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Phoenix Group Holdings Annual Report and Accounts 2011 02 Chairman’s statement 04 Group Chief Executive
Governance 54 Board of Directors 58 Our management team 60 Directors’ report 65 Corporate governance report 72 Remuneration report
Business and strategy 10 Our business 12 Operating structure 16 Our strategy
Business review 20 Key performance indicators 24 Cash generation 27 Group MCEV 30 Group IFRS operating profit 33 Group assets under management 34 Capital management 38 Risk management 42 Principal risks and uncertainties facing the Group
MCEV supplementary information 173 Statement of Directors’ responsibilities 174 Independent Auditor’s report 175 MCEV financial statements 179 Notes to the MCEV financial statements
Corporate responsibility 46 Corporate responsibility 46 Environment 47 Community 48 Workplace 50 External stakeholders 2011 Key performance indicators £810m Operating companies’ cash generation £2,118m Group MCEV
42p Dividend per share £72.1bn Group assets under management £46m Asset management IFRS operating profit
I am pleased to report to shareholders that this performance has led the Board to recommend a final dividend of 21p per share, bringing the total dividend for the financial year to 42p per share. Shareholders may again elect to receive their dividends as scrip.
Since the Premium Listing in 2010, which was a major step forward for Phoenix, there has been no diminution in the level of activity undertaken by the Group. We have continued to develop our operating platform for the management of our closed life funds in order to deliver greater efficiency, flexibility and resilience in the face of significant changes in economic and regulatory environments. The development of ‘The Phoenix Way’ provides us with a consistent methodology for the structuring, integration and management of closed life funds. In addition, Ignis has made significant progress towards becoming a high performing asset management business, providing above benchmark investment performance for our policyholders and developing an attractive proposition for third party clients.
The Group remains focused on our responsibilities to our 6 million customers, and our custodianship of policyholder assets. The progress of the Group, in conjunction with our outsourced partners, to improve customer service and outcomes has continued and will remain a top priority.
Turning to my own future within the Group, I have indicated my intention to retire from the Board during the course of 2012, once a suitable successor has been identified. Whilst the journey is by no means complete, Phoenix is now well positioned for the next stage of its development and I have decided that it is the right time to pass on the baton. Having made this decision, I feel it appropriate to give my Board colleagues ample notice of my intention to retire so that the process for the appointment of my successor can start immediately and with no time pressure to complete that task.
During the course of 2011, we announced that we had been approached by a number of parties regarding a possible transaction with the Group. These approaches were unsolicited and did not lead to any formal offers being made. They did not distract us from continuing to work towards our vision of being the saver-friendly, ‘industry solution’ for the safe, innovative and profitable management of closed life funds and a leading asset management business.
The scale and predictability of the Group’s cash flows underpin our ability to harvest value for our shareholders. This cash flow has allowed us to make further progress in delevering the Group’s capital structure during 2011 and, in due course, we expect that we will put in place new banking arrangements to provide the Group with the long-term capital structure that meets our strategic objectives and allows the fulfilment of the Group’s vision.
Introduction At the end of my first year as Group Chief Executive Officer, I am able to look back at 12 months of substantial achievement. The effective combination of the closed life fund business of Phoenix Life and the asset management capability of Ignis has proven itself able to create value in challenging market environments. We have continued to develop Phoenix’s business model and through ‘The Phoenix Way’ we have created a template that can be used to integrate additional closed life funds in the future.
Reterming our debt is our top priority in terms of corporate activity, as we look to align our debt profile to our longer term cash flows. The more tranquil market conditions since year end, and the improvements in our cash position and in our IGD headroom during 2011, reinforce our confidence in our ability to progress these reterming discussions.
Our year end MCEV was broadly unchanged at £2,118 million, despite the impact of investment market volatility in the second half of the year. MCEV included an incremental £165 million delivered through management actions, significantly in excess of our average annual target of £100 million.
Our estimated IGD surplus was £1.3 billion at 31 December 2011, up from £1.0 billion a year earlier, with headroom over our IGD capital policy of £0.4 billion. During 2011 we undertook several management actions to strengthen our IGD position through the simplification of the Group’s structure. The headroom over our IGD capital policy allows us greater flexibility in the repayment of our bank debt and we have identified additional actions that will improve this surplus further in 2012.
Phoenix Life highlights Phoenix Life, led by its Chief Executive Officer Mike Merrick, contributed IFRS operating profit of £395 million, slightly above the £388 million achieved in 2010.
The Group has a well established Solvency II programme and has continued to progress towards meeting the Solvency II requirements. The FSA has recently announced a change to the implementation date of Solvency II to 1 January 2014 (a year later than previously envisaged) and the Group is on track to meet this timetable.
Underpinning the development of the Solvency II internal model is the Group’s Actuarial Systems Transformation (‘AST’) project which will deliver a single actuarial modelling platform across the business, transforming modelling capability and efficiency.
Phoenix has continued to make considerable progress in 2011, despite volatile market conditions, and has a clear strategy to deliver shareholder value.
In co-operation with our outsourced partners, we have transformed many of our systems to improve customer service and operational efficiency. We have been working diligently to ensure that any customer complaints are dealt with in an efficient and timely manner and we have already seen a real improvement in customer satisfaction in this area.
We are always seeking initiatives that may be of benefit to our policyholders. During 2011 we launched a scheme to enable some holders of paid-up life insurance
Ignis highlights Ignis Asset Management, led by its Chief Executive Officer, Chris Samuel, was able to increase assets under management, administration and oversight by 3% to £70.7 billion. In addition, Ignis has shown stable financial performance in difficult markets, with an IFRS operating profit of £46 million in 2011.
Ignis is also in the process of putting in place an appropriate back office structure to support its future plans by partnering with HSBC Securities Services to deliver investment administration and other related activities. As with Phoenix Life, the use of outsourced partners allows Ignis to focus on the key areas of investment and distribution, whilst providing a more predictable and lower cost operating model for the Group.
As the Group’s life company assets run-off over time, it is important that Ignis develops its capabilities and brand as a manager of third party assets. In 2011 Ignis attracted
2012 Outlook and prospects Developing ‘The Phoenix Way’ The Phoenix Way characterises an approach and infrastructure for the efficient and effective structuring, integration and management of closed life funds and the investments they hold. By applying a consistent framework across the Group, The Phoenix Way reduces risk, complexity and cost; improves investment performance; enhances customer service through effectively working with our outsourced partners; increases MCEV and releases capital to shareholders.
The combination of cash flow generation and enhancement to MCEV will allow us to delever the Group’s capital structure. Having already achieved the target to reduce our level of gearing to below 50%, we have now set ourselves a further target to reduce this to 43% or below by the end of 2012.
Conclusion I look forward to 2012 with confidence and believe that we can continue to demonstrate the great strengths of Phoenix Life and Ignis, building and delivering value for all our stakeholders. I would like to thank my colleagues for their hard work during a challenging period. Although it is difficult to predict how the economic climate will develop, the quality of the teams in Phoenix Group, the discipline with which the Group manages risk and capital and the proven resilience of its business model will stand us in good stead during the coming year.
Clive Bannister Group Chief Executive Officer group chief executive officer’s report continued
Generated £810 million operating companies’ cash generation – above the mid-point of the target range
Further simplified life company structure through consolidation of life companies and recapture of internal reassurance, enhancing the IGD capital position of the Group
Completed the transfer of 2 million live policies onto the BaNCS administration platform
Restructured Ignis joint ventures to give the businesses a greater degree of independence in the future
Business and strategy 09In this section 10 Our business 12 Operating structure 16 Our strategy
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 so-called ‘closed life funds’ within the Group consist of millions of policyholders and a total of approximately £63 billion of financial assets.
Asset management Through Ignis, the Group both manages the funds that back the investments of our policyholders and develops investment propositions for third party clients in the institutional, retail and international markets.
Ignis has announced a restructuring of its operations to support its future strategy, including the use of its own outsourced partner to provide investment administration and related back office services.
Value generated by Phoenix Life and Ignis is distributed to the Holding Companies in the form of cash. The Holding Companies use this cash to fund group expenses, pension contributions, debt interest and repayments and shareholder dividends.
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.
The Group has continued its programme of activity to further integrate its life companies in order to optimise capital allocation and economies of scale. During 2011, the internal reassurance arrangement between Phoenix Life Limited (‘PLL’) and Phoenix Pensions Limited (‘PPL’) was also recaptured by PLL, resulting in PPL no longer holding any life assurance business.
Drive value Driving value consists of more than just targeting enhanced investment returns. The Group also aims to ensure that unrewarded exposure to market volatility is minimised or the risks from sudden market movements are managed through hedging. In addition, regular re-balancing of asset and liability positions is required to ensure that only those assets which deliver the appropriate level of return for the risk assumed are held within life funds and to take into account any guarantees which attach to the liabilities.
Our structure is aligned to the market sectors in which we operate. The Group has two core segments: life assurance – Phoenix Life; and asset management – Ignis. In addition, our Group functions provide support and coordination for the delivery of the Group’s strategic initiatives.
Business and strategy 13all administrative services required by the Group’s life companies. By using management services companies, the life companies benefit from price certainty and a transfer of some operational risks to the management services companies.
These outsourced partners have scale and common processes, often across multiple clients, which provide several benefits for the Group, including converting fixed costs to variable costs, reducing investment requirements, improving the technology used within our administrative capability, and reducing our operational risk.
areas including increasing estate distribution for with-profit policyholders and improving the speed of claims payouts. As in 2010, ensuring fast and efficient claims payouts for our customers continued to be a priority and in addition to using the ABI-sponsored Origo service for open market option payments relating to pension-to-annuity transfers, we also used it for pension-topension transfers during the year. This initiative reduced transfer times from around 30 days to under 12 days on average.
– As a result, developing further as a high quality, profitable company.
– Stability that comes from a strong governance and control culture and being part of the Phoenix Group.
An important part of The Phoenix Way involves addressing legacy issues to maximise cost efficiency and improve functionality.
The Group has grown through the acquisition of a number of closed life fund businesses, resulting in a disparate collection of actuarial valuation models on a variety of platforms. To address this, Phoenix Life has entered into a long-term relationship with Milliman to consolidate these valuation models onto the MG ALFA platform.
The Group will derive benefits from a number of areas: Deploying The Phoenix Way: Actuarial Systems Transformation (‘AST’)
Ignis Equities – UK – Europe – Far East – US – Global – Emerging markets
Ignis Real Estate – Unit trust – Investment trust – Segregated mandates
The benefits of this new partnership to the Group will be derived from a number of areas: – It allows Ignis to focus on its strategic priorities of investment and distribution
– It reduces and simplifies the network of external suppliers for both Ignis and Phoenix Life
Driven Investment (‘LDI’) products to the institutional market. An example of the success that Fixed Income and Solutions have already had in this area was in winning a £430 million LDI mandate from one of the Group’s pension schemes during 2011, competing against other third party providers.
Ignis has broad distribution capabilities and is well placed to take its strong investment capabilities to market in the coming year, with a particular focus on building its position within the institutional market.
Ignis has recently developed a number of pooled funds across a range of asset classes. The creation of these pooled funds has allowed Ignis to simplify its relationship with the Group’s life companies by replacing a large number of individually segregated mandates. In addition, Ignis is incentivised to maximise investment performance for policyholders through a performance fee structure.
At the same time, Ignis has further strengthened its investment, distribution and operations teams in order to develop its proposition to third party clients. Ignis develops new products that it believes would be of interest to the third party market, for example it launched an Absolute Return Government Bond Fund during 2011. Ignis has also sought to leverage its knowledge of the requirements of the Group’s life companies by creating solutions which target the provision of Liability
We are well positioned to adapt to new requirements arising from Solvency II regulatory changes. Simplifying our capital structure brings greater flexibility and is a fundamental enabler of the strategic growth ambitions of the Group.
Drive value At Phoenix we drive value in many ways. There are a number of management actions undertaken by the Group such as fund mergers and de-risking which can accelerate cash or increase our MCEV.
Management of costs is also an important aspect of our value creation. Part of The Phoenix Way involves improving the efficiency of operational management through the standardisation and streamlining of key processes across the Group which will in turn reduce costs, improve performance and maximise value.
Improve customer outcomes We have three key areas of focus in relation to our customers: Value – we aim to manage customer outcomes to their maximum benefit
The Group invests in its people whose talent, enthusiasm and support makes its strategy and objectives achievable.
Developing the platform for growth During 2011, the Group has made further progress in building a stable and simplified business. Results to date, both financial and non-financial, have continued to demonstrate the delivery of our strategy.
Achieved net third party sales of £1.7 billion Restructured Argonaut joint venture to provide the business with a greater degree of independence Initiated an outsourcing of Ignis’ investment administration and back office services, in partnership with HSBC Strengthened Ignis investment and distribution teams
Maintain strong cash flow delivery Examine opportunities to refinance and/or restructure existing Group debt arrangements Further strengthen risk capabilities Continue to develop our business readiness to acquire and integrate new closed life funds in the future Further reduction in tax risks and resolution of legacy tax issues Maintain high employee engagement Achieve employee retention above sector benchmark for each business unit Maintain our market presence to ensure visibility of potential opportunities Build reputation in public policy arena
Achieved cash flow generation of £810 million Reduced gearing to 46%, below our 50% target Resolved a number of legacy tax issues allowing the release of £47 million of provisions on an IFRS basis Increased employee engagement with an overall Group engagement score of 74% Won the 2011 Strategic Communications Management (Melcrum) Award for Employee Engagement Launched liability management initiatives for the Group pension schemes
In this section 20 Key performance indicators 24 Cash generation 27 Group MCEV 30 Group IFRS operating profit 33 Group assets under management 34 Capital management 38 Risk management 42 Principal risks and uncertainties facing the Group
The Group’s financial key performance indicators (‘KPIs’) are those that demonstrate the financial performance and strength of the Group.
Management actions in themselves generated cash flows of £359 million, mainly related to restructuring and de‑risking activities.
Quantified target The cumulative cash flow target for 2011 to 2016 is £3.2 billion.
The Board considers that MCEV provides the most relevant and consistent means of assessing the Group’s ability to increase value: Analysis MCEV increased by £14 million in the period reflecting the resilience of the Group. Value enhancing management actions delivered an incremental uplift to MCEV of £165 million against a target of £100 million.
Definition and calculation Note 1 of the MCEV supplementary information sets out the basis of calculation of Group MCEV.
IGD capital policy: The Group maintains group capital resources at the PLHL level at an amount in excess of 105% of the with‑profit insurance capital component (‘WPICC’), being an additional capital requirement of with‑profit funds, plus 145% of the group capital resource requirement less the WPICC.
IGD Excess Capital represents the total capital available to the Group (both policyholder and shareholder) in excess of capital requirements. It is a measure of the capital strength of the Group and the capital available to protect policyholders and shareholders from adverse events.
Definition and calculation IGD Excess Capital includes policyholder and certain shareholder capital currently excluded under FSA rules from the calculation of IGD surplus at the PLHL level and is explained on page 35.
Analysis The Board has recommended a final dividend of 21 pence per share bringing the total dividend for the year to 42 pence. The final dividend is due to be paid on 8 May 2012, subject to compliance with the processes set out in the Group’s main credit facilities and shareholder approval at the Company’s AGM. A scrip dividend option will be available to shareholders.
Definition and calculation Ignis’ IFRS operating profit excludes non‑recurring income and expenses.
The gearing ratio is the Group’s measure of its level of debt compared to its equity on an MCEV basis: Analysis The Group has met its target of reducing gearing to below 50% through strong cash generation and an increase in MCEV.
Target The Group’s target is to reduce the gearing ratio to 43% or below during the course of 2012.
2 Net shareholder debt is defined as shareholder debt (including hybrid debt) less Holding Company cash as set out on page 37.
3 Closing balance at 31 December 2011 includes required prudential cash buffer of £150 million (2010: £150 million).
The Phoenix Life IFRS operating profit is discussed in the Group IFRS operating profit section and reflects recurring margins and return on surplus assets, within the £275 million to £325 million expected annual range, plus the effects of non‑economic experience variances and assumption changes.
Non‑recurring cash outflows Non‑recurring cash outflows of £24 million were significantly lower than in 2010 (2010: £79 million) reflecting reduced investment in the Group’s transformation programmes with its outsourced partners which are nearing completion and the non‑recurrence of certain costs related to the Group’s Premium Listing in 2010.
