30 Management of capital resources

Capital structure

From a regulatory perspective the group is required to measure and monitor its capital resources on an ongoing basis and to comply with the minimum capital requirements of regulators in each territory in which it operates. At 31 December 2014, Legal & General’s unaudited Insurance Group Directive (IGD) capital resources were £3.9bn (2013: £4.0bn) in excess of capital requirements of £3.8bn (2013: £3.3bn), representing a solvency coverage ratio of 201% (2013: 221%). This surplus capital is after accruing for a 2014 final dividend of £496m (2013: £408m).

The group writes a range of long term insurance and investment business in the long term fund (LTF) of its main operating insurance subsidiary, Legal & General Assurance Society Limited (Society). This fund is segregated from the group’s other assets. The fund includes participating (with-profits) business where policyholders and shareholders share in the risks and rewards, and non-participating (non profit) business, where the shareholders receive profits or incur losses. Capital in excess of the amount required to cover the liabilities is currently held within Society. This capital provides support for new and existing non profit business within our UK non profit LGAS and Retirement businesses. In January 2015, Legal & General announced the closure of the with-profits fund to new business. There will be no change to how this fund is managed as a result of this closure.

The non-linked, non profit pensions and annuity business of Society is ceded, on arm’s length terms, to a wholly owned Insurance Special Purpose Vehicle (ISPV), Legal & General Pensions Limited (LGPL). Whilst an ISPV is not required to segregate policyholder assets within a LTF, LGPL continues to manage policyholder and shareholder assets separately for internal purposes.

Managed pension fund business is written through Legal & General Assurance (Pensions Management) Limited (PMC), which is a life company writing predominantly non-participating group pension business effected by trustees of occupational schemes in the UK (or their equivalent overseas). The assets are held in a LTF and are separate from other assets within the group.

In addition, the group operates a UK long term insurance business through Suffolk Life Annuities Limited. General insurance business is written in the UK by Legal & General Insurance Limited, and long term insurance business is also written by LGA, LGN and LGF.

Capital management policies and objectives

The group aims to manage its capital resources to maintain financial strength, policyholder security and relative external ratings advantage. The group also seeks to maximise its financial flexibility by maintaining strong liquidity and by utilising a range of alternative sources of capital including equity, senior debt, subordinated debt and reinsurance.

Capital measures

The group measures its capital on a number of different bases, including those which comply with the regulatory frameworks within which the group operates and those which the directors consider most appropriate for managing the business. The measures used by the group include:

Accounting bases

Management use financial information prepared on both an IFRS and an Economic Capital basis to manage capital and cash flow usage and to determine dividend paying capacity. In addition, the supplementary accounts prepared using EEV principles provide further insight into the value of the business to shareholders. Accordingly the group’s net asset value and total capital employed are also analysed and measured on this basis.

Regulatory bases

The financial strength of the group’s insurance subsidiaries is measured under various local regulatory requirements (see below). One of these regulatory measures, Individual Capital Assessment (ICA), measures capital using risk based stochastic techniques, and provides a measure of the level of economic capital required to run the group’s business. In addition, management assess financial strength under our current interpretation of the Solvency II rules.

Basis of regulatory capital and corresponding regulatory capital requirements

In each country in which the group operates, the local insurance regulator specifies rules and guidance for the minimum amount and type of capital which must be held by long term insurance subsidiaries in excess of their insurance liabilities. The minimum required capital must be maintained at all times throughout the year. This helps to ensure that payments to policyholders can be made as they fall due.

The required capital is calculated by either assessing the additional assets which would be required to meet the insurance company’s liabilities in specified, stressed financial conditions, or by applying fixed percentages to the insurance company’s liabilities and risk exposures. The requirements in the different jurisdictions in which the group operates are detailed below:

UK regulatory basis

Required capital for the life business is based on PRA rules. Society must hold assets in excess of the higher of two amounts; the first being calculated using the PRA rules specified by the Regulator (pillar 1), the second being an economic capital assessment by the Company which is reviewed by the PRA (pillar 2), otherwise known as ICA.

