NPI established 2013 WAS AN EVENTFUL YEAR FOR THE PHOENIX GROUP. WE HAVE PROGRESSED IN STRENGTHENING THE BALANCE SHEET AND SIMPLIFYING THE GROUP’S STRUCTURE AND WE HAVE ALSO DELIVERED AGAINST OUR FINANCIAL TARGETS.
BUSINESS OVERVIEW Phoenix Group is the UK’s largest specialist closed life and pension fund consolidator with over 5 million policyholders and £68.6 billion of Group assets under management. Our business manages closed life funds in an efficient and secure manner, protecting and enhancing policyholders’ interests whilst maximising value for the Group’s shareholders.
IGNIS ASSET MANAGEMENT Aims to deliver superior investment performance and client service
IFRS consolidated financial statements 102 Parent company accounts 197 Additional life company asset disclosures 208 MCEV supplementary information 220
For a detailed look at our KPIs Turn to page 24 01 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
2013 was an eventful and transformational year, which has positioned the Group well for the next phase of its development. I continue to believe in the industrial logic of, and societal need for, our business and remain convinced of our ability to generate value for both policyholders and shareholders.
During the year, our number of Board members has reduced from 14 to 11. I would like to thank Ian Ashken, Charles Clarke, Alastair Lyons and Hugh Osmond who left the Board during the year, for their substantial contribution during their tenure, and the support they provided, to me as Chairman. I would also like to welcome Alastair Barbour to the Board and to his role as Audit Committee Chairman and to thank our existing Board member, Ian Cormack, for taking on the role of Senior Independent Director following Alastair Lyons’ departure. After nine years with the Group, Manjit Dale has also notified me of his intention to step down from the Board with effect from our AGM on 30 April 2014. I would like to thank Manjit for his enormous contribution to the Group and on behalf of all of the Board, I would like to wish him well.
Finally, I would like to extend my thanks to my Phoenix colleagues. Without their hard work and commitment, the consistent delivery of management actions and the achievement of our financial targets would not be possible.
HOWARD DAVIES Chairman 03 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
JUXON HOUSE, LONDON The Group functions operate out of Juxon House. For further details turn to page 14.
INTRODUCTION 2013 was a year of significant achievements and I am delighted to report a very strong set of financial results.
The planned divestment of Ignis Asset Management, which we announced today, provides Phoenix with significant strategic and financial benefits. The transaction is compelling, increasing our embedded value, improving our financial flexibility through the prepayment of debt and allowing us to reduce our gearing. We will also continue to benefit from future acquisitions through the consolidation of closed life funds and our long-term strategic partnership with Standard Life Investments.
GROUP HIGHLIGHTS DELIVERY OF FINANCIAL TARGETS Phoenix Group sets targets against three key metrics; cash generation, incremental MCEV and gearing. During 2013, we exceeded our cash generation target, achieved our incremental MCEV target a year early, and made significant progress towards our 40% gearing target by the end of 2016.
Against our increased long-term cash generation target for the period from 2011 to 2016 of £3.5 billion, we have achieved £2.3 billion between 2011 and 2013. Today, we set a new long-term cash generation target from 2014 to 2019 of £2.8 billion. We have set the long-term target over the period to 2019, to coincide with the final maturity of the new Impala loan facility in June 2019.
Phoenix delivered another period of very strong financial performance in 2013. The capital raising and debt re-terming announced in January 2013 has significantly strengthened our balance sheet and capital structure, and we have achieved cash generation beyond the top end of our target range.
Our year end MCEV increased by £45 million to £2,378 million, versus £2,333 million at 31 December 2012 (on a pro forma basis to reflect the capital raising and debt re-terming). This included £170 million of incremental value generated through management actions. In total since 2011, we have generated £502 million of incremental MCEV compared to our cumulative target of £400 million between 2011 and 2014, significantly exceeding our target, a year ahead of plan.
We have a long-term target to reduce our level of gearing to 40% or below by the end of 2016, in line with our desire to access the debt capital markets prior to the maturity of the new Impala facility. During 2013, we repaid total bank debt of £696 million, being, a £450 million prepayment on the Impala facility, £120 million of mandatory and target amortisation on the Impala facility and an additional £100 million prepayment made in December 2013. This was in addition to £25 million of mandatory amortisation and a £1 million voluntary prepayment on the Pearl facility. These repayments have reduced our total outstanding senior bank debt to £1,613 million and, as a result, we have made significant progress towards our target with gearing at 44% at 31 December 2013.
the transitional measures once additional guidance is available from EIOPA and the PRA on their practical application. Provided the Solvency II Regulations operate as expected, it is the Group’s view that the solvency position of the Group will be largely unchanged and that Group solvency will continue to be measured at PLHL under the new regime.
GROUP ASSETS UNDER MANAGEMENT Group assets under management (‘AUM’) remained stable at £68.6 billion as at 31 December 2013, compared to £68.6 billion as at 31 December 2012. This reflects the expected run-off of the life company assets offset by strong net inflows from third parties, £1.2 billion of Guardian net assets transferred back to Ignis, which had been under transitional investment management arrangements at 31 December 2012 and positive market movements.
In addition to this important transaction, Phoenix Life made strong progress across several other areas in 2013: – We completed the migration of 3.2 million in-force policies administered by Diligenta onto the new administration platform, BaNCS, making policy administration more efficient and giving customers access to their policies online.
– We continued to streamline the Group’s actuarial modelling systems, and parallel ran the new model with existing models for 2013, simplifying modelling processes and allowing consistent capital management across the business. As a result, the existing models are expected to be decommissioned during 2014.
– We worked closely with our outsource partners to prevent £12.4 million of potential transfers to pensions liberation fraud schemes. Had these cases proceeded, policyholders could have suffered substantial tax charges and high administration fees and potentially could have been left with no pension at all when they reached retirement.
– In September 2013, we agreed the sale of our entire interest in BA(GI), which holds the Group’s residual, non-core general insurance business with liabilities totalling £38 million (net of reinsurance), to National Indemnity Company. Completion took place on 18 March 2014 following regulatory approval and is expected to have a marginally positive impact on the Group’s MCEV during 2014.
– During 2013, we increased the distributable estate by £565 million, with around 115,000 policyholders benefiting from the distribution of £157 million of estate during 2013.
In addition to the remaining Guardian assets which were repatriated, Ignis achieved £1.9 billion of net third party inflows, including liquidity (2012: £1.6 billion). Sales have been particularly strong in the Absolute Return Government Bond Fund (‘ARGBF’) with a net inflow of £1.4 billion, bringing the total fund size to over £2 billion at 31 December 2013. The Ignis UK Property Fund (now with over £1 billion of assets under management) and the European Smaller Companies fund also saw strong net sales. Third party assets as a proportion of total Group AUM have risen to 22%, doubling from 11% in 2010.
CUSTOMERS ‘Treating Customers Fairly’ is crucial to how we run our business. Security of our policyholder assets is first and foremost for us followed by our aim to maximise returns wherever possible primarily through enhanced distribution of the estate within the life funds. For example, maturity payouts are being enhanced in the Pearl with-profit fund of Phoenix Life Assurance Limited by up to 16%. This is 7% higher than the previous year.
We continually aim to improve customer service. Over the last few years we have been migrating many of our policies from legacy systems to the BaNCS utility platform with our outsource partner Diligenta. Moving more of our customers to one administration platform makes it easier to make improvements to our customer journey. Following migration, for example, more of our customers can now access electronic payments via the industry application Origo. During 2013 we have seen an improvement in the speed of claims pay-outs using this method from an average of 12.8 to 10.1 days.
We recognise the importance of customers obtaining the best rate on their annuity and how providers have a key role to play in ensuring customers are aware of their options. Ahead of the required implementation date of the ABI Code on
Retirement Choices in March 2013, we made improvements to both the literature and processes for our policyholders reaching retirement to make it easier for customers to understand the options open to them and how they might ‘shop around’ for a better deal. The code itself did not cover all pension types but in an effort to improve the clarity for the maximum number of customers we have extended our changes to include workplace schemes.
In January 2013, we entered into an arrangement enabling us to introduce our policyholders to Just Retirement. As a leading provider of enhanced annuities, Just Retirement is able to offer Phoenix policyholders access to enhanced annuity products, enabling our policyholders to potentially benefit from the higher rates typically offered to impaired lives.
In line with our strategy, we continue to try to find innovative initiatives for our policyholders. In the latter part of 2013, following legislation which allowed the commutation of small annuities, Phoenix launched an initiative to allow those customers with small pensions in payment to convert that to a lump sum payment. Customers wishing to continue to receive their regular payments can of course continue to do so – our aim is to introduce flexibility where that is of interest to our customers.
We have also been working with the regulators and industry bodies on their reviews of annuities and workplace pensions this year. We have been proactive in ensuring the needs of our key customer groups such as those with small pension pots and guarantees are not overlooked in the reviews. In light of the Government’s recent budget proposals, it is crucial that our existing customers with guarantees remain aware of the value of the guaranteed rates attached to their policies. Even for those customers who do not have guaranteed rates, we believe the lifelong certainty of income provided by an annuity should mean these products will continue to provide an attractive retirement option for some policyholders.
PEOPLE Phoenix’s ability to attract, retain and motivate outstanding talent has, for the second year in succession, been formally recognised through accreditation as one of ‘Britain’s Top Employers’, reflecting our commitment to employee development and engagement. For the first time, employee engagement comprises one element of the corporate component of the Annual Incentive Plan for senior managers and our 2013 employee engagement survey results again compared positively with the Financial Services benchmark.
Phoenix’s Corporate Responsibility programme was further embedded in 2013. Employees participated in a number of initiatives designed to minimise the impact on the environment in which we operate and in addition, the Group has promoted its ‘Health and Wellbeing’ offering, encouraging staff to get the most out of life, in and out of the workplace. Both initiatives contribute to the Group’s aim of building a long-term sustainable business. I am also particularly pleased that through the efforts of many of our employees, around £200,000 was raised for the Group’s various nominated charities, which includes Company ‘matching’, which has made a significant difference to those less fortunate than us.
2013 OUTLOOK AND PROSPECTS FINANCIAL TARGETS As always, the potential remains for our business to be impacted by economic headwinds, an inability to execute successful transactions or the uncertain and evolving regulatory environment. However, the Group’s financial performance during 2013 and the strength of our business model give me confidence in the resilience of the Group’s cash flow and MCEV and our ability to deliver value for all our stakeholders.
In addition, having already achieved £502 million of incremental MCEV between 2011 and 2013, thereby significantly exceeding our cumulative incremental MCEV target of £400 million between 2011 and 2014 with a year of the target period still to go, we have set a new incremental MCEV target of £300 million between 2014 and 2016 excluding the impact of the divestment.
The combination of cash generation and enhancements to MCEV during 2013 and the divestment of Ignis is expected to reduce gearing to 39%, thereby accelerating the achievement of our long-term gearing target of 40% and increasing the Group’s financial flexibility with regards to any potential future acquisition.
Our financial targets above are set on the assumption that Solvency II regulations operate as we expect.
CONCLUSION I would like to thank my colleagues for their hard work during 2013. It is their unwavering commitment to looking after our policyholders and investment management clients, delivering management actions through the effective management of capital, operations and risk, and achieving superior investment performance which allow us to look forward with great confidence to the future for Phoenix. I firmly believe that we can continue to deliver value for all our stakeholders through continued organic improvements and our renewed focus on growth.
OUR BUSINESS MODEL Phoenix Group is the UK’s largest specialist closed life and pension fund consolidator with over 5 million policyholders. The planned divestment of Ignis Asset Management to Standard Life Investments, subject to regulatory approval, will increase the emphasis on the efficient run off of our existing closed life business and the exploration of future consolidation opportunities, while at the same time leveraging the long-term strategic partnership with Standard Life Investments.
LIFE ASSURANCE Through Phoenix Life we manage life assurance funds which no longer actively sell new life assurance policies and which run off gradually over time. These ‘closed life funds’ within the Group consist of over 5 million policyholders and a total of approximately £50.9 billion of financial and property assets.
– As a closed life business, the release of cash and capital is reliable as the policies run off which allows the Group to support a higher degree of leverage in its capital structure than many of our peers who continue to write new business.
– The Group functions provide support for, and coordination and delivery of, the Group’s strategic objectives, whilst managing the relationships with our external stakeholders, including shareholders, banks, pension schemes and regulators. The Group functions also consider potential acquisition or disposal opportunities to enhance value for the Group.
OPERATING STRUCTURE The Group has two core segments: life assurance – Phoenix Life; and asset management – Ignis. Following the planned divestment of Ignis to Standard Life Investments, subject to regulatory approval, asset management will be performed by Ignis under Standard Life Investment’s ownership.
PHOENIX LIFE Phoenix Life is responsible for the management of the Group’s life funds. Phoenix Life’s experienced and focused management team is led by its Chief Executive Officer, Mike Merrick. Based in Wythall, near Birmingham, it has a track record of successfully integrating life assurance businesses and is developing a leading-edge model and infrastructure into which future acquired funds can be integrated.
Used by the management services companies to provide policy administration 14 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
As the number of policies held by the Group gradually declines over time, the fixed cost base of our operations as a proportion of policies will increase. Our management services team manages this risk by putting in place long-term arrangements for third party policy administration. By paying a fixed price per policy to our outsource partners we reduce the fixed cost element of our operations and convert to a variable cost structure.
These outsource partners have scale and common processes, often across multiple clients, which provide several benefits for the Group, including reducing investment requirements, improving the technology used within our administrative capability, and reducing our operational risk.
Specialist roles such as finance, actuarial, risk and compliance and oversight of the outsource partners are retained in-house, ensuring Phoenix Life retains full control over the core capabilities necessary to manage and integrate closed life funds.
Further details of our life company consolidations can be found on our website at phoenix-life/fund-transfers.aspx 15 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Ignis Fixed Income & Solutions – Liquidity – Rates – Credit – Liability Driven Investment (‘LDI’)
Ignis Equities – UK – Europe – Asia – Japan – US – Global – Emerging Markets £3.0 BILLION
Ignis Real Estate – Unit Trust – Investment Trust – Segregated Mandates £1.7 BILLION
Phoenix Group’s mission is to improve returns for its policyholders and deliver value for shareholders. The Group intends to achieve this by realising its vision of being the saver-friendly, ‘industry solution’ for the safe, innovative and profitable management of closed life funds.
HOW WE MEASURE DELIVERY Effective risk and investment management benefit our capital metrics: IGD surplus and PLHL ICA surplus, both key performance indicators (‘KPIs’) which are used to monitor the strength of our business and our strategy to manage capital efficiently. Our financial target to reduce gearing will help support the simplification of our capital structure and achievement of an investment grade credit rating.
– In the second half of 2013, we gained Court approval for the previously announced legal transfer of £5 billion of annuity liabilities and assets to Guardian Assurance Limited, effective 1 October 2013, improving our IGD surplus and PLHL ICA surplus to £1.2 billion and £1.2 billion respectively.
PRIORITIES FOR 2014 – Continue to implement new management actions to enhance our capital metrics
For further details of our capital KPIs Turn to page 39
Although the life companies are closed and generally do not write new business, they do accept additional policyholder contributions on in-force policies and allow certain policies, such as pension savings plans, to be reinvested at maturity into annuities. The Group has a strong and steady stream of internal annuities vesting, of which 64% of premiums written in 2013 had valuable guaranteed annuity rates.
Additional value can be generated from further acquisitions of closed life books of business, as detailed on page 22.
KEY INITIATIVES AND PROGRESS IN 2013 – In 2013 we exceeded our annual cash generation target and met our incremental MCEV enhancement target a year ahead of plan.
– Ignis generated third party sales of £1.9 billion including liquidity.
– 85% of Ignis assets under management performed above benchmark (2012: 79%), driving enhanced returns for policyholders and increased revenues for shareholders.
PRIORITIES FOR 2014: – Target cash flows of £500 million–£550 million in 2014, assuming Solvency II regulations operate as expected
– Achieve £300 million of MCEV enhancements through management actions over 2014 – 2016
– Service – customers want to be treated fairly, with empathy and respect in a timely fashion
– Security – customers expect their investment to be secure in a well managed company.
Financial services products are usually longterm and it is often the case that customers cease to be engaged with their product over time. There is more that we as an industry can do to help re-engage customers to ensure they are in a position to make informed decisions about these products. Phoenix is committed to increasing levels of engagement with its customers.
HOW WE MEASURE DELIVERY A programme of customer research continues, with an average of 1,500 customers each month participating in automated telephone surveys. The results remain positive, with customers scoring all aspects of service highly. Research of this type is invaluable as it helps inform our service proposition which puts customers at the heart of what we do, and creates an opportunity for customers to recommend improvement.
– The Group’s new ‘point to the web’ strategy has reduced the length of annual statements for 1.3 million customers from five pages to one, enabling customers to receive the right level of information.
– We have increased policyholder payments through inherited estate distribution totalling £157 million.
PRIORITIES FOR 2014: – Improve the pay-outs for customers where appropriate
– Enhance our service to our customers particularly at the points when they are claiming the proceeds of their policy.
– In 2013 we launched development programmes specifically designed to improve the skills of new and aspiring line managers. In addition, 40 of our senior leaders in Group and Phoenix Life attended development centres which assessed their core competencies and led to bespoke development plans.
– Our Executive Committee presented the Group’s goals to management and staff in face to face briefings and management conferences throughout the year. In the 2013 survey, 88% of staff responded positively that they have “a clear understanding of the purpose and objectives of the Phoenix Group”, 10% above Financial Services benchmark.
– Introduce new and contemporary means of communication and collaboration with our workforce
– Achieve engagement index targets for Phoenix Life and Group functions of 76% (75% achieved in 2013).
For further details of employee engagement initiatives See the full Corporate Responsibility report on our website
The UK closed life fund consolidation opportunity is supported by market dynamics which are expected to generate a supply of potentially attractive acquisition targets over the medium term. These dynamics include the potential impact of a changing regulatory framework for financial services companies including the Solvency II and Basel III regulations. Additionally, there is ongoing capital pressure within the sector, the trend of recycling and refocusing capital from mature to growth markets, the decline in new with-profit business, changing customer demands and regulatory change driving consolidation in the mutual sector. We believe this opportunity is also supported by the migration of products to alternative structures, the cost challenge posed by a fragmented sector and the run-off of closed life funds and the exit of international participants.
VALUE GENERATION THROUGH ACQUISITIONS Phoenix Group will assess potential acquisitions in light of the financial condition of the Group. At the time of the capital raising and debt re-terming, we identified the criteria we would target in making an acquisition, being: – Closed life. Any acquisition would be in the closed life fund sector within the UK and Ireland
– Reduces gearing. Any acquisition would only be undertaken if it resulted in a sustainable level of gearing for the combined Group of appreciably below 40% (around the mid-point of the 35% to 40%) consistent with the strategy of lowering the Group’s gearing to attain an appropriate credit rating and obtaining regulatory approval.
Additional value through acquisitions can be generated through synergies which, combined with our ability to add value to any acquired book through our four areas of management actions, are fundamental drivers of shareholder value. The process of extracting synergies is one which we have undertaken successfully from our existing book in recent years and we are well positioned to be able to replicate this in future.
Management actions in themselves generated cash flows of £332 million, mainly relating to the annuity transaction with Guardian Assurance Limited (‘Guardian’) and other de-risking activities.
Group MCEV increased by £256 million at 31 December 2013, benefiting from the net proceeds of the equity raise of £232 million and value enhancing management actions which have delivered an incremental uplift to MCEV of £170 million.
