REG - Phoenix Grp Hldgs - Phoenix Group Holdings - 2016 Annual Results <Origin Href="QuoteRef">PHNX.L</Origin> - Part 13
20/03/2017 07:07
- Part 13: For the preceding part double click ID:nRST8776Zl
winding-up of
PLL, the right of payment under the notes is subordinated to the rights of the higher-ranking creditors (principally
policyholders). As a result of the acquisition of the Phoenix Life businesses in 2009, these subordinated loan notes were
acquired at their fair value and as such, the outstanding principal of these subordinated loan notes differs from the
carrying value in the statement of consolidated financial position. The fair value adjustments, which were recognised on
acquisition, will unwind over the remaining life of these subordinated loan notes. With effect from 23 December 2014, minor
modifications were made to the terms of the notes to enable them to qualify as Tier 2 capital for regulatory reporting
purposes. Expenses incurred in effecting these modifications amounted to £10 million. Given the modifications were not
substantial, the carrying amount of the liability was adjusted accordingly and the expenses are being amortised over the
life of the notes.
f. On 7 July 2014, the Group's financing subsidiary, PGH Capital plc ('PGHC'), issued a £300 million 7-year senior
unsecured bond at an annual coupon rate of 5.75% ('PGH Capital senior bond'). The senior bond is subject to guarantee by
the Company.
g. In March 2016 the Group agreed an amendment of its £900 million 5-year unsecured bank facility ('PGH Capital
facility'), which comprised a £450 million revolving credit facility and a £450 million amortising term loan, into a £650
million unsecured revolving credit facility ('PGH Capital revolving credit facility'), maturing in June 2020. On 9 November
2016, this facility was fully repaid using proceeds from the rights issue before being drawn down again on 28 December
2016. On the same date the Group drew down a futher £250 million tranche of this facility to finance part of the Abbey Life
acquisition, increasing borrowing on the PGH Capital revolving credit facility to £900 million. On 29 December 2016, £50
million of the PGH Capital revolving credit facility was repaid, leaving £850 million outstanding as at 31 December 2016.
There are no mandatory or target amortisation payments associated with this facility but prepayments are permissible. The
facility accrues interest at LIBOR plus 1.35% p.a., which would change if there were a change in the guarantor's credit
rating. A utilisation fee of 0.40% p.a. is payable in respect of the facility, which would reduce if the amount outstanding
under the facility reduced to 67% or below.
h. On 23 January 2015, PGH Capital plc issued £428 million of subordinated notes ('PGH Capital subordinated notes') due
2025 at a coupon of 6.625%. Fees associated with these notes of £3 million have been deferred and amortised over the life
of the notes in the statement of consolidated financial position. The notes are subject to a subordinated guarantee by the
Company. Upon exchange £32 million of these notes were held by Group companies. These Group holdings have subsequently been
disposed of during January 2017.
i. On 27 May 2016, the Group entered into a £220 million AXA bridge facility agreement of which £182 million was drawn
down on 31 October 2016. The facility was repaid in full on 20 December 2016.
Changes to the Group's borrowings since 31 December 2016 have been detailed in note I9.
E6. risk Management - financial risk
This note forms one part of the risk management disclosures in the consolidated financial statements. The Group's
management of insurance risk is detailed in note F4.
E6.1 Financial risk and the asset liability management ('ALM') framework
The use of financial instruments naturally exposes the Group to the risks associated with them, chiefly market risk, credit
risk and financial soundness risk.
Responsibility for agreeing the financial risk profile rests with the board of each life company, as advised by investment
managers, internal committees and the actuarial function. In setting the risk profile, the board of each life company will
receive advice from the appointed investment managers, the relevant with-profit actuary and the relevant actuarial function
holder as to the potential implications of that risk profile with regard to the probability of both realistic insolvency
and of failing to meet the regulatory minimum capital requirement. The actuarial function holder will also advise the
extent to which the investment risk taken is consistent with the Group's commitment to treat customers fairly.
Derivatives are used in many of the Group's funds, within policy guidelines agreed by the board of each life company and
overseen by investment committees of the boards of each life company supported by management oversight committees.
Derivatives are primarily used for risk hedging purposes or for efficient portfolio management, including the activities of
the Group's Treasury function.
More detail on the Group's exposure to financial risk is provided in note E6.2 below.
The Group is also exposed to insurance risk arising from its Phoenix Life segment. Life insurance risk in the Group arises
through its exposure to longevity, persistency, mortality and to other variances between assumed and actual experience.
These variances can be in factors such as persistency levels and management, administrative expenses and new business
pricing. More detail on the Group's exposure to insurance risk is provided in note F4.
The Group's overall exposure to market and credit risk is monitored by appropriate committees, which agree policies for
managing each type of risk on an ongoing basis, in line with the investment strategy developed to achieve investment
returns in excess of amounts due in respect of insurance contracts. The effectiveness of the Group's ALM framework relies
on the matching of assets and liabilities arising from insurance and investment contracts, taking into account the types of
benefits payable to policyholders under each type of contract. Separate portfolios of assets are maintained for with-profit
business funds (which includes all of the Group's participating business), non-linked non-profit funds and unit-linked
funds.
