STRATEGIC REPORT Phoenix Group at a glance ...... IFC Chairman’s Statement ................ 2 Group Chief Executive Officer’s Report ........................... 4 Our Operating Structure ............. 8 Our Key Products ........................ 9 Our Business Segments ........... 10 The Marketplace ........................ 12 Business Model ......................... 14 Our Strategy and KPIs ............... 18 Business Review .......................28 Risk Management .....................39 Stakeholder Engagement .........47
OUR MISSION Improve outcomes for customers and deliver value for shareholders.
Will deliver the end state operating model for both the UK Heritage and UK Open segments. The end state operating model will be designed to respond to an evolving landscape from the Open business perspective while also providing a versatile platform for future consolidation.
Actuarial harmonisation In 2018 we delivered £500 million of capital synergies in respect of the Standard Life Assurance businesses. This principally consists of the benefits from capital synergies from implementing the Group’s equity and currency hedging strategy but also includes capital synergies by internally restructuring indemnity benefits within the Group.
We have increased our capital synergy target to £720 million to reflect the estimated impact of moving towards Phoenix’s strategic asset allocation for annuity backing assets and creating a single life company.
The Shareholder Capital coverage ratio also increased to 167% at 31 December 2018 from a 147% pro forma ratio at 31 December 2017, well within our target range of 140% to 180%.
New business New business is written across all open product lines of our European business.
New business Our Open business is growing through new business generated through the Client Service and Proposition Agreement with Standard Life Aberdeen and through an increase in pensions auto-enrolment.
Phoenix are responsible for providing the insurance product and the administration once the product is sold – this plays very much to our strengths given our existing expertise in product administration for our existing c. 5.5 million Phoenix Life customers. The relationship is built to work seamlessly for customers with the full proposition from distribution through to administration being done under the Standard Life brand.
We will continue to invest in the SunLife brand and its service offering which was awarded the 2018 Feefo Gold Trusted Service Provider for the third year running.
OUR STRATEGIC PRIORITIES HELP ENHANCE THE VALUE WE CREATE THROUGH OUR BUSINESS MODEL.
SKILLS Talented and experienced team. We will continue to invest in this expertise
KEY INITIATIVES AND PROGRESS IN 2018 – STANDARD LIFE ASSURANCE • Significant changes have been made to our online, app and telephony services in 2018 including extending our opening hours, implementing a new voice recognition system and extending our secure messaging facility which enables contact with us out of hours. We have implemented a new online registration process, making it easier to get registered, fingerprint, pin and facial recognition access to our mobile app and improvements to the investment switching journey online for trust schemes.
PRIORITIES FOR 2019 • Focus on improving the propositions we offer, the servicing and administration capabilities available and the overall experience we deliver to our clients, members and customers.
• The integration of the AXA Wealth and Abbey Life businesses completed ahead of plan delivering cost synergy benefits of £27 million per annum and cumulative cash generation of £986 million.
Analysis The Group’s Solvency II surplus of £3.2 billion has increased from a pro forma position of £2.5 billion2 driven by capital synergies from the acquisition of the Standard Life Assurance businesses together with management actions and the issuance of additional subordinated debt compared to that assumed in the pro forma. The increase was partly offset by financing costs and dividend payments including accrual of the 2018 final dividend.
Phoenix Group’s ability to attract, retain and motivate outstanding talent was, for the eighth year in succession, formally recognised in 2018 through our accreditation as one of the UK’s Top Employers. We are proud to be recognised as a responsible, sustainable and inclusive employer, who values and rewards the contribution our colleagues make to our business.
• Engage colleagues in the creation of a combined set of values for the Group, building on previous work conducted at Standard Life Assurance and Phoenix.
Why it is important? We aim to ensure that employees understand the purpose of their role and feel that their contribution is valued. We need to understand how well we are performing against these aims.
Workforce that is of Black, Asian or Minority Ethnic background2 141 107
IFRS results for the year ended 31 December 2018 include the Standard Life Assurance businesses for the four month period from 1 September post completion of the acquisition.
Non recurring cashflows also include a favourable collateral movement of £27 million on the Group’s other hedging positions relating to the Group’s debt. The remainder of the balance includes £43 million of expenses associated with the acquisition of the Standard Life Assurance businesses and £35 million of net other corporate costs, including integration costs.
UK Heritage net flows UK Heritage net outflows of £(7.1) billion comprise total premiums received in the year from inforce contracts, net of policyholder outflows on claims such as maturities, surrenders and annuities in payment. In addition, UK Heritage net flows include £1.5 billion of new business inflows arising from vesting annuities and the three bulk purchase annuity transactions completed in the year.
