REG - Legal & General Grp - L&G Half-year Report 2017 Part 3 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 3
09/08/2017 07:07
- Part 3: For the preceding part double click ID:nRSI4602Nb
Estimated TMTP of £0.2bn (net of tax). FY
16 included an increase to the risk margin of £1.1bn (net of tax) offset by an
increase in the Estimated TMTP of £1.0bn (net of tax).
8. Movement in subordinated debt includes $1.35bn US Dollar subordinated notes issued
and £0.6bn of sub-debt redeemed.
Operational Surplus Generation is the expected surplus generated from the assets and liabilities in-force at the start of
the year. It is based on real world assumed returns and best estimate non-market assumptions. It includes the impact of
management actions to the extent that, at the start of the year, these were reasonably expected to be implemented over the
year.
New Business Strain/Surplus is the cost of acquiring, and setting up Technical Provisions and SCR capital, on actual new
business written over the year. It is based on economic conditions at the point of sale.
Capital and Investments
Page 76
4.01 Group regulatory capital - Solvency II Directive (continued)
(e) Reconciliation of IFRS Net Release from Operations to Solvency II Net Surplus Generation
Reconciliation of the group's IFRS Release from Operations to Solvency II Operational Surplus Generation.
30.06.17 31.12.16
£bn £bn
IFRS Release from Operations 0.7 1.3
Expected release of IFRS prudential margins (0.3) (0.5)
Releases of IFRS specific reserves1 - (0.1)
Solvency II investment margin2,3 0.1 0.2
Release of Solvency II Capital Requirement and Risk Margin less TMTP amortisation4 0.2 0.4
Other Solvency II items and presentational differences (0.1) (0.1)
Solvency II Operational Surplus Generation 0.6 1.2
1. Release of prudence from IFRS specific reserves which are not included in Solvency II (e.g. long term expense margin or new business closure reserves).
2. Release of prudence related to differences between the EIOPA-defined Fundamental Spread and Legal & General's best estimate default assumption.
3. Expected market returns earned on LGR's free assets in excess of risk free rates over the period.
4. Solvency II Operational Surplus Generation includes management actions which at the start of 2017 were expected to take place within the group plan. These were limited to actions by LGR to deliver further eligible assets into the Matching Adjustment portfolio and other asset based management actions.
(ii) Reconciliation of the group's IFRS New Business Surplus to Solvency II New Business Strain.
30.06.17 31.12.16
£bn £bn
IFRS New Business Surplus - 0.2
Removal of requirement to set up prudential margins above best estimate on New Business 0.2 0.5
Set up of Solvency II Capital Requirement on New Business (0.2) (0.7)
Set up of Risk Margin on New Business (0.1) (0.1)
Solvency II New Business Strain (0.1) (0.1)
(f) Reconciliation of IFRS shareholders' equity to Solvency II Own Funds
30.06.17 31.12.16
£bn £bn
IFRS shareholders' equity 7.2 6.9
Remove DAC, goodwill and other intangible assets and liabilities (1.9) (2.1)
Add subordinated debt treated as available capital1 2.9 2.5
Insurance contract valuation differences2 7.1 7.9
Difference in value of net deferred tax liabilities (0.3) (0.5)
SCR for with-profits fund and final salary pension schemes (0.7) (0.7)
Other3 0.4 (0.3)
Eligibility restrictions4 (0.2) (0.1)
Own Funds5 14.5 13.6
1. Treated as available capital on the Solvency II balance sheet as the liabilities are subordinate to policyholder claims.
2. Differences in the measurement of liabilities between IFRS and Solvency II. This includes value of shareholder transfers of £0.3bn at H1 17 (FY 16: £0.2bn).
3. Reflects valuation differences on other assets and liabilities, predominately in respect of borrowings measured at fair value under Solvency II.
4. Relating to the surplus of with-profits fund and Own Funds of non-insurance regulated entities, subject to local regulatory rules.
