48 RISK MANAGEMENT AND CONTROL.


Risk management approach

A significant part of the Group’s business involves the acceptance and management of risk. The Group’s risk appetite framework and the methods used to assess and monitor risk exposures can be found in the Risk Management section. The Group is exposed to insurance, market, credit, liquidity and operational risks and operates a formal risk management framework to ensure that all significant risks are identified and managed. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties.

Insurance risk: exposure to loss arising from claims experience being different to that anticipated.

Market risk: exposure to loss as a direct or indirect result of fluctuations in the value of, or income from, specific assets.

Credit risk: exposure to loss if another party fails to perform its financial obligations to the Group.

Liquidity risk: the risk that the Group, though solvent, either does not have sufficient financial resources available to enable it to meet its obligations as they fall due, or can secure them only at excessive cost.

Operational risk: exposure to loss arising from inadequate or failed internal processes, people, systems, or from external events.

The Group seeks to manage its exposures to risk through control techniques which ensure that the residual risk exposures are within acceptable tolerances agreed by the Board. A description of the key products offered by the Group’s segments and the associated risks and control techniques is detailed below.

Risk

Principal Products

The Group’s Risk business comprises annuities, individual and group protection, and general insurance products. The majority of Risk products are non-participating contracts and as such profits on this business accrue solely to shareholders.

Annuities

Annuity products provide guaranteed income for a specified time, usually the life of the policyholder, in exchange for a lump sum capital payment. No surrender value is available under any of these products. Immediate and deferred are annuity contacts are offered. Immediate annuities provide a regular income stream to the policyholder, purchased with a lump sum investment, where the income stream starts immediately after the purchase. The income stream from a deferred annuity is delayed until a specified future date. Bulk annuities are also offered, where the Group accepts the assets and liabilities of a company pension scheme or a life fund. A small portfolio of immediate annuities has been written as participating business. Some non-participating deferred annuities sold by the Group contain guaranteed cash options, predominantly minimum factors for commuting part of the annuity income into cash at the date of vesting. The value of such guaranteed options are currently immaterial. There is a block of immediate and deferred annuities within the UK non profit business with benefits linked to changes in the RPI or for a minority the CPI, but with contractual maximum or minimum increases. In particular, most of these annuities have a provision that the annuity will not reduce if RPI, or for a minority CPI, becomes negative. The total of such annuities in payment at 31 December 2011 was £271m (2010: £247m). Thus, 1% negative inflation, which was reversed in the following year, would result in a guarantee cost of approximately £3m (2010: £2m). Negative inflation sustained over a longer period would give rise to significantly greater guarantee costs. Some of these guarantee costs have been partially matched through the purchase of negative inflation hedges and limited price indexation swaps.

Deferred annuity contracts

The Group has written some deferred annuity contracts with guaranteed minimum pensions. These options expose the Group to interest rate and longevity risk as the cost would be expected to increase with decreasing interest rates and improved longevity. The market consistent value of these guarantees carried in the balance sheet is £185m (2010: £125m).

Protection business (individual and group)

The Group offers protection products which provide mortality or morbidity benefits. They may include health, disability, critical illness and accident benefits; these additional benefits are commonly provided as supplements to main life policies but can also be sold separately. The benefit amounts would usually be specified in the policy terms. Some sickness benefits cover the policyholder’s mortgage repayments and are linked to the prevailing mortgage interest rates. In addition to these benefits, some contracts may guarantee premium rates, provide guaranteed insurability benefits and offer policyholders conversion options.

General insurance

The Group offers Household and Accident, Sickness and Unemployment (ASU) products:

  • Household. These contracts provide cover in respect of policyholders’ homes, investment properties, contents, personal belongings and incidental liabilities which they may incur as a property owner, occupier and individual. Exposure is normally limited to the rebuilding cost of the home, the replacement cost of belongings and a policy limit in respect of liability claims.
  • Accident, Sickness and Unemployment (ASU). These contracts provide cover in respect of continuing payment liabilities incurred by customers when they are unable to work as a result of accident, sickness or unemployment. They protect predominantly mortgage payments. Exposure is limited to the monthly payment level selected by the customer sufficient to cover the payment and associated costs, up to the duration limit specified in the policy, usually 12 months.

In addition, there are portfolios of Motor Insurance and Domestic Mortgage Indemnity Insurance (DMI) in run off. Since 1993, the DMI contract has included a maximum period of cover of ten years, and a cap on the maximum claim. For business accepted prior to 1993, cover is unlimited and lasts until the insured property is remortgaged or redeemed.

Insurance risks

(Download XLS:) Download Excel

Risk

Product

Control

Mortality & Morbidity Risks

 

 

For contracts providing death benefits, higher mortality rates would lead to an increase in claims costs. The cost of health related claims depends on both the incidence of policyholders becoming ill and the duration over which they remain ill. Higher than expected incidence or duration would increase costs over the level currently assumed in the calculation of liabilities.

Protection

The pricing of protection business is based on assumptions as to future trends in mortality and morbidity having regard to past experience. Underwriting criteria are defined setting out the risks that are unacceptable and the terms for non-standard risks presented by the lives to be insured. Extensive use of reinsurance is made within individual protection business, placing a proportion of all risks meeting prescribed criteria. Mortality and morbidity experience is compared to that assumed within the pricing basis with variances subject to actuarial investigation.

For annuity contracts, the Group is exposed to the risk that mortality experience is lower than assumed; lower than expected mortality would require payments to be made for longer and increase the cost of benefits provided.

Annuities

Annuity business is priced having regard to trends in improvements in future mortality. Enhanced annuities, which are priced taking account of impairments to life expectancy, are subject to specific underwriting criteria. Certain annuitant mortality risks, including enhanced annuities, are placed with reinsurers. The Group regularly reviews its mortality experience and industry projections of longevity and adjusts the pricing and valuation assumptions accordingly.

Persistency Risk

 

 

In the early years of a policy, lapses may result in a loss to the Group, as the acquisition costs associated with the contract would not have been recovered from product margins.

Protection

The pricing basis for protection business includes provision for policy lapses. Following the adoption of PS06/14 in 2006 the persistency assumption for non-participating protection business allows for the expected pattern of persistency, adjusted to incorporate a margin for adverse deviation. Actual trends in policy lapse rates are monitored with adverse trends being subject to actuarial investigation.

Expense Risk

 

 

In pricing long term insurance business, assumptions are made as to the future cost of product servicing. A significant adverse divergence in actual expenses experience could reduce product profitability.

Protection and annuities

In determining pricing assumptions, account is taken of changes in price indices and the costs of employment, with stress testing used to evaluate the effect of significant deviations. Product servicing costs are monitored relative to the costs assumed with the product pricing basis.

