REG - Phoenix Grp Hldgs - Phoenix Group Holdings - 2014 Annual Results <Origin Href="QuoteRef">PHNX.L</Origin> - Part 3
18/03/2015 07:01
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Executive Committee and Board level.
Targets are established in relation to regulatory capital requirements and debt ratios and are used in managing capital in
accordance with the Group's risk appetite and the interests of its stakeholders.
The capital policy of each life company is set and monitored by each life company board. These policies ensure there is
sufficient capital within each life company to meet regulatory capital requirements under a range of stress conditions. The
capital policy of each life company varies according to the risk profile and financial strength of that company.
Regulatory capital requirements
IGD surplus (estimated)
Each UK life company must maintain sufficient capital at all times to meet the regulatory capital requirements mandated by
the PRA. These measures are aggregated under the European Union Insurance Groups' Directive ('IGD') to calculate regulatory
capital adequacy at a Group level.
The Group's IGD assessment is made at the level of the highest EEA insurance group holding company, which is Phoenix Life
Holdings Limited ('PLHL'), a subsidiary of Phoenix Group Holdings. The estimated IGD surplus at 31 December 2014 is £1.2
billion (2013: £1.2 billion). The components of the estimated IGD calculation are shown below:
31 December 2014 31 December 2013
£bn £bn
Group capital 5.5 5.4
resources ('GCR')
Group capital resource requirement ('GCRR') (4.3) (4.2)
IGD surplus (estimated) 1.2 1.2
The IGD surplus has remained stable during the year as a result of the following offsetting factors:
- positive impact of the divestment of Ignis of £0.2 billion;
- dividend payments, debt financing and repayments of £0.6 billion, including the £206 million debt prepayment associated
with the £900 million debt facility refinancing and the £250 million payment associated with the divestment of Ignis;
offset by
- capital generation items of £0.4 billion, including capital benefits from management actions such as the close-out of
the PGL Pension Scheme longevity indemnity agreement.
The Group's regulatory capital policy, which is agreed with the PRA, is to maintain GCR at the PLHL level of:
- 105% of the with-profit insurance component ('WPICC'), being an additional capital requirement of with-profit funds
plus
- 145% of the GCRR less the WPICC.
The Group's headroom above the IGD regulatory capital policy at 31 December 2014 was £0.5 billion (2013: £0.5 billion).
PLHL ICA surplus (estimated)
In accordance with PRA requirements, the Group undertakes an Individual Capital Assessment ('ICA') at the level of the
highest EEA insurance group holding company, which is PLHL. This involves an assessment, on an economic basis, of the
capital resources and requirements arising from the obligations and risks which exist outside the life companies.
As agreed with the PRA, the Group aims to ensure that PLHL maintains an ICA surplus of at least £150 million. The estimated
PLHL ICA position at 31 December 2014 is set out below:
31 31
December December
2014 2013
£bn £bn
Capital resources1 1.0 1.5
Capital resource requirements2 (0.3) (0.3)
PLHL ICA surplus (estimated) 0.7 1.2
1 Capital resources includes the surplus over capital policy in the life companies and the net assets of the holding
companies less pension scheme obligations calculated on an economic basis.
2 Capital requirements relate to the risks arising outside of the life companies including those in relation to the
Group's staff pension schemes, offset by Group diversification benefits.
For further details of the Pillar 1 capital resources of the individual life companies
See note 39 of the IFRS consolidated financial statements.
Headroom over the Group's £150 million capital policy was £0.6 billion as at 31 December 2014 (2013: £1.1 billion).
The reduction in the estimated PLHL ICA surplus of £0.5 billion reflects:
- the positive impacts of the divestment of Ignis of £0.2 billion;
- dividend payments, debt financing and repayments of £0.8 billion, including the £206 million debt prepayment associated
with the £900 million debt facility refinancing and the £250 million payment associated with the divestment of Ignis;
- an adverse impact of £0.2 billion reflecting the strengthening of ICA stress assumptions related to longevity, credit
and correlations; and
- capital generation in the period of £0.3 billion, including the positive impact of management actions delivered in the
period of £0.2 billion, partly offset by the adverse impact of falling yields on the PLHL ICA surplus.
