For a detailed look at our business model Turn to page 12
OUR BUSINESS MODEL 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
PHOENIX LIFE Aims to deliver innovative financial management and operational excellence
delivering strong investment performance and high quality service to its clients.
Group Chief Executive Officer’s report 06 Our business model 12 Operating structure 14 Our strategy 17 Financial performance 24 Risk management 44 Corporate responsibility 51
Board of Directors 56 Our executive management team 58 Corporate governance report 59 Remuneration report 68 Directors’ report 90
During the second half of 2013, we were engaged in discussions with Swiss Re Limited (‘Swiss Re’) about the combination of Swiss Re’s UK closed life business unit, Admin Re with Phoenix. Although we announced in November that these talks had been terminated, we remain convinced that there are other opportunities for Phoenix to grow through M&A, and will continue to pursue potential transaction discussions, if we believe they meet our stated criteria.
Phoenix is a unique business, with longterm predictable cash generation and the financial and actuarial expertise to manage the run-off of in-force policies in a way which is beneficial for both policyholders and shareholders.
At our investor day in May, we focused on cash generation, management actions and opportunities for growth and talked in detail about the potential market opportunity for the consolidation of closed life funds within the UK. We estimate there are over £200 billion of assets within closed funds in the UK, and firmly believe there is value to be generated for policyholders and shareholders by these funds being owned and managed by a specialist consolidator like Phoenix. However, we will only make acquisitions if they meet our acquisition criteria of being at least MCEV neutral, helping to sustain our dividend and helping to degear the business.
HOWARD DAVIES Chairman 02 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
It is with great confidence that I look towards the future for Phoenix, and the value which can be generated for policyholders and shareholders alike.
In February, we completed the capital raising and debt re-terming, in which we raised £250 million of new equity, reduced the Group’s gearing ratio through the early repayment of £450 million of bank debt, extended the maturity of the Impala loan facility until 2019 and put in place a more flexible amortisation schedule, strengthening the Group strategically and providing us with greater flexibility over our dividend policy.
In September, we completed the legal process to formally transfer approximately £5 billion of annuity liabilities and assets to Guardian Assurance Limited (‘Guardian’), which further accelerated the release of capital, improved the Group’s solvency position and reduced our exposure to longevity risk.
We generated £817 million of cash from our operating companies in 2013, exceeding our 2013 annual cash generation target of £650 million to £750 million and continuing to demonstrate the underlying strength of the business model.
CLIVE BANNISTER Group Chief Executive Officer 06 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
The divestment of Ignis Asset Management (which is subject to regulatory approval and which is anticipated to complete by the end of the second quarter of 2014) and subsequent planned debt prepayment is expected to reduce gearing by a further 5 percentage points to 39%, thereby allowing us to accelerate the achievement of our long-term gearing target of 40% or below.
OUR CAPITAL POSITION Our estimated IGD surplus was £1.2 billion at 31 December 2013 with headroom over our IGD capital policy of £0.5 billion (2012 pro forma: £1.2 billion surplus, £0.4 billion headroom). The IGD position was strengthened by £0.2 billion through management actions including completion of the legal process to transfer the £5 billion of annuity liabilities and assets to Guardian. The divestment of Ignis Asset Management and subsequent planned debt prepayment is expected to have a broadly neutral impact on the IGD position.
The Group also 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 2013, our PLHL ICA surplus was estimated to be £1.2 billion (2012 pro forma: £0.8 billion surplus). The divestment of Ignis Asset Management and subsequent planned debt prepayment is expected to reduce the PLHL ICA surplus by £0.1 billion.
The Group’s Solvency II Delivery Programme is designed to ensure that the Group complies with the requirements of the new regime. We are working with the PRA during the pre-application period of our Internal Model and expect to make an application to the PRA to apply certain of
IFRS OPERATING PROFIT Finally, the Group achieved increased IFRS operating profits of £439 million (2012: £429 million), primarily due to higher terminal bonuses on with-profit funds, the positive impact of revised assumptions for longevity improvements and the non-recurrence of persistency assumption strengthening. This was offset by lower positive impacts from modelling improvements and policy harmonisation management actions (2013: £88 million; 2012: £117 million).
If the divestment of Ignis had occurred on 1 January 2013, the Group’s IFRS operating profits for the year ended 31 December 2013 would have been £49 million lower, reflecting the removal of Ignis’ contribution to the Group’s operating results during that period.
PHOENIX LIFE HIGHLIGHTS Phoenix Life contributed IFRS operating profit of £414 million, compared to £399 million in 2012, reflecting the abovementioned improvements compared with 2012.
One of the key successes for Phoenix Life during the second half of 2013 was the completion of the legal process to transfer approximately £5 billion of annuity liabilities and assets to Guardian.
– The outsourcing of Phoenix Life and Ignis investment administration and related back office services to HSBC Bank plc is now well progressed, with completion expected in 2015.
£439m 2012: £429m 08 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
IGNIS ASSET MANAGEMENT HIGHLIGHTS Ignis Asset Management has delivered strong financial performance with IFRS operating profits of £49 million in 2013 compared to £43 million in 2012. The growth in the third party franchise and strong investment performance have offset the natural run-off of life company assets and the impact of restructuring the former joint ventures.
Overall investment performance improved, with 85% of assets under management performing above benchmark (2012: 79%). This has been led by strong performance in Ignis’ key funds, with ARGBF delivering a 6% return over the last year (against a SONIA (Sterling Overnight Interbank Average benchmark) return of 0.4%). ARGBF also won the prestigious ‘Best Performing Fund Over 2 Years’ at the Hedge Fund Journal’s UCITS Hedge Awards 2013.
Ignis has been working to broaden its product offerings to accelerate the growth of the third party franchise. The Global Macro Government Bond Fund (‘GMGBF’) launched in October, designed as the hedge fund version of ARGBF, and building on this successful strategy, is suited to institutional clients with greater risk appetite who seek potentially greater returns. The Absolute Return Emerging Market Debt fund (‘AREMD’) was launched in November as the third fund in our absolute return fund suite.
Ignis’ strong financial performance was achieved whilst continuing to invest in major transformation in its operating platform. The joint ventures transition is nearing completion, with all of the businesses continuing on a standalone basis. The transformation partnership with HSBC Bank plc is ongoing, with completion of the back office outsourcing programme expected in 2015.
£1.9bn 2012: £1.6bn 09 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
We are backing up these improvements with policyholder research to make sure we are getting our communications right for all customers. Since 1 March 2013, we have seen an increase in the number of customers (without guarantees) taking an Open Market Option (‘OMO’) and we now have around 40% of our customers taking this option. For those customers who stay with us, our average pricing for the year was 97% of the average rate of the top five OMO providers.
By 31 December 2013, we had already achieved cash generation of £2.3 billion since 1 January 2011 against our target of £3.5 billion between 2011 and 2016. Today we have set a new long-term cash generation of £2.8 billion between 2014 and 2019 which has been set taking into account the proceeds of the divestment of Ignis. We have set the long-term target over the period to 2019, to coincide with the final maturity of the Impala loan facility in June 2019. We have also set a 2014 annual cash generation target of between £500 million and £550 million, excluding the proceeds expected to be received from the divestment.
We do not expect our financial targets to be materially impacted by the recent Budget proposals in relation to annuities.
CLIVE BANNISTER Group Chief Executive Officer 11 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
ASSET MANAGEMENT Ignis manages the funds that back the investments of Phoenix Life policyholders and develops investment propositions for third party clients in the UK and international markets.
Ignis aims to maximise risk-adjusted returns on the assets it manages for the benefit of policyholders, third party clients and shareholders.
External outsource partners are used for policy administration, thereby minimising fixed costs. This provides a more efficient operating model as the policies run off, in addition to a scalable and cost-effective platform to support the Group’s consolidation strategy.
Ignis is incentivised to maximise investment performance for the Group’s policyholders through performance fee arrangements. In addition, Ignis is seeking to grow the assets it manages for third party investors.
External outsource partners are used for back office administration, thereby minimising fixed costs and allowing Ignis to focus on its core capabilities of investment performance and distribution.
For further details of value creation through acquisitions Turn to page 22 13 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
In addition, the Group functions provide support for, and coordination and delivery of, the Group’s strategic objectives.
Following a series of life company consolidations, the Group now has three operating UK life companies, being Phoenix Life Limited, Phoenix Life Assurance Limited and National Provident Life Limited (‘NPLL’). Together, they comprise 14 with-profit funds and two non-profit funds. By bringing together separate life companies and funds, the Group’s business model is simplified which both reduces complexity and releases capital.
