REG - Legal & General Grp - L&G Half Year Results 2016 Part 3 <Origin Href="QuoteRef">LGEN.L</Origin> - Part 2
09/08/2016 07:08
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14.0 11.8 13.5
1. Treated as available capital on the Economic Capital balance sheet as the liabilities are subordinate to policyholder claims. 2. Differences in the measurement of liabilities between IFRS and Economic Capital, offset by the inclusion of the recapitalisation cost.3. Relating to the own funds of US captive reassurers and the UK with-profits fund. The figures that appear in this note are all pre-accrual for the 2016 interim dividend of £238m (H1 15: £205m; FY
15: £592m).
(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.
30.06.16 30.06.15 31.12.15
% % %
Interest Rate 3 6 4
Equity 11 14 13
Property 6 4 6
Credit1 48 44 48
Currency - 2 -
Inflation 4 (1) 3
Total Market Risk2 72 69 74
Counterparty Risk 2 2 1
Life Mortality - - -
Life Longevity3 6 9 4
Life Lapse 4 5 4
Life Catastrophe 4 3 4
Non-life underwriting 1 1 1
Health underwriting - 1 -
Expense 1 1 1
Total Insurance Risk 16 20 14
Operational Risk 7 7 7
Miscellaneous4 3 2 4
Total Economic Capital Requirement 100 100 100
1. Credit risk is Legal & General's most significant exposure, arising predominantly
from the portfolio of bonds backing the group's annuity business.2. In addition to
credit risk the group also has significant exposure to other market risks, primarily
due to the investment holdings within the shareholder funds but also the risk to fee
income from assets backing unit linked and with-profits Savings business.3. Longevity
risk is Legal & General's most significant insurance risk exposure, arising from the
annuity book on which the majority of the longevity risk is retained.4. Miscellaneous
includes the sectoral capital requirements for non-insurance regulated firms.
Capital and Investments
Page 78
4.02 Group Economic Capital (continued)
(g) Reconciliation from Economic Capital surplus to Solvency II surplus
The Economic Capital position does not reflect regulatory constraints. The regulatory
constraints imposed by the Solvency II regime result in a lower surplus. The table
below provides an analysis of the key differences between the two bases. The Solvency
II results are reported net of Transitional Measures on Technical Provisions (TMTP).
30.06.16 31.12.15
£bn £bn
Economic Capital surplus 8.1 7.6
Different matching adjustment1 (2.2) (1.4)
Risk margin vs Recapitalisation cost2 - -
Longevity calibration3 (0.6) (0.3)
Eligibility of group own funds4 (0.1) (0.5)
LGA on a D&A basis5 0.1 0.1
Solvency II surplus6 5.3 5.5
1. This is the difference between the Economic Matching Adjustment and the Solvency
II Matching Adjustment.2. The risk margin represents the amount a third party
insurance company would require to take on the obligations of a given insurance
company. It is equal to the cost of capital on the SCR necessary to support insurance
risks that cannot be hedged over the lifetime of the business. This is presented net
of TMTP. The recapitalisation cost is an equivalent measure under economic capital,
but represents the cost of recapitalising the balance sheet following a stress event.
It also removes elements of Solvency II specifications that are, in Legal & General's
view, uneconomic. 3. Economic Capital and Solvency II balance sheets use different
calibrations for longevity risk.4. Deductions for regulatory restrictions in respect
of fungibility and transferability restrictions. These do not apply to the Economic
Capital balance sheet.5. To ensure consistency of risk management across the group,
L&G America remains within the Internal Model for Economic Capital purposes.6. There
are also differences in the valuation of with-profits business and the group pension
scheme that have lower order impacts on the difference between the surpluses.
Capital and Investments
Page 79
4.03 Estimated Solvency II new business contribution
(a) New business by product1
Contri-
bution
from new
PVNBP business2 Margin
For the six months ended 30 June 2016 £m £m %
LGR - UK annuity business 3,743 382 10.2
UK Insurance Total 727 81 11.1
- Retail protection 565 69 12.2
- Group protection 162 12 7.4
LGA3 325 40 12.4
4,795 503 10.5
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, LGA reflects PVNBP of $435m and a contribution from new business of $54m.
(b) Assumptions
The key economic assumptions as at 30 June 2016 are as follows:
%
Risk margin 3.5
Risk free rate
- UK 1.1
- US 1.3
Risk discount rate (net of tax)
- UK 4.6
- US 4.8
Long-term rate of return on non profit annuities in LGR 3.2
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. Using the previous methodology the
risk free rate as at 30 June 2016 (for both the UK and the US) would be 1.5% and the risk discount rate would be 5.0%.
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
securities are calculated net of an allowance for default risk which takes account of the credit rating and the outstanding
term of the securities. The allowance for corporate defaults within the new business contribution is based on a level rate
deduction from the expected returns for the overall annuities portfolio of 20bps.
· 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 20% and subsequent planned future reductions
in corporation tax to 19% from 1 April 2017 and 18% 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 18%.
US, covered business profits are also grossed up using the long term corporate tax rates i.e. 35%.