The cumulative cash flow target for 2011 to 2016 was £3.5 billion, against which £2.3 billion had been achieved by 31 December 2013.
We set a new cumulative cash flow target of £2.8 billion for 2014 to 2019 which has been set taking into account the proceeds expected to be received from the divestment of Ignis. £500 million to £550 million of these cash flows are expected to be generated in 2014 in addition to the proceeds expected from the divestment.
Since 2011 the Group has generated £502 million of incremental MCEV, exceeding its cumulative target of £400 million between 2011 and 2014 with a year of the target period still to go.
£810m £734m £690m £817m £2,118m£2,104m £2,122m £2,378m 1 This target has been set on the assumption that Solvency II regulations operate as expected.
The dividend per share consists of the interim dividend per share paid in the year and the final dividend per share recommended for the year.
The Group’s target is to reduce the gearing ratio to 40% by the end of 2016.
The Group calculates its gearing as gross shareholder debt as a percentage of gross MCEV. Gross shareholder debt is defined as the sum of the IFRS carrying value of shareholder debt and 50% of the IFRS carrying value of the Tier 1 bonds given the hybrid nature of that instrument. Gross MCEV is defined as the sum of the Group MCEV and the value of the shareholder and hybrid debt as included in the MCEV.
The Board considers that Group IFRS operating profit is a more representative measure of performance than Group IFRS profit before tax as it provides long-term performance information unaffected by short-term economic volatility and gives an insight into the Group’s ability to generate cash flows to support dividends 1 The Group has adopted the revised accounting standard, IAS 19 Employee benefits for the first time in 2013 and has consequently changed its basis for determining income or expense relating to the defined benefit schemes. This change in accounting policy has been applied retrospectively resulting in a £19 million reduction in Group costs in 2012.
Insurance Groups’ Directive (‘IGD’) surplus is the Pillar 1 regulatory assessment of capital adequacy at a PLHL level
Group IFRS operating profit has increased by £10 million to £439 million due to one-off benefits generated from ongoing system and modelling improvements of £98 million (2012: £117 million) and the positive impact of assumption changes compared to the prior year, partly offset by the natural life company run-off.
The estimated IGD surplus has decreased to £1.2 billion following dividend payments, debt financing and repayments of £0.6 billion in the period net of proceeds from the equity raise, partly offset by £0.4 billion of capital items. The surplus of £1.2 billion represents headroom of £0.5 billion (2012: £0.6 billion) over the Group’s IGD capital policy.
The IGD surplus is a regulatory capital measure which calculates surplus capital at the highest EEA level insurance group holding company, which is Phoenix Life Holdings Limited (‘PLHL’). IGD surplus is defined as Group capital resources less the Group capital resource requirement.
PLHL ICA surplus is the economic regulatory assessment of capital adequacy at a PLHL level
IFRS operating profit is an indicator of Ignis’ growth and ability to generate cash flows for the Group
The PLHL ICA surplus increased during the year driven by free surplus generation within Phoenix Life which more than offset the impact of shareholder dividend, debt financing and repayments.
Group assets under management represent life company assets (excluding collateral on stocklending arrangements), holding company cash, and third party assets managed by Ignis.
£1.0bn £1.2bn £72.1bn£69.6bn £68.6bn £68.6bn £46m£46m £43m £49m 27 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
HOLDING COMPANIES’ CASH FLOWS The statement of cash flows prepared in accordance with IFRS combines cash flows relating to shareholders and cash flows relating to policyholders, but the practical management of cash within the Group maintains a distinction between the two, as well as taking into account regulatory and other restrictions on the availability and transferability of capital. For this reason, the following analysis of cash flows focuses on the holding companies’ cash flows, which reflect cash flows relating only to shareholders and which are, therefore, more representative of the cash that could potentially be distributed as dividends or used for the repayment of debt, the payment of debt interest, Group expenses and pension contributions. This cash flow analysis reflects the cash paid by the operating companies to the holding companies, as well as the uses of those cash receipts.
Uses of cash before debt repayments and shareholder dividend 283 223
2 Proceeds of the equity raise of £232 million net of associated fees and commission of £18 million, and after the deduction of £21 million of fees associated with the re-terming of the Impala loan facility.
OPERATING COMPANIES’ CASH GENERATION Cash remitted by Phoenix Life during 2013 was £794 million (2012: £661 million), reflecting the benefit of management actions implemented during the period and cash remitted by Ignis was £23 million (2012: £29 million). This enabled the Group to exceed its cash generation target range of £650 million to £750 million for the year ended 31 December 2013.
Total free surplus generated in the period of £809 million reflects completion of the legal transfer of the annuity liabilities and other management actions, the inherent release of capital requirements from the run-off of the life funds and the positive impact of increasing yields on capital requirements and policy. The prior period comparative included the net capital benefits of the reinsurance leg of the annuity transfer transaction and the transfer of the business of London Life Limited to Phoenix Life Assurance Limited.
RECURRING CASH OUTFLOWS Operating expenses of £34 million (2012: £37 million) decreased as a result of reduced corporate costs, reflecting the impact of cost management initiatives.
NON-RECURRING CASH OUTFLOWS Non-recurring cash outflows reflect investment in the Group’s transformation programmes.
DEBT REPAYMENTS AND SHAREHOLDER DIVIDEND Debt repayments of £696 million in the period comprise a £450 million voluntary debt prepayment, £120 million of mandatory and target repayments; an additional £100 million prepayment in respect of the Impala loan facility; a £25 million1 mandatory repayment and a £1 million voluntary prepayment in respect of the Pearl loan facility.
The shareholder dividend of £120 million comprises the payment of the 2012 final and 2013 interim dividend.
Future cash flows: Emergence of surplus2 1.1 Release of capital2 1.3 Recurring cash receipts generated by Phoenix Life 2.4 Other3 0.4 Operating companies’ cash generation target 2.8 2 Includes cash flows from management actions.
The resilience of the cash generation target is demonstrated by the following stress testing: Stress testing 2019 £bn
The Group has generated MCEV operating earnings after tax of £350 million (2012: £307 million).
Group MCEV operating earnings after tax 350 307 6 The Phoenix Group Market Consistent Embedded Value methodology (referred to herein and in the supplementary information as MCEV) is set out in note 1 in the MCEV supplementary information.
EXPECTED EXISTING BUSINESS CONTRIBUTION The Group uses long-term investment returns in calculating the expected existing business contribution. The expected contribution in 2013 of £125 million after tax is £59 million lower than in 2012, primarily due to a decrease in the long-term risk-free rate, narrowing corporate bond spreads and the impacts of equity hedging strategies. The long-term risk-free rate is based on the opening position at 1 January 2013.
The new business margin is 6% after tax (2012: 5%) and represents the ratio of the net of tax new business value to the amounts received as new single premiums.
NON-ECONOMIC EXPERIENCE VARIANCES AND ASSUMPTION CHANGES Non-economic experience variances and assumption changes increased MCEV by £165 million after tax (2012: £68 million). The main drivers of the increase are other operating variances of £83 million (2012: £92 million), reflecting the benefits of modelling improvements made in the period, and experience variances of £79 million (2012: £13 million) principally reflecting favourable longevity experience during the year and benefits from data cleansing projects.
The increase is further enhanced by positive assumption changes of £3 million (2012: negative £37 million). The 2012 result was adversely impacted by a reduction in assumed surrender rates in funds with valuable policyholder guarantees.
MANAGEMENT SERVICES AND IGNIS ASSET MANAGEMENT OPERATING PROFIT Commentary on the management services companies and Ignis Asset Management operating profit is provided in the Group IFRS operating profit section.
GROUP COSTS Group costs were £27 million before tax in the period (2012: £25 million).
ECONOMIC VARIANCES ON NON-LIFE BUSINESS Economic variances on non-life business are negative £48 million (2012: negative £6 million), reflecting the increased market value of the Tier 1 bonds which has decreased MCEV earnings by £84 million before tax (2012: decrease of £28 million before tax). This has been partly offset by fair value gains on interest rate swaps and excess returns on financial assets held by the holding companies.
NON-RECURRING ITEMS ON NON-LIFE BUSINESS Non-recurring items on non-life business reduced embedded value by £61 million before tax (2012: £39 million reduction). Non-recurring items include arrangement and structuring fees of £21 million associated with the re-terming of the Impala loan facility, a loss from a pension liability management exercise of £9 million and £31 million (2012: £39 million) of regulatory change, systems transformation and restructuring costs incurred by the management services companies, together with corporate project and other one-off costs.
Debt finance costs have increased by £17 million mainly reflecting higher interest costs following the re-terming of the Impala loan facility and increased costs associated with the Group’s interest rate swap arrangements.
Remeasurement gains of £2 million (2012: £108 million loss) were recognised in the year in relation to the Pearl Group Staff Pension Scheme. The comparative figure reflected the movement to an IAS 19 deficit as at 31 December 2012. Pension contributions of £18 million (net of tax) were recognised in the year in respect of the PGL Pension Scheme (2012: £23 million).
The operating profit on non-profit and unit-linked funds was £243 million (2012: £288 million). The reduction compared to the prior year reflects lower expected returns of £128 million (2012: £136 million), reduced new business from vesting annuities of £36 million (2012: £40 million) and lower positive impacts of £88 million from modelling improvements, policy harmonisations and data cleansing projects (2012: £117 million).
Of the £243 million of non-profit and unitlinked IFRS operating profits, £36 million was generated on annuity new business. Of this, £16 million related to policies without guaranteed annuity rates. Even for those customers who do not have guarantees, we believe the lifelong certainty of income provided by an annuity will mean these products should continue to provide an attractive retirement option for some policyholders, despite the recent Budget proposals.
The operating profit for management services of £32 million (2012: £28 million) comprises income from the life companies in accordance with the respective management service agreements less fees payable in relation to the outsourcing of services and other operating costs. The increase compared to the prior year reflects lower outsource partner costs and the positive impacts of cost management activities.
GROUP COSTS Group costs were £24 million (2012 restated: £13 million) in the period. The increase in Group costs compared to the prior year relates primarily to defined benefit pension scheme costs which have increased compared to the prior year. This is driven by higher net interest cost, reflecting the opening net defined benefit liability position compared to the opening net defined benefit asset position in the prior year. This was partly offset by miscellaneous income.
AMORTISATION OF ACQUIRED IN-FORCE BUSINESS AND OTHER INTANGIBLES Acquired in-force business and other intangibles of £2.7 billion were recognised on the acquisition of the Pearl businesses.
The acquired in-force business is being amortised in line with the run-off of the acquired businesses. Amortisation of acquired in-force business during the period totalled £99 million (2012: £109 million). Amortisation of other intangible assets totalled £19 million in the period (2012: £18 million).
Finance costs attributable to owners 126 111 1 Finance costs in respect of the Impala and Pearl loan facility agreements (and associated swap interest) and the Royal London PIK notes and facility.
Total including stock lending collateral £bn 1 Stock lending collateral managed by Ignis on behalf of the life companies.
3 Other net inflows of £0.9 billion consists of inflows and outflows relating to assets recaptured from Guardian following the Group’s 2012 annuity transfer transaction of £1.6 billion and £0.4 billion respectively, together with outflows from Group Pension Schemes of £0.3 billion.
Net inflows from third parties were £1.9 billion in the period (31 December 2012: £1.6 billion) with strong performance in the Absolute Return Government Bond Fund (‘ARGBF’) contributing net inflows of £1.4 billion.
In 2012 life company assets of £5.1 billion were transferred to Guardian under the terms of the Group’s annuity transfer transaction of which Ignis was selected to manage £4.7 billion and Castle Hill Asset Management LLC £0.4 billion. As at 31 December 2012, £3.1 billion of these assets had been recaptured and a further £1.6 billion were transferred to Ignis during 2013.
– To optimise the overall gearing ratio to ensure an efficient capital base
– To meet the dividend expectations of shareholders as set by the Group’s dividend policy, within the restrictions in the Group’s two main credit agreements.
The capital policy of each life company is set and monitored by each life company board. These policies ensure there is sufficient capital within each life company to meet regulatory capital requirements under a range of stress conditions. The capital policy of each life company varies according to the risk profile and financial strength of that company.
– capital generation items of £0.4 billion, which included the benefits of the completion of the legal transfer of the annuity liabilities to Guardian.
PLHL ICA SURPLUS (ESTIMATED) In accordance with PRA requirements, the Group undertakes an Individual Capital Assessment (‘ICA’) at the level of the highest EEA insurance group holding company, which is PLHL. This involves an assessment, on an economic basis, of the capital resources and requirements arising from the obligations and risks which exist outside the life companies.
PLHL ICA surplus (estimated) 1.2 1.0 1 Capital resources includes the surplus over capital policy in the life companies, a prudent assessment of the present value of future profits of Ignis Asset Management and the net assets of the holding companies less pension scheme obligations calculated on an economic basis.
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 below: Estimated IGD surplus
2 11-15 year term: AAA – 44bps, AA – 93bps, A – 111bps, BBB – 187bps.
SOLVENCY II 2013 has seen significant developments towards the implementation of the new Solvency II regime with the finalisation of more guidance and the increased certainty around the Solvency II go live date. The Group’s Solvency II delivery programme is designed to ensure that the Group complies with all requirements of the new regime.
LEVERAGE In managing capital the Group seeks to optimise the level of debt on its balance sheet. The Group’s closed book business model allows it to operate with higher leverage than life companies that are still writing new business, as it does not need to fund upfront capital requirements and new business acquisition expenses.
The Group monitors the level of debt on its balance sheet by reference to the gearing ratio calculated as gross shareholder debt3 as a percentage of gross MCEV4. The gearing ratio as at 31 December 2013 under the Group’s methodology is 44% (2012: 55%).
Gross shareholder debt and shareholder debt (including hybrid debt) included in MCEV at 31 December 2013: 2013 £m 2012 £m
Adjustments to include the following items at fair value: PLL subordinated debt 54 30
In February 2013, following a successful equity raising of £250 million, the Group made a £450 million voluntary repayment against the Impala facility and entered into an agreement with the lenders to extend the repayment terms to 2019 (the facility was previously scheduled to mature in the period from 2014 to 2016).
The Pearl facility remains unchanged and will mature in 2016. A £25 million5 mandatory repayment and a £1 million voluntary prepayment were made in the year.
LIQUIDITY MANAGEMENT Details of the Group’s objectives and policies for the management of liquidity risk are included within the Risk management section and note 39 of the IFRS consolidated financial statements.
3 Gross shareholder debt is defined as the sum of the IFRS carrying value of the shareholder debt and 50% of the IFRS carrying value of the Tier 1 bonds given the hybrid nature of that instrument.
4 Gross MCEV is defined as the sum of Group MCEV and the value of the shareholder and hybrid debt as included in the MCEV.
5 This includes £2 million paid to Phoenix Life Assurance Limited, a subsidiary undertaking. Phoenix Life Assurance is a lender under the Pearl facility.
For further details of shareholder debt See note 23 of the IFRS consolidated financial statements 43 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
THE GROUP’S RISK MANAGEMENT FRAMEWORK The Group operates a Risk Management Framework (‘RMF’) which seeks to establish a coherent and proactive set of arrangements and processes to support the effective management of risk throughout the Group. The components of the framework are shown below. The outputs of the RMF provide assurance that risks are being appropriately identified and managed and that an independent assessment of management’s approach to risk management is being performed.
For a summary of the principal risks and uncertainties facing the Group Turn to page 49 44 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
The risk appetite and control framework supports the Group in operating within the boundaries of these statements by seeking to limit the volatility of key parameters, under a range of adverse scenarios agreed with the Board. Risk appetite limits are chosen which specify the maximum acceptable likelihood for breaching the agreed limits. Assessment against the appetite targets is undertaken through scenario testing. Breaches of appetite are corrected through management actions where appropriate.
GOVERNANCE, ORGANISATION AND POLICIES GOVERNANCE Overall responsibility for approving, establishing and embedding the RMF rests with the Board. The Board recognises the critical importance of having an efficient and effective RMF and appropriate oversight of its operation. There is a clear organisational structure in place with documented, delegated authorities and responsibilities from the Group Board to the PLHL Board, the Boards of Phoenix Life, Ignis Asset Management and the Executive Committee.
For further details of the Level 1 risk categories Turn to note 39 of the IFRS consolidated financial statements 45 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
FIRST LINE: MANAGEMENT Management of risk is delegated from the Board to the Group Chief Executive Officer, Executive Committee members and through to business managers. A series of business unit management oversight committees operate within the Group. They are responsible for implementation of the RMF, ensuring the risks associated with the business activities are identified, assessed, controlled, monitored and reported.
First line of defence Third line of defenceSecond line of defence
BUSINESS PERFORMANCE AND CAPITAL MANAGEMENT Business unit plans are assessed to ensure that they do not breach any of the Board’s risk appetite statements over the planning horizon. Business performance is routinely monitored at a business unit executive level with consolidated reporting against the annual operating plan approved by the Board and reviewed by the Executive Committee.
TECHNOLOGY AND INFRASTRUCTURE The Group employs systems to support the assessment and reporting of the risks it faces. This enables management to document key risks and controls and evidence the assessment of them at a frequency appropriate to the operation of the control. During 2013 the Group rolled out a new Risk Management information system to further support the embedding of the RMF.
Further details of the Group’s exposure to financial and insurance risks and how these are managed are provided in note 39 of the IFRS consolidated financial statements.
The Group has ongoing obligations to meet payments to creditors which are funded by the release of capital and profits from its business units. 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 embedded value, financial condition and prospects.
The Group undertakes regular monitoring activities in relation to market risk exposure, including the monitoring of asset mixes, cash flow forecasting and stress and scenario testing. In response to this, the Group may implement de-risking strategies to mitigate against unwanted customer and shareholder outcomes. The Group also maintains cash buffers in its holding companies to reduce reliance on emerging cash flows.
Significant counterparty failure. Assets held to meet obligations to policyholders include debt securities. Phoenix Life is exposed to deterioration in the actual or perceived creditworthiness or default of issuers of relevant debt securities or from trading counterparties failing to meet all or part of their obligations; such as reinsurers failing to meet obligations assumed under reinsurance arrangements or derivative counterparties or stock-borrowers failing to pay as required. An increase in credit spreads on such securities, particularly if it is accompanied by a higher level of actual or expected issuer defaults, could have a material adverse impact on the Group’s financial condition.
The Group is targeting a gearing ratio of 40% by the end of 2016. At this lower level of gearing, a wider range of funding opportunities such as increased access to the debt capital markets should become available to the Group.
The Group has ongoing principal repayment and interest obligations to its lending syndicates. In the event that transfers from the Group’s operating subsidiaries are limited by any law, regulatory action or change in established approach or interpretation, this may impair the Group’s ability to service these obligations. In addition, if the legislation or regulation to which the Group is subject to in relation to Group capital is amended, interpreted or applied in a new way, the Group may have to retain more capital. The implementation of directives and other legislative changes such as Solvency II could have this effect and may therefore have a material adverse effect on the Group’s results, financial condition and cash flows.
The following report provides highlights of the Group’s 2013 Corporate Responsibility programme.
Corporate Responsibility (‘CR’) continues to be embedded within Phoenix Group. Since joining Business in the Community (‘BITC’) in 2010, the CR programme has grown in maturity, is better aligned to the business model and has increased commitment from staff. BITC is a business-led charity offering advice and support to its members, promoting the importance of future sustainability. The Group welcomes the tangible and intangible benefits that CR brings for all stakeholders – staff, suppliers, customers, shareholders, investors and the communities in which we are based.
As a responsible business, the Group has launched several initiatives to lessen or counteract the impact it is making on the environment.
