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

Report on the group financial statements

Our opinion

In our opinion, Legal & General Group Plc’s group financial statements (the “financial statements”):

  • give a true and fair view of the state of the group’s affairs as at 31 December 2014 and of its 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.

What we have audited

Legal & General Group Plc’s financial statements comprise:

  • the Consolidated Balance Sheet as at 31 December 2014;
  • the Consolidated Income Statement and Consolidated Statement of Comprehensive Income for the year then ended;
  • the Consolidated Cash Flow Statement for the year then ended;
  • the Consolidated Statement of Changes in Equity for the year then ended; and
  • the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information.

Certain required disclosures have been presented elsewhere in the Annual Report and Accounts (the “Annual Report”), rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited.

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

Our audit approach

Overview

PwC audit approach – here we have a diagram showing how the assessment of materiality determines the scope of the audit and subsequently the areas of focus for the audit. (chart)
  • Overall group materiality: £70 million which represents 5.5% of Operating profit before tax.
  • Of the Group’s 84 reporting units, we identified 30 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 8 reporting units.
  • These reporting units represent 87% of total assets, 87% of Operating profit before tax and 85% of IFRS profit after tax. We concluded that this, together with additional procedures performed at the Group level, gave us the evidence we needed for our opinion on the Group financial statements as a whole.
  • Valuation of non-participating insurance liabilities – retirement.
  • Valuation of participating and non-participating insurance liabilities – protection.
  • Valuation of complex financial investments and investment property.

The scope of our audit and our areas of focus

We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) (“ISAs (UK & Ireland)”).

We designed our audit by determining materiality and assessing the risks of material misstatement in the financial statements. In particular, we looked at where the Directors made subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain. As in all of our audits, we also addressed the risk of management override of internal controls, including evaluating whether there was evidence of bias by the Directors that represented a risk of material misstatement due to fraud.

The risks of material misstatement that had the greatest effect on our audit, including the allocation of our resources and effort, are identified as “areas of focus” in the table below. We have also set out how we tailored our audit to address these specific areas in order to provide an opinion on the financial statements as a whole, and any comments we make on the results of our procedures should be read in this context. This is not a complete list of all risks identified by our audit.

Area of focus

How our audit addressed the area of focus

Valuation of non-participating insurance liabilities – retirement
We focused on this area because the non-participating insurance liabilities for retirement products are significant in size and their estimation is inherently judgemental. The valuation of non-participating insurance liabilities for retirement 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 and benefit payments. The discount rate also includes an explicit allowance for future default and reinvestment risk on the asset portfolio; and
  • Longevity – how long the policyholders receiving annuity payments are expected to live and how that might change over time.
Refer to the Audit Committee Report and Note 1 to the group financial statements for the Directors’ disclosures of the basis of preparation and use of estimates and Note 20, Note 21 and Note 22 for related accounting policies and further information on judgements and estimates.

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 (IRR).

We understood and tested the group’s processes for ensuring that the relevant investment data was included in the calculation of the yield on the assets and did not identify any weaknesses in these processes or controls that would cause us to change our audit approach.

We tested the completeness and accuracy of that investment data by agreeing it to the third party custodiansand to independent pricing sources.

We tested the mathematical accuracy of the IRR calculations.

On a sample basis, we tested the credit ratings used to estimate the long term default allowance back to independent third party credit rating sources. Where internally generated ratings were used, we assessed the rating model and the methodology using specialist treasury expertise and tested the inputs to third party data.

We did not identify any significant exceptions in this testing.

Our work involved understanding the degree of rigour, challenge and oversight provided by Management and the Directors in relation to the setting of the credit default assumptions and the methodology used to model the cash flows. Using our actuarial specialist team members, we obtained and challenged technical papers that set out the relevant factors being taken into account by Management when making judgements on setting the credit default assumptions and changes to the valuation interest rate methodology.