Concentration Risk

 

 

Insurance risk may be concentrated in geographic regions, altering the risk profile of the Group. The most significant exposure of this type arises for the group protection business, where a single event could result in a large number of related claims.

Protection and general insurance

Group protection business contracts include an ‘event limit’ capping the total liability under the policy from a single event. Excess of loss reinsurance further mitigate the exposure. For general insurance business, the risk acceptance policy, terms and premiums reflect expected claims cost associated with a location and avoids adverse selection. Additionally, exposure by location is monitored to ensure there is a geographic spread of risk. Catastrophe reinsurance cover also reduces concentrations of risk.

Epidemics

 

 

The spread of an epidemic could cause large aggregate claims across the Group’s portfolio of protection businesses.

Protection

The pricing basis for protection business includes an assessment of potential claims as a result of epidemic risks. Quota share and excess of loss reinsurance contracts are used by individual and group protection, respectively, to further mitigate the risk. Depending on the nature of an epidemic, mortality experience may lead to a reduction in the cost of claims for annuity business.

Weather events

 

 

Significant weather events such as windstorms, and coastal and river floods can lead to significant claims.

General insurance

The impact of events are mitigated by excess of loss catastrophe treaties, under which the cost of claims from a weather event in excess of an agreed retention level, is recovered from insurers. The reinsurance is designed to protect against a modelled windstorm and coastal flood event with a return probability of 1 in 200 years.

Subsidence

 

 

The incidence of subsidence can have a significant impact on the level of claims on household policies.

General insurance

Underwriting criteria for general insurance business includes assessment of subsidence risk, with an appropriate premium being charged for the risk accepted. Reinsurance arrangements are used to further mitigate the risk.

Market risks

(Download XLS:) Download Excel

Risk

Product

Control

Investment Performance Risk

 

 

The Group is exposed to the risk that the income from, and value of, assets held to back insurance liabilities do not perform in line with investment and product pricing assumptions leading to a mismatch with contractual cash flows.

All

Stochastic models are used to assess the impact of a range of future return scenarios on investment values and associated liabilities in order to determine optimum portfolios of invested assets. For immediate annuities, which are sensitive to interest rate risk, analysis of the liabilities is undertaken to create a portfolio of securities, the value of which changes in line with the value of liabilities when interest rates change.

Currency Risk

 

 

To diversify credit risk within the annuities business corporate bond portfolio, investments are held in corporate bonds denominated in Euros and US Dollars. Fluctuations in the value of, or income from, these assets relative to liabilities denominated in sterling could result in unforeseen loss.

Annuities

To mitigate the risk of loss from currency fluctuations, currency swaps are used to hedge exposures to corporate bonds denominated in currencies other than sterling. Hedging arrangements are placed only with strongly rated counterparties with collateral requirements being subject to regular review and reconciliation with the counterparties.

Inflation Risk

 

 

Inflation risk is the potential for loss as a result of relative or absolute changes in inflation rates. Annuity contracts may provide for future benefits to be paid taking account of changes in the level of inflation. Annuity contracts in payment may include an annual adjustment for movements in prices indices.

Annuities

The investment strategy for annuities business takes explicit account of the effect of movements in price indices on contracted liabilities. Significant exposures that may adversely impact profitability are hedged using inflation swaps. Annuity contracts also typically provide for a cap on the annual increase in inflation linked benefits in payment.

Credit risks

(Download XLS:) Download Excel

Risk

Product

Control

Bond Default Risk

 

 

A significant portfolio of corporate bonds is held to back the liabilities arising from writing annuities business. Whilst the portfolio is diversified, the asset class is inherently exposed to the risk of issuer default.

Annuities and general insurance

Issuer limits are set by financial strength rating, sector and geographic region so as to limit exposure from a default event. Issuer limits are regularly reviewed to take account of changes in market conditions, sector performance and the re-assessment of financial strength by rating agencies and the Group’s own internal analysts. Exposures are monitored relative to limits. Financial instruments are also used to mitigate the impact of rating downgrades and defaults.

Reinsurance Counterparty Risk

 

 

Exposure to insurance risk is mitigated by ceding part of the risks assumed to the reinsurance market. Default of a reinsurer would require the business to be re-brokered potentially on less advantageous terms, or for the risks to be borne directly.

All

When selecting new reinsurance partners the Group considers only companies which have a minimum credit rating equivalent to A- from Standard & Poor’s. For each reinsurer exposure limits are determined based on credit ratings and projected exposure over the term of the treaty. Actual exposures are regularly monitored relative to these limits.

Liquidity risks

(Download XLS:) Download Excel

Risk

Product

Control

Contingent Event Risk

 

 

Within protection and general insurance business liquidity risks which stem from low probability events that, if not adequately planned for, may result in unanticipated liquidity requirements. Such events may include a flu pandemic or natural disaster leading to significantly higher levels of claims than would normally be expected and extreme market conditions impacting the timing of cash flows or the ability to realise investments at a given value within a specified timeframe.

Protection and general insurance

A limited level of contingent liquidity risk is an accepted element of writing contracts of insurance. However, the Group’s insurance businesses seek to maintain sufficient liquid assets and standby facilities to meet a prudent estimate of the cash outflows that may arise from contingent events. The level of required liquidity is identified using techniques including stress tests for shock events, with the profile of actual liquid assets being regularly compared to required profile. The Group’s treasury function provides formal facilities to the Group to cover contingent liquidity requirements arising from more extreme events and where investment assets may not be readily realisable. The level of insurance funds held in cash and other readily realisable assets at 31 December 2011 was £2.3bn (2010: £2.6bn).

Collateral Liquidity Risk

 

 

Within the annuities business, the use of financial instruments to hedge default, interest rate, currency and inflation risks can require the posting of collateral with counterparties, and as such an appropriate pool of the asset types specified by counterparties must either be held or readily available.

Annuities

Liquidity requirements to meet potential collateral calls are actively managed. Typically within the overall fund of investment assets held to meet the long term liabilities arising from annuity business, £350m is held in cash and other highly liquid investment types for general liquidity purposes. As at 31 December 2011 eligible assets worth 9 times the outstanding collateral were held.

Savings

Principal Products

The Group’s Savings products comprise:

  • Non-participating savings, pensions and endowment contracts;
  • Participating savings business, comprising endowment contracts and with-profits bonds;
  • Unit linked savings contracts, unit trusts and collective investment savings products.

Non-participating contracts

Non-participating business is written in the non profit part of the [Society] Long Term Fund (LTF). Profits accrue solely to shareholders. Participating contracts are supported by the with-profits part of the Society LTF. They offer policyholders the possibility of payment of benefits in addition to those guaranteed by the contract. The amount and timing of the additional benefits (usually called bonuses) are contractually at the discretion of the Group.

