As a closed life fund consolidator, Phoenix Life focuses on the efficient run-off of existing policies, maximising economies of scale and generating capital efficiencies through operational improvements. Ignis Asset Management focuses on delivering strong investment performance and high quality service to its clients.
To stay up-to-date with Phoenix Group news and other changes to our site’s content, you can sign up for e-mail alerts, which will notify you when content is added. To sign up visit
Group MCEV Group IFRS operating profit £690m £2,122m£410m IGD surplus (estimated) PLHL ICA surplus (estimated) Dividend per share
Business and strategy 12 Our business 14 Operating structure 20 Our strategy
Business review 23 Key performance indicators 26 Cash generation 29 Group MCEV
32 Group IFRS operating profit 36 Group assets under management 37 Capital management
Corporate responsibility 85 Corporate responsibility 85 Environment 86 Workplace 87 Community 88 External stakeholders
Governance 48 Board of Directors 52 Our executive management team 53 Corporate governance report 62 Remuneration report 79 Directors’ report
IFRS financial statements 91 Statement of Directors’ responsibilities 92 Independent Auditor’s report 93 Consolidated financial statements 100 Notes to the consolidated financial statements
Risk management 42 Risk management 46 Principal risks and uncertainties facing the Group
MCEV supplementary information 185 Statement of Directors’ responsibilities 186 Independent Auditor’s report 187 MCEV financial statements 191 Notes to the MCEV financial statements
I joined Phoenix as Chairman at an important time for the Group. Since joining, I have been impressed by the depth of knowledge within the Group and I look forward with confidence to the next phase of Phoenix’s development.
The comprehensive fund raising and refinancing package that we announced on 30 January 2013 allows us to reduce our borrowings substantially, extend our debt maturities and increase shareholder dividends. Importantly, the transaction also provides the Group with a longerterm capital structure and puts Phoenix in a stronger position, both financially and strategically.
Millions of individuals have a substantial portion of their savings invested in closed life funds. These funds can face an increasingly uncertain future of escalating administrative costs and diminishing expertise to maintain these policies. Phoenix’s consolidation approach is therefore important to both policyholders and shareholders. As the largest specialist UK consolidator, the Group’s scale and operating platform provide a unique opportunity to realise economies and provide responsive services to policyholders.
I am confident that given our strategy, the quality of our people and our record of performance, we will be able to deliver our longer term aim of being the saver-friendly solution for the safe, innovative and profitable management of closed funds.
I am pleased to report to shareholders that the Board has decided to recommend a final dividend of 26.7p per share, bringing the total dividend for the financial year to 47.7p per share.
Ian Ashken and Charles Clarke have decided not to stand for re-election at the AGM in May 2013. Both Directors have been with the Company since before its July 2010 Premium Listing, Ian Ashken since 2 September 2009 and Charles Clarke since 18 February 2010. Now that the Group has successfully re-termed its bank debt and raised new equity, both Directors believe the time is right for them to stand down. I wish to thank them on behalf of the Board for their significant contributions. As a key recommendation from the November 2012 Board Evaluation Report was to reduce the size of the Board, it is proposed not to replace the outgoing Directors.
Introduction I am delighted with what we have achieved in the last 12 months.
The re-terming of our bank debt follows a successful year of management actions which enabled us to conclude this transaction on the right terms and at the right time on behalf of our stakeholders.
Importantly, in November 2012 we entered into a new agreement with the Trustee of the Pearl Group Staff Pension Scheme. In return for a re-phasing of contributions, the new agreement delivers greater certainty and allows for a lower risk investment strategy. This new agreement improved our PLHL ICA surplus by £0.3 billion and reduced its sensitivity to external market stresses.
We also made significant progress in simplifying the Group’s structure and enhancing our capital strength through further consolidation of life companies within the Group. Since the Group’s Premium Listing in July 2010, the number of UK life companies has been reduced from seven to three.
In June 2012 we entered into an agreement to transfer approximately £5 billion of annuity in-payment liabilities to Guardian Assurance Limited (‘Guardian’). This transaction accelerated the release of capital, improved the Group’s solvency position and reduced our exposure to longevity risk.
We remain focused on our strategy to deliver shareholder value and continue to develop our business model to further improve the financial and operational efficiency of the Group’s underlying businesses. These achievements are particularly pleasing in light of the uncertain market conditions during the first half of 2012.
Despite this uncertainty, Phoenix Life and Ignis Asset Management have provided good customer service and investment returns and we continue to work with our outsource partners to improve our proposition for policyholders.
Group highlights Equity raising and debt re-terming I am pleased that 93% of our existing shareholders took up their open offer entitlement under the equity raising.
This equity raising enabled the re-terming of the Impala debt and allowed the £450 million prepayment on 22 February 2013. Following the re-terming the bullet repayments which were due in 2014, 2015 and 2016, and which had previously posed a refinancing challenge, have been replaced by a single tranche repayable by June 2019, subject to exercising our extension option from December 2017. The mandatory repayments on the Impala debt have been reduced from £125 million per annum to £60 million per annum which improves our resilience during periods of stress.
As a result of this transaction, gearing under our existing methodology reduced from 42% to 37% at 31 December 2012 on a pro forma basis. We are, however, adopting a new gearing calculation which is more closely aligned to market practice.
On this new basis our gearing reduced from 55% to 48% as a result of the transaction. We have also announced a new gearing target of 40% by the end of 2016, in line with our desire to access the debt capital markets prior to the maturity of the new Impala facility.
Delivery of financial targets In 2012, Phoenix Group achieved or exceeded its three financial targets.
To have outperformed the challenging target set at the beginning of the year demonstrates the cash generative strength of our business model. Earlier this year, we also announced an increased long-term cash generation target for the period from 2011 to 2016 of £3.3 billion (previously £3.2 billion).
Group Chief Executive Officer’s report continued 04 Phoenix Group Holdings Annual Report and Accounts 2012
Our capital position Our estimated IGD surplus was £1.4 billion at 31 December 2012 with headroom over our IGD capital policy of £0.6 billion. This compared to an estimated surplus of £1.3 billion at 31 December 2011, representing headroom of £0.4 billion. During 2012 we undertook several management actions to strengthen our IGD position through the simplification of the Group’s structure. The Group expects to realise in excess of £0.2 billion additional IGD benefits when the annuity liabilities are transferred to Guardian though the Part VII transfer expected to take place in the second half of this year.
As a result of the evolving regulatory environment, which is increasingly risk-focused across the industry, the Group undertakes a further group solvency calculation, the ‘PLHL ICA’, calculated for Phoenix Life Holdings Limited (‘PLHL’), the same level at which we perform our IGD calculation. This is an assessment on an economic basis of the capital resources and requirements arising from the obligations and risks which exist outside the life companies. At 31 December 2012, our PLHL ICA surplus was estimated to be £1.0 billion (30 June 2012: £0.4 billion) benefiting by £0.3 billion from the new agreement with the Trustee of the Pearl
Group Staff Pension Scheme, mainly as a result of revisions to the funding basis and investment strategy. The sensitivity of the PLHL ICA surplus to external market stresses is also reduced. The debt re-terming and equity raising reduced the PLHL ICA surplus by £0.2 billion in 2013.
IFRS operating profit Finally, the Group achieved increased IFRS operating profits of £410 million (2011: £387 million) despite life company run-off and the annuity transfer. One-off benefits were generated from modelling and policy harmonisations across the business as part of our ongoing programme of system and modelling improvements. These enhanced Phoenix Life’s operating profit by £117 million.
Phoenix Life highlights Phoenix Life contributed IFRS operating profit of £399 million, compared to £395 million in 2011, reflecting the above-mentioned one-off benefits.
One of the key successes for Phoenix Life during 2012 was the reinsurance of approximately £5 billion of annuity in-payment liabilities to Guardian. This increased the free surplus within the Group’s life companies by £252 million. The reinsurance agreement is expected to be replaced by a formal Part VII transfer of the annuity in-payment liabilities in the second half of 2013.
Ignis’ financials must be seen in the context of major transformation in the Ignis operating platform while building momentum in investment and distribution performance.
Group Chief Executive Officer’s report continued 06 Phoenix Group Holdings Annual Report and Accounts 2012
Ignis’ strength in Liquidity continues, with the Sterling Liquidity Fund’s £14.2 billion assets under management seeing top decile performance in the year. The fund has just received an iMoneyNet Award for the top performing offshore Sterling fund for 2012.
Ignis continues to develop as a manager of third party assets. In 2012, it attracted new third party inflows of £1.6 billion, excluding inflows related to the annuity transfer from Guardian, realigned its distribution capability to better fit its chosen channels and markets, and strengthened its sales teams. Ignis’ continued management of £4.7 billion of assets on behalf of Guardian as part of the annuity transfer by Phoenix Life was a significant win. It reinforced Ignis’ position as one of the largest managers of annuity assets in the UK.
Since the end of 2009, and taking into account the remaining £1.6 billion of assets relating to the annuity transfer transaction, third party assets as a proportion of total Group assets under management has almost doubled to 19%.
We continually aim to improve customer service. In 2012, we migrated 780,000 in-force policies from legacy systems to the BaNCS utility platform with our outsource partner Diligenta. This brings to three million the total number of in-force policies migrated onto BaNCS. This migration will help bring improvements and long-term stability to our customer offering.
Phoenix is able to attract specialist asset management and life fund expertise which sets the Group apart. Low levels of staff turnover and high levels of employee engagement demonstrate the Group’s ability to retain expertise. Phoenix was included on the list of ‘Britain’s Top Employers 2012’.
In embedding Phoenix’s Corporate Responsibility programme, staff have had the opportunity to shape the Group’s approach to the workplace and the communities in which we operate. This has contributed to our engagement survey results comparing very favourably with the Financial Services benchmark.
Economic and industry overview Financial markets in 2012 were uncertain and global economic growth was subdued. I expect the economic uncertainty to continue during 2013. Although Phoenix is not immune to further negative developments in the Eurozone and elsewhere, we have carefully managed our exposure to certain jurisdictions and we are well positioned to react to further changes to help ensure policyholder and shareholder investments are secure.
Group Chief Executive Officer’s report continued 08 Phoenix Group Holdings Annual Report and Accounts 2012
Going forward, we will provide policyholders with comparison tables on annuity pricing which will show the competitive position of our standard annuity rates. For policyholders who may be eligible for non-standard annuity rates we can help them find a specialist annuity provider.
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 within Phoenix, the discipline with which the Group manages risk and capital and the proven resilience of its business model will stand us in good stead going forward.
Further simplified life company structure through consolidation of life companies, enhancing the cash and capital position of the Group
Reached new agreement with Trustee of the Pearl Group Staff Pension Scheme increasing PLHL ICA headroom by £0.3 billion
Ignis achieved net third party sales of £1.6 billion, excluding Guardian inflows
Completed the transfer of Ignis’ back office functions to HSBC Bank plc
Other achievements 10 Phoenix Group Holdings Annual Report and Accounts 201210 Phoenix Group Holdings
“ Our business brings together complementary skills to deliver improved performance for our life company and asset management customers. With a simple mission and a clear strategy we are well positioned to capitalise on opportunities to deliver value as they arise in the future.”
Phoenix Life manages these funds using its skills and expertise in the areas of capital, financial, risk and cost management.
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 UK and international markets.
– The Group functions provide support for, and coordination and delivery of the Group’s strategic objectives and manage our relationships with our external stakeholders, including shareholders, our lenders, our Group pension schemes and the Financial Services Authority (‘FSA’).
We create value from our in-force book of closed life funds, generating profits from participation in investment returns, policyholder charges and management fees earned on assets (to the extent they exceed expenses). These additional profits from the in-force policies can also be released by the Group’s life companies as free surplus in the form of cash.
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.
Group functions At Group level, Phoenix operates centralised functions that provide Group-wide and corporate-level services and manage corporate activity. These operations include Group Finance, Treasury, Group Tax, Group Actuarial, Group Risk, Legal Services, HR, Corporate Communications, Strategy and Corporate Development, Investor Relations, Company Secretariat and Internal Audit.
Manage capital Phoenix Life continually manages the capital requirements of the Group’s life companies, ensuring that policyholder security is protected whilst maximising the release of capital as cash to the Group’s Holding Companies. We combine sophisticated asset liability matching techniques with a prudent approach to risk management to ensure the Group’s life companies are capital efficient.
The Group has continued its programme of activity to further consolidate its life companies in order to optimise capital allocation and economies of scale. During 2012, the business of NPI Limited was transferred into Phoenix Life Limited and the business of London Life Limited was transferred to Pearl Assurance Limited. The enlarged Pearl Assurance Limited was renamed Phoenix Life Assurance Limited following completion of the business transfer.
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 appropriate risk adjusted returns are held within life funds, taking into account any policyholder guarantees.
Although the life companies are closed and generally do not write new business, they do accept additional policyholder contributions on in-force policies and allow certain policies, such as pension savings plans, to be reinvested at maturity into annuities. The Group has a strong and steady stream of internal annuities vesting at a very low cost, and is therefore able to offer its policyholders competitive annuity rates. In 2012, £1.0 billion of vesting annuities were retained within the Group of which £0.5 billion related to policies with guaranteed annuity rates.
Management services The Group’s management services companies are charged with the efficient provision of financial and risk management services, sourcing strategies and delivering all 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.
As the number of policies held by the Group gradually declines over time, the fixed cost base of our operations as a proportion of policies will increase. Our management services team manages this risk by putting in place long-term arrangements for third party policy administration. By paying a fixed price per policy to our outsource partners we reduce the fixed cost element of our operations.
The Phoenix Way aims to provide a consistent approach to managing each Group life company which, given their different histories, have previously all adopted different methodologies.
The Phoenix Way covers areas such as operational management, outsourcing, investment management, restructuring and risk management. Examples include establishing a standardised with-profit ‘model fund’, consolidating outsourcing arrangements, and developing standard systems for actuarial modelling as part of our AST project.
The Group has grown through the acquisition of a number of closed life businesses, resulting in a corporate structure in Phoenix Life which is sub optimal. To address this, Phoenix Life has been running a programme to reduce the number of life companies and to ensure those remaining are run in a similar manner. Such rationalisation is done through the ‘Funds Merger programme’ and is carried out under Part VII of the Financial Services and Markets Act.
During 2012, two fund transfers were completed under which all of the long-term business of NPI Limited and London Life Limited was transferred to Phoenix Life Limited and Phoenix Life Assurance Limited (previously Pearl Assurance Limited) respectively.
Ignis’ vision is to become a leading asset management business committed to performance excellence and innovation where talented people want to work and most importantly, where clients want to invest their money.
A partnership culture that ensures clear accountability and supports both the work within Ignis and with Ignis’ clients and counterparties
Stability that comes from a strong governance and control culture, and being part of the Phoenix Group.
The formal transfer of back office and operational functions to HSBC Bank plc, was achieved in May 2012. The majority of transferred roles went to a newly created HSBC unit in Glasgow offering services including statutory reporting, tax, technology and performance measurement. This allows Ignis to focus on the key areas of investment and distribution and provides the Group with a more predictable and lower cost operating model.
Another key landmark was reached in the continuing strategy of the business when Ignis announced its intention to, in due course, sell its stake in the last of the joint ventures, Cartesian, paving the way for it to transition to a standalone business. This followed the establishment of Hexam and Argonaut as independent business partners and the transfer of people and responsibilities to Castle Hill. Transition away from the joint ventures model enables Ignis to focus on its core activities.
Ignis’ ability to transform its operational platform whilst continuing to deliver good investment performance and attract net new third party assets – all under challenging market conditions – is a testament to its strengths as a business.
Investment strategy in this product space has recently focused upon the development of a range of absolute return funds. These draw upon Ignis’ modelling tools created to meet the needs of Phoenix Life and its policyholders, and developed for third party investors.
ARGBF was developed internally and run as a paper portfolio by Ignis Fixed Income, before being launched with seeding from Phoenix Group shareholder funds.
Planned for 2013 is the launch of a hedge fund modelled on ARGBF. Ignis will also apply this approach to market its absolute return emerging market debt fund, which has delivered positive investment performance for Phoenix policyholders since its inception in 2011.
Areas of strategic focus Manage capital Risk management is a key component of the Group’s strategic agenda. The effective management of our risks and the efficient allocation of capital against them are critical in allowing us to achieve our strategic and operational objectives. This includes ensuring there are robust capital policies within the life companies.
Improve customer outcomes We have three key areas of focus in relation to our customers: Value – we aim to optimise customer outcomes
Developing the platform for growth During 2012, 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.