Based on the work undertaken, we found the valuation interest rate used to be appropriate.

Longevity assumptions
The estimates of the period over which an amount of annuity payments is projected using two sets of assumptions:

  • current (“base”) mortality experience calculated using the group’s own data and analysis (“experience analysis”) and compared to the industry base tables; and
  • future improvements to mortality (for example due to expected medical advances) estimated using external industry studies, Continuous Mortality Investigation (“CMI”), and guidance in the UK.

We evaluated the design and implementation as well as tested the operating effectiveness of controls over accuracy and completeness of the data used in the experience analysis. Where applicable, we also agreed data back to underlying policyholder data.

Using our actuarial expertise, we assessed the results of the experience analysis carried out for the retirement business to determine whether they provided support for the assumptions used.

In addition we evaluated the group’s choice of standard industry CMI tables and the group’s base life expectancy data compared to the industry base tables.

We compared the annuitant longevity assumptions with those adopted by other insurers using our own independent industry benchmarking survey.

Having performed our work we found the assumptions used in the models to be appropriate. We found that the methodologies and models used are in line with the prior year and industry standards, whilst reflecting the nature of the group’s Retirement business.

Valuation of participating and non-participating insurance liabilities – protection
We focused on this area because the participating and non-participating insurance liabilities for protection products in the UK are significant in size and their estimation is inherently judgemental. The valuation of insurance liabilities for protection is sensitive to:

  • persistency – the rate at which policies are retained over time and therefore continue to contribute premium income; and
  • mortality and morbidity – the rate at which policyholders die or suffer critical illness.
Refer to the Audit Committee Report and Note 1 to the group financial statements for the Directors’ disclosures of the basis of preparation and use of estimates and Note 20, Note 21 and Note 22 for related accounting policies and further information on judgements and estimates.

Persistency assumptions
The rate at which policyholders cease protection products is projected using the group’s historical experience and assumptions (“experience analysis”) about future changes to policyholder behaviour.

Using our actuarial expertise, we assessed the results of the experience analysis carried out by the group for the protection business to determine whether they provided support for the assumptions used. In undertaking our assessment we took account of the potential for future changes in experience arising from regulatory changes, including the Retail Distribution Review, auto-enrolment and, more recently, by the Finance Act 2014.

We evaluated the design and implementation as well as testing the operating effectiveness of controls over accuracy and completeness of the data used in the experience analysis and found them to be effective. We also agreed data back to policy documentation and claims history.

We compared the Directors’ persistency assumptions with those adopted by other insurers using our own independent industry benchmarking survey.

Persistency assumptions are inherently subjective, particularly in light of recent regulatory changes. However, we found that the assumptions used were reasonable in the context of the group’s products.

Mortality and morbidity assumptions
The estimates of the amount and timing of benefit payments is projected using current (“base”) mortality and morbidity experience calculated using the group’s own data and analysis (“experience analysis”).

Under IFRS, the setting of margins for adverse deviation are judgemental. The group uses an established methodology to set the margin in accordance with the UK regulatory rules for insurance provisions.

We evaluated the design and implementation as well as tested the operating effectiveness of controls over accuracy and completeness of the data used in the experience analysis and found them to be effective. We also agreed actuarial data back to underlying policyholder data.

We obtained the experience analysis performed by the protection business to determine whether they provided support for the assumptions used.

We compared the group’s mortality and morbidity assumptions including margins with those adopted by other insurers using our own independent industry benchmarking survey.

Having performed our work we found the assumptions used in the models to be appropriate. We found that the methodologies and models used are in line with the prior year and industry standards, whilst reflecting the nature of the group’s protection business.

Valuation of complex financial investments and investment property
The group’s financial and property investments enable it to support its insurance liabilities and meet regulatory capital requirements, as well as providing returns on shareholder assets (the assets available for distribution to shareholders after taking account of policyholder liabilities, including associated guarantees, options and bonuses).