For unit linked savings contracts, unit trusts and collective investment savings products there is a direct link between the investments and the obligations. The financial risk on these contracts is borne by the policyholders and therefore detailed risk disclosures have not been presented in respect of the associated assets and liabilities. Unit linked business is written in the Society LTF. Unit trust and collective investment business is administered by Legal & General (Unit Trust Managers) Limited and Legal & General (Portfolio Management Services) Limited, respectively.

Savings

A range of contracts are offered in a variety of different forms to meet customers’ long term savings objectives. Policyholders may choose to include a number of protection benefits within their savings contracts. Typically, any guarantees under the contract would only apply on maturity or earlier death. On certain older contracts there may be provisions guaranteeing surrender benefits. Savings contracts may or may not guarantee policyholders an investment return.

Pensions (individual and corporate)

These are long term savings contracts through which policyholders accumulate pension benefits. Some older contracts contain a basic guaranteed benefit expressed as an amount of pension payable or a guaranteed annuity option. Other options provided by these contracts include an open market option on maturity, early retirement and late retirement. The Group would generally have discretion over the terms on which the latter types of options are offered.

Endowment policies

These contracts provide a lump sum on maturity determined by the addition of annual and final bonuses over the duration of the contract. In addition, the contracts provide a minimum sum assured death benefit.

With-profits bonds

These contracts provide an investment return to the policyholder which is determined by the attribution of regular and final bonuses over the duration of the contract. In addition, the contracts provide a death benefit, typically of 101% of the value of the units allocated to the policyholder.

Participating contracts

Discretionary increases to benefits on participating contracts are allowed in one or both of annual and final bonus form. These bonuses are determined in accordance with the principles outlined in the Society’s PPFM for the management of the with-profits part of the Society LTF. The principles include:

  • The with-profits part of the [Society] LTF will be managed with the objective of ensuring that its assets are sufficient to meet its liabilities without the need for additional capital;
  • With-profits policies have no expectation of any distribution from the with-profits part of the Society LTF’s inherited estate. The inherited estate is the excess of assets held within the Society LTF over and above the amount required to meet liabilities, including those which arise from the regulatory duty to treat customers fairly in settling discretionary benefits; and
  • Bonus rates will be smoothed so that some of the short term fluctuations in the value of the investments of the with-profits part of the Society LTF and the business results achieved in the with-profits part of the UK LTF are not immediately reflected in payments under with-profits policies.

At 30 June 2005 an assessment was made of the expected cost of guarantees and options to be paid in the future, and funds with the same value to meet these costs were allocated from the capital in the with-profits sub-fund. The value of the funds is regularly assessed and is reduced by the cost of guarantees and options paid since 1 July 2005. At each assessment point, if the value of the funds is lower than the expected cost of guarantees and options, it is possible to make deductions from asset shares to cover the difference. It is intended to limit deductions to no more than 0.75% each year, up to a maximum of 5% per policy.

Following the movement in the expected cost of guarantees and options and the value of the associated funds up to 31 December 2011, and in accordance with the Society’s PPFM, a deduction of 0.75% was made to the asset shares. This followed a refund of 0.2% made in respect of the year to 31 December 2010. In the technical provisions, allowance was also made for future deductions in respect of the expected costs of meeting future guarantees and options not covered by the current year deduction. For policyholders who decide to surrender, a charge will generally be made in respect of the expected cost of guarantees and options not covered by the charge already taken. Some older participating contracts include a guaranteed minimum rate of roll up of the policyholder’s fund up to the date of retirement or maturity.

The distribution of surplus to shareholders depends upon the bonuses declared for the period. Typically, bonus rates are set having regard to investment returns, although the Group has some discretion setting rates and would normally smooth bonuses over time. The volatility of investment returns could impact the fund’s capital position and its ability to pay bonuses. If future investment conditions were less favourable than anticipated, the lower bonus levels resulting would also reduce future distributions to shareholders. Business which is written in the with-profits part of the Society LTF is managed to be self-supporting. The unallocated divisible surplus in the fund would normally be expected to absorb the impact of these investment risks. Only in extreme scenarios, where shareholders were required to provide support to the with-profits part of the Society LTF to meet its liabilities, would these risks affect equity. As part of the 2007 Society LTF restructure, the 1996 Sub-fund (£321m) was merged into the Shareholder Retained Capital (SRC). As a result, Society’s Board of Directors undertook to initially maintain £500m of assets within Society to support the with-profits business. The amount of the commitment reduced to £350m in 2011 and will then gradually reduce to zero over a period not exceeding seven years. The Group’s approach to setting bonus rates is designed to treat customers fairly. The approach is set out in the Society’s PPFM for the with-profits part of the Society LTF. In addition, bonus declarations are also affected by FSA regulations relating to Treating Customers Fairly (TCF), which limit the discretion available when setting bonus rates.

Insurance risks

(Download XLS:) Download Excel

Risk

Product

Control

Persistency

 

 

In the early years of a policy, lapses and surrenders are likely to result in a loss to the Group, as the acquisition costs associated with the contract would not have been recovered from product margins.

All

For insured contracts, terms and conditions typically include surrender deductions to mitigate the risk. In later periods, once the acquisition costs have been recouped, the effect of lapses and surrenders depends upon the relationship between the exit benefit, if any, and the liability for that contract. Exit benefits are not generally guaranteed and the Group has some discretion in determining the amount of the payment. As a result, the effect on profit in later periods is expected to be broadly neutral.

Expense Risk

 

 

In pricing long term savings business, assumptions are made as to the future cost of product servicing. A significant adverse divergence in actual expenses experience could reduce product profitability.

All

In determining pricing assumptions, account is taken of changes in price indices and the costs of employment, with stress testing used to evaluate the effect of significant deviations. Actual product servicing costs are actively monitored relative to the costs assumed with the product pricing basis, with variances investigated.

Mortality Risks

 

 

For savings contracts providing minimum assured death benefits, higher mortality rates may result in an increase in claims costs.

All

The pricing basis for contracts providing minimum assured death benefits include provision for future trends in mortality based on past experience. The level of mortality risk accepted within each contract is not sufficiently material to warrant formal underwriting at an individual policy level.
 

Older contracts containing a basic guaranteed benefit expressed as an amount of pension payable or a guaranteed annuity option, expose the Group to interest rate and longevity risk. The cost of guarantees increases during periods when interest rates are low or when annuitant mortality improves faster than expected.

Pensions

The ultimate cost of basic guarantees provided on older contracts will depend on the take up rate of any option and the final form of annuity selected by the policyholder. The Group has limited ability to control the take up of these options. However, the book of business itself is diminishing in size. As at 31 December 2011 the value of guarantees is estimated to be £57m (31 December 2010: £35m).