Full year cash generation target of £650 million – £750 million in 2013 and a cumulative cash flow target for 2011 to 2016 of £3.5 billion Reduce gearing to 40% by end-2016 Achieve cumulative target of £400 million of MCEV enhancing management actions between 2011 and 2014
Reduce gearing to 43% or below (under the Group’s existing methodology)
In January 2013, we announced a comprehensive refinancing transaction which included a £250 million equity raising and a £450 million debt prepayment and re-terming of the Impala facility to June 2019. This refinancing reduces our gearing, on a pro forma basis as at 31 December 2012, to 48% under our new gearing methodology
Reached new agreement with Trustee of the Pearl Group Staff Pension Scheme which increased PLHL ICA headroom by £0.3 billion and reduced its sensitivity to external market stresses
Progress further funds mergers Completed the transfers of the long-term business of NPI Limited to Phoenix Life Limited, and London Life Limited to Pearl Assurance Limited. Renamed Pearl Assurance Limited as Phoenix Life Assurance Limited enabling all Phoenix Life policyholders to be brought into the Phoenix brand
Significant progress made in preparations for regulatory change and development of the Actuarial Systems Transformation programme
Agreed £5 billion annuity transfer to Guardian accelerating release of capital and reducing longevity risk exposure Made considerable progress in strategy to exit from residual, non-core general insurance business
Gained new third party business inflows of £1.6 billion, excluding Guardian inflows Realigned distribution capability; strengthened sales teams; added Global Accounts; and Absolute Return Credit (‘ARC’) fund launch
In this section 23 Key performance indicators 26 Cash generation 29 Group MCEV
Key performance indicators 2012 £410m £387m £373m 2012 £690m £810m £734m £2,118m £2,104m
Maintaining strong cash flow delivery underpins debt servicing and repayment as well as shareholder dividends: Analysis Continued strong cash generation of £690 million by the Group’s operating companies enabled the Group to achieve the upper end of its 2012 target for cash generation of £600 million to £700 million.
The Board considers that MCEV provides the most relevant and consistent means of assessing the Group’s ability to increase value: Analysis MCEV remained stable in the period as value enhancing management actions delivered an incremental uplift to MCEV of £167 million against an average target of £100 million per annum, offset by the recognition of actuarial losses as the Pearl Group Staff Pension Scheme moved to an IFRS deficit, and the payment of the shareholder dividend.
Definition and calculation The basis of calculation of Group MCEV is set out in note 1 of the MCEV supplementary information.
Quantified target The Group’s target is an average contribution to embedded value from management actions of £100 million per annum between 2011 and 2014.
Analysis Group IFRS operating profit has increased to £410 million (2011: £387 million) despite the natural life company run-off and the annuity transfer transaction, primarily due to one-off benefits generated from ongoing system and modelling improvements of £117 million (2011: £72 million).
Insurance Groups’ Directive (‘IGD’) surplus is the Pillar 1 regulatory assessment of capital adequacy on a Group-wide basis: Analysis The estimated IGD surplus has increased to £1.4 billion with capital generation items of £0.6 billion offsetting the recognition of the IFRS deficit on the Pearl Group Staff Pension scheme of £0.2 billion and the payment of dividends, debt interest and debt repayments of £0.3 billion. The surplus of £1.4 billion represents headroom of £0.6 billion (2011: £0.4 billion) over the Group’s IGD capital policy.
Definition and calculation The IGD surplus is a regulatory capital measure which calculates surplus capital at the level of the ultimate insurance parent undertaking within the EEA, which is Phoenix Life Holdings Limited (‘PLHL’). IGD surplus is defined as group capital resources less the group capital resource requirement.
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 a gross MCEV basis: Analysis The Group has revised its definition of gearing during the period in order to adopt a calculation that is more consistent with the gearing calculations typically used by credit rating agencies.
Gearing ratio – new methodology 1 Gross shareholder debt is defined as the sum of the IFRS carrying value of shareholder debt and 50% of the IFRS carrying value of the Tier 1 Notes given the hybrid nature of that instrument.
Cash generation The Group’s cash flows are generated from the interest earned on capital, the release of excess capital as the life funds run-off, policyholder charges and fees earned on assets under management. The Group’s closed life funds provide predictable fund maturity and liability profiles, creating stable long-term cash flows for distribution to shareholders and for repayment of outstanding debt. Although investment returns are less predictable, some of the investment risk is borne by policyholders.
In 2012, the Group has delivered cash flows from its operating subsidiaries of £690 million, including cash flows of £209 million from management actions. The latter increased cash flows primarily through a reduction in the Group’s capital requirements as a result of fund merger activities, benefits delivered from modelling improvement exercises and other investment and operational derisking initiatives.
Pension scheme contributions of £50 million (2011: £35 million) increased as the Group Holding Companies are now bearing the entire cash cost of funding the Group’s two pension schemes. In prior periods, Phoenix Life funded a proportion of the contributions made to the PGL Pension scheme.
The shareholder dividend of £73 million comprises the payment of the 2011 final and 2012 interim dividend.
Future cash flows: Emergence of surplus 1.1 Release of capital 0.8 Recurring cash receipts generated by life companies 1.9 Other1 0.1 Total future cash flows target 2.0 Achieved cash flows 1.5 Operating companies’ cash generation target 3.5 1 Includes cash flows from Ignis and the management services companies.
Base case 6-year target 3.5 20% fall in equity markets 3.4 15% fall in property values 3.4 75bps increase in yields1 3.5 Credit spreads widening with no change in expected defaults2 3.3 1 Represents a real yield reduction of 25bps, given a 75bps parallel increase in nominal yields.
2 10 year term: AAA – 46bps, AA – 77bps, A – 99bps, BBB – 140bps.
MCEV operating earnings after tax were lower at £307 million (2011 restated: £417 million) primarily due to a reduction in the long-term risk free rate and the nonrecurrence of significant experience variances in 2011.
2 Life MCEV operating earnings are derived on an after tax basis. For presentational purposes Life MCEV operating earnings before tax have been calculated by grossing up the after tax Life MCEV operating earnings. Life MCEV operating earnings before tax of £360 million (2011: £556 million) are therefore calculated as £272 million operating earnings (2011: £409 million) grossed up for tax at 24.5% (2011: 26.5%).
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 2012 of £184 million after tax is £70 million lower than in 2011, primarily due to a decrease in the longterm 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.
New business value New business profits generated from vesting annuities during 2012 were £20 million after tax (2011: £13 million).
The new business margin is 5% after tax (2011: 5%) and represents the ratio of the net of tax new business value to the amounts received as new single premiums.
Experience variances of £13 million (2011: £181 million) principally reflect better than expected longevity experience during the year. Experience variances in 2011 included the benefits of improved asset allocations (£96 million), data cleansing projects (£30 million) and the resolution of legacy tax issues (£20 million).
During 2012, the Group amended its MCEV accounting policy for recognising contributions to pension schemes in an IFRS surplus position. Prior to 2012, these contributions were recognised in Group costs. These contributions are now recognised in other comprehensive income along with actuarial gains and losses on schemes that are in an IFRS deficit, such that these non-operating items are treated consistently.
The 2011 comparatives have been restated in this regard, increasing 2011 Group MCEV operating earnings after tax by £23 million, and reducing other comprehensive income by the same amount. There is no net impact on the MCEV.
Reconciliation of Group MCEV operating earnings to Group MCEV earnings Group MCEV operating earnings are reconciled to Group MCEV earnings, as follows: Year ended
Group MCEV operating earnings after tax 307 417 Economic variances on life business 24 (426) Economic variances on non-life business (6) 38 Other non-operating variances on life business 39 (12) Non-recurring items on non-life business (39) (9) Finance costs attributable to owners (123) (123) Tax on non-operating earnings – 169 Group MCEV earnings after tax 202 54
Economic variances on non-life business Economic variances on non-life business are £6 million negative (2011: £38 million positive), reflecting the increased market value of the Tier 1 bonds which has decreased MCEV earnings by £28 million before tax (2011: increase of £48 million before tax). This has been partly offset by fair value gains on interest rate swaps and excess returns on financial assets held by the Holding Companies.
Finance costs attributable to owners 123 123 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.
Capital and dividend flows (67) (49) Group MCEV at 31 December 2,122 2,118
Capital and dividend flows in 2012 mainly comprise external dividend cash payments of £73 million (2011: £55 million).
Group IFRS operating profit The Group has generated an IFRS operating profit of £410 million (2011: £387 million).
Phoenix Life 399 395 Ignis Asset Management 43 46 Group costs (32) (54) Operating profit before tax1 410 387 1 Operating profit is presented before adjusting items.
Operating profit includes the effect of variances in experience for non-economic items, such as mortality and expenses, and the effect of changes in noneconomic 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 owners’ one-ninth share of the policyholder with-profit bonus of £75 million increased by £6 million on the 2011 result, primarily due to higher terminal bonuses following an increase in maturities, and improved bonus rates in certain funds.
The operating profit on non-profit and unitlinked funds was £288 million (2011: £206 million. This includes margin emergence of £133 million (2011: £162 million), return on surplus assets of £1 million (2011: £10 million), new business from vesting annuities of £40 million (2011: £27 million) and positive longevity experience of £19 million. Modelling improvements and policy harmonisations have had a net positive impact of £117 million in 2012 (2011: £33m). The net impact of demographic assumption changes is broadly neutral for the period, whereas the 2011 result was impacted by negative assumption changes of £29 million.
The operating profit for the management services companies of £28 million (2011: £17 million) comprises income from the life companies in accordance with the respective management service agreements less fees payable in relation to the outsourcing of services and other operating costs. The increase compared to the prior year reflects reduced outsourcer costs and the positive impacts of cost reduction activities.
Group costs Group costs were £32 million in the period of which costs relating to Group functions amounted to £29 million before tax (2011: £39 million) reflecting an increased focus on cost management. The balance of the charge in both periods relates primarily to IAS 19 pension scheme costs (which have reduced compared to the prior year as a result of a lower net interest cost), partly offset by miscellaneous income.
IFRS result after tax The IFRS operating result is reconciled to the IFRS result after tax, as follows: Year ended 2012 £m
Investment return variances and economic assumption changes on long-term business Overall, the Phoenix Life business had positive investment return variances and economic assumption changes of £1 million in 2012 (2011: £338 million negative). The positive impact of narrowing credit spreads in the period was largely offset by the impacts of falling yields on short asset positions against the IFRS basis liabilities, negative property returns and fair value losses on equity hedging positions held by certain life funds on an economic basis.
The acquired in-force business is being amortised in line with the run-off of the acquired businesses. Amortisation of acquired in-force business during the period totalled £109 million (2011: £121 million). Amortisation of other intangible assets totalled £18 million in the period (2011: £18 million).
Debt finance costs1 97 96 Other finance costs 14 14 Finance costs attributable to owners 111 110 1 Finance costs in respect of the Impala and Pearl facility agreements (and associated swap interest) and the Royal London PIK notes and facility.
The Group tax credit for the period attributable to owners is £119 million (2011: £79 million) based on a profit before tax attributable to owners of £290 million. The difference between the actual credit of £119 million and the expected charge (based on the UK corporation tax rate of 24.5%) of £71 million is primarily driven by the valuation of previously unrecognised tax losses of £85 million, a £36 million benefit as a result of the ongoing reductions in UK corporate tax rates, and £64 million due to certain profits being non-taxable or taxed at a rate of less than 24.5%.
Group assets under management represents 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.
Life company assets of £5.1 billion were transferred to Guardian under the terms of the Group’s annuity transfer transaction undertaken in the period. Guardian has selected Ignis Asset Management to manage £4.7 billion of these assets (£0.4 billion will be managed by Castle Hill Asset Management LLC), with the total amount to be arranged as a series of mandates to be individually agreed with Guardian. As at 31 December 2012, £3.1 billion of these assets have been recaptured. The remaining assets of £1.6 billion are temporarily with a third party manager and are expected to transfer to Ignis during 2013, with the timing dependent on finalising the investment strategies and external factors such as the liquidity of the underlying assets.
Net inflows from third parties, excluding Guardian, were £1.6 billion in the period (2011: £1.7 billion) with positive inflows across all sales channels. Net inflows in the comparative period included £0.4 billion from a new rates liability driven investment mandate from a Group pension scheme.
Oversight and advice 7.0 – 7.0 – 7.0 Administration – – – – –
1 The agreement with Castle Hill Asset Management LLC was renegotiated in October 2012 following which £1.1 billion of life companies’ assets are no longer managed by Ignis.
– Ensure sufficient liquidity to meet obligations to policyholders and other creditors
Regulatory capital requirements IGD surplus (estimated) Each UK life company must maintain sufficient capital at all times to meet the regulatory capital requirements mandated by the FSA1. These measures are aggregated under the European Union Insurance Groups’ Directive (‘IGD’) as implemented by the FSA, to calculate regulatory capital adequacy at a Group level.
The Group’s IGD assessment is made at the level of the ultimate insurance parent undertaking within the EEA, which is PLHL. The estimated IGD surplus at 31 December 2012 is £1.4 billion (2011: £1.3 billion). The components of the estimated IGD calculation are shown below: December 2012 £bn
Group capital resources (‘GCR’) 5.6 5.6 Group capital resource requirement (‘GCRR’) (4.2) (4.3) IGD surplus (estimated) 1.4 1.3
The key drivers of the change in solvency position in the year are: – Capital generation items of £0.6 billion, which included the benefits of the transfer of the NPI Limited business into Phoenix Life Limited (‘PLL’) (effective from 1 January 2012) and the transfer of the London Life Limited business into Phoenix Life Assurance Limited (‘PLAL’) offset by
The Group’s capital policy, which is agreed with the FSA, is to maintain GCR at the PLHL level of: – 105% of the with-profit insurance component (‘WPICC’), being an additional capital requirement of withprofit funds plus
Had the capital raising and £450 million debt prepayment of the Impala facility (which occurred in February 2013) taken place on 31 December 2012, the Group’s IGD surplus and headroom over Group capital policy would have reduced by £0.2 billion.
Phoenix Life Pillar 1 capital The largest components of the GCR and GCRR of the Group’s IGD position are the Pillar 1 capital resources1 and the individual capital resource requirements of Phoenix Life respectively. Both are adjusted to take account of specific rules pertaining to the IGD calculation. For example, due to the Group’s current structure certain of the Group’s subsidiaries are only included in the IGD calculation at 75% of their regulatory value.
The key drivers of the increase in the PLHL ICA surplus in the second half of the year include: – The agreement reached with the Trustee of the Pearl Group Staff Pension Scheme with regard to a framework for contributions to the scheme and a revised investment strategy which resulted in a £0.3 billion increase in the ICA surplus
1 Further details of the Pillar 1 capital resources of the individual life companies are included within note 41 of the IFRS financial statements.
Had the capital raising and £450 million debt prepayment of the Impala facility (which occurred in February 2013) taken place on 31 December 2012, the Group’s ICA surplus would have reduced by £0.2 billion.
Following a 20% fall in equity markets 1.4 0.9 Following a 15% fall in property values 1.4 0.9 Following a 75bps parallel increase in yields 1.3 1.0 Following a 75bps parallel decrease in yields1 1.5 0.9 Following credit spread widening2 1.5 0.8 1 Represents a real yield reduction of 25bps, given a 75bps parallel decrease in nominal yields.
Capital resources The primary sources of capital used by the Group comprise equity shareholder funds as measured on an MCEV basis, the Tier 1 Notes and shareholder borrowings.
The Group has gross shareholder debt of £2,741 million (2011: £2,898 million). The gearing ratio4 under the Group’s revised methodology is 55% (2011: 57%).
Shareholder debt (including hybrid debt) at 31 December 2012: December £m
Further detail on shareholder debt is included in note 21 to the IFRS financial statements.
In February 2013, following a successful equity raising of £250 million, the Group made a £450 million prepayment against the Impala facility and entered into an agreement with the Impala lenders to extend the repayment terms to 2019 (the facility was previously scheduled to mature in the period from 2014 to 2016).
Liquidity management Details of the Group’s objectives and policies for the management of liquidity risk are included within the Risk management section and note 42 of the IFRS financial statements.
42 Risk management 46 Principal risks and uncertainties facing the Group
The risk appetite framework supports the Group in operating within the boundaries of these statements by seeking to limit the volatility of key parameters, defined with respect to the above statements, under a range of adverse scenarios agreed with the Board. Risk appetite limits are chosen which specify the maximum acceptable likelihood for breaching the agreed limits and assessment against the appetite targets is undertaken through scenario testing. Breaches of appetite are corrected through management actions where appropriate.
Second line: risk oversight is provided by the Group Risk function and business unit risk and compliance functions and the Board Risk Committee, which is responsible for the oversight of risk across the Group. The Board Risk Committee comprises five Non-Executive Directors, three of whom are independent. It is supported by the Chief Risk Officer and met seven times during the year.
Third line: independent verification of the adequacy and effectiveness of the internal controls and risk management is provided by the Board Audit Committee, which is supported by the Group Internal Audit function.