E6.2 Financial risk analysis
Transactions in financial instruments result in the Group assuming financial risks. These include credit risk, market risk
and financial soundness risk. Each of these are described below, together with a summary of how the Group manages
them.
E6.2.1 Credit risk
Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by failing
to discharge an obligation. These obligations can relate to both on and off balance sheet assets and liabilities.
There are two principal sources of credit risk for the Group:
- credit risk which results from direct investment activities, including investments in fixed and variable rate income
securities, derivatives, collective investment schemes and the placing of cash deposits; and
- credit risk which results indirectly from activities undertaken in the normal course of business. Such activities
include premium payments, outsourcing contracts, reinsurance, exposure from material suppliers and the lending of
securities.
The amount disclosed in the statement of consolidated financial position in respect of all financial assets, together with
rights secured under off balance sheet collateral arrangements, and excluding those that back unit-linked liabilities,
represents the Group's maximum exposure to credit risk.
The impact of non-government fixed and variable rate income securities and, inter alia, the change in market credit spreads
during the year is fully reflected in the values shown in these financial statements. Credit spreads are the excess of
corporate bond yields over gilt yields to reflect the higher level of risk. Similarly, the value of derivatives that the
Group holds takes into account fully the changes in swap rates.
There is an exposure to spread changes affecting the prices of corporate bonds and derivatives. This exposure applies to
with-profit funds, non-profit funds (where risks and rewards fall wholly to shareholders) and shareholders' funds.
The Group holds £6,253 million (2015: £3,942 million) of corporate bonds which are used to back annuity liabilities in
non-profit funds. These annuity liabilities include an aggregate credit default provision of £322 million (2015: £225
million) to fund against the risk of default.
A 100bps widening of credit spreads, with all other variables held constant and no change in assumed expected defaults,
would result in a decrease in the profit after tax in respect of a full financial year, and in equity, of £41 million
(2015: £55 million).
A 100bps narrowing of credit spreads, with all other variables held constant and no change in assumed expected defaults,
would result in an increase in the profit after tax in respect of a full financial year, and in equity, of £29 million
(2015: £62 million).
Credit risk is managed by the monitoring of aggregate Group exposures to individual counterparties and by appropriate
credit risk diversification. The Group manages the level of credit risk it accepts through credit risk tolerances. In
certain cases, protection against exposure to particular credit risk types may be achieved through the use of derivatives.
The credit risk borne by the shareholder on with-profit policies is dependent on the extent to which the underlying
insurance fund is relying on shareholder support.
Quality of credit assets
An indication of the Group's exposure to credit risk is the quality of the investments and counterparties with which it
transacts. The following table provides information regarding the aggregate credit exposure split by credit rating (ratings
obtained from reputable rating agencies are used in deriving the table below):
2016
AAA AA A BBB BB B and Non-rated £m Unit-linked £m Total
£m £m £m £m £m below £m
£m
Loans and receivables - 80 106 420 - - 623 3 1,232
Derivatives - 20 1,807 1,024 - - 145 7 3,003
Fixed and variable rate income securities 4,343 13,283 6,358 4,230 326 119 439 192 29,290
Reinsurers' share of insurance contract liabilities - 1,820 1,865 2 - - 57 - 3,744
Reinsurers' share of investment contract liabilities - - - - - - - 6,808 6,808
Cash and cash equivalents - 573 918 89 4 - - 82 1,666
4,343 15,776 11,054 5,765 330 119 1,264 7,092 45,743
2015
AAA AA A BBB BB B and Non-rated £m Unit-linked £m Total
£m £m £m £m £m below £m
£m
Loans and receivables - 90 133 40 - - 309 5 577
Derivatives 6 - 1,046 319 - - 127 - 1,498
Fixed and variable rate income securities 3,976 14,774 8,469 3,548 425 229 388 5 31,814
Reinsurers' share of insurance contract liabilities - 1,969 1,983 2 - - - - 3,954
Cash and cash equivalents - 483 3,415 7 - - - 35 3,940
3,982 17,316 15,046 3,916 425 229 824 45 41,783
Non-equity based derivatives are included in the credit risk table above.
Credit ratings have not been disclosed in the above tables for holdings in unconsolidated collective investment schemes.
The credit quality of the underlying debt securities within these vehicles is managed by the safeguards built into the
investment mandates for these vehicles.
The Group maintains accurate and consistent risk ratings across its asset portfolio. This enables management to focus on
the applicable risks and to compare credit exposures across all lines of business, geographical regions and products. The
rating system is supported by a variety of financial analytics combined with market information to provide the main inputs
for the measurement of counterparty risk. All risk ratings are tailored to the various categories of assets and are
assessed and updated regularly.
The Group has established an Internal Credit Rating Committee to monitor and control oversight of both externally rated and
internally rated assets. A variety of methods are used to validate the appropriateness of credit assessment from external
institutions and fund managers. Internally rated assets are those that do not have a public rating from an external credit
assessment institution. This committee reviews the policies, processes and practices to ensure the appropriateness of the
internal ratings assigned to asset classes.