SENSITIVITY AND SCENARIO ANALYSIS As part of the Group’s internal risk management processes, the regulatory capital requirements are tested against a number of financial scenarios. The results of that stress testing, are provided opposite and demonstrate the resilience of the PGH plc Solvency II surplus.
The Group has generated an operating profit of £708 million (2017: £368 million). The increase compared to the prior year is primarily driven by the inclusion of the Standard Life Assurance businesses for the four month period post completion of the acquisition together with net positive impacts of management actions, experience and actuarial assumption changes during 2018.
Investment return variances and economic assumption changes on long term business 283 (6)
Announcement of Diligenta as the Group’s preferred outsource partner will involve a major system and data migration to transfer c. 2 million of legacy Phoenix Life policies to a digitally enhanced customer platform.
OUR SUPPLIERS Following the acquisition of Standard Life Assurance Limited, the Group now has c. 1,000 suppliers of which c. 70 are considered Material Service Providers.
For Material Service Providers, Phoenix has a dedicated professional relationship manager assigned. Their role is to govern the relationship, measure and monitor performance and work to continually improve outcomes for all stakeholders.
The ‘Young Person’s Development Network’ aims to connect individuals across the organisation, providing a platform for individuals to learn, share and develop as they start out in their career journey.
Four dementia champions have been trained by Alzheimer’s Society to deliver awareness sessions to colleagues onsite. During 2018, 278 dementia friends were created. In addition colleagues can benefit from subsidised onsite massage, discounted gym membership and fitness classes at the larger sites.
Colleagues in Ireland have reviewed partnership opportunities and from February 2019 will be partnering with Irish charity, ALONE, which helps older individuals in the community.
In London our colleagues have supported St Joseph’s Primary School, where pupils are visited on a weekly basis, helping to develop reading skills. In addition, the Group’s CEO and management team visited Draper’s Academy in Harold Hill, to share their experiences of working life and routes into the profession. They also took time to read with pupils with Special Educational Needs.
Approximately 14% of 2018 emissions are estimated as full-year data is not available for all facilities. A sample of emissions from fuel use for companyowned transport, backup generation and fugitive emissions from refrigerants were calculated in previous years and were determined to be non-material to the overall footprint, so have not been included.
GREENHOUSE GAS EMISSIONS Absolute GHG emissions data in tonnes of CO2e
EXPERIENCE Campbell Fleming is the Global Head of Distribution at Aberdeen Standard Investments, the asset management business of Standard Life Aberdeen� He joined Aberdeen Asset Management in August 2016 from Columbia Threadneedle Investments where he was the Chief Executive – EMEA and Global COO for four years� Mr Fleming is the Chair of the Investment Association Trade Committee and previously held senior positions at JP Morgan Asset Management�
The current audit partner is Ed Jervis, who has held that role from the 2014 statutory audit and will rotate off after completion of the 2018 statutory audit responsibilities�
Significant matters discussed in 2018 Standard Life Assurance acquisition • To ensure the safe delivery of the
Adjusted Shareholder Solvency II Own Funds: Threshold, target and maximum levels increased by £1,837 million to reflect equity raised as part of the acquisition, net of any dividends paid or payable in the first 12 months arising from the additional equity. The range therefore increased from £2,863 million (threshold), £2,913 million (target), £3,013 million (maximum) to £4,700 million (threshold), £4,750 million (target), £4,850 million as shown below.
The Group CEO played the critical role in securing and delivering the transformational acquisition of the Standard Life Assurance businesses leading the negotiation, transaction, and pricing of the deal and welcoming Standard Life Aberdeen plc as a strategic partner. Subsequent to the closure of the above acquisition, repositioned the Group to leverage Edinburgh as an operational headquarters alongside sites in London and Wythall, with a joint leadership team appropriately representative of the enlarged entity.
James McConville, Group Finance Director and Group Director, Scotland (‘Group FD’)
The Committee were satisfied these adjustments ensured the LTIP continued to operate as originally intended with the targets no easier to satisfy as a result of the acquisition.
No changes were made to the targets for the 2016 and 2017 awards.
The number of shares for outstanding DBSS awards granted between 2015 and 2016 were increased to take into account the impact of the rights issues which took place on 9 November 2016 and 27 July 2018. The number of shares for outstanding DBSS awards granted between 2017 and 2018 were increased to take into account the impact of the rights issues which took place on 27 July 2018. All adjustments were based on the Theoretical Ex-Rights Price (‘TERP’) and approved by the Remuneration Committee. The share price on grant shown has also been adjusted to reflect the impact of the rights issue on all share prices.