Operating companies’ cash generation Cash remitted by Phoenix Life increased by £70 million to £778 million (2010: £708 million) reflecting the benefit of management actions. This strong cash generation coupled with increased cash flows from Ignis Asset Management of £32 million (2010: £26 million) enabled the Group to achieve its target for cash generation in 2011 of £750 million to £850 million despite challenging market conditions.
2 Position at 16 March 2012 increased to an estimated £250 million.
Debt repayments and shareholder dividend Debt repayments of £171 million in the period comprise a £21 million voluntary debt prepayment and scheduled repayments totalling £150 million1 in respect of the Group’s two main credit facilities.
The shareholder dividend of £55 million comprises the payment of the 2010 final and 2011 interim cash dividend.
4 20% fall in equity markets, 10% fall in property, 80bps increase in yields and credit spreads widening (10 year term: AAA – 70bps, AA – 97bps, A – 140bps, BBB – 205bps).
One‑off shocks would be expected to lead to a deferral of cash emergence rather than a permanent diminution.
cash generation continued 1 This includes £1 million paid to Pearl Assurance Limited, a subsidiary undertaking. Pearl Assurance Limited is a lender under the Pearl facility.
Life MCEV operating earnings after tax Other than vesting annuities and increments to existing policies, the Group’s life division is closed to new business. The principal underlying components of the life MCEV operating earnings are therefore the expected existing business contribution together with non‑economic experience variances and assumption changes.
Expected existing business contribution The Group uses long‑term investment returns in calculating the expected existing business contribution. The expected contribution in 2011 of £254 million after tax is £52 million lower than in 2010, primarily due to a decrease in the long‑term risk‑free rate and a lower opening MCEV for life business. The long‑term risk‑free rate is based on the opening position at 1 January.
The increase in MCEV despite difficult market conditions reflects the resilience of the life division and the realisation of significant value from management actions.
MCEV operating earnings after tax were lower at £394 million (2010: £543 million) primarily due to a decrease in the long‑term risk‑free rate and the non‑recurrence of significant positive experience variances in 2010.
The new business margin is 5% after tax (2010: 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 £142 million after tax in 2011, the main driver being positive experience variances.
Negative assumption changes were primarily driven by a reduction in assumed surrender rates in funds with valuable policyholder guarantees.
Group costs Group costs were £84 million before tax in the period, of which costs relating to Group functions amounted to £39 million (2010: £40 million). The balance of the charge in both periods relates primarily to pension scheme costs, partly offset by miscellaneous income. The pension scheme costs are different to IFRS as the MCEV does not recognise pension schemes in surplus.
Group MCEV operating earnings after tax 394 543 Economic variances on life business (426) 101 Economic variances on non‑life business 38 (38) Other non‑operating variances on life business (12) (54) Non‑recurring items on non‑life business (9) (75) Finance costs attributable to owners (123) (168) Tax on non‑operating earnings 169 (54) Group MCEV earnings after tax 31 255
Economic variances on life business Negative economic variances reflect the difference between actual short‑term rates and the long‑term investment return assumption, widening of credit spreads and the fall in equity and property markets; partly offset by the positive impact of a falling yield curve.
Group MCEV Group MCEV increased by £14 million over the year to £2,118 million at 31 December 2011 as shown below: Movement in Group MCEV
Group MCEV at 1 January 2,104 1,827 Group MCEV earnings after tax 31 255 Other comprehensive income: Actuarial gains on defined benefit pension scheme (net of tax) 32 27
Non‑recurring items on non‑life business Overall, non‑recurring items on non‑life business reduced embedded value by £9 million before tax. Non‑recurring items include restructuring costs of £51 million (2010: £68 million) and regulatory change and systems transformation costs of £12 million (2010: £7 million). These costs are offset by a gain of £19 million arising from closing the Pearl Group Staff Pension Scheme to future accrual and implementing a pension increase exchange programme and a £35 million recovery of historic costs under the management services agreements with the life division.
Finance costs attributable to owners 123 168 1 Finance costs in respect of the Impala and Pearl facility agreements (and associated swap interest) and the Royal London Payment in Kind (‘PIK’) notes and facility.
2 The 2010 amount includes the 2010 coupon and 2009 deferred coupon on the Tier 1 Bonds. The 2009 deferred Tier 1 Bond coupon of £33 million was paid in November 2010.
The with‑profit funds where internal capital support has been provided experienced an operating profit of £66 million (2010: £7 million operating loss). The 2011 result included the benefits of modeling improvements of £21 million (2010: negative £20 million) and data cleansing benefits of £18 million following the transfer of policies onto the BaNCS policy administration platform. This was partly offset by a reduction in assumed surrender rates in funds with valuable policyholder guarantees of £5 million (2010: £37 million). The 2010 operating profit included £17 million of margins on funds where internal capital support is no longer required.
The operating profit on non‑profit and unit‑linked funds was £206 million (2010: £278 million). This includes margin emergence of £162 million (2010: £168 million), return on surplus assets of £10 million (2010: £18 million) and new business from vesting annuities of £27 million (2010: £22 million). The benefits of data cleansing projects of £33 million in 2011 were offset by negative longevity and mortality assumption £387m IFRS operating profit
Group IFRS operating profit The Group has generated an IFRS operating profit of £387 million (2010: £373 million), demonstrating the strength of its business model.
Phoenix Life 395 388 Ignis Asset Management 46 46 Group costs (54) (61) Operating profit before tax1 387 373 1 Operating profit is presented before adjusting items.
Phoenix Life Operating profit for Phoenix Life is based on expected investment returns on financial investments backing shareholder and policyholder funds over the reporting period, with consistent allowance for the corresponding expected movements in liabilities (being the release of prudential margins and the interest cost of unwinding the discount on the liabilities). The principal assumptions underlying the calculation of the longer term investment return are set out in note 5 to the IFRS consolidated financial statements.
Operating profit includes the effect of variances in experience for non‑economic items, such as mortality and expenses, and the effect of changes in non‑economic assumptions. Changes due to economic items which give rise to variances between actual and expected investment returns, and the impact of changes in economic assumptions on liabilities, are accounted for outside of operating profit. Phoenix Life operating profit is net of policyholder finance charges and policyholder tax.
The longer term return on owners’ funds for 2011 of £37 million reflects the asset mix of owners’ funds: primarily cash based assets and fixed interest securities. The investment policy for managing these assets remains prudent.
Ignis Asset Management The operating profit of the asset management business was stable as the costs of new business development were partly offset by an increase in fees earned on managing stock lending collateral.
IFRS result after tax The IFRS operating result is reconciled to the IFRS result after tax, as follows: Year ended 2011 £m
Operating profit before adjusting items 387 373 Investment return variances and economic assumption changes on long‑term business (338) 18 Variance on owners’ funds 9 19 Amortisation of acquired in‑force business and other intangibles (139) (150) Non‑recurring items 14 (139) (Loss)/profit before finance costs attributable to owners (67) 121 Finance costs attributable to owners (110) (115) (Loss)/profit before the tax attributable to owners (177) 6 Tax credit attributable to owners 79 74 (Loss)/profit for the period attributable to owners (98) 80
Debt finance costs1 96 102 Other finance costs 14 13 Finance costs attributable to owners 110 115 1 Finance costs in respect of the Impala and Pearl facility agreements (and associated swap interest) and the Royal London PIK notes and facility.
Tax credit attributable to owners The Company is exempt from tax in the Cayman Islands on any profits, income, gains or appreciations for a period of 30 years from 11 May 2010 (the previous exemption was for 20 years from 15 January 2008).
Variance on owners’ funds The favourable variance on owners’ funds of £9 million for 2011, mainly relates to fair value gains on swaps and gilts held in the shareholder funds.
Non‑recurring items Non‑recurring items include restructuring costs of £37 million (2010: £103 million) and regulatory change and systems transformation costs of £21 million (2010: £36 million). These costs are offset by a gain of £37 million arising from closing the Group’s pension schemes to future accrual and implementing a pension increase exchange programme and a £35 million recovery of historic costs under the management services agreements with the life division.
Group assets under management represent all assets actively managed or administered by or on behalf of the Group including life companies’ funds managed by third parties. It includes Holding Company cash and cash equivalents but excludes stock lending collateral.
Third party (including Group pension schemes) net inflows were £1.7 billion in the year (2010: £1.3 billion) mainly reflecting strong sales of real estate and liquidity funds and a £0.4 billion new rates Liability Driven Investing (‘LDI’) mandate from the PGL Pension Scheme.
The Group’s IGD assessment is made at the level of the highest EEA insurance group holding company, which is PLHL. The estimated IGD surplus at 31 December 2011 is £1.3 billion (2010: £1.0 billion). The components of the estimated IGD calculation are shown below: 2011 £bn 2010 £bn
1 Capital generation includes increases in GCR as well as reductions in the GCRR.
The key drivers of the change in solvency position in the year are: – Capital generation items1 of £0.6 billion including capital benefits from the transfer of the Phoenix & London Assurance Limited business into Phoenix Life Limited (effective from 1 January 2011) and the recapture of an internal reinsurance arrangement
– Partly offset by the payment of dividends, debt interest and debt repayments of £0.3 billion.
The Group’s headroom at 31 December 2011 was £0.4 billion (2010: £0.1 billion).
IGD Excess Capital IGD Excess Capital represents a more realistic measure of the capital strength of the Group as it includes policyholder and certain shareholder capital which is currently excluded under FSA rules from the PLHL Group’s IGD surplus calculation. This capital provides the Group with financial flexibility and is available to protect policyholders and shareholders from adverse events.
The excluded capital relates to: – The surplus estate of the with‑profit funds which is treated as a policyholder liability for IGD purposes due to the closed fund nature of the business
Following a 20% fall in equity markets 1.3 3.0 Following a 15% fall in property values 1.2 3.0 Following a 75bps parallel increase in yields 1.2 2.9 Following a 75bps parallel decrease in yields 1.2 3.1 Following credit spread widening1 1.2 2.9 Combined stress2 1.1 2.5 1 10 year term: AAA – 52bps, AA – 72bps, A – 104bps, BBB – 152bps.
The relative insensitivity of the Group’s IGD surplus reflects the impact of hedges put in place as part of the long‑term strategy to protect the Group from extreme market movements. The IGD Excess Capital is more sensitive to market movements than the IGD surplus because it includes excess policyholder capital in the non‑supported with‑profit funds which hold more equities, property and non‑duration matched credit than other funds. This policyholder capital is excluded from in the IGD surplus.
The Group’s target is to reduce the gearing ratio to 43% or below during the course of 2012.
Capital resources The primary sources of capital used by the Group are equity and borrowings.
The Group has net shareholder debt of £2,140 million (2010: £2,733 million). The gearing ratio1 is 46% (2010: 52%) based on Ignis present value of future profits (‘PVFP’) of £0.4 billion (2010: £0.4 billion) and an MCEV of £2,118 million (2010: £2,104 million).
During the year, the Group has continued to strengthen the components of the RMF to ensure that they are aligned with the requirements of Solvency II and external best practice.
Governance, organisation and policies Overall responsibility for approving, establishing and maintaining 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 Board of Phoenix Life Holdings Limited (‘PLHL’) and the Executive Committee.
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.
The Group’s business units operate capital management processes that meet the Group’s Capital Management Policy. Under these processes, capital is allocated across risks where capital is held as a mitigant and, in turn, to individual risk owners who hold risk capital budgets. The amount of risk capital required is reviewed regularly to ensure the risk remains within budget. Any increases in capital allocation required are referred to the relevant business unit for approval to assess whether the increased capital allocation requested is within appetite for that particular risk type or whether further risk mitigation is required.
People and reward Effective risk management is central to the Group’s culture and its values. Processes are operated that seek to measure both individual and collective performance and discourage incentive mechanisms which could lead to undue risk taking. Training and development programmes are in place to support employees in their understanding of the operation of the RMF and during 2011, Group Risk delivered training and awareness sessions across the Group.
Risk and capital assessment The Group operates a standardised assessment framework for the identification and assessment of the different types of risk it may be exposed to and how much capital should be held in relation to those exposures. This framework is applicable across the Group and establishes a basis, not only for the approach to risk assessment, management and reporting but also for determining and embedding capital management at all levels of the Group.
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 outcomes. The Group also maintains cash buffers in its Holding Companies to reduce reliance on emerging cash flows.
The Group could be adversely affected by the level of its indebtedness and its financing structure.
Corporate Responsibility (‘CR’) is firmly embedded in our corporate culture and built into our governance framework through a Group CR Policy which is sponsored by the Group Chief Executive Officer.
At Phoenix Group we categorise and report on CR in four areas: Environment
How we treat our employees, including how we attract, develop and retain the best talent
Our relationships with customers, investors, lenders, outsourced and other business partners, suppliers, regulators, Government and the media
Some environmentally friendly initiatives undertaken by the Group this year are noted below: – We introduced a paper cup recycling facility (previously 900 cups per day were sent to landfill). This facility joins our other recycling collections – paper, plastic, cardboard, ink cartridges and mobile phones
– Employees collected in excess of five sacks of Christmas cards which were passed on to a recycling scheme that pledged to plant 1 tree for every 1,000 cards donated
– Two new flexible benefit options were introduced: the opportunity to purchase a bicycle tax-free for use in commuting to and from work and membership of the Woodland Trust
– Following site moves all unusable stationery items were donated to local schools and nurseries and surplus fixtures and fittings were recycled
At Phoenix Group we are committed to managing our business in a responsible manner, taking seriously the impact we have on our employees, our stakeholders, the communities in which we operate and the wider environment. We believe that operating responsibly creates value for our business through building the trust and confidence of our stakeholders.
Further details on our community activities are provided within the Corporate Responsibility section of our Group website.
In addition to the above donations made by the Group, over £20,000 was raised for charities selected by employees through fundraising activities organised on our premises.
Volunteering During the year the Group formalised its volunteering programme and gave staff at its Wythall site the opportunity to participate in two one-day events. The first, was undertaken as part of the national BITC ‘Give and Gain Day’, whilst the second, was arranged directly through links with a local secondary school. Both events were beneficial in helping forge stronger links with the local community and building employee engagement.
Community links The Group developed links with a variety of community groups operating close to its Wythall site including local schools, the City of Birmingham Choir and the Wythall Community Association.
2011 was the 15th successive year that Ignis Asset Management was the main sponsor of the annual Women’s 10k Road Race in Glasgow. The race regularly attracts over 12,000 runners and organisers Glasgow Life estimated that more than £1 million was raised for numerous charitable causes.
Alan Jones, Group HR Director comments on our CR staff awareness programme: “We aim to create a fulfilling working environment in which every individual can excel and contribute to our ongoing CR programme. By providing a platform for encouraging community and environmental awareness, we are providing staff with the necessary skills to make a difference, both at work and at home.”
The Group’s approach to charitable donations is three-fold: an annual programme of staff fundraising events held at our offices; matched donations for employees participating in charitable activity and donations to selected causes.
A staff volunteering programme was also established during the year and good links were forged with schools and community groups operating in the vicinity of our largest office in Wythall.
Diversity We value diversity in the workplace and have a strict equal opportunities policy. At least 11% of our workforce this year is of ‘non-white British’ origin, and our gender split is 60% male, 40% female. Three out of nine members of the Group Executive Committee are female and we have one female non-executive on the Phoenix Group Holdings Board. Our Chairman commented during the year on ‘Women on Boards’, noting that we have set targets of two female directors on the Phoenix Group Holdings Board by 2013 and a further female director by 2015.
Workplace Phoenix Group employed 1,394 staff at the end of December 2011 across three divisions – Group, Phoenix Life and Ignis Asset Management, mainly based at sites in London, Wythall and Glasgow.
All divisions participated in the same employee survey this year achieving an overall employee engagement index (‘EEI’) of 74% with a response rate of 93%.
Staff training In 2011 we started to track two new measures around external staff training and spend. In addition to the externally run training days, our Learning and Development team managed a range of in-house training sessions, ranging from induction programmes, through to coaching and leadership skills. During the year staff within our Phoenix Life and Group divisions received training on our Risk Management Framework, which amounted to 850 training days. This helps demonstrate our commitment to continuing education within the workplace and providing our staff with the necessary skills they need in a market which is becoming increasingly regulated and highly competitive. Recent benchmarking indicates that we invest approximately twice the sector average in learning and development.
