OPPORTUNITIES FOR GROWTH Phoenix Group Holdings Annual Report and Accounts 2016
To be the saver-friendly ‘industry solution’ for the safe, innovative and profitable management of closed life funds.
The risk remains that our business will be impacted by macroeconomic uncertainty or the evolving regulatory environment. However, in achieving its cash generation target for 2016 the Group has demonstrated its resilience and maintains a robust capital position.
We seek to generate value for all our stakeholders. The Group actively manages its assets and liabilities to help protect and enhance policyholder and shareholder returns.
APPLICATION OF “THE PHOENIX WAY”: “The Phoenix Way” characterises an approach and infrastructure for the efficient and effective structuring, integration and management of closed life funds and the investments they hold.
To maintain its competitive advantage, the Group develops specialist expertise to identify, pursue and execute suitable acquisition opportunities in the closed life space.
CAPITAL MANAGEMENT The effective management of the Group’s risks and the efficient allocation of capital against them maximises value generation. The Group’s Solvency II Internal Model, which has been approved by the PRA, enables us to quantify the capital and cash flow impact of specific management actions and acquisitions.
POLICYHOLDERS Optimised customer outcomes, treating customers fairly with empathy as well as respect and ensuring customer investments are secure.
– Further improvements of customer communications with focus on ensuring that customers are provided with more information to help them in making fully informed choices.
How we measure delivery (KPIs exclude the acquired AXA and Abbey Life businesses)
Cash generation in 2016 was £486 million, of which £117 million arose from the AXA acquisition. The Group met its full year cash generation target for 2016 of £350 million to £450 million.
The Group has met its key financial targets during 2016. Completion of the acquisitions of the AXA and Abbey Life businesses has strengthened the Group’s capital position and offers a significant increase in the Group’s cash generation capability. Our strategy has historically focused on holding companies’ cash flows and this remains the case under the new Solvency II framework, with the Group’s cash generation being driven by the Free Surplus generation of Phoenix Life.
With cash generation of £486 million, of which £117 million is from the acquired AXA business, the Group has achieved its full year cash generation target of £350 million to £450 million.
DEBT REPAYMENTS AND SHAREHOLDER DIVIDEND Total debt repayments of £239 million in 2016 were in respect of the repayment of the £182 million bank debt used to finance the acquisition of the AXA business, together with £50 million of the Group’s revolving credit facility. The remaining £6 million of outstanding Tier 1 bonds were also redeemed in March 2016.
Closing Free Surplus (pro forma) 0.7 1 The cash remittances to holding companies excludes cash receipts from Opal Re in the period of £85 million.
The pro forma Phoenix Life Free Surplus excludes £49 million of financial assets held in Opal Re as at 31 December 2016 (2015: £125 million).
2 Net other items reflect the impact of intragroup eliminations together with the recognition of cash and other assets held in companies above the PLHL sub group 3 The PGH pro forma position assumes the substitution of the issuer of the Group’s shareholder borrowings from PGH Capital plc to PGH effective from 20 March 2017, as if it occurred on 31 December 2016. See note I9 to the IFRS financial statements for further details.
The investment return variances have also been adversely impacted by losses arising on equity hedging positions held by the life funds following equity market gains in the period. Equity market gains in the period have resulted in an unfavourable variance as the value of the hedging instruments fall without the corresponding benefit from future profits within the life funds being recognised.
The emerging cash flows of the Group may be impacted during periods of severe market turbulence by the need to maintain appropriate levels of regulatory capital. The impact of market turbulence may also result in a material adverse impact on the Group’s capital position.
The conduct-focused regulator has had a greater focus on customer outcomes. This may continue to challenge existing approaches and/ or may result in remediation exercises where Phoenix Life cannot demonstrate that it met the expected customer outcomes in the eyes of the regulator.
SHAREHOLDERS I am grateful for the strong support of our shareholders in 2016.
The Group is governed by our Board of Directors. Biographical details of all Directors are shown below.
INTRODUCTION The Board is committed to high standards of corporate governance and the Group’s Corporate Governance policy is aligned to compliance with the UK Corporate Governance Code (‘the Code’) which sets standards of good practice for UK listed companies. It is the Board’s view that the Company has been fully compliant during 2016 with the provisions set down in the Code.
