Financial liabilities designated at fair value through profit or loss upon initial recognition: During the year, updates to the Group’s observations with regard to measures of market depth, bid-ask spreads and the extent to which inputs to the valuation of fixed and variable rate income securities are market observable resulted in a net transfer of financial assets from Level 3 to Levels 1 and 2.
Financial assets designated at fair value through profit or loss upon initial recognition: Investment in joint ventures 95 30 – – – – 125 – Fixed and variable rate income securities 500 104 827 (862) 390 (24) 935 70
Financial liabilities designated at fair value through profit or loss upon initial recognition: Net asset value attributable to unitholders 70 – – (70) – – – –
Borrowings of £194 million were transferred from Level 2 to Level 3 during 2013 as a significant model input was no longer considered market observable.
34. FINANCIAL INSTRUMENTS CONTINUED 34.3 COLLATERAL ARRANGEMENTS 34.3.1 Financial instrument collateral arrangements The Group has no financial assets and financial liabilities that have been offset in the statement of consolidated financial position as at 31 December 2014 (2013: none).
Where the Group receives collateral on OTC derivatives in the form of cash it is recognised in the statement of consolidated financial position along with a corresponding liability to repay the amount of collateral received, disclosed as ‘Obligations for the repayment of collateral received’. The amounts recognised as financial assets and liabilities from cash collateral received at 31 December 2014 are set out below.
34. FINANCIAL INSTRUMENTS CONTINUED 34.3 COLLATERAL ARRANGEMENTS CONTINUED 34.3.3 Stock lending collateral arrangements The Group lends listed financial assets held in its investment portfolio to other institutions. In 2014 the stocklending programme has been wound down.
The Group conducts its stock lending programme only with well-established, reputable institutions in accordance with established market conventions. The financial assets do not qualify for derecognition as the Group retains all the risks and rewards of the transferred assets except for the voting rights.
Where the Group receives collateral 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 the collateral received. The amount recognised as a financial asset and a financial liability at 31 December 2014 is £3 million (2013: £6,743 million) and £3 million (2013: £6,743 million) respectively.
34.3.5 Repurchase agreements In November 2014 the Group entered into agreements to sell securities in the form of UK Treasury Stocks to another party with an agreement to repurchase these stocks at an agreed date and price in the future. This is effectively a short term collateralised cash loan with the securities being used as collateral. These arrangements are completed only with well-established, reputable institutions in accordance with established market conventions.
167PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2014 35.1 INTERESTS IN CONSOLIDATED STRUCTURED ENTITIES The Group has determined that where it has control over funds, these investments are consolidated structured entities.
At 31 December 2014 the Group has granted loans to the PGH EBT of £6 million (2013: £1 million). Further loans are expected to be granted in 2015. Details are provided in note 18.
A summary of the Group’s interest in unconsolidated structured entities is included below. These are shown according to the financial asset categorisation in the consolidated statement of financial position and further analysed by type of fund in which the entity is invested.
Collective Investment schemes: Directly held collective investment schemes1: Short term liquidity 873 765
Details of commitments to subscribe to private equity funds and other unitised assets are included in note 42.
Investment broker balances 98 248 Cash collateral pledged 597 422 Other debtors 55 73
37. CASH AND CASH EQUIVALENTS This note analyses the cash and cash equivalents figure included in the statement of consolidated cash flows. The accounting policy adopted in the preparation of this note is detailed in note 1(t).
Bank and cash balances 1,007 1,210 Short-term deposits (including demand and time deposits) 4,060 8,084
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 £4,821 million (2013 Restated: £8,965 million) are primarily held for the benefit of policyholders and so are not generally available for use by the owners.
Profit for the period before tax from continuing operations 465 241 Loss for the period before tax from discontinued operations (see note 4.1.1) (27) (51) Profit for the period before tax 438 190 Non-cash movements in profit for the year before tax Fair value gains on: Investment property (200) (72) Financial assets (3,494) (281)
Change in fair value of borrowings 19 36 Depreciation of property, plant and equipment – 3 Amortisation of intangible assets 98 130 Change in present value of future profits 9 (9) Change in unallocated surplus 11 77 Share-based payment charge 7 6 Interest expense on borrowings 156 230 Net interest (income)/expense on Group defined benefit pension scheme asset/liability (4) 1 Other expenses and losses on pension schemes 3 12 Gain on transfer of business (see note 4.3) – (42) Gain on sale of BAGI (see note 4.4) (4) – Gain on divestment of Ignis (see note 4.1.1) (107) –
Decrease in investment assets 5,556 7,192 Decrease in reinsurance assets 43 349 Increase/(decrease) in insurance contract and investment contract liabilities 37 (2,519) Increase/(decrease) in deposits received from reinsurers 23 (69) Decrease in obligation for repayment of collateral received (6,330) (3,174) Net decrease/(increase) in working capital 23 (1,037) Cash (utilised)/generated by operations (3,716) 1,023
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 PRA.
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: Notes £m
Difference between IFRS and MCEV carrying values of shareholder borrowings 78 (4) Gross MCEV 4,408 4,639 1 As shown in the consolidated statement of financial position.