By continually listening to our customers, we can focus on any areas of improvement to ensure that we provide a responsible, fair and helpful service.
Improving outcomes As part of our overall strategy to improve outcomes for our customers, we wrote to a group of policyholders who held paid-up life insurance policies, to give them the opportunity to cash in without penalty and benefit from any proceeds immediately, or to keep the policy in force for their estate to benefit from the life insurance pay-out on their death. Over 85% of those contacted who were eligible for the offer, accepted and chose to cash in their benefits.
External stakeholders Risk management/governance Due to the highly regulated nature of our business and the importance of security to our policyholders, we take risk seriously and have a dedicated risk management team to measure and monitor all risks across our business. We also have a strong corporate governance framework in place. Information about the Group’s management of risk and the Group’s corporate governance framework can be viewed on pages 38 to 43 and 52 to 71 respectively.
Responsible investment Phoenix Group supports the principles of good stewardship as set out on our Ignis website www.ignisasset.com. We take our responsibilities seriously and consider the environmental, social and governance procedures of companies in which we invest.
Investors Two external presentations were given during the year by our Investor Relations department, to allow our investors to understand better our Phoenix Life and Ignis Asset Management divisions.
Procurement/suppliers During 2011 we strengthened our Procurement policy, commenced implementation of our Strategic Supplier Management Framework and reviewed our standard terms and conditions – all of which are in line with our CR programme. In 2012 we intend to optimise collaborative working across our Group with our suppliers and outsourced partners to achieve a higher level of integrated, sustainable and responsible supplier relationships.
Conclusion In summary, 2011 has been a busy year for our CR programme as we have been formalising and communicating our approach. We are delighted with the progress that has been made and in particular the support our employees have given. In 2012, we will give higher profile to the communication of different aspects of our programme to our employees and we will set measurable environmental targets. We are absolutely committed to remaining a responsible organisation and employer.
Further information on our complaints data can be viewed on our website.
Strong and effective governance is crucial to our aim of delivering value to shareholders and policyholders. The Board is committed to high standards of corporate governance. This section includes details of our application of the provisions of the UK Corporate Governance Code and profiles of our Board of Directors.
In this section 54 Board of Directors 58 Our management team 60 Directors’ report 65 Corporate governance report 72 Remuneration report
René-Pierre Azria Non-Executive Director René-Pierre Azria is Chief Executive Officer of Tegris Advisors LLC, a US private advisory firm specialised 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 and Audit Committee member of Jarden Corporation, a NYSE listed Fortune 500 US conglomerate and 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.
Charles Clarke Non-Executive Director Charles Clarke is a Jersey-resident Chartered Accountant who spent some 30 years with KPMG. Having qualified in London, he was a financial sector audit partner in London, Kuala Lumpur and Jersey. He was also senior partner of the KPMG Channel Island firm for seven years and, during his final year, Chairman of the grouping of KPMG member firms in offshore jurisdictions. Since retiring from KPMG at the end of 2005, he has acted as an independent Non-Executive Director (‘NED’) and established an offshore governance consultancy and NED recruitment service. His current NED appointments include SG Hambros Bank. Mr Clarke was appointed to the Board of Directors of the Company on 18 February 2010. He is a member of the Board Audit and Board Investment Committees.
He served on the Board of Directors 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.
Clive Bannister Group Chief Executive Officer – Lead and direct the Group’s businesses in delivery of the Group strategy and business plan
– Embed a risk-conscious Group culture which recognises policyholder obligations in terms of service and security
Paul Miles Acting Group Finance Director – Contribute to the development and delivery of the Group’s financial business plan in line with strategy
– Support the Group Chief Executive Officer in managing the Group’s key external stakeholders
Chris Samuel Chief Executive Officer, Ignis Asset Management – Lead development of Ignis’ business strategy and plans
– Ensure 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
– Ensure Ignis’ chosen foundations of innovative people, a partnership culture, suitable processes and technology and stability are in place to support these plans.
Fiona Clutterbuck Head of Strategy, Corporate Development and Communications – Support the Group Chief Executive Officer in the formulation of the strategy and the business planning for the Group
– Lead implementation of the Group’s strategy as regards any potential acquisitions or disposals
– Lead external Group Communications in liaison with the Group Finance Director and Head of Investor Relations.
Alan Jones Group Human Resources Director – Deliver high quality Human Resources services to the Group
– Provide guidance and support on all HR matters to the Group Chief Executive Officer, ExCo and Group Board.
Jane MacLeod General Counsel – Lead provision of legal advice to the Group Board, other Group Company Boards, ExCo and senior management
David Richardson Group Chief Actuary – Ensure capital is managed efficiently across the Group
– Identify and deliver opportunities to enhance shareholder value across the Group.
Introduction Principal activities and business review The Company is incorporated in the Cayman Islands and has a Premium Listing on the London Stock Exchange. The Company is not required to comply with the requirements of the UK Companies Act 2006. However, the Directors support these enhanced standards for disclosure and have sought to comply voluntarily with these requirements.
The UK Companies Act 2006 requires a company to set out in this report a fair review of the business of the Group during the financial year ended 31 December 2011, including an analysis of the position of the Group at the financial year end and a description of the principal risks and uncertainties facing the Group (known as a ‘Business review’).
The information that fulfils the Business review requirements can be found in the ‘Business and strategy’ and ‘Business review’ sections on pages 8 to 17 and 18 to 43 respectively and is incorporated by reference into this Directors’ report.
Paid interim dividend of 21p per share (last year 21p per share) Recommended final dividend of 21p per share (last year 21p per share) Total ordinary dividend of 42p per share (last year 42p per share)
Full details of the authorised, issued and fully paid share capital as at 31 December 2011 and movements in share capital during the period are presented in note 16 to the IFRS financial statements.
Name No. of ordinary shares held Percentage of shares in issue
TDR Capital Nominees Limited 28,003,087 16.05% Xercise2 Limited 22,610,453 12.96% Hugh Edward Mark Osmond1 9,161,266 5.25% Lloyds Banking Group plc 7,051,934 4.04% Nicholas Berggruen Charitable Trust 6,924,239 3.97% Royal London Asset Management Limited 6,862,908 3.93% William Alan McIntosh 6,844,529 3.92% Alpha-Gamma Shares Limited 6,585,499 3.77% Martin E Franklin 5,885,048 3.37% Jeff Greene 5,752,498 3.30% 1 Hugh Osmond’s share disclosure differs from that shown in the Directors’ interest table within the Remuneration report due to differing reporting requirements as a shareholder and a director under DTR3 and DTR5 respectively. Further information and details can be found within the announcements made on 8 October 2010 and 12 October 2011 and available on the ‘Investor Relations’ section of the Company’s website at www.thephoenixgroup.com.
Annual General Meeting (‘AGM’) The AGM of the Company will be held at 32, Commercial Street, St Helier, Jersey JE2 3RU on Thursday, 3 May 2012 at 1pm.
During 2011 and up to the date of this report, the following changes to the Board took place: – Jonathan Moss resigned from the Board on 7 February 2011. He was replaced as Group Chief Executive Officer by Clive Bannister who was appointed to the Board on 28 March 2011
Having thoroughly considered the going concern assessment, including a detailed review of the regulatory capital and cash flow positions of each subsidiary company and the availability across the Group of a range of management actions, the Board has concluded that there are no material uncertainties that may cast significant doubt about the Group and the Company’s ability to continue as a going concern. The Directors have a reasonable expectation that the Group and the Company have adequate resources to continue in operational existence for the foreseeable future. Thus, they continue to adopt the going concern basis of accounting in preparing the annual financial statements.
The Memorandum and Articles of Association are available on the Company’s website at www.thephoenixgroup.com/about-us/corporate-governance/articles-of-association.aspx.
There are change of control clauses contained in certain of the Group’s financing agreements. Upon a change of control of the Company, the principal amounts outstanding and the accrued interest under the Pearl and Impala facility agreements, the Pearl loan notes, the Royal London PIK facility and Royal London PIK notes would become immediately repayable or be required to be immediately redeemed.
In addition, certain provisions of the Articles relating to the City Code on Takeovers and Mergers apply in connection with a takeover bid. The Articles are available on the Company’s website at www.thephoenixgroup.com/about-us/corporate-governance/articles-of-association.aspx.
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.
Supplier payment policy The Company and its subsidiaries do not follow any code or standard on payment practice, but it is the policy to pay suppliers within 30 days of the invoice date or, if different, in accordance with any terms agreed with suppliers.
Charitable contributions During the year the Group made charitable donations of £98,083 details of which are presented in the Corporate Responsibility section on pages 44 to 51.
Introduction The Company is a member of the FTSE 250 Index, 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. The Code has applied to the Company from 1 January 2011 and the Company has implemented those new aspects of the Code which were not included in its predecessor, the Combined Code on Corporate Governance. In particular, in relation to the more notable new provisions of the Code, all Directors of the Company are subject to annual re-election by shareholders and evaluation of the Board will be externally facilitated at least every three years.
This report sets out details of how the Company has applied the principles and complied with the provisions of the Code during the period from 1 January 2011 to 31 December 2011.
The remuneration of the Directors is shown in the Remuneration report on pages 72 to 82. The terms and conditions of appointment of Non-Executive Directors are on the Group’s website. In accordance with the provisions of the Articles of Association and the Code, all Directors will submit themselves for election or re-election at the Company’s AGM on 3 May 2012.
During 2011, the steps taken by the Board to improve its governance arrangements included: – Adopting annual re-election of all Directors in accordance with the Code
– Undertaking an externally facilitated Board, Board Committee and individual Director evaluation
– Enhancing the Board education programme in response to the Board evaluation undertaken at the end of 2010, in particular including site visits to operational business units and presentations from management in those units
– Publishing a Chairman’s statement on “Women on Boards” in accordance with the Lord Davies Review
The Chairman, Group Chief Executive Officer and Senior Independent Director There is a division of responsibility, approved by the Board, between the Chairman, Ron Sandler, who is responsible for the leadership and effective operation of the Board and the Group Chief Executive Officer, Clive Bannister, who is responsible to the Board for the overall management and operation of the Group. The Chairman’s other significant commitments are set out in his biographical details on page 54.
The process involved completion by Directors of a questionnaire covering various aspects of Board and Director effectiveness, followed by individual meetings between EZI and each Director, concluding in a Board report which was discussed by the Board in November 2011. The process and report covered the following areas: – Board structure and composition
A review of each Director’s individual performance took place as part of the evaluation and the output from this will be used in revising the training programme for Directors.
Operation of the Board The terms of appointment for the Directors state that they are expected to attend in person regular (at least six per year) and emergency Board meetings of the Company and to devote appropriate preparation time ahead of each meeting. The Board met seven times during 2011 and is scheduled to meet seven times in 2012 including a two day strategy-setting meeting. Additional meetings will be held as required and the Non-Executive Directors will hold meetings with the Chairman, without the Executive Directors being present, as they did on several occasions in 2011.
Attendance by each of the Directors at Board meetings and at Committee meetings for Committees of which they were a member during 2011 was: Board
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.
The Company has adopted a Charter of Statutory Auditor Independence, which requires both the Company and the external auditors to take measures to safeguard the objectivity and independence of the external auditors. These measures include a prohibition regarding non-audit services in respect of specific areas, such as secondments to management positions, or those which could create a conflict or perceived conflict. It also includes details of the procedures for the rotation of the external audit engagement partner. The Charter can be found on the Company’s website.
– Assessed the effectiveness of both the external auditors and the internal audit function, the latter supported by an external effectiveness review
– Review of the structure, size and composition of the Board, taking account of the Board evaluation report
– Assessment of Board succession planning with the agreement that a further review, to include senior management succession planning, would be undertaken by the Committee in January 2012 utilising the results of the external Board evaluation undertaken at the end of 2011
– Consideration of the Lord Davies Review of ‘Women on Boards’ and the Chairman’s statement as follows which was released on the Phoenix Group website: “The Nomination Committee, which I chair, will continue to review on a regular basis the experience, skills, knowledge and independence of the Board. This encompasses, and will continue to encompass, the recommendations of the Lord Davies Review titled ‘Women on Boards’. Phoenix Group supports the recommendations in principle and we believe that it is appropriate for FTSE 350 companies to set out clear targets for female representation on their Boards. We are a recently listed FTSE 250 Company (from July 2010) and none of our Directors was appointed to the Board prior to September 2009. 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.
We embrace equality of opportunity in all parts of our organisation and I am pleased to say that we have three female members out of nine on our Executive Committee.”
The Remuneration Committee is responsible for making recommendations to the Board on the Company’s remuneration and compensation plans, policies and practices and for determining, within agreed terms of reference, specific remuneration packages for the Executive Directors. These include pension rights and executive incentive schemes to encourage superior performance. Details of the remuneration structure and the Committee’s activities in 2011 are provided in the Remuneration report on pages 72 to 82.
Hewitt New Bridge Street (up to August 2011) and FIT Remuneration Consultants (from August 2011) provided advice to the Remuneration Committee and are independent of the Company.
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 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’.
Risk Committee’s principal activities during 2011 – Recommending to the Board approval of the Group’s risk appetite
– Reviewing the Group’s risk profile and monitoring it against the FSA 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
– Consideration of risks, issues and matters that were escalated from principal business unit risk committees to ensure adequate coverage of the Group’s significant business risks and systems of internal control
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 2011 (as noted on page 84).
The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the Business and strategy and Business review sections on pages 8 to 17 and 18 to 43 respectively.
The financial position of the Group, its cash flows and liquidity position are described in the financial statements and notes.
The Board’s going concern assessment is included within the Directors’ report on page 62.
The Board (and its subsidiary company boards) monitor internal controls on a continual basis, in particular through Audit and Risk Committees. There is an ongoing process for identifying, evaluating and managing the significant risks faced by the Group, which has been in place throughout the period covered by this report and up to the date of approval of the Annual Report and Accounts for 2011, in accordance with the ‘Internal Control: Guidance to Directors’ published by the Financial Reporting Council.
I am pleased to introduce the Remuneration report for 2011. Following the changes to the senior executive remuneration arrangements made last year as a result of the Company’s Premium Listing, the Remuneration Committee (‘the Committee’) has determined that these arrangements remain appropriate for 2012.
In considering the remuneration arrangements, the Committee has been mindful of the intense scrutiny to which executive remuneration is currently subject including through the Financial Services Authority (‘FSA’) Remuneration Code and through the Department for Business, Innovation and Skills review into executive remuneration more generally. The Committee seeks to have regard to the highest levels of governance and to reflect developments in best practice.
The main elements of the Executive Directors’ packages, which are set out in more detail in the report which follows, are: – Base salary levels are appropriate for the size and complexity of the business, given relevant market data
– Annual incentive maximum potential remains appropriate at 150% of base salary with 20% of potential based on personal and strategic measures and 80% of potential based on corporate embedded value, cash generation and expense management targets, with one-third of any incentive deferred into shares for three years. The only changes for 2012 are to increase the weighting of the expense management target, given the Board’s continued focus on expense management, and to extend the deferral provisions to a wider population
– Consistent with best practice, the Committee operates a claw-back provision which will operate for any annual incentive amounts subsequently found to have been based on materially inaccurate results
– Consistent with best practice, the Committee operates share ownership guidelines. Executive Directors are required to build and maintain a specified shareholding in the Company (200% of salary for the Group Chief Executive Officer and 100% of salary for the Group Finance Director) through the retention of all post-tax shares which vest under the Long-Term Incentive Plan (‘LTIP’) (or any other discretionary long-term arrangement introduced in the future) until target holdings have been achieved.
The auditors have reported on certain parts of the Directors’ Remuneration Report and stated whether in their opinion those parts of the report have been properly prepared in accordance with the Companies Act 2006. The report has therefore been divided into separate sections for unaudited and audited information.
– Review the design of all share-based plans (or other plans requiring shareholder approval) 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 Committee meets at least twice a year but more frequently if required. During 2011, eight Committee meetings were held and details on attendance at these meetings are set out in the Corporate Governance report on page 67.
The Board has agreed that from 2012, certain responsibilities of the Committee should be assumed by a Committee of the Board of Phoenix Life Holdings Limited, the highest EEA insurance holding company within the Group. In particular, that Committee will oversee remuneration relating to UK based employees other than Executive Directors. The initial members of the two Committees will be the same. This will not impact the governance of remuneration from an external perspective, but it will simplify the oversight of remuneration matters affecting UK based employees.