Risk organisation The Chief Risk Officer manages the Group Risk function and has responsibility for the implementation and oversight of the Group’s RMF. The Group Risk function has responsibility for oversight of financial and operational risk, risk governance, FSA relationship management and regulatory risk. Risk review functions across the Group manage the RMF in line with the Group’s established standards. The risk functions ensure that business unit risk committees are provided with meaningful risk reports and that there is appropriate information to assess and aggregate risks.
Risk and capital assessment The Group operates a standardised assessment framework for the identification and assessment of the different types of risk to which 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.
Management information Overall monitoring and reporting against the risk universe is undertaken through business unit management committees through to the relevant business unit executive committee and reported to the Executive Committee, PLHL Board, the Board Risk Committee and the Board via regular risk reporting.
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 has ongoing principal repayment and interest obligations to its lending syndicates. In the event that transfers from the Group’s insurance and investment management subsidiaries are limited by any law, regulatory action or change in established approach, this may impair the Group’s ability to service these obligations. The implementation of directives and other legislative changes such as the ICA+ regime and eventually Solvency II could have this effect and may therefore have a material adverse effect on the Group’s results, financial condition and cash flows.
The Group regularly monitors its counterparty exposure and has specific limits relating to counterparty credit rating. Where possible, exposures are diversified through the use of a range of counterparty providers. All reinsurance and derivative positions are appropriately collateralised and guaranteed.
The Group has announced a gearing target of 40% by the end of 2016. At this lower level of gearing, a wider range of funding opportunities such as the debt capital markets will become available to the Group.
48 Board of Directors 52 Our executive management team 53 Corporate governance report 62 Remuneration report 79 Directors’ report
Howard Davies was appointed Chairman of the Board of Directors of the Company on 1 October 2012. Howard is the Chair of the British Government’s Airport Policy Review. He also is a Professor of Practice at the French School of Political Science in Paris (Sciences Po). He was previously a Director of the London School of Economics and Political Science from 2003 until May 2011. Prior to this appointment he was Chairman of the UK Financial Services Authority from 1997 to 2003. From 1995 to 1997 he was Deputy Governor of the Bank of England, after three years as the Director General of the Confederation of British Industry. Earlier in his career he worked in the Foreign and Commonwealth Office, the Treasury, McKinsey and Co. and as Controller of the Audit Commission. He has been an independent Director of Morgan Stanley Inc. since 2004, and chairs the Risk Committee. He also chairs the Risk Committee at Prudential plc, whose board he joined in 2010. He is a member of the Regulatory and Compliance Advisory Board of Millennium Management LLC, a New Yorkbased hedge fund. He has also been a member of the International Advisory Council of the China Banking Regulatory Commission since 2003 and, from 2012, is Chairman of the International Advisory Council of the China Securities Regulatory Commission. He is Chairman of the Board Nomination Committee.
Ian Ashken is Vice Chairman and Chief Financial Officer of Jarden Corporation, a NYSE listed Fortune 500 US diversified consumer products company. Mr Ashken has had extensive public company experience over the last 20 years, including as Chief Financial Officer of Benson Eyecare Corporation, Lumen Technologies and Bollé Inc. Mr Ashken is a Principal and Executive Officer of a number of private investment entities. He was appointed to the Board of Directors of the Company on 2 September 2009.
René-Pierre Azria is Chief Executive Officer of Tegris Advisors LLC, a US private advisory firm specialising in strategic financial analysis and mergers and acquisitions. Prior to founding Tegris, Mr Azria was a worldwide partner with Rothschild & Co. Before joining Rothschild in 1996, Mr Azria served as Managing Director of Blackstone Indosuez and President of Financiére Indosuez Inc. in New York. Mr Azria serves as a Director of two privately-held book publishers in France and the US. Mr Azria was appointed to the Board of Directors of the Company on 2 September 2009. He is a member of the Board Investment and Board Risk Committees.
David Barnes joined the RBS Group (then Williams & Glyn’s Bank) in 1973 and remained there in various roles until his early retirement in February 2009. His roles included Relationship Banker in the then newly established Corporate Division, Managing Director of the Financial Institutions Relationship Management team and member and subsequently Chairman of RBS’s Credit Committee. From 2005 he was responsible for all lending to financial institutions and for capital management for RBS’s Financial Institutions Group. Mr Barnes was appointed to the Board of Directors of the Company on 2 September 2009. He is a member of the Board Audit and Board Remuneration Committees.
Isabel Hudson is a former Executive Director of Prudential Assurance Company Limited. She was also Chief Financial Officer at Eureko BV. Ms Hudson is Non-Executive Chair of the National House Building Council and a Non-Executive Director of QBE Insurance, MGM Advantage and The Pensions Regulator. Ms Hudson is an ambassador to Scope, a UK charity, and has 31 years’ experience in the insurance industry in the UK and mainland Europe. She was appointed to the Board of Directors of the Company on 18 February 2010. She is a member of the Board Risk and Board Remuneration Committees.
Hugh Osmond founded Punch Group and served as its Executive Chairman between 1997 and 2001, during which time he built Punch Group into one of the UK’s largest pub companies. He previously co-led the acquisition and market listing of Pizza Express in 1993 and helped build it into the UK’s largest sit-down restaurant chain. He has also been a major investor in, and director of, many public and private companies across a wide variety of industries. He is a director and a shareholder of Sun Capital Partners Limited, formed in 2001, that specialises in identifying and advising on investment opportunities. Mr Osmond served on the Board of Directors of the former Pearl Group Limited from December 2004 until September 2009. He was appointed to the Board of Directors of the Company on 2 September 2009 and is a member of the Board Investment and Board Risk Committees.
– Leads and directs the Group’s businesses in delivery of the Group strategy and business plan
– Embeds a risk-conscious Group culture which recognises policyholder obligations in terms of service and security
Jim McConville Group Finance Director – Develops and delivers the Group’s financial business plan in line with strategy
– Ensures optimisation of outcomes for customers in terms of both value and security
– Ensures Phoenix Life deploys capital efficiently and effectively, with due regard to regulatory requirements and the risk universe and strategy.
– Ensures Ignis achieves its key goals of meeting or exceeding investment performance expectations, providing clients with creative solutions to changing product needs and maintaining a well controlled and efficient operating platform
– Ensures Ignis’ chosen foundations of innovative people, a partnership culture, suitable processes and technology and stability are in place to support these plans.
Jane MacLeod General Counsel – Leads provision of legal advice to the Group
– Oversees and co-ordinates adherence to appropriate corporate governance procedures across the Group
– Supports the Board Risk Committee in the oversight of the Group’s risk framework, in line with risk strategy and appetite.
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 2012 to 31 December 2012.
The following table shows the trajectory of corporate governance steps taken by the Board since the London Premium Listing in 2010.
Held the Company’s first Annual General Meeting (‘AGM’) at which all 22 resolutions were passed by a majority of at least 87% of votes cast
Undertook a successful AGM at which all 24 resolutions were passed by a majority of at least 96% of votes cast
Undertook a successful AGM at which all 21 resolutions were passed by a majority of at least 97% of votes cast
Established Audit, Nomination, Remuneration and Risk Committees, all consisting of Non-Executive Directors and in compliance with Combined Code requirements
Established an Investment Committee in response to the Board evaluation undertaken at the end of 2010
Undertook an internally-facilitated Board, Board Committee and individual Director evaluation led by the new Chairman
Enhanced the Board education programme in response to the Board evaluation undertaken at the end of 2010, in particular to include site visits to operational business units and presentations from management in those units
Published a Chairman’s statement on ‘Women on Boards’ in accordance with the Lord Davies Review
The remuneration of the Directors is shown in the Remuneration report on pages 62 to 78. The terms and conditions of appointment of Non-Executive Directors are on the Group’s website. In accordance with the provisions of the Company’s Articles of Association and the Code, all Directors (other than Ian Ashken and Charles Clarke who are standing down from the Board, as indicated in the Chairman’s statement) will submit themselves for election or re-election at the Company’s AGM on 2 May 2013.
The Board is responsible to the shareholders for the overall governance and performance of the Group. Overall, the Board’s role is to provide entrepreneurial leadership within a framework of prudent and effective controls which enables risk to be assessed and managed. The Board has a schedule of matters reserved for its consideration and approval supported by a set of operating principles. These matters include: – Group strategy and business plans
Board effectiveness In accordance with the Code, an evaluation of the performance of the Board and that of its Committees and individual Directors was undertaken in the latter part of 2012. The process involved completion by Directors of a questionnaire covering various aspects of Board and Director effectiveness followed by individual meetings between the Chairman and each Director, concluding in a Board report which was discussed by the Board in November 2012. The process and report focused on key aspects raised in the 2011 externally facilitated report and any other factors raised by Directors before or during the process. The following areas were covered: – Board structure and composition
– Individual Director performance which will be used in revising the training programme for Directors
An action list, with senior executive accountability, has been established to address the recommendations from the evaluation.
All Directors receive a tailored induction on joining the Board in accordance with a process approved by the Board. To ensure that the Directors maintain up-to-date skills and knowledge of the Company, all Directors receive regular presentations on different aspects of the Company’s business and on financial, legal and regulatory issues.
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 eight times during 2012 and is scheduled to meet seven times in 2013 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 2012.
1 Howard Davies was appointed to the Board on 1 October 2012.
2 Ron Sandler resigned from the Board on 30 September 2012.
The composition of the Committee is in accordance with the requirements of the Code that the Audit Committee should consist of at least three independent non-executive directors of whom at least one has recent and relevant financial experience. The Audit Committee met six times during 2012.
– Approved the Group Internal Audit Charter and the Group Internal Audit Plan (including its link to the Risk Management Framework), receiving regular reports to monitor progress against the plan
– Reviewed the annual internal controls effectiveness report (and the half-year interim update) prior to its consideration by the Board
The composition of the Nomination Committee is in accordance with the requirements of the Code that a majority of its members should be independent non-executive directors. The Nomination Committee is responsible for considering the size, composition and balance of the Board; the retirement and appointment of Directors; succession planning for the Board and senior management; and making recommendations to the Board on these matters. The Nomination Committee met three times in 2012. Alastair Lyons, Senior Independent Director, chaired the Committee (in compliance with the UK Corporate Governance Code) when it considered the appointment of the Chairman.
Nomination Committee’s principal activities during 2012 – Delivery of recommendations to the Board in connection with the appointments of the Chairman of the Board of
Directors of the Company and the Group Finance Director. The outcome was the appointment of Howard Davies (as Chairman from 1 October 2012) and of Jim McConville (as Finance Director from 28 June 2012). Alastair Lyons, Senior Independent Director led the process for the appointment of the Chairman and chaired the Committee during its consideration of this matter. The Committee also consulted Mr Lyons, as Chairman of the Audit Committee, in its consideration of the Group Finance Director appointment
– Review of the balance of skills, knowledge and experience of the Board, taking account of the Board Evaluation Report
– Review of the structure, size and composition of the Board, taking account of the Board Evaluation Report, noting the conclusion that the Board was too big and recommending that its size should be reduced with effect from the 2013 AGM
– Review of the non-executive directors of the Phoenix Life subsidiary Boards, in conjunction with the Chairman of the Phoenix Life Boards, prior to their re-appointment
– Assessment of Board succession planning with the agreement that a staggered programme of re-election of Directors should be implemented following the 2013 AGM when it was expected that Board numbers would reduce.
The Remuneration Committee is aware that there may be proposals in 2013 to change the remuneration sections of the UK Corporate Governance Code which the Company will keep under review.
Risk Committee David Woods, Chairman René Pierre Azria Tom Cross Brown Isabel Hudson Hugh Osmond
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’. The Risk Committee met seven times in 2012.
Risk Committee’s principal activities during 2012 – Recommending to the Board the Group’s risk appetite
– Monitoring of compliance with the Group’s principal risk policies and satisfying itself that action plans to address significant breaches of those policies are sufficient
– Oversight of, and challenge to, the design and execution of the Group’s stress and scenario testing, including any changes of assumptions.
Investment Committee Tom Cross Brown, Chairman René Pierre Azria Charles Clarke Manjit Dale Hugh Osmond
The Company’s Investor Relations department is dedicated to facilitating communication with investors and analysts and an active investor relations programme is maintained. The Company continued its communication and engagement with the investment community during 2012. The Chairman, Senior Independent Director and Executive Directors are available to meet investors and analysts when required. At these meetings a wide range of relevant issues including strategy, performance, management and governance are discussed. Should major shareholders wish to meet newly appointed Directors, or any of the Directors generally, they are welcome to do so.
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, Business review and Risk management sections on pages 11 to 21, 22 to 40 and 41 to 46 respectively.
The financial position of the Group, its cash flows and liquidity position are described in the IFRS financial statements and notes.
The Board’s going concern assessment is included within the Directors’ report on page 81.
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 2012, in accordance with the ‘Internal Control: Guidance to Directors’ published by the Financial Reporting Council.
Phoenix Group – Directors’ Remuneration report For the year ended 31 December 2012
No increases in basic salary have been awarded to the Directors for either 2012 or 2013.
The main elements of the Executive Directors’ reward, which are set out in more detail in the report which follows, are: – Base salary levels that are appropriate for the size and complexity of the business, given relevant market data
– Annual incentive maximum potential at 150% of base salary with 20% of potential based on personal and strategic measures and 80% of potential based on operating earnings, embedded value, cash generation and expense management targets with one-third of any incentive deferred into shares for three years. For 2013 onwards, two non-financial measures (customer satisfaction and employee engagement) will be added to create a more balanced scorecard of measures
– Consistent with best practice, a claw-back provision operates which permits the Committee to seek claw-back in appropriate cases. For 2013, the provisions have been amended to ensure they permit claw-back in a broader range of circumstances, including when reputational risk issues come to light
2012 represented a strong overall year for the Group with cash generation of £690 million at the upper end of the target announced to the market of £600 million to £700 million and embedded value up 4% before the dividend, and during the year. This resulted in an overall AIP award for the two Executive Directors of 69.14% of their potential in accordance with the rules.
The Committee considers that the current arrangements are appropriate to the Group and its commercial situation and reflect UK best practice. I encourage shareholders to support the arrangements.
Unaudited information Remuneration Committee The Group established the Committee in 2010. The terms of reference of the Committee are available at www.thephoenixgroup.com. During 2012 the Committee’s main responsibilities were to: – Review the framework for remuneration throughout the Group to confirm it remained appropriate, with particular emphasis on aligning the remuneration policy with the overall aims and risk appetite of the Group
– Determine and recommend to the Board the remuneration policy and the approval of all elements of pay for: the Chairman of the Board; Executive Directors; Executive Committee members; those individuals receiving a base salary greater than £200,000 or who have total target pay, or receive an award on joining to buy-out value from a former employer, which warrants the attention of the Committee even if their salary is below £200,000; and those individuals who perform a significant influence function and/or undertake activities which could have a material impact on the risk profile of the Group
– 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 2012, seven Committee meetings were held and details on attendance at meetings are set out in the Corporate governance report on page 56.
During 2012, certain responsibilities of the Committee were assumed by a committee of the board of Phoenix Life Holdings Limited, the highest EEA level insurance group holding company within the Group. In particular, that committee oversees remuneration relating to UK-based employees other than the Chairman and the Executive Directors. The current members of the two Committees are the same and this does not impact the governance of remuneration from any external perspective, but it does simplify the oversight of remuneration matters affecting UK-based employees. Accordingly, this report does not distinguish between the activities of the two Committees.
The Committee also consulted with the Group Chief Executive Officer, Group HR Director and General Counsel who attended, by invitation, various Committee meetings during the year, although no executive is ever permitted to participate in discussions or decisions regarding his or her own remuneration. Input is also sought from the Group Chief Risk Officer (without management present) and from representatives from the Group’s finance function, as appropriate.
Remuneration policy General policy Executive remuneration packages are structured so that they: – Are aligned to the Group’s strategy
– Are aligned with the interests of shareholders, with a significant proportion being performance-related to areas which impact value
– Do not promote unacceptable behaviours or encourage unacceptable risk taking. In particular, the Committee designed the annual incentive targets with a clear bias towards the delivery of corporate targets for senior executives recognising the importance of good team behaviours and co-operation for an insurance business as part of an effective approach to risk management. Within Ignis, consistent with standard industry practice, targets are more focused on individual objectives (but subject to a pool linked to overall Ignis profitability)
Only the fixed pay elements (salary, benefits and pension) of their package are included
Minimum performance targets for the AIP and LTIP are not achieved
Stretch performance targets for the AIP and LTIP are met and/or exceeded
For the LTIP awards, on target performance results in 55% of the total award vesting
The maximum AIP is 150% of base salary for all Executive Directors. One-third of any AIP award is deferred into shares, contingent on employment for a further three years, to further align the interests of the executives with those of shareholders.