39. CAPITAL STATEMENT CONTINUED GROUP CAPITAL CONTINUED PLHL ICA The Group undertakes a further group solvency calculation, the ‘PLHL ICA’, at the same level at which the IGD calculation is performed. This involves an assessment, on an economic basis, of the capital resources and requirements arising from the obligations and risks which exist outside of the life companies.
For this measure the capital resources include the surplus over capital policy in the life companies and the net assets of the holding companies, less the pension scheme obligations on an economic basis. The capital requirements relate to the risks arising outside of the life companies including those in relation to the Group’s staff pension schemes, offset by Group diversification benefits. As agreed with the PRA the Group aims to ensure that PLHL maintains an ICA surplus of at least £150 million. Further detail of the PLHL ICA position is provided in the business review (unaudited) on page 33.
Regulatory capital requirements of the life companies Each UK life company and the Group must retain sufficient capital at all times to meet the regulatory capital requirements mandated by the PRA. In addition to EU-directive-based ‘Pillar 1’ and group capital requirements, the PRA has also stipulated a ‘Pillar 2’ of risk-based capital requirements that have been implemented in the UK. A life company’s actual capital requirement is based on whichever of the Pillar 1 or Pillar 2 requirement turns out to be more onerous for the company. Each life company generally holds an amount of capital that is greater than the minimum required amount to allow for adverse events in the future that may use capital and might otherwise cause the company to fail the minimum level of regulatory capital test.
Pillar 1 With the exception of with-profit businesses, the regulatory capital requirement under Pillar 1 is the total amount held in respect of investment, expense and insurance risks (the ‘long-term insurance capital requirement’ (‘LTICR’)) and any additional amounts required to cover the more onerous of two specified stress tests (the ‘resilience capital requirement’ (‘RCR’)). The regulatory capital requirement is then deducted from the available capital resources to give the excess capital on a regulatory basis.
An alternative test to the RCR is required under Pillar 1 in respect of with-profit funds which may result in an additional capital requirement referred to as the ‘with-profit insurance capital component’ (‘WPICC’).
Regulatory capital position statement for the life companies The purpose of the capital position statement is to set out the Pillar 1 capital resources of the Group’s life companies calculated in accordance with the regulatory rules applicable to individual life companies. It provides an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital position statement also provides a reconciliation of the life companies owners’ funds to regulatory capital and an analysis of the regulatory capital between the Group’s with-profits funds, non-participating business and life business owners’ funds.
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. Restrictions apply to certain of these arrangements which require the PRA to approve the repayment of these loan arrangements. 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.
Owners’ funds held outside long-term fund – – 1,590 1,590 476 2,066 Owners’ funds held in long-term fund – 299 – 299 – 299
Notes 1 Regulatory adjustments to assets reflect adjustments to derecognise inadmissible assets such as intangibles and deferred tax assets as well as those adjustments that are necessary where asset and counterparty exposures exceed the prescribed regulatory limits.
3 Of the £434 million ((2013: £450 million) subordinated debt attributed to the Phoenix Life segment of the Group, £234 million (2013: £250 million) is internal to the Group. The remaining £200 million (2013: £200 million) is external subordinated debt, see note 23 for details.
An analysis of the movement in available capital resources for the period 1 January 2014 to 31 December 2014 is shown below: With-profit
Total available capital resources at 1 January 2014 1,496 616 1,345 179 615 772 59 1,207 6,289
Financing Costs – – – – – – – (15) (15) Intragroup Loan Interest – – – – – – 11 19 30 Changes in methodology and assumptions: Management actions: Distributions made by Phoenix Life – – – – – – – (466) (466)
Adjustment for internal loans in excess of counterparty limits – – – – – – – 63 63
New business and other factors: Adjustment for internal loans in excess of counterparty limits – – – – – – (75) (92) (167)
175PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2014 40. RISK MANAGEMENT This note sets out the major risks that the Group businesses are exposed to and describes the Group’s approach to managing these. The Group’s risk management framework is described in the risk management commentary on pages 36 to 41 of the Annual Report and Accounts.
40.1 RISK AND CAPITAL MANAGEMENT OBJECTIVES The risk management objectives and policies of the Group are based on the requirement to protect the Group’s regulatory capital position, thereby safeguarding policyholders’ guaranteed benefits whilst also ensuring the Group can meet its various cash flow requirements. Subject to this, the Group seeks to use available capital to achieve increased returns, balancing risk and reward, to generate additional value for policyholders and shareholders.
40.2 FINANCIAL RISK AND THE ASSET LIABILITY MANAGEMENT (‘ALM’) FRAMEWORK The use of financial instruments naturally exposes the Group to the risks associated with them, mainly, market risk, credit risk and financial soundness risk.
40.3 FINANCIAL RISK ANALYSIS Transactions in financial instruments result in the Group assuming financial risks. These include credit risk, market risk and financial soundness risk. Each of these are described below, together with a summary of how the Group manages them.
There are two principal sources of credit risk for the Group: – Credit risk which results from direct investment activities, including investments in fixed and variable rate income securities, derivatives, collective investment schemes and the placing of cash deposits; and
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 £97 million (2013: £84 million).