James McConville 21 March 2018 LTIP Nil cost option £879,908 25% 21 March 2021 See page 94
SHAREHOLDING REQUIREMENTS – AUDITED INFORMATION As explained in the Remuneration Policy under the Shareholding Guidelines section, the Executive Directors are subject to shareholding requirements.
PERFORMANCE GRAPH AND TABLE The graph below shows the value to 31 December 2018 on a TSR basis, of £100 invested in Phoenix Group Holdings on 5 July 2010 (the date of the Company’s Premium Listing) compared with the value of £100 invested in the FTSE 250 Index (excluding Investment Trusts).
PERCENTAGE CHANGE IN PAY OF THE GROUP CHIEF EXECUTIVE OFFICER 2017 TO 2018 In accordance with the 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 2017 and 2018 and the equivalent percentage changes in the average of all staff (representing all permanent staff during 2017 and 2018 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 annual report and accounts.
REMUNERATION COMMITTEE GOVERNANCE The Group originally established a Remuneration Committee in 2010. On 13 December 2018 the Phoenix Group Holdings plc Remuneration Committee was formally constituted following admission of the new entity to the London Stock Exchange. The terms of reference of the Committee are available at www.thephoenixgroup.com. The main determinations of the Committee in 2018 in respect of the application of the Remuneration Policy are summarised in the Committee Chairman’s letter to shareholders at the start of the Remuneration Report.
Disclosures under listing rule 9.8.4R For the purposes of Listing Rule 9.8.4C, the information required to be disclosed under Listing Rule 9.8.4R can be found within the following sections of the Report and Accounts: Section Requirement Location 1 Statement of interest capitalised
STATEMENT OF DIRECTORS’ RESPONSIBILITIES IN RESPECT OF THE ANNUAL REPORT AND ACCOUNTS OF PHOENIX GROUP HOLDINGS PLC The Directors are responsible for the preparation of the Annual Report and Accounts, the Strategic Report, the Directors’ Report, the Directors’ remuneration report, the consolidated financial statements and the Company financial statements in accordance with applicable law and regulations.
The statement of consolidated financial position as at 31 December 2018
We performed additional audit procedures on the ERM financial investments and the Standard Life modelled corporate bonds, such as private placements, which require judgement to be applied and for which quoted market prices are not readily available and consequently where management use models and other inputs to estimate their value.
We engaged our valuation specialists and actuaries to test valuation of ERMs and modelled corporate bonds.
Based on our procedures performed on the acquisition of the Standard Life assurance businesses, we are satisfied that, on an overall basis, the fair value of the assets and liabilities acquired lies within a reasonable range of what a market participant in an orderly transaction would pay for the identifiable assets and liabilities and there is a justification for the gain on acquisition.
MATTERS ON WHICH WE ARE REQUIRED TO REPORT BY EXCEPTION In the light of the knowledge and understanding of the Group and the parent company and its environment obtained in the course of the audit, we have not identified material misstatements in the Strategic Report or the Directors’ Report.
Shares distributed by the employee benefit trust – – 4 – – – (4) – – – –
Issue of ordinary share capital, net of associated commissions and expenses (note D1) – 2 – – – – – 2
Assets and liabilities are offset and the net amount reported in the statement of consolidated financial position only when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the assets and settle the liability simultaneously. Income and expenses are not offset in the consolidated income statement unless required or permitted by an International Financial Reporting Standard (‘IFRS’) or interpretation, as specifically disclosed in the accounting policies of the Group.
A3.6 Acquisition of the Standard Life Assurance businesses The identification and valuation of identifiable intangible assets, such as acquired in-force business or brand intangibles, arising from the Group’s acquisition of the Standard Life Assurance businesses requires the Group to make a number of judgements and estimates. Further details are included in notes G7 ‘Intangible assets’ and H2 ‘Acquisitions’.
Predominantly all external revenue presented for 2017 is attributable to customers in the UK. Additionally, predominantly all non-current assets (other than financial assets, deferred tax assets, pension schemes and rights arising under insurance contracts) for 2017 were located in the UK.
Basic earnings per share is as follows: 2018 pence 2017 pence
Interest income on financial assets designated at FVTPL on initial recognition 1,260 972
• the Company has transferred its rights to receive cash flows from the asset and has either transferred substantially all the risks and rewards of the asset, or has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset.
All other financial assets that are measured at fair value through profit or loss4 204,154
E. FINANCIAL ASSETS & LIABILITIES continued E2. Fair value hierarchy continued E2.2 Fair value hierarchy of financial instruments continued £m £m £m
E4.1 Financial instrument collateral arrangements The Group has no financial assets and financial liabilities that have been offset in the statement of consolidated financial position as at 31 December 2018 (2017: none).
