L&G FY Results 2006 - Part 5
Legal & General Group PLC
14 March 2007
Capital and Cash Flow Page 51
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5.01 Significant impacts
------------------------
The capital review update within the 2006 Review identifies three key initiatives implemented during the year. The
financial impact on capital and cash flow is set out below.
Corporate restructuring
-----------------------
On 31 December 2006, the non-linked non profit pensions and annuity business of Legal & General Assurance Society
Limited (Society) was ceded to a new, wholly owned, reinsurance company, Legal & General Pensions Limited (LGP). LGP
has been capitalised using £1.3bn of Society shareholder capital, £400m of which is represented by subordinated debt
(£200m upper tier II, £200m lower tier II) and £900m by equity. The reinsurance was effected on arm's length terms
resulting in an initial regulatory loss in LGP. Further funds of £571m have been injected from Society's LTF into LGP's
LTF by means of a contingent loan to cover this loss. On an IFRS basis, after adjusting for certain prudent reserves,
the transaction creates a pre-tax profit in SRC of £502m (see note 5.03(c)). The corresponding IFRS loss in LGP has
given rise to a deferred tax asset of £171m, resulting in a retained loss of £331m.
Prior to the capitalisation of LGP, the intra-group subordinated debt capital of £602m attributed to SRC was repaid to
Group Plc and an equivalent amount was lent to Society shareholder capital on a subordinated basis (£301m upper tier
II, £301m lower tier II).
The corporate restructuring has reduced Society's regulatory surplus capital by £0.5bn (2006 total surplus: £4.9bn) and
the IGD regulatory surplus by £0.5bn (2006 total surplus: £2.1bn), primarily due to the requirement to hold solvency
margins in both Society and LGP for the reinsured business.
Implementation of changes to FSA reporting and capital rules (Policy Statement 06/14)
-------------------------------------------------------------------------------------
In 2006, the FSA introduced a more realistic reserving framework for certain non profit business. As a result, there has
been a reduction in the regulatory reserves required for term assurance business of £641m (see note 5.03(c)), and a
consequent small reduction in the long term insurance capital requirement. The associated financial reinsurance
previously in place to finance these reserves was terminated and no credit has been taken for implicit items in the
regulatory balance sheet, of which approximately £240m related to term assurance. The net impact on Society's regulatory
capital surplus of the changes to reserving has been an increase of approximately £125m.
In addition, the FSA removed the requirement for Society to calculate a resilience capital requirement and changed the
calculation of the With-Profits Insurance Capital Component which has resulted in a decrease in Society's capital
resources requirement of £432m (see note 5.02(b)).
Review of annuity investment policy
-----------------------------------
During 2006 Society undertook a review of its asset liability matching policy for annuity business. Property assets
backing annuity liabilities were replaced with corporate bonds and Society entered into inflation swaps to mitigate
negative inflation risk. As a result, a closer match between assets and liabilities was achieved. Additionally, the
margin within the reserves to cover an interest rate mismatch was reviewed and reduced. These actions reduced the
regulatory reserves for Society by £422m (see note 5.03(c)).
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Page 52
5.02 Regulatory capital resources
---------------------------------
(a) Insurance Groups Directive
The Group is required to measure and monitor its capital resources on a regulatory basis and to comply with the minimum
capital requirements of regulators in each territory in which it operates. At Group level, Legal & General must comply
with the requirements of the Insurance Groups Directive (IGD). This is a very prudent measure of capital resources as
it excludes any amount of surplus capital within a Long Term Fund (£2.9bn for Society). The table below shows the
estimated unaudited total Group capital resources, Group capital resources requirement and the surplus.
2006 2005
£bn £bn
------------------------------------------------------------------------------------------------------------------------
Tier I 6.0 6.1
Upper tier II 0.4 0.4
Lower tier II 0.4 0.4
Deductions (0.1) (0.1)
------------------------------------------------------------------------------------------------------------------------
Group capital resources 6.7 6.8
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Group capital resources requirement 4.6 4.4
------------------------------------------------------------------------------------------------------------------------
Insurance Groups Directive surplus 2.1 2.4
========================================================================================================================
A segmental analysis is given below.