40. RISK MANAGEMENT CONTINUED 40.3 FINANCIAL RISK ANALYSIS CONTINUED A 100 basis point narrowing of credit spreads, with all other variables held constant and no change in assumed expected defaults, would result in an increase in the profit after tax in respect of a full financial year, and in equity, of £102 million (2013: £81 million).
Fixed and variable rate income securities 4,777 17,184 6,824 4,065 529 505 441 59 34,384 Reinsurers’ share of insurance contract liabilities – 631 2,138 2 – – 1 – 2,772 2013 Restated
Greater than 90 days £m Impaired £m Unit-linked £m Carrying value £m
Fixed and variable rate income securities 35,349 – – – – 111 35,460 Reinsurers’ share of insurance contract liabilities 2,851 – – – – – 2,851 Reinsurance receivables 34 – – – – – 34 Prepayments and accrued income 462 – – – – – 462
Please refer to page 200 for additional life company asset disclosures which include the life companies’ exposure to peripheral Eurozone debt securities. Peripheral Eurozone is defined as Portugal, Spain, Italy, Ireland and Greece. The Group’s exposure to peripheral Eurozone debt continues to be relatively small compared to total assets under management.
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.
– the income flow of management charges from the invested assets of the business.
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 £24 million (2013: an increase of £105 million).
A 10% increase in equity prices, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full financial year, and in equity, of £36 million (2013: a decrease of £35 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 £28 million (2013: an increase of £23 million).
40. RISK MANAGEMENT CONTINUED 40.3 FINANCIAL RISK ANALYSIS CONTINUED Certain Phoenix Life with-profit funds have an exposure to overseas assets which is not driven by liability considerations. The purpose of this exposure is to reduce overall risk whilst maximising returns by diversification. This exposure is limited and managed through investment mandates which are subject to the oversight of the Investment committees of the Boards of each life company. Fluctuations in exchange rates from certain holdings in overseas assets are hedged against currency risks.
Sensitivity of profit after tax and equity to fluctuations in currency exchange rates is not considered significant at 31 December 2014, since unhedged exposure to foreign currency was relatively low (2013: not considered significant).
– appropriate information on liquidity risk is available to those making decisions.
The vast majority of the Group’s derivative contracts are traded OTC 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.
Net asset value attributable to unitholders 5,744 – – – 5,744 Obligations for repayment of collateral received 6,981 67 236 – 7,284 Reinsurance payables 12 – – – 12 Payables related to direct insurance contracts 395 – – – 395 Accruals and deferred income 139 – – – 139 Other payables 307 – – – 307 1 These financial liabilities are disclosed at their undiscounted value and therefore differ to the statement of consolidated financial position which discloses the discounted value.
40.4 UNIT-LINKED CONTRACTS For unit-linked contracts the Group matches all the liabilities with assets in the portfolio on which the unit prices are based. There is therefore no interest, price, currency or credit risk for the Group on these contracts.
OPTIONS unanticipated changes in policyholder option exercise rates giving rise to increased claims costs.
It is therefore necessary for the Directors of each life company to make decisions, based on actuarial advice, which ensure an appropriate accumulation of assets relative to liabilities. These decisions include investment policy, bonus policy and, where discretion exists, the level of payments on early termination.
An increase of 5% in assurance mortality, 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 £14 million (2013: £18 million).
A decrease of 5% in annuitant longevity, with all other variables held constant, would result in an increase in the profit after tax in respect of a full year, and an increase in equity of £135 million (2013: £117 million).
An increase of 5% in annuitant longevity, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full year, and a decrease in equity of £135 million (2013: £116 million).
A decrease of 25% in lapse rates, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full year, and a decrease in equity of £53 million (2013: £50 million).
40.5.1 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.
During the year a number of changes were made to assumptions to reflect changes in expected experience or to harmonise the approach across the enlarged Group. The impact of material changes during the year was as follows: Decrease in insurance liabilities 2014 £m
Assets are firstly hypothecated to classes of business being valued. The valuation interest rates for each block of business are based on the expected returns of the hypothecated assets. The yield is then adjusted to make allowance for credit risk, liquidity risk, reinvestment risk and investment management expenses.
Valuation interest rates (after tax for life policies) are typically in the following ranges: Expense inflation Expenses are assumed to increase at the rate of increase in the Retail Price Index (‘RPI’) plus fixed margins in accordance with the various management service agreements (‘MSAs’) the Group has in place with outsource partners. For with-profit business the rate of RPI inflation is determined within each stochastic scenario. For other business it is based on the Bank of England inflation spot curve. For MSAs with contractual increases set by reference to national average earnings inflation, this is approximated as RPI inflation plus 1%. In instances in which inflation risk is not mitigated, a further margin for adverse deviations may then be added to the rate of expense inflation.
There are guaranteed surrender values on a small number of older contracts.
Some pensions contracts include guaranteed annuity options (see deferred annuities in note 40.5.2 for details). The total amount provided in the with-profit and non-profit funds in respect of the future costs of guaranteed annuity options are £1,809 million (2013: £1,575 million) and £6 million (2013: £29 million) respectively.
The table above excludes insurance contract liabilities and related reinsurer’s share of insurance contract liabilities classified as held for sale at 31 December 2014.