Advice The Committee received independent remuneration advice during the year from its appointed adviser, Hewitt New Bridge Street (‘HNBS’), part of Aon Hewitt (up to August 2011) and FIT Remuneration Consultants (‘FIT’) (from August 2011). A separate team within Aon Hewitt also provided advice to the Group in respect of actuarial pension services. The Committee did not believe that the independence of its adviser was compromised by this appointment. Both HNBS and FIT are members of the Remuneration Consultants Group (the professional body for consultants) and adhere to its code of conduct.
– Do not promote unacceptable behaviours or encourage unacceptable risk taking. In particular, the Committee recognises the interdependence of colleagues within an insurance business and so focuses the annual incentive targets for senior executives on the delivery of corporate financial targets. Within Ignis, consistent with standard industry practice, targets are more focused on individual objectives (but subject to a pool linked to overall Ignis profitability)
– Take into account Group-wide pay and employment conditions. The Committee reviews the average Group-wide base salary increase and bonus costs and is responsible for all discretionary and all employee share-based arrangements.
There are five main elements of the remuneration package for Executive Directors and senior executives: – Base salary
The policy for Executive Directors for 2011 is described in more detail below.
Base salary and benefits Executive Directors’ base salaries are reviewed annually by the Committee by reference to median data taking into account the responsibilities, skills and experience of each individual and salary levels within listed companies of a similar size and complexity. Base salary levels are as follows: Name Role From 1 January 2012 From 1 January 2011
2 Resigned from the Board on 21 December 2011 but remained in the Group’s employment to the end of February 2012.
Benefits received by Executive Directors comprise a car allowance, private medical insurance, relocation assistance and life assurance.
Annual incentives For 2011, annual incentive potential (‘AIP’) was capped at 150% of base salary for Executive Directors. Performance targets were based on the achievement of personal and strategic objectives for 20% of the bonus opportunity and, for the other 80%, financial targets based on a sliding scale as follows: Performance metric % of 80% of incentive potential based on financial measures
For Mr C Bannister, one-third of annual incentive awards for 2011 awarded (compared with any award above target operated in 2010) will be deferred into shares for three years. The shares comprising the deferred element will vest three years from the date of award and will normally be forfeited if the individual leaves the Group prior to vesting (unless designated as a good leaver).
Consistent with the awards in May 2010, for LTIP awards granted in April 2011, the performance measures are 50% based on MCEV growth and 50% based on net cumulative cash generation (i.e. after taking into account certain recurring costs), with both targets measured over the three financial years commencing 1 January 2011 and underpinned by a debt management assessment. A summary of the targets is set out below: MCEV growth (50% of awards)
25% of the cash generation component of the award will vest for cumulative cash generation of £1.217 billion rising on a pro rata basis until 100% vests for cash generation of £1.517 billion.
The current expectation is that MCEV and cash generation performance metrics will continue to be used for the 2012 awards (with TSR also being considered for part of the 2012 awards), with performance targets (which will be no less challenging than those presented above) set in advance of the awards being granted.
All employee share plans The Group operates a Sharesave scheme which is approved by HM Revenue & Customs. All eligible employees, including Executive Directors, are invited to participate on similar terms to save up to a maximum of £250 each month for a fixed period of three or five years. At the end of the savings period, individuals may use their savings plus a tax-free bonus to buy ordinary shares in the Company at a discount currently set at 15% of the market price set at the launch of each scheme.
In addition for 2012, the Committee has approved the launch of an HM Revenue & Customs approved Share Incentive Plan. This offers all eligible employees, including Executive Directors, the opportunity to purchase, out of their pre-tax salary, shares in the Company (up to a value of £125 per month) and receive one matching share for every six shares purchased.
Subject to Board approval, Executive Directors are permitted to accept outside appointments on external boards or committees as long as these are not deemed to interfere with the business of the Group. Neither Director was an outside director during 2011.
Former Executive Directors Jonathan Moss left the role of Group Chief Executive Officer on 7 February 2011 and left the Group on 29 March 2011. As reported last year, he received a payment in lieu of notice of £690,000 in aggregate, reflecting both his base salary and benefits in line with his contractual entitlements. In addition, a contribution of £857,188 was made to the Company’s Employee Benefit Trust (‘EBT’) subject to a recommendation that it was allocated to a sub-trust for the benefit of Jonathan Moss’ family in lieu of any annual incentive for 2010. Jonathan Moss also received £50,000 by way of compensation for loss of statutory employment rights and £4,800 in respect of his legal expenses and outplacement services. His long-term incentive awards continue to vest until the normal vesting date (with performance conditions and time pro-rating applying for the 2010 LTIP awards) with the exception of his 112,500 Bonus Share Plan shares which, consistent with the rules, vested on 29 March 2011.
In December 2011, the Company announced that Jonathan Yates would leave the Group at the end of February 2012. He remained employed throughout 2011 and his remuneration has been reported in the normal way. For 2012, he will receive his normal salary and benefits for the period he continued to be employed. He will not be eligible for a bonus for any part of 2012 and will not receive any termination payment in respect of his departure. However, the Committee has confirmed that he will be treated as a good leaver and therefore, will be entitled to early release, on departure, of the 16,259 shares held under the Deferred Bonus Share Scheme (being the deferred element of prior bonuses). He will retain his 2010 and 2011 LTIP awards which continue to vest until the normal vesting date (with performance conditions and time pro-rating applying).
Non-Executive Directors’ contracts The Non-Executive Directors, including the Group Chairman, have letters of appointment which set out their duties and responsibilities. Appointment is for a fixed term of three years, terminable by one month’s notice on either side. Non-Executive Directors are not eligible to participate in incentive arrangements or receive pension provision or other benefits such as private medical insurance (‘PMI’) and life assurance.
Non-Executive Chairman Ron Sandler 450,000 – – – – 450,000 450,000 Executive Directors Clive Bannister3 533,050 13,057 681,954 – – 1,228,061 – Non-Executive Directors Ian Ashken 100,000 – – – – 100,000 100,000 René-Pierre Azria 100,000 – – – – 100,000 100,000
Simon Smith7 – – – – – – 736,958 1 Benefits comprise car allowance, private medical insurance and life insurance.
2 Annual incentive amounts are presented inclusive of any amounts which must be deferred in shares for three years (i.e. one-third of the 2011 incentive award). Of the amounts presented above, £227,318 of Clive Bannister’s incentive payment will be deferred in shares for a period of 3 years. Full details of the number of shares under award will be disclosed in the 2012 Remuneration report.
Pensions Clive Bannister and Jonathan Yates received a Company contribution of 20% of base salary. Jonathan Moss received a Company contribution of 11.7% of salary (up to a maximum earnings limit of £123,600) to a defined contribution pension arrangement.
During the year to 31 December 2011, the Group has made the following contributions to the defined contribution arrangements: £
Clive Bannister LTIP3 12 Apr 2011 657.5p – 212,927 – – 212,927 12 Apr 2014
Jonathan Yates LTIP3,4 28 May 2010 627.5p 127,490 – – – 127,490 28 May 2013 127,490 126,235 – – 253,725 Jonathan Moss BSP1,5 21 Sep 2009 842.0p 112,500 – 112,500 – – 29 Mar 2011 393,021 – 112,500 – 280,521 1 The Bonus Share Plan (‘BSP’) was introduced to reward a small number of senior executives upon completion of the September 2009 refinancing. BSP awards vested on the second anniversary of grant, subject to continued service. In line with the BSP rules, Jonathan Moss’ BSP awards vested in full on the termination of his employment on 29 March 2011. No further BSP awards will be granted. The share price at vesting was 668p.
3 The performance conditions for the 2010 and 2011 awards are set out in the Remuneration policy section of this report (except that for the 2010 grant, the cash generation targets were £1.375 billion rising to £1.655 billion). Jonathan Moss’ award was pro-rated with the 207,171 shares presented in the table reduced to 57,547 shares.
Name As at 1 January 2011 or date of appointment if later As at 31 December 2011 and as at 22 March 2012
Clive Bannister – – Jonathan Yates – – Ian Ashken1 1,260,759 1,263,698 René-Pierre Azria 16,866 27,812 David Barnes 2,300 2,300 Charles Clarke 2,000 2,000 Ian Cormack – – Tom Cross Brown 1,615 1,664 Manjit Dale2 – – Isabel Hudson 1,587 3,249 Alastair Lyons 7,500 7,500 Hugh Osmond3 9,714,015 9,849,533 Ron Sandler 182,133 195,666 David Woods – – Jonathan Moss 162,505 275,005 1 Ian Ashken holds 1,113,698 shares in his own name. Tasburgh LLC, of which Ian Ashken is a managing member, holds 150,000 shares and is considered a connected person to Mr Ashken.
3 Hugh Osmond is a director of Xercise2 Limited, Xercise Limited and O-Re Holdings UK Limited and as such these are considered as connected persons. Hugh Osmond has a total interest in 30,095,410 shares of which he has beneficial interest over 9,849,533.
Performance graph The graph below shows the value by 31 December 2011, on a total shareholder return basis, of £100 invested in Phoenix Group Holdings on 5 July 2010 (the date of the Company’s Premium Listing) compared with the value of £100 invested in the FTSE 250 Index (excluding investment trusts).
Code Staff criteria The following groups of employees have been identified within the Code firms as meeting the FSA’s criteria for Code Staff: – Certain members of the Group Board and Executive Management Committee
Phoenix Group also operates a fully flexible bonus policy which allows zero bonus payments to be made when appropriate.
Benefits Code Staff receive benefits in line with other employees that include pension provision, and may include car allowance, private medical insurance and life assurance. Non-Executive Directors who are listed as Code Staff do not receive any benefits.
Annual incentives Rationale and eligibility criteria All executive Code Staff are eligible to receive an annual incentive. Annual incentives are designed to reward good financial and non-financial performance that supports the business strategy, taking into account the Group’s risk appetite and personal contribution.
Ignis employees’ bonuses are financed from a defined profit pool (subject to discretion being reserved to the Committee to adjust the percentage available). Distribution of the pool has due regard to objectives similar to those in the Group and life companies.
For senior staff in control functions (Internal Audit, Regulatory Compliance and Risk) reward will, from 1 January 2012, be linked to individual achievement against personal objectives and will exclude any direct link to financial performance.
Long-term incentives Group To encourage the creation of value over the long-term and to align the rewards of the participants with the returns to shareholders, the Group provides employees in senior roles (executive level and selected senior management) the opportunity to receive annual awards of long-term incentives. Details of the LTIP are given on page 75 of this report.
Ignis Selected 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. Awards with a grant date of 2010 reward growth over an initial value of £1 per notional share, whilst awards granted in respect of 2011 reward growth over an initial value of £1.15 per notional share. The value per notional share at the end of the year was £1.16. Where it has been necessary and as a part of the recruitment process, the Committee has provided an underpin to the value of the award to reflect the value forfeited by employees due to leaving previous employers.
Quantitative Remuneration Disclosure The Group is required to disclose aggregate quantitative remuneration information for Code Staff.
Auditor’s responsibility Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free from material misstatement.
In making those risk assessments, the auditor considers internal control relevant to the Group’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the Directors, as well as evaluating the overall presentation of the consolidated financial statements.
Report on other legal and regulatory requirements Directors’ Report in accordance with Dutch Civil Code Pursuant to the legal requirement under section 2:393 sub 5 at e and f of the Dutch Civil Code, we have no deficiencies to report as a result of our examination as to 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 information as required under section 2:392 sub 1 at b–h has been annexed. Further we report that the Directors’ report, to the extent we can assess, is consistent with the consolidated financial statements as required by section 2:391 sub 4 of the Dutch Civil Code.
Requirements of the Listing Rules We have nothing to report in respect of the following items that we are required to review under the Listing Rules: – the Directors’ statement, set out on page 62, 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; and
Matters on which we report by exception because of voluntary compliance with the UK Companies Act 2006 We have nothing to report in respect of the following items that we are required to report to you under the UK Companies Act 2006 if, in our opinion: – adequate accounting records have not been kept by the Group, or returns adequate for our audit have not been received from branches not visited by us; or
– the Directors’ Remuneration report to be audited is not in agreement with the accounting records and returns; or
– we have not received all the information and explanations we require for our audit; The Hague, 22 March 2012
Gross premiums written 1,473 1,534 Less: premiums ceded to reinsurers (85) (85) Net premiums written 1,388 1,449
Net investment income 7 4,920 5,907 Total revenue, net of reinsurance payable 6,478 7,518
Policyholder claims (4,968) (5,260) Less: reinsurance recoveries 224 210 Change in insurance contract liabilities (1,338) (252) Change in reinsurers’ share of insurance contract liabilities 222 89 Transfer from/(to) unallocated surplus 21 16 (143) Net policyholder claims and benefits incurred (5,844) (5,356)
Tax attributable to policyholders’ returns 13 (173) (5) (Loss)/profit before the tax attributable to owners (177) 6
Attributable to: Owners of the parent 121 106 Non-controlling interests 33 50
Tax credit attributable to owners 79 74 (Loss)/profit for the year attributable to owners (98) 80
STATEMENT OF CONSOLIDATED FINANCIAL POSITION As at 31 December 2011 £m
Equity attributable to owners of the parent Share capital 16 – – Share premium 1,054 1,109 Other reserves 5 5 Shares held by employee trust and Group entities 17 (11) (13) Foreign currency translation reserve 93 93 Retained earnings 511 386
Net asset value attributable to unit holders 3,209 1,937 Obligations for repayment of collateral received 25 13,005 10,160
Reinsurance payables 33 25 Payables related to direct insurance contracts 29 707 713
STATEMENT OF CONSOLIDATED CASH FLOWS For the year ended 31 December 2011 £m 2010 £m
Cash flows from financing activities Gross proceeds from issue of share capital – 33 Proceeds from issuing shares in subsidiaries to non-controlling interests 1 96 Partial buy back of non-controlling interests – (4) Proceeds of new policyholder borrowings 98 – Ordinary share dividends paid (55) (43) Coupon on Perpetual Reset Capital Securities paid (26) (62) Dividends paid to non-controlling interests (21) (18) Repayment of policyholder borrowings (825) (38) Repayment of shareholder borrowings (174) (127) Interest paid on policyholder borrowings (21) (12) Interest paid on shareholder borrowings (111) (110)
Cash and cash equivalents at the beginning of the year 9,188 6,081
STATEMENT OF CONSOLIDATED CHANGES IN EQUITY For the year ended 31 December 2011
(Loss)/profit for the year – – – – – (131) (131) 33 (98) Other comprehensive income for the year – – – – – 252 252 – 252 Total comprehensive income
Dividends paid on ordinary shares – (72) – – – – (72) – (72) Dividends paid to non-controlling
Coupon paid to non-controlling interests, net of tax relief – – – – – – – (19) (19) Shares issued in lieu of dividends – 17 – – – – 17 – 17 Credit to equity for equity-settled share-based payment – – – – – 6 6 – 6 Shares in subsidiaries subscribed for by non-controlling interests – – – – – – – 1 1 Shares distributed by employee
Profit for the year – – – – – 30 30 50 80 Other comprehensive income for the year – – – – – 76 76 – 76 Total comprehensive income
Shares acquired by employee trust – – – (10) – – (10) – (10) Shares distributed by employee trust – – – 4 – (4) – – –
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 (note 22).
1. Accounting policies (a) Basis of preparation The consolidated financial statements for the year ended 31 December 2011 comprise the financial statements of Phoenix Group Holdings (‘the Company’) and its subsidiaries (together referred to as ‘the Group’).
Basis of consolidation The consolidated financial statements include the financial statements of the Company and its subsidiary undertakings including collective investment schemes where the Group exercises overall control. Certain of the collective investment schemes have non-coterminous period ends and are consolidated on the basis of additional financial statements prepared to the period end. Intragroup balances and income and expenses arising from intragroup transactions are eliminated in preparing the consolidated financial statements.
Non-controlling interests are stated at the share of net assets attributed to the non-controlling interest holder, adjusted for the relevant share of subsequent changes in equity.
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 insurance and investment contract liabilities, determination of the fair value of financial assets and liabilities, impairment tests for intangible assets, income taxes and pension benefit assets and liabilities.