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 £100 million (2017: £53 million).
The Group has increased exposure to illiquid credit assets (eg equity release mortgages and commercial real estate loans) with the aim of achieving greater diversification and investment returns.
E. FINANCIAL ASSETS & LIABILITIES continued E6. Risk Management – financial risk continued E6.2 Financial risk analysis continued The sensitivity analysis for interest rate risk indicates how changes in the fair value or future cash flows of a financial instrument arising from changes in market interest rates at the reporting date result in a change in profit after tax and in equity. It takes into account the effect of such changes in market interest rates on all assets and liabilities that contribute to the Group’s reported profit after tax and in equity. Changes in the value of the Group’s holdings in swaptions as the result of time decay or changes to interest rate volatility are not captured in the sensitivity analysis.
Sensitivity of profit after tax and equity to fluctuations in currency exchange rates is not considered significant at 31 December 2018, since unhedged exposure to foreign currency was relatively low (2017: not considered significant).
The With-Profit Benefit Reserve (‘WPBR’) for an individual contract is determined by either a retrospective calculation of ‘accumulated asset share’ approach or by way of a prospective ‘bonus reserve valuation’ method. The cost of future policy-related liabilities is determined using a market consistent approach, mainly based on a stochastic model calibrated to market conditions at the end of the reporting period. Non-market related assumptions (for example, persistency, mortality and expenses) are based on experience adjusted to take into account of future trends. The realistic liability for any contract is equal to the sum of the WPBR and the cost of future policy-related liabilities.
Amounts due for settlement after 12 months 75,700 6,801 39,697 2,996
Expense inflation Expenses for the Phoenix Life companies are assumed to increase at the rate of increase in the Retail Price Index (‘RPI’) plus fixed margins in accordance with the various management service agreements (‘MSAs’) the Group has in place with outsource partners. For with-profit business the rate of RPI inflation is determined within each stochastic scenario. For other business it is based on the Bank of England inflation spot curve. For MSAs with contractual increases set by reference to national average earnings inflation, this is approximated as RPI inflation plus 1%. In instances in which inflation risk is not mitigated, a further margin for adverse deviations may then be added to the rate of expense inflation.
Assumption changes During the year a number of changes were made to assumptions to reflect changes in expected experience or to harmonise the approach across the Enlarged Group. The impact of material changes during the year was as follows: (Decrease)/ increase in insurance liabilities 2018 £m
F. INSURANCE CONTRACTS, INVESTMENT CONTRACTS WITH DPF AND REINSURANCE continued F4. Risk Management – Insurance risk continued F4.2 Managing product risk The following sections give an assessment of the risks associated with the Group’s main life assurance products and the ways in which the Group manages those risks.
The main risks associated with this product are longevity and investment risks. Longevity risk arises where the annuities are paid for the lifetime of the policyholder, and is managed through the initial pricing of the annuity and through reinsurance (appropriately collateralised) or transfer of existing liabilities. Annuities may also be a partial ‘natural hedge’ against losses incurred in protection business in the event of increased mortality (and vice versa) although the extent to which this occurs will depend on the similarity of the demographic profile of each book of business. In addition, the Group has in place longevity swaps that provide downside protection over longevity risk.
Provision for tax on that part of the economic surplus available as a refund on a winding-up of the Scheme (151) (147)
Obligations for repayment of stock lending collateral received (1,115) – (887) –
Principal assumptions The principal financial assumptions of the Pearl Scheme are set out in the table below: Rate of increase for pensions in payment (5% per annum or RPI if lower) 3.10 3.05
At the same time as the ‘buy-in’ transaction, there was a rule change made with respect to pre-1997 excess benefits for members of the Phoenix section of the PGL Pension Scheme. Pension increases are now increased in line with CPI inflation subject to a maximum of 5% per annum. Prior to this, members received discretionary increases in payment on these benefits with the discretionary increases not allowed for in the defined benefit obligation.
Change in provision for tax on economic surplus available as a refund – – (1) – (1)
Acquired in-force business Insurance and investment contracts with DPF acquired in business combinations and portfolio transfers are measured at fair value at the time of acquisition. The difference between the fair value of the contractual rights acquired and obligations assumed and the liability measured in accordance with the Group’s accounting policies for such contracts is recognised as acquired in-force business. This acquired in-force business is amortised over the estimated life of the contracts on a basis which recognises the emergence of the economic benefits. The value of acquired in-force business related to investment contracts without DPF is recognised at its fair value and is amortised on a diminishing balance basis. An impairment review is performed whenever there is an indication of impairment. When the recoverable amount is less than the carrying value, an impairment loss is recognised in the consolidated income statement. Acquired in-force business is also considered in the liability adequacy test for each reporting period. The acquired in-force business is allocated to relevant cashgenerating units for the purposes of impairment testing.