Actual vesting levels achieved will be disclosed following release of award shares.
Elements of the package There are five main elements of the remuneration package for Executive Directors and senior executives: – Base salary
Base salary This is the core element of pay and reflects the individual’s role and position within the Group with some adjustment to reflect their capability and contribution
The current base salary of the Group Chief Executive Officer (‘CEO’) is £700,000; and of the Group Finance Director (‘FD’) is £400,000
Pension To aid retention and remain competitive within the market place
All Executive Directors are eligible to participate in the Group Personal Pension Plan (‘GPPP’)
The Group CEO receives the payment into the GPPP. The Group FD received a cash supplement of 17.6% of salary (being 20% less employers’ national insurance contributions) which is not taken into account as salary for calculating AIP, LTIP or other benefits
Personal and strategic objectives account for 20% of the AIP opportunity
One-third of any annual AIP award paid is to be deferred into shares for a period of three years
Paid in one tranche (less the deferred share award) following the year end
The AIP remains unchanged for 2013 except that 20% of the bonus is now linked to non-financial (Customer Satisfaction and Employee Engagement) KPIs to provide a more balanced scorecard. The detailed weightings are set out on page 69. The element previously linked to financial measures now applies to 60%
It is expected that the same performance measures will be used for the 2013 LTIP awards
Recruitment policy It is difficult to be overly prescriptive regarding the appropriate package for an unknown potential recruit. The following is the Committee’s agreed policy but it reserves the ability to take such steps as it considers appropriate on a specific recruitment
The Committee would be mindful of best practice guidelines in considering whether any enhanced LTIP or other award was necessary on recruitment (e.g. to buy-out awards forgone at the incoming executive’s previous employer) and seek to avoiding paying more than it considers necessary to secure the preferred candidate
No special terms agreed on the recruitment of the new Group FD
Fee levels for NonExecutive Directors are reviewed annually with any changes taking effect from 1 January
Base salary and benefits Base salary levels are as follows: Name Role From 1 January 2012
Jim McConville joined with a slightly lower salary than his predecessor (£400,000 compared with £415,000) and did not receive any guaranteed or buy-out awards and his bonus for 2012 was pro-rated for the period of employment. Neither Executive Director received a salary increase in January 2013.
Annual incentives For 2012, AIP potential remained 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
For 2013, the on-target and maximum AIP potential remains at 75% and 150% of base salary for Executive Directors and the performance measures will be as follows: Performance metric
Operating Companies’ Cash Generation 30% Group MCEV 20% Expense Management 20% Group MCEV Operating Earnings after Tax 10% Customer Satisfaction 10% Employee Engagement 10%
This is felt to be more consistent with the types of balanced scorecards adopted elsewhere within the sector.
Consistent with best practice, the Committee operates a claw-back provision which will permit the Committee to seek claw-back in appropriate cases. For 2013 awards, this has been extended to cover the discovery of reputational or risk concerns.
Long-term incentives The LTIP is designed to retain executives and align their interests to the Group’s long-term goals and, through those goals, to the delivery of superior returns to shareholders. For 2013, the population has been reduced to 24 participants who receive contingent awards of shares in the Group which will permit the participant to receive shares three years after they were awarded, but only if both suitably stretching performance conditions measured over the three-year period are met and they remain employed (or are designated a good leaver).
The Committee selected these performance metrics as they are directly linked to the objectives set out in the Group’s strategy, there is a direct link with shareholder value, and there is a clear line of sight for participants between performance and reward.
The current expectation is that the above performance metrics will continue to be used for the 2013 awards, with performance targets (which will, in the view of the Committee, be no less challenging than those presented above) set in advance of the awards being granted.
Shareholding guidelines The Company operates share ownership guidelines for Executive Directors. Under the guidelines, Executive Directors are expected to retain all shares (net of tax) which vest under the AIP deferral, LTIP (or any other discretionary long-term incentive arrangement introduced in the future) until such time that they hold a specified value of shares (200% of salary for the Group CEO, 100% of salary for other Executive Directors). Once shareholding guidelines have been met, individuals are expected to retain these levels as a minimum. The Committee will review shareholdings annually in the context of this policy. The Committee will keep compliance with the policy under review as awards approach maturity.
During 2012, the Committee launched an HMRC 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.
Clive Bannister 7 February 2011 12 Jim McConville 6 June 2012 12
If a leaver is deemed to be a ‘good leaver’; ie leaving through voluntary redundancy, serious ill health or death or otherwise at the discretion of the Committee
No awards made Pro-rated amount plus retention of any deferred share awards
LTIP Will receive a pro-rated award subject to the application of the performance conditions at the normal measurement date
Non-Executive Director Date of letter of appointment Commencement date of appointment Expiry/notice terms Current expiration date
19 October 2012 1 October 2012 Six months 1 October 2015
24 September 2009 24 September 2009 One month 2 May 2013
11 December 2009 18 February 2010 One month 2 May 2013
2 September 2009 2 September 2009 One month 2 May 2013
The remuneration of the Non-Executive Directors is a matter for the Chairman and Executive members of the Board and the remuneration of the Non-Executive Chairman is a matter for the Committee and the Board. Fees for both Non-Executive Directors and the Non-Executive Chairman are reviewed from time to time with regard to the complexity of the Group, the time commitment required and the level of fees paid by comparable companies.
Audited information Directors’ emoluments The emoluments of the Directors for 2012 based on the current disclosure requirements were as follows: Name Salaries/fees £ Benefits1 £
Non-Executive Directors Ian Ashken 100,000 – – – 100,000 100,000 René-Pierre Azria 100,000 – – – 100,000 100,000
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 2012 AIP award). Of the amounts presented above, £241,990 of Clive Bannister‘s incentive payment will be deferred in shares for a period of three years and £79,017 of Jim McConville’s. Full details of the number of shares under award will be disclosed in the 2013 Remuneration report.
3 Clive Bannister joined the Phoenix Group on 7 February 2011 and was appointed to the Board as a Director on 28 March 2011. The detail shown for 2011 only relates to the period from his appointment as a Director to 31 December 2011, except for the AIP which includes the amount earned in respect of the period 7 February 2011 to 28 March 2011.
4 Jim McConville joined the Phoenix Group on 6 June 2012 and was appointed to the Board as a Director on 28 June 2012. The detail shown only relates to the period from his appointment as a Director to 31 December 2012, except for the AIP which includes the amount earned in respect of the period 6 June 2012 to 28 June 2012.
6 The Executive Directors are entitled to adjust their salary/benefit combination under flexible benefits arrangements and the figures shown are before individual elections.
3 Share plan gains include the intrinsic gain on the grants of SAYE grants.
7 Jim McConville joined the Phoenix Group on 6 June 2012 and was appointed to the Board as a Director on 28 June 2012. The detail shown only relates to the period from his appointment as a Director to 31 December 2012, except for the AIP which includes the amount earned in respect of the period 6 June 2012 to 28 June 2012.
During the year to 31 December 2012, the Group has made the following contributions: £
3 In addition to the shares awarded under the LTIP presented above and the deferred bonus shares in the next table, participants received an additional number of shares (based on the number of LTIP awards which actually vest) to reflect the dividends paid during the vesting period.
Sharesave At the end of the year, the Executive Directors’ Sharesave share options were as follows: As at 1 Jan 2012 Options granted
Name As at 1 January 2012 or date of appointment if later As at 31 December 2012 As at 21 March 2013 number of ordinary shares
Ian Cormack – – – Tom Cross Brown 1,664 1,664 1,988 Manjit Dale3 – – – Howard Davies – – –
2 Jim McConville holds options in respect of ordinary shares under the LTIP, details of which are included in the ‘Share-based awards‘ notes on page 74.
4 Hugh Osmond is a director of Xercise2 Limited which is considered to be a connected person. Hugh Osmond has a total interest in 17,394,353 shares of which he has beneficial interest over 13,229,201.
Performance graph The graph below shows the value by 31 December 2012, on a TSR basis, of £100 invested in Phoenix Group Holdings on 5 July 2010 (the date of the Company’s Premium Listing) compared with the value of £100 invested in the FTSE 250 Index (excluding investment trusts).
Additional FSA disclosures Code Staff The Remuneration Committee has identified the Group’s asset management subsidiary, Ignis, as a Code firm. By virtue of its influence over Ignis, the Committee has determined that Phoenix Group Holdings is also a Code firm. Both companies have been identified as Tier 4 (now renamed Tier 3) Code firms. The Committee has determined that 25 staff within Ignis qualify as Code Staff. The Committee has also determined that a further 26 Group employees, who have sufficient supervisory responsibility over Ignis’ activities, qualify as Code Staff.
– Employees performing a Significant Influence Function in relation to the code firm
Design and structure of remuneration The individual elements of employees’ remuneration packages at Phoenix Group Holdings comprise fixed pay (base salary, pension and other benefits) and performance-related pay (consisting of annual incentives, deferred awards and long-term incentives).
Salary and fees All Code Staff receive either a salary (employees) or fees (Non-Executive Directors) to reflect their experience, skills, competencies and contribution to the Group relative to the market for comparable roles. Phoenix Group Holdings ensures that fixed remuneration is sufficient to cover employees’ key financial needs while generally seeking to pay around a mid-market range.
Benefits Code Staff receive benefits in line with other employees that includes pension, life assurance, staff discounts (for Ignis employees) and may include car allowance and private medical insurance. 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 in the context that it was delivered.
Ignis employees’ bonuses are financed from a defined profit pool (subject to discretion being reserved to the Remuneration Committee to adjust the percentage available). Distribution of the pool has due regard to objectives similar to those in the Group and life companies.
Risk adjustment To manage the risk aspects of the remuneration policy, the Committee considers the performance of the Group and individual businesses against risk objectives in determining the bonus pool and requires the Group Chief Risk Officer to report to the Committee on this.
Quantitative remuneration disclosure The Group is required to disclose aggregate quantitative remuneration information for its Code Staff.
As at 31 December 2012, there were 26 Code Staff that had been classified as Group and 25 as Ignis. Aggregate remuneration expenditure is broken down as follows: Number of Staff £
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 2012, 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, Business review and Risk management sections on pages 11 to 21, 22 to 40 and 41 to 46 respectively and is incorporated by reference into this Directors’ report.
Share capital The issued share capital of the Company was increased by 114,333 ordinary shares during 2012. 114,333 shares were allotted under the Group’s scrip dividend scheme for the final 2011 dividend. At 31 December 2012, the issued ordinary share capital totalled 174,587,148. A further 50,000,000 ordinary shares were issued on 21 February 2013 increasing the total issued share capital to 224,587,148. Subsequently, 35,467 ordinary shares were issued in March 2013 in connection with the Company’s Save As You Earn (‘SAYE’) Scheme to bring the total in issue at the date of this report to 224,622,615.
The rights and obligations attaching to the Company’s ordinary shares are set out in the Company’s Articles of Association (‘the Articles’) which are available on the Company’s website at www.thephoenixgroup.com/about-us/corporategovernance /articles-of-association.aspx.
Where the Employee Benefit Trust (‘EBT’) holds shares for unvested awards the voting rights for these shares are exercisable by the trustees of the EBT at their discretion, taking into account the recommendations of the Group. For shares that have vested into respective sub funds underneath the EBT, the voting rights are exercisable by the trustees of the respective sub funds at their discretion, taking into account the recommendations of the relevant participant of the respective sub funds.
Under the Articles, the Directors may in certain circumstances refuse to register transfers of shares. In particular, the Board of Directors may refuse to register the transfer of shares to a person who is a Non-Qualified Person (as defined in the Articles).
Substantial shareholdings Information provided to the Company pursuant to the FSA’s Disclosure and Transparency Rules is published on a Regulatory Information Service and on the Company’s website. As at 21 March 2013, the Company had been notified or was aware of the following significant holdings of voting rights in its shares.
Number of voting rights in shares Percentage of shares in issue
Board Board of Directors The membership of the Board and biographical details of the Directors are given on pages 48 to 51 and are incorporated by reference into this report. Details of Directors and their connected persons’ beneficial and non-beneficial interests in the shares of the Company are shown in the Remuneration report on pages 62 to 78.
During 2012 and up to the date of this report, the following changes to the Board took place: – Howard Davies was appointed as Chairman of the Board with effect from 1 October 2012 in succession to Ron Sandler.
At the Company’s AGM held on 3 May 2012, shareholders granted the Company authority to purchase up to 10% of its issued ordinary shares. Any ordinary shares purchased under the authority would, subject to the Cayman Islands Companies Law (as amended), either be cancelled or held in treasury. These authorities were not used during the year or up to the date of this report.
Directors’ indemnities Following shareholder approval on 15 March 2010, the Company entered into a deed of indemnity by way of deed poll with its Directors whereby the Company has agreed to indemnify each Director against all losses incurred by them in the exercise, execution or discharge of their powers or duties as a Director of the Company, provided that the indemnity shall not apply to the extent prohibited by any applicable law.
The Board has followed the UK Financial Reporting Council’s ‘Going Concern and Liquidity Risk: Guidance for Directors of UK Companies 2009’ when performing its going concern assessment. As part of its comprehensive assessment of whether the Group and the Company are a going concern, the Board has undertaken a review of the valuation and liquidity of its investments as at the date of the statement of consolidated financial position. The Board has also reviewed solvency and cash flow projections under both normal and stressed conditions. Having thoroughly considered the going concern assessment, including a detailed review of the solvency 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.
Financial controls The Group operates a Risk Management Framework (‘RMF’) consisting of several components, as detailed in the Risk management section on page 42. The RMF provides a consistent approach to highlighting and controlling key risks throughout the organisation. This is achieved primarily through review and compliance, at a functional level, with the risk universe and related policies (and the risk appetites therein). At its highest level the RMF considers the following risks: strategic, market, credit, insurance, financial soundness and operational. As a result, in preparing the consolidated financial statements, assessment is given to a broad range of risk categories.
Contractual/other Significant agreements impacted by a change of control of the Company Details of the change of control provisions contained in the amended contingent rights agreements dated 22 June 2010 are set out in note 14 to the IFRS financial statements.
Supplier payment policy The Company and its subsidiaries have signed up to the Prompt Payment Code, signatories to which undertake to pay suppliers on time, give clear guidance to suppliers and encourage good practice. It remains the policy of the Group to pay suppliers within 30 days of the invoice date or, if different, in accordance with any terms agreed with suppliers.
Group employees The Group is committed to achieving equality of opportunity and the equal treatment of all our people and those applying to join us. To this end, all our people share an obligation to their colleagues, customers and business partners to provide a safe, fair and equitable working environment in which every individual can seek, obtain and continue employment without experiencing any unfair or unreasonable discrimination.
Employee practice Phoenix Group continues to communicate with staff across a variety of channels, including regular news bulletins via the intranet, staff magazines and newsletters, Executive Committee presentations and other face-to-face briefings. At these regular staff briefings and Executive Committee presentations the next stage of the Company’s strategy/development is outlined, and information provided to staff on the economic factors which could affect the Company’s strategy and performance. Regular feedback mechanisms are also in place, ensuring communication at Phoenix is a continuous twoway dialogue.
The views and opinions of staff are sought through Phoenix’s annual Engagement Survey and more regular ‘temperature check’ surveys and forums. Phoenix undertakes meaningful consultation with staff representatives on all major organisational changes and other matters affecting employees.
Charitable contributions During the year the Group made charitable donations of over £80,000 details of which are presented in the Corporate responsibility section on pages 84 to 89.
“ 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.”
We are delighted with the new links we have forged during the year, be it with other businesses, charities or educational institutions. These together with existing relationships are helping to shape where we go with our corporate responsibility offering, so together we are making a difference in the communities in which we are based.
The 2012 CR survey revealed positive scores in relation to the internal promotion of CR, increased understanding and commitment from staff, and an appreciation of a collective responsibility to ensure that the Group remains sustainable into the future.
CR is categorised and reported in four areas: Environment, Workplace, Community and External stakeholders, similar categorisation to that used by Business in the Community (‘BITC’). The Group has continued its membership with BITC, and values the support and resources it makes available. The Group completed the Responsible Business Check-up and achieved an improved score on the previous year’s submission, demonstrating the successes achieved on the CR programme during the year.
Environment – our commitment to monitoring and reducing our environmental footprint The Group’s environmental impact is relatively low, when compared to other industry sectors. However, it is accepted that steps can be taken to further reduce this impact.
During the year, a facility named ‘The Link’ was launched which provides information about the CR programme. The facility promotes the 3Rs – Reduce, Re-use and Recycle, and includes a book swap facility, and various recycling options. This has proved very popular and the proceeds actively support local charitable fundraising.
The Group’s IT system has gone through a period of transition and we have moved to a new service provider. Newly installed printers are eco-friendly, consume less energy, and produce lower CO2 emissions. Print statistics are being tracked, and employees are reminded of the environmental impact of printing.