A further indicator of the quality of the Group's financial assets is the extent to which they are neither past due nor
impaired. The following table gives information regarding the ageing of financial assets that are past due but not impaired
and the carrying value of financial assets that have been impaired.
2016
Neither past due nor impaired Less than 30-90 days £m Greater than 90 days Impaired Unit-linked £m Carrying value
£m 30 days £m £m £m
£m
Loans and receivables 1,229 - - - - 3 1,232
Derivatives 2,996 - - - - 7 3,003
Fixed and variable rate income securities 29,098 - - - - 192 29,290
Reinsurers' share of insurance contract liabilities 3,744 - - - - - 3,744
Reinsurers' share of investment contract liabilities - - - - - 6,808 6,808
Reinsurance receivables 37 - - - - - 37
Prepayments and accrued income 358 - - - - 3 361
Other receivables 493 - - - - 20 513
Cash and cash equivalents 1,584 - - - - 82 1,666
2015
Neither past due nor impaired Less than 30-90 days Greater than Impaired Unit-linked Carrying
£m 30 days £m 90 days £m £m value
£m £m £m
Loans and receivables 572 - - - - 5 577
Derivatives 1,498 - - - - - 1,498
Fixed and variable rate income securities 31,795 - - 2 12 5 31,814
Reinsurers' share of insurance contract liabilities 3,954 - - - - - 3,954
Reinsurance receivables 29 - - - - - 29
Prepayments and accrued income 335 - - - - - 335
Other receivables 474 - - - - - 474
Cash and cash equivalents 3,905 - - - - 35 3,940
Please refer to page 203 for additional life company asset disclosures which include the life companies' exposure to
peripheral Eurozone debt securities. Peripheral Eurozone is defined as Portugal, Spain, Italy, Ireland and Greece. The
Group's exposure to peripheral Eurozone debt continues to be relatively small compared with total assets.
Assets held directly by the life companies backing unit-linked business have not been analysed in these tables as the
credit risk on such financial assets is borne by the policyholders. However, these assets have been included as a separate
column in these tables to reconcile the information to the statement of consolidated financial position. Shareholder credit
exposure on unit-linked assets is limited to the level of fee income to the extent it is dependent on the underlying
assets.
Concentration of credit risk
Concentration of credit risk might exist where the Group has significant exposure to an individual counterparty or a group
of counterparties with similar economic characteristics that would cause their ability to meet contractual obligations to
be similarly affected by changes in economic and other conditions. The Group has most of its counterparty risk within its
life business and this is monitored by the counterparty limits contained within the investment guidelines and investment
management agreements, overlaid by regulatory requirements and the monitoring of aggregate counterparty exposures across
the Group against additional Group counterparty limits. Counterparty risk in respect of OTC derivative counterparties is
monitored using a Value-at-Risk (VaR) exposure metric.
The Group is also exposed to concentration risk with outsource partners. This is due to the nature of the outsourced
services market. The Group operates a policy to manage outsourcer service counterparty exposures and the impact from
default is reviewed regularly by executive committees and measured through stress and scenario testing.
Reinsurance
The Group is exposed to credit risk as a result of insurance risk transfer contracts with reinsurers. This also gives rise
to concentration of risk with individual reinsurers, due to the nature of the reinsurance market and the restricted range
of reinsurers that have acceptable credit ratings. The Group manages its exposure to reinsurance credit risk through the
operation of a credit policy, collateralisation where appropriate, and regular monitoring of exposures at the Reinsurance
Management Committee.
During 2016 the Group increased its reinsurance counterparty exposure to RGA International after entering into a £2.0
billion longevity swap arrangement on a portfolio of in-force immediate annuities. The exposure remains within agreed
limits.
The reinsurance exposure to ReAssure Life Limited was removed following successful completion of a Part VII Transfer.
Further details of this can be found in note F3.1.
Collateral
The credit risk of the Group is mitigated, in certain circumstances, by entering into collateral agreements. The amount and
type of collateral required depends on an assessment of the credit risk of the counterparty. Guidelines are implemented
regarding the acceptability of types of collateral and the valuation parameters. Collateral is mainly in respect of stock
lending, certain reinsurance arrangements and to provide security against the maturity proceeds of derivative financial
instruments. Management monitors the market value of the collateral received, requests additional collateral when needed,
and performs an impairment valuation when impairment indicators exist and the asset is not fully secured (and is not
carried at fair value). See note E4.1 for further information on collateral arrangements.
E6.2.2 Market risk
Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of
changes in market influences. Market risk comprises interest rate risk, currency risk and other price risk (comprising
equity risk, property risk, inflation risk and alternative asset class risk).
The Group is mainly exposed to market risk as a result of:
- the mismatch between liability profiles and the related asset investment portfolios;
- the investment of surplus assets including shareholder reserves yet to be distributed, surplus assets within the
with-profit funds and assets held to meet regulatory capital and solvency requirements; and
- the income flow of management charges from the invested assets of the business.