With-profit funds: Pensions: Deferred annuities – with guarantees 8,753 158 584 – Deferred annuities – without guarantees 1,698 – – – Immediate annuities 2,886 – 714 – Unitised with-profit 1,086 8,682 4 –
Life: Immediate annuities 62 – 5 – Unitised with-profit 648 694 2 – Life with-profit 4,448 – 12 1
Market and credit risk is influenced by the extent to which the cash flows under the contracts have been matched by suitable assets which is managed under the ALM framework. Asset/liability modelling is used to monitor this position on a regular basis.
40.6 OTHER RISKS 40.6.1 Customer risk Customer risk is the risk of reductions in earnings and/or value, through inappropriate or poor customer treatment (including poor advice).
40.6.2 Operational risk Operational risk is the risk of reductions in earnings and/or value, through financial or reputational loss, from inadequate or failed internal processes and systems, or from people related or external events.
187PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2014 41. OPERATING LEASES This note gives details of the Group’s commitments under operating leases. The accounting policy adopted in the preparation of this note is detailed in note 1(cc).
Not later than 1 year 10 14 Later than 1 year and not later than 5 years 33 45 Later than 5 years 7 15
To subscribe to private equity funds and other unlisted assets 334 371 To purchase, construct or develop investment property 28 33 For repairs, maintenance or enhancements of investment property 2 3 To acquire property, plant and equipment – 5 43. RELATED PARTY TRANSACTIONS This note gives details of the transactions between Group companies and related parties which comprise our pension schemes and key management personnel.
Pearl Group Staff Pension Scheme Payment of administrative expenses (4) – (4) –
The Pearl Scheme has invested in collective investment schemes that are controlled by the Group. At 31 December 2014 the Pearl Scheme held nil units (2013: 59,138,904 units) in the Castle Hill Enhanced Floating Rate Opportunities Limited Fund. The value of these investments at 31 December 2014 was £nil million (2013: £97 million).
43. RELATED PARTY TRANSACTIONS CONTINUED TRANSACTIONS WITH KEY MANAGEMENT PERSONNEL The total compensation of key management personnel, being those having authority and responsibility for planning, directing and controlling the activities of the Group, including the Executive and Non-Executive Directors, are as follows: 2013 £m
Insurance companies National Provident Life Limited (life assurance company) UK Phoenix Life Assurance Limited (life assurance company) UK Phoenix Life Limited (life assurance company) UK Scottish Mutual International Limited (life assurance company) ROI Non-insurance companies Impala Holdings Limited (holding company) UK Mutual Securitisation plc (finance company) ROI NP Life Holdings Limited (holding company) UK Opal Reassurance Limited (reassurance company)1 Bermuda PGH Capital Limited1 ROI PGH (LCA) Limited (finance company)1 UK PGH (LCB) Limited (finance company)1 UK PGH (LC1) Limited (finance company) UK PGH (LC2) Limited (finance company) UK PGH (MC1) Limited (finance company) UK PGH (MC2) Limited (finance company) UK PGH (TC1) Limited (holding company)1 UK PGH (TC2) Limited (holding company)1 UK Pearl Group Holdings (No. 1) Limited (finance company) UK Pearl Group Holdings (No. 2) Limited (holding company) UK Pearl Life Holdings Limited (holding company) UK Pearl Group Services Limited (management services company) UK Pearl Group Management Services Limited (management services company) UK Phoenix Life Holdings Limited (holding company) UK UK Commercial Property Trust Limited (property fund)2 Guernsey 1 These subsidiary undertakings are directly owned by Phoenix Group Holdings.
The information disclosed in the table is only in respect of those undertakings which materially affect the figures shown in the Group’s consolidated financial statements. These subsidiaries are wholly-owned unless otherwise indicated. There are a number of other subsidiaries and associated undertakings whose business does not materially affect the Group’s profits or the amount of its assets and particulars of these have been omitted in view of their excessive length. The information excludes collective investment schemes which have been consolidated within the Group financial statements.
In January 2015, the Group exchanged 99% of the Notes for £428 million of new subordinated notes issued by PGH Capital Limited and maturing in 2025. The terms of the new notes meet the requirement of Tier 2 capital under Solvency II and have a coupon of 6.625%. Upon exchange, £32 million of the new notes were held by Group companies.
Total comprehensive income for the year attributable to owners 125 92
The Company is exempt from tax in the Cayman Islands on any profits, income, gains or appreciations for a period of 30 years from 11 May 2010.
There are no other comprehensive income items for 2014 and 2013.
EQUITY AND LIABILITIES Equity attributable to owners Share capital 16 – – Share premium 976 1,095 Foreign currency translation reserve 89 89 Retained earnings 389 257
ASSETS Investments in Group entities I 1,317 1,308 Financial assets Collective investment schemes J 5 6 Loans and receivables K 270 244
Other amounts due from Group entities Q 8 5 Cash and cash equivalents L 3 9
Cash flows from operating activities Cash generated by operations M 15 75 Net cash flows from operating activities 15 75
Cash flows from investing activities Dividends received from Group entities 85 50 Loan advance to Group entities (6) (11) Repayment of loan from Group entities 1 29 Interest received from Group entities 18 19 Capital contributions to Group entities – (282) Net cash flows from investing activities 98 (195)
Cash flows from financing activities Proceeds from issuing ordinary shares, net of associated commission and expenses 1 233 Ordinary share dividends paid (120) (120) Net cash flows from financing activities (119) 113
Net decrease in cash and cash equivalents (6) (7) Cash and cash equivalents at the beginning of the year 9 16 Cash and cash equivalents at the end of the year L 3 9
A. ACCOUNTING POLICIES (a) BASIS OF PREPARATION The financial statements have been prepared on an historical cost basis except for those financial assets and financial liabilities that have been measured at fair value.