Market risks

(Download XLS:) Download Excel

Risk

Product

Control

Investment Performance Risk

 

 

The financial risk exposure for participating contracts is different from that for non-participating business. Greater emphasis is placed on investing to maximise future investment returns rather than matching assets to liabilities. This results in holding significant equity and property investments. Lower investment returns increase the costs associated with maturity and investment guarantees provided on these contracts.

With-profits

These risks are managed by maintaining capital sufficient to cover the consequences of mismatch under a number of adverse scenarios. In addition, different investment strategies are followed for assets backing policyholder asset shares and assets backing other participating liabilities and surplus. The former include significant equity and property holdings, whilst the latter are invested largely in fixed interest securities. The assets held are managed so as to provide a partial hedge to movements in fixed interest yields and equity markets. The methodology used to calculate the liabilities for participating contracts makes allowance for the possibility of adverse changes in investment markets on a basis consistent with the market cost of hedging the guarantees provided. The methodology also makes allowance for the cost of future discretionary benefits, guarantees and options. The value of future discretionary benefits depends on the return achieved on assets backing these contracts. The asset mix varies with investment conditions reflecting the Group’s investment policy, which aims to optimise returns to policyholders over time whilst limiting capital requirements for this business.

For unit linked contracts, there is a risk of volatility in asset management fee income due to the impact of interest rate and market price movements on the fair value of the assets held in the linked funds, on which investment management fees are based. There is also the risk of expense over-runs should the market depress the level of charges which could be imposed.

Unit linked

The risk is managed through maintaining a diversified range of funds in which customers may invest. The prodigality of all funds are subject to regular review. For some contracts the Group has discretion over the level of management charges levied.

Liquidity risks

(Download XLS:) Download Excel

Risk

Product

Control

Investment Liquidity Risk

 

 

Within the with-profit fund, exposure to liquidity risk may arise if the profile of investment assets held to meet obligations to policyholders is not aligned with the maturity profile of policies, or the profile does not adequately take account of the rights of policyholders to exercise options or guarantees to specified early surrender terms or minimum rates of return.
 

With-profits

Liquidity risk is managed ensuring that an appropriate proportion of the fund is held in cash or other readily realisable assets to meet each tranche of maturities and anticipated early withdrawals as they fall due. Where policyholders have discretion to require early payment of policy proceeds, contractual safeguards are in place to ensure that the fund and remaining policyholders are not disadvantaged should a material number of policyholders exercise this discretion.

Non-participating savings contracts are exposed to liquidity risk in that certain asset classes in which underlying funds invest, such as property, may not be readily realisable in certain market conditions, or only realisable at a diminution of value.

Non-participating savings

Liquidity risks associated with non-participating savings contracts are documented and communicated to customers within product terms and conditions. The terms also highlight that for certain asset classes such as property, the Group retains the right to defer the processing of fund withdrawal requests for up to six months, should underlying assets need to be realised to meet payment requests.

Investment management

Principal Products

LGIM offers both active and passive management on either a pooled or segregated basis. Assets are managed on behalf of pension funds, institutional clients, sovereign wealth clients, retails funds and subsidiary companies within the Legal & General Group. The core products are set out below.

Index Fund Management

LGIM provides a diversified range of pooled index funds, providing a wide choice and the ability to pursue specific benchmarks efficiently. In addition, segregated solutions are offered to institutional clients providing large scale customisation against established market capitalisation weighted and alternative indices.

Active Fixed Income and Liquidity Management

A range of pooled and segregated active fixed income funds. The LGIM liquidity funds offers institutional investors seeking an optimal solution for their cash management across a range of core currencies. The fund aims to deliver competitive returns with a high level of diversification, while focusing on capital preservation through portfolios of high quality, liquid assets.

Solution and Liability Driven Investment (LDI)

A wide variety of solutions to help de-risk defined benefit pension schemes and replace them with appropriate defined contribution or workplace savings schemes.

Active Equity

An active equity management business comprising focused teams managing stock selection across different regions.

Property and Venture Capital

A range of pooled or segregated real estate funds to both UK and overseas investors, offered via a mixture of pooled funds, specialist funds and partnerships. The business is based around in-house sector specialists with a dedicated research team. In addition LGIM provides institutional clients with private equity investment funds offered via a partnership structure.

Key risk and controls

The financial risks associated with LGIM’s businesses are directly borne by the investors in its funds. Therefore detailed risk disclosures have not been presented. The approach to the management of operational risks, including loss arising from trading errors, breach of fund management guidelines or valuation errors, where a breakdown in controls could lead to successful litigation against the company by one or more clients, is set out in the Operational risks section.

International

Principal Products

The principal products written by our International division are annuities (deferred and immediate), individual and group protection, universal life insurance, non-participating savings business and open ended investment vehicles.

Annuities

Immediate annuities have similar characteristics as products sold by the Risk division. Deferred annuity contracts written by LGA contain a provision that, at maturity, a policyholder may move the account value into an immediate annuity, at rates which are either those currently in effect, or rates guaranteed in the contract.

Protection business (individual and group)

Individual protection consists of individual term assurance, which provide death benefits over the medium to long term. The contracts have level premiums for an initial period with premiums set annually thereafter. During the initial period, there is generally an option to convert the contract to a universal life contract. After the initial period, the premium rates are not guaranteed, but cannot exceed the age related guaranteed premium.

Group protection business consists of group term assurance, renewable on an annual basis, sickness and disability, and medical expenses assurance. The group sickness and disability and medical expenses policies integrate with social security benefits providing a level of top-up to those benefits.

Reinsurance is used within the protection businesses to manage exposure to large individual and group claims. Within LGA, reinsurance and securitisation is also used to provide regulatory solvency relief (including relief from regulation Triple X). These practices lead to the establishment of reinsurance assets on the Group’s balance sheet.

Universal life

Universal life contracts written by LGA provide savings and death benefits over the medium to long term. The savings element has a guaranteed minimum growth rate. LGA has exposure to loss in the event that interest rates decrease and it is unable to earn enough on the underlying assets to cover the guaranteed rate. LGA is also exposed to loss should interest rates increase, as the underlying market value of assets will generally fall without a change in the surrender value. The reserves for universal life and deferred annuities totalled $688m and $200m respectively at 31 December 2011 ($708m and $218m at 31 December 2010 respectively). The guaranteed interest rates associated with those reserves ranged from 0% to 5.5%, with the majority of the policies having guaranteed rates ranging from 3% to 4% (2010: 3% to 4%).

Non-participating savings business

Savings products include contracts that provide minimum guaranteed rates of return. The guarantee is aligned with current and projected rates of return from government securities. Certain savings products include an exposure to interest rate and credit risk, managed through an active asset-liability management programme.