The Group manages the levels of market risk that it accepts through the operation of a market risk policy and an approach
to investment management that determines:
- the constituents of market risk for the Group;
- the basis used to fair value financial assets and liabilities;
- the asset allocation and portfolio limit structure;
- diversification from and within benchmarks by type of instrument and geographical area;
- the net exposure limits by each counterparty or group of counterparties, geographical and industry segments;
- control over hedging activities;
- reporting of market risk exposures and activities; and
- monitoring of compliance with market risk policy and review of market risk policy for pertinence to the changing
environment.
All operations comply with regulatory requirements relating to the taking of market risk.
Interest rate risk
Interest rate risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate relative
to the respective liability due to the impact of changes in market interest rates on the value of interest-bearing assets
and on the value of future guarantees provided under certain contracts of insurance.
Interest rate risk is managed by matching assets and liabilities where practicable and by entering into derivative
arrangements for hedging purposes where appropriate. This is particularly the case for the non-participating funds and
supported participating funds. For unsupported participating business, some element of investment mismatching is permitted
where it is consistent with the principles of treating customers fairly. The with-profit funds of the Group provide capital
to allow such mismatching to be effected. In practice, the life companies of the Group maintain an appropriate mix of fixed
and variable rate instruments according to the underlying insurance or investment contracts and will review this at regular
intervals to ensure that overall exposure is kept within the risk profile agreed for each particular fund. This also
requires the maturity profile of these assets to be managed in line with the liabilities to policyholders.
The sensitivity analysis for interest rate risk indicates how changes in the fair value or future cash flows of a financial
instrument arising from changes in market interest rates at the reporting date result in a change in profit after tax and
in equity. It takes into account the effect of such changes in market interest rates on all assets and liabilities that
contribute to the Group's reported profit after tax and in equity.
With-profit business and non-participating business within the with-profit funds are exposed to interest rate risk as
guaranteed liabilities are valued relative to market interest rates and investments include fixed interest securities and
derivatives. For unsupported with-profit business the profit or loss arising from mismatches between such assets and
liabilities is largely offset by increased or reduced discretionary policyholder benefits dependent on the existence of
policyholder guarantees. The contribution of unsupported participating business to the Group result is largely limited to
the shareholders' share of the declared annual bonus. The contribution of the supported participating business to the Group
result is determined by the shareholders' interest in any change in value in the capital advanced to the with-profit
funds.
In the non-participating funds, policy liabilities' sensitivity to interest rates are matched primarily with fixed and
variable rate income securities and hedging if necessary to match duration, with the result that sensitivity to changes in
interest rates is very low.
During the year and as a result of the Solvency II regime, management has reviewed the matching position of assets and
liabilities resulting in changes to the hedging positions for certain asset portfolios. As a result, an increase of 1% in
interest rates, with all other variables held constant, would now result in a decrease in profits after tax in respect of a
full financial year, and in equity, of £146 million (2015: £89 million).
A decrease of 1% in interest rates, with all other variables held constant, would result in an increase in profits after
tax in respect of a full financial year, and in equity, of £319 million (2015: £89 million).
Equity, property and inflation risk
The Group has exposure to financial assets and liabilities whose values will fluctuate as a result of changes in market
prices other than from interest rate and currency fluctuations. This is due to factors specific to individual instruments,
their issuers or factors affecting all instruments traded in the market. Accordingly, the Group limits its exposure to any
one counterparty in its investment portfolios and to any one foreign market.
The portfolio of marketable equity securities and property investments which is carried in the statement of consolidated
financial position at fair value, has exposure to price risk. The Group's objective in holding these assets is to earn
higher long-term returns by investing in a diverse portfolio of equities and properties. Portfolio characteristics are
analysed regularly and price risks are actively managed in line with investment mandates. The Group's holdings are
diversified across industries and concentrations in any one company or industry are limited.
Equity and property price risk is primarily borne in respect of assets held in with-profit or unit-linked funds. For
unit-linked funds this risk is borne by policyholders and asset movements directly impact unit prices and hence policy
values. For with-profit funds policyholders' future bonuses will be impacted by the investment returns achieved and hence
the price risk, whilst the Group also has exposure to the value of guarantees provided to with-profit policyholders. In
addition some equity investments are held in respect of shareholders' funds. The Group as a whole is exposed to price risk
fluctuations impacting the income flow of management charges from the invested assets of all funds.
Equity and property price risk is managed through the agreement and monitoring of financial risk profiles that are
appropriate for each of the Group's life funds in respect of maintaining adequate regulatory capital and treating customers
fairly. This is largely achieved through asset class diversification and within the Group's ALM framework through the
holding of derivatives or physical positions in relevant assets where appropriate.
The sensitivity analysis for equity and property price risk illustrates how a change in the fair value of equities and
properties affects the Group result. It takes into account the effect of such changes in equity and property prices on all
assets and liabilities that contribute to the Group's reported profit after tax and in equity (but excludes the impact on
the Group's pension schemes).
A 10% decrease in equity prices, with all other variables held constant, would result in an increase in profits after tax
in respect of a full financial year, and in equity, of £75 million (2015: £48 million).