Capital and Investments
Page 80
4.03 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 2016, 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, the Insurance Division and LGA.
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 2016.
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.
LGA is consolidated into the group solvency balance sheet on a US Statutory solvency basis. Therefore, the LGA margin is
largely unchanged from the EEV basis, where new business profitability was also based on the 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. LGA new business premiums and contribution reflect
the groupwide expected impact of LGA 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.
Capital and Investments
Page 81
4.03 Estimated Solvency II new business contribution (continued)
(c) Methodology (continued)
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 known 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 (30 June 2016: 14bps
for UK and 10bps 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.
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 18.4%.
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 premium reconciliation
30.06.16 30.06.15 31.12.15
Notes £bn £bn £bn
PVNBP 4.03(a) 4.8
Effect of capitalisation factor (0.9)
New business premiums from selected lines 3.9
Other1 0.3
Total LGR, Insurance and LGA new business 3.07/3.08 4.2 1.6 3.3
Annualisation impact of regular premium long-term business (0.1) (0.1) (0.2)
IFRS gross written premiums from existing long-term insurance business 1.3 1.3 2.6
IFRS gross written premiums from Savings business 0.1 0.2 0.5
Deposit accounting for lifetime mortgage advances (0.2) - (0.2)
General insurance gross written premiums 3.09 0.2 0.2 0.3
Total gross written premiums 5.5 3.2 6.3
1. Other principally includes annuity sales in the US and lifetime mortgage advances.
Capital and Investments
Page 82
4.04 Investment portfolio
Market Market Market
value value value
30.06.16 30.06.15 31.12.15
£m £m £m
Worldwide total assets 846,140 717,034 747,944
Client and policyholder assets (766,397) (649,882) (679,831)
Non-unit linked with-profits assets (12,478) (12,216) (11,644)
Investments to which shareholders are directly exposed 67,265 54,936 56,469
Analysed by investment class:
Other
non profit Other
LGR insurance LGC shareholder
investments investments investments1 investments Total Total Total
30.06.16 30.06.16 30.06.16 30.06.16 30.06.16 30.06.15 31.12.15
Note £m £m £m £m £m £m £m
Equities 56 - 2,350 188 2,594 2,409 2,252
Bonds 4.06 47,908 2,505 1,651 666 52,730 43,917 43,916
Derivative assets2 5,661 - 62 - 5,723 3,730 3,663
Property 4.07 2,257 - 196 4 2,457 2,220 2,347
Cash, cash equivalents,
loans & receivables 878 556 1,313 504 3,251 2,527 4,168
Financial investments 56,760 3,061 5,572 1,362 66,755 54,803 56,346
Other assets3 157 - 331 22 510 133 123
Total investments 56,917 3,061 5,903 1,384 67,265 54,936 56,469
1. Equity investments include a total of £323m in respect of CALA Group Limited, Peel Media Holdings Limited (MediaCityUK) and NTR Wind Management Ltd (30 June 2015: £280m; 31 December 2015: £295m).
2. Derivative assets are shown gross of derivative liabilities of £5.0bn (HY15: £2.0bn; FY15: £2.7bn). 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.
3. Other assets include reverse repurchase agreements of £464m (HY15: £nil; FY15: £82m).
Capital and Investments
Page 83
4.05 Direct Investments
(a) Analysed by asset class
Direct1, 2 Traded3 Direct1, 2 Traded3 Direct1, 2 Traded3
Investments securities Total Investments securities Total Investments securities Total
30.06.16 30.06.16 30.06.16 30.06.15 30.06.15 30.06.15 31.12.15 31.12.15 31.12.15
£m £m £m £m £m £m £m £m £m
Equities 508 2,086 2,594 410 1,999 2,409 432 1,820 2,252
Bonds 4,474 48,256 52,730 3,050 40,867 43,917 3,722 40,194 43,916
Derivative assets - 5,723 5,723 - 3,730 3,730 - 3,663 3,663
Property 2,457 - 2,457 2,220 - 2,220 2,347 - 2,347
Cash, cash equivalents,
loans & receivables 466 2,785 3,251 380 2,147 2,527 425 3,743 4,168
Other assets 46 464 510 133 - 133 41 82 123
7,951 59,314 67,265 6,193 48,743 54,936 6,967 49,420 56,469
1. Direct Investments constitute an agreement with another party and represent an exposure to untraded and often less volatile assets. Direct Investments include physical assets, bilateral loans and private equity but exclude hedge funds.
2. A further breakdown of property is provided in note 4.07.
3. Traded securities are defined by exclusion. If an instrument is not a Direct Investment, then it is classed as a traded security.
(b) Analysed by segment
LGR LGC LGA Insurance Total
30.06.16 30.06.16 30.06.16 30.06.16 30.06.16
£m £m £m £m £m
Equities - 508 - - 508
Bonds 3,932 197 345 - 4,474
Property 2,257 196 - 4 2,457
Cash, cash equivalents, loans & receivables 20 117 329 - 466
Other assets - 46 - - 46
6,209 1,064 674 4 7,951
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