The public pillar 1 capital calculation is calculated by applying fixed percentages to liabilities and sums assured at risk or setting aside a proportion of expenses (Peak 1). There are further stress tests for participating business, as measured in the Realistic Balance Sheet (Peak 2), which may increase the required capital under Peak 1 calculations.

The private pillar 2 capital calculation is an assessment of the economic capital required to ensure that the Company can meet its liabilities, with a high likelihood, as they fall due. This is achieved by application of stochastic modelling and scenario testing. The result is reviewed and may be modified by the PRA.

Regulatory capital for the general insurance business is also calculated using PRA pillar 1 and pillar 2 requirements. The pillar 1 calculation applies fixed percentages to premiums and claims. Pillar 2 creates a higher capital requirement and is therefore applied in this business.

The group has developed an internal model to meet the future Solvency II requirements. We anticipate that our Solvency II internal model will be approved in 2015, ready for use on the Solvency II go live date – 1 January 2016.

US regulatory basis

Required capital is determined to be the Company Action Level Risk Based Capital (RBC) based on the National Association of Insurance Commissioners RBC model. RBC is a method of measuring the minimum amount of capital appropriate for an insurance company to support its overall business operations, taking into account its size and risk profile. The calculation is based on applying factors to various asset, premium, claims, expense and reserve items, with higher factors used for those items with greater underlying risk and lower factors for less risky items.

French and Dutch regulatory bases

The minimum required capital is defined by the French Ministry of Finance’s ‘Code des Assurances’ and the ‘De Nederlandsche Bank N.V.’ (Dutch Supervisory Body) respectively. The basis of the calculation is a percentage of the liabilities plus a percentage of the sum assured at risk and, for some contracts, the premium. The percentages depend on the guarantees given and the amount of reinsurance cover.

Group regulatory basis

In addition to the regulatory capital calculations for the individual firms, the group is required to comply with the requirements of the Insurance Group’s Directive (IGD).

Available regulatory capital resources

Capital resources available to meet regulatory UK capital requirements are determined using PRA valuation rules. The asset valuation rules are based on applicable GAAP, adjusted for admissibility, counterparty exposure limits and specific valuation differences.

The group’s regulatory capital position statement in Table 1 sets out the different sources of capital held within the group. The group’s total available capital resources, under FRS 27 requirements, are £6.9bn (2013: £6.6bn) of which £4.6bn (2013: £4.5bn) is held by the life businesses. The use of capital held by the UK and overseas life businesses is generally constrained by local regulatory requirements, and may not be available to provide funding for other businesses.

The total available capital resources of the group’s with-profits business (with-profits estate) is determined in accordance with the Realistic Balance Sheet rules prescribed by the PRA.

At 31 December 2014, the excess of realistic assets over realistic liabilities was £0.4bn (2013: £0.8bn), excluding the risk capital margin. The capital resources reflect the surplus in that part of the fund which is in excess of any constructive obligation to policyholders. The liabilities within the Consolidated Balance Sheet do not include the amount representing the shareholders’ share of future bonuses.

Table 1 – Regulatory capital position statement

As at 31 December 2014

UK with-profits
£m

UK non profit and SRC1
£m

LGPL
£m

Over­seas and PMC
£m

Total life
£m

Share­holders’ equity and other activities
£m

Total
£m

1.

UK non profit and SRC includes Suffolk Life Annuities Limited.

2.

Other consists of shareholders’ share in realistic liabilities of £263m and changes to the values of assets and liabilities on a regulated basis of £1,654m.

