or material inconsistencies with the information in the supplementary interim financial
information.
Responsibilities for the supplementary interim financial information and the review
Our responsibilities and those of the directors
The interim management report, including the supplementary interim financial information, is the responsibility of, and has
been approved by, the directors. The directors are responsible for preparing the supplementary interim financial
information in accordance with the EEV basis set out in Note 5.08.
Our responsibility is to express to the company a conclusion on the supplementary interim financial information in the
interim management report based on our review. This report, including the conclusion, has been prepared for and only for
the company and for no other purpose. We do not, in giving this conclusion, accept or assume responsibility for any other
purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by
our prior consent in writing.
PricewaterhouseCoopers LLP
Chartered Accountants
5 August 2014
London
Notes:
(a) The maintenance and integrity of the Legal & General Group Plc website is the responsibility of the directors; the
work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no
responsibility for any changes that may have occurred to the financial information since it was initially presented on the
website.
(b) Legislation in the United Kingdom governing the preparation and dissemination of financial information may differ
from legislation in other jurisdictions.
This information is provided by RNS
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