A 10% increase in equity prices, with all other variables held constant, would result in a decrease in profits after tax in
respect of a full financial year, and in equity, of £74 million (2015: £46 million).
A 10% decrease in property prices, with all other variables held constant, would result in a decrease in profits after tax
in respect of a full financial year, and in equity, of £4 million (2015: £21 million).
A 10% increase in property prices, with all other variables held constant, would result in an increase in profits after tax
in respect of a full financial year, and in equity, of £2 million (2015: £21 million).
The Group is exposed to inflation risk through certain contracts, such as annuities, which may provide for future benefits
to be paid taking account of changes in the level of experienced and implied inflation, and also through the Group's cost
base. The Group seeks to manage inflation risk within the ALM framework through the holding of derivatives, such as
inflation swaps, or physical positions in relevant assets, such as index linked gilts, where appropriate.
Currency risk
The Group's principal transactions are carried out in sterling and therefore its exchange risk is limited principally to
historical business that was written in the Republic of Ireland, where the assets are generally held in the same currency
denomination as their liabilities, therefore, any foreign currency mismatch is largely mitigated. Consequently, the foreign
currency risk relating to this business mainly arises when the assets and liabilities are translated into sterling.
The Group's financial assets are primarily denominated in the same currencies as its insurance and investment liabilities.
Thus, the main foreign exchange risk arises from recognised assets and liabilities denominated in currencies other than
those in which insurance and investment liabilities are expected to be settled and, indirectly, from the earnings of UK
companies arising abroad.
Certain Phoenix Life with-profit funds have an exposure to overseas assets which is not driven by liability considerations.
The purpose of this exposure is to reduce overall risk whilst maximising returns by diversification. This exposure is
limited and managed through investment mandates which are subject to the oversight of the investment committees of the
boards of each life company. Fluctuations in exchange rates from certain holdings in overseas assets are hedged against
currency risks.
Sensitivity of profit after tax and equity to fluctuations in currency exchange rates is not considered significant at 31
December 2016, since unhedged exposure to foreign currency was relatively low (2015: not considered significant).
E6.2.3 Financial soundness risk
Financial soundness risk is a broad risk category encompassing capital management risk, tax risk, and liquidity and funding
risk.
Capital management risk is defined as the failure of the Group, or one of its separately regulated subsidiaries, to
maintain sufficient capital to provide appropriate security for policyholders and meet all regulatory capital requirements
whilst not retaining unnecessary capital. The PLHL Group has exposure to capital management risk through the requirements
of the Solvency II capital regime, as implemented by the PRA, to calculate regulatory capital adequacy at a Group level.
The Group's UK life subsidiaries have exposure to capital management risk through the Solvency II regulatory capital
requirements mandated by the PRA at the solo level. The Group's approach to managing capital management risk is described
in detail in note I4.
Tax risk is defined as the risk of financial or reputational loss arising from a lack of liquidity, funding or capital due
to an unforeseen tax cost, or by the inappropriate reporting and disclosure of information in relation to taxation. Tax
risk is managed by maintaining an appropriately staffed tax team who have the qualifications and experience to make
judgements on tax issues, augmented by advice from external specialists where required. The Group has a formal tax risk
policy, which sets out its risk appetite in relation to specific aspects of tax risk, and which details the controls the
Group has in place to manage those risks. These controls are subject to a regular review process. The Group's subsidiaries
have exposure to tax risk through the annual statutory and regulatory reporting and through the processing of policyholder
tax requirements. The UK government has confirmed restrictions on the rules relating to the loss absorbing capacity of
deferred tax will be introduced in 2017. Surplus assets have been retained within the Group to mitigate any potential
adverse impact of the change.
Liquidity and funding risk is defined as the failure of the Group to maintain adequate levels of financial resources to
enable it to meet its obligations as they fall due. The Group has exposure to liquidity risk as a result of servicing its
external debt and equity investors, and from the operating requirements of its subsidiaries. The Group's subsidiaries have
exposure to liquidity risk as a result of normal business activities, specifically the risk arising from an inability to
meet short-term cash flow requirements.
The Board of Phoenix Group Holdings has defined a number of governance objectives and principles and the liquidity risk
frameworks of each subsidiary are designed to ensure that:
- liquidity risk is managed in a manner consistent with the subsidiary company boards' strategic objectives, risk
appetite and Principles and Practices of Financial Management ('PPFM');
- cash flows are appropriately managed and the reputation of the Group is safeguarded; and
- appropriate information on liquidity risk is available to those making decisions.
The Group's policy is to maintain sufficient liquid assets of suitable credit quality at all times including, where
appropriate, by having access to borrowings so as to be able to meet all foreseeable current liabilities as they fall due
in a cost-effective manner. Forecasts are prepared regularly to predict required liquidity levels over both the short and
medium term allowing management to respond appropriately to changes in circumstances.
The vast majority of the Group's derivative contracts are traded OTC and have a two-day collateral settlement period. The
Group's derivative contracts are monitored daily, via an end-of-day valuation process, to assess the need for additional
funds to cover margin or collateral calls.
