20 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.

(i) 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 PRA 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 2014, 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 per annum (2013: 40bps) for unapproved securities backing non profit business and 35bps per annum (2013: 35bps) for unapproved securities backing non participating with-profits business. For approved securities and swaps backing the non profit annuity business, the allowance is 9bps per annum (2013: 9bps). For approved securities and swaps backing non participating with-profit business the allowance decreased to 5bps per annum (2013: 5bps). For unapproved securities backing non profit annuity business, the credit default allowances equate to 54bps per annum (2013: 56bps) when expressed over the duration of the assets held, leading to an overall total default provision of £2.3bn (2013: £1.8bn).

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, adjusted for the cost 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, with an appropriate allowance for prudence. These tables are based on industry-wide mortality and morbidity experience for insured lives.

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. The expense assumptions also include an appropriate allowance for prudence.

Premiums

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.

(ii) 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

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

Premiums

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.

Economic assumptions

The PRA’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, and for 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).

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.

(iii) Long term valuation assumptions

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

 

2014

2013

1.

For product groups where liabilities are positive, the lower interest rate of 1.75% (2013: 2.00%) is used. However, for product groups where liabilities are negative, the higher rate of 6.60% (2013: 6.60%) is used.

2.

The percentage of the table varies with the duration that the policy has been in-force for the first five years.

3.

The percentage of the table varies with the duration that the policy has been in-force for the first two years. For term assurance with critical illness, morbidity rates are assumed to deteriorate at a rate of 0.50% p.a. for males and 0.75% p.a. for females (2013: 0.50% p.a. for males and 0.75% p.a. for females). There is an additive loading of 1.00% (2013: 1.00%) for guaranteed term contracts post policy duration 5.

4.

Table created by blending PCXA00 with PNXA00 tables. The base table to be used for bulk purchase annuity 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 an adjusted version of CMIB’s mortality improvement model; CMI 2013 (2013: CMI 2012) with the following parameters:
Males: Long Term Rate of 2.00% p.a. (2013: 2.00% p.a.) up to age 85 tapering to 0% at 120;
Females: Long Term Rate of 1.50% p.a. (2013: 1.50% 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.
The basis above is applicable up to age 90. After age 90 the basis is blended towards a bespoke table from age 100 onwards.

Rate of interest/discount rates

 

 

Non-participating business

 

 

Life assurances1

1.75% pa and 6.60% pa

2.00% pa and 6.60% pa

Pension assurances1

1.75% pa and 6.60% pa

2.00% pa and 6.60% pa

Annuities in deferment

3.03% pa

3.96% pa

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

−0.26% pa

0.56% pa

Vested annuities

0.75% – 3.03% pa

1.00% – 3.96% pa

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

−0.26% pa

−0.20% – 0.56% pa

Participating business

 

 

Risk free rate (10 years)

1.94% pa

3.31% 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)

22.3%

22.4%

Property volatility

15.0%

15.0%

Mortality tables

 

 

Non-participating business

 

 

Non-linked individual term assurances:

 

 

Smokers

84% TMS00/TFS00 Sel 5

82% TMS00/TFS00 Sel 5

Non-smokers

86% TMN00/TFN00 Sel 5

89% TMN00/TFN00 Sel 5

Non-linked individual term assurances with terminal illness

 

 

Smokers2

68% – 87% TMS00/TFS00 Sel 5

83% – 100% TMS00/TFS00 Sel 5

Non-smokers2

75% – 94% TMN00/TFN00 Sel 5

79% – 103% TMN00/TFN00 Sel 5

Non-linked individual term assurances with critical illness

 

 

Smokers3

115% – 145% ACSL04M/F

91% – 102% CIBT93M/F Comb

Non-smokers3

130% – 173% ACNL04M/F

60% – 69% CIBT93M/F Comb

Other non-linked non profit life assurances

100% of A67/70 Ult

100% of A67/70 Ult

Annuities in deferment4

81.3% – 86.7% PNMA00/PNFA00

81.3% – 88.0% PNMA00/PNFA00

Vested annuities5

 

 

Bulk purchase annuities

82.2% – 86.7% PCMA00/PCFA00

82.2% – 88.0% PCMA00/PCFA00

Other annuities

63.9% – 122.3% PCMA00/PCFA00

63.9% – 111.9% PCMA00/PCFA00

Persistency assumptions

Lapse rates assumptions are used in the PRA statutory Peak 1 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 non profit business, as defined by the requirements of the annual returns to the PRA, is shown below. The lapse rates for unit linked business represent the decrement from in-force to surrender and for 2013 combine experience for non profit and non-participating business.