All Directors receive a tailored induction on joining the Board in accordance with a process approved by the Board. The new NonExecutive Directors, Wendy Mayall, John Pollock and Nicholas Shott, undertook a comprehensive induction, including detailed strategic and operational briefings and information, before and following their appointments in September 2016.
– The Audit Committee considered an analysis of the processes and conclusions in support of management’s conclusions that the Annual Report and Accounts are fair, balanced and understandable. In particular, the Audit Committee sought assurance as to the review processes that operated over the production of the Annual Report and Accounts.
– Taking account of the Board Evaluation Review, reviewed the structure, size and composition of the Board.
Last year I highlighted the negative effects that extended and frequent ‘prohibited periods’ that limit Directors’ and senior employees’ share transactions can have on our remuneration practices. This is particularly relevant for Phoenix because acquiring additional closed funds is core to our strategy and the time spent to properly consider acquisitions can mean extended prohibited periods. This constrains the normal timetables for awarding and vesting the Company’s share plans.
Long-Term Incentive Plan (‘LTIP’): Below, we show progress against the measures which apply for the 2014 LTIP awards. Embedded value growth, cumulative cash generation and TSR performance is shown over the three-year performance period (financial years 2014, 2015 and 2016). TSR is measured against the constituents of the FTSE 250 (ex. Investment Trusts), with median being the 50th percentile and upper quintile from the 80th percentile.
– The performance measures applied to AIP will be set by the Remuneration Committee and may be financial or non-financial and corporate, divisional or individual and in such proportions as it considers appropriate. However, the weighting of financial performance measures will not be reduced below 50% of total AIP potential in any year for the duration of this policy.
– The fees paid to the Chairman and the fees of the other Non-Executive Directors are set to be competitive with other listed companies of equivalent size and complexity.
While the Remuneration Committee does not consider this to form part of benefits in the normal usage of that term, it has been advised that corporate hospitality (whether paid for by the Company or another) and certain instances of business travel (including any related tax liabilities settled by the Company or another Group company) for Directors may technically be considered as benefits and so the Remuneration Committee expressly reserves the right to authorise such activities and reimbursement of associated expenses within its agreed policies.
40% of AIP outcomes for 2017 will be delivered as an award of deferred shares under the DBSS which will vest after a three-year deferral period.
PERCENTAGE CHANGE IN PAY OF THE GROUP CHIEF EXECUTIVE OFFICER 2015 TO 2016 In accordance with DRR regulations, the table below provides a comparison of the percentage change in the prescribed pay elements of the Group Chief Executive Officer (salary, taxable benefits and annual incentive outcomes) between financial years 2015 and 2016 and the equivalent percentage changes in the average of all staff (representing all permanent staff during 2015 and 2016 on a matched basis). This group was selected as being representative of the wider workforce using the same process as was used for this comparison in last year’s accounts.
2 The measure looks at servicing (i.e. not product or advice) complaints received as a percentage of customer transactions. It is calculated in accordance with the FCA requirements for reporting the volume of complaints.
Total share plan interests as at 31 December 2016 – Sharesave
Alastair Barbour 30 September 2016 1 October 2013 11 May 2017 2
As explained in the Chairman’s statement on page 5, the proposed dividend of 23.9p per share is an equivalent 5% increase to the 2015 level (rebased to take into account the bonus element of the rights issue completed in November 2016).
At the Company’s AGM held on 11 May 2016, shareholders granted the Company authority to purchase up to 10% of its issued ordinary shares. Any ordinary shares purchased under the authority would, subject to the Cayman Islands Companies Law (as amended), either be cancelled by operation of law or held in treasury.
– the Directors’ Report and the Strategic Report include a fair review of the development and the performance of the business and the position of the Company and its consolidated subsidiaries taken as a whole, together with a description of the principal risks and uncertainties that they face.
– The statement of consolidated financial position as at 31 December 2016
– Acquisition of AXA Wealth Limited and Abbey Life Assurance Company Limited.
Data There has been no change in assessment of this risk from the prior year.