5. Own Funds do not include an accrual for the dividend of £256m (FY 16: £616m) declared after the balance sheet date.
Capital and Investments
Page 77
4.01 Group regulatory capital - Solvency II Directive (continued)
(g) Sensitivity analysis
The following sensitivities are provided to give an indication
of how the group's Solvency II surplus as at 30 June 2017 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 Impact on Impact on
net of tax net of tax net of tax net of tax
Solvency II Solvency II Solvency II Solvency II
capital coverage capital coverage
surplus ratio surplus ratio
30.06.17 30.06.17 31.12.16 31.12.16
£bn % £bn %
Credit spreads widen by 100bps assuming an escalating addition 0.3 8 0.2 7
to ratings1,2
Credit migration3 (0.6) (8) (0.6) (8)
15% fall in property markets (0.3) (3) (0.2) (3)
100bps increase in risk free rates 1.0 24 1.0 22
50bps fall in risk free rates4 (0.5) (11) (0.5) (10)
1. The spread sensitivity applies to Legal & General's corporate
bond (and similar) holdings, with no change in the firm's long
term default expectations.
2. The stress for AA bonds is twice that for AAA bonds, for A
bonds it is three times, for BBB four times and so on, such that
the weighted average spread stress for the portfolio is 100
basis points.
3. 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.
4. In the interest rate down stress negative rates are allowed,
i.e. there is no floor at zero rates.
The above sensitivity analysis does not reflect all 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
30 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.
Capital and Investments
Page 78
4.02 Estimated Solvency II new business contribution
(a) New business by product1
Contri-
bution
from new
PVNBP business2 Margin3
For the six months ended 30 June 2017 £m £m %
LGR - UK annuity business 1,859 166 8.9
UK Protection Total 754 69 9.1
- Retail protection 632 61 9.6
- Group protection 122 8 6.5
US Protection4 376 48 12.8
1. Selected lines of business only.
2. The contribution from new business is defined as the present value at the point of sale of expected future Solvency II surplus emerging from new business written in the period using the risk discount rate applicable at the end of the reporting period.
3. Margin uses unrounded inputs.
4. In local currency, US Protection reflects PVNBP of $489m and a contribution from new business of $62m.
Contri-
bution
from new
PVNBP business2 Margin
For the year ended 31 December 20161 £m £m %
LGR - UK annuity business 6,661 693 10.4
UK Protection Total 1,466 153 10.4
- Retail protection 1,255 139 11.1
- Group protection 211 14 6.6
US Protection3 631 78 12.4
1. Selected lines of business only.
2. The contribution from new business is defined as the present value at the point of sale of expected future Solvency II surplus emerging from new business written in the period using the risk discount rate applicable at the end of the reporting period.
3. In local currency, US Protection reflects PVNBP of $855m and a contribution from new business of $106m.
Capital and Investments
Page 79
4.02 Estimated Solvency II new business contribution (continued)
(b) Assumptions
The key economic assumptions as at 30 June 2017 are as follows:
%
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
The cashflows are discounted using duration-based discount rates, which is the sum of a duration-based risk free rate and a
flat Risk Margin. The risk free rates have been based on a swap curve net of the EIOPA-specified Credit Risk Adjustment.
The risk free rate shown above is a weighted average based on the projected cash flows.
All other economic and non-economic assumptions and methodologies that would have a material impact on the margin for these
contracts are unchanged from those used for the European Embedded Value reporting at end 2015 other than the cost of
currency hedging which has been updated to reflect current market conditions and hedging activity in light of Solvency II.
In particular:
· 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. The returns on fixed and index-linked
assets are calculated net of an allowance for default risk which takes account of the credit rating and the outstanding
term of the assets. The allowance for corporate and other unapproved credit asset defaults within the new business
contribution is based on a level rate deduction from the expected returns for the overall annuities portfolio of 18 basis
points.