Some of the Group's commercial property investments are held through collective investment schemes. The collective
investment schemes have the power to restrict and/or suspend withdrawals, which would, in turn, affect liquidity. As a
result of the market volatility experienced following the result of the referendum on membership of the European Union, and
in line with other firms across the industry, customer-driven transactions in certain unit trusts were temporarily
suspended during July, August and September. All other unit trusts have continued to process investment and realisations in
a normal manner and have not imposed any restrictions or delays.
Some of the Group's cash and cash equivalents are held through collective investment schemes. The collective investment
schemes have the power, in extreme stress, to restrict and/or suspend withdrawals, which would, in turn, affect liquidity.
To date, the collective investment schemes have continued to process both investments and realisations in a normal manner
and have not imposed any restrictions or delays.
The following table provides a maturity analysis showing the remaining contractual maturities of the Group's undiscounted
financial liabilities and associated interest. Liabilities under insurance contract contractual maturities are included
based on the estimated timing of the amounts recognised in the statement of consolidated financial position in accordance
with the requirements of IFRS 4 Insurance Contracts:
2016
1 year or less or on demand £m 1-5 years Greater than No fixed Total
£m 5 years term £m
£m £m
Liabilities under insurance contracts 3,153 11,143 31,258 - 45,807
Investment contracts 27,332 - - - 27,332
Borrowings1 121 1,733 552 183 2,589
Deposits received from reinsurers1 29 103 327 - 459
Derivatives1 85 170 1,384 254 1,893
Net asset value attributable to unitholders 1,040 - - - 1,040
Obligations for repayment of collateral received 1,623 - - - 1,623
Reinsurance payables 21 - - - 21
Payables related to direct insurance contracts 484 - - - 484
Accruals and deferred income 204 - - - 204
Other payables 102 - - - 102
1 These financial liabilities are disclosed at their undiscounted value and therefore differ from the statement of
consolidated financial position which discloses the discounted value.
2015
1 year or less or on demand 1-5 years Greater than No fixed Total
£m £m 5 years term £m
£m £m
Liabilities under insurance contracts 2,646 9,611 26,961 765 39,983
Investment contracts 7,905 - - - 7,905
Borrowings1 32 1,056 1,155 194 2,437
Deposits received from reinsurers1 30 108 351 - 489
Derivatives1 104 137 1,760 - 2,001
Net asset value attributable to unitholders 5,120 - - - 5,120
Obligations for repayment of collateral received 725 - - - 725
Reinsurance payables 19 - - - 19
Payables related to direct insurance contracts 364 - - - 364
Accruals and deferred income 127 1 - - 128
Other payables 677 - - - 677
1 These financial liabilities are disclosed at their undiscounted value and therefore differ from the statement of
consolidated financial position which discloses the discounted value.
Investment contract policyholders have the option to terminate or transfer their contracts at any time and to receive the
surrender or transfer value of their policies. Although these liabilities are payable on demand, and are therefore included
in the contractual maturity analysis as due within one year, the Group does not expect all these amounts to be paid out
within one year of the reporting date.
A significant proportion of the Group's financial assets are held in equities, gilts, cash, supranationals and investment
grade securities which the Group considers sufficient to meet the liabilities as they fall due. The vast majority of these
investments are readily realisable since most of them are quoted in an active market.
E6.3 Unit-linked contracts
For unit-linked contracts the Group matches all the liabilities with assets in the portfolio on which the unit prices are
based. There is therefore no interest, price, currency or credit risk for the Group on these contracts.
In extreme circumstances, the Group could be exposed to liquidity risk in its unit-linked funds. This could occur where a
high volume of surrenders coincides with a tightening of liquidity in a unit-linked fund to the point where assets of that
fund have to be sold to meet those withdrawals. Where the fund affected consists of property, it can take several months to
complete a sale and this would impede the proper operation of the fund. In these situations, the Group considers its risk
to be low since there are steps that can be taken first within the funds themselves both to ensure the fair treatment of
all investors in those funds and to protect the Group's own risk exposure.
F. Insurance contracts, investment contracts with dpf and reinsurance
F1. Liabilities under insurance contracts
Classification of contracts
Contracts are classified as insurance contracts where the Group accepts significant insurance risk from the policyholder by
agreeing to compensate the policyholder if a specified uncertain event adversely affects the policyholder.
Contracts under which the transfer of insurance risk to the Group from the policyholder is not significant are classified
as investment contracts or derivatives and accounted for as financial liabilities (see notes E1 and E3 respectively).
Some insurance and investment contracts contain a DPF. This feature entitles the policyholder to additional discretionary
benefits as a supplement to guaranteed benefits. Investment contracts with a DPF are recognised, measured and presented as
insurance contracts.
Insurance contracts and investment contracts with DPF
Amounts recoverable from reinsurers are estimated in a manner consistent with the outstanding claims provision or settled
claims associated with the reinsured policy.
