REG - Legal & General Grp - L&G Half-year Report 2017 Part 1 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 2
09/08/2017 07:06
- Part 2: For the preceding part double click ID:nRSI4599Na
85%). This was primarily due to increased costs from
non-weather related claims in Q1, predominantly escape of water, in line with
wider market experience. We have taken action across pricing, underwriting and
claims management to address this and have seen improved claims experience in
Q2. We will continue to monitor this closely and will take further action if
required. In contrast, the H1 2016 comparator benefitted from better than
expected claims experience during that period.
savings
FINANCIAL HIGHLIGHTS £m H1 2017 H1 2016
Release from operations 53 51
New business strain (2) (3)
Net release from operations 51 48
Experience variances, assumption changes, tax and non-cash movements 1 1
Operating profit 52 49
- Mature Savings 52 55
- Disposed operations1 - (6)
Investment and other variances2 (7) 4
Profit before tax attributable to equity holders 45 53
1. Disposed operations comprises Suffolk Life which was sold on 25 May 2016,
and Cofunds and IPS which was sold on 3 January 2017.
2. H1 2016 includes a £4m gain resulting from the disposal of Suffolk Life.
robust operating profit
Net release from operations was higher reflecting market conditions, with
lower new business strain as the book declines.
Operating profit in Mature Savings remains robust at £52m (H1 2016: £55m).
Reducing unit costs, whilst maintaining customer service levels, has been
achieved through the introduction of robotics, and further automation.
Mature Savings had outflows of £(1.5)bn (H1 2016: £(1.3)bn), with assets under
administration of £30.2bn in H1 2017 (H1 2016: £29.4bn).
Mature Savings outflows increased year on year due to our products' maturity
profile. Since the introduction of the Pensions Reform legislation we have
seen an increase in the proportion of customers wishing to take their pension
pots as cash withdrawals, with c.80% electing to take cash payments. Our
average payment size is £14k.
Disposals
On 6th April 2017, the Group completed the sale of Legal & General Nederland
Levensverzekering Maatschappij N.V. to Chesnara plc for total consideration of
E161m resulting in a £17m profit on disposal.
On 1st January 2017, the Group completed the sale of Cofunds and IPS to Aegon
for total consideration of £147.5m. The Cofunds business was acquired in
stages between 2005 and 2013, for a total cash consideration of £153m.
Investment in Cofunds subsequent to the acquisition as well as our IPS
platform, including capitalised costs in respect of the Retail Distribution
Review, resulted in an impairment loss of £64m recognised in 2016.
The impact of these disposals improved the Group's H1 2017 Solvency II
coverage ratio by 2.5%.
borrowings
Legal & General continues to have a strong liquidity position including
amounts required for working capital and derivative collateral purposes. The
Group's outstanding core borrowings total £3.5bn (H1 2016: £3.1bn). There is
also a further £0.6bn (H1 2016: £0.4bn) of operational borrowings including
£0.2bn (H1 2016: £0.2bn) of non-recourse borrowings.
The Group accessed the US dollar market in March 2017 for the first time and
issued $850m of Tier 2 subordinated debt with a coupon of 5.25%. The proceeds
were utilised to refinance the Group's £600m Tier 1 notes with a coupon of
6.385% which were called in May 2017. This inaugural issue has given the Group
access to an alternative source of debt financing away from the Group's
traditional European institutional investor base. In April 2017 the Group
accessed the US dollar market again when it issued $500m of Tier 2
subordinated debt in private placement format with a coupon of 5.55%,
reflecting the longer duration compared to the March 2017 issue.
Group debt costs of £92m (H1 2016: £86m) reflect an average cost of debt of
5.0% per annum (H1 2016: 5.4% per annum) on average nominal value of debt
balances of £3.7bn (H1 2016: £3.2bn).
taxation - effective tax rate of 18.1%
Equity holders' Effective Tax Rate (%) H1 2017 H1 2016
Equity holders' total Effective Tax Rate 18.1 19.2
Annualised rate of UK corporation tax 19.25 20.00
In H1 2017, the Group's effective tax rate was lower than the UK corporation
tax rate. This reflects the overall positive impact from differences between
the measurement of accounting and taxable profits.