· Non-economic assumptions have been set at levels commensurate with recent operating experience, including those for
mortality, morbidity, persistency and maintenance expenses (excluding development costs). An allowance is made for future
mortality improvement. For new business, mortality assumptions may be modified to take certain scheme specific features
into account. These are normally reviewed annually.
Tax
The profits on the new business are calculated on an after tax basis and are grossed up by the notional attributed tax
rate. For the UK, the after tax basis assumes the annualised current rate of 19.25% and subsequent enacted future
reductions in corporation tax to 19% from 1 April 2017 and 17% from 1 April 2020 onwards. The tax rate used for grossing up
is the long term corporate tax rate in the territory concerned, which for the UK is 17%.
US covered business profits are also grossed up using the long term corporate tax rate of 35%.
Capital and Investments
Page 80
4.02 Estimated Solvency II new business contribution (continued)
(c) Methodology
Basis of preparation
The group is required to comply with the requirements established by the EU Solvency II Directive. Consequently, a Solvency
II value reporting framework, which incorporates a best estimate of cash flows in relation to insurance assets and
liabilities, has replaced EEV reporting in the management information used internally to measure and monitor capital
resources. Solvency II new business contribution reflects the portion of Solvency II value added by new business written
in the period, recognising that the statutory solvency in the UK is now on a Solvency II basis. It has been calculated in
a manner consistent with European Embedded Value (EEV) principles.
Solvency II new business contribution has been calculated for the group's most material insurance-related businesses,
namely, LGR, UK Insurance and LGI US.
Description of methodology
The objective of the Solvency II new business contribution is to provide shareholders with information on the long term
contribution of new business written in H1 17.
With the exception of the discount rate, cost of currency hedging and the statutory solvency basis, new business
contribution arising from the new business premiums written during the reporting period has been calculated on the same
economic and operating assumptions as would have been used under the EEV methodology.
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 calculation of the new business
contribution for the financial period.
The new business margin is defined as new business contribution divided by the PVNBP. The premium volumes used to calculate
the PVNBP are the same as those used to calculate new business contribution.
LGI US is consolidated into the group solvency balance sheet on a US Statutory solvency basis. 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. LGI US new business premiums and contribution reflect the groupwide expected impact
of LGI US directly-written business (i.e. looks through any intra-group reinsurance arrangements).
Comparison to EEV new business contribution
The key difference between Solvency II and EEV new business contribution is the Statutory solvency basis used for UK
business. Due to the different reserving and capital bases under Solvency II compared to Solvency I, the timing of profit
emergence changes. The impact on new business contribution therefore largely reflects the cost of capital effect of this
change in profit timing. The impact on new business contribution of moving to a Solvency II basis will differ by type of
business. Products which are more capital consumptive under Solvency II will have a lower new business value and vice
versa for less capital consumptive products.
Projection assumptions
Cash flow projections are determined using best estimate assumptions for each component of cash flow for each line of
business. Future economic and investment return assumptions are based on conditions at the end of the financial period.
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 new business, even if incurred elsewhere in the group, are allocated to the new 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 substantively enacted future changes.
Risk discount rate
The risk discount rate (RDR) is duration-based and is a combination of the risk free curve and a flat Risk Margin, which
reflects the residual risks inherent in the group's businesses, after taking account of margins in the statutory technical
provisions, the required capital and the specific allowance for financial options and guarantees.
The risk free rates have been based on a swap curve net of the EIOPA-specified Credit Risk Adjustment 16 basis points for
UK and 15basis points for US (FY 16: 17 basis points for UK and 15 basis points for US).
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.
Capital and Investments
Page 81
4.02 Estimated Solvency II new business contribution (continued)
(c) Methodology (continued)
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 time adjusted rate of 17.5% (FY 16: 17.7%).
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.