Most of the group’s financial investments are valued by reference to prices on active markets. However, some are priced by reference to market data and/or valuation models. They vary in complexity depending on the nature of the investments. Investments that are complex to value and require the use of significant judgement include:

  • commercial loans;
  • collateralised debt obligations (“CDOs”); and
  • over-the-counter (“OTC”) derivatives.
The group’s property portfolio is significant and involves a number of complex investment transactions including social housing projects, sale-and-leaseback transactions and asset based loans. Due to the size of the group’s property portfolio and the judgement involved in property valuations, the likelihood of misstatements is heightened.

Refer to the Audit Committee Report and Note 1 to the group financial statements for the Directors’ disclosures of the basis of preparation and use of estimates and Note 13 for related accounting policies and further information on judgements and estimates for investment risks.

Commercial loans, CDOs and OTC derivatives
We focused on the valuation of commercial loans, CDOs and OTC derivatives because they are significant in size and changes in estimates could result in material changes in their valuation.

Key estimates used in the valuation models reflect observable data such as forward interest rates, foreign exchange rates and forward inflation rate curves, as well as unobservable inputs such as future cash flows and expected defaults.

We also focused on the disclosure related to these complex financial instruments, which is extensive.

We assessed the investment valuation processes and tested controls in place over the valuation of all investments. We did not identify any defective controls.
For commercial loans, we:

  • tested the calculation in the discounted cash flow models for accuracy;
  • agreed the factual inputs to underlying contracts;
  • compared the market observable inputs to published data; and,
  • tested the non market observable inputs to calculations or supporting documents to check they were in line with our expectations.
For OTC derivatives, we:
  • validated the outstanding positions to direct feeds from the counterparties or where not available requested confirmations directly from the counterparties;
  • where confirmations were not received, we performed alternative procedures including tracing the positions to trade tickets;
  • obtained copies of the pricing methodology;
  • agreed market observable inputs to external sources;
  • tested that the models used by management were consistently applied and in line with our expectations for models used to value these types of investments; and
  • independently re-priced a sample using our internal valuations experts.
We did not identify any material exceptions in our testing and all models tested were found to be in line with our expectations.
For CDO investments, we:
  • obtained independent confirmation from the counterparties for all outstanding positions and associated collateral;
  • re-priced the collateral to independent external third party sources;
  • read the report from and met with the Directors’ external valuation expert to understand their objectivity, qualifications, approach, and their findings; and
  • compared the internal price, the counterparty price and Directors’ expert’s price and investigated differences over a tolerance based on the component materiality.
We did not identify any material exceptions in our testing of the confirmations, the collateral, or the comparison of different estimates of the prices.

We checked that the disclosures of the complex investments were compliant with IFRSs, and found that they were.

Investment property
We focused on this area because the valuation of investment property, by its nature, involves judgement. Furthermore, property valuations are generally performed less frequently than for other classes of asset. Some of the group’s property investment transactions are unique in terms of structure and therefore can require complex accounting treatments.

Key judgements involved in the valuation of investment property are:

  • expected changes in market rents;
  • occupancy rates; and
  • future management and maintenance expenses.

On a sample basis, we used our real estate valuation experts to read the property valuation reports from and meet with the Directors’ external valuation experts to understand their objectivity, qualifications, approach, and their findings.

We compared the data inputs and assumptions used in the valuation models to underlying lease agreements and industry data as applicable. We compared the key judgements on changes in rent, occupancy rates and expense to underlying lease agreements (for contractual rent changes), historical trends and forecast economic and property market data reflective current economic conditions. We did not identify any material exceptions during our testing.

For the sample, we used our relevant expertise to asses whether the valuation methodology was consistent with those used in the prior year and commonly used in the investment property industry for the type of property being valued. We found the models used and the valuations adopted to be appropriate for the group’s investment properties.

We agreed the valuations recognised to the Directors’ external valuation experts reports.