Insurance liabilities
Insurance contract liabilities for non-participating business, other than unit-linked insurance contracts, are calculated
on the basis of current data and assumptions, using either a net premium or gross premium method. Where a gross premium
method is used, the liability includes allowance for prudent lapses. Negative policy values are allowed for on individual
policies:
- where there are no guaranteed surrender values; or
- in the periods where guaranteed surrender values do not apply even though guaranteed surrender values are applicable
after a specified period of time.
For unit-linked insurance contract liabilities the provision is based on the fund value, together with an allowance for any
excess of future expenses over charges, where appropriate.
For participating business, the liabilities under insurance contracts and investment contracts with DPF are calculated in
accordance with the following methodology:
- liabilities to policyholders arising from the with-profit business are stated at the amount of the realistic value
of the liabilities, adjusted to exclude the owners' share of projected future bonuses;
- acquisition costs are not deferred; and
- reinsurance recoveries are measured on a basis that is consistent with the valuation of the liability to
policyholders to which the reinsurance applies.
The with-profit bonus reserve for an individual contract is determined by either a retrospective calculation of
'accumulated asset share' approach or by way of a prospective 'bonus reserve valuation' method. The cost of future
policy-related liabilities is determined using a market consistent approach, mainly based on a stochastic model calibrated
to market conditions at the end of the reporting period. Non-market-related assumptions (for example, persistency,
mortality and expenses) are based on experience adjusted to take into account of future trends.
The realistic liability for any contract is equal to the sum of the with-profit bonus reserve and the cost of future
policy-related liabilities.
Where policyholders have valuable guarantees, options or promises in respect of the with-profit business, these costs are
generally valued using a stochastic model.
In calculating the realistic liabilities, account is taken of the future management actions consistent with those set out
in the Principles and Practices of Financial Management ('PPFM').
Present value of future profits on non-participating business in the with-profit funds
For UK with-profit life funds, an amount may be recognised for the present value of future profits ('PVFP') on
non-participating business written in a with-profit fund where the determination of the realistic value of liabilities in
that with-profit fund takes account, directly or indirectly, of this value.
Where the value of future profits can be shown to be due to policyholders, this amount is recognised as a reduction in the
liability rather than as an intangible asset. This is then apportioned between the amounts that have been taken into
account in the measurement of liabilities and other amounts which are shown as an adjustment to the unallocated surplus.
Where it is not possible to apportion the future profits on this non-participating business to policyholders, the PVFP on
this business is recognised as an intangible asset and changes in its value are recorded as a separate item in the
consolidated income statement (see note G7).
The value of the PVFP is determined in a manner consistent with realistic measurement of liabilities. In particular, the
methodology and assumptions involve adjustments to reflect risk and uncertainty, are based on current estimates of future
experience and current market yields, and allow for market consistent valuation of any guarantees or options within the
contracts. The value is also adjusted to remove the value of capital backing the non-profit business if this is included in
the realistic calculation of PVFP. The principal assumptions used to calculate the PVFP are the same as those used in
calculating the insurance contract liabilities given in note F4.
Embedded derivatives
Embedded derivatives, including options to surrender insurance contracts, that meet the definition of insurance contracts
or are closely related to the host insurance contract, are not separately measured. All other embedded derivatives are
separated from the host contract and measured at fair value through profit or loss.
Liability adequacy
At each reporting date, liability adequacy tests are performed to assess whether the insurance contract and investment
contract with DPF liabilities are adequate. Current best estimates of future cash flows are compared with the carrying
value of the liabilities. Any deficiency is charged to the consolidated income statement.
The Group's accounting policies for insurance contracts meet the minimum specified requirements for liability adequacy
testing under IFRS 4 Insurance Contracts, as they allow for current estimates of all contractual cash flows and of related
cash flows such as claims handling costs. Cash flows resulting from embedded options and guarantees are also allowed for,
with any deficiency being recognised in the consolidated income statement.
Consolidated income statement recognition
Gross premiums
In respect of insurance contracts and investment contracts with DPF, premiums are accounted for on a receivable basis and
exclude any taxes or duties based on premiums. Funds at retirement under individual pension contracts converted to
annuities with the Group are, for accounting purposes, included in both claims incurred and premiums within gross premiums
written.
Gross benefits and claims
Claims on insurance contracts and investment contracts with DPF reflect the cost of all claims arising during the period,
including policyholder bonuses allocated in anticipation of a bonus declaration. Claims payable on maturity are recognised
when the claim becomes due for payment and claims payable on death are recognised on notification. Surrenders are accounted
for at the earlier of the payment date or when the policy ceases to be included within insurance contract liabilities.
Where claims are payable and the contract remains in-force, the claim instalment is accounted for when due for payment.
Claims payable include the costs of settlement.