SOLVENCY II
As at 30th June 2017, the Group had an estimated Solvency II surplus of £6.7bn
over its Solvency Capital Requirement, corresponding to a Solvency II coverage
ratio of 186% on a shareholder basis.
Capital (£bn) H1 20171 FY 20161
Own Funds 14.5 13.6
Solvency Capital Requirement (SCR) (7.8) (7.9)
Solvency II surplus 6.7 5.7
SCR coverage ratio (%) 186 171
1. Solvency II position on a shareholder basis and before the accrual of the
2017 interim dividend (H1 2017) and 2016 final dividend (FY 2016).
Analysis of movement from 1 January to 30 June 2017 (£bn) Solvency II surplus
Surplus arising from back-book (including release of SCR) 0.6
Release of Risk Margin2 0.2
Amortisation of TMTP3 (0.2)
Operational surplus generation 0.6
New business strain (0.1)
Net surplus generation 0.5
Dividends paid - 2016 final dividend (0.6)
Operating variances 0.5
Market movements 0.1
Subordinated debt 0.5
Total surplus movement (after dividends paid in the period) 1.0
2. Based on the risk margin in force at 31 December 2016 and does not include the release of any risk margin added by new business written in 2017.
3. TMTP amortisation based on a linear run down of the end-2016 TMTP of £5.9bn (net of tax, £7bn before tax) which was management's estimate of the TMTP on end-2016 market conditions.
The increase in surplus reflects the surplus generated over the first six
months of 2017 net of dividends paid of £0.6bn and interest payments on the
Group's debt of £0.1bn. The net surplus generation was £0.5bn, after allowing
for six months' amortisation of the opening Transitional Measures on Technical
Provisions (TMTP). New business strain was £0.1bn. The total surplus
generation includes a positive investment variance of £0.1bn reflecting market
movements over 2017, in particular an increase in risk free rates and
narrowing of credit spreads.
Operating variances include the impact of experience variances, changes to
valuation and capital calibration assumptions, and other management actions
including changes in asset mix, matching adjustment optimisation, hedging
strategies, M&A activities (sale of Cofunds and Legal & General Netherlands
contributed £0.1bn surplus), and update to the longevity assumptions.
The above incorporates management's estimate of the impact of recalculating
the Transitional Measures for Technical Provisions (TMTP) as at 30th June 2017
as we believe this provides the most up to date and meaningful view of our
Solvency II position. In line with PRA guidance, a formal recalculation of the
Group's TMTP will take place no later than 1st January 2018.
When stated on a proforma basis, including the SCR attributable to our
With-profits fund of £0.5bn and the final salary pension schemes of £0.2bn in
both the Group's Own Funds and the SCR, the Group's coverage ratio was 180%
(FY 2016: 165%).
reconcilation of ifrs net release from operations to solvency ii net surplus
generation
The table below gives a reconciliation of the Group's IFRS Release from
operations and Solvency II Operational surplus generation in H1 2017:
£bn
IFRS Release from operations 0.7
Expected release of IFRS prudential margins (0.3)
Release of IFRS specific reserves -
Solvency II investment margin 0.1
Release of Solvency II Capital Requirement and Risk Margin less TMTP amortisation 0.2
Other Solvency II items and presentational differences (0.1)
Solvency II Operational surplus generation 0.6
The table below gives a reconciliation of the Group's IFRS New business
surplus to Solvency II New business strain in H1 2017:
£bn
IFRS New business surplus -
Removal of requirement to set up prudential margins above best estimate on new business 0.2
Set up of Solvency II Capital Requirement on new business (0.2)
Set up of Risk Margin on new business (0.1)
Solvency II New business strain (0.1)
Sensitivity analysis
Impact on net of tax Solvency II capital surplus H1 2017 £bn Impact on net of tax Solvency II coverage ratio H1 2017%
Credit spreads widen by 100bps assuming an escalating addition to ratings 0.3 8
Credit migration1 (0.6) (8)
15% fall in property markets (0.3) (3)
100bps increase in risk free rates 1.0 24
50bps fall in risk free rates (0.5) (11)
1. Credit migration stress covers the cost of an immediate big letter downgrade on c.20% of annuity portfolio bonds, or 3 times level expected in the next 12 months.