Open Ended Investment Vehicles

These comprise SICAVS, the investment risks for which are borne by unit holders of these funds.

Key risks and controls

The principal risks and associated controls relevant to our International products are consistent with those identified for our Risk and Savings businesses and therefore have not been repeated here.

Balance sheet foreign exchange currency translation exposure in respect of the Group’s international subsidiaries is actively managed in accordance with a policy, agreed by the Group Board, which allows net foreign currency assets to be hedged through the use of derivatives.

Group capital and financing

Shareholder Funds

Shareholder assets include portfolios of equity, property, bond and other investments, not directly required to meet contractual obligations to policyholders. The value of, and income from, these assets is sensitive to conditions within investment markets and the broader economy. Potential volatility in returns are managed using a range of techniques, including performance benchmarks and limits on concentrations of exposures by asset type and geographic region.

Group Treasury and Liquidity Management

The Group’s treasury function manages the Group’s banking relationships, capital raising activities, overall cash and liquidity position and the payment of dividends. The Group seeks to manage its corporate funds and liquidity requirements on a pooled basis and to ensure the Group maintains sufficient liquid assets and standby facilities to meet a prudent estimate of its net cash outflows. In addition, it ensures that, even under adverse conditions, the Group has access to the funds necessary to cover surrenders, withdrawals and maturing liabilities. During 2011 the Group replaced its £960m syndicated borrowing facility (expiring in 2012), with a new five year £1bn revolving credit facility syndicated with 21 relationship banks. The facility provides flexibility in the management of the Group’s liquidity. No drawings were made under these facilities during 2011.

Accumulation of risks

There is limited potential for single incidents to give rise to a large number of claims across the different contract types written by the Group. In particular, there is little significant overlap between the long term and short term insurance business written by the Group. However, there are potentially material correlations of insurance risk with other types of risk exposure. These correlations are difficult to estimate though they would tend to be more acute as the underlying risk scenarios became more extreme. An example of the accumulation of risk is the correlation between reinsurer credit risk with mortality and morbidity exposures.

Operational risks

Potential for exposure to operational risk extends to all the Group’s businesses. All business managers are required to confirm regularly the adequacy of controls to mitigate those operational risks relevant to their responsibilities. Significant control issues are escalated to senior and executive management through the Group’s risk management framework. The framework is supported by the Operational Risk Management teams which facilitates the identification, assessment, monitoring and control of risks across the Group’s businesses.

There are a number of categories under which operational risk and its management across the Group can be considered, and these are outlined in the following paragraphs.

Internal process failure

The Group is potentially exposed to the risk of loss from failure of the internal processes with which it transacts its business. Each business division is responsible for ensuring the adequacy of the controls over its processes. Regular reviews are undertaken of their appropriateness and effectiveness.

People

The Group is potentially exposed to the risk of loss from inappropriate actions by its staff. Recruitment is managed centrally by HR functions, and all new recruits undergo a formal induction programme. All employees have job descriptions setting out their accountabilities and reporting lines, and are appraised annually in accordance with agreed performance management frameworks. Employees in regulated subsidiaries are provided with appropriate training to enable them to meet the relevant regulatory requirements. Risks relating to health and safety and other legislation are managed through the provision of relevant training to all staff.

Outsourcing

The Group is potentially exposed to the actions or failure of suppliers contracted to provide services on an outsourced basis. The Group has defined minimum standards of control to be applied for all outsourced arrangements within a formal outsourcing and critical supplier policy.

Legal

Legal risk is the risk of loss from unclear or deficient product documentation; inadequate documentation in support of material contracts such as reassurance treaties; the incorrect interpretation of changes in legislation; employment related disputes and claims; and commercial disputes with suppliers. The risks are actively managed through the Group Legal Risk framework, which defines minimum standards of control to be applied to minimise the risk of loss.

Compliance

Compliance risk within the Group relates to the risk of non-adherence to legislative requirements, regulations and internal policies and procedures. Responsibility for ensuring adherence to relevant legal and regulatory requirements is vested in individual business managers. A Group Regulatory Risk and Compliance function has oversight of the Group’s compliance with conduct of business requirements and standards, providing policy advice and guidance and oversight of compliance arrangements and responsibilities.

Event

Event risk relates to the potential for loss arising from significant external events such as terrorism, financial crisis, major changes in fiscal systems or disaster. Typically, such events have a low likelihood of occurrence, a material impact and can be difficult to prevent. The Group’s risk mitigation focuses on minimising the business disruption and potential financial loss which may ensue from such an event. This includes maintaining a framework for the management of major incidents, the maintenance and regular testing of detailed business, technical and location recovery plans and the provision of insurance cover for the loss of buildings, contents and information technology systems and for the increased cost of working in the event of business disruption.

Fraud

The Group is potentially exposed to the risk of internal fraud, claims-related fraud, and external action by third parties. The risk of internal fraud is managed through a number of processes including the screening of staff at recruitment, segregation of duties and management oversight. The activities of Internal Audit also act to counter the risk. Claims-related fraud is managed by ensuring business processes are designed to fully validate claims and ensure that only bona fide claims are settled. Anti-fraud techniques are regularly updated to mitigate risks and emerging threats. The Group’s approach to mitigating fraud and other dishonest acts is supported by promoting an open and honest culture in all dealings between employees, managers and those parties with which the Group has contact. A formal code of ethics sets out the Group’s expectations in this respect. Effective and honest communication is essential if malpractice is to be effectively dealt with. The Group has defined whistle blowing procedures to enable all employees and those who work with Legal & General to raise matters of concern relating to Legal & General in confidence.

Technology

The Group places a high degree of reliance on IT in its business activities. The failure of IT systems could potentially expose the Group to significant business disruption and loss. To mitigate this risk, standards and methodologies for developing, testing and operating IT systems are maintained. Disaster recovery facilities enable IT operations to be conducted at remote locations in the event of the loss of computer facilities. All records are remotely backed up and computer suites are equipped with alternative power sources.

Group Risk

The potential for contagion risk arises as a consequence of the use of a common brand across the majority of the Group and the provision of intra-group loans and indemnities. The Group has defined policies and procedures for managing matters that may have reputational implications, to ensure that Legal & General’s position is correctly understood. The Group also has defined policies for the provision of guarantees, indemnities and letters of comfort.

The Group controls its exposure to geographic price risks by using internal country credit ratings. These ratings are based on macroeconomic data and key qualitative indicators. The latter take into account economic, social and political environments. Table 1 below indicates the Group’s exposure to different equity markets around the world. Unit linked equity investments are excluded from the table as the risk is retained by the policyholder.