The planned divestment of Ignis, subject to regulatory approval, will have limited impact on the operating structure of Phoenix Life. The relationship with Ignis already operates on an arms length basis and this will continue with Ignis under the ownership of Standard Life Investments. The existing outsourcer model will be used to oversee and manage the relationship with Standard Life Investments.
IGNIS ASSET MANAGEMENT Ignis Asset Management is the Group’s asset management business and is led by its Chief Executive Officer, Chris Samuel.
Ignis is responsible for £65.9 billion of assets, including £50.9 billion of assets of the Group’s life and holding companies. Ignis also has a significant and growing third party business, now comprising 23% of its assets under management, providing investment management services to third party clients, including retail, wholesale and institutional investors in the UK and overseas.
Ignis operates a dedicated Insurance channel which services Phoenix Life and other life company clients. Ignis has sought to institutionalise all of its channels with Global Accounts added in 2012 to develop business outside of the UK with the larger institutions, sovereign wealth funds and other similar clients. Ignis operates dedicated support functions with a governance structure that includes an independent Board and independent Non-Executive Directors. This demonstrates an ability to operate as an independent asset manager which is key to marketing and growing the third party franchise.
The planned divestment of Ignis to Standard Life Investments, subject to regulatory approval, will result in a longterm strategic partnership between Phoenix Group and Standard Life Investments which will allow the Group to participate in future consolidation of the UK closed life fund market and generate further value for shareholders.
Further details of Ignis’ investment business units and product offerings can be found on our website at www.ignisasset.com 16 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
AREAS OF CURRENT STRATEGIC FOCUS The four key areas of current strategic focus for Phoenix Group are outlined in more detail over the next few pages.
We aim 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.
KEY INITIATIVES AND PROGRESS IN 2013 – In January 2013 we announced the successful £250 million capital raising and debt re-terming which strengthened the Group’s balance sheet and reduced gearing. We repaid £696 million of bank debt in 2013, reducing gearing to 44% while retaining a resilient IGD surplus and PLHL ICA surplus underpinned by strong cash generation.
– We further developed the Financial Management Group within Group functions to proactively manage financial risk, source and apply new market ideas and technologies, and build investment strategy processes and capabilities. In addition to other management actions in 2013, this enabled us to re-engineer our approach to asset and liability matching and reduce our capital requirements by eliminating unrewarded risks.
– Continue to monitor the potential impact of Solvency II and develop management actions to optimise the Solvency II balance sheet
– Further reduce gearing and examine opportunities to further simplify existing Group debt arrangements.
– We engaged in discussions with Swiss Re about the combination of Admin Re with Phoenix Group. These talks terminated in November 2013, but we continue to explore other acquisition opportunities.
– £791 million of vesting annuities were retained within the Group in 2013, of which £505 million related to policies with guaranteed annuity rates.
– We continued to streamline the Group’s actuarial modelling systems, and parallel ran the new model with existing models during 2013, simplifying modelling processes and allowing consistent capital management across the business. This and other management actions enhanced MCEV by £170 million in 2013.
– Phoenix Life and Ignis Asset Management continue to make progress in consolidating the investment administration and selected back office services with a single outsource provider, HSBC Bank plc, streamlining the operations and increasing efficiency.
Improving customer outcomes is central to our vision of being the saver-friendly ‘industry solution’. It is not only the right thing to do by our existing customers, but provides a safe home for future customers through our consolidation strategy. We have three key areas of focus in relation to our customers: – Value – we aim to optimise customer outcomes
KEY INITIATIVES AND PROGRESS IN 2013 – In the latter part of 2013, Phoenix launched an initiative to allow customers with small pensions-in-payment to convert them to a lump sum payment, and is one of the first life and pension providers to offer this option. Almost two-thirds of those policyholders mailed with the offer have taken advantage of it, and the Company has been praised by the media for looking after the needs of those with very small pension policies.
– The migration of over 3 million policies to the BaNCS utility platform has resulted in real improvements in the speed of claims payouts for both life and pensions customers, with payments now up to 18% faster than pre migration.
– We have also been working with the regulators and industry bodies on their reviews of annuities and workplace pensions this year. Both reviews are welcomed and we have been proactive in ensuring the needs of our key customer groups such as those with small pension pots and guarantees are not overlooked. In light of the Government’s recent budget proposals, it is crucial that our existing customers with guarantees remain aware of the value of the guaranteed rates attached to their policies.
– Increase customers’ engagement with their policies, ensuring customers take the right decisions at key life stages
For further details of customer service initiatives in 2013 See the full Corporate Responsibility report on our website
At Phoenix Group, we believe an engaged workforce, one that feels challenged, rewarded and committed to the goals of the organisation, is essential to delivering our financial and operational targets.
KEY INITIATIVES AND PROGRESS IN 2013 – In 2013, we achieved an overall Group engagement index score of 72%, in line with our Financial Services benchmark of 72% (2012: 73% against benchmark of 70%).
1 The Phoenix Group annual engagement survey is administered by ORC International, a global research company which benchmarks the Group’s results against 31 Financial Services companies in the UK.
OPPORTUNITIES FOR FUTURE GROWTH POTENTIAL MARKET OPPORTUNITIES We have estimated that the total UK closed life fund market opportunity for Phoenix is at least £200 billion of assets.
BROAD SPECTRUM OF POTENTIAL ACQUISITION SIZES AND STRUCTURES Phoenix Group is well placed to find solutions for a range of sellers of life insurance businesses due to the Group’s flexible approach to acquisitions, in particular its flexibility to acquire either life companies, funds or portfolios of businesses, and the Group’s appetite for all product types across the with-profit, non-profit and unit-linked spectrums.
The financial services sector is evolving and we believe the changing regulatory environment may result in vendors looking to dispose of various portions of their business. We are able to be flexible about the size and structure of any acquisition, which should provide us with a variety of opportunities.
During 2013, the Group has made further progress in building a stable and simplified business. In particular, the capital raising and debt re-terming announced in January 2013 provided a long-term capital structure and platform for future growth, and allows the Group to contemplate potential acquisition opportunities.
The planned divestment of Ignis, subject to regulatory approval, will result in a longterm strategic alliance with Standard Life Investments. Given its existing position as the UK’s largest specialist consolidator of closed life funds, Phoenix has agreed with Standard Life Investments a mechanism to share value resulting from any future transfers of assets from Phoenix to Standard Life Investments.
Potentially, our business may be unable to source and execute successful transactions, but as a standalone business and in the absence of further acquisitions, Phoenix is expected to continue to generate strong and predictable cash flows from the operating companies to support commitments at the holding companies including pension scheme contributions, debt servicing and shareholder dividends. However in order to grow and maximise value for all stakeholders, we will continue to pursue opportunities which meet the criteria set out above as and when they arise.
Closed life At least MCEV neutral Helps to sustain dividends Reduces gearing
Potential value and source of cash acceleration and value generation will vary depending on specific target 23 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Maintaining strong cash flow delivery underpins debt servicing and repayment as well as shareholder dividends
The Board considers that MCEV provides the most relevant and consistent means of assessing the Group’s ability to increase value through the delivery of incremental management actions
Continued strong cash generation of £817 million by the Group’s operating companies enabled the Group to exceed its 2013 target for cash generation of £650 million to £750 million.
We set a new incremental MCEV target of £300 million between 2014 and 2016.
Operating companies’ cash generation is a measure of cash and cash equivalents remitted by the Group’s operating companies to the holding companies and is available to cover dividends, debt servicing and repayment, pension scheme contributions and operating expenses.
The basis of calculation of Group MCEV is set out in note 1 of the MCEV supplementary information.
The gearing ratio is the Group’s measure of its level of debt compared to its equity on a gross MCEV basis
Gearing reduced to 44% at 31 December 2013 reflecting the net proceeds of the equity raise of £232 million, enhancing management actions and debt repayments of £696 million during the year.
42.0p42.0p 47.7p 53.4p 25 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
The Group maintains group capital resources at the PLHL level at an amount in excess of 105% of the with-profit insurance capital component (‘WPICC’), being an additional capital requirement of with-profit funds, plus 145% of the Group capital resource requirement less the WPICC as agreed with the PRA.
The basis of calculation of Group IFRS operating profit is set out in note 6 of the IFRS consolidated financial statements.
£439m £1.3bn £1.0bn £1.4bn £1.2bn 26 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Assets under management are a key driver of Ignis’ operating profit
The run-off of the closed life business was offset by third party inflows, including Guardian assets transferred back to Ignis, and positive market movements.
Ignis’ IFRS operating profit of £49 million benefited from higher third party revenues due to growth in third party business offset by a reduction in life company and joint venture revenues.