Phoenix Life and the Group offices have moved to a single IT provider, bringing a number of environmental benefits including eco-friendly printing equipment, enhanced remote working capability and ‘free’ telephone conferencing. All paper within the Group is sourced from sustainable, managed forests and payslips are now online. Customer annual statement mailings were also reduced by an estimated 5.2 million sheets of paper during the year.
At the end of 2013, the Group commenced a one-year partnership with the Heart of England Forest Limited, whose aim is to ‘conserve and establish trees for the benefit of the public’ and 1,000 oak trees were planted in an area close to the Phoenix Life site in Wythall.
Phoenix Group’s chosen intensity measurement: Emissions reported above normalised to per m2 0.03 tonnes CO2e/m2
Emissions reported above normalised to kgs per m2 34.83 kgs CO2e/m2
As this is the first year of mandatory greenhouse gas emissions reporting, there is no comparison year.
The Group is conscious of the contribution it makes to the communities in which it operates and obligations to the broader society. In 2013, the Group was actively engaged in supporting communities local to each site, with the aim of being a responsible member of that community.
The Group’s relationships with customers, investors, outsource and other business partners, suppliers, regulators, Government and the media remain key in the development of its CR programme.
The Group won the ‘Head of AML and Fraud Prevention of the Year’ award at the Thompson Reuter Compliance Awards in 2013 in recognition for the work done to protect policyholders from the negative impacts of pension liberation. In addition, the Group won the National Outsourcing Association ‘Academic Achievement’ award and was runner-up in the ‘Relationship Management Team of the Year’ award, recognising its commitment to continued development and management of strategic relationships.
CONCLUSION The Group remains committed to its CR programme and in 2014 will be driving through initiatives that continue to benefit both the Group and its many stakeholders. In addition, work will continue with staff to ensure the CR programme continues to be embedded into daily working life and that the benefits of CR best practice are continually shared.
WYTHALL GREEN, BIRMINGHAM Phoenix Life operates out of Wythall Green. For further details, turn to page 14.
René-Pierre Azria is Chief Executive Officer of Tegris Advisors LLC, a US private advisory firm specialising in strategic financial analysis and mergers and acquisitions. Prior to founding Tegris, Mr Azria was a worldwide partner with Rothschild & Co. Prior to joining Rothschild in 1996, Mr Azria served as Managing Director of Blackstone Indosuez and president of Financiére Indosuez Inc. in New York. Mr Azria serves as a director of two privately-held book publishers in France and the US. Mr Azria was appointed to the Board of Directors of the Company on 2 September 2009. He is a member of the Board Investment and Board Risk Committees.
David Barnes joined the RBS Group (then Williams & Glyn’s Bank) in 1973 and remained there in various roles until his early retirement in February 2009. His roles included Relationship Banker in the then newly established Corporate Division, Managing Director of the Financial Institutions Relationship Management team and member and subsequently Chairman of RBS’s credit committee. From 2005 he was responsible for all lending to financial institutions and for capital management for RBS’s Financial Institutions Group. Mr Barnes was appointed to the Board of Directors of the Company on 2 September 2009. He is a member of the Board Audit and Board Remuneration Committees.
Ian Cormack was appointed to the Board of Directors of the Company on 2 September 2009 and was appointed Senior Independent Director on 1 October 2013. Ian Cormack is Non-Executive Chairman of Maven Income & Growth VCT 4 plc and is a Senior Independent Director of Partnership Assurance Group plc, Bloomsbury Publishing Plc and Xchanging plc. Mr Cormack was Chief Executive Officer of AIG, Inc. in Europe from 2000 to 2002 and was Chairman of Citibank International plc and co-head of the Global Financial Institutions Client Group at Citigroup. Mr Cormack served on the Board of Directors of the former Pearl Group Limited from May 2005 to September 2009. Mr Cormack is Chairman of the Board Remuneration Committee and a member of the Board Nomination Committee.
Manjit Dale is a founding partner of TDR Capital, a private equity firm established in 2002. TDR Capital manages over €2.6 billion of assets on behalf of a variety of institutional pension funds, university endowments and private individuals. Prior to founding TDR Capital, Mr Dale was Managing Partner at Deutsche Bank Capital Partners Europe. He has served on the boards of Pizza Express and Center Parcs and currently also serves on the board of Algeco Scotsman. Mr Dale has over 20 years’ experience in private equity, finance and consulting gained with Bankers Trust, 3i plc, NM Rothschild and Andersen Consulting. Mr Dale graduated from Cambridge University with an honours degree in Economics. He served on the Board of the former Pearl Group Limited from December 2004 to September 2009. Mr Dale was appointed to the Board of Directors of the Company on 2 September 2009 and is a member of the Board Investment Committee.
OUR EXECUTIVE MANAGEMENT TEAM Executive management of the Group is led by the Group Chief Executive Officer, Clive Bannister, who is supported by the Executive Committee (‘ExCo’).
− Maximises shareholder value through clear, rigorous assessment of business opportunities.
− Leads development and delivery of the Phoenix Life business strategy, including the continued integration of life businesses
− Leads the Phoenix Life business to optimise outcomes for customers in terms of both value and security
− Ensures Phoenix Life deploys capital efficiently and effectively, with due regard to regulatory requirements and the risk universe and strategy.
− Ensures Ignis achieves its key goals of meeting or exceeding investment performance expectations, providing clients with creative solutions to changing product needs and maintaining a well controlled and efficient operating platform
− Leads external Group communications in liaison with the Group Finance Director and Head of Investor Relations.
− Leads provision of legal advice to the Group Board, other Phoenix Group Boards, ExCo and senior management
− Oversees and co-ordinates adherence to appropriate corporate governance procedures across the Group
− Leads the Group’s risk management function, embracing changes in best practice and regulation
− Oversees and manages the Group’s relationship with the FCA and PRA
− Supports the Group Board Risk Committee in the oversight of the Group’s risk framework, in line with risk strategy and appetite.
Set out below are the results of our governance code compliance and our shareholder meetings since 2010.
GOVERNANCE CODE − 2010 – Combined Code compliant in all but two matters
− 2011 – UK Corporate Governance Code compliant in all but one matter
− 2013 – UK Corporate Governance Code compliant in all matters.
SHAREHOLDER MEETINGS − 2010 AGM (first AGM) – all 22 resolutions passed by a majority of at least 87% of votes cast
− 2013 AGM – all 20 resolutions passed by a majority of at least 96% of votes cast.
The chart below shows how the membership of the Board has evolved. The UK Corporate Governance Code states that independent Non-Executive Directors should comprise at least half the Board, excluding the Chairman.
To ta l n um be r o f D ire ct or s
CORPORATE GOVERNANCE REPORT CONTINUED INTRODUCTION Phoenix Group Holdings is a member of the FTSE 250, having achieved a Premium Listing on the London Stock Exchange in July 2010. The Board is committed to high standards of corporate governance and supports 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 2013 with the provisions set down in the Code. These include the new provisions of the September 2012 version of the Code which apply to the Company for the 2013 reporting period. Several of the new provisions are addressed in the Audit Committee Report section of this report.
THE BOARD The Board comprises the Non-Executive Chairman, the Group Chief Executive Officer, the Group Finance Director and eight other NonExecutive Directors, six of whom are independent. Biographical details of all directors are provided on pages 56 to 57. The Board considers that the following directors are independent as they do not have any interest or business or other relationship which could, or could be perceived to, interfere materially with their ability to act in the best interests of the Company: Alastair Barbour, David Barnes, Ian Cormack, Tom Cross Brown, Isabel Hudson and David Woods. The Board has considered the criteria proposed by the Code in assessing the independence of the directors.
The Board is responsible to the shareholders for the overall governance and performance of the Group. Overall, the Board’s role is to provide entrepreneurial leadership within a framework of prudent and effective controls which enables risk to be assessed and managed. The Board has a schedule of matters reserved for its consideration and approval supported by a set of operating principles. These matters include: − Group strategy and business plans
BOARD EFFECTIVENESS In accordance with the Code, an evaluation of the performance of the Board and that of its committees and individual directors was undertaken in the latter part of 2013. The process involved completion by directors of a questionnaire covering various aspects of Board and director effectiveness followed by individual meetings between the Chairman and each director, concluding in a Board report which was discussed by the Board in December 2013. The following areas were covered: 60 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
− Individual director performance which will be used in revising the training programme for directors
The output from the Board and individual director reviews informed the review of the Board composition and structure undertaken by the Board Nomination Committee in January 2014, leading to the Board’s recommendations to shareholders regarding re-election of directors at the 2014 Annual General Meeting (‘AGM’).
All directors receive a tailored induction on joining the Board in accordance with a process approved by the Board. To ensure that the directors maintain up-to-date skills and knowledge of the Company, all directors receive regular presentations on different aspects of the Company’s business and on financial, legal and regulatory issues.
Maximum Actual Maximum Actual Maximum Actual Maximum Actual Maximum Actual Maximum Actual
Executive Directors Clive Bannister 7 6 – – – – – – – – – – Jim McConville 7 7 – – – – – – – – – – Non-Executive Directors Ian Ashken1 3 3 – – – – – – – – – –
2 Alastair Barbour was appointed to the Board on 1 October 2013.
3 Charles Clarke resigned from the Board on 2 May 2013.
CORPORATE GOVERNANCE REPORT CONTINUED BOARD COMMITTEES The Board has delegated specific responsibilities to five standing committees of the Board. The terms of reference of the committees can be found on the Company’s website.
AUDIT COMMITTEE ALASTAIR BARBOUR, Chairman (who succeeded Alastair Lyons as Chairman from 1 October 2013 following Mr Lyons’ resignation from the Board) DAVID BARNES ISABEL HUDSON The composition of the Audit Committee is in accordance with the requirements of the Code that the Audit Committee should consist of at least three independent Non-Executive Directors of whom at least one has recent and relevant financial experience. Both Alastair Barbour and Isabel Hudson have that experience. The Audit Committee met seven times during 2013. Its meetings are attended by the Chairman of the Risk Committee, the Group Finance Director, the Group Financial Controller, the Group Head of Internal Audit, the external auditors and usually also by the Group Chairman and the Group Chief Executive Officer. The Audit Committee holds private meetings at least annually with each of the Group Finance Director, the Group Head of Internal Audit and the external auditors.
− Monitoring the overall integrity of the financial reporting by the Company and its subsidiaries and the effectiveness of the Group’s internal controls
− Provision of advice to the Board to enable the Board to report on whether the Annual Report and Accounts, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the Group’s performance, business model and strategy
Statements, recommending their approval to the Board, as well as related disclosures and the financial reporting process, supported by reports from management and the external auditors
− Reviewed the financial forecasts prepared by management, supported by the sensitivity analysis on the key assumptions underpinning the forecasts, in support of the assumption that the Group will continue as a going concern and in support of dividend payments
External audit − Reviewed the effectiveness, engagement and remuneration of the external auditors, recommending their re-appointment to the Board and thence to shareholders
− Considered and agreed the timing for a tendering exercise for the external audit engagement – see ‘Auditor’s appointment’ below.
Standards, the conclusion being that the internal audit function remains effective in its role
− Considered, and agreed to aim for full compliance with, the proposals of the code of the Chartered Institute of Internal Auditors entitled ‘Effective Internal Audit in Financial Services’.
SIGNIFICANT ISSUES CONSIDERED BY THE AUDIT COMMITTEE IN RELATION TO THE FINANCIAL STATEMENTS Significant issues in relation to the 2013 IFRS financial statements and MCEV supplementary information
− A summary of these papers was presented for oversight review by the Audit Committee, and the Phoenix Life Audit Committee’s conclusions were reported to the Audit Committee through minutes of its meeting and a discussion between the Chairmen.
− The Audit Committee received and considered detailed written and verbal reporting from the external auditors setting out their observations and conclusions in respect of the assumptions, processes and actuarial models.
− Pension assumptions for use in the IAS 19 Employee Benefits valuations were reviewed by the Audit Committee prior to the finalisation of the valuation reports.
− The review considered tax risks, how these were rated and reserved and their potential impact on capital, cash, MCEV, gearing and the IFRS financial statements.
− Valuation of financial assets − Management presented papers setting out the basis of valuation of financial assets, including changes in methodology and assumptions, for the interim and year-end reporting periods to the Phoenix Life Audit Committee. The assumptions, valuations and processes, particularly for financial assets determined by valuation techniques using significant non-observable inputs (Level 3), were debated and challenged by the Phoenix Life Audit Committee prior to being approved.
− The valuation information was then presented for oversight review by the Audit Committee.
− Assessment of whether the Annual Report and Accounts are fair, balanced and understandable
− In November 2013 the Audit Committee approved the processes to be established that would provide comfort to the Board that the 2013 Annual Report and Accounts, taken as a whole, are fair, balanced and understandable. An update was provided at the January 2014 Audit Committee meeting which allowed the Committee to refine the process.
− During the March 2014 Audit Committee meeting, the Committee considered an analysis of the processes and conclusions in support of management’s conclusion that the Annual Report and Accounts are fair, balanced and understandable.
− The Audit Committee as part of their review of the Annual Report and Accounts and production processes satisfied themselves that this conclusion could be supported and reported their views to the Board.
− Going concern analysis − A comprehensive going concern assessment was undertaken by the Audit Committee for the 2013 year end and 2013 interim reporting periods, based on an assessment by management of the Group’s liquidity for the going concern review period together with forecasts and a stress and sensitivity analysis. The analysis also confirmed that all regulatory and working capital requirements would be met under the base case and adverse stress scenarios throughout the going concern review period.
− The Audit Committee reviewed the recommendations advocated by Lord Sharman’s report, ‘Going Concern and Liquidity Risks: Lessons For Companies and Auditors’ which was issued in January 2013 and improved the Group’s disclosures in this regard.
ASSESSMENT OF THE EFFECTIVENESS OF THE EXTERNAL AUDIT PROCESS The effectiveness of the external audit process was assessed through the completion of an assessment questionnaire by the key divisions and Group functions within Phoenix Group. The respondents were asked to answer questions to collate feedback in respect of three areas of audit performance: evaluation of the audit team; quality of service and communication; and interaction of auditors with client. The questions asked respondents to rate performance on a scale of one (poor) to four (excellent) and to provide comments. The effectiveness of the process was then reviewed by the Audit Committee supported by a presentation from the Group Finance Director.
The assessment process also informed the recommendation by the Audit Committee to the Board for the re-appointment of Ernst & Young (‘EY’) as the Group’s auditors which was approved by shareholders at the AGM on 2 May 2013.
AUDITOR’S APPOINTMENT The current auditors, EY, were appointed in September 2009. However, EY have been auditors to significant parts of the Group for a longer period. There are currently two group audit partners for Phoenix Group, the UK partner George Reid and Dutch partner Jasper Kolsters, who commenced his role in 2013. The UK partner will be replaced by Ed Jervis after the 2013 audit in accordance with the Group’s rotation principles. The Audit Committee has decided to undertake an audit tender during the next Group UK audit partner’s tenure, so that the tender will be undertaken between five and ten years after the current appointment commenced.
The standard process used by the Nomination Committee for Board appointments involves the use of an external search consultancy to source candidates external to the Group (and may in the case of executive appointments also consider internal candidates). Detailed assessments of short-listed candidates are undertaken by the search consultancy, followed by interviews with Committee members and other directors and the sourcing of references before the Committee recommends the appointments to the Board. This process was used for the appointment of the Audit Committee Chairman in 2013. The search consultancy used in 2013 for director appointments was The Zygos Partnership which has no other connection with the Company.
and the appointment of the Senior Independent Director (existing director). The outcome was the appointment of Alastair Barbour (as Audit Committee Chairman from 1 October 2013) and of Ian Cormack (as Senior Independent Director, also from 1 October 2013)
− Reviewed the balance of skills, diversity, experience, independence and knowledge on the Board, taking account of the Board Evaluation Report
− Reviewed the structure, size and composition of the Board, taking account of the Board Evaluation Report, endorsing the recommendation from the November 2012 Board Evaluation Review that the size of the Board should be reduced from 14 to around 12 in the near term and to around ten in the medium term
− Reviewed the time spent by directors in fulfilling their duties, noting that it was substantial in comparison with the FTSE 250 average
− Reviewed the proposed new Non-Executive Director appointments to the Ignis Asset Management Board, prior to their appointment.
The Board’s policy on diversity was outlined by the statement of former Chairman, Ron Sandler, released on the Phoenix Group website in October 2011 in response to the Lord Davies review of ‘Women on Boards’, as follows: “As we already have a large Board of 14 directors (including one female director) and are unlikely to want to increase its size, it is difficult at this stage to commit to firm percentages regarding the number of women on our Board in 2013 and 2015. Nonetheless, we have set targets of two female directors by 2013 and a further female director by 2015. Our overriding aim remains the appointment of the most appropriate candidates to the Board.” As stated in the Chairman’s introduction to this Report, the Board is now a size considered appropriate by recent Board evaluations, and the recruitment of an additional female director is a priority. The Board and Nomination Committee will continue to consider Board balance and diversity, in particular during the annual Board evaluation review.
CORPORATE GOVERNANCE REPORT CONTINUED RISK COMMITTEE DAVID WOODS, Chairman RENÉ PIERRE AZRIA TOM CROSS BROWN ISABEL HUDSON The establishment of a Risk Committee is not a requirement of the Code. However, the Board believes such a committee is important to ensure the robust oversight of the management of risk within the Group. The composition of the Risk Committee, with a majority of independent Non-Executive Directors, is in accordance with the final recommendations of the report by Sir David Walker titled ‘A review of corporate governance in UK banks and other financial industry entities’. The Risk Committee met six times in 2013.
RISK COMMITTEE’S PRINCIPAL ACTIVITIES DURING 2013 − Recommended to the Board the Group’s risk appetite
− Recommended to the Board the Group’s overall risk management strategy
− Reviewed the Group’s risk profile, monitoring it against the risk categories of Market, Insurance, Credit, Liquidity and Operational with particular attention to risk appetite, risk trends, risk concentrations, provisions, experience against budget and key performance indicators for risk
− Reviewed the performance of the Financial Management Group executive team whose main purpose is to focus on asset and liability management
The Company’s Investor Relations department is dedicated to facilitating communication with investors and analysts and an active investor relations programme is maintained. The Company continued its communication and engagement with the investment community during 2013. At these meetings a wide range of relevant issues including strategy, performance, management and governance are discussed. The Chairman, Senior Independent Director and Executive Directors are available to meet investors and analysts when required. Should major shareholders wish to meet newly appointed directors, or any of the directors generally, they are welcome to do so.
The directors consider it important to understand the views of the market. Board members regularly receive copies of the latest analyst reports on the Company and the sector, as well as market feedback to further develop their knowledge and understanding of external views about the Company. The Chairman and the Non-Executive Directors provide feedback to the Board on topics raised with them by major shareholders. In addition, investor days are conducted periodically. The Company also undertakes perception studies, when appropriate, designed to determine the investment community’s view of the core business from both institutional fund managers and sell-side analysts.
The Company’s AGM provides another opportunity to communicate with its shareholders. At the 2013 meeting, the Company complied with the Code provisions relating to voting and the separation of resolutions. Shareholders were invited to ask questions during the meeting. It is intended that the same processes will be followed at the 2014 AGM. In line with the Code, details of proxy voting by shareholders will be made available at the meeting and will be posted on the Company’s website following the meeting.
FINANCIAL REPORTING AND GOING CONCERN The directors have acknowledged their responsibilities in the Statement of Directors’ Responsibilities in relation to the IFRS financial statements for the year ended 31 December 2013.