Audit work at component locations for the purpose of obtaining audit coverage over significant financial statement accounts is undertaken based on a percentage of total performance materiality. The performance materiality set for each component is based on the relative scale and risk of the component to the Group as a whole and our assessment of the risk of misstatement at that component. In the current year, the range of performance materiality allocated to components was £7 million to £25 million (2015: £4.6 million to £18.4 million).
– Recognition of Deferred Tax Assets for Unrealised Losses (Amendments to IAS 12) (2017).
Total financial liabilities for which fair values are disclosed – 1,348 937 2,285
Fixed and variable rate income securities categorised as Level 3 investments, with the exception of a property investment structure and certain local authority loans, are valued using broker quotes. Although such valuations are sensitive to estimates, it is believed that changing one or more of the assumptions to reasonably possible alternative assumptions would not change the fair value significantly.
The valuation of the equity investment is sensitive to changes in the equity discount spread, whereby an increase of 5% in the discount spread would decrease the value by £2 million (2015: £2 million) and a 5% reduction would increase the value by £1 million (2015: £1 million). The valuation of the debt investment is sensitive to a change in the credit spread whereby an increase of 100bps in the credit spread would decrease the value by £1 million (2015: £1 million) and a spread reduction of 100bps would increase the value by £1 million (2015: £1 million).
An increase of 100bps in the swap curve would decrease the value by £10 million and a decrease of 100bps would increase the value by £10 million.
The Group conducts stock lending with only well-established, reputable institutions in accordance with established market conventions. The financial assets do not qualify for derecognition as the Group retains all the risks and rewards of the transferred assets except for the voting rights.
A 100bps narrowing of credit spreads, with all other variables held constant and no change in assumed expected defaults, would result in an increase in the profit after tax in respect of a full financial year, and in equity, of £29 million (2015: £62 million).
The Group cedes insurance risk in the normal course of business. Reinsurance assets represent balances due from reinsurance providers. Reinsurers’ share of insurance contract liabilities is dependent on expected claims and benefits arising under the related reinsured policies. Reinsurance assets are reviewed for impairment at each reporting date, or more frequently, when an indication of impairment arises during the reporting period. Impairment occurs when there is objective evidence, as a result of an event that occurred after initial recognition of the reinsurance asset, that the Group may not receive all outstanding amounts due under the terms of the contract and the event has a reliably measurable impact on the amounts that the Group will receive from the reinsurer. The impairment loss is recognised in the consolidated income statement. The reinsurers’ share of investment contract liabilities is measured on a basis that is consistent with the valuation of the liability to policyholders to which the reinsurance applies.
In accordance with the business transfer agreement, the reinsurance agreement was replaced by a transfer of the business using a scheme under Part VII of the Financial Services and Markets Act 2000 on 30 December 2016.
Insurance risk refers to the risk that the frequency or severity of insured events may be worse than expected and includes expense risk. The Phoenix Life segment contracts include the following sources of insurance risk, including the addition of new business pricing risk following the acquisition of the AXA businesses: Mortality higher than expected number of death claims on assurance products and occurrence of one or more large claims; Longevity faster than expected improvements in life expectancy on immediate and deferred annuity products; Morbidity higher than expected number of serious illness claims or more sickness claims which last longer on income protection policies; Expenses policies cost more to administer than expected; Lapses the numbers of policies terminating early is different to that expected in a way which increases expected claims costs or expenses or reduces future profits; Options unanticipated changes in policyholder option exercise rates giving rise to increased claims costs; and
Following the acquisition of the AXA businesses, the Group is exposed to increased mortality and new business pricing risk, although this provides a natural hedge to the annuity business.
Utilised during the year – (1) – (6) – – – (7)
Staff related provisions include provisions for unfunded pensions of £6 million (2015: £6 million) and private medical insurance costs for former employees of £3 million (2015: £3 million).
The PA(GI) provision of £33 million (2015: £6 million) represents the Group’s best estimate of the likely future costs. However, this is subject to a number of risks and uncertainties including volumes of future complaints, the rates by which those complaints are upheld and the average redress value. No allowance has been made for any third party recoveries.