Table 1 – Exposure to worldwide equity markets

(Download XLS:) Download Excel

 

Share-holder 2011
£m

Non profit non-unit linked 2011
£m

With-profits 2011
£m

Total
2011
£m

Share- holder 2010
£m

Non profit non-unit linked 2010
£m

With-profits 2010
£m

Total
2010
£m

United Kingdom

458

1,392

1,850

490

2,203

2,693

North America

746

746

30

425

455

Europe

117

558

675

127

743

870

Japan

402

402

492

492

Asia Pacific

50

566

616

49

448

497

Other

39

39

11

143

154

Listed equities

625

3,703

4,328

707

4,454

5,161

Unlisted UK equities

15

82

97

16

85

101

Holdings in unit trusts

273

479

752

253

456

709

Total equities

913

4,264

5,177

976

4,995

5,971

The Group holds shareholder and non profit non-unit linked property investments totalling £606m (2010: £275m), of which £601m (2010: £269m) are located in the UK.

A 10% reduction in the value of listed equities would result in a reduction in pre-tax profit attributable to shareholders of £63m (2010: £71m). The impact on the with-profits fund has not been provided as the reduction would be offset by a change in the unallocated divisible surplus.

Table 2 – Exposure to worldwide debt markets

(Download XLS:) Download Excel

Total debt securities and accrued interest1

Notes

Shareholder
and non profit
non-unit
linked
2011
£m

With-profits
2011
£m

Shareholder
and non profit
non-unit
linked
2010
£m

With-profits
2010
£m

1.

For risk management purposes, bespoke consolidated CDOs are considered net. For presentation in the balance sheet the components of the CDOs are shown within non profit non-unit linked investments (2011: £897m; 2010: £957m), cash equivalents (2011: £178m; 2010:£119m) and derivative liabilities (2011: £(203)m; 2010: £(164)m).

United Kingdom

 

11,758

5,001

10,517

4,605

USA

 

10,548

1,076

9,790

1,314

Spain

 

236

185

218

225

Portugal

 

44

4

76

6

Greece

 

5

15

13

Ireland

 

1,175

262

1,251

320

Italy

 

652

108

505

188

Other Europe

 

5,516

4,860

5,066

4,891

Japan

 

73

28

48

Asia Pacific

 

85

43

50

7

Other

 

2,141

570

1,333

542

 

 

32,228

12,142

28,869

12,111

 

 

 

 

 

 

Analysed as1

 

 

 

 

 

Debt securities

22(i)

31,764

11,924

28,444

11,887

Accrued interest

22(i)

464

218

425

224

 

 

32,228

12,142

28,869

12,111

(Download XLS:) Download Excel

Sovereign, supras and sub-sovereign debt1

Shareholder
and non profit
non-unit
linked
2011
£m

With-profits
2011
£m

Shareholder
and non profit
non-unit
linked
2010
£m

With-profits
2010
£m

1.

Sovereign, supras and sub-sovereign debt includes £4,909m (2010: £3,829m) shareholder and non profit non-linked government securities and £2,323m (2010: £2,277m) with-profits government securities.

United Kingdom

3,205

2,117

2,366

1,919

USA

782

177

524

210

Spain

29

20

43

20

Portugal

3

3

12

6

Greece

5

15

13

Ireland

4

10

45

10

Italy

281

14

189

32

Other Europe

1,813

2,855

1,737

3,112

Asia Pacific

18

1

Other

71

46

103

 

6,188

5,265

5,034

5,323

(Download XLS:) Download Excel

Other debt securities

Shareholder
and non profit
non-unit
linked
2011
£m

With-profits
2011
£m

Shareholder
and non profit
non-unit
linked
2010
£m

With-profits
2010
£m

United Kingdom

8,553

2,884

8,151

2,686

USA

9,766

899

9,266

1,104

Spain

207

165

175

205

Portugal

41

1

64

Greece

Ireland

1,171

252

1,206

310

Italy

371

94

316

156

Other Europe

3,703

2,005

3,329

1,779

Japan

73

28

48

Asia Pacific

85

25

50

6

Other

2,070

524

1,230

542

 

26,040

6,877

23,835

6,788

Table 3 – Currency risk

Table 3 below summarises the Group’s exposure to foreign currency exchange risk, in sterling. The functional currency represents the currency of the primary economic environment in which each of the Group’s subsidiaries operates.

(Download XLS:) Download Excel

As at 31 December 2011

 

 

 

 

 

 

Shareholder

Euro
£m

US Dollar
£m

Japanese Yen
£m

Other
£m

Functional currency
£m

Carrying value
£m

Total assets

721

592

43

81

10,624

12,061

Total liabilities

737

1,272

6,305

8,314

Net assets

(16)

(680)

43

81

4,319

3,747

Non profit non-unit linked

 

 

 

 

 

 

1.

For risk management purposes, bespoke consolidated CDOs are considered on a net basis. Accordingly, the table above presents derivative liabilities of £203m as a deduction to non profit non-unit linked assets and liabilities.

Total assets

127

9,728

19

23,197

33,071

Total liabilities1

148

9,795

21,677

31,620

Net assets

(21)

(67)

19

1,520

1,451

With-profits

 

 

 

 

 

 

Total assets

320

1,039

411

825

16,677

19,272

Total liabilities

(17)

301

2

3

18,951

19,240

Net assets

337

738

409

822

(2,274)

32

(Download XLS:) Download Excel

As at 31 December 2010

 

 

 

 

 

 

Shareholder

Euro
£m

US Dollar
£m

Japanese Yen
£m

Other
£m

Functional currency
£m

Carrying value
£m

Total assets

840

(562)

30

10,995

11,303

Total liabilities

974

68

7,135

8,177

Net assets

(134)

(630)

30

3,860

3,126

Non profit non-unit linked

 

 

 

 

 

 

1.

For risk management purposes, bespoke consolidated CDOs are considered on a net basis. Accordingly, the table above presents derivative liabilities of £164m as a deduction to non profit non-unit linked assets and liabilities.

Total assets

1,783

4,175

21

22,382

28,361

Total liabilities1

1,830

4,171

20,773

26,774

Net assets

(47)

4

21

1,609

1,587

With-profits

 

 

 

 

 

 

Total assets

1,626

917

505

797

16,458

20,303

Total liabilities

650

204

19,442

20,296

Net assets

976

713

505

797

(2,984)

7

The Group’s management of currency risk reduces shareholders’ exposure to exchange rate fluctuations. The Group’s exposure to a 10% exchange movement in the US Dollar and Euro on an [IFRS] basis, net of hedging activities, is detailed in Table 4.

