Independent auditors’ report to the members of Legal & General Group plc.

Independent auditors’ report to the members of Legal & General Group plc.

REPORT ON THE GROUP FINANCIAL STATEMENTS

Our opinion

In our opinion the Group financial statements, defined below:

  • give a true and fair view of the state of the Group’s affairs as at 31 December 2013 and of the Group’s profit and cash flows for the year then ended;
  • have been properly prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union; and
  • have been prepared in accordance with the requirements of the Companies Act 2006 and Article 4 of the IAS Regulation.

This opinion is to be read in the context of what we say in the remainder of this report.

What we have audited

The Group financial statements, which are prepared by Legal & General Group Plc, comprise:

  • the consolidated balance sheet as at 31 December 2013;
  • the consolidated income statement and consolidated statement of comprehensive income for the year then ended;
  • the consolidated statement of changes in equity and consolidated cash flow statement for the year then ended; and
  • the notes to the consolidated financial statements, which include a summary of significant accounting policies and other explanatory information.

The financial reporting framework that has been applied in their preparation comprises applicable law and IFRSs as adopted by the European Union.

Certain disclosures required by the financial reporting framework have been presented elsewhere in the Annual Report & Accounts, rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited.

What an audit of financial statements involves

We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) (‘ISAs (UK & Ireland)’). An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of:

  • whether the accounting policies are appropriate to the Group’s circumstances and have been consistently applied and adequately disclosed;
  • the reasonableness of significant accounting estimates made by the directors; and
  • the overall presentation of the financial statements.

In addition, we read all the financial and non-financial information in the Annual Report & Accounts to identify material inconsistencies with the audited Group financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.

Overview of our audit approach

Materiality

We set certain thresholds for materiality. These helped us to determine the nature, timing and extent of our audit procedures and to evaluate the effect of misstatements, both individually and on the financial statements as a whole.

Based on our professional judgement, we set materiality for the Group financial statements as a whole at £70m. We concluded that operating profit before tax was the relevant benchmark because it reflects the underlying profit of the business. Our view on overall materiality was communicated to the Audit Committee.

We agreed with the Audit Committee that we would report to them all uncorrected misstatements identified during our audit greater than £3.5m, as well as misstatements below that threshold that, in our view, warranted reporting for qualitative reasons.

Overview of the scope of our audit

The Group is reported in five reportable segments: Legal & General Assurance Society (LGAS), Legal & General Retirement (LGR), Legal & General Investment Management (LGIM), Legal & General America (LGA), and Legal & General Capital (LGC). The Group financial statements are a consolidation of 84 reporting units, comprising the Group’s operating businesses and centralised functions.

In establishing the overall approach to the group audit, we determined the type of work that needed to be performed on reporting units by us, as the group engagement team, or component audit teams within PwC UK and from other PwC network firms operating under our instructions. Where the work was performed by component auditors, we determined the level of involvement we needed to have in the audit work at those reporting units to be able to conclude whether sufficient audit evidence had been obtained as a basis for our opinion on the Group financial statements as a whole.

Accordingly, of the Group’s 84 reporting units, we identified 34 that, in our view, required an audit of their complete financial information, either due to their size or their risk characteristics. Specific audit procedures on specific balances and transactions were performed at a further 11 reporting units. This, together with additional procedures performed at the Group level, gave us 87% coverage over total assets and 88% coverage over profit after tax. We concluded that this gave us the evidence we needed for our opinion on the Group financial statements as a whole.

Areas of particular audit focus

In preparing the financial statements, the directors made a number of subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain. We primarily focused our work in these areas by assessing the directors’ judgements against available evidence, forming our own judgements, and evaluating the disclosures in the financial statements.

In our audit, we tested and examined information, using sampling and other auditing techniques, to the extent we considered necessary to provide a reasonable basis for us to draw conclusions. We obtained audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both.

We considered the following areas to be those that required particular focus in the current year. This is not a complete list of all risks or areas of focus identified by our audit.