Ordinary shareholders’ equity outside the LTF

13

1,261

1,832

3,106

1,174

4,280

Ordinary shareholders’ equity held in the LTF

1,718

30

1,748

1,748

Capital and reserves attributable to ordinary
equity holders of the Company

1,731

1,261

1,862

4,854

1,174

6,028

Adjustments onto regulatory basis:

 

 

 

 

 

 

 

Unallocated divisible surplus

689

294

983

983

Other2

(338)

(337)

(554)

(1,229)

(689)

(1,918)

Other qualifying capital:

 

 

 

 

 

 

 

Subordinated borrowings

2,346

2,346

Internal loans

Proposed dividend

(496)

(496)

Total available capital resources

351

1,394

1,261

1,602

4,608

2,335

6,943

 

 

 

 

 

 

 

 

IFRS liability analysis:

 

 

 

 

 

 

 

UK participating liabilities on realistic basis

 

 

 

 

 

 

 

– Options and guarantees

877

877

877

– Other policyholder obligations

10,694

14

10,708

10,708

Overseas participating liabilities

2,661

2,661

2,661

Unallocated divisible surplus

689

294

983

983

Value of in-force non-participating contracts

(208)

(208)

(208)

Participating contract liabilities

12,052

14

2,955

15,021

15,021

 

 

 

 

 

 

 

 

Unit linked non-participating life assurance liabilities

501

484

1,183

2,168

2,168

Non-linked non-participating life assurance liabilities

404

40,255

6,762

47,421

47,421

Unit linked non-participating investment
contract liabilities

8,788

30,123

249,647

288,558

288,558

General insurance liabilities

287

287

Non-participating contract liabilities

9,693

70,862

257,592

338,147

287

338,434

As at 31 December 2013

UK with-profits
£m

UK non profit and SRC1
£m

LGPL
£m

Over­seas and PMC
£m

Total life
£m

Share­holders’ equity and other activities
£m

Total
£m

1.

UK non profit and SRC includes Nationwide Life Limited, Lucida Limited and Suffolk Life Annuities Limited.

2.

Other consists of shareholders’ share in realistic liabilities of £297m and changes to the values of assets and liabilities on a regulated basis of £1,336m.

Ordinary shareholders’ equity outside the LTF

27

1,298

1,475

2,800

1,060

3,860

Ordinary shareholders’ equity held in the LTF

1,752

30

1,782

1,782

Capital and reserves attributable to equity
holders of the Company

1,779

1,298

1,505

4,582

1,060

5,642

Adjustments onto regulatory basis:

 

 

 

 

 

 

 

Unallocated divisible surplus

1,077

144

1,221

1,221

Other2

(314)

(505)

(520)

(1,339)

(294)

(1,633)

Other qualifying capital:

 

 

 

 

 

 

 

Subordinated borrowings

1,790

1,790

Internal loans

Proposed dividend

(408)

(408)

Total available capital resources

763

1,274

1,298

1,129

4,464

2,148

6,612

 

 

 

 

 

 

 

 

IFRS liability analysis:

 

 

 

 

 

 

 

UK participating liabilities on realistic basis

 

 

 

 

 

 

 

– Options and guarantees

689

689

689

– Other policyholder obligations

11,047

16

11,063

11,063

Overseas participating liabilities

2,713

2,713

2,713

Unallocated divisible surplus

1,077

144

1,221

1,221

Value of in-force non-participating contracts

(248)

(248)

(248)

Participating contract liabilities

12,565

16

2,857

15,438

15,438

 

 

 

 

 

 

 

 

Unit linked non-participating life assurance liabilities

516

479

1,260

2,255

2,255

Non-linked non-participating life assurance liabilities

2,223

33,255

2,242

37,720

37,720

Unit linked non-participating investment
contract liabilities

8,765

26,944

243,045

278,754

278,754

General insurance liabilities

-

-

298

298

Non-participating contract liabilities

11,504

60,678

246,547

318,729

298

319,027

Available regulatory capital resource risks

The group’s available capital resources are sensitive to changes in market conditions, both to changes in the value of the assets and to the impact which changes in investment conditions may have on the value of the liabilities. Capital resources are also sensitive to assumptions and experience relating to mortality and morbidity and, to a lesser extent, expenses and persistency. The most significant sensitivities arise from the following four risks:

  • market risk in relation to UK participating business which would crystallise if adverse changes in the value of the assets supporting this business could not be fully reflected in payments to policyholders because of the effect of guarantees and options. The capital position of this business would also deteriorate if increases to the market cost of derivatives resulted in an increase in the liability for guarantees and options in the realistic balance sheet.
  • market risk in relation to the UK annuity business, which would crystallise if the return from the fixed interest investments supporting this business were lower than that assumed for reserving.
  • mortality risk in relation to the UK annuity business, which would crystallise if the mortality of annuitants improved more rapidly than the assumptions used for reserving.
  • mortality risk in relation to the UK and US term assurance businesses, which would crystallise if mortality of the lives insured was higher than that assumed, possibly because of an epidemic.

