REG - Phoenix Grp Hldgs - Phoenix Group Holdings - 2016 Annual Results <Origin Href="QuoteRef">PHNX.L</Origin> - Part 3
20/03/2017 07:07
- Part 3: For the preceding part double click ID:nRST8776Zb
IFRS
consolidated financial statements.
Operating profit includes the effect of variances in experience for non-economic items, such as mortality and persistency,
and the effect of changes in non-economic assumptions. Changes due to economic items, for example market value movements
and interest rate changes, which give rise to variances between actual and expected investment returns, and the impact of
changes in economic assumptions on liabilities, are accounted for outside of operating profit. Phoenix Life operating
profit is net of policyholder finance charges and policyholder tax.
Phoenix Life operating profit Year ended Year ended
31 December 2016 31 December 2015
£m £m
With-profit 81 92
With-profit where internal capital support provided (72) 84
Non-profit and unit-linked 283 124
One-off impact of IFRS methodology change 31 -
Long-term return on owners' funds 7 6
Management services 27 30
Phoenix Life operating profit before tax 357 336
The with-profit operating profit of £81 million (2015: £92 million). represents the shareholders' one-ninth share of the
policyholder bonuses, and has reduced due to lower bonus rates.
The with-profit funds where internal capital support has been provided generated an operating loss of £72 million (2015:
£84 million profit). The loss is principally driven by impact of strengthening actuarial assumptions to reflect the impact
of the continued low interest rate environment on the Group's expectations of persistency for products with valuable
guarantees. The 2015 comparative included the positive impact of actuarial modelling enhancements implemented in the year
of £49 million.
The operating profit on non-profit and unit-linked funds increased to £283 million (2015: £124 million) primarily
reflecting the outcomes of management actions of £117 million undertaken during the period, and positive experience which
has more than offset some adverse one-off impacts of actuarial modelling enhancements undertaken in the period.
Following the implementation of Solvency II, certain changes have been made to the assumptions and estimates used in the
valuation of insurance contract liabilities to more closely align the IFRS reserving methodology with Solvency II
requirements. As the Group manages its capital on a Solvency II basis, the changes mean that the IFRS results now more
closely reflect the way the business is managed and the Group's risk hedging strategies. The implementation of the changes
at 1 January 2016 resulted in an overall favourable impact of £31 million to Phoenix Life operating profit. The overall
profile for the emergence of future operating profit is expected to be materially unchanged as a result of these updates.
More details on the changes are provided in note F4 to the IFRS consolidated financial statements.
The long-term return on owners' funds of £7 million (2015: £6 million) reflects the asset mix of owners' funds, primarily
cash-based assets and fixed interest securities. The investment policy for managing these assets remains prudent.
The operating profit for management services of £27 million (2015: £30 million) comprises income from the Life Companies in
accordance with the respective management service agreements less fees related to the outsourcing of services and other
operating costs. The decrease compared to the prior period reflects the impact of life company run-off and increased
project costs incurred during the year.
GROUP COSTS
Group costs in the period were £6 million (2015: £12 million). The reduction compared to the prior period principally
reflects an increased return on the higher opening pension scheme surpluses of both the PGL Pension Scheme and the Pearl
Group Staff Pension Scheme.
INVESTMENT RETURN VARIANCES AND ECONOMIC ASSUMPTION CHANGES ON LONG-TERM BUSINESS
The negative investment return variances and economic assumption changes on long-term business of £207 million (2015: £13
million positive) are primarily driven by adverse market movements during the year.
The majority of the negative variance is driven by the adverse impact of falling yields on the life funds which has
increased the margin held within insurance liabilities in respect of longevity risk.
The investment return variances have also been adversely impacted by losses arising on equity hedging positions held by the
life funds following equity market gains in the period. Equity market gains in the period have resulted in an unfavourable
variance as the value of the hedging instruments fall without the corresponding benefit from future profits within the life
funds being recognised.
VARIANCE ON OWNERS' FUNDS
The negative variance on owners' funds of £5 million (2015: £12 million negative) is driven by losses from equity hedging
positions held in the Group Holding Companies, offset by gains from interest rate hedging positions held in the Life
Companies' shareholders' funds arising from falling yields.