As agreed with the PRA, the Group aims to ensure that PLHL maintains an ICA surplus of at least £150 million.
PLHL ICA surplus represents an assessment on an economic basis of the capital resources and requirements arising from the obligations and risks which exist outside the life companies. The measure is calculated at the highest EEA level insurance group holding company, being PLHL.
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 2013, the Group delivered cash flows from its operating subsidiaries of £817 million, including cash flows of £332 million from management actions. The latter increased cash flows primarily through the annuity transfer transaction with Guardian together with benefits delivered from modelling improvement exercises and other investment and operational de-risking initiatives.
Operating companies’ cash generation: Cash receipts from Phoenix Life 794 661
Cash and cash equivalents at 31 December3 995 1,066 1 Includes amounts received by the holding companies in respect of tax losses surrendered to the operating companies.
3 Closing balance at 31 December 2013 includes required prudential cash buffer of £150 million (2012: £150 million).
Phoenix Life free surplus The generation of free surplus, net of movements in required capital, underpins the cash remittances from Phoenix Life. The table below analyses the movement in free surplus of Phoenix Life which represents the life companies’ free surplus plus the IFRS net assets of the service companies: Year ended 31 £m
Closing free surplus4 529 514 4 Includes differences between valuation of assets and liabilities on an IFRS basis versus a capital basis.
Pension scheme contributions of £96 million (2012: £50 million) increased primarily due to the revised contribution profile as agreed with the Pearl pension scheme trustees which increased contributions by £46 million in 2013.
Debt interest of £147 million (2012: £115 million) increased following the re-terming of the Impala loan facility and also reflects increased costs associated with the Group’s interest rate swap arrangements.
1 This includes £2 million paid to Phoenix Life Assurance Limited, a subsidiary undertaking. Phoenix Life Assurance is a lender under the Pearl facility.
TARGET CASH FLOWS The cumulative cash flow target for 2011 to 2016 was £3.5 billion, against which £2.3 billion had been achieved by 31 December 2013. The Group is targeting a new operating companies’ cash generation target from 1 January 2014 to 31 December 2019 of £2.8 billion to coincide with the final maturity of the Impala loan facility in June 2019. This has been set taking into account the proceeds expected to be received from the divestment of Ignis.
The above targets have been set on the assumption that Solvency II regulations operate as we expect.
Base case 6-year target 2.8 20% fall in equity markets 2.7 15% fall in property values 2.7 75bps increase in nominal yields4 2.8 75bps decrease in nominal yields4 2.8 Credit spreads widening with no change in expected defaults5 2.6 4 Represents a real yield reduction of 25bps, given a 75bps increase/decrease in nominal yields.
5 11-15 year term: AAA – 44bps, AA – 93bps, A – 111bps, BBB – 187bps.
One-off shocks would be expected to lead to a deferral of cash emergence rather than a permanent diminution.
7 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 £401 million (2012: £360 million) are therefore calculated as £308 million operating earnings (2012: £272 million) grossed up for tax at 23.25% (2012: 24.5%).
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.
In addition, the MCEV includes the value of future profits expected to be earned on annuities with guaranteed rates, based on long-term profit margins and projected take-up rate assumptions.
As at 31 December 2013, the Group MCEV included £191 million in respect of these policies (2012: £177 million). We believe the attractive rates provided by our policies with guarantees, which are typically around twice the standard rate (for example, a 65 year old male could receive an 11.1% annuity), should continue to be valuable for policyholders.
On 25 March 2014, the Group and Standard Life Investments signed a disposal agreement under which Standard Life Investments agreed to acquire the entire share capital of Ignis Asset Management. Details of the disposal agreement and the impact on the MCEV can be found in note 1 to the MCEV supplementary information.
ECONOMIC VARIANCES ON LIFE BUSINESS Positive economic variances on life business of £138 million (2012: positive £24 million) reflect the positive impacts of narrowing corporate bond spreads, improved equity and property returns and a reduced cost of capital due to improved life company solvency. These have been partly offset by the negative impact of the difference between actual short-term rates and the long-term investment return assumption on which operating earnings is based and the increased market value of the PLL subordinated debt held as a liability in the MCEV.
OTHER NON-OPERATING VARIANCES ON LIFE BUSINESS Other non-operating variances on life business of negative £35 million (2012: positive £39 million) include regulatory change and systems transformation costs incurred by the life companies, together with the impact of certain tax items including the impact of corporate tax rate reductions.
Finance costs attributable to owners 140 123 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.
Other comprehensive income: Remeasurements and contributions on defined benefit pension schemes (net of tax) (16) (131)
Operating profit before tax1 439 429 1 Operating profit is presented before adjusting items. See table on page 36 for details of adjusting items.
Operating profit includes the effect of variances in experience for non-economic items, such as mortality and persistency, and the effect of changes in noneconomic assumptions. Changes due to economic items, for example market value movements and interest rate changes, 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 £106 million increased by £31 million on the 2012 result, primarily due to higher bonus rates, increased estate distribution and a £10 million benefit from shareholder transfers that were underestimated in prior years.
The with-profit funds where internal capital support has been provided generated an operating profit of £20 million (2012: £14 million operating loss). The increase reflects the positive impact of the adoption of revised assumptions for longevity improvement. The 2012 comparative result was adversely impacted by the reduction in the assumed surrender rates in funds with valuable policyholder guarantees (£28 million).
The longer term return on owners’ funds of £13 million (2012: £22 million) reflects the asset mix of owners’ funds, primarily cash based assets and fixed interest securities. The reduction compared to the prior year reflects the upstreaming of dividends in the period and lower expected investment return assumptions for 2013 for non-cash assets (calculated by reference to the market yields on risk-free fixed interest assets at the start of the year). The investment policy for managing these assets remains prudent.
Ignis revenue of £150 million (2012: £143 million) has increased primarily due to higher third party revenues and strong investment performance offsetting a reduction in life fund revenues partly due to run-off. Despite continued investment in the business, expenses are relatively flat overall. Increased staff costs are offset by cost management activities reducing other operating expenses.
On 25 March 2014, the Group and Standard Life Investments signed a disposal agreement under which Standard Life Investments agreed to acquire the entire issued share capital of Ignis Asset Management. Details of the disposal agreement and the IFRS impact can be found in note 45 to the IFRS consolidated financial statements.
The Group has adopted the revised accounting standard, IAS 19 Employee benefits for the first time in 2013 (see note 3 to the IFRS consolidated financial statements) and has consequently changed its basis for determining income or expense relating to the defined benefit pension schemes. This change in accounting policy has been applied retrospectively, resulting in a £19 million reduction in Group costs for 2012.
Investment return variances and economic assumption changes on long-term business 64 1
INVESTMENT RETURN VARIANCES AND ECONOMIC ASSUMPTION CHANGES ON LONG-TERM BUSINESS The Phoenix Life business recognised positive investment return variances and economic assumption changes of £64 million in 2013 (2012: £1 million positive). The positive impacts of narrowing credit spreads, increasing yields and improved property returns have been partly offset by losses on equity hedging positions held within the shareholder funds.
VARIANCE ON OWNERS’ FUNDS The negative variance on owners’ funds of £31 million for 2013 is driven by fair value losses on credit default swaps, futures and interest rate swaps held within the shareholder funds of the life companies as part of the Group’s hedging strategies. This has been partly offset by a fair value gain on interest rate swaps held by the holding companies. All interest rate swaps held by the shareholder funds and holding companies were closed out during 2013.
NON-RECURRING ITEMS Non-recurring items include a gain of £42 million on completion of the legal transfer of annuity liabilities to Guardian offset by arrangement and structuring fees of £21 million associated with the extinguishment and re-terming of the Impala loan facility, regulatory change and systems transformation costs of £25 million (2012: £34 million) and a loss from a pension liability management exercise of £9 million (2012: £2 million). Net other items of positive £2 million (2012: £11 million) include a gain on the reinsurance arrangement with Guardian as a result of data review procedures offset by corporate project costs. The 2012 result was impacted by a £177 million gain recognised upon entering into the reinsurance agreement with Guardian.
Debt finance costs have increased by £15 million mainly reflecting higher interest charges following the re-terming of the Impala loan facility and the impact of increased costs associated with the Group’s interest rate swap arrangements. All interest rate swaps were closed out during 2013.
TAX CREDIT ATTRIBUTABLE TO OWNERS The Company is exempt from tax in the Cayman Islands on any profits, income, gains or appreciations for a period of 30 years from 11 May 2010 (the previous exemption was for 20 years from 15 January 2008).
