7 Principal products
A significant part of the group’s business involves the acceptance and management of risk.
A description of the principal products offered by the group’s segments is outlined below. The group seeks to manage its exposure to risk through control techniques which ensure that the residual exposures are within acceptable tolerances agreed by the Board. The group’s risk appetite framework and the methods used to monitor risk exposures can be found in the Risk management section.
LGAS business comprises retail and group protection, general insurance products, the businesses in France and Netherlands and savings products.
Protection business (retail 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.
The group offers Household and Accident, Sickness and Unemployment (ASU) products:
- Household 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) 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. The group also sells pet insurance products.
Legal & General France (LGF) and Legal & General Netherlands (LGN)
In addition to protection products, LGF and LGN also write savings business.
In LGF this includes unit linked savings, including shares of open ended investment vehicles (SICAVS), risks for which are borne by unit holders of these funds, Euro denominated funds with a 100% profit sharing clause and bank based investment accounts.
In LGN this includes unit linked and index linked savings products, bank based investment accounts and corporate pension products.
Certain savings products include an exposure to interest rate and credit risk, managed through an active asset-liability management programme.
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. The contracts fall into three main types:
- Non-participating savings, pensions and endowment contracts;
- Participating savings business, comprising endowment contracts and with-profits bonds; and
- Unit linked savings contracts and collective investment savings products.
For unit linked savings contracts 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 LGAS LTF (long term fund). Collective investment business is administered by Legal & General (Portfolio Management Services) Limited.
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.
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.
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.
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 group’s Principles Practices of Financial Management (PPFM) for the management of the with-profits part of the LGAS LTF. The principles include:
- The with-profits part of the LGAS 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 LGAS LTF’s inherited estate. The inherited estate is the excess of assets held within the LGAS 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;
- 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 LGAS LTF are not immediately reflected in payments under with-profits policies; and
- 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.
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 or refunds to 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. In 2013 the timing of the deduction/refund was changed to be based on the period ending 30 September to ensure that in future the deduction/refund could be included in the forthcoming bonus declarations rather than delaying for a year.
Following the movement in the expected cost of guarantees and options and the value of the associated funds up to 30 September 2014, and in accordance with the Society’s PPFM, a refund of 0.55% was made to asset shares. This followed a zero deduction in respect of the period from 31 December 2012 to 30 September 2013. The refund of 0.55% to asset shares has returned all outstanding past charges to policyholders.
In addition, a charge of 1.25% would be levied on all unitised with-profits policies in the February 2015 bonus investigation to adjust their asset shares in respect of unrecovered expenses on future claims so that fairness between different groups of with-profits policies can be maintained.
The distribution of surplus to shareholders depends upon the bonuses declared for the year. 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 £150m at the end of 2014 and will then gradually reduce to zero at the end of 2017.
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 annuity contracts 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 2014 was £524m (2013: £311m). Thus, 1% negative inflation, which was reversed in the following year, would result in a guarantee cost of approximately £5m (2013: £3m). 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.
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 £196m (2013: £140m).
Longevity insurance contracts
The group also provides longevity insurance products for company pension schemes, under which regular payments are made to the scheme reflecting their actual longevity experience, while the scheme makes an agreed set of regular payments in return. Some policies contain a guaranteed surrender value which is currently immaterial.
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 offer institutional investors a solution for their cash management requirements across a range of core currencies. The liquidity funds aim to deliver competitive returns with a high level of diversification, whilst focusing on capital preservation through portfolios of high quality, liquid assets.
Solutions and Liability Driven Investment (LDI)
A range of pooled and bespoke solutions to help de-risk defined benefit pension schemes. These solutions will usually combine active or passive underlying portfolios with derivative overlays designed to meet clients’ specific requirements.
Solutions also includes a range of pooled multi-asset funds for retail and institutional clients, built using LGIM’s expertise in asset allocation which is informed by an in-house research capability. The underlying asset classes may be managed on an active or passive basis within LGIM. An allocation strategy service is also offered to institutional clients, which may also allocate some of the portfolio to managers other than LGIM.
An active equity management business comprising focused teams managing stock selection across different regions.
A range of pooled or segregated real estate funds for 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.
Investment Strategy and Implementation
Shareholder assets, which are managed by LGC, include portfolios of equity, property, bond and other direct 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, foreign exchange hedging and limits on investment variance and, concentrations of exposures by asset type and geographic region.
Direct Investments and Structuring
Direct Investments are becoming an increasingly important part of our growth strategy. We define Direct Investments as “one off” investments made with another counterparty, for example; a loan made directly to a UK SME; a property purchased and held or an equity stake in a private company. We invest in Direct Investments for a number of reasons including when they offer better risk adjusted returns; give diversity to our traded market instruments, and where synergies arise with other parts of our business. All with the aim of increasing shareholder returns.
We currently have a sector focus on Housing, Urban Regeneration, Energy and Alternate Financing for investments made in LGC.
Protection consists of individual term assurance, which provides 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.
Reinsurance is used within the protection businesses to manage exposure to large claims. These practices lead to the establishment of reinsurance assets on the group’s balance sheet. Within LGA, reinsurance and securitisation is also used to provide regulatory solvency relief (including relief from regulation governing term insurance and universal life reserves).
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 totalled $653m (£419m) at 31 December 2014 ($666m (£402m) at 31 December 2013). The guaranteed interest rates associated with those reserves ranged from 1.5% to 6%, with the majority of the policies having guaranteed rates ranging from 3% to 4% (2013: 3% to 4%).
Immediate annuities have similar characteristics as products sold by LGR. 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. The reserves for immediate annuities and deferred annuities totalled $10m (£6m) and $194m (£124m), respectively, at 31 December 2014 ($11m (£7m) and $193m (£117m) at 31 December 2013, respectively).