2006 2005
£bn £bn
------------------------------------------------------------------------------------------------------------------------
Society Long Term Fund 3.7 4.1
Society Shareholder Capital 1.3 1.9
L&G Pensions 1.4 -
L&G Insurance 0.1 0.1
L&G France 0.1 0.1
L&G Netherlands 0.1 0.1
L&G America 0.2 0.2
Investment Management 0.3 0.3
Other 0.5 1.2
Tier II capital 0.8 0.8
Debt (1.8) (2.0)
------------------------------------------------------------------------------------------------------------------------
Group capital resources 6.7 6.8
------------------------------------------------------------------------------------------------------------------------
Society Long Term Fund 3.7 4.1
L&G Pensions 0.6 -
Other 0.3 0.3
------------------------------------------------------------------------------------------------------------------------
Group capital resources requirement 4.6 4.4
========================================================================================================================
A reconciliation of the Group capital resources on an IGD basis to the capital and reserves attributable to the equity
holders of the company on an IFRS basis is given below.
2006 2005
£bn £bn
------------------------------------------------------------------------------------------------------------------------
Capital and reserves attributable to equity holders on an IFRS basis 5.4 4.7
Tier II capital 0.8 0.4
Additional capital available from Society 0.9 2.1
Adjustment to reflect regulatory value of L&G America (0.4) (0.4)
------------------------------------------------------------------------------------------------------------------------
Group capital resources 6.7 6.8
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Page 53
5.02 Regulatory capital resources (continued)
(b) Society capital surplus
Society is required to measure and monitor its capital resources on a regulatory basis. The figures in the table below
are unaudited.
2006 2006 2005 2005
Long term General Long term General
business insurance business insurance
£bn £bn £bn £bn
------------------------------------------------------------------------------------------------------------------------
Tier I 8.7 0.1 7.9 0.1
Upper tier II 0.3 - 0.6 -
Lower tier II 0.3 - - -
------------------------------------------------------------------------------------------------------------------------
Available capital resources 9.3 0.1 8.5 0.1
------------------------------------------------------------------------------------------------------------------------
Insurance capital requirement 1.7 - 1.8 -
Resilience capital requirement - - 0.7 -
With-Profits Insurance Capital Component 2.0 - 1.5 -
Capital requirements of regulated related undertakings 0.7 0.1 0.1 0.1
------------------------------------------------------------------------------------------------------------------------
Capital resources requirement 4.4 0.1 4.1 0.1
------------------------------------------------------------------------------------------------------------------------
Regulatory capital surplus 4.9 - 4.4 -
========================================================================================================================
In 2005, tier I resources included an implicit item relating to non profit business of £540m and financial reinsurance
relating to term assurance. There is no implicit item or financial reinsurance in 2006.
The table below summarises the realistic position of the with-profits part of Society's LTF:
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
With-profits surplus 1,128 842
Risk capital margin 465 327
------------------------------------------------------------------------------------------------------------------------
Surplus 663 515
========================================================================================================================
Society is required to maintain a surplus in the with-profits part of the fund on a realistic basis (Peak 2). If the
surplus on a realistic basis is lower than the surplus using Peak 1 solvency rules, then a further capital requirement,
the With-Profits Insurance Capital Component (WPICC), is required. In 2006, the WPICC was reduced to reflect the value
of shareholder transfers of £432m within the risk capital margin calculation.
(c) LGP capital surplus
2006 2005
Long term Long term
business business
£bn £bn
------------------------------------------------------------------------------------------------------------------------
Tier I 1.0 -
Upper tier II 0.2 -
Lower tier II 0.2 -
------------------------------------------------------------------------------------------------------------------------
Available capital resources 1.4 -
------------------------------------------------------------------------------------------------------------------------
Insurance capital requirement 0.6 -
------------------------------------------------------------------------------------------------------------------------
Capital resources requirement 0.6 -
------------------------------------------------------------------------------------------------------------------------
Regulatory capital surplus 0.8 -
========================================================================================================================
The regulatory capital surplus in LGP of £0.8bn is included within the IGD calculation (see note 5.02(a)). For Society's
regulatory capital calculation (on the adjusted solo basis), the regulatory capital surplus of LGP is reduced by £0.3bn
to reflect ineligible surplus capital. As a result, LGP is included at a regulatory value of £0.5bn in Society's
regulatory capital surplus. The figures in the table above are unaudited.