The Group tax charge for the period attributable to owners is £10 million (2012 restated: £115 million credit) based on a profit before tax attributable to owners of £217 million (2012 restated: £309 million). The difference between the actual charge of £10 million and the expected charge (based on the UK corporation tax rate of 23.25%) of £50 million is primarily driven by a £36 million benefit as a result of the reductions in future UK corporate tax rates, and £38 million due to certain profits being non-taxable or taxed at a rate less than 23.35%. This has been partly offset by adverse adjustments to the shareholder tax charge in respect of prior years and the impact of certain disallowable expenses.
2 Outflows include approximately £4.4 billion of net life company run-off and approximately £1.4 billion return of derivative collateral, recouponing and other items.
Of the assets in the table above, Ignis manages or provides oversight and advisory services on the following: Ignis assets under management
Oversight and advice 7.0 – 7.0 – 7.0 4 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.
CAPITAL MANAGEMENT FRAMEWORK The Group’s capital management framework is designed to achieve the following objectives: – To provide appropriate security for policyholders and meet all regulatory capital requirements whilst not retaining unnecessary excess capital
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 PRA. These measures are aggregated under the European Union Insurance Groups’ Directive (‘IGD’) to calculate regulatory capital adequacy at a Group level.
For further details of the regulatory capital requirements of the individual life companies See note 38 of the IFRS consolidated financial statements 40 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
The Group’s headroom at 31 December 2013 was £0.5 billion (2012: £0.6 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 resources2 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.
At 31 December 2013, the aggregate unadjusted Pillar 1 Phoenix Life capital resources are £6.3 billion (2012: £6.5 billion) and aggregate unadjusted Pillar 1 Phoenix Life capital requirements are £5.0 billion (2012: £5.1 billion). Due to the closed fund nature of the Phoenix Life business and the Pillar 1 rules for with-profits funds, the surplus estate of the Phoenix Life with-profit funds is treated as a policyholder liability. This has the effect of increasing capital requirements. If the funds were open to new business, it is estimated that the Phoenix Life Pillar 1 capital requirement would reduce to £3.2 billion (2012: £3.5 billion) and the capital coverage for Phoenix Life would be 197% (2012: 186%).
As agreed with the PRA, the Group aims to ensure that PLHL maintains an ICA surplus of at least £150 million. PLHL’s ICA position at 31 December 2013 is set out below: 2013 £bn 2012 £bn
2 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.
The key drivers of the increase in the PLHL surplus include: – capital generation items and positive market movements of £0.9 billion. This includes the benefits of the completion of the legal transfer of the annuity liabilities, partly offset by
– dividend payments, debt financing and repayments net of the proceeds from the equity raise of £0.7 billion.
For further details of the Pillar 1 capital resources of the individual life companies See note 38 of the IFRS consolidated financial statements 41 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Had the divestment of Ignis (which is hoped to complete by the end of the second quarter of 2014) and the £250 million debt prepayment expected to be made in respect of the Impala facility following completion of the divestment taken place before 31 December 2013, the PLHL ICA surplus and headroom over Group capital policy would have decreased by £0.1 billion.
Following credit spread widening2 1.3 1.1 1 75bps increase/decrease in nominal yields and a 75bps increase/ decrease in inflation.
The relative insensitivity of the Group’s IGD surplus reflects the nature of Pillar 1 rules for with-profit funds which stipulate that the surplus estate is treated as policyholder liabilities. The sensitivities reflect the impact of market movements not only on the Group’s life companies but also on its staff pension schemes.
Tier 1 bonds at 50% of IFRS carrying value (see note 20 to the IFRS consolidated financial statements) 204 204
Further detail on shareholder debt is included in note 23 to the IFRS consolidated financial statements.
The Group has two main credit agreements (the Pearl and Impala facilities), which have separate security arrangements.
In addition £120 million of mandatory and target repayments and an additional £100 million prepayment were made in respect of the Impala loan facility during the year.
Had the divestment of Ignis (which is hoped to complete by the end of the second quarter of 2014) and the £250 million debt prepayment expected to be made in respect of the Impala facility following completion of the divestment taken place before 31 December 2013, gearing would have reduced to 39%.
During the year, the Group has continued to strengthen and embed the components of the RMF to ensure that they are aligned with evolving regulatory requirements including Solvency II. This has included, for example, an increasing focus on independent reviews by the Group Risk function of the risk profile of the Group.
RISK APPETITE The Group’s risk appetite framework consists of a set of statements and targets that articulate the level of risk the Group is willing to accept, in pursuit of shareholder value and achievement of the Group’s strategic objectives. The statements encapsulate policyholder security, earnings volatility, liquidity and the internal control environment as follows: − Capital – The Group and each life company will hold sufficient capital to meet regulatory requirements in a number of asset and liability stress scenarios.
− Cash flow – The Group will seek to ensure that it has sufficient cash flow to meet its financial obligations and will continue to do this in a volatile business environment.
− Embedded value – The Group will take action to protect embedded value.
− Regulation – The Group and each life company will, at all times, operate a strong control environment to ensure compliance with all internal policies and applicable laws and regulations, in a commercially effective manner.
RISK UNIVERSE A key element of effective risk management is to ensure that the business has a complete and robust understanding of the risks it faces. Within the Group, these are set out, categorised and defined in the risk universe. The risk universe allows the Group to deploy a common risk language, allowing for meaningful comparisons to be made across business units. There are 3 levels of risk universe categories. The highest risk universe category is Level 1 and these risks are set out below: − Credit
SECOND LINE: RISK OVERSIGHT Risk oversight is provided by the Group Risk function and the Board Risk Committee. The Board Risk Committee comprises four NonExecutive Directors, three of whom are independent. It is supported by the Chief Risk Officer and met six times during the year.
THIRD LINE: INDEPENDENT ASSURANCE 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.
For further details of the Board Audit and Risk Committees and their principal activities Turn to pages 62 and 66 46 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
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 over financial, operational and regulatory risk. The PRA / FCA relationship team manages the relationship and interactions with our primary regulators and reports to the Chief Risk Officer.
RISK POLICIES The Group policy framework comprises a set of 30 policies that support the delivery of the Group’s strategy by establishing operating principles and expectations for managing the key risks to our business. The policy set contains the minimum control standards that each business unit must adhere to and reports compliance against through the operation of local processes/procedures. The policies define: − the individual risks the policy is intended to manage; − the degree of risk the Group is willing to accept, which is set out in the policy risk appetite statements; − the minimum controls required in order to manage the risk to an acceptable level; and
Each policy is the responsibility of a member of the Executive Committee who is charged with overseeing compliance with the policy throughout the Group.
The Group’s business units operate capital management processes that meet the Group’s Capital Management Policy. Under these processes, capital is allocated across risks where capital is held as a mitigant and, in turn, to individual risk owners who hold risk capital budgets. The amount of risk capital required is reviewed regularly to ensure the risk exposure remains within budget. Any requests to increase budgets are referred to the relevant business unit for approval.
PEOPLE AND REWARD Effective risk management is central to the Group’s culture and its values. Processes are operated that seek to measure both individual and collective performance and discourage incentive mechanisms which could lead to undue risk taking. Training and development programmes are in place to support employees in their understanding of the operation of the RMF. During 2013, to assess how well the RMF is embedding across the Group and how this has impacted our employees, Group Risk commissioned the first Risk Culture survey. This annual survey will enable us to assess and measure our Risk Culture over time.
PRINCIPAL RISKS AND UNCERTAINTIES FACING THE GROUP The Group’s top 5 principal risks and uncertainties are detailed below together with their potential impact and mitigating actions which are in place. As economic changes occur and the industry and regulatory environment evolves, the Group will continue to monitor the potential impact of these principal risks and uncertainties facing the Group.
In times of severe market turbulence, the Group may not have sufficient liquid assets to meet its payment obligations or may suffer a loss in value.
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 material reinsurance and derivative positions are appropriately collateralised and guaranteed.
The Group has liabilities under annuities and other policies that are sensitive to future longevity and mortality rates. Changes in assumptions may lead to changes in the assessed level of liabilities to policyholders. The amount of additional capital required to meet those liabilities could have a material adverse impact on the Group’s embedded value, results, financial condition and prospects.
The Group may not be able to refinance the outstanding amount on its debt facilities as they mature on terms which are as favourable as the existing terms or it may be unable to refinance these obligations at all.
The potential limitation on distributions from the Group’s PRA / FCA regulated companies and changes to legislation or regulation in relation to Group capital may impair the ability of the Group to service its existing debt commitments.
The Group puts considerable effort into managing relationships with its regulators so that it is able to maintain a forward view regarding potential changes in the regulatory landscape. The Group assesses the risks of regulatory change and their impact on our operations and lobbies where appropriate. Controls are in place to reduce the likelihood that the Group’s regulated entities are not able to distribute proceeds in line with the Group’s target projections.
