Risk based capital model

Our risk based capital model seeks to ensure that the capital we hold is commensurate with the risks to which our businesses are exposed

RISK PROFILE
Risk profile [Credit Risk, Market Risk, Insurance Risk, Operational Risk] (We are sorry but the exact percentages were not known at the time of publication.) (pie chart)

Our model

Our risk based capital model seeks to provide a quantitative assessment of the risks to which the group is exposed. It plays a central role in risk management across the group, through informing and influencing a proportionate response to identified risk exposures and forms part of the suite of tools that we use to evaluate our strategic plans, set risk appetite, allocate capital and evaluate product pricing. We also use our model in the assessment of significant transactions, including large bulk annuities and business acquisitions.

The key output from our risk based capital model is the generation of capital requirements calculated on an economic basis. We calibrate our model to a 99.5% value at risk confidence level over one year, equivalent to ensuring that we hold sufficient capital reserves to survive our assessment of a worse case 1-in-200 year event. The model covers the material risk exposures identified within our risk landscape where they are quantifiable.

Risk profile

Measured in terms of economic capital requirement, credit and longevity risks are the most significant risks to the group, substantially driven by our Legal & General Retirement business.

Bond default

The primary driver of the capital requirement for credit risk reflects that the issuers of bonds could default on their obligations to us. We actively manage our portfolio of bond investments to mitigate the risk of default, however, there remains a residual risk that in very extreme conditions a systematic default event could result in the financial failure of even strongly rated issuers of debt.

Longevity

Our capital requirement for longevity risk reflects that life expectancy may improve at a much faster rate than the assumptions we have made in determining our best estimate of required reserves for longevity. We undertake extensive analysis of trends in longevity to ensure that our assessment of future rates of mortality remains appropriate, however, as set out in our assessment of principal risks and uncertainties, a dramatic advance in medical science could improve the life expectancy for the portfolio of lives that we insure.

Solvency II

Solvency II is targeted for regulatory implementation in January 2016. We have been preparing for the new capital regime for over five years, significantly enhancing our economic capital and risk framework by delivering our risk based capital model. We will be making our formal application to the PRA to use our risk based capital model as the basis for determining our regulatory capital requirement under Solvency II, in the second quarter of 2015. The success of our application will be dependent upon agreement by the PRA of our model and the calibrations for our key risks. Factors such as PRA interpretation of the matching adjustment rules are also areas of continuing uncertainty. These factors mean that we are exposed to the risk that our surplus capital is lower under Solvency II than under current rules.

SUMMARY OF ASSESSED PRINCIPAL RISKS AND UNCERTAINTIES

In the Principal risks and uncertainties section, we summarise our assessment of principal risks and uncertainties, along with the associated trends and outlooks, and the steps we take to mitigate them. As with understanding our risk landscape, these can be grouped around three categories, with the majority arising from the environment in which we operate:

The products we write

The investments we hold to meet our obligations

The environment in which we operate

Reserves for long term business may require revisions as a result of changes in experience, regulation or legislation.

Investment market performance or conditions in the broader economy may adversely impact our earnings and profitability.

Changes in regulation or legislation may have a detrimental effect on our strategy.

 

In dealing with issuers of debt and other types of counterparty the group is exposed to the risk of financial loss.

As a UK-based group, our earnings are influenced by the performance and perception of the UK financial services sector as a whole.

 

 

The group may not maximise opportunities from structural and other changes within the financial services sector, adversely impacting future earnings.

 

 

A material failure in our business processes may result in unanticipated financial loss or reputation damage.

 

 

The financial services sector is increasingly becoming a target of ‘cyber crime’.