The above sensitivity analysis does not reflect all of the 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.
These results all allow (on an approximate basis) for the recalculation of
estimated TMTP as at 30th June 2017 where the impact of the stress would cause
this to change materially. The impacts of these stresses are not linear
therefore these results should not be used to interpolate or 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.
Solvency II new business contribution
Management estimates of the value of new business and the margin as at 30th
June 2017 are shown below:
Contribution from
PVNBP new business Margin %
LGR1(£m) 1,859 166 8.9
UK Protection Total (£m) 754 69 9.1
- Retail protection 632 61 9.6
- Group protection 122 8 6.5
US Protection (£m) 376 48 12.8
1. UK annuity business.
Key assumptions in calculating the Solvency II new business contribution are
shown below:
Risk margin 3.1%
Risk free rate
- UK 1.7%
- US 2.1%
Risk discount rate (net of tax)
- UK 4.8%
- US 5.2%
Long term rate of return on non-profit annuities in LGR 3.1%
All assumptions and methodologies that would have a material impact on the
margin for these contracts are unchanged from end 2016 other than the cost of
currency hedging which has been updated to reflect current market conditions
and hedging activity in light of Solvency II.
principal risks and UNCERTAINTIES
Legal & General runs a portfolio of risk taking businesses; we accept risk in
the normal course of business and aim to deliver sustainable returns on risk
based capital to our investors in excess of our cost of capital. We manage the
portfolio of risk that we accept to build a sustainable franchise for the
interests of all our stakeholders; we do not aim to eliminate that risk. We
have an appetite for risks that we understand deeply and are rewarded for, and
which are consistent with delivery of our strategic objectives. Risk
management is embedded within the business. The Group's Principal Risks and
Uncertainties summarise key matters that may impact the delivery of the
Group's strategy, earnings or profitability.
RISKS AND UNCERTAINTIES TREND, OUTLOOK AND MITIGATION
Reserves and our assessment of capital requirements may require revision as a result of changes in experience, regulation or legislation.The writing of long-term insurance business requires the setting of assumptions for long term trends in factors such as mortality, lapse rates, valuation interest rates, expenses and credit defaults. Actual experience may require recalibration of these assumptions impacting profitability. Management estimates are also required in the derivation of Solvency II capital metrics. These include modelling simplifications to reflect that it is not possible to perfectly model the external environment, with adjustment necessitated where new data emerges. Forced changes in reserves can also arise from regulatory or legislative intervention impacting capital requirements and profitability. We undertake significant analysis of the variables associated with writing long-term insurance business to ensure that a suitable premium is charged for the risks we take on, and that reserves continue to remain appropriate for factors including mortality,
lapse rates, valuation interest rates, expenses and credit defaults. We remain, however, inherently exposed to certain extreme events which could require us to adjust our reserves. For example, in our annuities business, while recent trend data continues
to suggest the rate of longevity improvement may be slowing, we're inherently exposed to the risk that a dramatic advance in medical science beyond that anticipated leads to an unexpected change in life expectancy. This could require adjustment to reserves
as improvements in mortality emerge. In our protection businesses, the emergence of new factors with potential to cause widespread mortality/morbidity or significant policy lapse rates may similarly require us to re-evaluate reserves. To mitigate these
risks we remain focused on developing a comprehensive understanding of longevity science and continue to evolve and develop our underwriting capabilities for protection business. Our continued selective use of reinsurance also acts to reduce the impacts of
these risk factors.