(d) PVNBP to gross written premiums reconciliation
30.06.17 31.12.16
Notes £bn £bn
PVNBP 4.02(a) 3.0 8.8
Effect of capitalisation factor (1.0) (1.8)
New business premiums from selected lines 2.0 7.0
Other1 1.3 1.9
Total LGR, Insurance and LGI US new business 3.07/3.08 3.3 8.9
Annualisation impact of regular premium long-term business (0.1) (0.1)
IFRS gross written premiums from existing long-term insurance business 1.4 2.5
IFRS gross written premiums from Savings business 0.1 0.2
Deposit accounting for lifetime mortgage advances (0.4) (0.6)
General Insurance gross written premiums 3.09 0.2 0.3
Future premiums on longevity swap new business (0.8) (0.9)
Total gross written premiums 3.7 10.3
1. Other principally includes annuity sales in the US, lifetime mortgage advances and discounted future cash flows on longevity swap new business.
Capital and Investments
Page 82
4.03 Group Economic Capital
Legal & General defines Economic Capital to be the amount of capital that the Board believes the group needs to hold, over
and above its liabilities, in order to meet its 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 our investors, rating agencies, customers and intermediaries.
The Economic Capital results are estimated.
The table below shows the estimated group Own Funds, Economic Capital Requirement and Surplus Own Funds based on group's
Economic Capital model.
(a) Capital position
As at 30 June 2017, the group had an estimated Economic Capital surplus of £9.2bn (FY 16: £8.3bn), corresponding to an Economic Capital coverage ratio of 247% (31 December 2016: 230%). The Economic Capital position is as follows:
30.06.17 31.12.16
£bn £bn
Core tier 1 Own Funds 12.2 11.9
Tier 1 subordinated liabilities1 - 0.6
Tier 2 subordinated liabilities2 3.2 2.1
Own Funds3 15.4 14.6
Economic Capital Requirement (ECR)4 (6.2) (6.3)
Surplus Own Funds 9.2 8.3
ECR coverage ratio5 247% 230%
1. Tier 1 subordinated liabilities of £0.6bn were repaid on 2 May 2017.
2. Tier 2 subordinated liabilities include $1.35bn of USD subordinated notes issued in 2017.
3. Economic Capital Own Funds do not include an accrual for the dividend of £256m (FY 16: £616m) declared after the balance sheet date.
4. The EC balance sheet and ECR are not subject to audit.
5. Coverage ratio uses unrounded inputs.
The Economic Capital position does not exclude the ECR for with-profits fund and the final salary pension schemes for both Own Funds and ECR.
(b) Methodology
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 adjustments to remove intangibles and deferred acquisition costs, and to value
reassurers' share of technical provisions on a basis consistent with the liabilities on the Economic Capital balance
sheet.
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 firms 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 our 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 debt and allowing for
diversification between all group entities.
All material insurance firms, including Legal & General Assurance Society Limited, Legal & General Insurance Limited and
Legal & General Assurance (Pensions Management) Limited (LGIM's insurance subsidiary) are incorporated into the group's
Economic Capital model assessment of required capital, assuming diversification of the risks between the different firms
within the group and between the risks to which they are exposed. These firms, as well as the non-EEA insurance firms
(Legal & General America (LGI US) and Legal & General Reinsurance Company Limited based in Bermuda) contribute over 98% of
the group's ECR.
Firms for which the capital requirements are less material, are valued on the Solvency II Standard Formula basis.
Non-insurance firms are included using their current regulatory surplus, without allowing for any diversification with the
rest of the group.
Allowance is made within the Economic Capital balance sheet for the group's defined benefit pension schemes based upon the
scheme's funding basis, and allowance is made within the capital requirement by stressing the funding position, using the
same Economic Capital basis as for the insurance firms.
Capital and Investments
Page 83
4.04 Investment portfolio
Market Market1 Market1
value value value
30.06.17 30.06.16 31.12.16
£m £m £m
Worldwide total assets 952,100 846,140 903,886
Client and policyholder assets1 (864,740) (766,397) (821,978)
Non-unit linked with-profits assets (11,551) (12,478) (11,924)
Investments to which shareholders are directly exposed 75,809 67,265 69,984
Analysed by investment class:
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