Reinsurance
The Group cedes insurance risk in the normal course of business. Reinsurance assets represent balances due from reinsurance
providers. Reinsurers' share of insurance contract liabilities is dependent on expected claims and benefits arising under
the related reinsured policies. Reinsurance assets are reviewed for impairment at each reporting date, or more frequently,
when an indication of impairment arises during the reporting period. Impairment occurs when there is objective evidence, as
a result of an event that occurred after initial recognition of the reinsurance asset, that the Group may not receive all
outstanding amounts due under the terms of the contract and the event has a reliably measurable impact on the amounts that
the Group will receive from the reinsurer. The impairment loss is recognised in the consolidated income statement. The
reinsurers' share of investment contract liabilities is measured on a basis that is consistent with the valuation of the
liability to policyholders to which the reinsurance applies.
Reinsurance premiums payable in respect of certain reinsured individual and group pensions annuity contracts are payable by
quarterly instalments and are accounted for on a payable basis. Due to the period of time over which reinsurance premiums
are payable under these arrangements, the reinsurance premiums and related payables are discounted to present values using
a pre-tax risk-free rate of return. The unwinding of the discount is included as a charge within the consolidated income
statement.
Reinsurance claims are recognised when the related gross insurance claim is recognised according to the terms of the
relevant contract.
Gains or losses on purchasing reinsurance are recognised in the consolidated income statement at the date of purchase and
are not amortised. They are the difference between the premiums ceded to reinsurers and the related change in the
reinsurers' share of insurance contract liabilities.
The table below shows a summary of the liabilities under insurance contracts and the related reinsurers' share included
within assets in the statement of consolidated financial position.
Gross Reinsurers' Gross Reinsurers'
liabilities share liabilities share
2016 2016 2015 2015
£m £m £m £m
Life assurance business:
Insurance contracts 34,749 3,743 31,150 5,474
Investment contracts with DPF 11,058 1 10,420 1
45,807 3,744 41,570 5,475
Less amounts classified as held for sale (note I1) - - (1,587) (1,521)
45,807 3,744 39,983 3,954
Amounts due for settlement after 12 months 42,401 3,478 37,337 3,909
Gross Reinsurers' Gross Reinsurers'
liabilities share liabilities share
2016 2016 2015 2015
£m £m £m £m
At 1 January 39,983 3,954 42,930 2,772
Amounts classified as held for sale at 1 January 1,587 1,521 1,776 1,713
41,570 5,475 44,706 4,485
Premiums 999 75 902 1,376
Claims (3,726) (456) (3,931) (326)
Foreign exchange adjustments 44 32 (19) (13)
Acquisition of the AXA businesses and Abbey Life1 (see note H2) 3,875 100 - -
Annuity liabilities transfer (see note I1.1)) (1,652) (1,582) - -
Disposal of SMI (see note H2.4) - - (158) -
Other changes in liabilities 4,697 100 70 (47)
45,807 3,744 41,570 5,475
Less amounts classified as held for sale (note I1) at 31 December - - (1,587) (1,521)
At 31 December 45,807 3,744 39,983 3,954
1 Gross liabilities in respect of the acquisition of the AXA businesses and Abbey Life are stated after the
recognition of negative reserves of £181 million that arise on acquisition of the AXA businesses (see note H2).
F2. Unallocated surplus
The unallocated surplus comprises the excess of the assets over the policyholder liabilities of the with-profit business of
the Group's life operations. For the Group's with-profit funds this represents amounts which have yet to be allocated to
owners since the unallocated surplus attributable to policyholders has been included within liabilities under insurance
contracts.
If the realistic value of liabilities to policyholders exceeds the value of the assets in the with-profit fund, the
unallocated surplus is valued at £nil.
2016 2015
£m £m
At 1 January 877 981
Transfer to consolidated income statement (4) (84)
Acquisition of Abbey Life (see note H2) 6 -
Disposal of SMI (see note H2.3) - (20)
At 31 December 879 877
F3. Reinsurance
This section includes disclosures in relation to reinsurance. Further disclosures and accounting policies relating to
reinsurance are included in note F1.
F3.1 Premiums ceded to reinsurers
Premiums ceded to reinsurers during the period were £75 million (2015: £1,376 million).
During 2016, the Group entered into a longevity swap arrangement with RGA International in respect of a portfolio of the
Group's in-force immediate annuity liabilities of £2.0 billion.
On 9 November 2015, the Group entered into an agreement with RGA International, effective from 1 November 2015, to reinsure
substantively all of the PLAL annuity liabilities previously ceded to Opal Reassurance Limited ('Opal Re'), a subsidiary
undertaking of the Company. The Group paid a reinsurance premium of £1,346 million to RGA International. Under the terms of
the arrangement, RGA International holds assets in a collateral account over which the Group has a floating charge as
disclosed in note F3.2.
On 31 July 2014, the Group entered into a business transfer agreement with ReAssure Life Limited (formerly Guardian
Assurance Limited (see note I1.1). The transfer was initially effected under a reinsurance agreement effective from 1
January 2014.
In accordance with the business transfer agreement, the reinsurance agreement was replaced by a transfer of the business
using a scheme under Part VII of the Financial Services and Markets Act 2000 on 30 December 2016.
Prior to the Part VII, in order to mitigate the risk of counterparty default, ReAssure Life Limited held assets in a
collateral account over which the Group had a fixed charge as disclosed in note F3.2.
F3.2 Collateral arrangements
It is the
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