AMORTISATION OF ACQUIRED IN-FORCE BUSINESS AND OTHER INTANGIBLES
Acquired in-force business and other intangibles of £2.7 billion were recognised on the acquisition of the operating
companies in 2009. Following the acquisition of the AXA and Abbey Life businesses in 2016, a further £0.2 billion of
acquired-in-force business and other intangibles have been recognised in the Group's balance sheet.
The acquired in-force business is being amortised in line with the run-off of the life companies. Amortisation of acquired
in-force business during the period totalled £68 million (2015: £75 million). Amortisation of other intangible assets
totalled £14 million in the period (2015: £15 million).
other NON-operating ITEMS
Other non-operating items of £(95) million (2015: £49 million positive) include a £26 million gain on the implementation of
a longevity swap reassurance contract on a portfolio of the Group's annuities and a £14 million gain as a result of a
premium adjustment of the 2015 reassurance arrangement with RGA International following completion of a data review.
These items have been more than offset by:
- acquisition costs of £31 million, comprising £12 million of transaction costs related to the acquisition of AXA
Wealth's pensions and protection business and £19 million of transaction costs related to acquisition of Abbey Life;
- a provision for costs of £30m associated with the integration and restructuring of the acquired AXA businesses;
- the costs of providing for claims and associated costs relating to creditor insurance underwritten prior to 2016 by
a subsidiary of the Group, PA (GI) Limited, of £33 million;
- recognition of costs of £10 million associated with the introduction of regulations that cap early exit charges for
pension customers aged over 55 at 1%, which will come into force from 2017;
- costs of £6 million associated with the transfer of non-profit annuities from with-profit funds to non-profit
matching adjustment funds;
- the costs of £4 million associated with the PGL pension scheme buy-in;
- other corporate project costs of £19 million; and
- net other one-off items totalling a cost of £2 million.
The prior period positive other non-operating result of £49 million included a gain of £49 million arising on the
reassurance of a portfolio of PLAL annuities with an external reinsurer and a £17 million release of cost provisions
associated with external regulatory changes, partly offset by £11 million of corporate project costs and negative £3
million of net other items.
FINANCE COSTS ATTRIBUTABLE TO OWNERS
Year ended Year ended
31 December 2016 31 December 2015
£m £m
Bank finance costs 16 28
Other finance costs 74 71
Finance costs attributable to owners 90 99
Finance costs have decreased by £9 million, comprising a £12 million reduction in bank finance costs primarily driven by
restructuring and repayments of bank debt, and a £3 million increase in other finance costs attributable to interest on the
£428 million subordinated notes issued during the first half of 2015.
TAX CREDIT ATTRIBUTABLE TO OWNERS
The Group's approach to the management of its tax affairs is set out in its Tax Strategy document which will shortly be
available in the governance section of the Group's website. The Group's tax affairs and tax controls are managed by an
in-house tax team who report on them to the Board and the Audit Committee on a regular basis throughout the year. The Board
believes that its Tax Strategy accords with the Group's approach to its wider Corporate Social Responsibility.
Implicit in the Group's Tax Strategy and the management of its tax affairs is a desire for greater transparency and
openness that will help the Group's stakeholders better understand the published tax numbers. In this way the Group aims to
participate in a substantive manner with HMRC and other insurance industry stakeholders on consultative documents and tax
law changes that potentially impact on the insurance sector.
Following the 2015 disposal of the Group's overseas insurance interests, all of the Group's insurance operations are based
in the UK and are liable to tax in accordance with applicable UK legislation. The Group derives a de-minimis level of
income from non-UK sources. Although Phoenix Group Holdings is a Jersey resident holding company and subject to a 0% tax
rate, its primary source of income is its UK subsidiaries. The tax residency of Phoenix Group Holdings has a negligible
impact on the UK tax payable by the Group.