Table 4 – Currency sensitivity analysis

(Download XLS:) Download Excel

Currency sensitivity test

Impact on
pre-tax profit
2011
£m

Impact on equity
2011
£m

Impact on
pre-tax profit
2010
£m

Impact on equity
2010
£m

10% Euro appreciation

(4)

(3)

(18)

(13)

10% US Dollar appreciation

(75)

(55)

(63)

(45)

The credit profile of the Group’s assets exposed to credit risk is shown in Table 5. The credit rating bands are provided by independent rating agencies. For unrated assets, the Group maintains internal ratings which are used to manage exposure to these counterparties. Unit linked assets have not been included as shareholders are not directly exposed to risk.

Table 5 – Exposure to credit risk

(Download XLS:) Download Excel

As at 31 December 2011

Notes

AAA
£m

AA
£m

A
£m

BBB
£m

BB and
below
£m

Unrated bespoke CDOs
£m

Unrated other
£m

Total
£m

1.

‘A’ rated cash and cash equivalents include £nil (2010: £247m) holdings in commercial paper which are short term instruments which carry a short term rating of A1+/A1 from Standard & Poor’s.

Shareholder

 

 

 

 

 

 

 

 

 

Government securities

 

1,643

139

80

3

4

3

1,872

Other fixed rate securities

 

442

455

1,278

738

53

7

2,973

Variable rate securities

 

468

159

202

91

6

926

Total debt securities

22(i)

2,553

753

1,560

832

63

10

5,771

Accrued interest

22(i)

28

7

20

14

1

6

76

Loans and receivables

22(ii)

11

74

85

Derivative assets

23

55

244

9

308

Cash and cash equivalents1

27

258

842

598

4

129

1,831

Financial assets

 

2,839

1,657

2,433

850

64

228

8,071

Reinsurers’ share of non-participating insurance contracts

 

6

91

97

117

311

Other assets

26

85

23

85

5

407

605

 

 

2,930

1,771

2,615

855

64

752

8,987

Non profit non-unit linked

 

 

 

 

 

 

 

 

 

1.

For risk management purposes, bespoke consolidated CDOs are considered net. For presentation in the balance sheet the components of the CDOs are shown within investments (£897m), cash equivalents (£178m) and derivative liabilities (£(203)m).

Government securities

 

2,795

3

200

39

3,037

Other fixed rate securities

 

1,301

2,565

8,007

6,372

412

616

19,273

Variable rate securities1

 

614

286

1,341

331

1

872

238

3,683

Total debt securities

22(i)

4,710

2,854

9,548

6,742

413

872

854

25,993

Accrued interest

22(i)

36

43

162

133

5

9

388

Loans and receivables

22(ii)

Derivative assets

23

1

438

2,667

1

3,107

Cash and cash equivalents1

27

20

140

140

40

340

Financial assets

 

4,767

3,475

12,517

6,875

419

872

903

29,828

Reinsurers’ share of non-participating insurance contracts

 

1,244

393

151

1,788

Other assets

26

14

259

273

 

 

4,767

4,733

12,910

6,875

419

872

1,313

31,889

With-profits

 

 

 

 

 

 

 

 

 

Government securities

 

2,251

24

30

17

1

2,323

Other fixed rate securities

 

3,717

1,334

2,260

1,851

127

203

9,492

Variable rate securities

 

33

9

45

14

3

5

109

Total debt securities

22(i)

6,001

1,367

2,335

1,865

147

209

11,924

Accrued interest

22(i)

92

26

51

45

2

2

218

Loans and receivables

22(ii)

1

1

Derivative assets

23

10

155

2

167

Cash and cash equivalents

27

474

490

163

3

1,130

Financial assets

 

6,567

1,893

2,704

1,910

152

214

13,440

Reinsurers’ share of participating insurance contracts

 

1

1

Reinsurers’ share of non-participating insurance contracts

 

8

8

Reinsurers’ share of non-participating investment contracts

 

11

11

Other assets

26

169

169

 

 

6,567

1,894

2,704

1,910

152

402

13,629

At the year end, the Group held £419m (2010: £222m) of collateral in respect of non-unit linked derivative assets.

(Download XLS:) Download Excel

As at 31 December 2010

Notes

AAA
£m

AA
£m

A
£m

BBB
£m

BB and
below
£m

Unrated bespoke CDOs
£m

Unrated other
£m

Total
£m

Shareholder

 

 

 

 

 

 

 

 

 

Government securities

 

1,586

136

14

1

1

5

1,743

Other fixed rate securities

 

375

337

1,060

641

85

22

2,520

Variable rate securities

 

619

133

86

51

13

2

904

Total debt securities

22(i)

2,580

606

1,160

693

99

29

5,167

Accrued interest

22(i)

30

7

17

13

1

68

Loans and receivables

22(ii)

6

14

73

93

Derivative assets

23

153

135

288

Cash and cash equivalents

27

166

450

998

2

277

1,893

Financial assets

 

2,776

1,222

2,324

706

102

379

7,509

Reinsurers’ share of non-participating insurance contracts

 

6

84

126

88

304

Other assets

26

82

65

79

7

265

498

 

 

2,864

1,371

2,529

713

102

732

8,311

Non profit non-unit linked

 

 

 

 

 

 

 

 

 

1.

For risk management purposes, bespoke consolidated CDOs are considered net. For presentation in the balance sheet the components of the CDOs are shown within investments (£957m), cash equivalents (£119m) and derivative liabilities (£(164)m).

Government securities

 

1,967

73

9

37

2,086

Other fixed rate securities

 

1,090

1,965

7,561

5,286

373

575

16,850

Variable rate securities1

 

1,298

403

1,217

282

1

912

229

4,342

Total debt securities

22(i)

4,355

2,441

8,787

5,605

374

912

804

23,278

Accrued interest

22(i)

31

38

160

113

5

9

356

Loans and receivables

22(ii)

Derivative assets

23

2

295

1,128

1,425

Cash and cash equivalents

27

39

165

344

9

557

Financial assets

 

4,427

2,939

10,419

5,718

379

912

822

25,616

Reinsurers’ share of non-participating insurance contracts

 

769

859

161

1,789

Other assets

26

117

117

 

 

4,427

3,708

11,278

5,718

379

912

1,100

27,522

With-profits

 

 

 

 

 

 

 

 

 

Government securities

 

2,168

49

36

10

13

1

2,277

Other fixed rate securities

 

3,707

1,323

2,585

1,323

144

373

9,455

Variable rate securities

 

82

23

41

4

5

155

Total debt securities

22(i)

5,957

1,395

2,662

1,337

157

379

11,887

Accrued interest

22(i)

97

26

64

31

2

4

224

Loans and receivables

22(ii)

40

47

1

88

Derivative assets

23

6

49

29

84

Cash and cash equivalents

27

330

549

389

1

1

1,270

Financial assets

 

6,384

2,016

3,211

1,369

159

414

13,553

Reinsurers’ share of participating insurance contracts

 

2

2

Other assets

26

191

191

 

 

6,384

2,016

3,213

1,369

159

605

13,746

Impairment

The Group reviews the carrying value of its financial assets (other than those held at FVTPL) at each balance sheet date. If the carrying value of a financial asset is impaired, the carrying value is reduced through a charge to the income statement. There must be objective evidence of impairment as a result of one or more events which have occurred after the initial recognition of the asset. Impairment is only recognised if the loss event has an impact on the estimated future cash flows of assets held at amortised cost or fair value of assets classified as AFS.