(i) Investments in Group entities Investments in Group entities are carried in the statement of financial position at cost less impairment.
B. FINANCIAL INFORMATION In preparing the financial statements the Company has adopted the standards, interpretations and amendments effective 1 January 2014 which have been issued by the IASB as detailed in note 2 of the consolidated financial statements, none of which have had a significant impact on the Company’s financial statements. Details of standards, interpretations and amendments to be adopted in future periods are also detailed in note 2.
Investment income Dividend income from other Group entities 94 58 Interest income from other Group entities 48 49
On 16 July 2010, the Company was granted a loan from Impala Holdings Limited of £3 million. The loan accrues interest at six-month LIBOR plus 3.25% (2013: 2%) which is capitalised semi-annually on 7 April and 7 October. The loan has a maturity date of 31 December 2016. Interest of £0.1 million (2013: £0.1 million) was accrued during the year. The balance outstanding at 31 December 2014 was £3 million (2013: £3 million).
All borrowings are categorised as Level 3 financial instruments. The fair value of borrowings with no external market is determined by internally developed discounted cash flow models using a risk adjusted discount rate corroborated with external market data where possible.
Warrants over shares in Phoenix Group Holdings – 5 – 5
On 27 February 2013, the Company made capital contributions of £116 million to each of PGH (TC1) Limited and PGH (TC2) Limited.
On 22 March 2010, the Company subscribed for £325 million of Eurobonds which were issued equally by PGH (LCA) Limited and PGH (LCB) Limited. On 23 March 2010, the Eurobonds were listed on the Channel Islands Stock Exchange. Interest accrues on these Eurobonds at a rate of LIBOR plus a margin of 2.5% and the final maturity date to 30 June 2025. The Eurobonds were initially recognised at fair value and are accreted to par over the period to 2025. At 31 December, £160 million was due (2013: £144 million).
On 16 July 2010, the Company entered into an interest free facility arrangement with Phoenix Group Holdings’ Employee Benefit (‘EBT’). In 2014, £6 million was drawn down against this facility (2013: £11 million). The loan is recoverable until the awards held by the EBT vest to the participants, at which point the loan is reviewed for impairment. Any impairments are determined by comparing the carrying value to the estimated recoverable amount of the loan. Following the vesting of awards in 2014, the value of the EBT loan of £10 million has been written off.
Details of the factors considered in determination of the fair value are included in note 34.2.1 to the consolidated financial statements.
Adjustments to reconcile profit for the year to cash flows from operating activities Interest income from other Group entities (48) (49) Fair value gains/(losses) on derivatives (5) 2 Dividends received (94) (58) Write down of loans to Group entities 10 –
Share-based payment charge 7 6 Net decrease/(increase) in investment assets 26 (6) Net (increase)/decrease in working capital (6) 88 Cash generated by operations 15 75
N. CAPITAL AND RISK MANAGEMENT The Company’s capital comprises share capital and all reserves. At 31 December 2014, total capital was £1,454 million (2013: £1,441 million). The movement in capital in the year comprises the total comprehensive income for the year attributable to owners of £125 million (2013: £92 million), proceeds from the issue of ordinary share capital, net of associated commission and expenses, of £1 million (2013: £233 million), payment of dividends of £120 million (2013: £120 million) and a credit to equity for equity-settled share-based payments of £7 million (2013: £6 million).
The principal risks and uncertainties facing the Company are: – interest rate risk, since the movement in interest rates will impact the value of interest receivable and payable by the Company; – liquidity risk, exposure to liquidity risk as a result of normal business activities, specifically the risk arising from an inability to meet short-term cash flow requirements; and
P. DIRECTORS’ REMUNERATION Details of the remuneration of the Directors of Phoenix Group Holdings is included in the Directors’ remuneration report on pages 60 to 82 of the Annual Report and Accounts.
Q. RELATED PARTY TRANSACTIONS The Company has related party transactions with Group entities and its key management personnel. Details of the total compensation of key management personnel, being those having authority and responsibility for planning, directing and controlling the activities of the Group, including the Executive and Non-Executive Directors, are included in note 43.