2013 was all about making a difference, whether that be to the lives of our staff, the communities in which we are based, or the charities we have partnered with during the year.
GOVERNANCE Staff actively embrace CR activity across the Group and are made aware of the CR Policy and accompanying Code of Business Ethics and Ethical Conduct annually. The CR programme is sponsored at the highest level by the Group Chief Executive Officer, and two members from the Executive Committee sit on the Group’s CR working group. This forum meets quarterly to determine CR strategy and oversee the agreed programme of activity. The Executive Committee as a whole is updated on progress against the CR plan on a bi-annual basis.
HIGHLIGHTS The aim for 2013 was to raise awareness of the Group’s CR programme and to achieve greater staff involvement in company-led initiatives. CR within the Group is reported in four areas which are similar categories to those championed by BITC. The highlights of our CR activities in 2013 are included below.
Following a review of waste management suppliers, two of the Group’s sites now generate no waste to landfill and a third site review is planned for 2014.
This section includes mandatory reporting of greenhouse gas emissions pursuant to the Companies Act 2006 (Strategic and Directors’ Reports) Regulations 2013.
The full Corporate Responsibility Report is available on the Group’s website at www.thephoenixgroup.com/ CRreport2013
GREENHOUSE GAS EMISSIONS1 Global GHG emissions data for period: 1 January 2013 to 31 December 2013 Emissions from: Tonnes of CO2e
Combustion of fuel and operation of facilities 3,365 Electricity, heat, steam and cooling purchased for own use 11,600 Total Carbon Footprint (Tonnes of CO2e) 14,965
Emissions from Group corporate offices normalised per FTE 4.96 tonnes of CO2e/FTE
1 We have used the main requirements of ISO14064 Part 1 and the GHG Protocol Corporate Accounting and Reporting Standard (revised edition) for our methodology, using energy consumption data from our owned and/or occupied properties. We have established that Fluorinated Gas and owned transport emissions are non material. We have used emissions factors from the UK Government conversion factors for company reporting.
The Group’s business ethics and dignity at work principles have regard for and are aligned to relevant Articles of the United Nations Universal Declaration of Human Rights.
As part of the workplace agenda promoting health and lifestyle services available to staff, the Group launched a ‘Health and Wellbeing’ initiative, encouraging staff to get the most out of life, both in and out of the workplace.
CR questions were included for the first time in the Group’s employee engagement survey and the Group achieved an overall employee engagement index score of 72% (2012: 73%).
Through fundraising efforts, approximately £200,000 was raised for local charities. Of this, £125,000 was donated to Birmingham St Mary’s Hospice and £48,000 to Trinity Hospice, the two Group charities chosen in 2013. An additional £15,000 was donated through the staff matched donation schemes for causes supported by employees outside of work and £10,000 was donated to a number of community based projects.
Staff donated over 800 hours to staff volunteering programmes in our local communities through activities ranging from team events to ad-hoc one-to-one mentoring sessions.
The Group achieved an increased score of 12 points in BITC’s Responsible Business Check-Up, a gap analysis and benchmarking tool designed to help companies develop a strategic approach to their CR programme.
The Group has continued to embed the UK Government’s Prompt Payment Code to ensure suppliers are paid on time, something that is taken very seriously.
Ignis was accepted as a signatory to the United Nations Principles of Responsible Investment (‘UNPRI’). UNPRI is an international network of investors which works towards incorporating the principles of responsible investment decision making processes, including environmental and social governance, into investment analysis, policies and practices.
Howard Davies was appointed Chairman of the Board of Directors of the Company on 1 October 2012. Howard is the Chairman of the British Government’s Airport Commission. He also is a Professor of Practice at the French School of Political Science in Paris (Sciences Po). He was previously the 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 is Chairman of the risk committee. He is also Chairman of the risk committee at Prudential PLC, whose board he joined in 2010. He is a Director of the Royal National Theatre, whose board he joined in 2011. He is a member of the Regulatory and Compliance Advisory Board of Millennium 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.
Clive Bannister joined the Group in February 2011 as Group Chief Executive Officer. Prior to this, he was Group Managing Director of Insurance and Asset Management at HSBC Holdings plc. He joined HSBC in 1994 and held various leadership roles in planning and strategy in the Investment Bank (USA) and was Group General Manager and CEO of HSBC Group Private Banking. He started his career at First National Bank of Boston and prior to working at HSBC was a partner in Booz Allen Hamilton in the Financial Services Practice providing strategic support to financial institutions including leading insurance companies, banks and investment banks. Mr Bannister is also Chairman of the Museum of London. Mr Bannister was appointed to the Board of Directors of the Company on 28 March 2011.
Tom Cross Brown was Global Chief Executive of ABN AMRO Asset Management (which managed €160 billion of assets, with offices in 30 countries around the world) from 2000 to 2003, as well as Chairman of ABN AMRO Asset Management in the UK from 1997 to 2003. Prior to this, he spent 21 years with Lazard Brothers in London, latterly as Chief Executive Officer of Lazard Brothers Asset Management. Mr Cross Brown is Non-Executive Chairman of Just Retirement Group plc and is a Non-Executive Director of Artemis Alpha Trust plc, as well as of other private companies and charities. Mr Cross Brown served on the Board of Directors of the former Pearl Group Limited from May 2005 until September 2009. He was appointed to the Board of Directors of the Company on 24 September 2009. He is Chairman of the Board Investment Committee and a member of the Board Nomination and Board Risk 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 and The Pensions Regulator. Ms Hudson is an ambassador to Scope, a UK charity, and has 33 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 Audit, Board Risk and Board Remuneration Committees.
− Leads the development of the Group’s strategy for agreement by the Board
− Leads and directs the Group’s businesses in delivery of the Group strategy and business plan
− Leads the Group to safeguard returns for policyholders and grow shareholder value
− Embeds a risk-conscious Group culture which recognises policyholder obligations in terms of service and security
− Develops and delivers the Group’s financial business plan in line with strategy
− Ensures that the Group’s finances and capital are managed and controlled
− Develops and delivers the Group’s Debt Capital Strategy and other treasury matters
− Ensures the Group has effective processes in place to ensure reporting obligations are met
− Supports the Group Chief Executive Officer in managing the Group’s key external stakeholders and investor relations
− Delivers, over the longer term, Ignis’ vision of becoming a leading asset management business committed to performance excellence and innovation
− Ensures Ignis’ chosen foundations of innovative people, a partnership culture, suitable processes and technology and stability are in place to support these plans.
− Supports the Group Chief Executive Officer in the formulation of the strategy and the business planning for the Group
− Leads implementation of the Group’s strategy as regards any potential acquisitions or disposals
− Leads the implementation of the Group’s employee strategy in order to recruit, retain, motivate and develop high quality employees
− Provides guidance and support on all human resources (‘HR’) matters to the Group Chief Executive Officer, ExCo, Group Board and Remuneration Committee
− Oversees the operation of the legal risk framework within the Group including compliance by Group companies and staff with relevant legal obligations.
− Identifies and delivers opportunities to enhance shareholder value across the Group.
Phoenix Group Holdings is a relatively new company which achieved a Premium Listing on the London Stock Exchange in July 2010 and inclusion in the FTSE 250 later that year. Our governance standards since the listing have evolved and improved.
− 2012 – UK Corporate Governance Code compliant in all matters
− 2011 AGM – all 24 resolutions passed by a majority of at least 96% of votes cast
− 2012 AGM – all 21 resolutions passed by a majority of at least 97% of votes cast
− 2013 EGM – both resolutions passed by a majority of at least 96% of votes cast
Governance has to evolve as the environment in which we operate changes. We will therefore continually monitor and aim to improve our governance processes and the quality and type of information provided to the Board. We will regularly assess the composition of the Board to ensure it remains balanced and appropriate for our business and to recruit directors to the Board informed by our Board evaluations and the reviews by the Nomination Committee on the structure, skills and composition of the Board.
When I became Chairman in October 2012, a key target was to reduce the number of directors as the Board was considered too large to function at its best level. The optimum number of directors suggested by both the 2011 and 2012 Board evaluations was considered to be around ten. I am pleased that the number of directors has reduced from 14 to 11 since the end of 2012 and that this has been achieved whilst increasing the proportion of independent directors.
I have referred to the Board changes which occurred in 2013, and that proposed for the AGM in April 2014, in my opening statement to the Annual Report and Accounts.
Given the formerly large size of the Board, it would, until now, have been inappropriate to appoint additional directors except in the case of a specific requirement (for example, Alastair Barbour’s appointment as Audit Committee Chairman) or to fill a skills gap. However, now that the Board is at a more manageable size, we are taking immediate action to recruit an additional female director to add better balance to the Board.