A range of management actions is available to mitigate any adverse impact from changing market conditions and experience, including pricing changes, cost management, reinsurance structure, investment strategy, changes to with-profits bonus rates, changes to discretionary surrender terms and charging for guarantees. To the extent that management actions are expected only to offset partially adverse experience, then liabilities would be increased to anticipate the future impact of the adverse experience and total capital resources would be reduced.

Table 2 provides management estimates of the impact on the IGD surplus of changes in market conditions.

Table 2 – IGD sensitivity analysis

 

Impact on surplus capital
2014
£bn

Impact on surplus capital
2013
£bn

Sensitivity test

 

 

20% fall in equity values

(0.4)

(0.6)

40% fall in equity values

(1.0)

(1.5)

15% fall in property values

(0.2)

(0.1)

100bp increase in interest rates

0.4

(0.1)

100bp decrease in interest rates

(0.6)

0.1

100bp increase in credit spreads

(0.1)

(0.1)

100bp decrease in credit spreads

0.1

0.1

We have applied a consistent methodology to the IFRS sensitivity analysis in Note 21.

The above sensitivity analysis does not reflect management actions which could be taken to reduce the impacts. In practice, the group actively manages its asset and liability positions to respond to market movements. Additionally, the sensitivity tests are considered in isolation, although in practice there is likely to be a correlation between the scenarios.

The impacts of these stresses are not linear therefore these results should not be used to extrapolate the impact of a smaller or larger stress. The results of these tests are indicative of the market conditions prevailing at the balance sheet date. The results would be different if performed at an alternative reporting date.

The interest rate sensitivity assumes a 100 basis point change in the gross redemption yield on fixed interest securities together with a 100 basis point change in the real yields on variable securities. For the UK long term funds, valuation interest rates are assumed to move in line with market yields adjusted to allow for the impact of PRA regulations. The interest rate sensitivities reflect the impact of the regulatory restrictions on the reinvestment rate used to value the liabilities of the long term business.

Modelling improvements have been made in the year, which more accurately isolate the impacts of discrete assumptions changes. This, coupled with the increase in the group’s annuity liabilities, has led to an increase in the reported sensitivities to interest rates movements. Zero yield floors have not been applied in the estimation of the stresses, despite the low interest rate environment at the balance sheet date.

Table 3 – Movements in life business regulatory capital resources

 

UK with-profits
£m

UK non profit and SRC1
£m

LGPL
£m

Overseas and PMC
£m

Total life
£m

1.

UK non profit and SRC includes Suffolk Life Annuities Limited.

As at 1 January 2014

763

1,274

1,298

1,129

4,464

Effect of investment variations

(100)

(29)

71

162

104

Effect of changes in valuation assumptions

(29)

61

82

114

Changes in management policy

Changes in regulatory requirements

4

4

New business

(12)

(1)

2

347

336

Cash distributions

(158)

(204)

(362)

Other factors

(271)

243

(192)

168

(52)

As at 31 December 2014

351

1,394

1,261

1,602

4,608

 

UK with-profits
£m

UK non profit and SRC1
£m

LGPL
£m

Overseas and PMC
£m

Total life
£m

1.

UK non profit and SRC includes Suffolk Life Annuities Limited, Lucida Limited and Nationwide Life Limited.

As at 1 January 2013

659

1,139

1,243

1,123

4,164

Effect of investment variations

94

31

37

(62)

100

Effect of changes in valuation assumptions

(68)

11

(9)

(66)

Changes in management policy

Changes in regulatory requirements

19

19

New business

(8)

(17)

(82)

(51)

(158)

Cash distributions

(150)

(206)

(356)

Other factors

86

241

109

325

761

As at 31 December 2013

763

1,274

1,298

1,129

4,464