The Board’s going concern assessment is included within the Directors’ report on page 92.
DEAR SHAREHOLDER On behalf of the Board, I am pleased to welcome you to our Directors’ Remuneration Report for the year ended 31 December 2013.
This year’s Remuneration Report is the first to be prepared under the new UK regime for the reporting of executive pay and to comply with the requirements of the new regime, we now have two sections of the report that cover the following matters: − Part A: the Company’s Remuneration Policy for each of the components of Directors’ remuneration (the Directors’ Remuneration Policy Report)
Performance of the Company in 2013 2013 was again a successful year at Phoenix Group and this is fully detailed in the Group Chief Executive Officer’s report at the beginning of this Annual Report and Accounts. Particular performance highlights included: − The successful capital raising and debt re-terming in February 2013
− Incremental MCEV of £502 million achieved since 2011, exceeding our target a year ahead of plan
− Gearing reduced by 11 percentage points to 44% during 2013.
Consistent with this strong performance, the Committee approved a corporate factor under the Annual Incentive Plan (‘AIP’) of 75% of maximum. Consistent with previous years, the Remuneration Committee looked at the indicative out-turn suggested by the formula and applied judgement to moderate the result to reduce the factor to this level having regard to progress against stretching internal strategic goals set by the Board which, while demonstrative of good progress, warranted some level of moderation.
− The salary level for the Group Finance Director, James McConville, was increased by 10%. Consistent with best practice guidelines, James McConville was originally recruited in 2012 on a lower starting salary than his predecessor, and the increase now being made reflects that he is fully established in the role. Clive Bannister declined a proposed salary increase in 2014 and in consequence, his salary remains unchanged from his initial appointment in 2011.
− More broadly, the Remuneration Committee continues to consider the appropriate comparators for the Group’s pay structure to be both relevant insurance companies and companies in the FTSE 31-100 as a whole (being a pan-sector group which is closely aligned with pay across the insurance sector more generally). The broader pan-sector group is seen as providing an appropriate comparison to Phoenix Group in terms of the total enterprise value of the entity (taking account of Phoenix Group’s shareholder debt) and the complexity of the business. Additionally, when the Group recruits senior executives it is generally in competition with this category of company. However, as explained in our Directors’ Remuneration Policy, the Remuneration Committee does not follow such data strictly but instead uses it as a reference point to inform its judgement.
In considering the Company’s remuneration arrangements, the Remuneration Committee has been mindful of developments in both regulatory and best practice. At the time of writing, we still await guidance on the form and timing of any insurance specific remuneration guidelines which may form part of the Solvency II implementation process, although the Remuneration Committee continues to apply the more general Financial Conduct Authority (‘FCA’) Remuneration Code as appropriate as being reflective of best practice.
The Remuneration Committee considers that the current arrangements are appropriate to the Group and its commercial situation and reflect UK best practice, and I hope that we can rely on the support of our shareholders for the resolutions on remuneration matters which will be proposed at the 2014 AGM.
INTRODUCTION We have presented this Remuneration Report to reflect the recent changes in reporting requirements on remuneration matters for companies with a UK governance profile, particularly the UK’s new Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 (the ‘new UK regulations’). The Company intends to comply with the reporting obligations within the new UK regulations as a matter of good practice although it is not strictly required to do so as a non-UK incorporated quoted company. The Remuneration Report also describes how the Board has complied with the provisions set out in the UK Corporate Governance Code relating to remuneration matters.
− 2013 base salaries were as follows: Group Chief Executive Officer – £700,000; Group Finance Director – £400,000
− No base salary increases were implemented for Executive Directors in January 2011, January 2012 or January 2013
− The Group Chief Executive Officer declined any salary increase for 2014. The Group Finance Director’s salary is £440,000 from 1 January 2014 (10% increase)
Pension To provide retirement benefits and remain competitive within the market place
− All Executive Directors are eligible to participate in the Group Personal Pension (‘GPP’). Executive Directors receive a contribution to GPP or they may opt to receive the contribution in cash if they are impacted by the relevant lifetime or annual limits
− Phoenix will honour the pensions obligations entered into under all previous policies in accordance with the terms of such obligations
− Both the Group Chief Executive Officer and Group Finance Director received contributions equivalent to 20% of base salary. The Group Chief Executive Officer receives a payment into the GPP up to the HMRC annual contributions limit and the balance of his annual contribution was received as a cash supplement (less a deduction for employers’ national insurance contributions). The Group Finance Director’s contribution was received as a cash supplement (less a deduction for employers’ national insurance contributions). Such supplements are not taken into account as base salary for calculation of AIP, LTIP or other benefits *This section does not technically form part of the Directors’ Remuneration Policy but does form part of the Annual Implementation Report. It is included here for information only.
− Deferral of AIP outcomes into shares is currently made under the Phoenix Group Holdings’ Deferred Bonus Share Scheme (‘DBSS’) and DBSS awards are made following the announcement of annual results in accordance with the DBSS rules
− In respect of the financial performance measures, attaining the threshold performance level produces a £nil annual incentive payment and for non-financial performance measures the threshold level of performance produces an annual incentive outcome that is 10% of the weighting given to these measures
− The outcomes against the performance measures for 2013 are summarised within the AIP Outcomes table following the Single Figure of Remuneration table 2014 AIP − The AIP maximum potential level for 2014 and the potential proportion payable at target is unchanged from that for 2013 as stated above
− Proposed performance measures for 2014 AIP are summarised in the notes to the Policy Table *This section does not technically form part of the Directors’ Remuneration Policy but does form part of the Annual Implementation Report. It is included here for information only.
− Awards are made following the announcement of annual results in accordance with the LTIP rules
− The Company will honour the vesting of all awards granted under previous policies in accordance with the terms of such awards
− The formal limit under the LTIP is 300% of base salary per annum (and 400% per annum in exceptional cases)
2013 LTIP − Annual awards were made to the Group Chief Executive Officer and Group Finance Director at the level of 200% of base salary per annum
− As referred to in the Remuneration Committee Chairman’s introduction, due to regulatory constraints the Company was not able to make these awards at the normal time (April 2013) and accordingly made them in November 2013
− The performance conditions for the 2013 LTIP awards are described on page 86 2014 LTIP − LTIP awards in 2014 will be made at comparable levels to those for 2013
− Performance measures and performance targets for LTIP awards in 2014 will be set on a similar basis to those for 2013, and more details are given below this table *This section does not technically form part of the Directors’ Remuneration Policy but does form part of the Annual Implementation Report. It is included here for information only.
− Sharesave – the Remuneration Committee has the facility to allow individuals to save up to a maximum of £500 each month (or such other level as permitted by HMRC legislation) for a fixed period of three or five years. At the end of the savings period, individuals may use their savings to buy ordinary shares in the Company at a discount of up to 20% (although for 2014 and past years this has been set at 15%) of the market price set at the launch of each scheme
− Consistent with normal practice, such awards are not subject to performance conditions
− Only beneficially owned shares and vested share awards (discounted for anticipated tax liabilities) may be counted for the purposes of the guidelines. Share awards do not count prior to vesting (including DBSS awards)
− Once shareholding guidelines have been met, individuals are expected to retain these levels as a minimum. The Remuneration Committee will review shareholdings annually in the context of this policy
− 200% of base salary for the Group Chief Executive Officer, 100% of base salary for all other Executive Directors
− Additional fees are paid to Non-Executive Directors who chair or sit on a board committee, or on boards of subsidiary entities or on the Solvency II Model Governance Committee and to the Senior Independent Director (‘SID’)
− Fee levels for Non-Executive Directors are reviewed annually with any changes normally taking effect from 1 January
− In 2013, fee levels remained at £325,000 for the Chairman, £90,000 for the role of Non-Executive Director with additional fees of: (i) £5,000 payable for the role of SID; and/or (ii) £10,000 payable where an individual also chairs the Audit, Investment, Remuneration or Risk Committee; and/or (iii) £20,000 payable where a Non-Executive Director also serves on the board of a subsidiary company and/or (iv) £10,000 payable for service on the Solvency II Model Governance Committee. The fees of Non-Executive Directors who are not paid for serving on subsidiary company boards remained at £100,000 in accordance with their agreements on joining the Board *This section does not technically form part of the Directors’ Remuneration Policy but does form part of the Annual Implementation Report. It is included here for information only.
NOTES TO THE REMUNERATION POLICY TABLE 1. AIP performance measures For 2014, AIP performance measures are based on the achievement of strategic and individual objectives for 30% of the annual incentive opportunity and, for the other 70% of annual incentive opportunity, performance measures are based on financial and non-financial performance indicators as follows: Performance metric % of 70% of incentive potential based on KPIs
These weightings between financial and strategic and individual measures for the 2014 AIP, and within the matrix of applicable financial measures, represent a minor change from the equivalent weightings applied for the 2013 AIP. The proportion dependent on strategic and individual objectives has been increased for 2014 in light of the priority given to key strategic targets. The weighting for subsequent years will be kept under review.
Given the closed fund nature of the Company, and that the Board periodically looks at other transactions to enhance value for shareholders, whilst the performance measures for AIP are disclosed, the detailed targets for the performance measures are considered commercially sensitive. Such information is likely to remain so and accordingly will not be disclosed subsequently.
2. Performance conditions for LTIP awards in 2014 LTIP awards to be made to the Executive Directors in 2014 have performance measures of which 40% is based on MCEV growth, 40% is based on cumulative cash generation and the remaining 20% is subject to TSR performance against the constituents of the FTSE 250 (excluding investment trusts), with each target measured over the three financial years commencing 1 January 2014. The performance targets for each of the performance measures will be determined by the Remuneration Committee shortly before the awards are made.
The Remuneration Committee selected these performance measures for 2014 as they are directly linked to the objectives set out in the Group’s strategy, there is a direct link with shareholder value and there is a clear line of sight for participants between performance and reward. The balance between the performance measures is appropriate and consistent with the types of balanced scorecards seen elsewhere in the sector.
4. Stating maximum amounts for the Remuneration Policy The new UK regulations and related investor guidance encourages companies to disclose a cap within which each element of remuneration policy will operate. Although the Company is not subject to these provisions, the Remuneration Committee has decided to set and disclose limits in this report on a voluntary basis. Where maximum amounts for elements of remuneration have been set within the Directors’ Remuneration Policy, these will operate simply as caps and are not indicative of any aspiration.
RECRUITMENT REMUNERATION POLICY The Company’s recruitment remuneration policy aims to give the Remuneration Committee sufficient flexibility to secure the appointment and promotion of high-calibre executives to strengthen the management team and secure the skill sets to deliver our strategic aims.
− For an internal appointment, any variable pay element awarded in respect of the prior role may either continue on its original terms or be adjusted to reflect the new appointment as appropriate
− For external and internal appointments, the Remuneration Committee may agree that the Company will meet certain relocation expenses as it considers appropriate
− All such replacement awards, whether under the AIP, LTIP or otherwise, will take account of the service obligations and performance requirements for any remuneration relinquished by the individual when leaving a previous employer. The Remuneration Committee will seek to make replacement awards subject to what are, in its opinion, comparable requirements in respect of, service and performance. However, the Committee may choose to relax this requirement in certain cases (such as where the service and/or performance requirements are materially completed), and where the Remuneration Committee considers it to be in the interest of shareholders or where such factors are, in the view of the Remuneration Committee, reflected in some other way, such as a significant discount to the face value of the awards forfeited. Exceptionally, where necessary, this may include a guaranteed or non pro-rated annual incentive in the year of joining
Benefits measured as benefits paid in 2013 as set out in the single figure table but excluding relocation payments for James McConville which ceased in May 2013
On-target Based on what the Director would receive if performance was on-target: − AIP: consists of the on-target annual incentive (75% of base salary)
− LTIP: consists of the threshold level of vesting (50% of base salary). The benefit of a single year’s participation in the Sharesave scheme is recognised using an expected value for the Sharesave options of 30%. The benefit of a single year’s participation in the SIP is recognised using one matching share for every six shares invested on the maximum value which can be invested
− LTIP: assumes maximum vesting of awards and valued as on the date of grant (200% of base salary). Sharesave and SIP valued on the same basis as in the on-target column
Clive Bannister 7 February 2011 12 James McConville 28 May 2012 12
Termination policy summary In practice, the facts surrounding any termination do not always fit neatly into defined categories for good or bad leavers. Therefore, it is appropriate for the Remuneration Committee to consider the suitable treatment on a termination having regard to all of the relevant facts and circumstances available at that time. This policy applies both to any negotiations linked to notice periods on a termination and any treatment which the Remuneration Committee may choose to apply under the discretions available to it under the terms of the AIP, DBSS and LTIP plans. The potential treatments on termination under these plans are summarised below.
If a leaver is deemed to be a ‘bad leaver’; typically voluntary resignation or leaving for disciplinary reasons
AIP Pro-rated annual incentive. Prorating to reflect only the period worked. Performance metrics determined by the Remuneration Committee
The Company has power to enter into settlement agreements with executives and to pay compensation to settle potential legal claims. In addition, and consistent with market practice, in the event of termination of an Executive Director, the Company may pay a contribution towards the individual’s legal fees and fees for outplacement services as part of a negotiated settlement. Any such fees would be disclosed as part of the detail of termination arrangements. For the avoidance of doubt, the policy does not include an explicit cap on the cost of termination payments.
CONSIDERATION OF EMPLOYMENT CONDITIONS ELSEWHERE IN THE GROUP As explained in the general policy section of the Directors’ Remuneration Policy, the Remuneration Committee takes into account Groupwide pay and employment conditions. The Remuneration Committee reviews the average Group-wide base salary increase and annual incentive costs and is responsible for all discretionary and all-employee share arrangements.
Consistent with normal practice, the Remuneration Committee did not consult with employees in preparing the Directors’ Remuneration Policy.
The Remuneration Committee also seeks to build an active and productive dialogue with investors on developments in the remuneration aspects of corporate governance generally and any changes to the Company’s executive pay arrangements in particular. The Remuneration Committee consulted with its largest shareholders before awarding the 2014 base salary increase to the Group Finance Director.
Information contained in Part A which is expressly stated as forming part of the Annual Implementation Report is incorporated in this Part B by reference.
− Review the design of and agree targets for any performance-related incentive schemes operated by the Group and approve the total annual payments made under such schemes.
− Re-consider the 2013 LTIP grants given the delay in their being awarded.
− Review the design of all share-based plans for approval by the Board and shareholders, including the overall level of awards in any year, the individual award levels for Executive Directors and senior executives and performance targets.
The table below shows the independent Non-Executive Directors who served on the Remuneration Committee during 2013 and their date of appointment: Member From To
Ian Cormack (Remuneration Committee Chairman) 18 February 2010 To date David Barnes 18 February 2010 To date Isabel Hudson 18 February 2010 To date
The Remuneration Committee also consulted with the Group Chief Executive Officer, Group HR Director – Alan Jones and General Counsel – Jane MacLeod who attended, by invitation, various Remuneration Committee meetings during the year although no executive is ever permitted to participate in discussions or decisions regarding his or her own remuneration. Input is also sought from the Chief Risk Officer – Wayne Snow (without management present) and from representatives from finance, as appropriate.
Relative importance of spend on pay £m 5 July 2010 31 December 2010 31 December 201331 December 201231 December 2011
Jonathan Moss2 704 n/a n/a 1 The long-term incentive vesting rate is shown at 67%. This accounts for all of the differential between the single total figure of remuneration for 2012 (where no long-term awards vested) and that for 2013. In addition, Phoenix’s share price rose by 37% over the financial year and this impacts the value for the vesting long-term incentives for the purposes of the single figure. The performance conditions were met as to 100% although the Group Chief Executive Officer has decided to voluntarily waive any entitlement in excess of two-thirds of the shares which would otherwise vest.
3 Long-term incentive vesting rates against maximum opportunity values are not applicable for 2011 and 2012 due to no awards vesting in those financial years.
4 Jonathan Moss’ 2011 single figure of remuneration figure does not include compensation for loss of office.
PERCENTAGE CHANGE IN PAY OF THE GROUP CHIEF EXECUTIVE OFFICER 2012 TO 2013 In accordance with The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, the percentage change in the prescribed pay elements of the Group Chief Executive Officer (salaries, taxable benefits, and annual incentive outcomes) and the average percentage change for a matched sample of staff representing all staff (other than Ignis employees) who did not receive significant promotions during either year for these elements between the financial years 2012 and 2013 was as follows: This group was selected as being representative of the wider workforce (Ignis being excluded as its pay arrangements are separate from Group and Life). Overall, the data shows broadly unchanged levels of pay inflation for the Group Chief Executive Officer compared with this group whereas staff more generally received their increases through a broadly equal split of salary increases and AIP. The median level of salary increase for staff was lower at 2.25%.
3 James McConville joined the Phoenix Group on 6 June 2012 and was appointed to the Board as a Director on 28 June 2012. 2012 figures only relate to the period from his appointment as a Director to 31 December 2012, except for the AIP which also includes the amount earned in respect of the period 6 June 2012 to 28 June 2012.
Notes: The Executive Directors are entitled to adjust their salary/benefit combination under flexible benefits arrangements and the figures shown are before individual elections.
Annual incentive amounts are presented inclusive of any amounts which must be deferred in shares for three years (i.e. one-third of the AIP award). In 2013 and 2012, £241,666 and £241,990 respectively of Clive Bannister’s incentive payment is deferred in shares for a period of three years and £145,000 and £79,017 of James McConville’s incentive payment is similarly deferred. Details of the performance measures and targets applicable to the annual incentive for 2013 are set out below.
Cash generation 50% Target range between cumulative net cash generation of £1.217 billion and cash generation of £1.517 billion
Non-Executive Chairman Howard Davies 325,000 – 325,000 81,250 Non-Executive Directors Ian Ashken 34,103 – 34,103 100,000 René-Pierre Azria 100,000 – 100,000 100,000 Alastair Barbour 30,000 – 30,000 –
PENSIONS Clive Bannister and James McConville are entitled to each receive a Company contribution of 20% of base salary (less an amount equivalent to employers’ NICs if paid as a cash supplement) which may, at their choice, be paid to a GPP or received in cash if the individual is impacted by the lifetime or annual allowance.
Share-based awards As at 31 December 2013, Directors’ interests under long-term share-based arrangements were as follows: LTIP
The performance conditions for the 2011, 2012 and 2013 awards are set out below: Performance measure 2011 award (50% MCEV and 50% cash generation)
MCEV growth 25% of this part vests at threshold performance rising on a pro rata basis until 100% vests
Measured over three financial years commencing with the year of award
Target range between MCEV growth in excess of the risk-free rate by 3% per annum and MCEV growth in excess of the risk-free rate by 6% per annum
Target range between cumulative net cash generation of £1.217 billion and cash generation of £1.517 billion
Target range between cumulative net cash generation of £1.329 billion and cash generation of £1.529 billion
Target range between median performance against the constituents of the FTSE 250 (excluding investment trusts) rising on a pro rata basis until full vesting for upper quintile performance
Sharesave options are granted with an option price that is a 15% discount to the three day average share price when invitations are made. This is permitted by HMRC regulations for such options.
The Sharesave options granted to James McConville represents options granted for the then maximum monthly savings of £250 per calendar month for three years.
During the year ended 31 December 2013, the highest mid-market price of the Company’s shares was 788.5p and the lowest mid-market price was 531.3p. At 31 December 2013, the Company’s share price was 727.5p.