Workplace – how we treat our employees, including how we attract, develop and retain the best talent The Group was voted one of ‘Britain’s Top Employers 2012’, which is a certification awarded only to organisations that meet the highest standards in Human Resources policy benchmarking. Companies awarded this accreditation are independently recognised as being amongst the best companies to work for in the UK.
Employee engagement and benefits 96% of employees participated in the 2012 employee survey, which achieved an overall employee engagement index of 73% (2011: 74%). 39 questions were asked, and when ranked against either the Financial Services or Private Sector benchmarks, the Group achieved 32 questions which were either equal to or above benchmark.
Employee metrics The Group employs a diverse workforce as evidenced by the percentage of ethnic minority employees compared to our peers, and relatively high numbers of female employees compared to the financial services sector as a whole.
New starter survey responses continue to generate positive results, an example being 95% of respondents agreeing with the statement ‘I would tell people this is a great place to work’, against a Financial Services benchmark of 61%.
Community – the contribution we make to the communities in which we operate and our obligations to the broader society
Additional information on all staff fundraising activity is included within the CR section of the Group website, together with charity partner information.
During 2012, over £80,000 was donated by the Group to charitable causes. In addition, £23,000 was raised through fundraising activities onsite. Due to the number of causes supported, details are only provided on the largest donations and any Groupwide activity.
Staff at the Wythall site voted to support the Willow Foundation as part of an extended fundraiser, which was aptly named ‘Challenge 2012’ in the spirit of the year’s wider sporting achievements. In excess of £25,000 was raised. Staff were involved in various challenges, ranging from a static triathlon, a mile run around the site, a bike ride from Wythall to the London office, and participation in the Bupa Great Birmingham Run. Willow provides positive and lifeenhancing special day experiences for seriously ill 16-40 year olds.
In lieu of sending printed Christmas cards, the Group donated £5,000 to the Anthony Nolan charity. This charity was chosen by way of a Group-wide staff vote. Anthony Nolan charity saves the lives of people with blood cancer by matching donors who are willing to donate their blood stem cells to people who need lifesaving transplants.
The Group has recently partnered with the Credit Action charity to roll out their financial education training to 11-16 year olds at schools within the vicinity of Wythall. 20 members of staff have been trained, and will visit schools from March 2013 as part of the year-long volunteering programme.
The Group is a corporate member of the Plain English Campaign, demonstrating its commitment to provide customers with communications that are fair, clear and not misleading. The ‘All Formats’ charter mark is referenced on customer communications, highlighting that information is available in alternative formats, such as large print, Braille, on cassette or CD.
Media The Group continues to keep local media up-to-date with CR initiatives and fundraising, which helps to raise awareness of the Group in the communities in which we are based.
Responsible investment The Group continues to support the principles of good stewardship as set out on Ignis’ website www.ignisasset.com. The Group takes its responsibilities seriously and considers the environmental, social and governance procedures of any companies in which it invests.
Conclusion We continue to be committed to our CR agenda, and seek to remain a responsible organisation and employer in the communities in which we are based.
For more information on the Group’s CR programme, please contact Lucy Symonds, Corporate Responsibility Manager, at corporateresponsibility@thephoenixgroup.com
IFRS financial statements 90 Phoenix Group Holdings Annual Report and Accounts 2012
− the Annual Report and Accounts describes the principal risks facing Phoenix Group Holdings.
St Helier, Jersey 21 March 2013 1 The Company’s home member state is the Netherlands as a result of its original listing on Euronext Amsterdam and is therefore governed by the Dutch Financial Markets
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgement, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error.
Matters on which we are required to report by exception 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 81, 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
Net investment income 8 4,581 4,920 Total revenue, net of reinsurance payable 1,174 6,478
Policyholder claims (5,166) (4,968) Less: reinsurance recoveries 364 224 Change in insurance contract liabilities 645 (1,338) Change in reinsurers’ share of insurance contract liabilities 5,142 222 Transfer (to)/from unallocated surplus 20 (45) 16 Net policyholder claims and benefits incurred 940 (5,844)
Change in investment contract liabilities (750) 260 Acquisition costs (3) (13) Change in present value of future profits 32 – (19) Amortisation of acquired in-force business 32 (122) (134) Amortisation of customer relationships 32 (18) (18)
Net (expense)/income attributable to unitholders (111) 131 Total operating expenses (649) (6,243)
Tax attributable to policyholders’ returns 12 (33) (173) Profit/(loss) before the tax attributable to owners 290 (177)
Tax credit/(charge) 12 86 (94) Add: tax attributable to policyholders’ returns 12 33 173 Tax credit attributable to owners 12 119 79 Profit/(loss) for the year attributable to owners 409 (98)
Attributable to: Owners of the parent 392 (131) Non-controlling interests 18 17 33
Other comprehensive income: Actuarial (losses)/gains of defined benefit pension schemes 31 (422) 251 Foreign exchange rate movements (8) –
Attributable to: Owners of the parent 72 121 Non-controlling interests 17 33
Operating profit Phoenix Life 399 395 Ignis Asset Management 43 46
Group costs (32) (54) Total operating profit before adjusting items 410 387
Finance costs attributable to owners (111) (110) Profit/(loss) before the tax attributable to owners 4.2 290 (177)
Tax credit attributable to owners 119 79 Profit/(loss) for the year attributable to owners 409 (98)
Reinsurance payables 47 33 Payables related to direct insurance contracts 28 393 707
Statement of consolidated financial position As at 31 December 2012 continued £m 2011 £m
Fixed and variable rate income securities 40,892 42,010 Collective investment schemes 6,044 6,251
Reinsurers’ share of insurance contract liabilities 19 3,204 3,153 Reinsurance receivables 64 257 Insurance contract receivables 10 14
Statement of consolidated changes in equity For the year ended 31 December 2012
Coupon paid to non-controlling interests, net of tax relief – – – – – – – (19) (19) Shares issued in lieu of cash dividends – 1 – – – – 1 – 1 Credit to equity for equity-settled share-based payment – – – – – 5 5 – 5 Shares in subsidiaries subscribed for by non-controlling interests – – – – – – – 35 35 Shares sold by employee trust – – – 1 – – 1 – 1
There is a restriction on the ability of certain subsidiary companies to distribute funds to Phoenix Group Holdings as a result of restrictions imposed by the Group’s two main credit agreements, namely the Pearl Facility and the Impala Facility (as described in note 21).
Impairment of intangible assets Intangible assets are subject to regular impairment reviews as detailed in accounting policy (n). Impairments are measured as 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 32.
The accounting policy for income taxes (both current and deferred) is discussed in more detail in accounting policy (l).
Pension scheme assets and liabilities The valuation of pension scheme assets and liabilities is determined using actuarial valuations that include a number of assumptions. As defined benefit pension plans are long-term in nature, such assumptions are subject to significant uncertainty. Details of the key assumptions used are shown in note 31.
− all resulting exchange differences are recognised through the statement of consolidated comprehensive income.
Insurance liabilities Insurance contract liabilities for non-participating business, other than unit-linked insurance contracts, are calculated on the basis of current data and assumptions, 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
For participating business, the liabilities under insurance contracts and investment contracts with DPF are calculated in accordance with the following methodology: − liabilities to policyholders arising from the with-profit business are stated at the amount of the realistic value of the liabilities, adjusted to exclude the owners’ share of projected future bonuses; − acquisition costs are not deferred; and
Unallocated surplus The unallocated surplus comprises the excess of the assets over the policyholder liabilities of the with-profit business of the Group’s life operations. For the Group’s with-profit funds this represents amounts which have yet to be allocated to owners since the unallocated surplus attributable to policyholders has been included within liabilities under insurance contracts.
(f) Investment contracts without DPF Receipts and payments on investment contracts without DPF are accounted for using deposit accounting, under which the amounts collected and paid out are recognised in the statement of consolidated financial position as an adjustment to the liability to the policyholder.
Subsequent to initial recognition, financial liabilities (except for liabilities under investment contracts and other liabilities designated at fair value through profit or loss) are measured at amortised cost using the effective interest method. Financial liabilities are designated upon initial recognition at fair value through profit or loss when doing so results in more meaningful information because either: − it eliminates or significantly reduces accounting mismatches that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases; or
Notes to the consolidated financial statements continued 1. Accounting policies (continued) (h) Borrowings The majority of interest bearing borrowings are recognised initially at fair value less any attributable transaction costs. The difference between initial cost and the redemption value is amortised through the consolidated income statement over the period of the borrowing using the effective interest method.
(i) Deposits from reinsurers It is the Group’s practice to obtain collateral to cover certain reinsurance transactions, usually in the form of cash or marketable securities. Where cash collateral is available to the Group for investment purposes, it is recognised as a ’financial asset’ and the collateral repayable is recognised as ‘deposits received from reinsurers’ in the statement of consolidated financial position.
(l) Income tax Income tax comprises current and deferred tax. Income tax is recognised in the consolidated income statement except to the extent that it relates to items recognised in the statement of consolidated comprehensive income or the statement of consolidated changes in equity, in which case it is recognised in these statements.
Notes to the consolidated financial statements continued 1. Accounting policies (continued) (n) Intangible assets (continued) Customer relationships Intangible assets include vesting pension premiums and investment management contracts as detailed in note 32. These are measured on initial recognition at cost. The cost of intangible assets acquired in a business combination is their fair value as at the date of acquisition. Following initial recognition, intangible assets are carried at cost less any accumulated amortisation and any accumulated impairment losses. Internally generated intangible assets are not capitalised and expenditure is reflected in the consolidated income statement in the year in which the expenditure is incurred.
(o) Property, plant and equipment Owner-occupied property is stated at revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and impairment. Owner-occupied property is depreciated over its estimated useful life, which is taken as 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.
Derivative financial instruments are classified as held for trading. They are recognised initially at fair value and subsequently are re-measured to fair value. The gain or loss on re-measurement to fair value is recognised in the consolidated income statement.
Equities, fixed and variable rate income securities and collective investment schemes are designated at fair value through profit or loss and accordingly are stated in the statement of consolidated financial position at fair value. They are designated at fair value through profit or loss because this is reflective of the manner in which they are managed and the risks are evaluated.
Impairment of financial assets The Group assesses at each period end whether a financial asset or group of financial assets held at amortised cost is impaired. The Group first assesses whether objective evidence of impairment exists. If it is determined that no objective evidence of impairment exists for an individually assessed financial asset, the asset is included in a group of financial assets with similar credit risk characteristics and that group of financial assets is collectively assessed for impairment. Assets that are individually assessed for impairment and for which an impairment loss is, or continues to be recognised, are not included in the collective assessment of impairment.
Notes to the consolidated financial statements continued 1. Accounting policies (continued) (t) Cash and cash equivalents Cash and cash equivalents comprise cash balances and short-term deposits with an original maturity term of three months or less at the date of placement. Bank overdrafts that are repayable on demand and form an integral part of the Group’s cash management are deducted from cash and cash equivalents for the purpose of the statement of consolidated cash flows.
(u) Provisions and contingent liabilities A provision is recognised when the Group has a present legal or constructive obligation as a result of a past event and it is probable that an outflow of economic benefits will be required to settle the obligation. If the effect is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. Where the Group has a present legal or constructive obligation, but it is not probable that there will be an outflow of resources to settle the obligation or the amount cannot be reliably estimated, this is disclosed as a contingent liability.
Fee and commission income Fee and commission income relates to the following: − fund management based fees, which are recognised as the services are provided; − investment contract income – investment contract policyholders are charged for policy administration services, investment management services, surrenders and other contract fees. These fees are recognised as revenue over the period in which the related services are performed. If the fees are for services provided in future periods, then they are deferred and recognised over those periods. ‘Front end’ fees are charged on some non-participating investment contracts. Where the non-participating investment contract is measured at fair value, such fees which relate to the provision of investment management services are deferred and recognised as the services are provided; and
− other fees, which are recognised as the services are provided.
Share-based payments Equity-settled share-based payments to employees and others providing services are measured at the fair value of the equity instruments at the grant date. The fair value excludes the effect of non-market-based vesting conditions. Details regarding the determination of the fair value of equity-settled share-based transactions are set out in note 17.
Shares held by the employee trust and Group entities Where an employee trust or other 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.
(bb) Leases Where a significant element of the risks and rewards of title to the asset is retained by the lessor, such leases are treated as operating leases. Property leased out by the Group under operating leases are included in investment property, rental income from such leases is recognised as income in the statement of comprehensive income on a straight line basis over the period of the lease.
(dd) Segmental reporting The Group’s results are analysed across two reportable segments: Phoenix Life and Ignis Asset Management. The revenues generated in each reported segment are shown in the segmental information in note 4.
2. Financial information The consolidated financial statements for the year ended 31 December 2012, set out on pages 93 to 176, were authorised on 21 March 2013 by the Board of Directors for issue.
In preparing the consolidated financial statements the Group has adopted for the first time the following standards, interpretations and amendments which have been issued by the International Accounting Standards Board (‘IASB’) and have been adopted for use by the EU. None of these have a material effect on the results of the Group.
− Deferred tax – Recovery of Underlying Assets (Amendments to IAS 12) (2012). This provides a practical approach to the measurement of deferred tax liabilities and assets when investment property is measured at fair value, according to whether the entity expects to recover an asset by using or selling it.
− 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 28 Investments in Associates and Joint Ventures (Revised) (2013). This standard supersedes IAS 28 Investments in Associates and prescribes the accounting for investments in associates and sets out the requirements for the application of the equity method when accounting for investments in associates and joint ventures.
− Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27) (2014).
When IFRS 10, IFRS 11, IFRS 12, IAS 28 (Revised) and the consequential amendments to these were issued by the IASB the effective date of these standards was 1 January 2013. However, the EU endorsed these standards to be effective from 1 January 2014, with early adoption permitted. The Group currently intends to adopt these standards effective for the period commencing on 1 January 2014.
Assets classified as held for sale: Goodwill 19 Acquired in-force business 138 Financial assets 61 Reinsurer’s share of insurance contract liabilities 5,083 Other assets 9
Liabilities classified as held for sale: Liabilities under insurance contracts 5,404 Deferred tax liabilities 23 Payables related to direct insurance contracts 42 Other liabilities 10
Annuity liabilities transfer The Group entered into a reinsurance agreement, effective 1 July 2012, to reinsure certain portfolios of the Group’s annuity liabilities to Guardian in exchange for the transfer of financial assets of £5.1 billion. It is highly probable that the reinsurance agreement will be replaced by a formal Part VII transfer of the annuity liabilities to Guardian in the second half of 2013 and accordingly the assets and liabilities to be transferred have been classified as held for sale.
The Group will make a net payment to Guardian at the time of the Part VII transfer for their assumption of the administration of the contracts.
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
Notes to the consolidated financial statements continued 4. Segmental analysis (continued) 4.1 Segmental result 2012
Net premiums written from: External customers (3,564) – – – (3,564)
Fees from: External customers 123 34 – – 157 Other segment – 103 – (103) –
Net investment income: Offset interest income on interest swaps against interest expenses1 – – (19) – (19)
Net policyholder claims and benefits incurred: Non-recurring 35 – – – 35
Other operating expenses: Profit/(loss) before finance costs and tax 220 39 (31) – 228
Notes to the consolidated financial statements continued 4. Segmental analysis (continued) 4.2 Reconciliation of operating profit/(loss) before adjusting items to the segmental result 2012
Operating profit/(loss) before adjusting items 399 43 (32) 410 Investment return variances and economic assumption changes on long-term business 1 – – 1 Variance on owners’ funds (35) – 22 (13) Amortisation of acquired in-force business (109) – – (109) Amortisation of customer relationships (15) (3) – (18)
Financing costs attributable to owners – – (111) (111) Segment result before the tax attributable to owners 380 38 (128) 290
5.2 Owners’ funds For non-long-term business including owners’ funds, the total investment income, including fair value gains, is analysed between a calculated longer-term return and short-term fluctuations.
Variances on owners’ funds of: Subsidiary undertakings (13) 7 The Company – 2
5.3 Calculation of the long-term investment return The expected return on investments for both owner and policyholder funds is based on opening economic assumptions applied to the funds under management at the beginning of the reporting period. Expected investment return assumptions are derived actively, based on market yields on risk-free fixed interest assets at the start of each financial year. The same margins are applied on a consistent basis across the Group to gross risk-free yields, to obtain investment return assumptions for equities and properties.
Gilts (15 year gilt) 2.6 4.0 Other fixed interest 3.6 4.6
Notes to the consolidated financial statements continued 6. Premiums ceded to reinsurers On 27 June 2012, the Company entered into a reinsurance agreement with Guardian to reassure selected portfolios of its pension annuity in-payment liabilities with effect from 1 July 2012.