Our areas of focus were communicated to the Audit Committee. The Audit Committee Report sets out those matters that they consider to be significant issues in relation to the financial statements.

Area of focus specific to Legal & General Group Plc

How the scope of our audit addressed the area of focus

Valuation of non-participating insurance liabilities
We focused on this area because the estimation of non-participating insurance liabilities is inherently judgemental. The most significant element is the annuity liabilities, whose valuation is sensitive to:
– valuation interest rate – the discount rate derived from the yield on the assets backing the annuity liability used in calculating the present value of annuity payments. The discount rate also includes an explicit allowance for future default on the asset portfolio; and
– longevity – how long the policyholders receiving annuity payments are expected to live.

Valuation interest rate
The valuation interest rate is particularly sensitive to:
– investment data used to calculate the yield on the assets backing the insurance liabilities;
– credit default assumptions; and
– the methodology used to model the asset cash flows to calculate the internal rate of return.

We assessed the directors’ processes for ensuring that the relevant investment data was included in the calculation of the yield on the assets, and tested the completeness and accuracy of that investment data and the calculations. We also tested the implementation of the strategic asset reporting system and other changes to the related processes.

We assessed the appropriateness of the credit default allowance in light of changing market conditions and other market information available.

We challenged the rationale for and tested changes to the actuarial process and model underlying the calculation of the valuation interest rate.

Longevity assumptions
The longevity assumptions are calculated using internal experience analysis and the estimated future rate of mortality improvements.

We tested the operating effectiveness of controls over accuracy and completeness of the data used in determining the longevity assumptions.

We tested the assumptions used by assessing the experience analysis performed and management’s allowance for specific market indicators.

We compared the annuitant longevity assumptions against independent industry data and challenged differences identified.

Financial investments
Financial investments vary in complexity. Investments which are complex to value and require the use of significant judgement include:
– over-the-counter (OTC) derivatives;
– commercial mortgages; and
– collateralised debt obligations.

Valuation of complex investments
We focused on the valuation of complex investments because changes in estimates could result in material changes in their valuation.

Key estimates used in the valuation models reflect observable and unobservable inputs such as forward interest rates, foreign exchange rates and forward inflation rate curve.

We also focused on the disclosure of financial instruments, which is complex under IFRSs.

We assessed the investment valuation processes and controls in place over all investments.

We performed detailed testing of investments, comparing the valuation to independent external sources where available, or testing the financial models used to value the complex financial instruments.

We compared the estimates used by the directors to external industry data, and in certain instances independently modelled valuations, to assess and challenge the appropriateness of the directors’ models and key assumptions used.

We checked that complex investments, such as derivatives and structured solutions were accounted for and disclosed in accordance with IFRSs.

Business combinations
During 2013 Legal & General Group Plc made a number of acquisitions, notably Cofunds Limited and Lucida Limited.

Business combinations
The acquisitions of Lucida Limited and Cofunds Limited during the year were treated as business combinations which require a number of estimates and adjustments to be made including:
– adjustments to the fair value of assets and liabilities acquired as part of the acquisition; and
– the fair valuation of previously unrecognised identifiable intangible assets (brand name, customer relationships) and subsequent consideration of impairment of these assets.

We assessed the adequacy of the presentation of the acquisitions during the year.

We tested the fair value of tangible assets and liabilities acquired including the adjustments to fair value made on initial recognition.

We tested the inputs and key judgements used in estimating the fair value of the acquired intangible assets and the calculation of goodwill.


Areas of focus derived from auditing standards


How the scope of our audit addressed the area of focus

Fraud in revenue recognition
ISAs (UK & Ireland) presume there is a risk of fraud in revenue recognition because of the pressure management may feel to achieve the planned results. There is an inherent risk that revenue might be materially misstated.

We understood and evaluated the controls surrounding revenue recognition. We identified significant or unusual revenue transactions and agreed them to source documentation to check the validity of the revenue transaction.