As at 1 January 2013 or date of appointment if later
1 Ian Ashken held 1,330,585 shares in his own name. Tasburgh LLC, of which Ian Ashken is a managing member, holds 179,211 shares and was considered a connected person to Mr Ashken. Mr Ashken’s share interests are shown as at his date of leaving on 2 May 2013.
3 Manjit Dale is a director of TDR Capital Nominees Limited and as such this company is considered as a connected person. Total interests held by this entity amount to 13,923,409.
4 Alastair Lyons’ share interests are shown as at his date of leaving on 30 September 2013.
As explained in the Directors’ Remuneration Policy, the Executive Directors are subject to share ownership guidelines.
The extent to which Executive Directors have achieved the guideline requirements by 31 December 2013 can be summarised as follows: Executive Director Share Ownership Guideline
Note: The Executive Directors are required to sign a declaration that they have not and will not at any time during their employment with the Phoenix Group, enter into any hedging contract in respect of their participation in the AIP, LTIP, SAYE, SIP or any other incentive plan of the Company, or pledge awards in such plans as collateral, and additionally that they will neither enter into a hedging contract in respect of, nor pledge as collateral, any shares which are required to be held for the purposes of the Company’s Share Ownership Guidelines.
Whilst not all of Phoenix Group’s activities are covered by the FCA Remuneration Code, the Remuneration Committee anticipates broadly equivalent provisions will apply, in due course, via Solvency II. The Remuneration Committee considers the FCA Remuneration Code to reflect best practice and has due regard to it across the Group.
CODE STAFF CRITERIA The following groups of employees have been identified within the Code firms as meeting the FCA’s criteria for Code Staff: − Certain members of the Group Board and Executive Committee
DESIGN AND STRUCTURE OF REMUNERATION The individual elements of employees’ remuneration packages at Phoenix Group comprise fixed pay (base salary, pension and other benefits) and performance-related pay (consisting of annual incentives, deferred awards and long-term incentives).
Phoenix Group also operates a fully flexible annual incentive policy which allows zero annual incentive payments to be made when appropriate.
Ignis employees’ annual incentives are financed from a defined profit pool (subject to discretion being reserved to the Remuneration Committee to adjust the percentage available). Distribution of the pool has due regard to objectives similar to those in the Group and Life company.
Ignis Executive level and selected senior management employees are eligible to receive awards subject to the rules of the Ignis Long Term Phantom Option Plan (‘LTOP’). Awards may be made annually but are typically one-off in nature and reward the growth in the notional value of Ignis over a six year period (with one-third of the award vesting on the fourth, fifth and sixth anniversaries of the grant date). Awards take the form of a cash settled option. Where it has been necessary as a part of the recruitment process, the Remuneration Committee has provided an underpin to the value of the award to reflect the value forfeited by employees due to leaving previous employers.
RISK ADJUSTMENT To manage the risk aspects of the Remuneration Policy, the Remuneration Committee considers the performance of the Group and individual businesses against risk objectives in determining the annual incentive pool and requires the Chief Risk Officer to report to the Remuneration Committee on this.
IAN CORMACK Remuneration Committee Chairman 25 March 2014 89 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
SHARE CAPITAL The issued share capital of the Company was increased by 50,231,153 ordinary shares during 2013. 50,000,000 were allotted as a result of the placing and open offer which took place in February 2013 and the balance related to the Company’s Sharesave Scheme. At 31 December 2013, the issued ordinary share capital totalled 224,818,301. Subsequently, 3,109 ordinary shares have been issued in 2014 in connection with the Company’s Save As You Earn (‘SAYE’) Scheme to bring the total in issue to 224,821,410 at the date of this report.
The rights and obligations attaching to the Company’s ordinary shares are set out in the Company’s Articles of Association (the ‘Company’s Articles’) which are available on the Company’s website at www.thephoenixgroup.com/about-us/corporate-governance/articles-ofassociation. aspx.
ANNUAL GENERAL MEETING (‘AGM’) The AGM of the Company will be held at 32 Commercial Street, St Helier, Jersey JE2 3RU on Wednesday, 30 April 2014 at 1pm.
− Alastair Barbour joined the Board as a Non-Executive Director with effect from 1 October 2013
Details of related party transactions which took place during the year with directors of the Company and consolidated entities where directors are deemed to have significant influence, are provided in the Remuneration Report and in note 42 to the IFRS consolidated financial statements.
The rules about the appointment and replacement of directors are contained in the Company’s Articles. These state that a director may be appointed by an ordinary resolution of the shareholders or by a resolution of the directors. If appointed by a resolution of the directors, the director concerned holds office only until the conclusion of the next AGM following the appointment.
All directors and employees of the Company and its subsidiaries are subject to the Group conflicts of interest policy which has been established to provide a clear framework for an effective system of internal control to manage conflicts of interest throughout the Group.
DIRECTORS’ AND OFFICERS’ LIABILITY INSURANCE The Company maintains Directors’ and Officers’ liability insurance cover which is renewed annually.
GOVERNANCE GOING CONCERN The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the Strategic Report. In addition the Strategic Report also provides details of any key events affecting the Company (and any subsidiaries included in its consolidating) since the end of the financial year. The Strategic Report includes details of the Group’s cash flow and solvency position, including sensitivities for both. Principal risks and their mitigation are detailed on page 49. In addition, the financial statements include, amongst other things, notes on the Group’s borrowings (note 23), management of its financial and insurance risk including market, credit and liquidity risk (note 39), its commitments and contingent liabilities (notes 41 and 43) and its capital position and management (note 38). The Strategic Report (on pages 12 to 23) sets out the business model and how we create value for shareholders and policyholders.
CORPORATE GOVERNANCE STATEMENT The disclosures required by section 7.2 of the FCA’s Disclosure and Transparency Rules can be found in the Corporate Governance Report on pages 59 to 67 which is incorporated by reference into this Directors’ Report and comprises the Company’s Corporate Governance Statement. The UK Corporate Governance Code (the ‘Code’) applies to the Company and full details on the Company’s Compliance with the Code are included in the Corporate Governance Report. The Code is available on the website of the Financial Reporting Council – www.frc.org.uk.
GREENHOUSE GAS EMISSIONS All disclosures concerning the Group’s greenhouse emissions are contained in the Corporate Responsibility Report forming part of the Strategic Report on pages 51 to 53.
The Memorandum and Articles are available on the Company’s website at www.thephoenixgroup.com/about-us/corporategovernance /articles-of-association.aspx.
Details of fees paid to Ernst & Young during 2013 for audit and non-audit work are disclosed in note 11 to the IFRS consolidated financial statements.
DISCLOSURE OF INFORMATION TO AUDITORS The Directors who held office at the date of approval of this Directors’ Report confirm that, so far as they are aware, there is no relevant audit information of which the Company’s auditor is unaware and that each director has taken all the steps that they ought to have taken as a director to make themselves aware of any relevant audit information and to establish that the Company’s auditor is aware of that information.
GROUP COMPANY SECRETARY The Group Company Secretary throughout the period was Gerald Watson.
ESSENTIAL CONTRACTS OR ARRANGEMENTS There are a number of relationships with third parties which are of significant value to the Group. Apart from the two main credit facilities, no single relationship is considered to be essential to the Group.
OTHER MATTERS The Board has prepared a Strategic Report which provides an overview of the development and performance of the Group’s business for the year ended 31 December 2013 and which covers the future developments in the business of Phoenix Group Holdings and its consolidated subsidiaries. For the purposes of compliance with DTR 4.1.5R(2) and DTR 4.1.8R, the required content of the ‘Management Report’ can be found in the Strategic Report and this Directors Report, including the sections of the Annual Report and Accounts incorporated by reference.
In addition, the directors at the date of this report consider that the Annual Report and Accounts, taken as a whole, provides users (who have a reasonable knowledge of business and economic activities) the information necessary to assess the Group’s performance, business model and strategy and is fair, balanced and understandable.
The Strategic Report and the Directors Report were approved by the Board of Directors on 25 March 2014.
CLIVE BANNISTER JAMES MCCONVILLE Group Chief Executive Officer Group Finance Director St Helier, Jersey 25 March 2014 95 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
BOARD RESPONSIBILITY STATEMENT ACCORDING TO SECTION 5:25C (2) (C) OF THE DUTCH FINANCIAL MARKETS SUPERVISION ACT The Board of Directors of Phoenix Group Holdings hereby declares that, to the best of its knowledge: − the Directors are responsible for the preparation of the Annual Report and Accounts in accordance with applicable Dutch law and International Financial Reporting Standards (‘IFRS’) as adopted by the European Union; − the IFRS financial statements for the year ended 31 December 2013 give a true and fair view of the assets, liabilities, financial position and results of Phoenix Group Holdings and its consolidated subsidiaries taken as a whole; − the Annual Report and Accounts gives a true and fair view of the state of affairs of Phoenix Group Holdings and its consolidated subsidiaries as at 31 December 2013 and their development in the financial year to which the Annual Report and Accounts relate; and
−the Annual Report and Accounts describes the principal risks facing Phoenix Group Holdings.
In addition, the directors at the date of this report consider that the Annual Report and Accounts, taken as a whole, provides users (who have a reasonable knowledge of business and economic activities) with the information necessary to assess the Group’s performance, business model and strategy and is fair, balanced and understandable.
CLIVE BANNISTER JAMES MCCONVILLE Group Chief Executive Officer Group Finance Director St Helier, Jersey 25 March 2014 98 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Dutch law, including the Dutch Standards on Auditing. This requires that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
In addition, the Company has also instructed us to: − review the Directors’ statement on going concern which, for a listed UK company, is specified for review by the Listing Rules of the Financial Conduct Authority; and
−audit the section of the Directors’ Remuneration Report that has been described as audited and state whether it has been properly prepared in accordance with the basis of preparation described therein.
We agreed with the Audit Committee that we would report to the Committee all audit differences in excess of £1.8 million, as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds.
AN OVERVIEW OF THE SCOPE OF OUR AUDIT Following our assessment of the risk of material misstatement to the Group financial statements, we have selected four components which represent the principal business units within the Group’s two reportable segments and account for all of the Group’s total assets and all of the Group’s profit before tax. Phoenix Life was subject to a full scope audit, whilst Ignis Asset Management, Opal Re and Group functions were subject to a specific scope audit where the extent of audit work was based on our assessment of the risks of material misstatement and of the materiality of the Group’s business operations at those locations. They were also selected to provide an appropriate basis for undertaking audit work to address the risks of material misstatement identified above.
−We considered the appropriateness of management’s assumptions and estimates in deriving the tax provisions and recognising deferred tax assets, and challenged those assumptions and estimates by considering the supporting information and forecasts.
OPINION ON OTHER MATTERS REPORT ON THE DIRECTORS’ REPORT AND OTHER INFORMATION Pursuant to the legal requirement under Part 9 of Book 2 of the Dutch Civil Code regarding our responsibility to report on the Directors’ Report and the other information: −We have no deficiencies to report as a result of our examination whether the Directors’ Report, to the extent we can assess, has been prepared in accordance with Part 9 of Book 2 of this Code, and whether the other information as required under Section 2: 392 sub 1 at b-h has been annexed.
−We report that the Directors’ Report, to the extent we can assess, is consistent with the financial statements.
−certain disclosures of Directors’ remuneration specified by law are not made; or
UNDER THE LISTING RULES, WE HAVE NOTHING TO REPORT IN RESPECT OF THE FOLLOWING MATTERS THAT WE ARE REQUIRED, OR YOU HAVE REQUESTED US, TO REVIEW: −the Directors’ statement, set out on page 92, in relation to going concern; − the part of the Corporate Governance Statement relating to the Company’s compliance with the nine provisions of the UK Corporate Governance Code specified for our review.
Gain on transfer of business 4 42 – Other operating income 8 13 Net income 4,247 1,206
Net income attributable to unitholders (252) (111) Total operating expenses (3,827) (649)
Tax attributable to policyholders’ returns 13 27 (33) Profit before the tax attributable to owners 217 309
Earnings per ordinary share Basic (pence per share) 15 68.2p 235.0p Diluted (pence per share) 15 68.1p 234.9p 102 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Other comprehensive income/(expense): Items that are or may be reclassified to profit or loss: Foreign exchange rate movements – (8) Reclassification adjustments relating to foreign collective investment schemes disposed of in the year 8 –
Items that will not be reclassified to profit or loss: Remeasurements of net defined benefit asset/liability – (441) Tax relating to other comprehensive income items 13 (12) 114
PRO FORMA RECONCILIATION OF GROUP OPERATING PROFIT TO RESULT ATTRIBUTABLE TO OWNERS For the year ended 31 December 2013 £m £m
Operating profit Phoenix Life 414 399 Ignis Asset Management 49 43
Investment return variances and economic assumption changes on long-term business 6 64 1 Variance on owners’ funds 6 (31) (13) Amortisation of acquired in-force business (99) (109) Amortisation of customer relationships and other intangibles (19) (18) Non-recurring items 5.2 (11) 130 Profit before finance costs attributable to owners 343 420
Tax (charge)/credit attributable to owners (10) 115 Profit for the year attributable to owners 207 424 103 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Total equity and liabilities 74,073 86,094 104 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Fixed and variable rate income securities 35,262 40,892 Collective investment schemes 6,390 6,044
Reinsurers’ share of insurance contract liabilities 21 2,851 3,204 Reinsurance receivables 34 64 Insurance contract receivables 12 10
Cash flows from operating activities Cash generated/(utilised) by operations 37 1,010 (2,291) Taxation paid (11) (70)
Profit for the year – – – – – 145 145 62 207 Other comprehensive income/(expense) for
Total comprehensive income for the year – – – – 8 133 141 62 203
Dividends paid on ordinary shares – (73) – – – – (73) – (73) Dividends paid to non-controlling interests – – – – – – – (23) (23) Coupon paid to non-controlling interests, net of tax relief – – – – – – – (19) (19) Shares issued in lieu of dividends – 1 – – – – 1 – 1 Credit to equity for equity-settled share-based payments – – – – – 5 5 – 5 Shares in subsidiaries subscribed for by noncontrolling interests – – – – – – – 35 35 Shares sold by employee trust – – – 1 – – 1 – 1
There is a restriction on the ability of certain subsidiary companies to distribute funds to Phoenix Group Holdings as a result of restrictions imposed by the Group’s two main credit agreements, namely the Pearl Facility and the Impala Facility (as described in note 23).
Subsidiary undertakings are consolidated from the date that effective control is obtained by the Group and are excluded from consolidation from the date they cease to be subsidiary undertakings. For subsidiary undertakings disposed of during the year, any difference between the net proceeds, plus the fair value of any retained interest, and the carrying amount of the subsidiary undertaking including non-controlling interests, is recognised in the consolidated income statement.
The Group uses the purchase method to account for the acquisition of subsidiary undertakings. The cost of an acquisition is measured at the fair value of the consideration. Any excess of the cost of acquisition over the fair value of the net assets acquired is recognised as goodwill. Any excess of the fair value of the net assets acquired over the cost of acquisition is recognised in the consolidated income statement. Directly attributable acquisition costs are included within administrative expenses, except for acquisitions undertaken prior to 2010 when they are included within the cost of the acquisition. Costs directly related to the issuing of debt or equity securities are included within the initial carrying amount of debt or equity securities where these are not carried at fair value.
(b) Critical accounting estimates and judgements The preparation of financial statements requires management to make judgements, estimates and assumptions that affect the application of policies and reported amounts of assets and liabilities, income and expenses. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of the judgements about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
Critical accounting estimates are those which involve the most complex or subjective judgements or assessments. The areas of the Group’s business that typically require such estimates are the measurement of insurance and investment contract liabilities, determination of the fair value of financial assets and liabilities, impairment tests for intangible assets, income tax assets and liabilities and pension scheme assets and liabilities.
Income tax assets and liabilities Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all the available evidence, it can be regarded as more likely than not that there will be suitable taxable profits against which the losses can be relieved. The UK taxation regime applies separate rules to trading and capital profits and losses. The distinction between temporary differences that arise from items of either a capital or trading nature may affect the recognition of deferred tax assets. Any judgements made, and uncertainties considered, in arriving at the carrying value of deferred tax in the financial statements are discussed in note 26.
The results and financial position of all Group companies that have a functional currency different from the presentation currency are translated into the presentation currency as follows: −assets and liabilities are translated at the closing rate at the period end; − income, expenses and cash flows denominated in foreign currencies are translated at average exchange rates; and
(d) Classification of contracts Contracts under which the Group accepts significant insurance risk are classified as insurance contracts.
(e) Insurance contracts and investment contracts with DPF Under current IFRS requirements the Group’s insurance contracts and investment contracts with DPF are measured using accounting policies consistent with those previously adopted under UK GAAP. Amounts recoverable from reinsurers are estimated in a manner consistent with the outstanding claims provision or settled claims associated with the reinsured policy.
For participating business, the liabilities under insurance contracts and investment contracts with DPF are calculated in accordance with the following methodology: − liabilities to policyholders arising from the with-profit business are stated at the amount of the realistic value of the liabilities, adjusted to exclude the owners’ share of projected future bonuses; −acquisition costs are not deferred; and
−reinsurance recoveries are measured on a basis that is consistent with the valuation of the liability to policyholders to which the reinsurance applies.
−a group of financial assets, financial liabilities or both is managed and its performance is evaluated and managed on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the investments is provided internally on that basis to the Group’s key management personnel.
(h) Borrowings The majority of interest-bearing borrowings are recognised initially at fair value less any attributable transaction costs. The difference between initial cost and the redemption value is amortised through the consolidated income statement over the period of the borrowing using the effective interest method.
(i) Deposits from reinsurers It is the Group’s practice to obtain collateral to cover certain reinsurance transactions, usually in the form of cash or marketable securities. Where cash collateral is available to the Group for investment purposes, it is recognised as a ‘financial asset’ and the collateral repayable is recognised as ‘deposits received from reinsurers’ in the statement of consolidated financial position.
(k) Obligations for repayment of collateral received It is the Group’s practice to obtain collateral in stock lending and derivative transactions, usually in the form of cash or marketable securities. Where cash collateral is available to the Group for investment purposes, it is recognised as a ‘financial asset’ and the collateral repayable is recognised as ‘obligations for repayment of collateral received’ in the statement of consolidated financial position. The ‘obligations for repayment of collateral received’ are measured at amortised cost, which in the case of cash is equivalent to the fair value of the consideration received.
As required by IFRIC 14, IAS 19 –The limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction, to the extent that the economic surplus will be available as a refund, the economic surplus is stated after a provision for tax that would be borne by the scheme administrators when the refund is made. Additionally, under IFRIC 14, pension funding contributions are considered to be a minimum funding requirement and, to the extent that the contributions payable will not be available to the Group after they are paid into the scheme, a liability is recognised when the obligation arises. The net defined benefit asset/liability represents the economic surplus net of all adjustments noted above.
Part of the cost of changes in the longevity assumptions of the PGL Pension Scheme is recoverable from certain with-profit funds to the extent that cash contributions are made to the pension scheme. Recoveries are recognised when the related cash contributions are agreed with the Trustee of the pension scheme and are accounted for as a transfer to other comprehensive income from insurance contract liabilities.
Goodwill is measured on initial recognition at cost. Following initial recognition, goodwill is stated at cost less any accumulated impairment losses. It is tested for impairment annually or when there is evidence of possible impairment. Goodwill is not amortised. For impairment testing, goodwill is allocated to cash generating units (Phoenix Life and Ignis Asset Management). Goodwill is impaired when the recoverable amount is less than the carrying value.
Acquired in-force business Insurance and investment contracts with and without 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.