Customer relationships The customer relationship intangible asset includes vesting pension premiums and is measured on initial recognition at cost. The cost of this intangible assets acquired in a business combination is their fair value as at the date of acquisition. Following initial recognition, the customer relationship intangible asset is carried at cost less any accumulated amortisation and any accumulated impairment losses. The intangible asset is amortised on a straight-line basis over its useful economic life and assessed for impairment whenever there is an indication that the recoverable amount of the intangible asset is less than its carrying value. The customer relationship intangible asset is allocated to relevant cash-generating units for the purposes of impairment testing. Internally generated intangible assets are not capitalised and expenditure is reflected in the consolidated income statement in the year in which the expenditure is incurred.
Owner-occupied property is stated at its revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and impairment. Owner-occupied property is depreciated over its estimated useful life, which is taken as 20 – 50 years. Land is not depreciated. Gains and losses on owner-occupied property are recognised in the statement of consolidated comprehensive income. Equipment consists primarily of computer equipment and equipment and fittings. Equipment is stated at historical cost less deprecation. Where acquired in a business combination, historical cost equates to the fair value at the acquisition date. Depreciation on equipment is charged to the consolidated income statement over its estimated useful life of between 2 and 15 years.
• a decrease of 10% in the mortality rate would decrease the market value by £1 million.
The Group’s interest in UKCPT is held in the with-profit funds of the Group’s life companies. Therefore, the shareholder exposure to fair value movements in the Group’s investment in UKCPT is limited to the impact of those movements on the shareholder share of distributed profits of the relevant fund.
Pearl Life Services Limited (property management company) Wythall1 Ordinary Shares 100.00% Phoenix SCP Pensions Trustees Limited (trustee company) Wythall1 Ordinary Shares 100.00% Phoenix SCP Trustees Limited (trustee company) Edinburgh27 Ordinary Shares 100.00% SLA Belgium No.1 SA (property company) Belgium3 Société Anonyme 100.00% 330 Avenida de Aragon SL (property management company) Madrid40 Ordinary Shares 100.00% SLIF Property Investment GP Limited (General Partner to SLIF Property Investment)
The London Life Association Limited (dormant company) Wythall1 Limited by Guarantee 100.00% The Pearl Martineau Galleries Limited Partnership (dormant company)
Equity-settled share-based payments to employees and others providing services are measured at the fair value of the equity instruments at the grant date. The fair value excludes the effect of non-market-based vesting conditions. Further details regarding the determination of the fair value of equity-settled share-based transactions are set out below. The fair value determined at the grant date of the equity-settled share-based payments is expensed on a straight-line basis over the vesting period, based on the Group’s estimate of equity instruments that will eventually vest. At each period end, the Group revises its estimate of the number of equity instruments expected to vest as a result of the effect of non-market-based vesting conditions. The impact of the revision of the original estimates, if any, is recognised in the consolidated income statement such that the cumulative expense reflects the revised estimate with a corresponding adjustment to equity.
Following the scheme of arrangement, participants in the Old PGH sharesave plan exchanged their options over Old PGH shares for equivalent options over PGH plc ordinary shares. All sharesave options were increased in November 2016 and again in July 2018 following the Group’s rights issues (see note D1) and the exercise price of these awards was also amended as a result of these issues. The 2018 sharesave options were granted on 10 April 2018.
Other risks Customer risk Customer risk is the risk of reductions in earnings and/or value, through inappropriate or poor customer treatment (including poor advice).
e. On 12 December 2018, the Company became an additional borrower on an unsecured revolving credit facility, maturing in June 2022. The facility is undrawn as at 31 December 2018 and accrues interest at LIBOR plus 1.1%. A utilisation fee of between 0.1% and 0.4% is applicable dependent on the amount drawn.
Amounts due from related parties at the end of the year: 2018 £m
3 This information is presented on a look through basis to underlying funds where available. 4 Includes equity release mortgages of £2,020 million, commercial real estate loans of £449 million, income strips of £654 million, policy loans of £9 million, other loans of £170 million, net derivative assets of £2,832 million, reinsurers’ share of investment contracts of £5,417 million and other investments of £712 million.
• availability to be called up on demand to fully absorb losses on a going-concern basis, as well as in the case of windingup (‘permanent availability’); and