The Group tax credit for the period attributable to owners is £28 million (2015: £64 million) based on a loss (before tax
attributable to owners) of £128 million (2015: £185 million profit). The tax credit is different from the expected tax
credit (based on the UK corporation tax rate of 20%) of £26 million primarily due to the impact of disallowable expenses
including £7 million relating to the provision for costs recognised in respect of the creditor insurance underwritten by PA
(GI) Limited and the impact of the consolidation treatment of the PGL pension scheme buy-in agreement of £12 million. These
items have been partly offset by the benefit of a 1% reduction in future corporation tax rates and the treatment of certain
recurring income and expenses as either non-taxable or taxable at rates of less than 20%. See note C5 to the IFRS
consolidated financial statements for further analysis.
Risk management
"OUR RISK INFRASTRUCTURE HAS ENABLED THE GROUP TO DELIVER KEY STRATEGIC INITIATIVES AMIDST A VOLATILE ECONOMIC AND
POLITICAL ENVIRONMENT."
Wayne Snow
Group Chief Risk Officer
THE GROUP'S RISK MANAGEMENT FRAMEWORK
The Group's Risk Management Framework ('RMF') embeds proactive and effective risk management across the Group. It seeks to
ensure that all risks are identified and managed effectively and that the Group is appropriately rewarded for the risks it
takes.
During the year, the Group strengthened its RMF to meet evolving regulatory requirements including Solvency II and the UK
Corporate Governance Code. I was pleased to see our approach to risk management recognised in the investment grade rating
reaffirmed by Fitch Ratings following our two acquisitions.
Further detail on the ten components of our RMF and the principal risks facing the Group are provided below.
The Group is now implementing its risk management approach in the AXA Wealth and Abbey Life businesses and using its
framework to manage the associated integration risks.
RISK CULTURE
The Group seeks to embed a culture that is forward-looking and competent in its assessment and management of risk, a
culture where everyone in the Group is aligned in their goals to deliver better risk-based decisions.
To support this goal, the Group defined a Risk Culture Statement which sets out the Group's aspirations for Risk
Management:
"The Group has a balanced risk culture, supportive of commercial risk-taking coupled with strong execution in line with its
risk appetite."
At its core are the Group's values and behaviours, clarity of accountability and a healthy tension between the first and
second lines of defence.
Collectively this means people understand the Group's approach to risk, take personal responsibility to manage risk in
everything they do and encourage others to follow their example."
During 2016, Group Risk conducted its latest annual Risk Culture survey. The results of this survey enable us to assess and
measure the Group's Risk Culture over time as well as being able to tailor training programmes to ensure the continued
engagement and development of our employees.
OWN RISK AND SOLVENCY ASSESSMENT (ORSA)
The Group carries out an ORSA process to assess its risk profile on an ongoing basis. The ORSA considers risk, capital and
return within the context of the business strategy on a forward-looking basis.
The ORSA is a fundamental part of the strategic risk and capital management processes of the business to prompt
consideration of management actions and help shape strategic decision-making.
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 assists the business achieve its strategic objectives by supporting a more stable, well managed business with improved
customer and shareholder outcomes.
This is achieved not by risk avoidance, but through the identification and management of an acceptable level of risk (its
'risk appetite') and by ensuring that the Group is appropriately rewarded for the risks it takes.
To ensure that all risks are managed effectively the Group is committed to:
- embedding a risk aware culture;
- maintaining a strong system of internal controls;
- enhancing and protecting customer and shareholder value by continuous and proactive risk management;
- maintaining an efficient capital structure; and
- ensuring that risk management is embedded into day-to-day management and decision-making processes.
RISK APPETITE
The Group's risk appetite is the level of risk the Group is willing to accept in pursuit of its strategic objectives. The
statements below encapsulate our risk appetite for policyholder security and conduct, earnings volatility, liquidity and
our control environment:
- Capital - The Group and each Life Company will hold sufficient capital to meet regulatory requirements in a number
of asset and liability stress scenarios.
- Cash flow - The Group will seek to ensure that it has sufficient cash flow to meet its financial obligations and
will continue to do this in a volatile business environment.
- Shareholder Value - The Group will take action to protect its shareholder value.
- Regulation - The Group and each Life Company will, at all times, operate a strong control environment to ensure
compliance with all internal policies and applicable laws and regulations, in a commercially effective manner.