Intangible assets with indefinite useful lives are tested for impairment annually, either individually or at the cash generating unit level. Such intangibles are not amortised.
(p) Investment property Investment property is stated at fair value. Fair value is the price that would be received to sell a property in an orderly transaction between market participants at the measurement date. Gains and losses arising from the change in fair value are recognised in the consolidated income statement.
Collateral The Group receives and pledges collateral in the form of cash or non-cash assets in respect of stock lending transactions, derivative contracts and reinsurance arrangements in order to reduce the credit risk of these transactions. The amount and type of collateral required where the Group receives collateral depends on an assessment of the credit risk of the counterparty.
(t) Cash and cash equivalents Cash and cash equivalents comprise cash balances and short-term deposits with an original maturity term of three months or less at the date of placement. Bank overdrafts that are repayable on demand and form an integral part of the Group’s cash management are deducted from cash and cash equivalents for the purpose of the statement of consolidated cash flows.
(w) Dividends Final dividends on ordinary shares are recognised as a liability and deducted from equity when they are approved by the Group’s owners. Interim dividends are deducted from equity when they are paid. As permitted by Cayman Islands Companies Law, dividends have been charged within equity against the share premium account and other reserves account. Where shareholders exercise a scrip dividend option, the amount of the related dividend is credited to share premium in the statement of consolidated changes in equity and an amount equal to the nominal value of the shares issued is transferred from share premium to share capital.
Declared dividends are those that are appropriately authorised and are no longer at the discretion of the entity.
Reinsurance premiums Outward reinsurance premiums are accounted for on a payable basis.
Net investment income Net investment income comprises interest, dividends, rents receivable, net expected return on pension assets and liabilities, fair value gains and losses on financial assets and investment property at fair value and impairment losses on loans and receivables.
(cc) General business The general insurance business has been closed to new business for a number of years and is in run-off. The results are included within other operating income in the consolidated income statement. Provisions are made for the estimated cost of claims, including claims incurred but not reported after taking into account handling costs, anticipated inflation and settlement trends. Any difference between the estimated provision and subsequent settlement is included in the consolidated income statement.
(dd) Segmental reporting The Group’s results are analysed across two reportable segments: Phoenix Life and Ignis Asset Management. The revenues generated in each reported segment are shown in the segmental information in note 5.
There are no differences between the measurement of the assets and liabilities reflected in the primary statements and that reported for the segments. A reconciliation between the reported segment revenues and expenses and the Group’s revenues and expenses is shown in note 5.
In preparing the consolidated financial statements, the Group has adopted the following standards, interpretations and amendments which have been issued by the International Accounting Standards Board (‘IASB’) and have been adopted for use by the EU.
−Disclosures - Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7 Financial Instruments: Disclosures) (2013). The amendment requires an entity to disclose information about rights to set-off financial instruments and related arrangements. The new disclosure requirements are intended to help users of financial statements better assess the effect or potential effect of offsetting arrangements on an entity’s financial position.
The IASB has issued the following standards, interpretations and amendments which, subject to adoption for use by the EU, apply from the dates shown. The Group has decided not to early adopt any of these standards, interpretations or amendments where this is permitted. The impact on the Group of adopting them is subject to evaluation: − IFRS 9 Financial Instruments. This is the first two parts of a replacement standard for IAS 39 Financial Instruments: Recognition and Measurement and deals with the classification and measurement of financial assets and financial liabilities, including some hybrid contracts and general hedge accounting. The mandatory effective date of 2015 has been removed and a new effective will be set by the IASB at a later date.
−Novation of Derivatives and Continuation of Hedge Accounting (Amendments to IAS 39 Financial Instruments: Recognition and Measurement) (2014). These amendments include an exception to the requirement for the discontinuation of hedge accounting in IAS 39.
−Annual Improvements to IFRS 2010-2012 cycle (2014). This makes a number of minor improvements to existing standards and interpretations.
When IFRS 10, IFRS 11, IFRS 12, IAS 28 (Revised) and the consequential amendments to these were issued by the IASB the effective date of these standards was 1 January 2013. However, the EU endorsed these standards to be effective from 1 January 2014, with early adoption permitted. The Group currently intends to adopt these standards effective for the period commencing on 1 January 2014. An exercise is currently being undertaken to assess the impact of adopting these standards and it is expected that there will be no significant impact on net assets.
In addition, the following standards, interpretations and amendments have been issued but are not currently relevant to the Group: − IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine (2013).
(b) Defined benefit pension schemes The Group has also adopted the revised version of IAS 19 (2011) with a date of initial application of 1 January 2013 and has consequently changed its basis for determining the income or expense related to defined benefit pension schemes.
As a result of the change, the Group now determines the net interest expense/income on the net defined benefit asset/liability for the period by applying the discount rate used to measure the defined benefit obligation at the beginning of the annual period to the net defined benefit asset/liability at the beginning of the annual period. It takes into account any changes in the net defined benefit asset/liability during the period as a result of contributions and benefit payments. The net interest on the net surplus/deficit comprises: − interest cost on the defined benefit obligation; − interest income on scheme assets; and
− interest on the provision for tax on the economic surplus available as a refund and on the minimum funding requirement obligation.
The change in accounting policy had no impact on net assets or cash flows as at 31 December 2012. The impact on earnings per share for the comparative period was to increase basic and diluted earnings per share for the year ended 31 December 2012 by 8.7p per share to 235.0p and 234.9p per share respectively.
Assets classified as held for sale: Goodwill – 19 Acquired in-force business – 138 Financial assets 55 61 Reinsurer’s share of insurance contract liabilities – 5,083 Other assets 11 9
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 5. SEGMENTAL ANALYSIS CONTINUED 5.1 SEGMENTAL RESULT 2013
Fees from: External customers 132 48 – – 180 Other segment – 102 – (102) –
Other operating income: Gain on transfer of business: Non-recurring 42 – – – 42
Other operating expenses: Profit/(loss) before finance costs and tax 404 51 (35) – 420
Net policyholder claims and benefits incurred: Non-recurring 177 – – – 177
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 5. SEGMENTAL ANALYSIS CONTINUED 5.2 RECONCILIATION OF OPERATING PROFIT/(LOSS) BEFORE ADJUSTING ITEMS TO THE SEGMENTAL RESULT 2013
Variance on owners’ funds (67) – 36 (31) Amortisation of acquired in-force business (99) – – (99) Amortisation of customer relationships (16) (3) – (19)
Variance on owners’ funds (35) – 22 (13) Amortisation of acquired in-force business (109) – – (109) Amortisation of customer relationships (15) (3) – (18)
6. INVESTMENT RETURN VARIANCES AND ECONOMIC ASSUMPTION CHANGES The long-term nature of much of the Group’s operations means that, for internal performance management, the effects of short-term economic volatility are treated as non-operating items. The Group focuses instead on an operating profit measure that incorporates an expected return on investments supporting its long-term business. This note explains the methodology behind this.
The Company paid a reinsurance premium of £5,104 million to Guardian and a non-recurring gain of £177 million, gross of tax, was recognised in the consolidated income statement in 2012. In September 2013, the reinsurance agreement was replaced by a transfer of the related liabilities under Part VII of the Financial Services and Markets Act 2000. For further details see note 4.
Where the Group receives collateral in the form of marketable financial instruments which it is not permitted to sell or re-pledge except in the case of default, it is not recognised in the statement of consolidated financial position. The fair value of financial assets accepted as collateral for reinsurance transactions but not recognised in the statement of consolidated financial position amounts to £1,881 million (2012: £7,350 million). The large decrease in collateral for reinsurance transactions is largely driven by the replacement of the Guardian reinsurance agreement by the Part VII transfer of liabilities completed in September 2013.
Fund management based fees 87 63 Investment contract income 93 94 128 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
9. NET INVESTMENT INCOME This note analyses the Group’s net investment income. The accounting policy adopted in the preparation of this note is detailed in note 1(x).
Designated upon initial recognition 576 1,788 Held for trading – derivatives (314) (354)
Net investment income 2,673 4,600 129 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Employee costs 158 144 Outsourcer expenses 125 134 Professional fees 50 76 Office costs 43 49 Depreciation of property, plant and equipment 3 3 Investment management expenses and transaction costs 96 89 Direct costs of life companies 8 27 Direct costs of collective investment schemes 35 28 Pension service costs and curtailments 13 5 Impairment of property, plant and equipment – 4
Total auditor’s remuneration 7.6 7.6 130 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Interest expense On financial liabilities at amortised cost 195 189 On financial liabilities at fair value through profit or loss 35 26
Current tax: UK Corporation tax 50 24 Overseas tax 14 15
Adjustment in respect of prior years (10) 6 Total current tax 54 45 Deferred tax: Impact of new life tax regime – (12) Origination and reversal of temporary differences (61) (45) Change in the rate of UK corporation tax (35) (28) Movement in unrecognised deferred tax 25 (42)
Total deferred tax credit (71) (127) Total tax credit (17) (82)
Profit before tax 190 342 Policyholder tax credit/(charge) 27 (33) Profit before the tax attributable to owners 217 309
Tax at standard UK1 rate of 23.25% (2012: 24.5%) 50 75 Non-taxable income and gains 4 (29) Disallowable expenses 7 2 Adjustment to shareholders tax charge in respect of prior years 21 18 Profits taxed at rates other than 23.25% (2012: 24.5%) (38) (35) Recognition of previously unrecognised deferred tax assets – (85) Deferred tax rate change (36) (36) Temporary differences not valued 4 (7) Impact of new life tax regime – (12)
14. DIVIDENDS ON ORDINARY SHARES This note analyses the total dividends paid during the year and does not include the final dividend proposed after the year end as it is not recognised as a liability in the 2013 consolidated financial statements. The accounting policy adopted in the preparation of this note is detailed in note 1(w).
On 21 March 2013, the Board recommended a final dividend of 26.7p per share in respect of the year ended 31 December 2012. The dividend was approved at the Company’s Annual General Meeting, which was held on 2 May 2013. The dividend amounted to £60 million and was settled on 3 May 2013.
On 21 August 2013, the Board declared an interim dividend of 26.7p per share for the half year ended 30 June 2013. The total dividend amounted to £60 million and was paid on 3 October 2013.
15. EARNINGS PER SHARE This note shows how the Group calculates earnings per share based on the present shares in issue (basic earnings per share) and on the potential future shares in issue, including the conversion of share awards granted to employees (diluted earnings per share). The accounting policy adopted in the preparation of this note is detailed in note 1(v).
The profit attributable to owners for the purposes of calculating earnings per share has been calculated as set out below. This is after adjusting for profits attributable to non-controlling interests.
The basic earnings per share of 68.2p (2012 (restated): 235.0p) has been based on the profit attributable to owners of the parent of £145 million (2012 (restated): £407 million) and a weighted average number of ordinary shares outstanding during the year of 212 million (2012: 173 million), calculated as follows: Number million
Issued ordinary shares at beginning of the year 174 174 Effect of ordinary shares issued/redeemed 39 – Own shares held by employee trust and Group entities (1) (1) Weighted average number of ordinary shares 212 173
The diluted earnings per share of 68.1p (2012 (restated): 234.9p) has been based on the profit attributable to owners of the parent of £145 million (2012 (restated): £407 million) and a diluted weighted average number of ordinary shares outstanding during the year of 212 million (2012: 173 million). The Group’s Deferred BSP share-based scheme increased the weighted average number of shares on a diluted based by 176,832 shares (2012: 94,198).
The following instruments could potentially dilute basic earnings per share in the future but have not been included in the diluted earnings per share figure because they did not have a dilutive effect for the periods presented due to the exercise price of the warrants being significantly higher than the share price of the Company: −5 million warrants issued to certain entities providing finance to the Group (‘the Lenders’) on 2 September 2009; −12.36 million warrants issued to Royal London on 2 September 2009; and
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 16. SHARE CAPITAL This note gives details of Phoenix Group Holding’s ordinary share capital and shows the movements during the year. The accounting policy adopted in the preparation of this note is detailed in note 1(z).
Issued and fully paid: 224.8 million (2012: 174.6 million) ordinary shares of €0.0001 each 18,418 14,174
During the year, the Company issued 231,153 shares at a premium of £1 million in order to satisfy its obligations to employees under the Group’s share schemes.
Shares in issue at 1 January 174,472,815 14,165 Ordinary shares issued for scrip dividend 114,333 9 Shares in issue at 31 December 174,587,148 14,174
During 2012, the Company did not issue any shares to employees under the Group’s share schemes.
17. OTHER RESERVES This note gives details of the other reserve balance which arose on 2 September 2009, when the Company issued 36,000,000 contingent rights over its shares.
On 5 July 2010, the Company completed the restructure of the contingent rights over its shares which saw 32,400,000 of the contingent rights over shares converted into the same number of ordinary shares. The holders of the contingent rights over shares would have been entitled to receive a further 3,600,000 ordinary shares in aggregate if before 22 June 2013 (i) an offer had been made to acquire all or a majority of the Company’s issued ordinary share capital or substantially all of the Company’s assets; or (ii) any party or parties acting in concert had become interested in more than 50% of the ordinary shares of the Company through the issue of shares by the Company.
None of these conditions were met by 22 June 2013, and therefore the remaining 3,600,000 contingent rights over shares will not be converted into ordinary shares. The balance of other reserves of £5 million has therefore been reclassified within equity to retained earnings.
Shares acquired in year 11 – Vested to employees in year (8) – Shares sold in year – (1)
Expense arising from equity-settled share-based payment transactions 6 5 19.2 SHARE-BASED PAYMENT SCHEMES IN ISSUE Long-term incentive plan (‘LTIP’) In 2009, the Group implemented a long-term incentive plan to retain and motivate its senior management group. The awards under this plan are in the form of nil-cost options to acquire an allocated number of ordinary shares. Assuming no good leavers or other events which would trigger early vesting rights, these awards will be subject to performance conditions tied to the Company’s financial performance in respect of growth in embedded value, cumulative cash generation over a three year period and, with respect to the 2012 and 2013 LTIPs only, total shareholder return (‘TSR’). There are no cash settlement alternatives. The 2010 LTIP awards vested during the year. The 2011 award will vest on 12 April 2014, the 2012 award will vest on 2 April 2015 and the 2013 award will vest on 15 November 2016. The 2010, 2011 and 2012 LTIP awards were increased during the year as a result of the equity raising on 21 February 2013 (see note 16).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 19. SHARE-BASED PAYMENT CONTINUED 19.2 SHARE-BASED PAYMENT SCHEMES IN ISSUE CONTINUED Save As You Earn (‘SAYE’) The SAYE scheme allows participating employees to save up to £250 each month over a period of either 3 or 5 years.
The fair value of the awards has been determined using a Black-Scholes valuation model. Key assumptions within this valuation model included expected share price volatility and expected dividend yield.
The 2010, 2011 and 2012 SAYE awards were increased during the year as a result of the equity raising on 21 February 2013 (see note 16).
0.6 (for 3.25 year scheme) and 1.1 (for 5.25 year scheme)
1.8 (for 3.25 year scheme) and 2.6 (for 5.25 year scheme)
2.0 (for 3.25 year scheme) and 2.8 (for 5.25 year scheme)
Expected volatility (%) based on the Company’s share price volatility to date 30.0 30.0 30.0 30.0
Deferred bonus share scheme (‘DBSS’) With effect from 31 December 2010, part of the annual incentive for certain executives, for any year, is deferred into Phoenix Group Holdings’ shares. This grant of shares is conditional on the employee remaining in employment with the Group for a period of 3 years. The 2011 DBSS are expected to vest on 6 April 2014, the 2012 DBSS are expected to vest on 2 April 2015 and the 2013 DBSS are expected to vest on 27 March 2016. The 2011 and 2012 DBSS awards were increased during the year as a result of the equity raising on 21 February 2013 (see note 16).
The fair value of these awards is estimated at the share price at the grant date, taking into account the terms and conditions upon which the options were granted.
19.3 MOVEMENTS IN THE YEAR The following tables illustrate the number of, and movements in, share options during the year: No of share options 2013
The weighted average share price at the date of exercise for the rewards exercised is £6.88 (2012: £5.11).
20. NON-CONTROLLING INTERESTS This note gives details of the Group’s non-controlling interests and shows the movements during the year. The accounting policy adopted in the preparation of this note is detailed in note 1(a).
Profit for the year 20 42 62 Dividends paid – (25) (25) Coupon paid, net of tax relief (20) – (20) Shares in subsidiaries subscribed for by non-controlling interests – 37 37
Profit/(loss) for the year 20 (3) 17 Dividends paid – (23) (23) Coupon paid, net of tax relief (19) – (19) Shares in subsidiaries subscribed for by non-controlling interests – 35 35 137 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
If PGH1 opts to defer a coupon payment, then PGH1 has the option to either leave the coupon outstanding or satisfy the deferred coupon payment by the issue of securities (‘ACSM instruments’) by either PGH1 or a special purpose subsidiary of PGH1 established for the purpose of issuing ACSM instruments and which are guaranteed by PGH1. The obligations of PGH1 in respect of such securities will be subordinated to and rank or be expressed to rank junior to the Notes as to rights to payments of interest and participation in the assets of PGH1 in a winding-up and shall comply with the then current requirements of the PRA in relation to Tier 1 capital. ACSM instruments will in the first instance be offered to related parties (as defined in the Terms and Conditions of the Notes as amended by the Supplemental Trust Deed dated 30 July 2008) and to third parties if not purchased by related parties. In the event that neither such related parties nor third parties will purchase the required ACSM instruments, then PGH2 is required to use its best endeavours to raise such funds as are deemed necessary to purchase the required amounts of ACSM instruments.
20.2 UK COMMERCIAL PROPERTY TRUST LIMITED UK Commercial Property Trust Limited (‘UKCPT’) is a property investment subsidiary which is domiciled in Guernsey and is admitted to the Official List of the UK Listing Authority and to trading on the LSE.
The Group now holds 58% (2012: 62%) of the issued share capital of UKCPT.
Amounts due for settlement after 12 months 39,126 2,775 41,375 3,054
Less amounts classified as held for sale (note 4) – – (5,404) (5,083)
Property Reversions loan (note b) 186 194 186 194 £200 million 7.25% unsecured subordinated loan (note e) 151 143 205 173 £2,260 million syndicated loan facility (note f) 1,182 1,852 1,182 1,797 £100 million PIK notes and facility (note g) 121 116 118 98 £75 million secured loan note (note h) 76 75 49 35
DEBENTURE LOANS a. In 1998, National Provident Institution raised £260 million of capital through the securitisation of embedded value on a block of existing unit-linked and unitised with-profit life and pension policies. Following the demutualisation of National Provident Institution, these were transferred to National Provident Life Limited (‘NPLL’). The bonds were split between two classes, which rank pari passu. The £140 million 7.39% class A1 limited recourse bonds matured in 2012 with no remaining outstanding principal. The £120 million 7.59% class A2 limited recourse bonds with an outstanding principal of £105 million (2012: £116 million) have an average remaining life of 5 years maturing in 2022. NPLL has provided collateral of £44 million (2012: £50 million) to provide security to the holders of the NPLL recourse bonds in issue. During 2013, repayments totalling £11 million were made.
b. The Property Reversions loan from Santander UK plc (‘Santander’) was brought into the consolidated financial statements at fair value. It relates to the sale of Extra-Income Plan policies that Santander finances to the value of the associated property reversions. With effect from 1 January 2012, Phoenix Life Limited (‘PLL’) became party to a loan agreement with Santander UK plc (‘Santander’). As part of the arrangement Santander receive an amount calculated by reference to the movement in the Halifax House Price Index and PLL is required to indemnify Santander against profits or losses arising from mortality or surrender experience which differs from the basis used to calculate the reversion amount. Repayment will be on a policy-by-policy basis and is expected to occur over the next 10 to 20 years. During 2013, repayments totalling £22 million were made. Note 34 contains details of the assets that support this loan.
e. Scottish Mutual Assurance Limited issued £200 million 7.25% undated, unsecured subordinated loan notes on 23 July 2001 (‘PLL subordinated debt’). The earliest repayment date of the notes is 25 March 2021 and thereafter on each fifth anniversary so long as the notes are outstanding. With effect from 1 January 2009, as a part of a Part VII transfer, these loan notes were transferred into the shareholder fund of PLL. In the event of the winding-up of PLL, the right of payment under the notes is subordinated to the rights of the higher-ranking creditors (principally policyholders). As a result of the acquisition of the Phoenix Life businesses in 2009, these subordinated loan notes were acquired at their fair value and as such, the outstanding principal of these subordinated loan notes differs from the carrying value in the statement of financial position. The fair value adjustments, which were recognised on acquisition, will unwind over the remaining life of these subordinated loan notes.