Sensitivity and scenario analysis
As part of the Group's internal risk management processes, the regulatory capital requirements are tested against a number
of financial scenarios. The results of that stress testing are provided below:
Estimated IGD surplus Estimated PLHL ICA surplus
Base: 31 December 2014 1.2 0.7
Following a 20% fall in equity markets 1.2 0.6
Following a 15% fall in property values 1.2 0.6
Following a 75bps increase in nominal yields1 1.1 0.8
Following a 75bps decrease in nominal yields1 1.2 0.6
Following credit spread widening2 1.2 0.5
1 75bps increase/decrease in nominal yields and a 75bps increase/decrease in inflation.
2 11-15 year term: AAA - 46bps, AA - 69bps, A - 102bps, BBB - 144bps.
The relative insensitivity of the Group's IGD surplus reflects the nature of Pillar 1 rules for with-profit funds which
stipulate that the surplus estate is treated as policyholder liabilities. The sensitivities reflect the impact of market
movements not only on the Group's life companies but also on its staff pension schemes.
Capital resources
The primary sources of capital used by the Group comprise equity shareholder funds as measured on an MCEV basis, the
Perpetual Reset Capital Securities (Tier 1 notes) and shareholder borrowings.
Leverage
In managing capital the Group seeks to optimise the level of debt on its balance sheet. The Group's closed book business
model allows it to operate with higher leverage than life companies that are still writing new business, as it does not
need to fund upfront capital requirements and new business acquisition expenses.
Gearing ratio
The Group previously monitored the level of debt in its statement of consolidated financial position by reference to the
gearing ratio calculated as gross shareholder debt (gearing basis)1 as a percentage of gross MCEV2. Having completed the
divestment of Ignis and comprehensive debt refinancing in July, the gearing ratio as at 31 December 2014 under the Group's
methodology reduced to 34% (2013: 44%), thus meeting our original 40% target ahead of schedule.
1 Gross shareholder debt (gearing basis) is defined as the sum of the IFRS carrying value of the shareholder debt and 50%
of the IFRS carrying value of the Tier 1 notes given the hybrid nature of that instrument.
2 Gross MCEV is defined as the sum of Group MCEV and the value of the shareholder and hybrid debt as included in the
MCEV.
Gross shareholder debt (gearing basis) and shareholder debt (including hybrid debt) included in MCEV at 31 December 2014
are set out in the table below:
31 31
December December
2014 2013
£m £m
Bank debt
- Pearl facility - 327
- Pearl loan notes - 76
- Impala facility - 1,182
Royal London PIK - 121
notes and facility
PGH Capital facility 828 -
PGH Capital 298 -
senior bond
PLL subordinated debt 149 151
Tier 1 notes at 50% of IFRS carrying value (see note 20 to the IFRS consolidated financial statements) 204 204
Gross shareholder debt (gearing basis) 1,479 2,061
Adjustments to include the following items
at fair value:
PLL subordinated debt 63 54
PGH Capital 24 -
senior bond
Tier 1 notes 183 146
(100% of fair value)
Adjustment to include the following item at face value:
PGH Capital facility 12 -
Shareholder debt (including hybrid debt) included in MCEV 1,761 2,261
The Group's gross shareholder debt decreased by £582 million to £1,479 million in the year. This reduction includes the
impacts of the £250 million prepayment following the divestment of Ignis, the £206 million prepayment from internal
resources relating to the £900 million debt facility refinancing, a £30 million targeted prepayment and a £30 million
scheduled repayment made during the period in respect of the Impala facility, a scheduled repayment of £25 million1 made in
respect of the Pearl loan facility, and a £30 million targeted prepayment and a scheduled £30 million repayment in respect
of the PGH Capital facility.
In January 2015, the Group announced the exchange of 99% of the Group's Tier 1 notes for £428 million of new subordinated
notes, issued by PGH Capital. As the new bonds mature in 2025, the bonds will be included in the gearing calculation at
100% of their IFRS carrying value in future reporting periods. Had the Tier 1 notes exchange and associated coupon payment
occurred on 31 December 2014, the gearing ratio would have increased to 38%.
In light of the completion of the Tier 1 notes exchange and in order to align the Group's measure of its level of debt to
that used to determine the interest margin payable on its bank facilities, the Group will monitor the financial leverage
ratio going forwards. Details on its calculation are included below.
