14th Mar 2007 07:02
Legal & General Group PLC14 March 2007 Capital and Cash Flow Page 51===================== 5.01 Significant impacts------------------------ The capital review update within the 2006 Review identifies three key initiatives implemented during the year. Thefinancial 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 SocietyLimited (Society) was ceded to a new, wholly owned, reinsurance company, Legal & General Pensions Limited (LGP). LGPhas 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 termsresulting in an initial regulatory loss in LGP. Further funds of £571m have been injected from Society's LTF into LGP'sLTF 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 hasgiven 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 toGroup Plc and an equivalent amount was lent to Society shareholder capital on a subordinated basis (£301m upper tierII, £301m lower tier II). The corporate restructuring has reduced Society's regulatory surplus capital by £0.5bn (2006 total surplus: £4.9bn) andthe IGD regulatory surplus by £0.5bn (2006 total surplus: £2.1bn), primarily due to the requirement to hold solvencymargins 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 hasbeen a reduction in the regulatory reserves required for term assurance business of £641m (see note 5.03(c)), and aconsequent small reduction in the long term insurance capital requirement. The associated financial reinsurancepreviously in place to finance these reserves was terminated and no credit has been taken for implicit items in theregulatory balance sheet, of which approximately £240m related to term assurance. The net impact on Society's regulatorycapital 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 thecalculation of the With-Profits Insurance Capital Component which has resulted in a decrease in Society's capitalresources 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 assetsbacking annuity liabilities were replaced with corporate bonds and Society entered into inflation swaps to mitigatenegative inflation risk. As a result, a closer match between assets and liabilities was achieved. Additionally, themargin within the reserves to cover an interest rate mismatch was reviewed and reduced. These actions reduced theregulatory reserves for Society by £422m (see note 5.03(c)). ======================================================================================================================== Page 525.02 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 minimumcapital requirements of regulators in each territory in which it operates. At Group level, Legal & General must complywith the requirements of the Insurance Groups Directive (IGD). This is a very prudent measure of capital resources asit excludes any amount of surplus capital within a Long Term Fund (£2.9bn for Society). The table below shows theestimated unaudited total Group capital resources, Group capital resources requirement and the surplus. 2006 2005 £bn £bn------------------------------------------------------------------------------------------------------------------------Tier I 6.0 6.1Upper tier II 0.4 0.4Lower tier II 0.4 0.4Deductions (0.1) (0.1)------------------------------------------------------------------------------------------------------------------------Group capital resources 6.7 6.8------------------------------------------------------------------------------------------------------------------------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 4.1Society Shareholder Capital 1.3 1.9L&G Pensions 1.4 -L&G Insurance 0.1 0.1L&G France 0.1 0.1L&G Netherlands 0.1 0.1L&G America 0.2 0.2Investment Management 0.3 0.3Other 0.5 1.2Tier II capital 0.8 0.8Debt (1.8) (2.0)------------------------------------------------------------------------------------------------------------------------Group capital resources 6.7 6.8------------------------------------------------------------------------------------------------------------------------ Society Long Term Fund 3.7 4.1L&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 equityholders 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 4.7Tier II capital 0.8 0.4Additional capital available from Society 0.9 2.1Adjustment to reflect regulatory value of L&G America (0.4) (0.4)------------------------------------------------------------------------------------------------------------------------Group capital resources 6.7 6.8======================================================================================================================== ======================================================================================================================== Page 535.02 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 beloware 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 0.1Upper 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 reinsurancerelating 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 842Risk 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 thesurplus 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 valueof 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'sregulatory capital calculation (on the adjusted solo basis), the regulatory capital surplus of LGP is reduced by £0.3bnto reflect ineligible surplus capital. As a result, LGP is included at a regulatory value of £0.5bn in Society'sregulatory capital surplus. The figures in the table above are unaudited. ======================================================================================================================== Page 545.03 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 ofensuring financial strength to support long term growth of the business. Of this total, £2.2bn is held outside anyLong Term Fund as Society shareholder capital (SSC) of which approximately £1.0bn is within LGP; the remainder of £3.3bnis held within Society's LTF as Shareholder Retained Capital (SRC). An analysis of the movement in total Society capitalon 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 250Transfer from Society Long Term Fund 338 265Dividends from subsidiaries 2 105Capital 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 1,896Held within:LGP 950 -Society 1,307 1,896 Investment return 303 387Net capital released from Society non profit business 5.03(c) 1,972 478Distribution 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 thenet capital contributed to LGP non profit business of £502m (gross of tax £717m) and the net capital released fromSociety 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======================================================================================================================== ======================================================================================================================== Page 55 5.03 IFRS capital resources (continued)--------------------------------------- Financing arrangements represent the impact on new business strain and expected capital released from financialreinsurance. 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 businessif the embedded value assumptions are borne out in practice. The experience variances are calculated with reference toembedded 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 forunder IFRS. On average, the capital invested in new non profit business, including solvency margin, is repaid fromproduct cash flows in approximately six years. An analysis of the experience variances, non-economic assumption changes and non-cash items, all net of tax, isprovided below: Experience variances 2006 2005 £m £m------------------------------------------------------------------------------------------------------------------------Persistency 4 13Mortality / morbidity - 15Expenses (28) (8)Bulk Purchase Annuity data loading 157 78Investment 27 121Other (70) 55------------------------------------------------------------------------------------------------------------------------ 90 274======================================================================================================================== Changes to non-economic assumptions 2006 2005 £m £m------------------------------------------------------------------------------------------------------------------------Mortality / morbidity (27) 33Expenses (50) (19)Negative inflation - (33)Other (13) (16)------------------------------------------------------------------------------------------------------------------------ (90) (35)======================================================================================================================== Movements in non-cash items 2006 2005 £m £m------------------------------------------------------------------------------------------------------------------------Deferred tax (123) 34Deferred acquisition costs (21) 160Deferred 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 strengthratings from Standard & Poor's, Moody's and A.M.Best were maintained at AA+, Aa1 and A+ respectively, all with a stableoutlook. The Group's current long term and short term debt ratings are, from Standard & Poor's, AA- and A1+ and, from Moody's A1and P1. ======================================================================================================================== Page 565.05 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. Theformula is the aggregate of the shareholders' share of the with-profits surplus, a smoothed investment return of 7% onthe 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 1,762Less: subordinated debt - - - (602)Less: LGP shareholders' fund - (1,280) - -Contingent loan 571 (571) - -Add back: pension deficit attributable to SNW (5) 60 - 51Add back: distributions - 272 - 219------------------------------------------------------------------------------------------------------------------------ 2,209 2,309 2,387 1,430Distribution formula - full year 5.0% 7.0% 5.0% 7.0%------------------------------------------------------------------------------------------------------------------------Distribution after tax 110 162 119 100Tax 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 219With-profits transfer 66 46------------------------------------------------------------------------------------------------------------------------Transfer from Society's Long Term Fund 338 265Subordinated debt interest 24 26------------------------------------------------------------------------------------------------------------------------Distribution to shareholders after tax 362 291Tax 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 709Dividend 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 1Proceeds from issue of subordinated borrowings - 397Repayment of convertible bond (525) -Working capital movements (52) (136)------------------------------------------------------------------------------------------------------------------------Net cash (outflow)/inflow (478) 624======================================================================================================================== This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
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