The rate will be reduced by 0.25% per annum with effect from 1 January 2015, if by that date the borrowers have made voluntary repayments of not less than £200 million in addition to all mandatory and target repayments.
During 2013, scheduled repayments of £60 million (2012: £125 million), target repayments of £60 million and voluntary repayments of £100 million (2012: £15 million) were made in addition to the £450 million.
h. On 15 November 2006, PGH (LCA) Limited and PGH (LCB) Limited jointly became a party to a £905 million loan facility from a syndicate of external banks. This loan was subsequently amended on 2 September 2009, leaving £425 million outstanding on this facility (the ‘Pearl Facility’) and £75 million of secured C loan notes (the ‘Pearl loan notes’).
The £425 million facility is repayable over the period from 30 June 2011 to 30 June 2016, attracting interest at LIBOR plus a margin of 1.25%. The £75 million secured C loan notes are repayable 15 years after amendment and attract interest at LIBOR plus a margin of 1.00%.
During the year, a scheduled repayment of £24 million (2012: £24 million) was made on the £425 million loan facility and interest of £1 million (£2012: £2 million) was capitalised on the £75 million secured C loan notes.
Warrants over shares in Phoenix Group Holdings – 5 – 3
The amount recoverable after one year is £1,003 million (2012: £2,829 million). The amount payable after one year is £1,229 million (2012: £2,222 million).
24.2 Warrants over shares On 1 January 2013, the Company had in issue the following warrants: IPO warrants Number
The fair value of warrants over shares are as follows: Liabilities £m
The exercise period for the IPO warrants commenced on 2 September 2009, and will expire at the close of trading on the LSE on 3 September 2014, or earlier upon redemption or liquidation. The Company may call the warrants for redemption: − in whole but not in part; −at a price of €0.01 per warrant; −upon not less than 30 days’ prior written notice of redemption to each warrant holder; − if, and only if, the reported last sale price of the share equals or exceeds €13.75 per share for any 20 trading days within a period of 30 consecutive trading days ending on the third business day prior to the notice of redemption to warrant holders. On 2 September 2009, the threshold of €13.75 was increased to €16.50. At 31 December 2012, the threshold was reduced to €16.05 following an issue of ordinary shares by the Company under a scrip dividend in 2012; and
−the valuation incorporates the impact of amending some of the terms of the warrants on 8 May 2012.
LENDERS’ WARRANTS On 2 September 2009, the Company issued 5 million warrants over its shares to the Lenders. These warrants entitled the holder to purchase one ‘B’ ordinary share at a price of £15 per share, subject to adjustment. Following the achievement of the Company’s Premium Listing on 5 July 2010, the Lenders’ warrants relate to ordinary shares rather than ‘B’ ordinary shares. At 31 December 2013 the terms of Lenders’ warrants entitled the holders to purchase 1.027873 (2012: 1.027873) ordinary shares per Lenders’ warrant for an exercise price of £14.59 (2012: £14.59).
The exercise period terminates on the first to occur of: −15th anniversary of the date issued; −date fixed for the redemption of the warrants; and
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 24. DERIVATIVES CONTINUED ROYAL LONDON WARRANTS On 2 September 2009, the Company issued 12.36 million warrants (2 million transferable and 10.36 million non-transferable) over its shares to Royal London as part consideration for acquiring the benefit of £250 million of the PIK notes and facility outstanding (comprising principal and capitalised interest). These warrants entitled the holder to purchase one ‘B’ ordinary share at a price of €11 per share, subject to adjustment. Following the achievement of the Company’s Premium Listing, the Royal London warrants relate to ordinary shares rather than ’B’ ordinary shares. At 31 December 2013, the terms of the Royal London warrants entitled the holders to purchase 1.027873 (2012: 1.027873) ordinary shares per Royal London warrant for an exercise price of €10.70 (2012: €10.70).
The exercise period terminates on the first to occur of: −5th anniversary of the date issued; −date fixed for the redemption of the warrants; and
The key assumptions used to ascertain a value as at 31 December 2013, are as for the IPO warrants (see before). The value of the warrants at the year end was £3 million (2012: £2 million).
25. PROVISIONS This note details the non-insurance provisions that the Group holds and shows the movements in these during the year. The accounting policy adopted in the preparation of this note is detailed in note 1(u).
Staff related provisions include provisions for Ignis Asset Management long-term incentive plans of £18 million (2012: £13 million), for unfunded pensions of £6 million (2012: £6 million) and private medical insurance costs for former employees of £3 million (2012: £3 million).
Expenses and deferred acquisition costs carried forward 5 32 – – 37 Provisions and other temporary differences 3 (6) – – (3)
IFRS transitional adjustments (88) 16 – – (72) Adjustment for insurance policies held with related parties in respect of the PGL pension scheme (23) 4 – – (19)
Expenses and deferred acquisition costs carried forward 14 (9) – – 5 Provisions and other temporary differences 3 – – – 3 Pension scheme deficit – (16) 113 – 97 Accelerated capital allowances 18 (1) – – 17
The Finance Act 2012 set the rate of corporation tax at 23% from 1 April 2013 and further reductions to 21% from 1 April 2014 and 20% from 1 April 2015 were set by the Finance Act 2013. Consequently, a blended rate of tax has been used for the purposes of providing for deferred tax in these financial statements.
The Finance Act 2012 introduced new rules for the taxation of insurance companies, with effect from 1 January 2013. The deferred tax on the non-profit surplus has reversed and is replaced with IFRS transitional adjustments. The deferred tax on the transitional adjustments will be amortised over a 10 year period on a straight-line basis commencing in 2013 and ending in 2022, as the IFRS tax transitional adjustment is brought into account in the current year tax computations.
Deferred tax assets have not been recognised in respect of: Tax losses carried forward 50 52 Excess expenses and deferred acquisition costs 2 – Provisions and other temporary differences 9 7 Deferred tax assets not recognised on capital losses1 121 229 1 These can only be recognised against future capital gains and have no expiry date.
PGL Pension Scheme Economic surplus (including £313 million (2012: £285 million) available as a refund on a winding-up of the Scheme) 368 344 Adjustment for insurance policies eliminated on consolidation (95) (95) Net economic surplus 273 249 Minimum funding requirement obligation (17) (25) Provision for tax on that part of the economic surplus available as a refund on a winding-up of the Scheme (96) (87) Net defined benefit asset 160 137
Life expectancy – the majority of the scheme’s obligations are to provide benefits for the life of the member, so increases in life expectancy will result in an increase in the liabilities.
The valuation has been based on an assessment of the liabilities of the Pearl Scheme as at 31 December 2013, undertaken by independent qualified actuaries. The present values of the defined benefit obligation and the related current service costs have been measured using the projected unit credit method.
Funding A triennial funding valuation of the Pearl Scheme as at 30 June 2012, was completed in May 2013. This showed a deficit as at 30 June 2012 of £480 million, on the agreed technical provisions basis.
(ii) to reach full funding on a gilts flat basis by 30 June 2031; − the Trustee continues to benefit from a first charge over shares in Phoenix Life Assurance Limited, National Provident Life Limited, Pearl Group Services Limited and PGS2 Limited. The value of the security claim granted under the share charges is, since 30 June 2012, capped at the lower of £600 million and 60% of the Pearl Scheme deficit (calculated on a basis linked to UK government securities) revalued every three years thereafter. Immediately following the repayment of the £425 million loan facility and £75 million of secured C loan notes (see note 23) the value of the security claim increases to 100% of the Pearl Scheme deficit (on a basis linked to UK government securities) revalued every three years, subject to a £600 million cap; and
An additional liability of £84 million (2012: £83 million) has been recognised, reflecting a charge on any refund of the resultant IAS 19 surplus of £241 million (2012: £237 million) (£294 million of discounted future contributions less a current deficit of £53 million) in accordance with the minimum funding requirement. A deferred tax asset of £59 million (2012: £81 million) has also been recognised to reflect tax relief at a rate of 20% (2012: 23%) that is expected to be available on the contributions, once paid into the scheme.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 30. PENSION SCHEMES CONTINUED 30.1 PEARL GROUP STAFF PENSION SCHEME CONTINUED Summary of amounts recognised in the consolidated financial statements The amounts recognised in the consolidated financial statements are as follows: Fair value of scheme assets £m
Past service cost – 3 – – 3 Included in profit or loss 89 (83) (1) – 5
Remeasurements: Return on plan assets excluding amounts included in interest income (21) – – – (21)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 30. PENSION SCHEMES CONTINUED 30.1 PEARL GROUP STAFF PENSION SCHEME CONTINUED Scheme assets The distribution of the scheme assets at the end of the year was as follows: Total £m
Cash and other 57 – 135 – Obligations for repayment of stock lending collateral received (1,137) – (548) –
The Group ensures that the investment positions are managed within an asset liability matching (ALM) framework that has been developed to achieve long-term investments that are in line with the obligations under the pension scheme. Within this framework an allocation of 25% of the scheme assets is invested in collateral for interest rate and inflation rate hedging where the intention is to hedge greater than 90% of the interest rate and inflation rate risk measured on the Technical Provisions basis. The hedge ratio will be further increased to 100% when market conditions appear favourable.
Defined benefit obligation The calculation of the defined benefit obligation can be allocated to the scheme’s members as follows: −Deferred scheme members: 41% (2012: 43%)
Principal assumptions The principal financial assumptions of the Pearl Scheme are set out in the table below: %
It has been assumed that post-retirement mortality is in line with a scheme-specific table which was derived from the actual mortality experience in recent years, performed as part of the actuarial funding valuation as at 30 June 2012, based on the SAPS standard tables for males and for females based on year of use. Future longevity improvements are in line with current Group best estimate longevity improvements, which are based on CMI 2012 Core Projections and a long-term rate of improvement of 2% p.a. up to and including age 75 then decreasing linearly to 0% p.a. at age 110. Under these assumptions, the average life expectancy from retirement for a member currently aged 40 retiring at age 60 is 29.8 years and 32.9 years for male and female members respectively.
A quantitative sensitivity analysis for significant actuarial assumptions as at 31 December 2013, is shown below: 2013 Assumptions Base Discount rate RPI Life expectancy
The PGL Scheme is administered by a separate Trustee company, PGL Pension Trustee Ltd. The Trustee company is comprised of two representatives from the Group, three member nominated representatives and one independent trustee in accordance with the Trustee company’s articles of association. The Trustee is required by law to act in the interest of all relevant beneficiaries and is responsible for the investment policy with regard to the assets plus the day-to-day administration of the benefits.
The valuation has been based on an assessment of the liabilities of the PGL Pension Scheme as at 31 December 2013, undertaken by independent qualified actuaries.
Funding A triennial funding valuation of the PGL Pension Scheme as at 30 June 2012, was completed in September 2013. This showed a deficit as at 30 June 2012 of £39 million. Following discussions with the Trustee of the PGL Pension Scheme it was agreed that the existing schedule of cash contributions to the scheme amounting to £59 million would continue to be paid over the period from October 2013 to August 2017. Total future contributions amount to £55 million at 31 December 2013 and contributions totalling £15 million are expected to be paid into the scheme in 2014.
In accordance with an agreement dated November 2005, certain of the Group’s with-profit funds have indemnified the shareholders in respect of contribution calls equal to their share of the costs of changes in longevity assumptions. Following completion of the triennial funding valuation as at 30 June 2012, a process has commenced to determine the quantum of the contribution to be received from the with-profit funds in this regard.
Past service cost – 1 – – 1 Gains and losses on settlements (37) 30 – – (7) Administrative expenses (3) – – – (3) Included in profit or loss 40 (28) (7) – 5
Remeasurements: Return on plan assets excluding amounts included in interest income (65) – – – (65)
Loss from change in demographic assumptions – (10) – – (10) Loss from change in financial assumptions – (82) – – (82) Experience gains/(losses) – (63) – – (63) Change in provision for tax on economic surplus available as a refund – – 69 – 69 Change in minimum funding requirement obligation – – – (25) (25)
Employer’s contributions 31 – – – 31 Benefit payments (57) 57 – – –
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 30. PENSION SCHEMES CONTINUED 30.2 PGL PENSION SCHEME CONTINUED Scheme assets The distribution of the scheme assets at the end of the year was as follows: Total £m
Fixed interest gilts 1,199 – 1,214 – Index-linked bonds 508 – 297 – Corporate bonds – – 423 – Swaps 50 – – –
The PGL Scheme uses swaps, UK Government bonds and UK Government stock lending to hedge the interest rate and inflation exposure arising from the liabilities. Under the Scheme’s stock lending programme, the Scheme lends a Government bond to an approved counterparty and receives a similar value of cash in return which it typically reinvested into other Government bonds. The Scheme retains economic exposure to the Government bonds, hence the value of the gilts continues to be recognised as a scheme asset with a corresponding liability to repay the cash received as disclosed in the table above.
It has been assumed that post-retirement mortality is in line with 90% of S1PXA base tables with future longevity improvements in line with CMI 2012 Core Projections and a long-term rate of improvement of 2% p.a. up to and including age 75 then decreasing linearly to 0% at age 110. Under these assumptions, the average life expectancy from retirement for a member currently aged 42 retiring at age 62 is 28.4 years and 30.7 years for male and female members respectively.
The UK Government currently intends to equalise benefits between males and females arising from the accrual of Guaranteed Minimum Pensions (‘GMP’) requirements. Legislation will be implemented following completion of the current consultation on this matter. Once this consultation process has reached a conclusion, the Group will be able to quantify the impact of this change.
Cost or valuation At 1 January 96 2,048 445 23 2,612
Charge for the year – 111 19 – 130 157 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
GOODWILL The carrying value of goodwill has been tested for impairment at the period end. No impairment has resulted as the value in use of this intangible continues to exceed its carrying value. Value in use has been determined as the present value of certain future cash flows associated with the Ignis Asset Management business and the management services business of the Phoenix Life segment. The cash flows used in this calculation are consistent with those adopted by management in the Group’s operating plan and for the period 2018 and beyond, reflect the anticipated run-off of the Phoenix Life insurance business.
Other intangibles of £3 million relate to software costs capitalised during the year.
PRESENT VALUE OF FUTURE PROFITS ON NON-PARTICIPATING BUSINESS IN THE WITH-PROFIT FUND The value of the present value of future profits is determined on a realistic basis and is allocated in full to the Phoenix Life segment. The principal assumptions used to calculate the present value of future profits are the same as those used in calculating the insurance contract liabilities given in note 39.5.1. Revaluation of the present value of future profits is charged or credited to the consolidated income statement as appropriate.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 32. PROPERTY, PLANT AND EQUIPMENT This note analyses the Group’s tangible fixed assets which consists primarily of land and buildings at valuation, computer equipment and equipment and fittings. Fair value hierarchy disclosures for land and buildings at valuation are also included. The accounting policy adopted in the preparation of this note is detailed in note 1(o).
The following table shows a reconciliation from the opening to the closing fair value for the Level 3 land and buildings at valuation: £m
The fair value of the land and building valuation would increase (decrease) if the expected rental value per square foot were to be higher (lower) and the capitalisation rate were to be lower (higher).
Gains/(losses) on adjustments to fair value (recognised in profit and loss) 72 (85)
Commercial investment property is measured at fair value by independent property valuers having appropriate recognised professional qualifications and recent experiences in the location and category of the property being valued. The valuations are carried out in accordance with the Royal Institute of Chartered Surveyors (RICS) guidelines with expected income and capitalisation rate as the key nonobservable inputs.
Yield methodology Expected income per sq. ft. £3.35 – £235 (£28.77)
The estimated fair value of the commercial properties (held by life companies and UK Commercial Property Trust) would increase (decrease) if: −The expected income were to be higher (lower); or
The fair value of the residential property reversions (held by life companies) would increase (decrease) if: −The market value of the property were to be higher (lower); −The life expectancy of the policyholders were to decrease (increase); or
34. FINANCIAL INSTRUMENTS This note analyses the carrying values and fair values of the Group’s financial assets and liabilities. The note also explains the methodologies applied in valuing our financial assets and liabilities that are carried at fair value and also when measured on another basis but where fair value is disclosed. An analysis is provided of these financial assets and liabilities within a fair value hierarchy, determined by the market observability of valuation inputs. The accounting policies adopted in the preparation of this note are detailed in notes 1(f), (g), (i), (j), (k) and (r).
Where we are giving disclosures in the IFRS financial statements for the first time in accordance with IFRS 13, comparatives are not required and have not been provided, except where previously disclosed on a voluntary basis in prior periods.
Financial assets measured at carrying and fair values Loans and receivables at amortised cost 1,977 145 1,985 Financial assets at fair value through profit or loss: Held for trading – derivatives 1,948 1,003 1,948 Designated upon initial recognition: Fixed and variable rate income securities 35,312 25,973 35,312 Collective investment schemes1 6,395 – 6,395
Less amounts classified as held for sale (note 4) (55) – (55) Total financial assets 56,888 56,896
Financial liabilities measured at carrying and fair values Financial liabilities at fair value through profit or loss: Designated upon initial recognition: Borrowings 186 186 186 Net asset value attributable to unitholders1 5,309 – 5,309 Investment contract liabilities1 8,578 – 8,578
Held for trading – derivatives 2,156 1,229 2,156 Financial liabilities measured at amortised cost: Deposits received from reinsurers 385 350 385 Obligations for repayment of collateral received2 7,284 – –
2 These liabilities have no expected settlement date. As the obligations relate to the repayment of collateral received in the form of cash, the liability is stated at the value of the consideration received, and therefore no fair value has been disclosed.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 34. FINANCIAL INSTRUMENTS CONTINUED 34.1 FAIR VALUES CONTINUED
Financial assets measured at carrying and fair values Loans and receivables at amortised cost 1,914 221 1,912 Financial assets at fair value through profit or loss: Held for trading – derivatives 3,665 2,829 3,665 Designated upon initial recognition: Fixed and variable rate income securities 40,945 29,074 40,945 Collective investment schemes1 6,052 – 6,052
Held for trading – derivatives 3,026 2,222 3,026 Financial liabilities measured at amortised cost: Deposits received from reinsurers 454 420 454 Obligations for repayment of collateral received 10,458 – –
Total financial liabilities 29,751 19,199 34.2 FAIR VALUE HIERARCHY 34.2.1 Determination of fair value and fair value hierarchy of financial instruments Level 1 financial instruments The fair value of financial instruments traded in active markets (such as exchange traded securities and derivatives) is based on quoted market prices at the period end provided by recognised pricing services. Market depth and bid ask spreads are used to corroborate whether an active market exists for an instrument. Greater depth and narrower bid-ask spread indicates higher liquidity in the instrument and are classed as Level 1 inputs. For collective investment schemes, fair value is by reference to published bid prices.