During the year ended 31 December 2014, the Company entered into the following transactions with Group entities: 2014 £m 2013 £m
Amounts due from related parties at the end of the year: 2014 £m 2013 £m
Loans due to Group entities 3 3 Other amounts due to Group entities 146 118
Cash and cash equivalents in Group holding companies 988 Cash and financial assets in other Group companies 116 Financial assets held by the non-controlling interest in the consolidated UKCPT 736 Financial assets held by the non-controlling interest in consolidated collective investment schemes 4,652 Adjustments on consolidation (14) Total Group consolidated assets 58,755 Comprised of: Investment property 1,858 Financial assets 54,022 Cash and cash equivalents 5,067 Derivative liabilities (2,192)
Cash and cash equivalents in Group holding companies 995 Cash and financial assets in other Group companies 224 Financial assets held by the non-controlling interest in UKCPT 584 Financial assets held by the non-controlling interest in consolidated collective investment schemes 5,579 Adjustments on consolidation 9 Total Group consolidated assets 65,944 Comprised of: Investment property 1,603 Financial assets 57,208 Cash and cash equivalents 9,294 Derivative liabilities (2,161)
The life companies’ debt portfolio was £29.5 billion at 31 December 2014. Shareholders had direct exposure to £12.1 billion of these assets (including supported participating funds), of which 94% were investment grade rated securities. 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.
At 31 December 2014, the life companies had £5 million (2013: £4 million) shareholder exposure to sovereign debt of the Peripheral Eurozone, defined as Portugal, Italy, Ireland, Greece and Spain.
For each of the life companies’ significant financial institution counterparties, industry and other data has been used to assess the exposure of the individual counterparties. As part of the Group’s risk appetite framework and analysis of shareholder exposure to a potential worsening of the economic situation, this assessment has been used to identify counterparties considered to be most at risk from defaults. The financial impact on these counterparties, and the contagion impact on the rest of the shareholder portfolio, is assessed under various scenarios and assumptions. This analysis is regularly reviewed to reflect the latest economic outlook, economic data and changes to asset portfolios. The results are used to inform the Group’s views on whether any management actions are required.
Participating non-supported £m Unit-linked £m Total £m 97% of rated securities were investment grade at 31 December 2014 (2013: 97%). The percentage of rated securities that were investment grade in relation to the shareholder and policyholders’ funds were 95% and 98% respectively (2013: 95% and 98% respectively).
When compliance with the CFO Forum MCEV principles published in June 2008 and amended in October 2009 is stated those principles require the Directors to prepare supplementary information in accordance with the MCEV principles and to disclose and provide reasons for any non-compliance with the principles.
The MCEV methodology adopted by the Group is in accordance with these MCEV principles with the exception of: – risk-free rates have been defined as the annually compounded UK Government bond nominal spot curve plus ten basis points rather than as the swap rate curve; – the value of the asset management and the management service companies has been included on an IFRS basis; and
STATEMENT OF DIRECTORS’ RESPONSIBILITIES IN RESPECT OF THE MARKET CONSISTENT EMBEDDED VALUE
We have audited the Consolidated Phoenix Group MCEV (‘Phoenix Group MCEV’) supplementary information for the year ended 31 December 2014 which comprises the Summarised consolidated income statement – Group MCEV basis, MCEV earnings per ordinary share, Statement of consolidated comprehensive income – Group MCEV basis, Reconciliation of movement in equity – Group MCEV basis, Group MCEV analysis of earnings, Reconciliation of Group IFRS equity to MCEV net worth and related notes 1 to 7. The Phoenix Group MCEV supplementary information has been prepared by the Directors of Phoenix Group Holdings (‘the Group’) in accordance with the basis of preparation set out on pages 216 to 218.
DIRECTORS’ RESPONSIBILITIES FOR THE PHOENIX GROUP MCEV SUPPLEMENTARY INFORMATION The Directors are responsible for the preparation of the Phoenix Group MCEV supplementary information in accordance with the basis of preparation set out on pages 216 to 218 and for such internal control as the Directors determine is necessary to enable the preparation of supplementary information that is free from material misstatement, whether due to fraud or error.
OPINION In our opinion the Phoenix Group MCEV supplementary information, for the year ended 31 December 2014, has been prepared, in all material respects, in accordance with the basis of preparation set out on pages 216 to 218.
BASIS OF ACCOUNTING AND RESTRICTION ON USE Without modifying our opinion, we draw attention to pages 216 to 218 of the Phoenix Group MCEV supplementary information, which describe the basis of preparation. The Phoenix Group MCEV supplementary information is prepared by Phoenix Group Holdings in accordance with the basis of preparation set out on pages 216 to 218. As a result, the Phoenix Group MCEV supplementary information may not be suitable for another purpose. This report, including the opinion, has been prepared for and only for the Group’s Directors as a body in accordance with our letter of engagement dated 1 August 2014 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
OTHER MATTER We have reported separately on the IFRS consolidated financial statements of Phoenix Group Holdings for the year ended 31 December 2014. The information contained in the Phoenix Group MCEV supplementary information should be read in conjunction with the consolidated financial statements prepared on an IFRS basis.