On acquisition of Abbey Life on 30 December 2016, obligations arising as a result of past practices in the areas covered by the two thematic reviews described above were assessed. As a result, it was determined appropriate to recognise a provision of £25 million on a fair value basis in this regard. Any resultant outflow of economic benefits is subject to uncertainty given the absence of final findings from the FCA review procedures, which would determine the extent to which the FCA may require Abbey Life to carry out remediation activities or impose financial penalties.
Expenses and deferred acquisition costs carried forward 2 14 – – 16
– Inflation risk – a significant proportion of the schemes’ benefit obligations are linked to inflation, and higher inflation will lead to higher liabilities (although in most cases, caps on the level of inflationary increases are in place to protect against extreme inflation). Assets in both schemes are invested so as to hedge a significant proportion of the inflation risks, further details of which are included in this note.
As the acquisition of Abbey Life took place on 30 December 2016, no amounts are recognised in the consolidated income statement or in the statement of comprehensive income in relation to the Abbey Life Scheme.
Defined benefit obligation The calculation of the defined benefit obligation can be allocated to the scheme’s members as follows: – Active scheme members: 5%
Later than 1 year and not later than 5 years 57 56
The Group's interest in unconsolidated structured entities has increased during the year as a result of the acquisitions undertaken (see note H2) and the deconsolidation of the Ignis Liquidity Fund plc – Sterling Liquidity Fund due to loss of effective control.
Details of commitments to subscribe to private equity funds and other unlisted assets are included in note I7.
Scottish Mutual Pension Funds Investment Limited (trustee company) Glasgow10 Ordinary shares 100.00%
The Scottish Mutual Assurance Society (dormant company) Glasgow10 Limited by guarantee N/A
AXA Fixed Interest Investment ICVC – Sterling Strategic Bond Fund London18 OEIC, sub fund 57.80%
Aberdeen Financial Equity Fund A Inc London19 OEIC, sub fund 85.61%
Basic Own Funds represents the excess of assets over liabilities from the Solvency II balance sheet adjusted to add back any relevant subordinated liabilities that meet the criteria to be treated as capital items.
The Group capital resources is based on the Group's pro forma Own Funds adjusted for shareholder borrowings as analysed below: Unaudited
To subscribe to private equity funds and other unlisted assets 646 443
On 17 March 2017, the Board recommended a final dividend of 23.9p per share (2015: 26.7p per share) for the year ended 31 December 2016. Payment of the final dividend is subject to shareholder approval at the AGM. The cost of this dividend has not been recognised as a liability in the financial statements for 2016 and will be charged to the statement of consolidated changes in equity in 2017.
Credit to equity for equity-settled share-based payments (note I2.1) – – – 4 4
On 9 November 2016, the Company entered into a joint loan agreement with PGH (LCA) Limited and PGH (LCB) Limited and advanced payment of £650 million. The loan accrued interest at LIBOR plus a margin of 0.85% and was fully repaid on 28 December 2016.
For the purposes of the additional fair value disclosures for assets recognised at amortised cost, all loans and receivables are categorised as Level 3 financial instruments. The fair value of loans and receivables with no external market is determined by internally developed discounted cash flow models using a risk-adjusted discount rate corroborated with external market data where possible.
The analysis of the asset portfolio provided below comprises the assets held by the Group’s life companies, and is stated net of derivative liabilities. It excludes other Group assets such as cash held in the holding and service companies and the assets held by the non-controlling interests in consolidated collective investment schemes.
Financial assets held by the non-controlling interest in the consolidated UKCPT 838
PLHL’s Tier 1 capital accounts for 83% (2015: 86%) of total Own Funds and comprise of ordinary share capital, surplus funds of the unsupported with-profit funds which are recognised only to a maximum of the SCR, and the accumulated profits of the remaining business.
DIVIDEND MANDATES Shareholders may find it convenient to have their dividends paid directly to their bank or building society account. If you wish to take advantage of this facility please call Computershare and request a ‘Dividend Mandate’ form.
As a result, the Group’s actual future financial condition, performance and results may differ materially from the plans, goals and expectations set out in the forward-looking statements and other financial and/or statistical data within the 2016 Annual Report and Accounts.
GAR Guaranteed Annuity Rate – A rate available to certain pension policyholders to acquire an annuity at a contractually guaranteed conversion rate