- Conduct - Phoenix has zero appetite for deliberate acts of misconduct, including omissions, that result in customer
detriment, reputational damage and/or pose a risk to the Financial Conduct Authority ('FCA') statutory objectives.
The risk appetite and control framework supports the Group in operating within the boundaries of these statements by
limiting the volatility of key parameters under adverse scenarios. Risk appetite limits are chosen which specify the
maximum acceptable likelihood for breaching the agreed limits. Assessment against these limits is undertaken through
extensive scenario and reverse stress testing.
RISK UNIVERSE
A key element of effective risk management is ensuring that the business has a complete understanding of the risks it
faces. These risks are defined in the Group's risk universe.
The risk universe allows the Group to deploy a common risk language, allowing for meaningful comparisons to be made across
the business. There are three levels of risk universe categories. The highest risk universe category is Level 1 and
includes:
- strategic risk;
- customer risk;
- financial soundness risk;
- market risk;
- credit risk;
- insurance risk; and
- operational risk.
Embedded within these categories, and Customer risk in particular, are the conduct risks faced by the Group and its
customers. These risks are separately monitored and reported on across the organisation to ensure that conduct risk
receives appropriate emphasis and oversight.
The Group has developed a PGH Board-approved risk appetite statement to manage conduct risk. The appetite statement is
supported by the assessment of all conduct related risks faced by the Group on a quarterly basis. This regular assessment
and reporting enables us to be forward-looking and proactive in the management of conduct risk.
EXTERNAL COMMUNICATION AND STAKEHOLDER MANAGEMENT
The Group has a number of internal and external stakeholders, each of whom has an active interest in the Group's
performance, including how risks are managed. Significant effort is made to ensure that our stakeholders have appropriate,
timely and accurate information to support them in forming views of the Group.
GOVERNANCE, ORGANISATION AND POLICIES
GOVERNANCE
Overall responsibility for approving, establishing and embedding the RMF rests with the Board. The Board recognises the
critical importance of having an efficient and effective RMF and appropriate oversight of its operation. There is a clear
organisational structure in place with documented, delegated authorities and responsibilities from the Group Board to the
PLHL Board, Life Company Boards and the Executive Committee.
The RMF is underpinned by the operation of a three lines of defence model with clearly defined roles and responsibilities
for statutory boards and their committees, management oversight committees, Group Risk and Group Internal Audit.
First line: Management
Management of risk is delegated from the Board to the Group Chief Executive Officer, Executive Committee members and
through to business managers. A series of business unit management oversight committees operate within the Group. They are
responsible for implementation of the RMF, ensuring the risks associated with the business activities are identified,
assessed, controlled, monitored and reported.
Second line: Risk Oversight
Risk oversight is provided by the Group Risk function and the Board Risk Committee. The Board Risk Committee comprises four
independent Non-Executive Directors. It is supported by the Group Chief Risk Officer and met six times during 2016. During
2016, the Risk Committee of the Phoenix Life Board met five times and provided additional Board Committee focus on risk
matters at Phoenix Life.
Third line: Independent Assurance
Independent verification of the adequacy and effectiveness of the internal controls and risk management is provided by the
Group Internal Audit function, which is supported by the Board Audit Committee.
ORGANISATION
The Group Chief Risk Officer manages the Group Risk function and has responsibility for the implementation and oversight of
the Group's RMF. The Group Risk function has responsibility for oversight over financial, operational and regulatory risk.
The PRA/FCA relationship team manages the relationship and interactions with our primary regulators and reports to the
Group Chief Risk Officer.
POLICIES
The Group policy framework comprises a set of policies that supports the delivery of the Group's strategy by establishing
operating principles and expectations for managing the key risks to our business. The policy set contains the minimum
control standards to which each business unit must adhere to and against which they report compliance.
The policies define:
- the individual risks the policy is intended to manage;
- the degree of risk the Group is willing to accept, which is set out in the policy risk appetite statements;
- the minimum controls required in order to manage the risk to an acceptable level; and
- the frequency of the control's operation.
Each policy is the responsibility of a member of the Executive Committee who is charged with overseeing compliance
throughout the Group.
The governance framework in operation throughout the Group can be found in the chart below.