Dividend income 674 679 Rental income 88 86 Net expected return on pension assets (4) (11)
Financial assets at fair value through profit or loss Designated upon initial recognition 1,788 595 Held for trading – derivatives (354) 960
Employee costs 144 149 Outsourcer expenses 134 160 Professional fees 76 107 Office costs 49 45 Depreciation of property, plant and equipment 3 3 Investment management expenses and transaction costs 89 99 Direct costs of life companies 27 9 Direct costs of collective investment schemes 28 27 Pension service costs and curtailments 5 (21) Impairment of property, plant and equipment 4 8
Interest expense On financial liabilities at amortised cost 189 215 On financial liabilities at fair value through profit or loss 26 36
Current tax: UK Corporation tax 24 68 Overseas tax 15 16
Deferred tax: Impact of new life tax regime: Transitional adjustment on move to IFRS basis of taxation 88 – Unwind of timing differences recognised under previous tax regime (62) (9) Offset of 2012 losses against corresponding transitional gain (32) – Other impacts of new life tax rules (6) –
Utilisation of tax losses 8 131 Change in the rate of corporation tax (28) (41) Prior year deferred tax (3) –
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 £33 million (2011: £173 million).
On 22 August 2012, the Board declared an interim dividend of 21p per share for the half year ended 30 June 2012. The total dividend amounted to £36 million and was paid on 4 October 2012.
The diluted earnings per share of 226.2p (2011: (76.2p)) has been based on the profit attributable to owners of the parent of £392 million (2011: loss of £131 million) and a diluted weighted average number of ordinary shares outstanding during the year of 173 million (2011: 171 million). The Group’s Deferred BSP share-based scheme has increased the weighted average number of shares on a diluted based by 94,198 shares (2011: nil).
− IPO warrants from 2 September 2009 on which date the exercise price of the outstanding warrants was increased from €7 to €11.
There are 3,600,000 remaining contingent rights over ordinary shares which will result in the issue of ordinary shares on a one-for-one basis if on or before 22 June 2013 (i) an offer is made to acquire all or a majority of the Company’s issued ordinary share capital or substantially all of the Company’s assets (in each case such transaction having become unconditional in all respects); or (ii) any party or parties acting in concert becomes interested in more than 50% of the ordinary shares of the Company through the issue of shares by the Company. As the conditions for this conversion were not met in the reporting period, these additional shares have not been included in the diluted earnings per share figures.
On 21 February 2013 50 million ordinary shares were issued (see note 48). This equity raising contributed to the £450 million prepayment on 22 February 2013 which enabled the re-terming of the Impala facility (see note 21).
The holders of ordinary shares are entitled to one vote per share on matters to be voted on by owners and to receive such dividends, if any, as may be declared by the Board of Directors in its discretion out of legally available profits. Movements in issued share capital during the year: Shares in issue at 1 January 174,472,815 14,165 Ordinary shares issued for scrip dividend 114,333 9 Shares in issue at 31 December 174,587,148 14,174
During the year, the Company did not issue any shares to employees under the Group’s share schemes.
Shares in issue at 1 January 171,455,610 13,904 Ordinary shares issued for scrip dividend 3,005,093 260 Other ordinary shares issued in the year 12,112 1 Shares in issue at 31 December 174,472,815 14,165
16. Shares held by the employee trust and Group entities £m £m
17. Share-based payment 17.1 Share-based payment expense The expense recognised for employee services receivable during the year is as follows: £m £m
Expense arising from equity-settled share-based payment transactions 5 6 Expense arising from cash-settled share-based payment transactions – 1 Total expense arising from share based payment transactions 5 7
Under the SAYE arrangement, participants remaining in the Group’s employment at the end of the 3 or 5 year saving period are entitled to use their savings to purchase shares at an exercise price at a discount to the share price on the date of grant. Employees leaving the Group for certain reasons are able to use their savings to purchase shares if they leave less than six months before the end of their 3 or 5 year periods.
The following information was relevant in the determination of the fair value of the 2010 SAYE, 2011 SAYE and 2012 SAYE awards in the year: Share price (p) 524.5 669.5 650.0 Exercise price (£) 4.78 5.72 5.63 Expected life (years) 3.25 and 5.25 3.25 and 5.25 3.25 and 5.25 Risk-free rate (%) – based on UK government gilts commensurate with the expected term of the award 0.6 (for 3.25 year scheme) and 1.1 (for 5.25 year scheme 1.8 (for 3.25 year scheme) and 2.6 (for 5.25 year scheme 2.0 (for 3.25 year scheme) and 2.8 (for 5.25 year scheme)
Following the equity raising on 21 February 2013 (see note 48) the exercise prices of the 2012 SAYE, 2011 SAYE and 2010 SAYE have been adjusted to £4.66, £5.58 and £5.49 respectively.
Deferred cash plan With effect from 2 September 2009, a number of executives were given deferred cash awards, the value of which was equal to a fixed number of Phoenix Group Holdings shares on 2 September 2012. As the award was through a cashsettled scheme, the fair value of the expense was updated at every period end to reflect movements in Phoenix Group Holdings’ share price, and was determined on the assumption that all the granted awards would vest.
17.3 Movements in the year The following tables illustrate the number of, and movements in, share options during the year: No of share options 2012
The weighted average share price at the date of exercise for the rewards exercised is £5.11 (2011: £5.84).
Profit/(loss) for the year 20 (3) 17 Dividends paid – (23) (23) Coupon paid, net of tax relief (19) – (19) Shares in subsidiaries subscribed for by non-controlling interests – 35 35
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 18.1 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.
Life assurance business: Insurance contracts 39,806 8,287 40,517 3,153 Investment contracts with DPF 11,328 – 11,283 –
Amounts due for settlement after 12 months 41,375 3,054 46,759 2,792
Less amounts classified as held for sale (note 3) (5,404) (5,083) – –
Limited recourse bonds 2012 7.39% (note a) – 11 – 11
The above analysis reflects the position as at 31 December 2012 and therefore does not reflect the £450 million prepayment made on 22 February 2013 in connection with of the re-terming of the Impala facility (see note 48).
b. The Property Reversions loan from Santander UK plc (‘Santander’) was brought into the consolidated financial statements at fair value. It relates to the sale of Extra-Income Plan policies that Santander finances to the value of the associated property reversions. With effect from 1 January 2012, Phoenix Life Limited (‘PLL’) became party to a loan agreement with Santander UK plc (‘Santander’). As part of the arrangement Santander receive an amount calculated by reference to the movement in the Halifax House Price Index and PLL is required to indemnify Santander against profits or losses arising from mortality or surrender experience which differs from the basis used to calculate the reversion amount. Repayment will be on a policy-by-policy basis and is expected to occur over the next 10 to 20 years. During the year, repayments totalling £29 million were made. Note 34 contains details of the assets that support this loan.
c. In 2008, UKCPT entered into an £80 million revolving loan facility agreement. This loan accrues interest at LIBOR plus a variable margin of 0.50% to 0.60% per annum. The lender holds a floating charge over certain assets of UKCPT and its subsidiaries. The repayment date for this facility is 19 June 2015. This facility was fully utilised during 2011 and 2012 in order to increase UKCPT’s property portfolio.
e. 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 PLL. In the event of the winding-up of PLL, the right of payment under the notes is subordinated to the rights of the higher-ranking creditors (principally policyholders). As a result of the acquisition of the Phoenix Life businesses in 2009 these subordinated loan notes were acquired at their fair value and as such, the outstanding principal of these subordinated loan notes differs from the carrying value in the statement of financial position. The fair value adjustments which were recognised on acquisition will unwind over the remaining life of these subordinated loan notes.
g. 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 were: − 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
The borrowings under this facility are secured by, amongst other things: − first fixed and floating charges over all the assets and undertaking of PGH (LC1) Limited and PGH (LC2) Limited (including their respective 12.5% shareholdings in Impala, all real estate, book debts, bank accounts, investments and other assets); − a limited recourse share charge granted by Pearl Group Holdings (No. 2) Limited (‘PGH2’) over its 75% shareholding in Impala.
During 2012, a scheduled repayment of £125 million (2011: £125 million) and a voluntary repayment of £15 million (2011: £20 million) were made.
On 22 February 2013, a £450 million prepayment was made against the facility and its terms were revised. Please see note 48 for further information.
During the year a scheduled repayment of £24 million (2011: £24 million) was made on the £425 million loan facility and interest of £2 million (£2011: £1 million) was capitalised on the £75 million secured C loan notes.
Warrants over shares in Phoenix Group Holdings – 3 – 3
Credit default options 10 4 33 – Credit linked note 32 – – – Contract for differences 2 – – –
Warrants over shares On 1 January 2012, the Company had in issue the following warrants: IPO
− if, and only if, the reported last sale price of the share equals or exceeds €13.75 per share for any 20 trading days within a period of 30 consecutive trading days ending on the third business day prior to the notice of redemption to warrant holders. On 2 September 2009 the threshold of €13.75 was increased to €16.50. At 31 December 2012 the threshold was reduced to €16.05 (2011: €16.06) following an issue of ordinary shares by the Company under a scrip dividend.
The IPO warrants are listed and were previously valued using the warrant price quoted on the LSE for the Company. Due to the relatively low number of IPO warrants in issue, they are thinly traded and the quoted price is not considered to be the best indicator of their fair value. As a result the IPO warrants have been valued using an extended Black-Scholes valuation model. The key assumptions used to ascertain a value as at 31 December 2012 are as follows: − share price as at 31 December 2012 of £5.45; − volatility of 30%; − the warrants are not adjusted for dividends; and
Lenders’ warrants On 2 September 2009, the Company issued 5 million warrants over its shares to the Lenders. These warrants entitled the holder to purchase one ‘B’ ordinary share at a price of £15 per share, subject to adjustment. Following the achievement of the Company’s Premium Listing on 5 July 2010, the Lenders’ warrants relate to ordinary shares rather than ‘B’ ordinary shares. At 31 December 2012 the terms of Lenders’ warrants entitled the holders to purchase 1.027873 (2011: 1.0272) ordinary shares per Lenders’ warrant for an exercise price of £14.59 (2011: £14.60).
The exercise period terminates on the first to occur of: − 15th anniversary of the date issued; − date fixed for the redemption of the warrants; and
These Lenders’ warrants are not traded in an active market and have therefore been valued using an extended BlackScholes 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 £200,000 (2011: £250,000).
The holders are entitled to exercise their warrants for cash, assignment of an amount of outstanding principal plus accrued interest of any Global Debt (e.g. 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.
Financial liabilities at fair value through profit or loss: Designated upon initial recognition 12,961 11,404 12,961 11,404 Held for trading – derivatives 3,026 4,292 3,026 4,292
Notes to the consolidated financial statements continued 27. Tax assets and liabilities (continued) Deferred tax liabilities comprise: £m 2011 £m
Acquired in-force business 501 593 Customer relationships 88 100 Surplus within the non-profit funds – 62 IFRS transitional adjustments 88 – Provisions and other temporary differences 6 8 Adjustment for insurance policies held with related parties in respect of the PGL
Pension Scheme 23 24 Gross deferred tax liabilities 706 787 Less: offset against deferred tax assets (297) (114) Net deferred tax liabilities 409 673
Amounts credited/(charged) to the income statement 131 (67) Amounts credited to the statement of other comprehensive income 110 1 Amounts classified as held for sale (note 3) 23 –
The Finance Act 2012 set the rate of corporation tax at 23% from 1 April 2013. Consequently a rate of 23% has been used for the purposes of providing for deferred tax in these consolidated financial statements. Further reductions to 21% in April 2014 and 20% from April 2015 have been announced and will be introduced by future legislation. The benefit to the Group’s net assets arising from the further 3% reduction in the tax rate is estimated at £25 million in total and will be recognised as the legislation is substantively enacted.
The Finance Act 2012 introduced new rules for the taxation of insurance companies, with effect from 1 January 2013. The deferred tax on the non-profit surplus has reversed and is replaced with IFRS transitional adjustments. The increase to the Group’s net assets arising from the introduction of the new rules is estimated as £12 million in total. The impact is included in the tax reconciliation in note 12.3. The deferred tax liability will be amortised over a 10 year period on a straight line basis commencing in 2013 and ending in 2022 as the IFRS tax transitional adjustment is brought into account in the current year tax computations.
The carrying value of the defined benefit pension schemes is set out below.
Pearl Group Staff Pension Scheme Economic (deficit)/surplus including £nil (2011: £56 million) available as a refund on a winding-up of the scheme (114) 56 Irrecoverable amount of deficit reduction contributions (83) – Provision for tax on that part of the economic surplus available as a refund on a winding-up of the scheme – (19) Reported (deficit)/surplus (197) 37
Defined contribution scheme Contributions in the year amounted to £1 million (2011: £1 million).
Rate of increase for pensions in payment (5% per annum or RPI if lower) 2.90 3.10 Rate of increase for deferred pensions (CPI) 2.25 2.10 Discount rate 4.50 4.90 Inflation – RPI 3.00 3.10 Inflation – CPI 2.25 2.10 Expected rate of return on scheme assets 4.50 3.70
The discount rate and inflation rate assumptions used for the calculation of the liabilities have been determined by considering the shape of the appropriate yield curves and the duration of the Pearl Scheme’s liabilities. This method determines an equivalent single rate for each of the discount and inflation rates, which is derived from the profile of projected benefit payments.
It has been assumed that post-retirement mortality is in line with a scheme-specific table which was derived from the actual mortality experience in recent years, performed as part of the actuarial valuation as at 30 June 2012, based on the SAPS standard tables for males and for females based on year of use. This includes the 2011 CMI Core Projections mortality improvements, with a long-term trend assumption of 1.5% per annum. Under these assumptions, the average life expectancy from retirement for a member currently aged 40 retiring at age 60 is 30.1 years and 33.5 years for male and female members respectively.
On 27 November 2012 the principal employer and the Trustee of the Pearl Scheme entered into a revised pensions funding agreement (the ‘Pensions Agreement’), which forms the basis of the 30 June 2012 triennial valuation. The principal terms of the Pensions Agreement are: − cash payments into the scheme of £70 million payable on 30 September in both 2013 and 2014, followed by payments of £40 million each year from 2015 and 2021. The Pensions Agreement includes a sharing mechanism that in certain circumstances allows for an acceleration of the contributions to be paid to the Pearl Scheme; − increased and further contributions may become payable if the scheme is not anticipated to meet the two agreed funding targets: (i) to reach full funding on the technical provisions basis by 30 June 2022; and
Under IFRIC 14, pension funding contributions are considered to be a minimum funding requirement and, to the extent that the contributions payable will not be available to the Group after they are paid into the scheme, a liability is recognised when the obligation arises. An additional liability of £83 million has been recognised, reflecting a charge on any refund of the resultant IAS 19 surplus of £237 million (£351 million of discounted future contributions less a current deficit of £114 million) in accordance with the minimum funding requirement. A deferred tax asset of £81 million has also been recognised to reflect tax relief at a rate of 23% that is expected to be available on the contributions, once paid into the scheme.
The amounts recognised in the income statement are as follows: £m £m
Current service cost (1) (1) Interest cost (85) (95) Expected return on scheme assets 75 81 Past service cost 3 16 Curtailment gain – 3
Notes to the consolidated financial statements continued 31. Pension schemes (continued) 31.1 Pearl Group Staff Pension Scheme (continued) The net actuarial (losses)/gains recognised in other comprehensive income comprise the following: £m 2011 £m
Actual return less expected return on scheme assets (7) 110 Experience losses arising on scheme liabilities (24) (22) (Loss)/gain due to changes in assumptions underlying scheme liabilities (157) 12
Irrecoverable amount of deficit reduction contributions (83) – Change in provision for tax on the economic surplus available as a refund 19 (19)
The actual return on the scheme assets comprises the following: £m 2011 £m
The change in the present value of the defined benefit obligation is as follows: £m 2011 £m
The defined benefit obligation arises from plans that are wholly or partly funded.
Expected return on scheme assets 75 81 Actual return less expected return on scheme assets (7) 110 Contributions by the employer 26 28 Benefits paid (89) (79)
Defined benefit scheme The defined benefit section of the PGL Pension Scheme is a final salary arrangement which is closed to new entrants.
The scheme has been closed to future accrual by active members since 1 July 2011. A curtailment gain of £7 million, was recognised in the consolidated income statement during 2011.
In November 2011, following formal consultation, the Group carried out a PIE exercise, the same as that outlined for the Pearl Scheme. The financial effects of the exercise were treated in the same way as for the Pearl Scheme. The financial effects of all acceptances in the period, and any reversals of acceptances received in the period to 31 December 2012, have been recognised in the consolidated financial statements and the reduction in scheme liabilities of £2 million (2011: £11 million) is shown as a negative past service cost in the consolidated income statement.