Further detail on shareholder debt is included in note 23 to the IFRS consolidated financial statements.
1 This includes £2 million paid to Phoenix Life Assurance Limited, a subsidiary undertaking. Phoenix Life Assurance was a
lender under the Pearl facility.
Financial leverage ratio
In addition to the gearing ratio, management also monitor the level of its debt by reference to the financial leverage
ratio. The financial leverage ratio is used to determine the interest margin payable on the PGH Capital bank facility.
The financial leverage ratio is calculated as gross shareholder debt (financial leverage basis) as a percentage of gross
MCEV. The definition of gross shareholder debt (financial leverage basis) differs from that used in the gearing ratio, as
the debt instruments are included at their notional face values as opposed to their IFRS carrying values. The Tier 1 notes
are included at 100% of their face value. Gross MCEV is calculated on a consistent basis to the gearing ratio calculation.
The table below sets out the calculation of gross shareholder debt (financial leverage basis):
31 December 2014 31
£m December 2013
£m
Bank debt
- Pearl facility - 327
- Pearl loan notes - 76
- Impala facility - 1,182
Royal London PIK - 121
notes and facility
PGH Capital facility 840 -
PGH Capital 300 -
senior bond
PLL subordinated debt 200 200
Tier 1 notes1 394 394
Gross shareholder debt (financial leverage basis) 1,734 2,300
1 Total face value of the Tier 1 notes is £425 million, of which bonds with a face value of £31 million are held by Group
companies.
The financial leverage ratio as at 31 December 2014 reduced to 39.3% (2013: 49.6%). The drivers of the reduction are
consistent with the movement in the gearing ratio and the reduction below 40% has reduced the margin above LIBOR payable on
the PGH Capital bank facility from 350bps to 312.5bps. Had the Tier 1 notes exchange and associated coupon payment occurred
on 31 December 2014, the financial leverage ratio would have been 39.7%.
The Group will target a financial leverage level consistent with the achievement of an investment grade rating.
Liquidity management
Details of the Group's objectives and policies for the management of liquidity risk are included within the Risk management
section and note 40 of the IFRS consolidated financial statements.
For further details of shareholder debt
See note 23 of the IFRS consolidated financial statements.
RISK management
THE GROUP OPERATES A RISK MANAGEMENT FRAMEWORK ('RMF') WHICH SEEKS TO ESTABLISH A COHERENT AND PROACTIVE SET OF
ARRANGEMENTS AND PROCESSES TO SUPPORT The EFFECTIVE MANAGEMENT OF RISK THROUGHOUT THE Group.
The Group's Risk Management Framework
The RMF comprises ten components which are set out in detail below. The outputs of the RMF provide assurance that all risks
are being appropriately identified and managed effectively and that an independent assessment of management's approach to
risk management is being performed.
During the year, the Group has continued to strengthen and embed the components of the RMF to ensure that they are aligned
with evolving regulatory requirements including Solvency II.
The new provisions of the UK Corporate Governance Code (September 2014) apply to Phoenix Group Holdings from the financial
year commencing 1 January 2015. We are well placed to comply with the new risk management and internal control provisions
and, as required, will report against them in our 2015 Annual Report.
One of the new provisions in the Code relates to being able to monitor the Company's RMF. Group Risk conducts an annual
assessment of the Group's adherence to the RMF. Now in its third year, this assessment, known as Operation of the Risk
Management Framework (ORMF) provides assurance to management and the Boards that the RMF has been implemented consistently
and is operating effectively across the Group.
An effective and embedded RMF supports the delivery of the Group's strategy by ensuring that risks are identified,
measured, managed, monitored and reported in a consistent manner.
In addition to these activities, Group Risk has conducted a number of independent reviews of the management of the most
material risks to which the Group is exposed.
Risk strategy
The Group's risk strategy provides an overarching view of how risk management is incorporated consistently across all
levels of the business, from decision-making to strategy implementation. It also sets out how risk management within the
Group is proportionate to the nature, scale and complexity of the risks faced by the business.
Risk appetite
The Group's risk appetite framework consists of a set of statements and targets that articulate the level of risk the Group
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