34 LONG TERM INSURANCE VALUATION ASSUMPTIONS.


The Group’s insurance assumptions, described below, relate exclusively to the UK insurance business. The non-UK businesses do not constitute a material component of the Group’s operations and consideration of geographically determined assumptions is therefore not included.

Non-participating business

For its non-participating business the Group seeks to make prudent assumptions about its future experience based on current market conditions and recent experience. The approach used to set non-participating assumptions is generally similar to that used to determine the assumptions used for FSA statutory Peak 1, although the actual assumptions may sometimes differ from those used for regulatory reporting purposes. These assumptions incorporate prudent margins in excess of our best estimate assumptions to reduce the possibility of actual experience being less favourable than assumed.

Valuation rates of interest and discount rates

The valuation interest rate for each contract type is based on the yield on the assets backing the contract adjusted for the risk that asset proceeds are not received by the Group. For some business, this yield is the gross redemption yield on fixed interest securities and the running yield on variable interest securities. For other business it is the Internal Rate of Return on the portfolio of backing assets.

In 2011, the Group continued to hold an additional reserve to protect against the risk of an uplift in defaults in the current economic environment and also maintained the level of the long term default allowance at 40bps (2010: 40bps) per annum for unapproved securities backing non profit business, 35bps (2010: 35bps) per annum for unapproved securities backing with-profits business, 3bps (2010: 3bps) per annum for approved securities and swaps and 27.3bps (2010: 53.4bps) for property. For unapproved securities backing non profit annuity business, the credit default allowances equate to 61bps (2010: 64bps) per annum when experienced over the duration of the assets held, leading to an overall total default provision of £1.6bn (2010: £1.5bn). A similar methodology has been used for assets backing with-profits business.

The Group believes the total default allowance is prudent to cover all reasonably foreseeable circumstances.

For equity investments, the yield is based on the current dividend yield, adjusted for prudence.

For property holdings, yields are based on the rental income payable calculated by considering different categories of tenant separately, adjusted for the possibility of default. Default rates used in the calculations vary by tenant category.

Mortality and morbidity

Mortality and morbidity assumptions are set with reference to standard tables drawn up by the Continuous Mortality Investigation Bureau (CMIB) of the Institute and Faculty of Actuaries. These tables are based on industry-wide experience.

The majority of internal statistical investigations are carried out at least annually to determine the extent to which the Group’s experience differs from that of the industry and suggest appropriate adjustments which need to be made to the valuation assumptions.

Persistency

The Group monitors its persistency experience and carries out detailed investigations annually. Persistency can be volatile and past experience may not be an appropriate future indicator.

The Group tries to balance past experience and future conditions by making prudent assumptions about the future expected long term average persistency levels.

For non-participating contracts where explicit persistency assumptions are not made, prudence is also incorporated into the liabilities by ensuring that they are sufficient to cover the more onerous of the two scenarios where the policies either remain in-force until maturity or where they discontinue at the valuation date.

Expenses

The Group monitors its expense experience and carries out detailed investigations regularly to determine the expenses incurred in writing and administering the different products and classes of business. Adjustments may be made for known future changes in the administration processes, in line with the Group’s business plan. An allowance for expense inflation in the future is also made, taking account of both salary and price information.

Participating business

For its participating business, the Group seeks to establish its liabilities at their realistic value in line with the requirements set out in FRS 27.

Non-economic assumptions are set to represent the Group’s best estimates of future experience.

Economic assumptions

The FSA’s realistic reporting regime requires a market consistent economic model. The model is calibrated using market data from a variety of market sources. This enables assumptions to be determined for the term structure of risk free interest rates, property and equity volatility. Risk free interest rates are determined with reference to the gilt yield curve on the valuation date increased by ten basis points.

Property volatility is set with reference to historic variations in property prices. Equity volatility is set so that the model reproduces observed market prices of traded equity derivatives. Correlations between asset classes are based on historic data.

Each investment scenario contains a consistent set of assumptions for investment returns and inflation.

Future bonuses

Future reversionary and terminal bonuses are consistent with the bonus policies set out in [Society]’s Principles and Practices of Financial Management (PPFM).

Value of in-force non-participating contracts

The Group makes a deduction from the liabilities for the expected value of future profits arising on non-participating contracts written in the with-profits part of the Society LTF.

The economic assumptions used to calculate the value of these profits are consistent with those used to calculate liabilities for with-profits business, with the addition of a liquidity premium in respect of assets backing non-participating annuity business. Non-economic assumptions represent best estimates of expected future experience on this business. An explicit allowance is made for non-market risk.

Guaranteed annuity options

The guarantees are valued on a market consistent basis. The valuation methodology allows for the correlation between interest rates and the proportion of the policyholders who take up the option.

Guaranteed cash options

The liability is determined assuming that policyholders choose the most valuable alternative between the annuity and cash available at retirement.