Insurance and investment contract liabilities Insurance and investment contract liability accounting is discussed in more detail in accounting policies (e) and (f) with further detail of the key assumptions made in determining insurance and investment contract liabilities included in note 43.
Impairment of intangible assets Intangible assets are subject to regular impairment reviews as detailed in accounting policy (n). Impairments are measured at the difference between the carrying value of a particular asset and its recoverable amount. Impairments are recognised in the consolidated income statement in the period in which they occur. Further details of estimates made are included in note 33.
Insurance contract liabilities for non-participating business are calculated using either a net premium or gross premium method. Where a gross premium method is used, the liability includes allowance for prudent lapses. Negative policy values are allowed for on individual policies: – where there are no guaranteed surrender values; or
The value of the PVFP is determined in accordance with the FSA’s realistic capital regime. The principal assumptions used to calculate the PVFP are the same as those used in calculating the insurance contract liabilities given in note 43.
1. Accounting policies (continued) (e) Insurance contracts and investment contracts with DPF (continued) Liability adequacy At each reporting date, liability adequacy tests are performed to assess whether the insurance contract and investment contract with DPF liabilities are adequate. Current best estimates of future cash flows are compared to the carrying value of the liabilities. Any deficiency is charged to the consolidated income statement.
(g) Financial liabilities On initial recognition, financial liabilities are recognised when due and measured at the fair value of the consideration received less directly attributable transaction costs (with the exception of liabilities at fair value through profit or loss for which all transaction costs are expensed).
– 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 Group is provided internally on that basis to the Group’s key management personnel.
Certain borrowings are designated upon initial recognition at fair value through profit or loss and measured at fair value where doing so provides more meaningful information due to the reasons stated above in the financial
IFRS financial statements liabilities accounting policy. Transaction costs relating to borrowings designated upon initial recognition at fair value through profit or loss are expensed as incurred.
(m) Employee benefits Defined contribution pension plans Obligations for contributions to defined contribution pension plans are recognised as an expense in the consolidated income statement as incurred.
Defined benefit pension schemes The net surplus or deficit (the economic surplus or deficit) in respect of the defined benefit pension schemes is calculated by estimating the amount of future benefit that employees have earned in return for their service in the current and prior years; that benefit is discounted to determine its present value and the fair value of any scheme assets is deducted. The discount rate is the yield at the period end on AA credit rated bonds that have maturity dates approximating to the terms of the Group’s obligations. The calculation is performed by a qualified actuary using the projected unit credit method. As required by IFRIC 14, to the extent that the economic surplus will be available as a refund, the scheme assets are stated after a provision for tax that would be borne by the scheme administrators when the refund is made.
1. Accounting policies (continued) (m) Employee benefits (continued) Defined benefit pension schemes (continued) The economic surplus or deficit is subsequently adjusted to eliminate on consolidation the carrying value of insurance policies issued by Group entities to the defined benefit pension schemes (the reported surplus or deficit). A corresponding adjustment is made to the carrying values of insurance contracts liabilities and investment contracts liabilities.
The movement in the reported surplus/deficit is analysed between the service cost, past service cost, curtailments and settlements (recognised within administrative expenses in the consolidated income statement), the interest cost on the liabilities less the expected return on assets, including any reimbursement assets (recognised within net investment income in the consolidated income statement), actuarial gains and losses (recognised in other comprehensive income) and employer contributions. All actuarial gains and losses are recognised in full.
(o) Property, plant and equipment Owner-occupied property is stated at fair value, being the estimated amount for which the property could be exchanged on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction. Owner-occupied property is depreciated over its estimated useful life, which is taken as 50 years, except where the residual value is greater than its carrying value in which case no depreciation is charged to profit or loss. Land is not depreciated. Gains and losses on owner-occupied property are recognised in the statement of consolidated comprehensive income.
(p) Investment property Investment property is stated at fair value. Fair value is based on market values, being the estimated amount for which a property could be exchanged on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction. Gains and losses arising from the change in fair value are recognised in the consolidated income statement.
1. Accounting policies (continued) (r) Financial assets (continued) Fair value estimation (continued) For units in unit trusts and shares in open-ended investment companies, fair value is determined by reference to published bid-values. The fair value of receivables and floating rate and overnight deposits with credit institutions is their carrying value. The fair value of fixed interest-bearing deposits is estimated using discounted cash flow techniques.
Cash and non-cash collateral pledged where the Group retains the contractual rights to receive the cash flows generated is not derecognised from the statement of consolidated financial position, unless the Group defaults on its obligations under the relevant agreement.
Shares held by the employee trust and Group entities Where an employee trust or a Group entity acquires shares in the Company or obtains rights to purchase its shares, the consideration paid (including any attributable transaction costs, net of tax) is shown as a deduction from owners’ equity. Gains and losses on sales of shares held by the employee trust and Group entities are charged or credited to the own shares account in equity.
– IAS 32 Financial Instruments Presentation (Amendment). The amendment alters the definition of a financial liability in IAS 32 to enable entities to classify rights issues and certain options or warrants as equity instruments.
– IFRIC 14 Prepayments of a Minimum Funding Requirement (Amendment). The amendment permits a prepayment of future service costs in accordance with a minimum funding requirement to be recognised as a pension asset.
– Annual improvements 2010. This makes a number of minor improvements to existing standards and interpretations.
2. Financial information (continued) 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 (2015). This is the first two parts of a replacements 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.
– Disclosure – Transfer of Financial Assets (Amendments to IFRS 7) (2012). This revises the required disclosures to help users of financial statements evaluate the risk exposures relating to transfers of financial assets and the effect of those risks on an entity’s financial position.
– IFRS 12 Disclosure of Interests in Other Entities (2013) combines, enhances and replaces the disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities.
– Presentation of Items of Other Comprehensive Income (Amendments to IAS 1) (2013). The amendment requires companies to group together items within other comprehensive income that may be reclassified to the profit or loss section of the income statement.
– IAS 19 Employee Benefits (Amendment) (2013). The IASB has issued numerous amendments to IAS 19. These range from fundamental changes such as removing the corridor mechanism and the concept of expected returns on plan assets to simple clarifications and re-wording.
– Disclosures – Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7) (2013). 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.
– Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32) (2014). The amendments address inconsistencies in current practice when applying the offsetting criteria in IAS 32.
– IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine (2013).
4. Segmental analysis The Group defines and presents operating segments based on the information which is provided to the Board.
For management purposes, the Group is organised into business units based on their products and services and has two operating segments as follows: – Phoenix Life – this segment manages a range of whole life, term assurance and pension products; and
– Ignis Asset Management – this segment provides investment management services to the life companies within the Group and to third parties, covering both retail and institutional investors.
Other operating income: Net policyholder claims and benefits incurred: Non-recurring 35 – – – 35
Depreciation, impairment and amortisation: Depreciation of property, plant and equipment – (3) – – (3) Impairment losses on property, plant and equipment (8) – – – (8) Amortisation of acquired in-force business (134) – – – (134) Amortisation of customer relationships (13) (5) – – (18)
Profit/(loss) before finance costs and tax 220 39 (31) – 228
Profit/(loss) before tax 98 39 (141) – (4) Tax attributable to policyholders’ returns (173) – – – (173) Segmental result before the tax attributable 1 The Group has entered into derivatives to protect its net exposure to interest rate fluctuations and this reallocation reflects the net economic interest exposure of the Group.
Depreciation, and amortisation: Depreciation of property, plant and equipment – (3) – – (3) Amortisation of acquired in-force business (147) – – – (147) Amortisation of customer relationships (15) (3) – – (18)
Other operating expenses: Profit/(loss) before finance costs and tax 274 43 (90) – 227
Profit/(loss) before tax 173 43 (205) – 11 Tax attributable to policyholders’ returns (5) – – – (5) Segmental result before the tax attributable 2 The Group has entered into derivatives to protect its net exposure to interest rate fluctuations and this reallocation reflects the net economic interest exposure of the Group.
Operating profit/(loss) before adjusting items 395 46 (54) 387 Investment return variances and economic assumption changes on long-term business (338) – – (338) Variance on owners’ funds 17 – (8) 9 Amortisation of acquired in-force business (121) – – (121) Amortisation of customer relationships (13) (5) – (18)
Non-recurring items include: – restructuring costs of £37 million; – regulatory change and systems transformation costs of £21 million; – a gain of £37 million arising from closing the Group’s pension schemes to future accrual and implementing a pension increase exchange programme; and
– a £35 million recovery of historic costs under the management services agreements with the life division.
Variances on owners’ funds of: Subsidiary undertakings 7 7 The Company 2 12
The variances on owners’ funds of the Company comprise fair value gains arising from movements in the fair value of warrants in issue over the Company’s shares.
Investment income Interest income on loans and receivables 49 57 Interest income on impaired financial assets 7 5 Interest income on financial assets designated at fair value through profit or loss on initial recognition 2,554 1,911 Dividend income 679 492 Rental income 86 78 Net expected return on pension assets (11) (18)
Employee costs 128 158 Outsourcer expenses 160 183 Investment management expenses and transaction costs 99 142 Professional fees 73 61 Office costs 45 53 Impairment of property, plant and equipment 8 – Operating expenses in respect of investment properties 6 4 Depreciation of property, plant and equipment 3 3
Certain prior year disclosures in note 10 have been amended to conform to current year presentation.
Included with other pension costs are the benefits associated with liability management exercises undertaken on the Group’s defined benefit pension schemes as detailed in note 32.
Average number of persons employed Phoenix Life 804 758 Ignis Asset Management 551 520 11. Auditors’ remuneration The remuneration of the Company’s auditors, including their associates, in respect of services supplied to members of the Group was £6.7 million (2010: £13.6 million). No services were provided by the Company’s auditors to the Group’s pension schemes.
The total remuneration of the Company’s auditors for services as reporting accountants during the prior year mainly comprised services provided in respect of the Premium Listing.
Interest expense On borrowings at amortised cost 215 196 On borrowings at fair value through profit or loss 36 73
Deferred tax: Reversal/origination of temporary differences On non-profit surpluses (9) (32) On amortisation of acquired in-force business (44) (50) On amortisation of customer relationship intangible (5) (5) Capital allowances in excess of depreciation 6 – On accrued interest 7 (38) Losses on group restructuring not matched in accounts – (33) Tax losses arising in the current year carried forward – (17) Pension scheme movements 30 19 On provisions for future expenditure 2 (6) Other temporary differences 3 –
Utilisation of tax losses 131 57 Change in the rate of corporation tax (41) (19) Write (up)/down of deferred tax assets (13) 2
The Group, as a proxy for policyholders in the UK, is required to pay taxes on investment income and gains each year. Accordingly, the tax benefit or expense attributable to UK life assurance policyholder earnings is included in income tax expense. The tax charge attributable to policyholder earnings was £173 million (2010: £5 million).
Policyholder tax charge 173 5 Total tax charge/(credit) for the year 94 (69) 1 The Group’s two operating segments operate predominantly in the UK. The reconciliation of the tax credit has, therefore, been completed by reference to the standard rate of UK tax rather than by reference to the Jersey income tax rate of 0% which is applicable to Phoenix Group Holdings.
On 24 August 2011, the Board declared an interim dividend of £0.21 per share for the half year ended 30 June 2011. A scrip dividend option was available to shareholders and the total dividend that was settled on 7 October 2011 amounted to £36 million of which £10 million was settled via the scrip dividend option.
15. Earnings per share 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.
(Loss)/profit for the year (98) 80 Share of result attributable to non-controlling interests (33) (50) (Loss)/profit attributable to owners (131) 30
15. Earnings per share (continued) The basic earnings per share of (76.2p) (2010: 20.1p) has been based on the loss of £131million (2010: profit £30 million) and a weighted average number of ordinary shares outstanding during the year of 172 million (2010: 149 million), calculated as follows: Number million
Issued ordinary shares at beginning of the year 171 130 Effect of ordinary shares issued/redeemed 1 19 Weighted average number of ordinary shares 172 149
The diluted earnings per share of (76.2p) (2010: 20.1p) has been based on the loss of £131 million (2010: profit £30 million) and a diluted weighted average number of ordinary shares outstanding during the year of 172 million (2010: 149 million) calculated as follows: Number million
Weighted average number of ordinary shares 172 149 Effect of warrants in issue – – Weighted average number of ordinary shares (diluted) 172 149
During the year, the Company issued 12,112 shares at a premium of £68,190 in order to satisfy its obligation to employees under the Group’s share schemes.
Expense arising from equity-settled share-based payment transactions 6 8 Expense arising from cash-settled share-based payment transactions 1 1 Total expense arising from share-based payment transactions 7 9
(for 5.25 year scheme) based on UK Government Gilts with a term commensurate with the expected term for each award 2.0 (for 3.25 year scheme) and 2.8 (for 5.25 year scheme) based on UK Government Gilts with a term commensurate with the expected term for each award.
Expected volatility (%) 30.0 which is based on the Company’s share price volatility to date 30.0 which is based on the Company’s share price volatility to date.
Bonus share plan (‘BSP’) In 2009, certain employees were granted nil-cost options to acquire an allocated number of ordinary shares. There were no performance criteria associated with these awards and no cash settlement alternatives. The contractual life of the awards is two years. 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. The majority of awards vested in 2011.
Deferred cash plan With effect from 2 September 2009, a number of executives were given deferred cash awards the value of which will be equal to a fixed number of Phoenix Group Holdings shares on 2 September 2012 and will be payable on this date provided the executive remains in employment by the Group.
Outstanding at the beginning of the year 403,750 – 403,750 – – Granted during the year 1,601,087 1,163,948 40,000 229,370 – Forfeited during the year (106,241) (121,395) – – – Exercised during the year (474,047) (5,339) (117,500) – – Outstanding at the end of the year 1,424,549 1,037,214 326,250 229,370 –
The weighted average remaining contractual life for the rewards outstanding as at 31 December 2011 is 2.0 years (2010: 2.5 years).
Profit for the year 15 18 33 Dividends paid – (21) (21) Coupon paid, net of tax relief (19) – (19) Shares in subsidiaries subscribed for by non-controlling interests – 1 1
19. Non-controlling interests (continued) 19.1 Perpetual Reset Capital Securities On 1 January 2010, Pearl Group Holdings (No. 1) Limited (‘PGH1’) had in issue £500 million of Perpetual Reset Capital Securities (‘the Notes’) which are admitted to the Official List of the UK Listing Authority and to trading on the LSE. Following amendments made to the Notes in 2010, the principal amount outstanding is now £425 million.
On 25 April 2011, the 2011 coupon was settled in full.
19.2 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.
Amounts due for settlement after 12 months 46,759 2,792 42,376 2,719
Transfer to statement of consolidated comprehensive income in respect of actuarial losses of defined benefit pension scheme – – (27) –
£200 million 7.25% unsecured subordinated loan (note f) 135 127 154 170 Unsecured loan notes (note g) 7 12 7 12 £100 million PIK notes and facility (note i) 111 106 111 106 £75 million secured loan note (note j) 73 72 73 72
22. Borrowings (continued) 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 are split between two classes, which rank pari passu. The £140 million 7.39% class A1 limited recourse bonds with an outstanding principal of £11 million (2010: £27 million) mature in 2012. A principal repayment of £16 million was made in September 2011 as per the terms of the agreement. The £120 million 7.59% limited recourse bonds with an outstanding principal of £120 million (2010: £120 million) have an average remaining life of 7 years maturing in 2022. NPLL has provided collateral of £65 million (2010: £77 million) to provide security to the holders of the NPLL recourse bonds in issue.
b. On 21 March 2011, the £779 million loan, £15 million loan and £4 million loan were all settled for consideration of £782 million as part of the restructure of a £1.2 billion portfolio of corporate loans.
c. The Property Reversions loan from Abbey National Property Investments was brought into the consolidated financial statements at fair value. It relates to the sale of Extra-Income Plan policies that Abbey National Property Investments finances to the value of the associated property reversions. As part of the arrangement Abbey National Property Investments receive an amount calculated by reference to the movement in the Halifax House Price Index and NPLL and NPI Limited have undertaken to indemnify Abbey National Property Investments 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 the year, a repayment of £27 million was made. Note 35 contains details of the assets that support this loan.
e. On 19 May 2011, UKCPT entered into a £150 million investment term loan facility agreement.
f. Scottish Mutual Assurance Limited issued £200 million 7.25% undated, unsecured subordinated loan notes on 23 July 2001. 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 Phoenix Life Limited (‘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). Phoenix Group Holdings assumed these subordinated loan notes as a result of the acquisition of the Pearl businesses 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.
g. Unsecured loan notes of £72 million were issued by Impala Holdings Limited (‘Impala’) at par on 14 May 2008 at an interest rate of LIBOR minus 1% per annum which are due to mature at the end of 2012. During the year £5 million (2010: £6 million) of these loan notes have been repaid and £7 million (2010: £12 million) were outstanding.
