Principal Risks and Uncertainties

A significant part of the Group’s business involves the acceptance and management of risk.

• Legislation and Regulation
• Financial Market and Economic Conditions
• Counterparty and Third Party Risks
• Confidence in the Financial Services Sector
• Reputation and Contagion Risks
• Mortality and Catastrophe Risks
• Other Insurance Assumption Uncertainties
• Future Development of Savings Market
• Resources.

A detailed review of the [Group’s] inherent exposures to market, credit, insurance, liquidity and operational risks, together with the framework for their management and control, is set out at Note 50 to the Financial Statements. An overview of the Group’s risk management structure is given as part of the review of Corporate Governance Statement.

Legislation and Regulation

The financial services markets in which the [Group] operates are highly regulated, with regulation defining the overall framework for the design, marketing and distribution of products; the acceptance and administration of business; and the prudential capital that regulated companies should hold. Government fiscal policy may also influence the design of products distributed by the Group, retention of existing business and the required reserves for future liabilities. Additionally, there is a continuing growing international dimension, with the pace and volume of regulatory and legislative change increasing.

The [Group’s] activities and strategies are based upon prevailing legislation and regulation, with continuous monitoring to ensure that the Group meets its regulatory obligations. The potential for change is continuously identified and analysed. Where appropriate the Group engages with regulatory and legislative authorities to assist in the evaluation of change on the sector and its stakeholders. Sudden, unanticipated changes in fiscal policy or legal and regulatory regimes without consultation or advanced notification to the sector, or the differing interpretation and application of regulation over time, may have a detrimental effect on the Group’s strategy and profitability both in terms of the generation of new business and the retention of existing business. Fundamental changes in regulation, such as the proposed requirements of the EU’s Solvency II Directive or those that may arise from market events, may also impact the strategies of the Group.

Financial Market and Economic Conditions

The earnings and profitability of Legal & General’s businesses are influenced by a broad range of factors including the performance and liquidity of investment markets, interest rate movements and inflation. The [Group] uses a range of risk management strategies including inflation, interest and credit default swaps to manage volatility from these factors. However, extreme market events, over which the Group has no direct influence, can impact the execution of these strategies exposing the Group to unanticipated loss. Examples of events include those causing widespread default amongst issuers of corporate debt or default amongst counterparties to swap agreements. As well as impacting the value of assets backing the obligations and capital of the Group, significant falls in equity markets, property values and other classes of investment asset can also impact earnings from Investment management; the flows of funds to and from the Group’s Investment management businesses; and the cost of guarantees in certain long term products. The value of investments denominated in currencies other than sterling and holdings in overseas subsidiaries can also be impacted by fluctuations in exchange rates. General economic conditions also influence customer behaviour in terms of timing and frequency of purchase of financial services products and the lapse rates for products.

Counterparty and Third Party Risks

In addition to default risk associated with issuers of corporate debt and financial instruments, the [Group] is exposed to counterparty credit risk in respect of money market and reassurance transactions. The Group applies defined criteria in selecting counterparties with which it deals, sets exposure limits relative to the risks associated with each type of transaction and monitors both exposures and limits relative to the broader economic environment. However, potential remains in extreme conditions for a material impact on the Group’s profitability should a significant banking or reassurance counterparty fail. A significant level of financial failure among the Group’s product distributors may also impact the earnings of the Group. Risk also arises from reliance on external suppliers of certain administration and [IT] development services. The Group seeks to mitigate the potential for, and impact of, supplier failure through performing due diligence at the outset of new relationships, monitoring the ongoing performance of key contracts and where necessary maintaining contingency arrangements in the event that bespoke services cease to be available. Dependencies also exist on the provision of banking infrastructure, the availability of security dealing and custody services. Unforeseen events leading to the loss of any of these services may impact operational effectiveness.

Confidence in the Financial Services Sector

The [Group] has followed a strategy of offering value-for-money products to its customers and continually improving customers’ overall experience of doing business with Legal & General. However, earnings and profitability are also influenced by the perception and confidence of the retail and wholesale investor in relation to the financial services sector as a whole, a number of these drivers are beyond the Group’s control. Such factors include the adverse performance of investment markets, actions by regulators within the sector and shock events such as significant market failures, although the Group seeks wherever practicable to mitigate the effects of these risks.

Reputation and Contagion Risks

As well as the factors outlined above, the [Group’s] reputation can be affected by events impacting parties with which the Group has a relationship, internal process failures and the consequences of external events. The Group seeks to maintain a control environment to ensure that for those factors it can control, the potential for financial loss and reputational damage is minimised to a commercial level. However, extreme events that cannot be readily controlled may affect the reputational consequences of the earning streams of the Group. As well as impacting reputation, the failure of other financial services organisations can have a direct impact on the Group through its participation in the Financial Services Compensation Scheme. In the event of a significant level of market failure, the Group may be obliged to provide additional funding over a sustained period of time, reducing capital available to the Group. Similarly, pools such as the Pension Protection Fund can result in calls for funds on the Group through its defined benefit pension schemes.

Mortality and Catastrophe Risks

Legal & General writes significant levels of immediate and deferred annuity business. The [Group] uses its pricing capability for longevity risks to ensure that an appropriate risk premium is applied to this business, taking account of all known risk factors. Significant unforeseen and rapid medical advances may result in the requirement to increase reserves for these lines of business. With regard to the Group’s Protection business, while the risk of adverse claims experience is fully assessed and reserved for, an event causing widespread mortality or morbidity, coupled with a reinsurer default, may also impact the capital available to the Group. Similarly, a series of extreme weather events may impact earnings to the Group from its General Insurance business.

Other Insurance Assumption Uncertainties

In addition to pricing for mortality and catastrophe risks, as part of the processes to determine its long term liabilities, the Group makes assumptions in respect of other factors including persistency, interest rate and credit defaults within its investment portfolio. Assumptions are subject to critical challenge, with potential variances from assumptions being stress tested as part of the Group’s processes to assess adequacy of prudential capital. However, extreme shifts in financial markets and in the broader economic environment may require certain assumptions to be recalibrated, impacting the profitability of the Group.

Future Development of the Savings Market

A number of Legal & General’s businesses are focused on the long term savings and retirement markets. The reasons customers save and make provision for old age are influenced by a number of factors including government policy, social conditions and the general economic environment. The Group seeks to participate actively in debate to highlight those matters which are key to encouraging consumers to save and make adequate provision for old age. However, consumer uncertainty in any of the above factors may have a detrimental effect on these markets. A protracted period of low growth in asset values or low interest rate returns, may lead to a re-assessment by consumers of the way they plan for retirement and their requirements for long term saving products.

Resources

The [Group] actively focuses on recruiting and retaining high quality individuals. It ensures that key dependencies do not arise, through employee training and development programmes, remuneration strategies and succession planning. However, the sudden unanticipated loss of teams of expertise may, in the short term, impact certain segments of Legal & General’s businesses.