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Page 54
5.03 IFRS capital resources
---------------------------
(a) Group capital resources
The Group's total capital resources of £8.4bn on an IFRS basis, comprise ordinary equity holders' capital (£5.4bn)
(see note 4.15), subordinated debt (£0.8bn), and unallocated divisible surplus (£2.2bn, including £0.3bn of Sub-fund).
(b) Society capital resources
Society has been allocated capital of £5.5bn, reflecting the significance of this operation and the importance of
ensuring financial strength to support long term growth of the business. Of this total, £2.2bn is held outside any
Long Term Fund as Society shareholder capital (SSC) of which approximately £1.0bn is within LGP; the remainder of £3.3bn
is held within Society's LTF as Shareholder Retained Capital (SRC). An analysis of the movement in total Society capital
on the IFRS basis is provided in the table below:
2006 2006 2005 2005
SSC SRC SSC SRC
Notes £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
SSC/SRC as at 1 January 1,896 2,560 1,973 2,196
Investment return 186 250
Transfer from Society Long Term Fund 338 265
Dividends from subsidiaries 2 105
Capital invested in subsidiaries (13) -
Net capital contributed to LGP non profit business 5.01 (502) -
Distribution to shareholders (380) (638)
Issue of subordinated loan capital 602 -
Tax 140 (57)
Other (12) (2)
------------------------------------------------------------------------------------------------------------------------
SSC at 31 December 2,257 1,896
Held within:
LGP 950 -
Society 1,307 1,896
Investment return 303 387
Net capital released from Society non profit business 5.03(c) 1,972 478
Distribution of operating profit from Society non profit business (422) (349)
Repayment of subordinated loan capital (602) -
Tax (550) (148)
SRC movement included in the statement of recognised income and expense 2 (4)
------------------------------------------------------------------------------------------------------------------------
SRC at 31 December 3,263 2,560
------------------------------------------------------------------------------------------------------------------------
Society capital at 31 December 2,257 3,263 1,896 2,560
========================================================================================================================
The total net capital released from the non profit business is £1,255m (2005: £478m) (see note 4.07), consisting of the
net capital contributed to LGP non profit business of £502m (gross of tax £717m) and the net capital released from
Society of £1,972m.
(c) Analysis of net capital released from Society non profit business
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Net capital released from Society non profit business comprises:
New business
- Strain, before financing arrangements (546) (466)
- Changes to FSA reporting and capital rules 5.01 278 -
- Financing arrangements - 125
Existing business
- Expected capital release, before financing arrangements 555 499
Termination of financing arrangements (125) -
Experience variances 90 274
Changes to non-economic assumptions (90) (35)
Effect of corporate restructuring 5.01 502 -
Annuity investment policy 5.01 422 -
Changes to FSA reporting and capital rules 5.01 363 -
Movements in non-cash items (96) (67)
Other 27 5
------------------------------------------------------------------------------------------------------------------------
1,380 335
Tax gross-up 592 143
------------------------------------------------------------------------------------------------------------------------
1,972 478
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Page 55
5.03 IFRS capital resources (continued)
---------------------------------------
Financing arrangements represent the impact on new business strain and expected capital released from financial
reinsurance. As a result of PS 06/14, the financial reinsurance has been terminated.
Expected capital release represents the capital and profit generated in the period from the in-force non profit business
if the embedded value assumptions are borne out in practice. The experience variances are calculated with reference to
embedded value assumptions, including the apportionment of investment return and tax in the EEV model.