IFRS financial statements h. On 14 May 2008, PGH (LC1) Limited and PGH (LC2) Limited jointly obtained a £2,260 million loan facility from a syndicate of external banks (the ‘Impala Facility’). This facility was split into Tranche loans A, B and C of £1,275 million, £492.5 million and £492.5 million respectively. The terms of this facility are: – Tranche A loan of £1,275 million is repayable over the period from 30 April 2011 to 30 November 2014 and attracts interest at LIBOR plus a cash margin of 1.00% and a PIK margin of 1.00% for the first four years and LIBOR plus a cash margin of 2.50% for the subsequent years; – Tranche B loan of £492.5 million is repayable on 30 November 2015 and attracts interest at LIBOR plus a cash margin of 1.25% and a PIK margin of 0.75% for the first four years and LIBOR plus a cash margin of 3.25% for the subsequent years; and
j. 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 (the ‘Pearl Facility‘). This loan was subsequently amended on 2 September 2009, leaving £425 million outstanding on this facility and £75 million of secured C loan notes.
During the year a scheduled repayment of £24 million was made on the £425 million loan facility and interest of £1 million (£2010: £2 million) was capitalised on the £75 million secured C loan notes.
24. Derivatives The Group purchases derivative financial instruments in connection with the management of its insurance contract and investment contract liabilities based on the principles of reduction of risk and efficient portfolio management.
– first anniversary of the date the units were admitted to trading on Euronext.
The IPO warrants will expire at the close of trading on the LSE on 3 September 2014 or earlier upon redemption or liquidation. Once the warrants become exercisable, 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; and
If the Company calls the warrants for redemption as described above, it will have the option to require any holder that wishes to exercise its warrant to do so on a cashless basis.
At 31 December 2011 the IPO warrants were valued at £1 million (2010: £2 million).
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. On 15 October 2010, following an issue of ordinary shares by the Company under a scrip dividend, the terms of the warrants were amended to entitle the holder to purchase 1.009507 ordinary shares per warrant.
24. Derivatives (continued) Lenders’ warrants (continued) These Lenders’ warrants are not traded in an active market and have therefore been valued using an extended Black-Scholes valuation model to capture the embedded barrier feature. The key assumptions used to ascertain a value are the same as for the IPO warrants (see above). The value of the warrants at the year end was £250,000 (2010: £280,000).
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. On 15 October 2010, following an issue of ordinary shares by the Company under a scrip dividend, the terms of the warrants were amended to entitle the holder to purchase 1.009507 ordinary shares per warrant.
All outstanding warrants may be redeemed at the option of the Company at any time after they become exercisable and prior to their expiration at a price of €0.01 per warrant, provided that the last closing bid price of the ordinary shares is equal to or exceeds €16.50 on each of 20 consecutive trading days. On 15 October 2010, this threshold of €16.50 was amended to €16.34. The Company must give not less than 30 days’ notice of the redemption date. Each warrant may then be exercised by the warrant holder (in whole or any part) at its option.
The holders are entitled to exercise their warrants for cash, assignment of an amount of outstanding principal plus accrued interest of any Global Debt (i.e. the PIK facility) or on a cashless basis where the Company redeems the warrants. Any warrant either not exercised or tendered back to the Company by the redemption date shall be cancelled on the books of the Company and have no further value except for the €0.01 redemption price.
Carrying value and fair value: Amount due for settlement after 12 months 1,552 628 26. Financial liabilities Carrying value Fair value £m £m
Staff related provisions primarily relate to costs associated with restructuring across the Group. These include provisions for unfunded pensions of £5 million (2010: £5 million) and private medical insurance costs for former employees of £3 million (2010: £4 million). These provisions have been calculated on a realistic basis.
Current tax receivables 8 5 Net deferred tax assets – – Total tax assets 8 5
Trading losses 37 82 Expenses and deferred acquisition costs carried forward 14 86 Provisions and other temporary differences 11 20 Pension scheme deficit – 21 Accelerated capital allowances 18 25 Unpaid interest 34 44 Gross deferred tax assets 114 278 Less: offset against deferred tax liabilities (114) (278) Net deferred tax assets – –
28. Tax assets and liabilities (continued) Deferred tax liabilities comprise £m £m
Acquired in-force business 593 670 Customer relationships 100 114 Surplus within the non-profit funds 62 64 Provisions and other temporary differences 8 17 Adjustment for insurance policies held with related parties in respect of the
PGL Pension Scheme 24 20 Gross deferred tax liabilities 787 885 Less: offset against deferred tax assets (114) (278) Net deferred tax liabilities 673 607
Deferred tax assets have not been recognised in respect of: Tax losses carried forward 102 103 Excess expenses and deferred acquisition costs carried forward 22 22 Provisions and other temporary differences 14 7 Deferred tax assets not recognised on capital losses1 262 165 1 These can only be recognised against future capital gains and have no expiry date.
Payables relating to direct insurance contracts include claims outstanding on general insurance and life assurance. The general insurance element amounts to £240 million (2010: £263 million).
Pearl Group Staff Pension Scheme Economic surplus/(deficit) (including £56 million (2010: nil) available as a refund on a winding-up of the scheme 56 (77) Provision for tax on that part of the economic surplus available as a refund on a winding-up of the scheme (19) – Reported surplus/(deficit) 37 (77)
Adjustment for insurance policies held with related parties and eliminated on consolidation (94) (74)
Pearl Group Staff Pension Scheme 81 38 PGL Pension Scheme 170 7 Total actuarial gains 251 45
Defined contribution scheme Contributions in the year amounted to £1 million (2010: £2 million).
IFRS financial statements of all acceptances received up to 31 December 2011 has been recognised in the consolidated financial statements and the reduction in scheme liabilities of £16 million is shown as a negative past service cost.
The principal financial assumptions of the Pearl Scheme are set out below.
The principal employer and the Trustees of the Pearl Scheme have entered into an agreement, the principal terms of which provide for the following: – Cash payments into the scheme of £25 million per annum for a period of 10 years, commencing on 30 September 2010, subject to certain capital resource and other requirements being maintained. The payments due between 2020 and 2027 are calculated from projected scheme deficits, on a funding basis, as follows: £2 million payable on or before 30 June 2020, £39 million payable on or before 30 June 2021; £35 million payable on or before each of 30 June 2022, 30 June 2023 and 30 June 2024, and £41 million payable on each of 30 June 2025, 30 June 2026 and 30 June 2027. The amounts payable on and from 30 June 2021 may alter in light of any funding shortfall disclosed as at the triennial funding valuation immediately preceding their date of payment.
– The Trustees being granted a first charge over shares in Pearl Assurance Limited, National Provident Life Limited, London Life Limited, Pearl Group Services Limited and PGS 2 Limited to secure an amount not exceeding 60% of the deficit arising on the triennial scheme valuation (as calculated in accordance with the terms of the agreement), subject to an initial amount and a maximum of £600 million, such security ceasing on a scheme buy out, the principal employer discharging its liabilities under the agreement or upon a valuation of the scheme demonstrating there is no funding deficit if earlier. Enforcement of the security may take place on the occurrence of various events, the main ones being (i) a failure by the principal employer to pay agreed cash contributions to the scheme, (ii) an insolvency or other similar financial difficulties of the principal employer, (iii) except in certain defined circumstances, payments of interest or principal to the principal employer’s lenders or of dividends to the principal employer’s owners being made at a time when the principal employer has failed to maintain an embedded value of at least 1.3 times the amount secured, (iv) the principal employer failing to maintain an embedded value of at least 1.05 times the amount secured or (v) the principal employer granting certain types of security over its assets. NP Life Holdings Limited has also granted a limited recourse share charge over the shares it holds in National Provident Life Limited in favour of the Trustee in respect of the principal employer’s obligation under this agreement. This security is granted on substantially the same terms as the security granted by the principal employer.
32. Pension schemes (continued) 32.1 Pearl Group Staff Pension Scheme (continued) The amounts recognised in the income statement are as follows: £m
Current service cost (1) (1) Interest cost (95) (100) Expected return on scheme assets 81 82 Past service cost 16 − Curtailment gain 3 −
Actual return less expected return on scheme assets 110 19 Experience (losses)/gains arising on scheme liabilities (22) 70 Gain/(loss) due to changes in assumptions underlying scheme liabilities 12 (51)
The surplus/(deficit) recognised in the statement of financial position is as follows: £m
Fair value of scheme assets 1,846 1,725 Present value of defined benefit obligation (1,809) (1,802)
Contributions totalling £27 million are expected to be paid into the scheme in 2012 in accordance with the agreement with the Trustee of the Pearl Scheme.
Fair value of scheme assets 1,846 1,725 1,684 Defined benefit obligation (1,809) (1,802) (1,805)
Defined contribution scheme Contributions in the year amounted to £2 million (2010: £4 million).
32. Pension schemes (continued) 32.2 PGL Pension scheme (continued) In November 2011, following formal consultation, the Group carried out a PIE exercise, the same as outlined for the Pearl Scheme, although its offer period ended on 30 December 2011. The financial effects of the exercise were treated in the same way as for the Pearl Scheme. The financial effects of all acceptances received up to 31 December 2011 have been reflected as a negative past service cost of £11 million in the current year. The effect has been to reduce the Scheme liabilities by £11 million.
A triennial funding valuation of the PGL Pension Scheme as at 30 June 2009 was completed in September 2010. This showed a deficit on the funding basis as at 30 June 2009 of £255 million. Following discussions with the Trustee of the PGL Pension Scheme it was agreed that new cash contributions to the scheme amounting to £160 million would be paid over the period from September 2010 to August 2017. Together with the outstanding contributions of £28 million, due to the scheme as at the end of August 2010 following the previous triennial valuation, the total future contributions amount to £188 million.
The amounts recognised in the income statement are as follows: £m
Current service cost (3) (4) Interest cost (63) (63) Expected return on scheme assets 66 63 Past service cost 11 − Gain on curtailment 7 −
Actual return less expected return on scheme assets 327 81 Experience loss arising on scheme liabilities (15) (23) Loss due to changes in assumptions underlying scheme liabilities (25) (19)
The cumulative net actuarial gains recognised in other comprehensive income amounted to £253 million (2010: £83 million).
Fair value of scheme assets 1,511 1,252 Present value of defined benefit obligation (1,234) (1,193)
The actual return on the scheme assets comprises the following: £m
Expected return on scheme assets 66 63 Actual return less expected return on scheme assets 327 81 Provision for tax on the economic surplus available as a refund (117) (32) Contributions by the employer 30 60 Benefits paid (47) (46)
Cash and other 100 33 Provision for tax on the economic surplus available as a refund (149) (32)
Contributions totalling £23 million are expected to be paid into the scheme in 2012.
Fair value of scheme assets 1,511 1,252 1,126 Defined benefit obligation (1,234) (1,193) (1,130)
Cost or valuation At 1 January – as restated 115 2,213 445 35 2,808
Impairment tests have been performed using assumptions which management consider reasonable. Given the magnitude of the excess of the value in use over carrying value, management believes that it is unlikely that there would be a change in key assumptions such that carrying value would exceed value in use.
The carrying amount of goodwill allocated to the Phoenix Life segment is £58 million (2010: £58 million) and to the Ignis Asset Management segment is £57 million (2010: £57 million).
33. Intangible assets (continued) Acquired in-force business Acquired in-force business represents the difference between the fair value of the contractual rights acquired and obligations assumed under insurance and investment contracts with and without DPF and the liability measured in accordance with the Group’s accounting policies for such contracts. This intangible is being amortised in accordance with the run-off of the book of business within the Phoenix Life segment.
The valuation of land and buildings is carried out at least every three years as at 31 December by external surveyors in accordance with the Royal Institution of Chartered Surveyors’ requirements under an open market valuation basis. The Group’s main operating site in Wythall is owned by one of the Group’s with-profit funds. During 2011, an agreement in principle was reached for the purchase of that site by one of the Group’s management services companies. A valuation was undertaken in connection with the sale and has resulted in an impairment of £8 million being recognised in the Phoenix Life segment.
Direct operating expenses (included within administrative expenses) in respect of investment properties that generated rental income during the year amounted to £4 million (2010: £2 million). The direct operating expenses arising from investment property that did not generate rental income during the year amounted to £2 million (2010: £2 million).
Loans and receivables at amortised cost 3,529 2,293 Financial assets at fair value through profit or loss
Level 2 financial instruments The fair values of investments that are not traded in an active market are determined using valuation techniques with observable market inputs. The fair value of shares and other variable yield securities and of derivative financial instruments, are estimated using pricing models, discounted cash flow techniques or broker quotes. Where pricing models are used, inputs are based on market related data at the period end. Where discounted cash flow techniques are used, estimated future cash flows are based on management’s best estimates and the discount rate used is a market related rate for a similar instrument.
Level 3 financial instruments The Group’s financial assets determined by valuation techniques using non-observable inputs are based on a combination of independent third party evidence and internally developed models. Third party evidence in the form of net asset valuation statements, are used in the valuation of the majority of indirect property, private equity and hedge funds. Broker quotes are received for certain bonds where the market is considered to be inactive. Internally developed models have been used in the valuation of a small number of investment vehicles which due to their nature and complexity have no external market. Inputs into the internally developed models are based on market observable data where available.
Financial assets at fair value Derivatives – 6,038 61 6,099 Financial assets designated at fair value through profit or loss upon
Financial assets at fair value Derivatives 24 3,084 89 3,197 Financial assets designated at fair value through profit or loss upon initial recognition Equities 11,667 – 793 12,460 Fixed and variable rate income securities 34,336 5,816 747 40,899
The first of these investments has been independently valued using a multi scenario discounted cash flow model. Under the optimistic scenario, the fair value of the investment would increase by £36 million (2010: £36 million) and in the worst case scenario the fair value would decrease by £38 million (2010: £63 million).
Financial assets at fair value Financial assets designated at fair value through profit or loss upon initial recognition
Fixed and variable rate income securities 819 (43) 32 (61) 747 150
Net asset value attributable to unitholders 154 14 – – 168 43
38. Stock lending and collateral 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.
Where the Group receives collateral in the form of marketable securities which it is not permitted to sell or re-pledge except in the case of default, such collateral is not recognised in the statement of consolidated financial position. The fair value of financial assets accepted as such collateral amounts to £255 million (2010: £648 million).
The maximum exposure to credit risk in respect of stock lending transactions is £10,924 million (2010: £9,994 million) of which credit risk of £10,913 million (2010: £9,714 million) is mitigated through the use of collateral arrangements.
The maximum exposure to credit risk in respect of OTC derivative assets is £6,045 million (2010: £3,154 million) of which credit risk of £5,871 million (2010: £2,893 million) is mitigated by use of collateral arrangements (which are settled net after taking account of any OTC derivative liabilities owed to the counterparty).
Credit risk on exchange traded derivative assets of £54 million (2010: £43 million) is mitigated through regular merging and the protection offered by the exchange.
IFRS financial statements 41. Cash flows from operating activities £m 2010 £m
Fair value gains on: Investment property (4) (87) Financial assets (1,572) (3,324)
Decrease/(increase) in investment assets 1,400 (1,308) Increase in reinsurance assets (201) (69) Increase in insurance contract and investment contract liabilities 450 423 Increase/(decrease) in deposits received from reinsurers 53 (12) Increase in obligation for repayment of collateral received 2,845 6,054 Net decrease in working capital 310 1,114 Cash generated by operations 3,692 3,392 42. Capital statement Capital Management Framework The Group’s Capital Management Framework is designed to achieve the following objectives: – provide appropriate security for policyholders and meet all regulatory capital requirements whilst not retaining unnecessary excess capital; – ensure sufficient liquidity to meet obligations to policyholders and other creditors; and
– optimise the overall gearing to ensure an efficient capital base.