The following report provides further details of the work undertaken by our Board and its committees and shows how the Company has in 2013 achieved full compliance with the provisions set down in the UK Corporate Governance Code.
The Group’s Board stands wholeheartedly behind the statement that strong and effective governance is crucial to the Group’s aim of delivering value to policyholders and shareholders. As Chairman, I am committed to leading the Board in achieving high standards of corporate governance.
All the directors of the Company are PRA and FCA Approved Persons in respect of the Company’s regulated subsidiaries.
The schedule of matters reserved for the Board is available from the Group Company Secretary. Matters which are not reserved for the Board and also its committees under their terms of reference (which are available on the Group website), or for shareholders in general meetings, are delegated to the executive management under a schedule of delegated authorities approved by the Board.
THE CHAIRMAN, GROUP CHIEF EXECUTIVE OFFICER AND SENIOR INDEPENDENT DIRECTOR Howard Davies became Chairman of the Board of Directors of the Company on 1 October 2012. There is a division of responsibility, approved by the Board, between the Chairman, who is responsible for the leadership and effective operation of the Board and the Group Chief Executive Officer, Clive Bannister, who is responsible to the Board for the overall management and operation of the Group. The Chairman’s other significant commitments are set out in his biographical details on page 56.
The Senior Independent Director, appointed by the Board, is Ian Cormack. His role is to be available to shareholders whose concerns are not resolved through the normal channels or when such channels are inappropriate. He is also responsible for leading the annual appraisal of the Chairman’s performance by the Non-Executive Directors, which took place in December 2013, and for leading the process for appointment of a new Chairman.
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 additional Board meetings of the Company and to devote appropriate preparation time ahead of each meeting. The Board met seven times during 2013 and is scheduled to meet eight times in 2014 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 2013.
Attendance by each of the directors at Board meetings and at committee meetings for committees of which they were a member during 2013 is detailed below: Board meetings Audit Committee Nomination Committee
1 Ian Ashken resigned from the Board on 2 May 2013.
4 Alastair Lyons resigned from the Board on 30 September 2013.
5 Hugh Osmond resigned from the Board on 21 August 2013.
AUDIT COMMITTEE’S ROLE − Receiving and reviewing the Annual Report and Accounts and other related financial disclosures, although the ultimate responsibility for these matters remain with the Board
− Responsible for making recommendations to the Board on the appointment of the external auditors and their terms of engagement and for reviewing the performance, objectivity and independence of the external auditors. The terms of reference of the Audit Committee state that it shall meet the external auditor at least once a year without management being present
− Responsible for reviewing the effectiveness of the internal audit function.
PRINCIPAL ACTIVITIES OF THE AUDIT COMMITTEE DURING 2013 External reporting and controls − Reviewed the Company’s 2012 Annual Report and Accounts, 2013 Interim Financial Statements and 2013 Interim Management
− Considered and addressed a number of significant issues in relation to these financial statements as summarised in the table opposite
− Reviewed the annual internal controls effectiveness report (and the half-year interim update) prior to its consideration by the Board.
− Reviewed and monitored the independence of the external auditors including their provision of non-audit services
Internal audit − Reviewed the self-assessment of the internal audit function, undertaken in accordance with the Institute of Internal Auditors’ International
− 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 internal audit macro-opinion report on the adequacy of risk management and control in the Group
Audit Committee’s performance − Reviewed the Audit Committee’s performance, constitution and terms of reference, noting that all its duties had been addressed in accordance with its terms of reference, and that the Board would undertake its own review of the performance of the Board committees.
General − Reviewed arrangements for whistleblowing should an employee wish to raise concerns, in confidence, about any possible improprieties.
− Setting of actuarial assumptions and reviewing the robustness of actuarial modelling processes
− Management presented papers to the Phoenix Life Audit Committee detailing recommendations for the actuarial assumptions and processes to be used for the interim and year-end reporting periods with justification and benchmarking as appropriate. These assumptions and processes were debated and challenged by the Phoenix Life Audit Committee, focusing on longevity and persistency in relation to demographics and on credit in relation to economics, prior to being approved.
− Tax provisioning − The Audit Committee undertook a review of tax provisioning and exposure, encompassing comprehensive reports from the Group Tax Director presented to two Audit Committee meetings, receiving detail of how both Phoenix Life and Group tax planning risks were adequately addressed in the assessment of capital requirements and in the financial statements.
AUDITOR’S INDEPENDENCE The Company has adopted a Charter of Statutory Auditor Independence, which requires the Company and the external auditors to take measures to safeguard the objectivity and independence of the external auditors. These measures include a prohibition regarding non-audit services in respect of specific areas, such as secondments to management positions, or those which could create a conflict or perceived conflict. It also includes details of the procedures for the rotation of the external engagement partner. The Charter can be found on the Company’s website.
NOMINATION COMMITTEE HOWARD DAVIES, Chairman IAN CORMACK TOM CROSS BROWN 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 four times during 2013.
− Reviewed the succession plan for Executive and Non-Executive Directors and recommended its approval to the Board
REMUNERATION COMMITTEE IAN CORMACK, Chairman DAVID BARNES ISABEL HUDSON The composition of the Remuneration Committee accords with the requirements of the Code that the Remuneration Committee should consist of at least three independent Non-Executive Directors. The Remuneration Committee met seven times during 2013.
The Remuneration Committee is responsible for making recommendations to the Board on the Company’s remuneration and compensation plans, policies and practices and for determining, within agreed terms of reference, specific remuneration packages for the Executive Directors. These include pension rights and executive incentive schemes to encourage superior performance. Details of the remuneration structure and the Remuneration Committee’s activities in 2013 are provided in the Remuneration report on pages 68 to 89.
FIT Remuneration Consultants provided advice to the Remuneration Committee in 2013 and is independent of the Company.
The Risk Committee advises the Board on risk appetite and tolerance in setting the future strategy, taking account of the Board’s overall degree of risk aversion, the current financial situation of the Group and the Group’s capacity to manage and control risks within the agreed strategy. It advises the Board on all high level risk matters. Details of the Risk Management Framework, for which the Risk Committee has oversight, are provided in the Risk Management section on pages 44 to 50.
− Monitored compliance with the Group’s principal risk policies, satisfying itself that action plans to address significant breaches of those policies were sufficient
− Provided 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 MANJIT DALE The Investment Committee was formed in May 2011 in response to a recommendation from the Board evaluation undertaken at the end of 2010 to provide greater focus on investment strategy and performance. The Investment Committee reviews investment performance and strategic asset allocation across the Group. It met three times in 2013. In its December 2013 Board and Committee evaluation, the Board concluded that the Investment Committee continued to undertake an important role through its contribution to the oversight of the Group’s overall investment position.
− Reviewed proposals to enhance strategic asset allocation for the Group’s annuity portfolio
The Company’s Annual Report and Accounts, together with the Company’s Interim Report, Interim Management Statements and other public announcements and presentations are designed to present a fair, balanced and understandable view of the Group’s activities and prospects. These are available on the Company’s website at www.thephoenixgroup.com, along with a wide range of relevant information for private and institutional investors, including the Company’s financial calendar.
The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the Strategic Report on pages 6 to 53.
REVIEW OF SYSTEM OF INTERNAL CONTROLS The Code requires directors to review the effectiveness of the Company’s risk management and internal control systems which includes financial, operational and compliance controls. The Board has overall responsibility for the Group’s risk management and internal control systems and for reviewing their effectiveness. The Group’s systems of internal controls are designed to manage rather than eliminate the risk of failure to achieve business objectives and can provide only reasonable and not absolute assurance against material misstatement or loss. The Board’s review of the period covered by this report, which was undertaken with the assistance of the Audit and Risk Committees, was completed on 25 March 2014. Where any significant weaknesses were identified, corrective actions have been taken, or are being taken and monitored.
In addition, due to our cash generation and MCEV performance over the three year period from January 2011 to December 2013, our 2011 LTIP awards have met their performance conditions at 100%, and these awards are anticipated to vest in full in April 2014. For our Group Chief Executive Officer, Clive Bannister, this will be the first occasion since his appointment in 2011 that he has participated in an LTIP vesting, and this accordingly impacts his reported remuneration for 2013. While that level of vesting is considered appropriate, the Group Chief Executive Officer decided to voluntarily waive any entitlement under the LTIP in excess of two-thirds of the shares which would otherwise vest.