Notes to the consolidated financial statements continued 31. Pension schemes (continued) 31.2 PGL Pension Scheme (continued) 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. Total future contributions amount to £77 million at 31 December 2012. The triennial funding valuation of the PGL Pension Scheme as at 30 June 2012 is currently being performed and the initial estimate prepared by the actuary for the PGL Pension Scheme is that the deficit was £64 million as at 30 June 2012, using the technical provisions basis underlying the valuation (updated for market conditions as at 30 June 2012).
In accordance with an agreement dated November 2005, certain of the Group’s with-profit funds have indemnified the Shareholders in respect of contribution calls equal to their share of the costs of changes in longevity assumptions. The potential for any recovery from the Group’s with-profit funds will be considered as part of the process to finalise the triennial funding valuation as at 30 June 2012.
The economic value of the PGL Pension Scheme assets as at 31 December 2012 amounted to £1,704 million (2011: £1,589 million) and the economic value of the surplus amounted to £344 million (2011: £520 million). For financial reporting purposes the carrying value of the insurance policies effected by the PGL Pension Scheme with the Group have been eliminated on consolidation, resulting in reported assets of the PGL Pension Scheme as at 31 December 2012 of £1,609 million (2011: £1,660 million) and a reported surplus of £137 million (2011: £277 million).
Current service cost (1) (3) Interest cost (56) (63) Expected return on scheme assets 62 66 Past service cost 1 11 Settlement cost – ETV (7) – Gain on curtailment – 7
The net actuarial (losses)/gains recognised in other comprehensive income comprise the following: £m £m
Change in provision for tax on the economic surplus available as a refund 37 (117)
Fair value of scheme assets 1,609 1,660 Present value of defined benefit obligation (1,360) (1,234) Provision for tax on the economic surplus available as a refund (112) (149)
The actual return on the scheme assets comprises the following: £m £m
Expected return on scheme assets 62 66 Actual return less expected return on scheme assets (51) 327
The change in the present value of the defined benefit obligation is as follows: £m £m
Notes to the consolidated financial statements continued 31. Pension schemes (continued) 31.2 PGL Pension Scheme (continued) The change in the fair value of the scheme assets is as follows: £m 2011 £m
The distribution of the scheme assets at the end of the year was as follows: £m 2011 £m
Provision for tax on the economic surplus available as a refund (112) (149) (32) –
Five years historical information is not available, as prior to 2009 Phoenix Group Holdings did not prepare consolidated financial statements.
At 1 January Amounts classified as held for sale (note 3) (19) (165) – – (184)
Cost or valuation At 1 January 115 2,213 445 42 2,815
Notes to the consolidated financial statements continued 32. Intangible assets (continued) Goodwill The carrying value of goodwill has been tested for impairment at the period end. No impairment has resulted as the value in use of this intangible continues to exceed its carrying value. Value in use has been determined as the present value of certain future cash flows associated with the Ignis Asset Management business and the management services business of the Phoenix Life segment. The cash flows used in this calculation are consistent with those adopted by management in the Group’s operating plan and for the period 2017 and beyond, reflect the anticipated run-off of the Phoenix Life insurance business.
Future cash flows have been valued using a discount rate of 10.1% (2011: 10.0%) for the Ignis Asset Management business and a discount rate of 7.8% (2011: 6.7%) for the management services business of the Phoenix Life segment.
The acquired in-force business is allocated to the Phoenix Life segment.
PVFP on non-participating business in the with-profit fund The value of the PVFP is determined on a realistic basis and is allocated in full to the Phoenix Life segment. The principal assumptions used to calculate the PVFP are the same as those used in calculating the insurance contract liabilities given in note 42.5.1. Revaluation of PVFP is charged or credited to the consolidated income statement as appropriate.
Investment properties include £199 million (2011: £221 million) property reversions arising from sales of the NPI Extra Income Plan. With effect from 1 January 2012, as part of a Part VII transfer, the NPI Limited property reversions were transferred to PLL. The reversionary interest is valued as the PLL and NPLL proportion of the current market value, projected for the lifetime of the policyholder at the assumed future increase in house prices, then discounted back by the valuation rate of interest. The acquisition of these investment properties was financed by the Property Reversions loan as detailed in note 21.
Notes to the consolidated financial statements continued 35. Financial assets £m 2011 £m
Loans and receivables at amortised cost 1,914 3,529 Financial assets at fair value through profit or loss
Held for trading – derivatives 3,665 6,099 Designated upon initial recognition
Fixed and variable rate income securities 40,945 42,010 Collective investment schemes 6,052 6,251
The fair value of loans and receivables at amortised cost amounted to £1,912 million (2011: £3,494 million).
36. Financial instrument fair value hierarchy 36.1 Determination of fair value and fair value hierarchy of financial instruments Level 1 financial instruments The fair value of financial instruments traded in active markets (such as publicly traded securities and derivatives) is based on quoted market prices at the period end. The quoted market price used for financial assets is the current bid price on the trade date. If the bid price is unavailable a ‘last traded’ approach is adopted. For units in unit trusts and shares in open ended investment companies, fair value is by reference to published bid values.
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 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.
36.2 Fair value hierarchy of financial instruments measured at fair value 2012
Financial liabilities at fair value Derivatives – 3,023 3 3,026 Financial liabilities designated at fair value through profit or loss upon initial recognition
Financial liabilities at fair value Derivatives – 4,292 – 4,292 Financial liabilities designated at fair value through profit or loss upon initial recognition
All the Group’s Level 1 and Level 2 assets have been valued using standard market pricing sources, which have not changed during 2012.
Financial liabilities Derivative liabilities – 3 – – 3 (4) Financial liabilities designated at fair value through profit or loss upon initial recognition
Net asset value attributable to unitholders 169 2 (101) – 70 2
Level 3 financial instruments are transferred to Level 1 or Level 2 as and when the conditions of each Level are met. During 2012 the Group saw an increase in observable inputs, due to improving market liquidity, leading to a decrease in Level 3 financial instruments.
Financial assets designated at fair value through profit or loss upon initial recognition
Fixed and variable rate income securities 747 9 (3) 109 862 (1)
Financial liabilities Derivative liabilities 11 (11) – – – – Financial liabilities designated at fair value through profit or loss upon initial recognition
Net asset value attributable to unitholders 168 1 – – 169 44
The financial assets do not qualify for derecognition as the Group retains all the risks and rewards of the transferred assets except for the voting rights. The carrying value of listed financial assets lent at 31 December 2012 that have not been derecognised amounted to fixed and variable rate income securities of £9,179 million (2011: £10,924 million).
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 £83 million (2011: £255 million).
Collateral and pledges Assets accepted It is the Group’s practice to obtain collateral to mitigate the counterparty risk related to over-the-counter (‘OTC’) derivatives and reinsurance transactions, usually in the form of cash or marketable securities.
Notes to the consolidated financial statements continued 37. Stock lending and collateral (continued) Collateral and pledges (continued) 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, it is not recognised in the statement of consolidated financial position. The fair value of financial assets accepted as collateral for OTC derivatives and reinsurance transactions but not recognised in the statement of consolidated financial position amounts to £245 million and £7,350 million respectively (2011: £371 million and £2,089 million). The increase in collateral for reinsurance transactions is largely driven by the reinsurance agreement entered into with Guardian during the period over selected portfolios of the Group’s annuity liabilities.
Where the Group receives collateral on OTC derivatives and reinsurance transactions in the form of cash it is recognised in the statement of consolidated financial position along with a corresponding liability to repay the amount of collateral received, disclosed as ‘Obligations for the repayment of collateral received’ and ‘Deposits received from reinsurers’ respectively. The amounts recognised as financial assets and liabilities from cash collateral received at 31 December 2012 are set out below.
Assets pledged The Group pledges collateral in respect of its OTC derivative liabilities.
All deposits are subject to fixed interest rates. The carrying amounts approximate to fair value at the period end. Cash and cash equivalents in long-term business operations and collective investment schemes of £8,552 million (2011: £11,387 million) are primarily held for the benefit of policyholders and so are not generally available for use by the owners.
Fair value losses/(gains) on: Investment property 85 (4) Financial assets (1,445) (1,572)
Regulatory capital adequacy at a group level is calculated at the ultimate insurance parent undertaking which is PLHL. PLHL aims to maintain group regulatory surplus at least equal to the capital buffers agreed with the FSA.
Group capital Capital resources The primary sources of capital used by the Group comprise equity shareholder funds as measured on an MCEV basis, the Perpetual Reset Capital Securities and shareholder borrowings. This is analysed as follows: £m 2011 £m
2 As detailed in the reconciliation of Group IFRS equity to MCEV net worth in the MCEV financial statements.
The capital position statement shown above presents the total capital that the Group manages on a Pillar 1 basis in respect of its life insurance companies. It is different from the total capital available in the IGD calculation on the basis that the IGD is assessed at the PLHL level and is subject to different rules pertaining to its calculation. For example, due to the Group’s current corporate structure, certain of the Group’s subsidiaries are only included in the IGD calculation at 75% of their regulatory value, including capital requirements. The capital position statement includes these subsidiaries in full. This difference and other adjustments amount to a reduction of £916 million (2011: £1,168 million) in Phoenix Life available capital resources of £6,532 million (estimated) (2011 (actual): £6,777 million) compared with PLHL Group Capital Resources of £5,616 million (estimated) (2011 (actual): £5,608 million). Further detail of the PLHL IGD position (unaudited) is provided in the business review on page 37.
Regulatory capital requirements of the life companies Each UK life company and the Group must retain sufficient capital at all times to meet the regulatory capital requirements mandated by the 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.
The Group has a number of internal loan arrangements in place, which allow the Group to provide capital support to other areas of the business. In addition to these internal loan arrangements, the Group has in place a number of internal reinsurance contracts which are structured to manage the capital position between certain life funds.
Notes to the consolidated financial statements continued 41. Capital statement (continued) Regulatory capital position statement (continued) The capital statement and movement analysis that follows presents information about the capital resources for the Group’s UK life businesses.
Adjustments onto a regulatory basis: Unallocated surplus 883 10 – 893 Adjustments to assets1 (31) (214) (604) (849) Adjustments to liabilities2 3,687 (149) 42 3,580
Adjustments onto a regulatory basis: Unallocated surplus 843 5 – 848 Adjustments to assets1 (34) (251) (535) (820)
Owners’ funds held outside long-term fund – – – – – – –
Notes to the consolidated financial statements continued 41. Capital statement (continued)
Total available capital resources at 1 January 2012 1,120 857 996 327 711 877 267 1,622 6,777
Adjustment for internal loans in excess of counterparty limits – – – – – – (52) (82) (134)
An analysis of the movement in available capital resources for the period 1 January 2011 to 31 December 2011 is shown below: With-profit Nonparticipating £m
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 2012 generally comprise payment of dividends to Group entities.
42.2 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 is the most relevant of the financial soundness risks for financial instruments.
The Group’s overall exposure to market and credit risk is monitored by appropriate committees, which agree policies for managing each type of risk on an ongoing basis, in line with the investment strategy developed to achieve investment returns in excess of amounts due in respect of insurance contracts. The effectiveness of the Group’s ALM relies on the matching of assets and liabilities arising from insurance and investment contracts, taking into account the types of benefits payable to policyholders under each type of contract. Separate portfolios of assets are maintained for with-profit business, (which includes all of the Group’s participating business), non-linked non-participating business and unit-linked business.
The Group holds £2,866 billion of corporate bonds which are used to back annuity in payment liabilities in non-profit funds (this excludes the liabilities reinsured to Opal Reassurance Limited. These annuity liabilities include an aggregate credit default provision of £228 million to fund against the risk of default.
A 100 basis point widening of credit spreads, with all other variables held constant and no change in assumed expected defaults, would result in a decrease in the profit after tax in respect of a full financial year, and in equity, of £51 million (2011: £82 million).
Credit risk is managed by the monitoring of aggregate Group exposures to individual counterparties and by appropriate credit risk diversification. The Group manages the level of credit risk it accepts through credit risk tolerances. In certain cases, protection against exposure to particular credit risk types may be achieved through the use of derivatives. The credit risk borne by the shareholder on with-profit policies is dependent on the extent to which the underlying insurance fund is relying on shareholder support.
Fixed and variable rate income securities 40,760 – – – – 132 40,892 Reinsurers’ share of insurance contract liabilities 3,204 – – – – – 3,204 Reinsurance receivables 64 – – – – – 64 Prepayments and accrued income 500 – – – – – 500 Other receivables 439 – – – – – 439 Cash and cash equivalents 8,882 – – – – 146 9,028
Other receivables 200 – – – – – 200 Cash and cash equivalents 11,591 – – – – 132 11,723
The Group is also exposed to concentration risk with outsource 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 stock 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).
42.3.2 Market risk Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market influences. Market risk comprises interest rate risk, currency risk and other price risk (comprising equity risk, property risk, inflation risk and alternative asset class risk).
Notes to the consolidated financial statements continued 42. Risk management (continued) 42.3 Financial risk analysis (continued) The Group manages the levels of market risk that it accepts through an approach to investment management that determines: − the constituents of market risk for the Group; − the basis used to fair value financial assets and liabilities; − the asset allocation and portfolio limit structure; − diversification from and within benchmarks by type of instrument and geographical area; − the net exposure limits by each counterparty or group of counterparties, geographical and industry segments; − control over hedging activities; − reporting of market risk exposures and activities; and
− monitoring of compliance with market risk policy and review of market risk policy for pertinence to the changing environment.
An increase of 1% in interest rates, with all other variables held constant, would result in an increase in the profit after tax in respect of a full financial year, and in equity, of £41 million (2011: an increase of £2 million). A decrease of 1% in interest rates, with all other variables held constant, would result in a decrease in profit after tax in respect of a full financial year, and in equity, of £79 million (2011: a decrease of £6 million).
A 10% increase in property prices, with all other variables held constant, would result in an increase in the profit after tax in respect of a full financial year, and in equity, of £20 million (2011: £45 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 experienced and implied 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.
Sensitivity of profit after tax and equity to fluctuations in currency exchange rates is not considered significant at 31 December 2012, since unhedged exposure to foreign currency was relatively low (2011: not considered significant).
42.3.3 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.
The Board of Phoenix Group Holdings has defined a number of governance objectives and principles and the liquidity risk frameworks of each subsidiary are designed to ensure that: − liquidity risk is managed in a manner consistent with the subsidiary company Boards’ strategic objectives, risk appetite and Principles and Practices of Financial Management (‘PPFM’); − cash flows are appropriately managed and the reputation of the Group is safeguarded; and
− appropriate information on liquidity risk is available to those making decisions.
The Group’s policy is to maintain sufficient liquid assets of suitable credit quality at all times including, where appropriate, by having access to borrowings so as to be able to meet all foreseeable current liabilities as they fall due in a cost-effective manner. Forecasts are prepared regularly to predict required liquidity levels over both the short and medium term allowing management to respond appropriately to changes in circumstances.
The vast majority of the Group’s derivative contracts are traded OTC (over-the-counter) and have a two day collateral settlement period. The Group’s derivative contracts are monitored daily, via an end of day valuation process, to assess the need for additional funds to cover margin or collateral calls.
Some of the Group’s commercial property investments are held through collective investment schemes which are either managed or overseen by Ignis Asset Management. The collective investment schemes have the power to restrict and/or suspend withdrawals, which would, in turn, affect liquidity. To date, the collective investment schemes have continued to process both investments and realisations in a normal manner and have not imposed any restrictions or delays.
The following table provides a maturity analysis showing the remaining contractual maturities of the Group’s undiscounted financial liabilities and associated interest. Liabilities under insurance contract contractual maturities are included based on the estimated timing of the amounts recognised in the statement of consolidated financial position in accordance with the requirements of IFRS 4: less or on demand £m 1–5 years £m
The Group has a number of small books of general insurance which are currently classified as amounts held for sale. These have been closed to new business for a number of years and are in run-off. Further information can be found in note 3.
An increase of 5% in annuitant longevity, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full year, and a decrease in equity of £130 million (2011: £186 million).
An increase of 25% in lapse rates, with all other variables held constant, would result in an increase in the profit after tax in respect of a full year, and an increase in equity of £47 million (2011: £51 million).
42.5.1 Assumptions Valuation of participating insurance and investment contracts For participating business, which is with-profit business (insurance and investment contracts), the insurance contract liability is calculated on a realistic basis, adjusted to exclude the shareholders’ share of future bonuses and the associated tax liability. This is a market consistent valuation, which involves placing a value on liabilities similar to the market value of assets with similar cash flow patterns.
Notes to the consolidated financial statements continued 42. Risk management (continued) 42.5 Insurance risk (continued) During the year a number of changes were made to assumptions to reflect changes in expected experience or to harmonise the approach across the enlarged Group. The impact of material changes during the year was as follows: Increase/ (decrease) in insurance liabilities
Notes to the consolidated financial statements continued 42. Risk management (continued) 42.5 Insurance risk (continued) 42.5.2 Managing product risk The following sections give an assessment of the risks associated with the Group’s main life assurance products, as shown below, and the ways in which the Group manages those risks.