 

2014 Average lapse rate for the policy years

Product

1-5
%

6-10
%

11-15
%

16-20
%

Level term

12.1

8.5

6.1

4.1

Decreasing term

12.0

8.5

6.3

6.3

Accelerated critical illness cover

18.9

12.0

5.4

5.2

Pensions term

10.7

7.6

5.7

5.6

Whole of Life (conventional non profit)

5.3

2.2

1.2

1.1

Bond (unit linked non profit)

1.7

6.1

3.3

2.8

Individual pension regular premium (unit linked non profit)

3.2

3.2

1.9

1.9

Group pension regular premium (unit linked non profit)

0.7

1.3

1.1

1.0

Individual pension single premium (unit linked non profit)

4.8

5.2

2.2

2.1

Group pension single premium (unit linked non profit)

3.8

4.2

2.8

2.8

Trustee Investment Plan single premium (unit linked non profit)

2.1

8.0

6.9

6.9

 

2013 Average lapse rate for the policy years

Product

1-5
%

6-10
%

11-15
%

16-20
%

Level term

12.5

8.8

6.5

4.6

Decreasing term

12.5

8.8

6.7

6.7

Accelerated critical illness cover

19.7

11.9

5.6

5.6

Pensions term

11.3

7.9

6.0

6.0

Whole of Life (conventional non profit)

7.4

2.3

Bond (unit linked non profit)

1.7

6.2

3.7

3.0

Individual pension regular premium (unit linked non profit)

2.8

2.4

1.6

1.5

Group pension regular premium (unit linked non profit)

2.2

2.4

1.8

1.7

Individual pension single premium (unit linked non profit)

4.0

3.8

2.1

2.0

Group pension single premium (unit linked non profit)

3.8

3.8

3.8

3.8

Trustee Investment Plan single premium (unit linked non profit)

3.1

7.2

4.1

3.9

For with-profits business the Peak 2 (realistic) valuation is currently the biting basis and therefore detail of the long term best estimate lapse rates is given below for unitised with-profits (UWP) and unit linked non-participating products. The lapse rates for unit linked business represent the decrement from in-force to surrender and combine experience for non profit and non-participating business.

 

2014 Average lapse rate for the policy years

Product

1-5
%

6-10
%

11-15
%

16-20
%

Savings endowment (unitised with-profits)

6.7

8.9

Target cash endowment (unitised with-profits)

6.1

4.6

Savings endowment (unit linked non-participating)

6.7

8.9

Target cash endowment (unit linked non-participating)

6.1

4.6

Bond (unitised with-profits)

2.1

7.1

6.1

4.7

Bond (unit linked non-participating)

5.3

6.2

5.1

Individual pension regular premium (unitised with-profits)

4.5

4.5

4.5

4.5

Individual pension regular premium (unit linked non-participating)

5.9

5.4

5.1

5.1

Group pension regular premium (unitised with-profits)

14.5

14.4

14.1

14.1

Group pension regular premium (unit linked non-participating)

8.9

7.7

6.0

6.0

Individual pension single premium (unitised with-profits)

3.7

3.6

3.6

3.6

Individual pension single premium (unit linked non-participating)

4.9

4.3

4.0

4.0

Group pension single premium (unitised with-profits)

6.9

6.8

6.6

6.6

Group pension single premium (unit linked non-participating)

12.1

11.4

8.8

9.1

Trustee Investment Plan single premium (unitised with-profits)

3.5

19.2

16.3

16.3

Trustee Investment Plan single premium (unit linked non-participating)

3.5

19.2

16.3

16.3

 

2013 Average lapse rate for the policy years

Product

1-5
%

6-10
%

11-15
%

16-20
%

Savings endowment (unitised with-profits)

0.2

4.0

7.8

Target cash endowment (unitised with-profits)

5.8

4.8

Savings endowment (unit linked non-participating)

0.2

4.0

7.8

Target cash endowment (unit linked non-participating)

5.8

4.8

Bond (unitised with-profits)

1.8

5.4

6.6

3.8

Bond (unit linked non-participating)

3.4

12.4

7.4

6.0

Individual pension regular premium (unitised with-profits)

4.0

4.0

4.0

4.0

Individual pension regular premium (unit linked non-participating)

5.6

4.8

3.2

3.0

Group pension regular premium (unitised with-profits)

12.8

12.8

12.6

12.4

Group pension regular premium (unit linked non-participating)

4.4

4.8

3.6

3.4

Individual pension single premium (unitised with-profits)

3.6

3.6

3.4

3.4

Individual pension single premium (unit linked non-participating)

8.0

7.6

4.2

4.0

Group pension single premium (unitised with-profits)

16.8

16.8

16.8

16.8

Group pension single premium (unit linked non-participating)

7.6

7.6

7.6

7.6

Trustee Investment Plan single premium (unitised with-profits)

6.0

15.2

8.2

7.6

Trustee Investment Plan single premium (unit linked non-participating)

6.2

14.4

8.2

7.6

Endowment reserve

The endowment reserve has been set taking reasonable account of assessment of the expected future population of complaints, the expected uphold rate for these companies, the potential impact of any Financial Ombudsmen 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 operation, local actuarial tables and interest rates are used.