Remuneration Policy for 2014 2013 was the first occasion since the 2010 Premium Listing that the Company has undertaken a broader remuneration review. The Remuneration Committee’s conclusion from this review was that the Company’s Remuneration Policy remains appropriate and correctly aligned to the Group’s overall business strategy. There were, however, certain specific changes to remuneration practice which were recommended by the review and accordingly the following changes were made to the detail of our policy: − The first increases to senior executive base salaries since 2010 were proposed, with increases taking effect from 1 January 2014.
− AIP maximum potential remains appropriate at 150% of base salary for 2014, with a similar balanced scorecard of annual performance metrics applying as for 2013. There are no planned material changes to the operation of the AIP for 2014 although, consistent with past practice, the precise weightings under the balanced scorecard are set each year having regard to strategic priorities. The Remuneration Committee has also introduced a more formal process for considering its existing discretion to moderate outcomes in light of its broader assessment of both corporate and individual performance.
− The structure of the LTIP and the use of embedded value, cash generation and relative total shareholder return (‘TSR’) performance measures remains appropriate and in line with the Group’s strategy. As has been publicised, for much of 2013 the Group was exploring potential M&A activity. This prevented the 2013 annual LTIP awards from being made in the usual period following the announcement of annual results and they were eventually granted on 15 November 2013 (being the first open period after the normal grant window).
The Remuneration Committee remains comfortable that with these changes, its Remuneration Policy continues to be appropriate, and that the policy has the correct balance between retention and incentivisation for executives which will be in shareholders’ interests in the longer term.
Shareholder approval At the Annual General Meeting (‘AGM’) on 30 April 2014, shareholders will be invited to approve the Directors’ Remuneration Policy and to approve the 2013 Remuneration Report (excluding the Directors’ Remuneration Policy). Although Phoenix is not a UK registered quoted company and thus is not subject to the technical consequences of non-compliance with the new UK regime for reporting and approval by shareholders of executive pay, the Company will maintain its current policy of adopting a high level of voluntary compliance with all aspects of the regulations applicable to pay for UK companies.
As Phoenix is a non-UK incorporated company both votes will technically be advisory.
The auditors have reported on certain parts of the Remuneration Report and stated whether, in their opinion, those parts of the Remuneration Report have been properly prepared in accordance with the Companies Act 2006. Those sections of the Remuneration Report which have been subject to audit are clearly indicated.
The Directors’ Remuneration Policy as set out in this section of the Remuneration Report will take effect for all payments made to Directors from the date of the AGM on 30 April 2014.
GENERAL POLICY The Remuneration Policy for Executive Directors is summarised in the table opposite along with the position of the Chairman’s and the Non-Executive Directors’ fees: 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; − are competitive but not excessive, in relation to the UK life insurance and asset management markets; − do not promote unacceptable behaviours or encourage unacceptable risk taking. In particular, the Remuneration Committee designed the annual incentive targets for senior executives with a clear bias towards the delivery of corporate targets for senior executives, recognising the criticality of good team behaviours and co-operation for an insurance business as part of an effective approach to risk management; and
− take into account Group-wide pay and employment conditions. The Remuneration Committee reviews the average Group-wide base salary increase and annual incentive costs and is responsible for all-employee share arrangements.
*This section does not technically form part of the Directors’ Remuneration Policy and is for information only.
− The Remuneration Committee does not strictly follow data but uses it as a reference point in considering, in its judgement, the appropriate level of salary having regard to other relevant factors including corporate and individual performance and any changes in an individual’s role and responsibilities, and the level of salary increase awarded to other employees of the Group
− The Remuneration Committee will apply the factors set out in the previous column in considering any salary adjustments during the duration of this policy and, in any event, no increase will be made if it would take an Executive Director’s salary above the median level of salaries for the Remuneration Committee’s assessment of that role in the FTSE 31-100 at or shortly prior to when any increase is considered
− The Group provides market competitive benefits-in-kind. Details of the benefits provided in 2013 and 2014 are set out in the section below. The Remuneration Committee reserves discretion to introduce new benefits where it concludes that it is in the interests of Phoenix Group to do so, having regard to the particular circumstances and to market practice
− It is not possible to prescribe the likely change in the cost of insured benefits or the cost of some of the other reported benefits year-to-year, but the provision of benefits will normally operate within an annual limit of 10% of an Executive Director’s base salary
− The Remuneration Committee will monitor the costs in practice and ensure that the overall costs do not increase by more than the Remuneration Committee considers to be appropriate in all the circumstances
− The benefits received by Executive Directors included a car allowance, private medical insurance, life assurance and voluntary benefits through our flexible benefits scheme. No changes were made to this element of remuneration within the year
− In addition, following his appointment in 2012, James McConville has received the benefit of relocation assistance. The taxable element of this assistance (paid until May 2013) was £10,000 and is included in the single figure of remuneration in the Annual Implementation Report *This section does not technically form part of the Directors’ Remuneration Policy but does form part of the Annual Implementation Report. It is included here for information only.
− A contribution limit of 20% of base salary per annum per Executive Director has been set for the duration of this policy
− No changes were made to the pension arrangements in 2013 and no changes to these pension arrangements are anticipated for 2014
− AIP levels and the appropriateness of measures are reviewed annually to ensure they continue to support the Group’s strategy
− One third of any annual AIP award is to be deferred into shares for a period of three years although the Remuneration Committee reserves discretion to alter the current practice of deferral (whether by altering the portion deferred, the period of deferral or whether amounts are deferred into cash or shares). Such alterations may be required to ensure compliance with regulatory guidelines for pay within the insurance sector, but will not otherwise reduce the current portion deferred or the period of deferral
− Awards under DBSS will be in the standard form of awards to receive shares for nil-cost (with the shares either being delivered automatically at vesting or being delivered at a time following vesting at the individual’s choice)
− During the period until vesting of DBSS awards, the number of shares within such awards are cumulatively increased by the value of dividends notionally payable in respect of the vesting shares
− Malus/clawback provisions apply to the AIP and to amounts deferred and may be operated in a broad range of circumstances, including those prescribed by the FCA’s Remuneration Code
− The performance measures applied to AIP will be set by the Remuneration Committee and may be financial or non-financial and corporate, divisional or individual and in such proportions as it considers appropriate
− The AIP operates subject to three levels of moderation: i. The Remuneration Committee sets targets for relevant AIP metrics. Recognising that the business of the Company is to engage in corporate activity, the Remuneration Committee may adjust targets during the year to ensure they operate as originally intended if there is activity not contemplated by the business plan (which may or may not include reflecting the consequences of such activity depending on the circumstances)
ii. For 2014 onwards, there is a specific multiplier of 80%-120% of the provisional out-turn whereby the Remuneration Committee may adjust the provisional figure (but subject to any overriding cap) to take account of its broad assessment of performance both against pre-set targets and more generally, of the wider shareholder experience. With respect to financial performance measures, this assessment will include consideration of the quality of how particular outcomes were achieved iii. The AIP remains a discretionary arrangement and the Remuneration Committee reserves discretion to adjust the out-turn (from zero to any cap) should it consider that to be appropriate. In particular, the Remuneration Committee may operate this discretion in respect of any risk concerns 73 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
− The annual incentive out-turn for the 2013 financial year in respect of the Group Chief Executive Officer and Group Finance Director was £725,000, and £435,000 (being 69% and 72.5% of the maximum respectively)
− During the period until vesting of LTIP awards, the number of shares within such awards is cumulatively increased by the value of dividends notionally payable in respect of the vesting shares
− Malus/clawback provisions apply on a basis consistent with the equivalent provisions in the AIP and DBSS
− The Remuneration Committee expressly reserves discretion to make such awards as it considers appropriate within these limits.
− The Remuneration Committee may set such performance conditions for LTIP awards as it considers appropriate (whether financial or non-financial and whether corporate, divisional or individual)
− Once set, performance measures and targets will generally remain unaltered unless events occur which, in the Remuneration Committee’s opinion, make it appropriate to make adjustments to the performance conditions, provided that any adjusted performance condition is, in its opinion, neither materially more nor less difficult to satisfy than the original condition
All-employee share plans To encourage share ownership by employees, thereby allowing them to share in the long-term success of the Group and align their interests with those of the shareholders
− Executive Directors are able to participate in all-employee share plans on the same terms as other Group employees as required by HMRC legislation
− Share Incentive Plan (‘SIP’) – the Remuneration Committee has the facility to allow individuals to have the opportunity to purchase, out of their pre-tax salary, shares in the Company (up to such level as permitted by the Company in line with HMRC legislation) and receive up to two matching shares for every purchased share (although for 2014 and past years matching has been offered at one matching share for every six shares purchased). SIP also has the facility to allow for reinvestment of dividends in further shares, or the award of additional free shares (up to the limits as permitted by HMRC legislation)
− Executive Directors are expected to retain all shares (net of tax) which vest under the DBSS and under the LTIP (or any other discretionary long-term incentive arrangement introduced in the future) until such time as they hold a specified value of shares
REMUNERATION POLICY TABLE CONTINUED Element and purpose Policy and operation Maximum Performance measures
− Fee levels are periodically reviewed. The Company does not adopt a quantitative approach to pay positioning and exercises judgement as to what it considers to be reasonable in all the circumstances as regards quantum
− The aggregate fees of the Chairman and Non-Executive directors will not exceed the limit from time to time prescribed within the Company’s Articles of Association for such fees (currently £2 million per annum in aggregate)
− The Company reserves the right to vary the structure of fees within this limit including, for example, introducing timebased fees or reflecting the establishment of new board committees
Operating companies’ cash generation 25% Group MCEV 25% Expense management 15% Group MCEV operating earnings after tax 15% Customer satisfaction 10% Employee engagement 10%
The Remuneration Committee selected these performance measures for the 2014 AIP performance period to focus participants on achieving appropriate financial performance results as well as other relevant operational measures.