Investment market performance and conditions in the broader economy may adversely impact earnings, profitability or surplus capital.The performance and liquidity of investment markets, interest rate movements and inflation impact the value of investments we hold in shareholders' funds and those to meet the obligations from insurance business, with the movement in certain investments directly impacting profitability. Interest rate movements and inflation can also change the value of our obligations. We use a range of techniques to manage mismatches between assets and liabilities. However, loss can still arise from adverse markets. Interest rate expectations leading to falls in the risk free yield curve can also create a greater degree of inherent volatility to be managed in the Solvency II balance sheet, than the underlying economic position would dictate, potentially impacting capital requirements and surplus capital. In addition, significant falls in investment values can reduce fee income to our investment management business. Whilst the global economic outlook generally remains positive, we continue to monitor a range of risk factors that could trigger a reappraisal of asset values or influence a change in broader central bank monetary policies. In the US, financial markets
have responded favourably to a pro-growth pro-business agenda, nevertheless, political and policy uncertainties remain; in China, private debt levels leading to a disorderly default and a contraction in global growth remains a credible, if more remote
risk; and in the UK, a lengthy period of negotiation and an uncertain "Brexit" outcome has potential to create on-going volatility for financial markets and the broader UK economy in which we operate. Although we cannot fully eliminate the downside impacts
from these and other risk factors on our earnings, profitability or surplus capital, as part of our on-going business planning activity we continue to model a broad range of economic and financial market scenarios so as to try to ensure our strategies will
remain resilient in projected conditions.
In dealing with issuers of debt and other types of counterparty the group is exposed to the risk of financial loss.A systemic default event within the corporate sector, or a major sovereign debt event, could result in dislocation of bond markets, significantly widening credit spreads and in extreme scenarios trigger defaults impacting the value of bond portfolios. We are also exposed to banking, money market and reinsurance counterparties, and settlement, custody and other bespoke business services, a failure of which could expose us to both financial loss and operational disruption of our business processes. Under Solvency II, a widespread widening of credit spreads and downgrades can also result in a reduction in our Solvency II balance sheet surplus, despite already setting aside significant capital for credit risk. We continue to actively manage our exposure to default risks within our bond portfolios, setting selection criteria and exposure limits, and using the capabilities of LGIM's global credit team to ensure the risks are effectively controlled, and if
appropriate, trade out to improve credit quality. We also seek to closely manage risks to our Solvency II balance sheet through monitoring factors that could give rise to a heightened level of default risk. However, we can never completely eliminate
default risks or their impacts, although we seek to hold a strong balance sheet that we believe to be prudent for a range of adverse scenarios. Current factors that could lead to an increase in the level of default risk if they were to occur include a
material deterioration in economic conditions; a renewed banking crisis within the Euro zone area; and default on debt linked to emerging markets.
Changes in regulation or legislation may have a detrimental effect on our strategy.Legislation and government fiscal policy influence our product design, the period of retention of products and required reserves for future liabilities. Regulation defines the overall framework for the design, marketing, taxation and distribution of our products; and the prudential capital that we hold. Significant changes in legislation or regulation may increase our cost base, reduce our future revenues and impact profitability or require us to hold more capital. The prominence of the risk increases where change is implemented without prior engagement with the sector. The nature of long-term business can also result in some changes in regulation, and the re-interpretation of regulation over time, having a retrospective effect on our in-force books of business, impacting the future cash generation. The financial services sector continues to see significant regulatory driven change, both from the EU and from within the UK. Our internal control framework seeks to ensure on-going compliance with relevant legislation and regulation and we are
progressing our responses to EU driven financial services regulation including UCITS V, MiFID II and PRIIPS. We have also established a programme of action to meet the requirements of the EU General Data Protection Directive (GDPR) which comes into force
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