How we tailored the audit scope

We tailored the scope of our audit to ensure that we performed enough work to be able to give an opinion on the financial statements as a whole, taking into account the geographic structure of the group, the accounting processes and controls, and the industry in which the group operates.

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). These segments are disaggregated into reporting units. The group’s financial statements are a consolidation of these reporting units. 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, from other PwC network firms and non PwC firms operating under our instructions.

Of the group’s 84 reporting units, we identified 30 that, in our view, required an audit of their complete financial information, either due to their size or risk. Specific audit procedures on specific balances and transactions were performed on a further 8 reporting units. Additional procedures were performed at a group level over expenses. This gave us 87% coverage over total assets, 87% of Operating profit before tax, and 85% of IFRS profit after tax. We concluded that this gave us the evidence we needed for our opinion on the group financial statements as a whole.

Materiality

The scope of our audit was influenced by our application of materiality. We set certain quantitative thresholds for materiality. These, together with qualitative considerations, helped us to determine the scope of our audit and 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.

Overall group materiality

£70 million (2013: £70 million).

How we determined it

Based on our professional judgement, we determined materiality for the financial statements as a whole of £70 million which represents 5.5% of Operating profit before tax (2013: 7.5%).

Rationale for benchmark applied

We concluded that Operating profit before tax was the most relevant benchmark because it reflects the underlying profit of the business. While this is not an IFRS measure of profit, it is reconciled to IFRS profit before tax in the financial statements and is one of the key metrics used by the group in running its business.

Whilst overall materiality was assessed with reference to Operating profit before tax, we compared our materiality level against other relevant benchmarks, such as total assets, total revenue and IFRS profit before tax in order to ensure the materiality benchmark selected was appropriate for our audit.

We agreed with the Audit Committee that we would report to them misstatements identified during our audit above £3.5 million (2013: £3.5 million) as well as misstatements below that amount that, in our view, warranted reporting for qualitative reasons.

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 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.

Other required reporting

Consistency of other information

Companies Act 2006 opinions

In our opinion:

  • the information given in the Strategic Report and the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements; and
  • the information given in the Corporate Governance Statement and Directors’ report with respect to internal control and risk management systems and about share capital structures is consistent with the financial statements.

ISAs (UK & Ireland) reporting

Under ISAs (UK & Ireland) we are required to report to you if, in our opinion:

  • information in the Annual Report is:
    • materially inconsistent with the information in the audited 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
    • otherwise misleading.

We have no exceptions to report arising from this responsibility.

  • the statement given by the Directors in the Directors’ report, in accordance with provision C.1.1 of the UK Corporate Governance Code (“the Code”), that they consider the Annual Report 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 is materially inconsistent with our knowledge of the group acquired in the course of performing our audit.

We have no exceptions to report arising from this responsibility.

  • The work of the Committee during 2014 section of the Annual Report, as required by provision C.3.8 of the Code, 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.

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 to you if, in our opinion, certain disclosures of Directors’ remuneration specified by law are not made. We have no exceptions to report arising from this responsibility.

Corporate governance statement

Under the Companies Act 2006 we are required to report to you if, in our opinion, a corporate governance statement has not been prepared by the parent company. We have no exceptions to report arising from this responsibility.

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

Responsibilities for the financial statements and the audit

Our responsibilities and those of the Directors

As explained more fully in the Statement of Directors’ Responsibilities, the Directors are responsible for the preparation of the 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 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.

What an audit of financial statements involves

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.

We primarily focus 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.

We test and examine information, using sampling and other auditing techniques, to the extent we consider necessary to provide a reasonable basis for us to draw conclusions. We obtain audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both.

In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited 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.

Other matter

We have reported separately on the parent company financial statements of Legal & General Group Plc for the year ended 31 December 2014 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
3 March 2015

(a) The maintenance and integrity of the Legal & General Group Plc website is the responsibility of the Directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website.
(b) Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.