42. Capital statement (continued) Capital Management Framework (continued) 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 the company.
Regulatory capital requirements Each UK life company and the Group must retain sufficient capital at all times to meet the regulatory capital requirements mandated by the FSA. In addition to EU-directive-based ‘Pillar 1’ and group capital requirements, the FSA 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.
An alternative test to the RCR is required under Pillar 1 in respect of with-profit funds which may result in an additional capital requirement referred to as the ‘with-profit insurance capital component (‘WPICC’).
Insurance Groups’ Directive (‘IGD’) FSA regulated insurance groups (including their holding companies) are also required to provide an assessment of capital adequacy on a Group-wide basis to enable the FSA 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 and is the Group’s primary capital and solvency measure.
Regulatory capital position statement The purpose of the capital position statement is to set out the capital resources of the life assurance businesses of the Phoenix Life segment of the Group and to provide an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital position statement also provides a reconciliation of owners’ funds to regulatory capital and an analysis of the regulatory capital between the Group’s with-profit funds, non-participating business, life business owners’ funds and its other activities.
Adjustments onto a regulatory basis: Unallocated surplus 843 5 – 848 Adjustments to assets (note 1) (34) (251) (535) (820) Adjustments to liabilities (note 2) 3,667 (141) 33 3,559
Total available capital resources at 31 December 2011 4,888 267 1,622 6,777
Total owners’ funds at 31 December 2011 – – – – – – –
Owners’ funds held outside long-term fund – – 2,194 2,194 (1,329) 865 Owners’ funds held in long-term fund – 715 – 715 – 715 Total owners’ funds at 31 December 2010 – 715 2,194 2,909 (1,329) 1,580
Adjustments onto a regulatory basis: Unallocated surplus 853 11 – 864 Adjustments to assets (note 1) (93) (319) (422) (834) Adjustments to liabilities (note 2) 3,526 (120) 54 3,460
Other qualifying capital: Subordinated debt (note 3) – – 645 645 Contingent loans 736 216 (772) 180 Allocation of Group capital 52 206 (258) –
Total available capital resources at 31 December 2010 5,074 709 1,441 7,224
Total owners’ funds at 31 December 2010 – – – – – – –
Other qualifying capital: Contingent loans – – – – – 736 736 Allocation of Group capital – – – – – 52 52
Total available capital resources at 31 December 2010 1,048 963 1,032 295 713 1,023 5,074
3 Of the £645 million (2010: £645 million) subordinated debt attributed to the Phoenix Life segment of the Group £445 million (2010: £445 million) is internal to the Group, comprising £250 million (2010: £250 million) provided to Pearl Assurance Limited and £195 million provided to Phoenix & London Assurance Limited which was transferred to PLL on 1 January 2011 following a Part VII transfer. The remaining £200 million (2010: £200 million) is external subordinated debt, see note 22 for details.
4 ‘Other activities and consolidation adjustments’ represent the contribution to consolidated owners’ funds arising outside of the Phoenix Life business. This includes the owners’ funds of Ignis Asset Management and the holding companies of the Group but primarily consists of the consolidation adjustments to eliminate the cost of the Group’s investment in the Phoenix Life business.
42. Capital statement (continued) An analysis of the movement in available capital resources for the period 1 January 2010 to 31 December 2010 is shown below: With-profit
Adjustment for internal loans in excess of counterparty limits – – – – – – (15) 64 49
Management actions The management actions that have had the most significant impact on available capital resources of the Phoenix Life segment of the Group during the period to 31 December 2011 generally comprise payment of dividends to Group entities.
IFRS financial statements 43. Risk management The Group’s overall approach to risk management is described in the Performance section of the Annual Report and Accounts 43.1 Risk and capital management objectives The risk management objectives and policies of the Group are based on the requirement to protect the Group’s regulatory capital position, thereby safeguarding policyholders’ guaranteed benefits whilst also ensuring the Group can meet its various cash flow requirements. Subject to this, the Group seeks to use available capital to achieve increased returns, balancing risk and reward, to generate additional value for policyholders and shareholders.
43.2 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. Financial soundness risk is a broad risk category encompassing financial control and reporting risk, capital management risk, liquidity and funding risk, and tax risk. Liquidity and funding risk are the most relevant of the financial soundness risks for financial instruments.
Responsibility for agreeing the financial risk profile rests with the Board of each life company, as advised by investment managers, internal committees and the actuarial function. In setting the risk profile, the Board of each life company will receive advice from the appointed investment managers and the relevant actuarial function holder as to the potential implications of that risk profile with regard to the probability of both realistic insolvency and of failing to meet the regulatory minimum capital requirement. The actuarial function holder will also advise the extent to which the investment risk taken is consistent with the Group’s commitment to treat customers fairly.
More detail on the Group’s exposure to financial risk is provided in note 43.3 below.
The Group is also exposed to insurance risk arising from its Phoenix Life segment. Life insurance risk in the Group arises through its exposure to mortality, longevity and to variances between assumed and actual experience in factors such as persistency levels and management and administrative expenses. More details on the Group’s exposure to insurance risk are provided in note 43.5 below.
There are two principal sources of credit risk for the Group: – Credit risk which results from direct investment activities, including investments in fixed and variable rate income securities, equities, derivatives, collective investment schemes and the placing of cash deposits; and
Quality of credit assets An indication of the Group’s exposure to credit risk is the quality of the investments and counterparties with which it transacts. The following table provides information regarding the aggregate credit exposure with external credit ratings (the S&P rating is used in deriving the table below): AAA
Non-equity based derivatives are included in the credit risk table above.
Credit ratings have also not been disclosed in the above tables for holdings in collective investment schemes. The credit quality of the underlying debt securities within these vehicles is managed by the safeguards built into the investment mandates for these vehicles.
Fixed and variable rate income securities 41,842 – – – – 168 42,010 Reinsurers’ share of insurance contract liabilities 3,153 – – – – – 3,153 Reinsurance receivables 257 – – – – – 257 Prepayments and accrued income 599 – – – – – 599 Other receivables 200 – – – – – 200 Cash and cash equivalents 11,591 – – – – 132 11,723
Fixed and variable rate income securities 40,762 – – – – 137 40,899 Reinsurers’ share of insurance
Reinsurance receivables 263 – – – – – 263 Prepayments and accrued income 603 – – – – – 603
Cash and cash equivalents 8,999 – – – – 189 9,188
43. Risk management (continued) 43.3 Financial risk analysis (continued) 43.3.1 Credit risk (continued) Please refer to page 166 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 is also exposed to concentration risk with outsourced partners. This is due to the nature of the outsourced services market. The Group operates a policy to manage outsourcer service counterparty exposures and the impact from default is reviewed regularly by Executive Committees and measured though the ICA stress and scenario testing.
Collateral The credit risk of the Group is mitigated, in certain circumstances, by entering into collateral agreements. The amount and type of collateral required depends on an assessment of the credit risk of the counterparty. Guidelines are implemented regarding the acceptability of types of collateral and the valuation parameters. Collateral is mainly obtained for securities lending, certain reinsurance arrangements and to provide security against the maturity proceeds of derivative financial instruments. Management monitors the market value of the collateral received, requests additional collateral when needed, and performs an impairment valuation when impairment indicators exist and the asset is not fully secured (and is not carried at fair value).
– monitoring of compliance with market risk policy and review of market risk policy for pertinence to the changing environment.
Interest rate risk Interest rate risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in market interest rates due to the effect such movements have on the value of interest-bearing assets and on the value of future guarantees provided under certain contracts of insurance.
Equity, property and inflation risk The Group has exposure to financial assets and liabilities whose values will fluctuate as a result of changes in market prices other than from interest rate and currency fluctuations. This is due to factors specific to individual instruments, their issuers or factors affecting all instruments traded in the market. Accordingly, the Group limits its exposure to any one counterparty in its investment portfolios and to any one foreign market.
Equity and property price risk is managed through the agreement and monitoring of financial risk profiles that are appropriate for each of the Group’s life funds in respect of maintaining adequate regulatory capital and treating customers fairly. This is largely achieved through asset class diversification and within the Group’s ALM framework through the holding of derivatives or physical positions in relevant assets where appropriate. 1 55bps is assumed to relate to default risk, after allowing for additional prudence on an IFRS basis.
43. Risk management (continued) 43.3 Financial risk analysis (continued) 43.3.2 Market risk (continued) The sensitivity analysis for equity and property price risk illustrates how a change in the fair value of equities and properties affects the Group result. It takes into account the effect of such changes in equity and property prices on all assets and liabilities that contribute to the Group’s reported profit after tax and in equity (but excludes the impact on the Group’s defined benefit pension schemes).
A 10% decrease in equity prices, with all other variables held constant, would result in a increase in the profit after tax in respect of a full financial year and, in equity, of £16 million (2010: a decrease of £22 million).
A 10% decrease in property prices, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full financial year, and in equity, of £43 million (2010: £52 million).
The Group is exposed to inflation risk through certain contracts, such as annuities, which may provide for future benefits to be paid taking account of changes in the level of inflation, and also through the Group’s cost base. The Group seeks to manage inflation risk within the ALM framework through the holding of derivatives, such as inflation swaps, or physical positions in relevant assets, such as index-linked gilts, where appropriate.
Currency risk The Group’s principal transactions are carried out in sterling and therefore its exchange risk is limited principally to historic business that was written in the Republic of Ireland, where the assets are generally held in the same currency denomination as their liabilities, therefore, any foreign currency mismatch is largely mitigated. Consequently, the foreign currency risk relating to this business mainly arises when the assets and liabilities are translated into sterling.
Sensitivity of profit after tax and equity to fluctuations in currency exchange rates is not considered significant at 31 December 2011, since unhedged exposure to foreign currency was relatively low. (2010: not considered significant)
43.3.3 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 the annual entity report and accounts and annual regulatory reporting.
Tax risk is defined as the failure of the Group to appropriately record, report or disclose taxation information. The Group has exposure to tax risk through the production of its Interim and Annual Report and Accounts. The Group’s subsidiaries have exposure to tax risk through the annual entity report and accounts, annual regulatory reporting and through the processing of policyholder tax requirements.
Net asset value attributable to unitholders 3,209 – – – 3,209 Obligations for repayment of collateral received 11,453 255 1,297 – 13,005 Reinsurance payables 33 – – – 33 Payables related to direct insurance contracts 668 39 – – 707 Accruals and deferred income 169 4 – 2 175 1 year or less or on demand £m 1–5 years £m
43. Risk management (continued) 43.3 Financial risk analysis (continued) 43.3.3 Financial soundness risk (continued)
43.5 Insurance risk Insurance risk refers to the risk that the frequency or severity of insured events may be worse than expected and includes expense risk. The Phoenix Life segment contracts include the following sources of insurance risk: Mortality – higher than expected number of death claims on assurance products and occurrence of one or more large claims; Longevity – faster than expected improvements in life expectancy on immediate and deferred annuity products; Morbidity – higher than expected number of serious illness claims or more sickness claims which last longer on income protection policies; Expenses – policies cost more to administer than expected; Lapses – the numbers of policies terminating early is different to that expected in a way which increases expected claims costs or expenses or reduces future profits; Options – unanticipated changes in policyholder option exercise rates giving rise to increased claims costs; and
The Group has a number of small books of general insurance. These have been closed to new business for a number of years and are in run-off.
43. Risk management (continued) 43.5 Insurance risk (continued) Process used to determine assumptions (continued) For other business, demographic assumptions are derived by adding a prudent margin to best estimate assumptions. Economic assumptions are prudent estimates of the returns expected to be achieved on the assets backing the liabilities.
With-profit funds: Pensions: Deferred annuities – with guarantees 9,823 79 795 – Deferred annuities – without guarantees 1,930 105 – – Immediate annuities 3,651 – 688 – Unitised with-profit 1,202 9,033 3 –
43. Risk management (continued) 43.5 Insurance risk (continued) 43.5.2 Managing product risk (continued)
Non-profit funds: Deferred annuities – with guarantees 132 – 56 – Deferred annuities – without guarantees 1,013 6 477 – Immediate annuities 8,592 – 701 –
Not later than 1 year 15 11 Later than 1 year and no later than 5 years 56 41 Later than 5 years 35 47
Pearl Group Staff Pension Scheme Investment management fees 0.6 0.2 0.5 0.7 Payment of administrative expenses (4.0) – (3.0) –
The Pearl Scheme has invested in collective investment schemes that are controlled by the Group. At 31 December 2011 the Pearl Scheme held 1,118,197 units (2010: 1,118,197 units) in the Ignis Systematic Strategies Fund and 53,243,341 units (2010: 147,928,525 units) in the Ignis Liquidity Fund. The value of these investments at 31 December 2011 was £169 million (2010: £168 million) and £53 million (2010: £148 million) respectively.
Transactions with key management personnel The total compensation of key management personnel, being those having authority and responsibility for planning, directing and controlling the activities of the Group, including the Executive and Non-Executive Directors, are as follows: £m 2010 £m
Salary and other short-term benefits 4.8 4.1 Equity compensation plans 2.2 3.1 Termination payments 0.7 0.5
48. Group entities As at 31 December 2011, the principal subsidiary undertakings of the Group are as follows: Country of incorporation and principal place of operation Class of shares held (wholly-owned unless otherwise indicated)
Insurance companies BA (GI) Limited (general insurance company) UK Ordinary shares of £0.05 London Life Limited (life assurance company) UK Ordinary shares of £1 National Provident Life Limited (life assurance company UK Ordinary shares of £1 NPI Limited (life assurance company UK Ordinary shares of £1 Pearl Assurance Limited (life assurance company) UK ‘A’ ordinary shares of £0.05
Phoenix Life Limited (life assurance company) UK Ordinary shares of £1 Scottish Mutual International Limited (life assurance company) ROI Ordinary shares of €1.25 Non-insurance companies Ignis Asset Management Limited (investment management company) UK Ordinary shares of £1 Ignis Fund Managers Limited (unit trust management company) UK Ordinary shares of £1 Ignis Investment Services Limited (investment management company) UK Ordinary shares of £1
PGH (LC2) Limited (finance company) UK Ordinary shares of £1 and
PGH (MC2) Limited (finance company) UK Ordinary shares of £1 and
PGH (TC1) Limited (holding company) UK ‘A’ ordinary shares of £1 and
(holding company) UK Ordinary shares of £1 Pearl Life Holdings Limited (holding company) UK Ordinary shares of £1 Pearl Group Services Limited (management services company) UK Ordinary shares of £1 PGS 2 Limited (finance company) UK Ordinary shares of £1 Pearl Group Management Services Limited
(management services company) UK Ordinary shares of £1 Phoenix Life Holdings Limited
(holding company) UK Ordinary shares of £1 UK Commercial Property Trust Limited
165In this section 166 Additional life company asset disclosures asset disclosures
The life companies’ debt portfolio was £38.9 billion at 31 December 2011. Shareholders had direct exposure to £14.9 billion of these assets (including supported participating funds), of which 95% of rated securities were investment grade. The shareholders’ credit risk exposure to the non-supported participating funds is primarily limited to the shareholders’ share of future bonuses. Shareholders’ credit risk exposure to the unit-linked funds is limited to the level of asset manager fee which is dependent on the underlying assets.
The life companies have in place a comprehensive database that consolidates credit exposures across counterparties, geographies and business lines. This database is used for credit monitoring, stress testing and scenario planning. The life companies continue to manage their balance sheets prudently and have taken extra measures to ensure their market exposures remain within risk appetite. With effect from 31 December 2011, the European government bond benchmarks have been strengthened for funds with non-discretionary mandates.
The life companies had £88 million shareholder exposure to financial institution corporate debt of the Peripheral Eurozone at 31 December 2011. This exposure has been reduced from £319 million at 30 June 2011, a reduction of £231 million, of which £70 million is accounted for by the reclassification of certain holdings from Spain to the UK to better reflect the geographical exposure and £48 million by the reclassification of two with-profit funds from ‘Participating supported’ to ‘Participating non-supported’. The £2,896 million total shareholder exposure comprised £2,148 million senior debt, £261 million Tier 1 debt and £487 million Tier 2 debt.