INDEPENDENT AUDITOR’S REPORT TO THE DIRECTORS OF PHOENIX GROUP HOLDINGS ON THE CONSOLIDATED PHOENIX GROUP MCEV
Total tax (78) (147) Group MCEV earnings after tax 411 162 Analysed between: Group MCEV earnings after tax from continuing operations 429 204 Group MCEV earnings after tax from discontinued operations (18) (42) Group MCEV earnings after tax 411 162
2 Based on 225 million shares (2013: 212 million) as set out in note 15 of the IFRS consolidated financial statements.
213PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2014 2014 £m 2013 £m
Group MCEV earnings for the year after tax 411 162 Other comprehensive income Remeasurements and pension scheme contributions on defined benefit pension schemes (net of tax) (27) (16) Total comprehensive income for the year 384 146
RECONCILIATION OF MOVEMENT IN EQUITY – GROUP MCEV BASIS FOR THE YEAR ENDED 31 DECEMBER 2014 2014 £m 2013 £m
Issue of ordinary share capital, net of associated commissions and expenses 1 233 Dividends paid on ordinary shares (120) (120) Dividends paid on shares held by the employee trust and Group entities 1 2 Shares sold by Group entities 4 – Movement in equity for equity-settled share-based payments 7 6 Shares acquired by the employee trust (8) (11)
Capital and dividend flows – internal (421) (12) (29) 462 – Capital and dividend flows – external – – – (115) (115)
3 Comprises capital flows relating to the disposals of Ignis and BA(GI) Limited (see note 1)
2 Comprises the Group holding companies that do not form part of the Phoenix Life and Ignis divisions.
GROUP MCEV ANALYSIS OF EARNINGS FOR THE YEAR ENDED 31 DECEMBER 2014
Group net assets attributable to owners of the parent as reported under IFRS 2,365 1,909 Goodwill and other intangibles in accordance with IFRS removed (net of tax) (217) (391) Value of in-force business in accordance with IFRS removed (net of tax) (1,011) (1,083) Adjustments to IFRS reserving (130) (144) Tax adjustments 33 33 Revalue listed debt to market value (68) 5 Fair value adjustments1 – 8 Eliminate after tax pension scheme surpluses (including IFRIC 14 adjustments)2 (492) (210)
3 Includes adjustments to revalue unlisted debt carried at amortised cost under IFRS at face value.
The MCEV methodology adopted by the Group is in accordance with the MCEV principles and guidance published by the CFO Forum in June 2008 and amended in October 2009, except that: – risk-free rates have been defined as the annually compounded UK Government nominal spot curve plus 10 basis points rather than as a swap rate curve; – no allowance for the cost of residual non-hedgeable risk (‘CNHR’) has been made because, in the opinion of the Directors, the Group operates a robust outsourcer model in terms of operational risk, does not write new business, is focused entirely on the back book, and has succeeded in closing out significant legacy risks. The theoretical value of CNHR is disclosed separately in note 1(b); and
On 18 March 2014, the Group completed the sale of its entire interest in BA(GI) Limited to National Indemnity Company for cash consideration of £21 million. A gain on disposal of £4 million has been recognised in ‘non-recurring items on non-life business’.
On 25 March 2014, the Group and Standard Life Investments (Holdings) Limited (‘Standard Life Investments’) signed a disposal agreement under which Standard Life Investments agreed to acquire the entire issued share capital of Ignis in return for gross cash consideration of £390 million. The divestment was completed on 1 July 2014 and the results for the business have been included in the MCEV Supplementary Information up to this date. A post completion payment of £6 million calculated in accordance with the sale and purchase agreement, was paid to Standard Life Investments on 24 September 2014. Attributable transaction expenses were £5 million, and a gain on disposal of £288 million has been recognised in ‘non-recurring items on non-life business’. £250 million of the disposal proceeds were used to prepay the Impala loan facility.
On 7 July 2014, the Group’s new financing subsidiary, PGH Capital Limited, issued a £300 million 7 year senior unsecured bond at an annual coupon rate of 5.75%. The net proceeds from the bond issue of £296 million were used to prepay the Impala loan facility.
On 31 July 2014, the Group entered into a reinsurance agreement, effective 1 January 2014, to transfer approximately £1.7 billion of annuity in-payment liabilities, currently held within the Group’s with-profit funds, to Guardian Assurance Limited (‘Guardian’). On 11 August 2014, the Group made an associated transfer of £1.7 billion of assets to Guardian as the related reinsurance premium for the transferred annuity liabilities. It is highly probable that the reinsurance agreement will be replaced by a formal scheme under Part VII of the Financial Services and Market Act 2000 to transfer the annuity liabilities to Guardian in the second half of 2015. The adverse impact of the reinsurance transaction of £12 million has been recognised in the MCEV as at 31 December 2014.
COVERED BUSINESS The MCEV calculations cover all long-term insurance business written by the Group, but exclude Ignis and the management service companies.
The key components of MCEV are net worth plus the value of in-force covered business.
The VIF consists of the following components: Present value of future profits (‘PVFP’) The PVFP represents the present value of profits attributable to shareholders arising from the in-force business. The PVFP is calculated by projecting and discounting using risk-free rates, with an allowance for liquidity premiums where appropriate.
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 142% of the Pillar 1 minimum regulatory capital requirement or 124% of the Pillar 2 minimum regulatory capital requirement (2013: 145% Pillar 1, 128% Pillar 2).
h) Events after the reporting period On 17 March 2015, the Board recommended a final dividend of 26.7p per share (2013: 26.7p per share) for the year ended 31 December 2014. Payment of the final dividend is subject to shareholder approval at the AGM. The cost of this dividend will be charged to the Reconciliation of Movement in Equity – Group MCEV basis in 2015.
219PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2014 2. COMPONENTS OF THE MCEV OF COVERED BUSINESS
New business value 7 4 11 Expected existing business contribution (reference rate)1 31 79 110 Expected existing business contribution (in excess of reference rate)2 (8) 35 27 Transfer from VIF to net worth 179 (179) –
New business value 13 5 18 Expected existing business contribution (reference rate) 27 56 83 Expected existing business contribution (in excess of reference rate) 2 40 42 Transfer from VIF to net worth 188 (188) –
4. NEW BUSINESS The value generated by new business written during the period is calculated as the present value of the projected stream of after-tax distributable profits from that business. This contribution has been valued using economic and non-economic assumptions at the point of sale. The value of new business is shown after the effect of frictional costs of holding required capital on the same basis as for the in-force covered business.
Had the Group used the swap rate curve as set out in the CFO Forum principles, the MCEV would have been £218 million lower (2013: £160 million lower).
The liabilities to which a liquidity premium is applied include immediate annuities, pensions policies with benefits defined as an annuity or in-the-money guaranteed annuity options. The liquidity premium is determined by reference to the yield on the bond portfolios held after allowing for credit risk by deducting margins for best estimate defaults and unexpected default risk premiums. The additional yield above risk-free rates implied by the calculated liquidity premium is as follows: Additional yield over risk-free rates 0.46% 0.36%
INFLATION For purposes of the MCEV calculation, the rate of increase in the UK Retail Price Index (‘RPI’) as at 31 December 2014, 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 2014 (2013: RPI plus 100 basis points).
A LIBOR Market Model with displaced diffusion and stochastic volatility (LMM-DDSV) is used to generate risk-free rates over a complete yield curve, calibrated to the UK nominal spot curve plus 10 basis points, consistent with the deterministic projections. Interest rate volatility is calibrated to swaption implied volatilities, as per the sample below.
Real interest rates have been modelled using the two-factor Hull-White model, calibrated to index-linked gilts.
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 short-term rate and is more consistent with the Group’s expectation of longer-term rates of return. Therefore, the Group calculates the expected contribution on existing business using a 15-year gilt rate at the beginning of the reporting period plus 10 basis points and long-term expectations of excess investment returns.
Unlisted debt has been included at face value: 2014 Face value £m 2013 Face value £m
The specialist expertise of our employees is central to maximising value for customers and shareholders.
The voting results for our 2014 AGM, including proxy votes and votes withheld, will be available on the Group’s website shortly after the meeting.
Ex-dividend date 26 March 2015 Record date 27 March 2015 Payment date for the recommended final dividend 27 April 2015
Statements containing the words: ‘believes’, ‘intends’, ‘will’, ‘expects’, ‘plans’, ‘aims’, ‘seeks’, ‘targets’, ‘continues’ and ‘anticipates’ or other words of similar meaning are forward-looking. Such forward-looking statements and other financial and/or statistical data involve risk and uncertainty because they relate to future events and circumstances that are beyond the Group’s control. For example, certain insurance risk disclosures are dependent on the Group’s choices about assumptions and models, which by their nature are estimates. As such, actual future gains and losses could differ materially from those that we have estimated. Other factors which could cause actual results to differ materially from those estimated by forward-looking statements include but are not limited to: – Domestic and global economic and business conditions
– The timing, impact and other uncertainties of future acquisitions or combinations within relevant industries
As a result, the Group’s actual future financial condition, performance and results may differ materially from the plans, goals and expectations set out in the forward-looking statements within the 2014 Annual Report and Accounts.
The 2014 Annual Report and Accounts has been prepared for the members of the Company and no one else. The Company, its directors or agents do not accept or assume responsibility to any other person in connection with this document and any such responsibility or liability is expressly disclaimed.
EMBEDDED VALUE The value to equity shareholders of the net assets and expected future profits of a life company
FREE SURPLUS The amount of capital held in life companies in excess of that needed to support their minimum regulatory capital requirement, which is the greater of Pillar 1 and Pillar 2 capital requirements, plus the capital required under the Group’s capital management policy
NON-ECONOMIC ASSUMPTIONS Assumptions related to future levels of mortality, morbidity, persistency and expenses
NON-PROFIT FUND A fund which is not a with-profit fund (see page 232), where risks and rewards of the fund fall wholly to shareholders
PRA Prudential Regulation Authority – The body responsible for the prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms. The PRA and FCA use a Memorandum of Understanding to co-ordinate and carry out their respective responsibilities
TIER 1 NOTES £500 million Perpetual Reset Capital Securities issued by Pearl Group Holdings (No. 1) Limited. Following amendments to the Notes in 2010, the principal amount outstanding as at 31 December 2014 is £425 million
TOTAL SHAREHOLDER RETURN The total return, over a fixed period, to an investor in terms of share price growth and dividends (assuming that dividends paid are re-invested, on the ex-dividend date, in acquiring further shares)
UK CORPORATE GOVERNANCE CODE Standards of good corporate governance practice in the UK relating to issues such as board composition and development, remuneration, accountability, audit and relations with shareholders