34.2.2 Fair value hierarchy of financial instruments The tables below separately identify financial instruments carried at fair value from those measured on another basis but for which fair value is disclosed.
Financial assets measured at fair value Derivatives 54 1,894 – 1,948 Financial assets designated at fair value through profit or loss upon
Less amounts classified as held for sale (note 4) (55) – – (55) Total financial assets measured at fair value 40,889 12,021 2,001 54,911 Financial assets for which fair values are disclosed Loans and receivables at amortised cost – 1,869 116 1,985
Fair value hierarchy information for non-financial assets measured at fair value is included in note 32 for land and buildings at valuation and in note 33 for investment properties.
Total financial liabilities measured at fair value 5,252 10,691 286 16,229 Financial liabilities for which fair values are disclosed Borrowings at amortised cost – 229 1,965 2,194 Deposits received from reinsurers – 385 – 385 Total financial liabilities for which fair values are disclosed – 614 1,965 2,579 165 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Less amounts classified as held for sale (note 4) (61) – – (61) Total financial assets measured at fair value 44,038 16,088 1,480 61,606 £m £m
Financial liabilities measured at fair value Derivatives – 3,023 3 3,026 Financial liabilities designated at fair value through profit or loss upon initial recognition: Investment contract liabilities – 8,096 – 8,096
Total financial liabilities measured at fair value 4,601 11,313 73 15,987 34.2.3 Level 3 financial instrument sensitivities Included in Level 3 investments are two property investment structures with a value of £15 million (2012: £6 million) and £119 million (2012: £102 million) respectively.
Level 3 investments in indirect property, equities (including private equity) and collective investment schemes (including hedge funds) are valued using net asset statements provided by independent third parties, and therefore no sensitivity analysis has been prepared.
Borrowings measured at fair value and categorised as Level 3 financial liabilities comprise the property reversion loans, measured using an internally developed model. The valuation is sensitive to increases (decreases) in the fair value of relevant residential property reversions which would result in a higher (lower) fair value of property reversion loans. Details of the valuation of the underlying residential property reversions are included in note 23.
Fixed and variable rate income securities 725 240 Collective investment schemes 243 –
There were no transfers of financial liabilities at fair value between Level 1 and Level 2 and between Level 2 and Level 1 in 2012.
The application of the Group’s fair value hierarchy classification methodology at an individual security level, in particular observations with regard to measures of market depth and bid-ask spreads, have resulted in an overall net movement of financial assets from Level 1 to Level 2 in the period.
34.2.5 Movement in Level 3 financial instruments measured at fair value £m
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 34. FINANCIAL INSTRUMENTS CONTINUED 34.2 FAIR VALUE HIERARCHY CONTINUED Borrowings of £194 million were transferred from Level 2 to Level 3 during the year as a significant model input is no longer considered market observable.
Financial assets designated at fair value through profit or loss upon initial recognition: Equities 814 9 (9) (4) 810 (6) Fixed and variable rate income securities 862 (67) (171) (124) 500 (72)
Financial liabilities Derivatives – 3 – – 3 (4) Financial liabilities designated at fair value through profit or loss upon initial recognition: Net asset value attributable to unitholders 169 2 (101) – 70 2 168 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
34.3 COLLATERAL ARRANGEMENTS 34.3.1 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 2013 (2012: none).
Net amount £m 169 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 34. FINANCIAL INSTRUMENTS CONTINUED 34.3 COLLATERAL ARRANGEMENTS CONTINUED 34.3.2 Derivative collateral arrangements Assets accepted It is the Group’s practice to obtain collateral to mitigate the counterparty risk related to over-the-counter (‘OTC’) derivatives usually in the form of cash or marketable financial instruments.
Where the Group receives collateral on OTC derivatives in the form of cash it is recognised in the statement of consolidated financial position along with a corresponding liability to repay the amount of collateral received, disclosed as ‘Obligations for the repayment of collateral received’. The amounts recognised as financial assets and liabilities from cash collateral received at 31 December 2013 are set out below.
34.3.3 Stock lending collateral arrangements The Group lends listed financial assets held in its investment portfolio to other institutions. The Group conducts its stock lending programme only with 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.
The maximum exposure to credit risk in respect of stock lending transactions is £6,672 million (2012: £9,179 million) of which credit risk of £6,672 million (2012: £9,179 million) is mitigated through the use of collateral arrangements.
34.3.4 Loans and receivables collateral arrangements The Group has invested into Tri-party loans with Euroclear, a financial services company, whereby it lends cash to other reputable institutions. The cash on loan is derecognised and a loans and receivables balance recognised in the statement of consolidated financial position. The amount recognised as a financial asset in this regard is £1,789 million as at 31 December 2013 (2012: £1,683 million).
The maximum exposure to credit risk in respect of these loan transactions is £1,789 million (2012: £1,683 million) of which credit risk of £1,789 million (2012: £1,683 million) is mitigated through the use of collateral arrangements.
Investment broker balances 253 331 Other debtors 64 108 Cash collateral pledged 422 –
36. CASH AND CASH EQUIVALENTS This note analyses the cash and cash equivalents figure included in the statement of consolidated cash flows. The accounting policy adopted in the preparation of this note is detailed in note 1(t).
Bank and cash balances 1,193 1,764 Short-term deposits (including demand and time deposits) 8,031 7,264
All deposits are subject to fixed interest rates. The carrying amounts approximate to fair value at the period end. Cash and cash equivalents in long-term business operations and collective investment schemes of £8,895 million (2012: £8,552 million) are primarily held for the benefit of policyholders and so are not generally available for use by the owners.
Decrease in investment assets 6,858 7,082 Decrease in reinsurance assets 349 156 Decrease in insurance contract and investment contract liabilities (2,519) (6,262) Decrease in deposits received from reinsurers (69) (18) Decrease in obligation for repayment of collateral received (3,174) (2,547) Net increase in working capital (698) (97) Cash generated/(utilised) by operations 1,010 (2,291)
GROUP CAPITAL Capital resources The primary sources of capital used by the Group comprise equity shareholder funds as measured on an MCEV basis, the Perpetual Reset Capital Securities and shareholder borrowings. This is analysed as follows: £m £m
Further detail on the Group’s gearing calculation (unaudited) is provided in the business review on page 43.
Regulatory capital requirements of the Group Insurance Groups’ Directive (‘IGD’) PRA regulated insurance groups (including their holding companies) are also required to assess capital adequacy on a Group-wide basis to enable the PRA to assess both the level of insurance and financial risk within the Group and the capital resources available to cover that risk. The assessment is known as the IGD.
The Group’s IGD assessment is made at the ultimate insurance parent undertaking within the EEA, which is PLHL.
The capital position statement shown above presents the total capital that the Group manages on a Pillar 1 basis in respect of its life insurance companies. It is different from the total capital available in the IGD calculation on the basis that the IGD is assessed at the PLHL level and is subject to different rules pertaining to its calculation. For example, due to the Group’s current corporate structure, certain of the Group’s subsidiaries are only included in the IGD calculation at 75% of their regulatory value, including capital requirements. The capital position statement includes these subsidiaries in full. This difference and other adjustments amount to a reduction of £905 million (2012: £916 million) in Phoenix Life available capital resources of £6,290 million (estimated) (2012 (actual): £6,532 million) compared with PLHL Group Capital Resources of £5,385 million (estimated) (2012 (actual): £5,616 million). Further detail of the PLHL IGD position (unaudited) is provided in the business review on page 40.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 38. CAPITAL STATEMENT CONTINUED GROUP CAPITAL CONTINUED Regulatory capital requirements of the life companies Each UK life company and the Group must retain sufficient capital at all times to meet the regulatory capital requirements mandated by the PRA. In addition to EU-directive-based ‘Pillar 1’ and group capital requirements, the PRA has also stipulated a ‘Pillar 2’ of risk-based capital requirements that have been implemented in the UK. A life company’s actual capital requirement is based on whichever of the Pillar 1 or Pillar 2 requirement turns out to be more onerous for the company. Each life company generally holds an amount of capital that is greater than the minimum required amount to allow for adverse events in the future that may use capital and might otherwise cause the company to fail the minimum level of regulatory capital test.
Pillar 2 The Pillar 2 capital requirements are based on a self-assessment methodology, called the ‘Individual Capital Assessment’ (‘ICA’). This methodology determines the capital requirement to ensure that the life company’s realistic liabilities can be met in one year’s time with a 99.5% confidence level, or in other words to be able to withstand a one in 200 year event. The PRA reviews each life company’s ICA and may impose additional capital requirements if necessary in the form of ‘Individual Capital Guidance’ (‘ICG’).
Adjustments onto a regulatory basis: Unallocated surplus 954 17 – 971 Adjustments to assets1 (72) (203) (758) (1,033)
Owners’ funds held outside long-term fund – – 1,822 1,822 (605) 1,217 Owners’ funds held in long-term fund – 441 – 441 – 441
Other qualifying capital: Subordinated debt3 – – 645 645 Contingent loans 350 (55) (295) –
Owners’ funds held in long-term fund – – – – – – – Total owners’ funds – – – – – – –
An analysis of the movement in available capital resources for the period 1 January 2013 to 31 December 2013, is shown below: With-profit
New business and other factors: Intragroup capital movement – – – – – (130) (242) 177 (195)
Total available capital resources 177 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 38. CAPITAL STATEMENT CONTINUED GROUP CAPITAL CONTINUED An analysis of the movement in available capital resources for the period 1 January 2012 to 31 December 2012, is shown below: With-profit
Changes in methodology and assumptions: Longevity 2 18 1 6 3 56 2 – 88
Changes in methodology and assumptions Changes to capital resources arising from changes in methodology and assumptions occur in the normal course of the assumption-setting process and reflect changes in available data inputs. In addition, on-going work to standardise actuarial modelling and methodology has produced further changes to capital resources during the year to 31 December 2013.
39. RISK MANAGEMENT This note sets out the major risks that the Group businesses are exposed to and describes the Group’s approach to managing these. The Group’s risk management framework is described in the risk management commentary on pages 44 to 50 of the Annual Report and Accounts.
In pursuing these objectives, the Group deploys financial assets and incurs insurance contract liabilities and financial liabilities. Financial assets principally comprise investments in equity securities, fixed and variable rate income securities, collective investment schemes, property, derivatives, reinsurance, trade and other receivables, and banking deposits. Financial liabilities comprise investment contracts, borrowings for financing purposes, derivative liabilities and other payables.
39.2 FINANCIAL RISK AND THE ASSET LIABILITY MANAGEMENT (‘ALM’) FRAMEWORK The use of financial instruments naturally exposes the Group to the risks associated with them, mainly, market risk, credit risk and financial soundness risk.
Derivatives are used in a number of the Group’s funds, within policy guidelines agreed by the Board of each life company and overseen by Investment Committees of the Boards of each life company supported by management oversight committees. Derivatives are primarily used for efficient portfolio management or for risk hedging purposes, including the activities of the Group’s Treasury function.
More detail on the Group’s exposure to financial risk is provided in note 39.3 below.
The Group’s overall exposure to market and credit risk is monitored by appropriate committees, which agree policies for managing each type of risk on an ongoing basis, in line with the investment strategy developed to achieve investment returns in excess of amounts due in respect of insurance contracts. The effectiveness of the Group’s ALM relies on the matching of assets and liabilities arising from insurance and investment contracts, taking into account the types of benefits payable to policyholders under each type of contract. Separate portfolios of assets are maintained for with-profit business funds (which includes all of the Group’s participating business), non-linked non-profit funds and unit-linked funds.
39.3 FINANCIAL RISK ANALYSIS Transactions in financial instruments result in the Group assuming financial risks. These include credit risk, market risk and financial soundness risk. Each of these are described below, together with a summary of how the Group manages them.
−Credit risk which results indirectly from activities undertaken in the normal course of business. Such activities include premium payments, outsourcing contracts, reinsurance, exposure from material suppliers and the lending of securities.
The amount disclosed in the statement of consolidated financial position in respect of all financial assets, together with rights secured under off balance sheet collateral arrangements, and excluding those that back unit-linked liabilities, represents the Group’s maximum exposure to credit risk.
A 100 basis point 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 £81 million (2012: £72 million).
Fixed and variable rate income securities 24,956 6,502 4,461 3,495 376 527 443 132 40,892 Reinsurers’ share of insurance contract
Please refer to page 208 for additional life company asset disclosures which include the life companies’ exposure to peripheral Eurozone debt securities. Peripheral Eurozone is defined as Portugal, Spain, Italy, Ireland and Greece. The Group’s exposure to peripheral Eurozone debt is now relatively small compared to total assets under management.
Concentration of credit risk Concentration of credit risk might exist where the Group has significant exposure to an individual counterparty or a group of counterparties with similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic and other conditions. The Group has most of its counterparty risk within its life business and this is monitored by the counterparty limits contained within the investment guidelines and investment management agreements, overlaid by regulatory requirements and the monitoring of aggregate counterparty exposures across the Group against additional Group counterparty limits. Counterparty risk in respect of OTC (over-the-counter) derivative counterparties is monitored using a Value-at-Risk (VaR) exposure metric.
−monitoring of compliance with market risk policy and review of market risk policy for pertinence to the changing environment.
Interest rate risk is managed by matching assets and liabilities where practicable and by entering into derivative arrangements for hedging purposes where appropriate. This is particularly the case for the non-participating funds. For participating business, some element of investment mismatching is permitted where it is consistent with the principles of treating customers fairly. The with-profit funds of the Group provide capital to allow such mismatching to be effected. In practice, the life companies of the Group maintain an appropriate mix of fixed and variable rate instruments according to the underlying insurance or investment contracts and will review this at regular intervals to ensure that overall exposure is kept within the risk profile agreed for each particular fund. This also requires the maturity profile of these assets to be managed in line with the liabilities to policyholders.
An increase of 1% in interest rates, with all other variables held constant, would result in an increase in the profit after tax in respect of a full financial year, and in equity, of £105 million (2012: an increase of £41 million). A decrease of 1% in interest rates, with all other variables held constant, would result in a decrease in profit after tax in respect of a full financial year, and in equity, of £142 million (2012: a decrease of £79 million).
A 10% increase in property prices, with all other variables held constant, would result in an increase in the profit after tax in respect of a full financial year, and in equity, of £23 million (2012: £20 million).
Certain Phoenix Life with-profit funds have an exposure to overseas assets which is not driven by liability considerations. The purpose of this exposure is to reduce overall risk whilst maximising returns by diversification. This exposure is limited and managed through investment mandates which are subject to the oversight of the Investment committees of the Boards of each life company. Fluctuations in exchange rates from certain holdings in overseas assets are hedged against currency risks.
Sensitivity of profit after tax and equity to fluctuations in currency exchange rates is not considered significant at 31 December 2013, since unhedged exposure to foreign currency was relatively low (2012: not considered significant).
39.3.3 Financial soundness risk Financial soundness risk is a broad risk category encompassing financial control and reporting risk, capital management risk, liquidity and funding risk, and tax risk.
Financial control and reporting risk is defined as the failure of the Group to appropriately record, report or disclose financial information. The Group has exposure to financial control and reporting risk through the production of its Interim and Annual Report and Accounts. The Group’s subsidiaries have exposure to financial control and reporting risk through their annual entity statutory and regulatory reporting.
Capital management risk is defined as the failure of the Group, or one of its separately regulated subsidiaries, to maintain sufficient capital to provide appropriate security for policyholders and meet all regulatory capital requirements whilst not retaining unnecessary capital. The PLHL Group has exposure to capital management risk through the requirements of the IGD and ICA, as implemented by the PRA, to calculate regulatory capital adequacy at a Group level. The Group’s UK life subsidiaries have exposure to capital management risk through the regulatory capital requirements mandated by the PRA. The Group’s approach to managing capital management risk is described in detail in note 38.
Tax risk is defined as the risk of financial or reputational loss arising from a lack of liquidity, funding or capital due to an unforeseen tax cost, or by the inappropriate reporting and disclosure of information in relation to taxation. The Group has exposure to tax risk through the production of its Interim and Annual Report and Accounts and the provisions for taxation therein. Tax risk is managed by maintaining an appropriately-staffed tax team who have the qualifications and experience to make judgements on tax issues, augmented by advice from external specialists where required. The Group has a formal tax risk policy, which sets out its risk appetite in relation to specific aspects of tax risk, and which details the controls the Group has in place to manage those risks. These controls are subject to a regular review process. The Group’s subsidiaries have exposure to tax risk through the annual statutory and regulatory reporting and through the processing of policyholder tax requirements.
−appropriate information on liquidity risk is available to those making decisions.
The following table provides a maturity analysis showing the remaining contractual maturities of the Group’s undiscounted financial liabilities and associated interest. Liabilities under insurance contract contractual maturities are included based on the estimated timing of the amounts recognised in the statement of consolidated financial position in accordance with the requirements of IFRS 4: 1 year or less or on demand £m 1–5 years £m
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 39. RISK MANAGEMENT CONTINUED 39.3 FINANCIAL RISK ANALYSIS CONTINUED
39.4 UNIT-LINKED CONTRACTS For unit-linked contracts the Group matches all the liabilities with assets in the portfolio on which the unit prices are based. There is therefore no interest, price, currency or credit risk for the Group on these contracts.
In extreme circumstances, the Group could be exposed to liquidity risk in its unit-linked funds. This could occur where a high volume of surrenders coincides with a tightening of liquidity in a unit-linked fund to the point where assets of that fund have to be sold to meet those withdrawals. Where the fund affected consists of property, it can take several months to complete a sale and this would impede the proper operation of the fund. In these situations, the Group considers its risk to be low since there are steps that can be taken first within the funds themselves, both to ensure the fair treatment of all investors in those funds and to protect the Group’s own risk exposure.
General insurance higher than expected number of non-life claims on general insurance policies and occurrence of one or more large claims.
The estimation of the provisions for the ultimate cost of claims for asbestos and environmental pollution is subject to a range of uncertainties that is generally greater than those encountered for other classes of insurance business and as a consequence of this uncertainty, the eventual costs of settlement of outstanding claims and unexpired risks can vary substantially from the estimates.
Sensitivities Insurance liabilities are sensitive to changes in risk variables, such as prevailing market interest rates, currency rates and equity prices, since these variations alter the value of the financial assets held to meet obligations arising from insurance contracts and changes in investment conditions also have an impact on the value of insurance liabilities themselves. Additionally, insurance liabilities are sensitive to the assumptions which have been applied in their calculation, such as mortality and lapse rates. Sometimes, allowance must also be made for the effect on future assumptions of management or policyholder actions in certain economic scenarios. This could lead to changes in assumed asset mix or future bonus rates. The most significant non-economic sensitivities arise from mortality, longevity and lapse risk.
A decrease of 5% in assurance mortality, with all other variables held constant, would result in an increase in the profit after tax in respect of a full year, and an increase in equity of £18 million (2012: £25 million).
A decrease of 5% in annuitant longevity, with all other variables held constant, would result in an increase in the profit after tax in respect of a full year, and an increase in equity of £117 million (2012: £132 million).
An increase of 5% in annuitant longevity, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full year, and a decrease in equity of £116 million (2012: £130 million).
A decrease of 25% in lapse rates, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full year, and a decrease in equity of £50 million (2012: £51 million).
Change in longevity assumptions (6) (5) Change in persistency assumptions 6 32 Change in expenses assumptions (7) (1)