For each of the life companies’ significant financial institution counterparties, industry and other data has been used to assess the exposure of the individual counterparties to Peripheral Eurozone markets. As part of the Group’s risk appetite framework and analysis of shareholder exposure to a worsening of the Eurozone situation, this assessment has been used to identify counterparties considered to be most at risk from Peripheral Eurozone sovereign defaults. The financial impact on these counterparties, and the contagion impact on the rest of the shareholder corporate bond portfolio, is assessed under various Eurozone scenarios and assumptions. This analysis is regularly reviewed to reflect the latest Eurozone outlook, economic data and changes to asset portfolios. The results are used to inform the Group’s views on whether any management actions are required.
responsibilities 174 Independent Auditor’s report 175 Summarised consolidated income statement – Group MCEV basis 175 MCEV earnings per ordinary share 176 Statement of consolidated comprehensive income – Group MCEV basis 176 Reconciliation of movement in equity – Group MCEV basis 177 Group MCEV analysis of earnings 178 Reconciliation of Group IFRS
STATEMENT OF DIRECTORS’ RESPONSIBILITIES For the year ended 31 December 2011
The MCEV methodology adopted by the Group is in accordance with these MCEV principles with the exception of: – risk-free rates have been defined as the annually compounded UK Government bond nominal spot curve plus 10 basis points rather than as the swap rate curve; – the value of asset management and the management service companies has been included on an IFRS basis; and
Specifically, the Directors have: – determined assumptions on a realistic basis, having regard to past, current and expected future experience and to relevant external data, and then applied them consistently; – made estimates that are reasonable and consistent; and
We have audited the Consolidated Phoenix Group MCEV (‘Phoenix Group MCEV’) supplementary information for the year ended 31 December 2011, which comprises the Summarised consolidated income statement – Group MCEV basis, MCEV earnings per ordinary share, Statement of consolidated comprehensive income – Group MCEV basis, Reconciliation of movement in equity – Group MCEV basis, Group MCEV analysis of earnings, Reconciliation of Group IFRS equity to Group MCEV net worth and related notes. The Phoenix Group MCEV supplementary information has been prepared by the Directors of Phoenix Group Holdings in accordance with the basis of preparation set out on pages 179 to 181.
MCEV EARNINGS PER ORDINARY SHARE for the year ended 31 December 2011 £m
STATEMENT OF CONSOLIDATED COMPREHENSIVE INCOME – GROUP MCEV BASIS For the year ended 31 December 2011 £m 2010 £m
Total comprehensive income for the year 63 282 1 The actuarial gain on the Pearl Group Staff Pension Scheme reflected in the MCEV does not include the IFRS surplus at 31 December 2011.
Issue of share capital – 33 Conversion of warrants into ordinary shares – 7 Movement in equity for equity-settled share-based payments 6 (2) Dividends paid on ordinary shares (72) (54) Shares issued in lieu of dividends 17 11 Total capital and dividend flows – external (49) (5)
GROUP MCEV ANALYSIS OF EARNINGS For the year ended 31 December 2011
Other comprehensive income – – – 32 32 Capital and dividend flows – internal (800) (26) (19) 845 – Capital and dividend flows – external – – – (49) (49)
Closing value at 31 December 2011 3,804 82 68 (1,836) 2,118 1 Comprises the Group holding companies that do not form part of the Phoenix Life and Ignis Asset Management divisions.
Operating MCEV earnings (after tax) 546 14 33 (50) 543 Non-operating MCEV earnings (after tax) 34 (54) – (268) (288)
Other comprehensive income – – – 27 27 Capital and dividend flows – internal2 (794) 64 (18) 748 – Capital and dividend flows – external – – – (5) (5)
The MCEV methodology adopted by the Group is in accordance with the MCEV principles and guidance published by the CFO Forum in October 2009, except that: – risk-free rates have been defined as the annually compounded UK Government nominal spot curve plus 10 basis points rather than as a swap rate curve; – no allowance for the cost of residual non-hedgeable risk (‘CNHR’) has been made because, in the opinion of the Directors, the Group operates a robust outsourcer model in terms of operational risk, does not write new business, is focused entirely on the back book, and has succeeded in closing out significant legacy risks. The theoretical value of CNHR is disclosed separately in note 1 (b); and
A gradual reduction in the UK corporation tax rate from 28% to 24% over four years was announced in the Emergency Budget of 22 June 2010 with further 1% reductions being announced in each of the Budgets of 23 March 2011 and 21 March 2012. The Finance (No. 2) Act 2010 included the first of the 1% rate reductions with effect from April 2011, a further 1% reduction was substantively enacted on 29 March 2011 under the Provisional Collection of Taxes Act 1968 and a further 1% reduction was included in the Finance Act 2011. Further reductions are to be introduced by future legislation. The 2011 MCEV includes the impact of the tax rate being reduced to 25%. The impact of the further 3% reduction of rate is not expected to be material.
The consultation process is still ongoing in relation to certain aspects of the new rules, and as a consequence of this and the complexity of the proposed changes it has not been possible to estimate their potential future impact on the Group MCEV.
Opal Re is included within covered business and is valued on a basis consistent with the annuity business within the life companies.
Present value of future profits (‘PVFP’) The present value of future profits represents the present value of profits attributable to shareholders arising from the in-force business. The PVFP is calculated by projecting and discounting using risk-free rates, with an allowance for liquidity premiums where appropriate.
This equates to 128% (2010: 119%) of the minimum regulatory capital requirement.
Solvency II will introduce a new capital regime for insurers from the end of 2013. These disclosures do not take account of the impact of the change in regime as this is still under development.
CNHR The CNHR should allow for risks that can have an asymmetric impact on shareholder value to the extent these risks have not already been reflected in the PVFP or TVFOGs. The majority of such risks within the Group are operational and tax risks.
For other business the cost would be £130 million (2010: £137 million). This equates to an equivalent average cost of capital charge of 1.2% (2010: 1.2%). The level of capital assumed in this calculation is determined based on a 99.5% confidence level over a one year time horizon, consistent with the ICA methodology. Allowance is made for diversification benefits between non-hedgeable risks, but not between hedgeable and non-hedgeable risks.
e) New business The MCEV places a value on the profits expected to be earned on annuities arising from policies vesting with guaranteed annuity terms. These policies are excluded from the definition of new business on the basis that the annuity being provided is an obligation under an existing policy and the life companies are already reserving for the cost of these guarantees.
The net worth of covered business of £1,175 million at 31 December 2011 (2010: £1,770 million) consists of £11 million of free surplus in excess of required capital which includes the capital required under the Group’s capital management policy (2010: £670 million). This does not include the IFRS net assets of management services of £82 million (2010: £80 million) as shown in the free surplus reconciliation for Phoenix Life on page 25.
New business value 16 3 19 Expected existing business contribution (reference rate) 102 122 224 Expected existing business contribution (in excess of reference rate) 43 39 82 Transfer from VIF to net worth 145 (145) –
4. New business The value generated by new business written during the period is calculated as the present value of the projected stream of after-tax distributable profits from that business. This contribution has been valued using economic and non-economic assumptions at the point of sale. The value of new business is shown after the effect of frictional costs of holding required capital on the same basis as for the in-force covered business.
The swaps rates above are only applicable to sensitivity (16) as disclosed in note 7.
The liabilities to which a liquidity premium is applied include immediate annuities, pensions policies with benefits defined as an annuity or in-the-money guaranteed annuity options. The liquidity premium is determined by reference to the yield on the bond portfolios held after allowing for credit risk by deducting margins for best estimate defaults and unexpected default risk premiums. The additional yield above risk-free rates implied by the calculated liquidity premium is as follows: Additional yield over risk-free rates 0.90% 0.48%
Inflation For purposes of the MCEV calculation, the rate of increase in the UK Retail Price Index (‘RPI’) as at 31 December 2011 was taken from the implied inflation curve at a term appropriate to the liabilities. The rate of increase in UK National Average Earnings inflation is assumed to be RPI + 100 basis points as at 31 December 2011 (2010: RPI + 100 basis points).
A LIBOR Market Model is used to generate risk-free rates over a complete yield curve, calibrated to the UK nominal spot curve plus 10 basis points, consistent with the deterministic projections. Interest rate volatility is calibrated to swaption implied volatilities, as per the sample below.
Best estimate levels of volatility are assumed for directly held property. The model implied volatility for 2011 is 15% (2010: 15%).
6. Assumptions (continued) Operating earnings The Group uses normalised investment returns in calculating the expected existing business contribution. The Group considers that an average return over the remaining term of our in-force business is more appropriate than using a short-term rate and is more consistent with the Group’s expectation of longer term rates of return. Therefore, the Group calculates the expected contribution on existing business using a 15-year gilt rate at the beginning of the reporting period plus 10 basis points and long-term expectations of excess investment returns.
The table below sets outs the asset risk premiums used: The return assumed on corporate bond portfolios is the redemption yield for the portfolio less an allowance for credit risk.
Valuation of debt and non-controlling interests The Group’s consolidated balance sheet as at 31 December 2011 includes Perpetual Reset Capital Securities with principal outstanding of £425 million (2010: £425 million) and subordinated debt with a face value of £200 million (2010: £200 million). These listed securities have been included within the MCEV at their market value quoted at the reporting date.
The table below summarises the value of these debt obligations: Face value (including accrued interest) £m
Unlisted debt Pearl and Impala facilities 2,471 2,639 Royal London PIK notes and facility 111 106
MCEV supplementary information 7. Sensitivity to assumptions The table below summarises the key sensitivities of the MCEV of covered business at 31 December 2011: 2011 Life MCEV
Jan 11 Dec 11Nov 11Oct 11Sep 11Aug 11Jul 11Jun 11May 11Apr 11Mar 11Feb 11
The voting results for our 2012 AGM, including proxy votes and votes withheld, will be available on the Group’s website shortly after the meeting.
Analysis of shareholders No. of shareholders % No. of shares %
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Details of any share dealing facilities that the Company endorses will be included in Company mailings.
Annual General Meeting 3 May 2012 Announcement of first quarter interim management statement 4 May 2012 Announcement of unaudited six months’ interim results 23 August 2012 Announcement of third quarter interim management statement 31 October 2012
Statements containing the words: ‘believes’, ‘intends’, ‘expects’, ‘plans’, ‘seeks’, ‘targets’, ‘continues’ and ’anticipates’ or other words of similar meaning are forward-looking. Forward-looking statements involve risk and uncertainty because they relate to future events and circumstances that are beyond the Group’s control. For example, certain insurance risk disclosures are dependent on the Group’s choices about assumptions and models, which by their nature are estimates. As such, actual future gains and losses could differ materially from those that we have estimated. Other factors which could cause actual results to differ materially from those estimated by forward-looking statements include but are not limited to: – Domestic and global economic and business conditions
– The policies and actions of governmental and/or regulatory authorities, including, for example, new government initiatives related to the financial crisis and the effect of the European Union’s ‘Solvency II’ requirements on the Group’s capital maintenance requirements
– Risks associated with arrangements with third parties, including joint ventures
The 2011 Annual Report and Accounts has been prepared for the members of the Company and no one else. The Company, its Directors or agents do not accept or assume responsibility to any other person in connection with this document and any such responsibility or liability is expressly disclaimed. Nothing in the 2011 Annual Report and Accounts should be construed as a profit forecast.
ABI Association of British Insurers – A trade association for the UK’s insurance industry ABS Asset Backed Securities – A collateralised security whose value and income payments are derived from a specified pool of underlying assets ACSM Alternative Coupon Satisfaction Mechanism – The process through which the deferred coupon on certain securities is settled AGM Annual General Meeting – a meeting which companies with shareholders are required by law to hold ALM Asset Liability Management – Management of mismatches between assets and liabilities within risk appetite Annuity policy A policy that pays out regular benefit amounts, either immediately and for the remainder of a policyholder’s lifetime (immediate annuity), or deferred to commence at some future date (deferred annuity)
Black-Scholes A mathematical model used to calculate the value of an option BREEAM Building Research Establishment Environmental Assessment Method – a voluntary measurement rating for green buildings that was established in the UK by the Building Research Establishment
CFO Forum A high-level discussion group formed of the Chief Financial Officers of major European listed and non-listed insurance companies. Its aim is to discuss and influence the development of accounting, financial reporting and related regulatory developments in the insurance industry on behalf of its members
EBT Employee Benefit Trust – A trust set up to enable its Trustee to purchase and hold shares to satisfy employee share-based incentive plan awards
EIOPA European Insurers and Occupational Pensions Authority – the Committee is composed of high-level representatives from the insurance and occupational pensions supervisory authorities of European Union member states and is currently consulting with the industry on the technical requirements of Solvency II
EV Embedded Value – The value to equity shareholders of the net assets and expected future profits of a life company
Expense risk The risk of financial or reputational losses arising from unexpected timing or value of expenses incurred
Free surplus The amount of capital held in life companies in excess of that needed to support their minimum regulatory capital requirement, which is the greater of Pillar 1 and Pillar 2 capital requirements, plus the capital required under the Group’s capital management policy
FSA Financial Services Authority – The regulatory authority for the UK financial services industry GAR Guaranteed Annuity Rate – A rate available to certain pension policyholders to acquire an annuity at a contractually guaranteed conversion rate GCO Guaranteed Cash Option – An option through which exercise is accomplished by a payment in cash, rather than by delivering the underlying security GCR Group Capital Resources – In accordance with the UK capital adequacy regime for insurance groups, this is the aggregate of the individual capital resources for each of the regulated related undertakings less the book value of investments by the Group in those capital resources
IGD Insurance Groups Directive – The European Directive setting out the current capital adequacy regime for insurance groups
IGD surplus plus policyholder and certain shareholder capital currently excluded under FSA rules from the calculation of the IGD surplus. The excluded capital relates to the surplus estate of the with-profit funds and other restricted surplus
Inherited estate The assets of the long-term with-profit funds less the realistic reserves for non-profit policies written into the non-profit fund, less asset shares aggregated across the with-profit policies and any additional amounts expected at the valuation date to be paid to in-force policyholders in the future in respect of smoothing costs and guarantees
LSE London Stock Exchange LTICR Long-Term Insurance Capital Requirement – Capital required to be held by life companies for regulatory purposes in respect of investment, expense and insurance risks on a Pillar 1 base LTIP Long-Term Incentive Plan – The part of an executive’s remuneration designed to incentivise long-term value for shareholders through an award of shares with vesting contingent on employment and the satisfaction of stretching performance conditions linked to Group strategy
MG ALFA An asset liability modelling system developed by Milliman that forms the foundation platform for actuarial modelling and is uniquely capable of meeting Solvency II requirements for enhanced stochastic modelling capability
Shareholder debt (including hybrid debt) less Holding Company cash and cash equivalents
Refers to the trading companies within Phoenix Life (which includes Opal Reassurance Limited) and all trading companies within Ignis Asset Management
Persistency risk The risk of financial or reputational losses arising from adverse movements in either surrender rates or persistency rates on policies with guaranteed benefits leading to losses. This includes the risk of greater than expected policyholder option exercise rates giving rise to increased claims costs
Pillar 1 surplus The excess of available capital resources over regulatory capital resource requirements as mandated by the FSA for individual insurance companies
Pillar 2 surplus The excess of available capital resources over capital calculated on an economic basis required to ensure entities can meet their liabilities. It is based on a self-assessment methodology called the ICA (Individual Capital Assessment) which is reviewed by the FSA
Protection policy A policy which provides benefits payable on certain events. The benefits may be a single lump sum or a series of payments and may be payable on death, serious illness or sickness
The total return, over a fixed period, to an investor in terms of both share price growth and dividends (assuming that any dividends paid are re-invested, on the ex-dividend date, in acquiring further shares)
UK GAAP Generally Accepted Accounting Principles adopted within the UK Unit-linked policy A policy where the benefits are determined by the market value of the underlying assets in the unit linked fund VIF The Value of In-Force business – The Present Value of Future Profits (PVFP) plus the Time
With-profit fund A fund where policyholders are entitled to a share of the profits of the fund. Normally, policyholders receive their share of the profits through bonuses, which reflect both the investment return from the assets which premiums are invested in and other profits the fund makes. Also known as a participating fund as shareholders have a participating interest in the with-profit funds and any declared bonuses. Generally, policyholder and shareholder participation in the with-profit funds in the UK is split 90:10
WPICC With-Profit Insurance Capital Component. The WPICC is the amount by which the regulatory surplus exceeds the realistic surplus
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Phoenix Life Aims to deliver innovative financial management and operational excellence