Both new business strain and expected capital release exclude required solvency margin, as this is not accounted for
under IFRS. On average, the capital invested in new non profit business, including solvency margin, is repaid from
product cash flows in approximately six years.
An analysis of the experience variances, non-economic assumption changes and non-cash items, all net of tax, is
provided below:
Experience variances 2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Persistency 4 13
Mortality / morbidity - 15
Expenses (28) (8)
Bulk Purchase Annuity data loading 157 78
Investment 27 121
Other (70) 55
------------------------------------------------------------------------------------------------------------------------
90 274
========================================================================================================================
Changes to non-economic assumptions 2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Mortality / morbidity (27) 33
Expenses (50) (19)
Negative inflation - (33)
Other (13) (16)
------------------------------------------------------------------------------------------------------------------------
(90) (35)
========================================================================================================================
Movements in non-cash items 2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Deferred tax (123) 34
Deferred acquisition costs (21) 160
Deferred income liabilities (78) (110)
IFRS adjustment for financial reinsurance 125 (125)
Other 1 (26)
------------------------------------------------------------------------------------------------------------------------
(96) (67)
========================================================================================================================
5.04 Group credit ratings
-------------------------
Society continues to be one of the two highest rated European life assurers. As at March 2007, our financial strength
ratings from Standard & Poor's, Moody's and A.M.Best were maintained at AA+, Aa1 and A+ respectively, all with a stable
outlook.
The Group's current long term and short term debt ratings are, from Standard & Poor's, AA- and A1+ and, from Moody's A1
and P1.
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Page 56
5.05 Distributions to shareholders from Society's Long Term Fund
----------------------------------------------------------------
(a) Calculation of distribution relating to non profit and shareholder net worth
The transfer to shareholders from Society's Long Term Fund is limited by a formula agreed with our regulator. The
formula is the aggregate of the shareholders' share of the with-profits surplus, a smoothed investment return of 7% on
the embedded value of the SRC and Sub-fund and 5% on the embedded value of the non profit business of Society and LGP,
adjusted to remove the impact of the contingent loan between SRC and LGP and the SNW of LGP.
2006 2006 2005 2005
Non profit SNW Non profit SNW
£m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Embedded value at end of period 1,643 3,828 2,387 1,762
Less: subordinated debt - - - (602)
Less: LGP shareholders' fund - (1,280) - -
Contingent loan 571 (571) - -
Add back: pension deficit attributable to SNW (5) 60 - 51
Add back: distributions - 272 - 219
------------------------------------------------------------------------------------------------------------------------
2,209 2,309 2,387 1,430
Distribution formula - full year 5.0% 7.0% 5.0% 7.0%
------------------------------------------------------------------------------------------------------------------------
Distribution after tax 110 162 119 100
Tax gross up @ 30% 47 69 51 42
------------------------------------------------------------------------------------------------------------------------
Distribution before tax 157 231 170 142
========================================================================================================================
(b) Analysis of distribution to shareholders
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Non profit transfer 272 219
With-profits transfer 66 46
------------------------------------------------------------------------------------------------------------------------
Transfer from Society's Long Term Fund 338 265
Subordinated debt interest 24 26
------------------------------------------------------------------------------------------------------------------------
Distribution to shareholders after tax 362 291
Tax gross up @ 30% 155 124
------------------------------------------------------------------------------------------------------------------------
Distribution to shareholders before tax 517 415
========================================================================================================================
5.06 Group cash flow statement
------------------------------
The table below shows the cash flows in the year relating to the Group's parent company.
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Dividends received:
UK life and pensions 380 533
General insurance - 105
Investment management 50 69
Other 3 2
------------------------------------------------------------------------------------------------------------------------
433 709
Dividend distributions to ordinary equity holders of the Company during the year (349) (331)
Distributions during the year on subordinated borrowings designated as equity - (16)
Proceeds from issue of equity 15 1
Proceeds from issue of subordinated borrowings - 397
Repayment of convertible bond (525) -
Working capital movements (52) (136)
------------------------------------------------------------------------------------------------------------------------
Net cash (outflow)/inflow (478) 624
========================================================================================================================
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