Life: Immediate annuities 76 – 6 – Unitised with-profit 721 773 2 – Life with-profit 5,298 – 13 –
Life: Immediate annuities 101 – 6 – Unitised with-profit 859 832 2 – Life with-profit 6,083 – 11 –
Unitised and traditional with-profit policies are exposed to equivalent risks, the main difference being that unitised with-profit policies purchase notional units in a with-profit fund whereas traditional with-profit policies do not. Benefit payments for unitised policies are then dependent on unit prices at the time of a claim, although charges may be applied. A unitised with-profit fund price is typically guaranteed not to fall and increases in line with any discretionary bonus payments over the course of 1 year.
Notes to the consolidated financial statements continued 42. Risk management (continued) 42.5 Insurance risk (continued) 42.5.2 Managing product risk (continued) Deferred annuities Deferred annuity policies are written to provide either a cash benefit at retirement, which the policyholder can use to buy an annuity on the terms then applicable, or an annuity payable from retirement. The policies contain an element of guarantee expressed in the form that the contract is written in i.e. to provide cash or an annuity. Deferred annuity policies written to provide a cash benefit may also contain an option to convert the cash benefit to an annuity benefit on guaranteed terms; these are known as GAR policies. Deferred annuity policies written to provide an annuity benefit may also contain an option to convert the annuity benefit into cash benefits on guaranteed terms; these are known as Guaranteed Cash Option (‘GCO’) policies.
The pricing assumption for mortality risk is based on both historic internal information and externally generated information on mortality experience, including allowances for future mortality improvements. Pricing will also include a contingency margin for adverse deviations in assumptions.
43. Operating leases Operating lease rentals charged within administrative expenses amounted to £14 million (2011: £16 million).
To subscribe to private equity funds and other unlisted assets 286 356 To purchase, construct or develop investment property 46 61 For repairs, maintenance or enhancements of investment property 2 1 To acquire property, plant and equipment 5 –
Pearl Group Staff Pension Scheme Investment management fees 0.6 0.1 0.6 0.2 Payment of administrative expenses (4.0) – (4.0) –
The Pearl Scheme has invested in collective investment schemes that are controlled by the Group. At 31 December 2012 the Pearl Scheme held 458,795 units (2011: 1,118,197 units) in the Ignis Systematic Strategies Fund and 121,909,177 units (2011: 53,243,341 units) in the Ignis Liquidity Fund. The value of these investments at 31 December 2012 was £70 million (2011: £169 million) and £122 million (2011: £53 million) respectively.
Notes to the consolidated financial statements continued 46. Contingent liabilities In the normal course of business the Group is exposed to certain legal issues, which involve litigation and arbitration. At the period end, the Group has a number of contingent liabilities in this regard, none of which are considered by the directors to be material.
47. Group entities As at 31 December 2012, 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 National Provident Life Limited (life assurance company) UK Ordinary shares of £1
UK ‘A’ ordinary shares of £0.05 ‘B’ ordinary shares of £1
ordinary shares of £1 Opal Reassurance Limited (reassurance company) Bermuda ‘A’ ordinary shares of £1
Preference 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 Preference shares of £1
PGH (TC1) Limited (holding company) UK ‘A’ ordinary shares of £1 and Preference shares of £1
PGH (TC2) Limited (holding company) UK ‘A’ ordinary shares of £1 and Preference shares of £1
Phoenix Life Holdings Limited (holding company) UK Ordinary shares of £1 UK Commercial Property Trust Limited
(ii) 0.5% per annum if additional target repayments of £60 million per annum have not occured within the required period. The additional interest charge applies from the end of the period when the repayment was due until the repayment had been made.
The life companies’ debt portfolio was £33.7 billion at 31 December 2012. Shareholders had direct exposure to £11.4 billion of these assets (including supported participating funds), of which 94% 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 management fee, which is dependent on the underlying assets.
Sovereign and supranational debt represented 47% of the debt portfolio in respect of shareholder exposure, or £5.4 billion, at 31 December 2012. The vast majority of the life companies’ exposure to sovereign and supranational debt holdings is to UK gilts.
Ireland – – – – – Greece – – – – –
At 31 December 2012, the life companies had £4 million shareholder exposure to sovereign debt of the Peripheral Eurozone, defined as Portugal, Italy, Ireland, Greece and Spain. This exposure has been reduced from £9 million at 31 December 2011. This reduction of £5 million reflects a decision to reduce the levels of Peripheral Eurozone sovereign debt in certain funds.
MCEV supplementary information 184 Phoenix Group Holdings Annual Report and Accounts 2012
Statement of Directors’ responsibilities in respect of the Market Consistent Embedded Value (‘MCEV’) basis
– no allowance for the costs of residual non-hedgeable risk has been made.
– provided additional disclosures when compliance with the specific requirements of the MCEV principles is insufficient to enable users to understand the impact of particular transactions, other events and conditions and the Group’s financial position and financial performance.
Opinion In our opinion the Phoenix Group MCEV supplementary information, for the year ended 31 December 2012, has been prepared, in all material respects, in accordance with the basis of preparation set out on pages 191 to 194.
Other matter Ernst & Young Accountants LLP have reported separately on the IFRS consolidated financial statements of Phoenix Group Holdings for the year ended 31 December 2012. The information contained in the Phoenix Group MCEV supplementary information should be read in conjunction with the IFRS consolidated financial statements.
Life MCEV operating earnings 360 556 Management services operating profit 28 17 Ignis Asset Management operating profit 43 46 Group costs (25) (54) Group MCEV operating earnings before tax 406 565 Economic variances on life business 24 (426) Economic variances on non-life business (6) 38 Other non-operating variances on life business 39 (12) Non-recurring items on non- life business (39) (9) Finance costs attributable to owners (123) (123) Group MCEV earnings before tax 301 33 Tax on operating earnings (99) (148) Tax on non-operating earnings – 169 Total tax (99) 21 Group MCEV earnings after tax 202 54 1 During 2012, the Group has amended its MCEV policy for recognising contributions to Group pension schemes in an IFRS (IAS 19) surplus position (refer note 1 g). The 2011 comparatives have been restated in this regard. The impact of the 2011 restatement is to reduce ‘Group costs’ by £30 million from £84 million to £54 million, to increase ‘Tax on operating earnings’ by £7 million from £141 million to £148 million and other comprehensive income reduces by £23 million.
2 Based on 173 million shares (2011: 171 million) as set out in note 14 of the IFRS consolidated financial statements.
Statement of consolidated comprehensive income – Group MCEV basis For the year ended 31 December 2012 £m
Reconciliation of movement in equity – Group MCEV basis For the year ended 31 December 2012 £m
Movement in equity for equity-settled share-based payments 5 6 Dividends paid on ordinary shares (73) (72) Shares issued in lieu of dividends 1 17 Total capital and dividend flows – external (67) (49)
Group MCEV analysis of earnings For the year ended 31 December 2012
2 Removal of value attributed to contingent loans issued by holding companies to long-term funds as their expected repayments are captured within the MCEV VIF calculations.
– the asset management and management service companies values are calculated on an IFRS basis. Under CFO Forum principles and guidance productivity gains should not be recognised until achieved. This treatment is inconsistent with the cost profile of a closed fund where continual cost reductions are expected to maintain unit costs as the business runs off. In the opinion of the Directors, if the MCEV principles and guidance were to be applied to the asset management and the management service companies, it would not provide a fair reflection of the Group’s financial position. These companies are therefore reported alongside the Group’s other holding companies at their IFRS net asset value.
In January 2013 the Group announced the re-terming of the Impala facility and an equity raising of £250 million. The equity raising comprised equity placings with certain Och-Ziff funds and an open offer to raise aggregate gross proceeds of £250 million through the issuance on 21 February 2013 of 50 million ordinary shares. The Group MCEV reported at 31 December 2012 does not include the proceeds of the equity raising net of deduction of commissions, fees and expenses of £232 million and has not allowed for the arrangement and restructuring fees of £21 million paid in connection with the amendments to the Impala facility agreement and £450 million prepayment on 22 February 2013. The value of in-force business has been reduced by £21 million to reflect the lower level of tax attributes expected to be available to relieve tax on emerging surpluses due to the accelerated repayment of debt.
The Finance Act 2012 set the rate of corporation tax at 23% from 1 April 2013. Consequently a rate of 23% has been used for the 2012 closing MCEV. Further reductions to 21% in April 2014 and 20% from April 2015 have been announced and will be introduced by future legislation. The impact on the Group’s MCEV from the further 3% reduction in the tax rate is not expected to be significant and will be recognised as the legislation is substantively enacted.
The 2012 MCEV allows for the new rules for the taxation of insurance companies introduced by the Finance Act 2012 with effect from 1 January 2013. The new rules did not have a significant impact on the Group’s MCEV.
On 27 June 2012 the Group announced that it had entered into a reinsurance agreement, effective 1 July 2012, to transfer approximately £5 billion of annuity in-payment liabilities, around 40% of the Group’s annuity portfolio, to Guardian Assurance Limited (‘Guardian’). It is expected that the reinsurance agreement will be replaced by a formal Part VII transfer of the annuity liabilities to Guardian in the second half of 2013. The 31 December 2012 Group MCEV allows for the negative impact of the reinsurance agreement of £84 million and the expense savings of £122 million expected following the Part VII transfer of the annuity liabilities to Guardian.
Time value of financial options and guarantees (‘TVFOGs’) The Group’s embedded value includes an explicit allowance for the time value of financial options and guarantees embedded within insurance contracts, including investment performance guarantees on participating business and guaranteed vesting annuity rates. The cost of these options and guarantees to shareholders is calculated using marketconsistent stochastic models calibrated to the market prices of financial instruments as at the period end.
Required capital is defined as the 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. This equates to 150% of the Pillar 1 minimum regulatory capital requirement or 129% of the Pillar 2 minimum regulatory capital requirement (2011: 154% Pillar 1,128% Pillar 2).
For with-profits business the CNHR would increase the TVFOGs by £52 million (2011: £46 million).
The time value of options and guarantees used in the calculation of MCEV also allows for expected management action and policyholder response to the varying external economic conditions simulated by the economic scenario generators. Policyholder response has been modelled based on historical experience. Management actions have been set in accordance with each life company’s Principles and Practices of Financial Management.
During 2012, the Group amended its MCEV policy for recognising contributions to pension schemes in an IFRS surplus position. Prior to 2012, these contributions were recognised in ‘Group costs’. These contributions are now recognised in other comprehensive income along with actuarial gains and losses on Group schemes that are in an IFRS deficit, so that these non-operating items are treated consistently.
The net worth of covered business of £886 million at 31 December 2012 (2011: £1,175 million) consists of £514 million of free surplus in excess of required capital (2011: £11 million).
Total £m 6. Assumptions Reference rates (a) Risk-free rates Risk-free rates are based on the annually compounded UK Government bond nominal spot curve plus 10 basis points, extrapolated as necessary to meet the term of the liabilities.
Had the Group used the swap rate curve as set out in the CFO Forum principles, the MCEV would have been £168 million lower (2011: £50 million lower).
Inflation For purposes of the MCEV calculation, the rate of increase in the UK Retail Price Index (‘RPI’) as at 31 December 2012 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 plus 100 basis points as at 31 December 2012 (2011: RPI plus 100 basis points).
Real interest rates have been modelled using the two-factor Vasicek model, calibrated to index-linked gilts.
Notes to the MCEV financial statements continued 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 its in-force business is more appropriate than using a shortterm 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.
Expenses Each life company’s projected per policy expenses are based on existing management services agreements with the Group’s management service companies, adjusted to allow for additional costs incurred directly by the life companies, including, for example, regulatory fees and one-time expenses.
Valuation of debt and non-controlling interests The Group’s consolidated balance sheet as at 31 December 2012 includes Perpetual Reset Capital Securities with principal outstanding of £425 million (2011: £425 million) and subordinated debt with a face value of £200 million (2011: £200 million). These listed securities have been included within the MCEV at their market value quoted at the reporting date.
Listed debt and non-controlling interests Perpetual Reset Capital Securities 444 286 444 256 Phoenix Life Limited subordinated debt 211 173 211 139
Unlisted debt Pearl and Impala facilities 2,307 2,471 Royal London PIK notes and facility 116 111
Additional information In this section 201 Shareholder information 204 Glossary 200 Phoenix Group Holdings Annual Report and Accounts 2012
The voting results for our 2013 AGM, including proxy votes and votes withheld, will be available on the Group’s website shortly after the meeting.
Phoenix Group Holdings share price performance Price (rebased to PHNX) pence
Dividend mandates Shareholders may find it convenient to have their dividends paid directly to their bank or building society account. If you wish to take advantage of this facility please call Computershare and request a ‘Dividend Mandate’ form.
– Report the matter to the FSA by calling 0845 606 1234
Share price You can access the current share price of Phoenix Group Holdings on the Group’s website.
Group financial calendar for 2013 Annual General Meeting 2 May 2013 Announcement of first quarter interim management statement 3 May 2013 Announcement of unaudited six months’ interim results 23 August 2013 Announcement of third quarter interim management statement 25 October 2013 Ordinary shares – 2012 final dividend Ex-dividend date 3 April 2013 Record date 5 April 2013 Payment date for the recommended final dividend 3 May 2013
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
– Inability of reinsurers to meet obligations or unavailability of reinsurance coverage
Black-Scholes A mathematical model used to calculate the value of an option
CFO Forum A high-level discussion group formed of the Chief Financial Officers of major European insurance companies. Its aim is to influence the development of financial reporting and related regulatory developments for insurance companies on behalf of its members
EEA European Economic Area – Established on 1 January 1994 and is an agreement between Norway, Iceland, Liechtenstein and the European Union. It allows these countries to participate in the EU’s single market without joining the EU
The UK’s independent regulator responsible for promoting high quality corporate governance and reporting to foster investment
Gross MCEV Gross MCEV is the sum of the Group MCEV and the value of the shareholder and hybrid debt as included in the MCEV
Refers to Phoenix Group Holdings, Phoenix Life Holdings Limited, Pearl Group Holdings (No. 2) Limited, Impala Holdings Limited, Pearl Group Holdings (No. 1) Limited, PGH (TC1) Limited, PGH (TC2) Limited, PGH (MC1) Limited, PGH (MC2) Limited, PGH (LCA) Limited, PGH (LCB) Limited, PGH (LC1) Limited, PGH (LC2) Limited and Pearl Life Holdings Limited
ICA+ The FSA has indicated that due to continuing uncertainties over the timetable for the introduction of Solvency II, it will work with the industry to enhance the existing Pillar 2 ICA regime to an ‘ICA+’ regime leveraging the investments firms have made preparing for Solvency II
IGD Insurance Groups Directive – The European Directive setting out the current capital adequacy regime for insurance groups as implemented by the FSA. IGD surplus is defined as Group Capital Resource (‘GCR’) less the Group Capital Resource Requirement (‘GCRR’)
MCEV Market Consistent Embedded Value – A measure of the consolidated value of shareholders’ interests calculated using the Group’s MCEV methodology as described in the Basis of preparation section of the MCEV supplementary information
MSA Management Services Agreement - Contracts that exists between Phoenix Life and management services companies or between management services companies and their outsource partners
Non-profit fund A fund which is not a with-profit fund (see below), where risks and rewards of the fund fall wholly to shareholders
PIK Payment-in-kind - Interest on a bond is paid other than in cash, most commonly by increasing the principal
Pillar 1 EU-directive-based capital requirements as implemented by the FSA for insurance companies. The Pillar 1 surplus is the excess of available capital resources over the regulatory capital resource requirements
Solvency II A fundamental review of the capital adequacy regime for the European insurance industry. Solvency II aims to establish a set of EU-wide capital requirements and risk management standards that will replace the current Solvency I requirements
UKCPT UK Commercial Property Trust Limited – A property subsidiary of the Group which is domiciled in Guernsey and listed on the London Stock Exchange
VIF The Value of In-Force business in the MCEV –The Present Value of Future Profits (‘PVFP’) plus the Time Value of Financial Options and Guarantees (‘TVFOG’) less the Frictional Cost of Required Capital (‘COC’)
WPICC With-Profit Insurance Capital Component. The WPICC is the amount by which the regulatory surplus exceeds the realistic surplus for with-profit funds
Business overview Phoenix Group is the UK’s largest specialist closed life and pension fund consolidator with approximately 6 million policyholders and £68.6 billion of assets under management.
Our Investor Relations section includes information such as our most recent news and announcements, results presentations, annual and interim reports, share-price performance, AGM and EGM information, FSA returns and contact information.