The table below sets out the current valuation assumptions used to establish the long term liabilities for Society, Legal & General Pensions Limited (LGPL) and Legal & General Assurance (Pensions Management) Limited.

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2011

2010

1.

For product groups where liabilities are positive, the lower interest rate of 2.25% is used. However, for product groups where liabilities are negative, the higher rate of 6.60% is used.

2.

For 2011, the percentage of the table varies with the duration that the policy has been in-force for the first five years. In 2010, a fixed percentage of the table was used for all years.

3.

For 2011 the percentage of the table varies with the duration that the policy has been in-force for the first two years. In 2010 a fixed percentage of the table was used for all years. For term assurance with critical illness, morbidity rates are assumed to deteriorate at a rate of 0.5% p.a. for males and 0.75% p.a. for females (2010: 0.50% p.a. for males and 0.75% p.a. for females). There is an additive loading of 1% (2010: 1%) for guaranteed term contracts post policy duration 5.

4.

Table created by blending PCXA00 with PNXA00 tables. The base table to be used for [BPA] policies in deferment is PNMA00 up to and including age 55 and PCMA00 for age 65 and above for males. The identical method is applied to females using PNFA00 and PCFA00.

5.

For vested annuities, mortality rates are assumed to reduce according to CMIB’s mortality improvement model; CMI 2009 with the following parameters:
Males: Long Term Rate of 2% p.a. (2010: 2% p.a.) up to age 85 tapering to 0% at 120;
Females: Long Term Rate of 1.5% p.a. (2010: 1.5% p.a.) up to age 85 tapering to 0% at 120.
For certain annuities, a further allowance is made for the effect of initial selection.

Rate of interest/discount rates

 

 

Non-participating business

 

 

Life assurances

2.25% pa and 6.60% pa1

2.25% pa and 7.60% pa1

Pension assurances

2.25% pa and 6.60% pa1

2.50% – 3.50% pa and 7.60% pa1

Annuities in deferment

4.601% pa

4.975% pa

Annuities in deferment (RPI-linked; net rate after allowance for inflation)

0.86% pa

1.040% pa

Vested annuities

1.75% – 4.601% pa

2% – 4.975% pa

Vested annuities (RPI-linked; net rate after allowance for inflation)

-0.40% – 0.86% pa

0.40% – 1.040% pa

Participating business

 

 

Risk free rate (10 years)

2.23% pa

3.78% pa

Future bonuses

Determined stochastically
in line with bonus policy
as stated in PPFM

Determined stochastically
in line with bonus policy
as stated in PPFM

UK equity volatility (10 year option term)

27.2%

26.2%

Property volatility

15.0%

15.0%

Mortality tables

 

 

Non-participating business

 

 

Non-linked individual term assurances:

 

 

Smokers

78% TMS00/TFS00 Sel 5

116% TMS00/TFS00 Sel 5

Non-smokers

90% TMN00/TFN00 Sel 5

136% TMN00/TFN00 Sel 5

Smoker status unknown

83% TM00/TF00 Sel 5

103% TM00/TF00 Sel 5

Non-linked individual term assurances with terminal illness

 

 

Smokers

90% – 112% TMS00/TFS00 Sel 52

96% TMS00/TFS00 Sel 52

Non-smokers

85% – 115% TMN00/TFN00 Sel 52

93% TMN00/TFN00 Sel 52

Non-linked individual term assurances with critical illness

 

 

Smokers

91% – 101% CIBT93M/F Ult Comb3

99% CIBT93M/F Ult Comb3

Non-smokers

57% – 67% CIBT93M/F Ult Comb3

68% CIBT93M/F Ult Comb3

Other non-linked non profit life assurances

100% of A67/70 ultimate tables

100% of A67/70 ultimate tables

Annuities in deferment

82.5% – 89.4% PNMA00/PNFA004

88% – 92% PNMA00/PNFA004

Vested annuities5

 

 

Bulk purchase annuities

84.3% – 90.4% PCMA00/PCFA00

89% – 93% PCMA00/PCFA00

Other annuities

62.2% – 115.4% PCMA00/PCFA00

55% – 86% PCMA00/PCFA00

Premiums – non-participating business

For those contracts where the policyholder does not have the right to vary the amount of the premium paid, full credit is taken for the premiums contractually due at the valuation date. For contracts where the policyholder has the option to vary the rate of premium, the provision is taken as being the higher of the amount calculated as if the policyholder continues to make premium payments or, alternatively, ceases to pay premiums altogether.

Persistency – non-participating business

Lapse rates are used in the valuation of certain classes of long term business. Where this is the case, the valuation persistency basis is set by applying a prudential margin over the best estimate assumptions. The tables below show the major products where lapse rates have been used.