Assets which are subject to amortisation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use.

Table 6 provides information regarding the carrying value of financial assets which have been impaired and the ageing analysis of financial assets which are past due but not impaired. Unit linked assets have not been included as shareholders are not exposed to the risks from unit linked policies.

Table 6 – Ageing of financial assets that are past due but not impaired

(Download XLS:) Download Excel

 

 

Financial assets
that are past due but not impaired

 

 

As at 31 December 2011

Neither
past
due nor
impaired
£m

0-3
months
£m

3-6
months
£m

6 months-
1 year
£m

Over
1 year
£m

Financial assets that have been impaired
£m

Carrying
value
£m

1.

For risk management purposes, bespoke consolidated CDOs are considered net. For presentation in the balance sheet the components of the CDOs are shown within investments (£897m), cash equivalents (£178m) and derivative liabilities (£(203)m).

Shareholder

8,475

22

1

8,498

Non profit non-unit linked1

31,518

107

8

2

9

31,644

With-profits

13,535

19

1

13,555

(Download XLS:) Download Excel

 

 

Financial assets
that are past due but not impaired

 

 

As at 31 December 2010

Neither
past
due nor
impaired
£m

0-3
months
£m

3-6
months
£m

6 months-
1 year
£m

Over
1 year
£m

Financial assets that have been impaired
£m

Carrying
value
£m

1.

For risk management purposes, bespoke consolidated CDOs are considered net. For presentation in the balance sheet the components of the CDOs are shown within investments (£957m), cash equivalents (£119m) and derivative liabilities (£(164)m).

Shareholder

7,715

30

2

4

7,751

Non profit non-unit linked1

27,377

2

27,379

With-profits

13,663

2

1

13,666

Sensitivity analysis

Table 7 – UK long term business IFRS sensitivity analysis

(Download XLS:) Download Excel

 

Impact on
pre-tax profit net of reinsurance
2011
£m

Impact on equity
net of reinsurance
2011
£m

Impact on
pre-tax profit net of reinsurance
2010
£m

Impact on equity
net of reinsurance
2010
£m

Sensitivity test

 

 

 

 

1% increase in interest rates

49

36

35

25

1% decrease in interest rates

(142)

(104)

1

1

Credit spread widens by 100 bps with no change in expected defaults

(52)

(38)

(76)

(55)

1% increase in inflation

37

28

17

12

Default of largest reinsurer

(694)

(510)

(681)

(490)

1% decrease in annuitant mortality

(76)

(55)

(66)

(47)

The interest rate sensitivities reflect the impact of the regulatory restrictions on the reinvestment rate used to value the liabilities of the UK long term business. This scenario does not reflect management action which could be taken to reduce the impact of a decrease in interest rates. In a scenario where the bases are not adjusted for regulatory restrictions i.e. changes to the reinvestment rate are ignored, the sensitivitiy to a +/-1% interest rate movement would be +/-£7m.

  • In calculating the alternative values, all other assumptions are left unchanged. In practice, items of the Group’s experience may be correlated.
  • The Group seeks to actively manage its asset and liability position. A change in market conditions may lead to changes in the asset allocation or charging structure which may have a more, or less, significant impact on the value of the liabilities. The analysis also ignores any second order effects of the assumption change, including the potential impact on the Group asset and liability position and any second order tax effects.
  • These stresses use the assets that back the liabilities. Any excess assets have not been stressed in these calculations.
  • The sensitivity of the profit to changes in assumptions may not be linear. They should not be extrapolated to changes of a much larger order.
  • The change in interest rate test assumes a 100bps change in the gross redemption yield on a fixed interest securities together with a 100bps change in the real yields on variable securities. Valuation interest rates are assumed to move in line with market yields adjusted to allow for the impact of FSA regulations.
  • In the sensitivity for credit spreads, corporate bond yields have increased by 100bps, gilt and approved security yields unchanged, and there has been no adjustment to the default assumptions.
  • The inflation stress adopted is a 1% pa increase in inflation resulting in a 1% pa reduction in real yield and no change to the nominal yield. In addition the expense inflation rate is increased by 1% pa.
  • The reinsurer stress shown is equal to the technical provisions ceded to that insurer.
  • The annuitant mortality stress is a 1% reduction in the mortality rates for immediate and deferred annuitants with no change to the mortality improvement rates.
  • Default of largest reinsurer: The largest reinsurer was deducted at an entity level by mathematical reserves ceded. The largest reinsurer is Swiss Re. The increase in reserves is consistent with the reinsured reserves.

Details of IGD sensitivity analysis can be found in Table 2 of Note 46.

The Group also uses embedded value financial statements information to manage risk. The effect of alternative assumptions on the long term embedded value, prepared in accordance with the guidance issued by the European Insurance CFO Forum in October 2005 are contained within the Supplementary Financial Statements of the Annual Report and Accounts.

Table 8 – General insurance sensitivity analysis

(Download XLS:) Download Excel

 

Impact on
pre-tax profit net of reinsurance
2011
£m

Impact on equity
net of reinsurance
2011
£m

Impact on
pre-tax profit net of reinsurance
2010
£m

Impact on equity
net of reinsurance
2010
£m

Sensitivity test

 

 

 

 

Single storm event with 1 in 200 year probability

(90)

(66)

(55)

(40)

Subsidence event – worst claim ratio in last 30 years

(41)

(30)

(39)

(28)

Economic downturn

(43)

(32)

(38)

(28)

5% decrease in overall claims ratio

9

7

9

6

5% surplus over claims liabilities

5

3

6

4

For any single event with claims in excess of £30m (2010: £30m) but less than £265m (2010: £235m), the ultimate cost to Legal & General Insurance Limited (LGI) would be £30m (2010: £30m). The ultimate cost to the Group is greater as a proportion of the catastrophe reinsurance cover is placed with Legal & General Assurance Society Limited, which is exposed to 70% of claims between £30m and £50m, 50% of claims between £50m and £120m and 20% of claims between £120m and £265m. The impact of a 1 in 500 year modelled windstorm and coastal flood event would exceed the upper limit of the catastrophe cover by approximately £192m (2010: £131m), with an estimated total cost to LGI of £245m (2010: £180m) and to the Group of £317m (2010: £227m).

top


Share this page.