BUSINESS PERFORMANCE AND CAPITAL MANAGEMENT
The Annual Operating Plan is assessed to ensure that the Group operates within our stated risk appetite. Business
performance is routinely monitored with consolidated reporting against performance targets.
The Group operates a Capital Management Policy where capital is allocated across risks where capital is held as a mitigant
and the amount of risk capital required is reviewed regularly.
RISK AND CAPITAL ASSESSMENT
The Group operates a standardised assessment framework for the identification and assessment of the risks to which it may
be exposed and how much capital should be held in relation to those exposures. This framework is applicable across the
Group and establishes a basis, not only for the approach to risk assessment, management and reporting but also for
determining and embedding capital management at all levels of the Group in line with Solvency II requirements.
Risk assessment activity is a continuous process and is performed on the basis of identifying and managing the significant
risks to the achievement of the Group's objectives.
Stress and scenario tests are used extensively to support the assessment of risk and provide analysis of their financial
impact.
Independent reviews conducted by Group Risk provide further assurance to management and the Board that individual risk
exposures and changes to our risk profile are being effectively managed.
MANAGEMENT INFORMATION
Overall monitoring and reporting against the risk universe takes place in business unit management committees and Boards.
This is then reported to the Executive Committee, PLHL Board and the Group Board via regular risk reporting.
The Board Risk Committee receives a consolidated risk report on a quarterly basis, detailing the risks facing the Group and
the overall position against risk appetite limits. The Board Risk Committee is also provided with regular reports on the
activities of the Group Risk function.
People and reward
Effective risk management is central to the Group's culture and its values. Processes are operated that seek to measure
both individual and collective performance and discourage incentive mechanisms which could lead to undue risk taking.
Training and development programmes are in place to support employees in their understanding of the RMF.
TECHNOLOGY AND INFRASTRUCTURE
The Group employs market leading risk systems to support the assessment and reporting of the risks it faces. This enables
management to document key risks and controls and evidence the assessment of them at a frequency appropriate to the
operation of the control.
RISK MANAGEMENT EFFECTIVENESS
The provisions of the UK Corporate Governance Code require an annual review of the effectiveness of Risk Management.
This assessment provides assurance to management and the Boards that the RMF has been implemented consistently and is
operating effectively across the Group.
Principal risks and uncertainties facing the group
The Group's top principal risks and uncertainties are detailed in the table below, together with their potential impact,
mitigating actions which are in place, links to the Group's strategic objectives and changes in the risk profile from last
year. As economic changes occur and the industry and regulatory environment evolves, the Group will continue to monitor
their potential impact.
Further details of the Group's exposure to financial and insurance risks and how these are managed are provided in note E6
of the IFRS consolidated financial statements.
Key to Strategic objectives icons
Improve Customer outcomes
Drive Value
Manage Capital
Engage People
Change in risk from last year Risk Improving No Change Risk Deteriorating
Change in risk from last year
Risk Improving
No Change
Risk Deteriorating
Risk Impact Mitigation Change from last year
In times of severe market turbulence, the Group may not have sufficient capital or liquid assets to meet its cash flow targets or may suffer a loss in value. The emerging cash flows of the Group may be impacted during periods of severe market turbulence by the need to maintain The Group undertakes regular monitoring activities in relation to market risk exposure, including limits in each asset class, cash flow forecasting and stress and scenario testing. In response to this, the Group has implemented de-risking strategies to mitigate against unwanted customer and shareholder outcomes. The Group also maintains cash buffers in its holding companies to reduce reliance on emerging cash flows.The Group's excess capital position continues to be closely monitored and managed, particularly in the low interest environment. Markets have been turbulent following the EU Referendum. Yields on UK swap rates fell markedly over the first half of the year, although they have since recovered. Phoenix prepared for this potential outcome by reducing residual interest rate exposure using a combination of interest rate swaps and swaptions.Recent currency volatility does not materially impact the Group.
appropriate levels of regulatory capital. The impact of market turbulence may also result in a material adverse impact on the
Group's capital position.Since the introduction of Solvency II and a swaps-based discount rate, the Group is more sensitive to
movements in swap yields.