Risk of management override of internal controls
ISA (UK & Ireland) 240 requires that we consider this because there is an inherent risk that management might override controls that otherwise appear to be operating effectively.

We assessed the overall control environment of the Group, including the arrangements for staff to “whistle-blow” inappropriate actions, and interviewed senior management and the Group’s internal audit function.

We tested key reconciliations and manual journal entries.

We examined the significant accounting estimates and judgements relevant to the financial statements for evidence of bias by the directors that may represent a risk of material misstatement due to fraud.

We also built in an element of “unpredictability” into our testing.

Going concern

Under the Listing Rules we are required to review the directors’ statement in relation to going concern. We have nothing to report having performed our review.

As noted in the directors’ statement, the directors have concluded that it is appropriate to prepare the Group’s financial statements using the going concern basis of accounting. The going concern basis presumes that the Group has adequate resources to remain in operation, and that the directors intend it to do so, for at least one year from the date the financial statements were signed. As part of our audit we have concluded that the directors’ use of the going concern basis is appropriate.

However, because not all future events or conditions can be predicted, these statements are not a guarantee as to the Group’s ability to continue as a going concern.

Opinion on other matters prescribed by the Companies Act 2006

In our opinion the information given in the Strategic Report and the Directors’ Report for the financial year for which the Group financial statements are prepared is consistent with the Group financial statements.

Other matters on which we are required to report by exception

Adequacy of information and explanations received

Under the Companies Act 2006 we are required to report to you if, in our opinion, we have not received all the information and explanations we require for our audit. We have no exceptions to report arising from this responsibility.

Directors’ remuneration

Under the Companies Act 2006 we are required to report if, in our opinion, certain disclosures of directors’ remuneration specified by law have not been made. We have no exceptions to report arising from this responsibility.

Corporate Governance Statement

Under the Listing Rules we are required to review the part of the Corporate Governance Statement relating to the Company’s compliance with nine provisions of the UK Corporate Governance Code (the Code). We have nothing to report having performed our review.

In the director’s report of the Annual Report & Accounts, as required by the Code Provision C.1.1, the directors state that they consider the Annual Report & Accounts taken as a whole to be fair, balanced and understandable and provides the information necessary for members to assess the Group’s performance, business model and strategy. In the Audit Committee report, as required by C.3.8 of the Code, the Audit Committee has set out the significant issues that it considered in relation to the financial statements, and how they were addressed. Under ISAs (UK & Ireland) we are required to report to you if, in our opinion:

  • the statement given by the directors is materially inconsistent with our knowledge of the Group acquired in the course of performing our audit; or
  • the section of the Annual Report & Accounts describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee.

We have no exceptions to report arising from this responsibility.

Other information in the Annual Report & Accounts

Under ISAs (UK & Ireland), we are required to report to you if, in our opinion, information in the Annual Report & Accounts is:

  • materially inconsistent with the information in the audited Group financial statements; or
  • apparently materially incorrect based on, or materially inconsistent with, our knowledge of the Group acquired in the course of performing our audit; or
  • is otherwise misleading.

We have no exceptions to report arising from this responsibility.

Responsibilities for the Financial Statements and the Audit

Our responsibilities and those of the directors

As explained more fully in the Directors’ Responsibilities Statement set out in the director’s report, the directors are responsible for the preparation of the Group financial statements and for being satisfied that they give a true and fair view.

Our responsibility is to audit and express an opinion on the Group financial statements in accordance with applicable law and ISAs (UK & Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.

This report, including the opinions, has been prepared for and only for the Company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.

Other matter

We have reported separately on the parent company financial statements of Legal & General Group Plc for the year ended 2013 and on the information in the Directors’ Remuneration Report that is described as having been audited.

Signature Andrew Kail, Senior Statutory Auditor (handwriting)

Andrew Kail (Senior Statutory Auditor)
for and on behalf of PricewaterhouseCoopers LLP
Chartered Accountants and Statutory Auditors
London
4 March 2014

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