For term assurance business, the margin acts to increase the best estimate lapse rate in the early part of a policy’s lifetime (when it is treated as an asset) but to reduce the best estimate lapse rate later in the policy’s lifetime (when it is treated as a liability). The crossover point at which the margin changes direction is assessed for broad product groups but applied at a policy by policy level. Any liability to reinsurers on discontinuance within the first four years from inception is allowed for explicitly in the cash flows, using the valuation lapse basis, together with a prudent allowance for clawback of commission from agents upon lapse.

For unitised business, the margin acts to either increase or decrease the best estimate lapse rates, depending upon which approach results in the higher liability. The direction of the margin is assessed for unit life business and unit pensions business separately.

A summary of the lapse basis for major classes of business, as defined by the requirements of the annual returns to the FSA, is shown below:

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2011 Average lapse rate for the policy years

Product

1 – 5
%

6 – 10
%

11 – 15
%

16 – 20
%

Level term

13.9

9.2

5.6

2.9

Decreasing term

14.0

9.3

6.0

5.5

Accelerated critical illness cover

21.7

11.1

5.3

5.0

Pensions term

13.0

8.5

5.6

5.1

Whole of Life (conventional non profit)

3.9

1.9

1.0

Savings endowment (unitised with-profits)

1.4

1.6

4.0

Target cash endowment (unitised with-profits)

3.6

3.0

2.4

Savings endowment (unit linked)

1.4

1.6

4.0

Target cash endowment (unit linked)

3.6

3.0

2.4

Bond (unitised with-profits)

1.0

2.0

2.3

1.8

Bond (unit linked)

2.6

5.9

3.6

3.3

Individual pension regular premium (unitised with-profits)

1.4

1.3

1.3

1.3

Individual pension regular premium (unit linked)

2.4

1.7

1.6

1.6

Group pension regular premium (unitised with-profits)

2.2

2.3

2.1

2.1

Group pension regular premium (unit linked)

2.6

2.3

1.4

1.4

Trustee Investment Plan regular premium (unitised with-profits)

1.3

1.3

1.3

1.3

Trustee Investment Plan regular premium (unit linked)

1.3

1.3

1.3

1.3

Individual pension single premium (unitised with-profits)

3.5

3.4

3.4

3.4

Individual pension single premium (unit linked)

4.4

3.8

2.9

2.9

Group pension single premium (unitised with-profits)

10.9

10.9

10.9

10.9

Group pension single premium (unit linked)

6.7

6.7

6.7

6.7

Trustee Investment Plan single premium (unitised with-profits)

6.8

5.6

3.8

3.8

Trustee Investment Plan single premium (unit linked)

6.8

5.6

3.7

3.7

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2010 Average lapse rate for the policy years

Product

1 – 5
%

6 – 10
%

11 – 15
%

16 – 20
%

Level term

13.9

9.4

6.0

3.1

Decreasing term

14.1

9.5

6.4

6.0

Accelerated critical illness cover

21.2

10.7

5.5

5.2

Pensions term

12.7

8.5

6.0

5.6

Whole of Life (conventional non profit)

4.1

1.9

0.9

Savings endowment (unitised with-profits)

1.7

2.2

4.4

Target cash endowment (unitised with-profits)

3.2

3.2

3.2

2.6

Savings endowment (unit linked)

1.7

2.2

4.4

Target cash endowment (unit linked)

3.2

3.2

3.2

2.6

Bond (unitised with-profits)

1.1

2.0

2.5

2.4

Bond (unit linked)

2.6

6.3

3.9

3.5

Individual pension regular premium (unitised with-profits)

1.2

1.1

1.1

1.1

Individual pension regular premium (unit linked)

2.2

1.6

1.4

1.4

Group pension regular premium (unitised with-profits)

2.1

2.1

2.0

2.0

Group pension regular premium (unit linked)

2.1

1.9

1.3

1.3

Trustee Investment Plan regular premium (unitised with-profits)

1.4

1.4

1.4

1.4

Trustee Investment Plan regular premium (unit linked)

1.3

1.3

1.3

1.3

Individual pension single premium (unitised with-profits)

3.4

3.3

3.2

3.2

Individual pension single premium (unit linked)

4.0

3.5

2.7

2.7

Group pension single premium (unitised with-profits)

11.2

11.2

11.2

11.2

Group pension single premium (unit linked)

7.6

7.6

7.6

7.6

Trustee Investment Plan single premium (unitised with-profits)

6.4

5.3

3.8

3.8

Trustee Investment Plan single premium (unit linked)

6.8

5.8

4.3

4.3

Endowment reserve

The endowment reserve has been set taking reasonable account of an assessment of the expected future population of complaints, the expected uphold rate for these complaints, the potential impact of any Financial Ombudsman Service decisions on referred complaints and the average compensation per complaint.

Overseas business

In calculating the long term business provisions for international long term business operations, local actuarial tables and interest rates are used.

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