Adverse changes in experience versus actuarial assumptions. The Group has liabilities under annuities and other policies that are sensitive to future longevity, persistency and mortality The Group undertakes regular reviews of experience and annuitant survival checks to identify any trends or variances in assumptions.The Group continues to actively manage its longevity risk exposures, which includes the use of reinsurance contracts to maintain this risk within appetite. Policyholder persistency rates, rates of early and late retirement and the take-up of valuable guarantees were affected by the Pensions Freedoms legislation and the low interest rate environment.While the acquisition of the SunLife protection business exposes the Group to increased mortality and new business pricing risk, this business provides a natural hedge to our annuity business.During the year, the Group entered into a longevity swap arrangement to reinsure £2.0 billion of annuity liabilities.
rates. For example, if our annuity policyholders live for longer than expected, then their benefits will be paid for longer. The
amount of additional capital required to meet those additional liabilities could have a material adverse impact on the Group's
ability to meet its cash flow targets.
Significant counterparty failure. Assets held to meet obligations to policyholders include debt securities. Phoenix Life is exposed to deterioration in the actual The Group regularly monitors its counterparty exposure and has specific limits relating to individual exposures, counterparty credit rating, sector and geography.Where possible, exposures are diversified through the use of a range of counterparty providers. All material reinsurance and derivative positions are appropriately collateralised and guaranteed. During the year, exposure to reinsurance counterparties increased as the result of the longevity transaction referenced above. The Group also acquired reinsurance contracts with a number of external reinsurers through the AXA Wealth and Abbey Life acquisitions.
or perceived creditworthiness or default of issuers.This risk is reflected in the higher expected return, or spread, over less
risky assets.An increase in credit spreads on debt securities, particularly if it is accompanied by a higher level of actual or
expected issuer defaults, could adversely impact the value of the Group's assets.The Group is also exposed to trading
counterparties failing to meet all or part of their obligations, such as reinsurers failing to meet obligations assumed under
reinsurance arrangements.
Changes in the regulatory and legislative landscape. The conduct-focused regulator has had a greater focus on customer outcomes. This may continue to challenge existing approaches The Group puts considerable effort into managing relationships with its regulators so that it is able to maintain a forward view regarding potential changes in the regulatory landscape. The Group assesses the risks of regulatory and legislative change and the impact on our operations and lobbies where appropriate. Phoenix has focused on activities identified following publication of the 'Fair Treatment of long-standing Customers' review to enhance our management of conduct risk.The Abbey Life acquisition increases the Group's regulatory risk exposure from ongoing FCA investigations. However, warranties and indemnities were agreed as part of the acquisition which mitigate against an adverse outcome.Surplus assets have been retained in life companies to mitigate any potential adverse impact of deferred tax restrictions being introduced in 2017.PGH waiver in respect of Group regulatory supervision expires at 30 June
and/or may result in remediation exercises where Phoenix Life cannot demonstrate that it met the expected customer outcomes in 2017.
the eyes of the regulator.Changes in legislation such as the Pension Freedoms and taxation can also impact the Group's financial
position.
The Group fails to effectively integrate the acquired businesses. The challenge of integrating two new businesses into the Group could introduce structural or operational inefficiencies that The financial and operational risks of target businesses were assessed as part of the acquisition phase.Integration plans are developed and resourced with appropriately skilled staff to ensure that the target operating models are delivered in line with expectations. New risk.
results in Phoenix failing to generate the expected outcomes for policyholders or value for shareholders.
Greater than anticipated redress cost relating to creditor insurance. High Court ruling that PA (GI) Limited ('PAGI'), a Group company, retained liability in relation to creditor insurance The Group has established efficient processes to review complaints received, and where appropriate, provide redress to the policyholder.The Group continues to monitor the level of complaints and emerging experience to ensure that the provisions remain appropriate.The Group is considering options in respect of seeking to recover incurred costs from third parties. (Further details in note G1 to the IFRS financial statements). New risk.
originally underwritten by PAGI.Cost of redress for these complaints may be greater than provisions held due to uncertainties
with regard to the volumes of future complaints, the rates by which those complaints are upheld and the average redress value.
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