NOTES TO THE REMUNERATION POLICY TABLE CONTINUED 3. Differences between the policy on remuneration for directors from the policy on remuneration of other employees Where Phoenix’s pay policy for Directors differs to its pay policies for groups of employees, this reflects the appropriate market rate position for the relevant roles. However, elements of consistency of treatment are promoted through a single Group-wide (other than for Ignis) annual incentive arrangement (although quantum and the mix of performance metrics vary according to seniority), Group-wide share plans and flexible benefits programmes.
− In terms of the principles for setting a package for a new Executive Director, the starting point for the Remuneration Committee will be to apply the general policy for Executive Directors as set out above and structure a package in accordance with that policy. Consistent with the new UK regulations, the caps contained within the policy for fixed pay do not apply to new recruits, although the Remuneration Committee would not envisage exceeding these caps in practice
− The AIP and LTIP will operate (including the maximum award levels) as detailed in the general policy in relation to any newly appointed Executive Director
− For external candidates, it may be necessary to make additional awards in connection with the recruitment to replace awards forfeited by the individual on leaving a previous employer. For such replacement awards, Phoenix Group will not pay more than is, in the view of the Remuneration Committee, necessary and will in all cases seek, in the first instance, to deliver any such awards under the terms of the existing incentive pay structure. It may, however, be necessary in some cases to make such awards on terms that are more bespoke than the existing annual and equity-based pay structures in Phoenix in order to secure a candidate. Details of any recruitment-related awards will be appropriately disclosed
− For the avoidance of doubt, such replacement awards are not subject to a formal cap. The Remuneration Committee has not placed a maximum limit on any such awards which it may be necessary to make as it is not considered to be in shareholders’ interests to set any expectations for prospective candidates regarding such awards. Any recruitment-related awards which do not replace awards with a previous employer will be subject to the limits for incentive pay as stated in the general policy
POTENTIAL REWARDS UNDER VARIOUS SCENARIOS The potential total rewards available to the Executive Directors, ignoring any change in share price and roll-up of dividends are: The above chart aims to show how the remuneration policy set out above for Executive Directors is applied using the following assumptions.
Based on the maximum remuneration receivable: − AIP: consists of the maximum annual incentive (150% of base salary)
DIRECTORS’ SERVICE CONTRACTS Executive Directors Executive Director service contracts, which do not contain expiry dates, provide that compensation provisions for termination without notice will only extend to 12 months of salary, certain fixed benefits and pension (which may be payable in instalments and subject to mitigation). By excluding any entitlement to compensation for loss of the opportunity to earn variable pay, the Remuneration Committee believes the contracts to be consistent with best practice. The Remuneration Committee also has discretion to mitigate further by paying on a phased basis with unpaid instalments ceasing after the initial period of six months if the executive finds alternative employment. Contracts do not contain change of control provisions.
DBSS Deferred awards vest Deferred awards normally lapse Deferred awards vest
Non-Executive Directors’ contracts The Non-Executive Directors, including the Chairman, have letters of appointment which set out their duties and responsibilities. Appointment is for a fixed term of three years, terminable by one month’s notice on either side. Non-Executive Directors are not eligible to participate in incentive arrangements or receive pension provision or other benefits such as private medical insurance and life insurance.
Name Date of letter of appointment Appointment end date Unexpired term (months)
CONSIDERATION OF SHAREHOLDERS’ VIEWS Each year the Remuneration Committee takes into account the approval levels of remuneration related matters at our AGM in determining that the current Directors’ Remuneration Policy remains appropriate for the Company.
UNAUDITED INFORMATION REMUNERATION COMMITTEE The Group established the Remuneration Committee in 2010. The terms of reference of the Remuneration Committee are available at www.thephoenixgroup.com. During 2013 the Remuneration Committee’s main responsibilities were to: − Undertake a full review of all aspects of executive remuneration practice for the Group, including a review of base salaries.
− Agree the impact of the February 2013 placing and open offer on our share plans (with no adjustments being made to performance conditions).
− Receive reports on remuneration practices within Ignis Asset Management, applying similar overall principles as applied to the rest of the Group but relating these to an appropriate peer group of asset managers.
− Review the Company’s remuneration policy for Executive Directors in the context of the revised disclosure obligations of the new UK regulations.
The Remuneration Committee meets at least twice a year but more frequently if required. During 2013, seven Remuneration Committee meetings were held and details of attendance at meetings are set out in the Corporate Governance Report on page 61.
As reported last year, during 2013, certain responsibilities of the Remuneration Committee were assumed by the Remuneration Committee of the Board of Phoenix Life Holdings Limited, the highest EEA insurance holding company within the Group. In particular, that Remuneration 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. Meetings of this committee are in addition to the seven meetings of the Phoenix Group Holdings Remuneration Committee referred to above.
None of the Remuneration Committee members has any personal financial interest (other than as shareholders), conflicts of interests arising from cross-directorships or day-to-day involvement in running the business.
The Remuneration Committee makes recommendations to the Board. No Director plays a part in any discussion about his or her own remuneration.
Advice The Remuneration Committee received independent remuneration advice during the year from its appointed adviser, FIT Remuneration Consultants LLP (‘FIT’). FIT is a member of the Remuneration Consultants Group (the professional body for consultants) and adheres to its code of conduct. This appointment was made by the Remuneration Committee following consideration of FIT’s experience in this sector. FIT provided no other services to the Group and accordingly the Remuneration Committee was satisfied that the advice provided by FIT was objective and independent. FIT’s fees in respect of 2013 were £221,574 (plus VAT). FIT’s fees were charged on the basis of the firm’s standard terms of business for advice provided.
Distribution statement 1 Profit distributed by way of dividend has been taken as the dividend paid in respect of the relevant financial year. For 2013 this is the interim dividend paid (£60 million) and the recommended final dividend of 26.7p multiplied by the total share capital issued at the date of the annual report. No share buy-backs were made in either year.
2 Overall expenditure on pay has been taken as the employee costs as set out in note 10 Administrative expenses in the notes to the IFRS consolidated financial statements.
Performance graph and table The graph below shows the value to 31 December 2013, 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).
2 Jonathan Moss left the role of Group Chief Executive Officer on 7 February 2011 and left the Group on 29 March 2011. Clive Bannister joined Phoenix Group on 7 February 2011 and was appointed to the Board as a Director on 28 March 2011.
Voting outcomes from the 2013 AGM The table below shows the votes cast to approve the Directors’ Remuneration Report, for the year ended 31 December 2012, at the 2013 AGM held on 2 May 2013.
To approve the Directors’ Remuneration Report for the year ended 31 December 2012 146,109,177 99.25% 1,096,716 0.75% 2,298
Salary/fees Benefits1 Annual incentive Long-term incentives2 Pension Total 1 Benefits comprise car allowance, private medical insurance and life assurance and, for James McConville, an allowance of £2,000 per month in respect of relocation assistance was payable until May 2013.
2 Clive Bannister’s total single figure of remuneration for 2013 includes the first vesting of long-term incentive awards since his appointment in 2011.
No long-term incentive awards for the current Executive Directors vested during 2012 or 2013 although the new UK regulations require the inclusion of figures for the 2011 LTIP awards due to vest in 2014 in respect of a performance period ending on 31 December 2013. 2011’s LTIP awards are expected to vest at 67% due to a combination of full achievement of the applicable MCEV and cumulative cash generation performance measures (see below) and the decision of Clive Bannister to voluntarily waive any vesting of this award in excess of twothirds of the shares which would otherwise vest. The 2013 long-term incentives value in the above table has been calculated by multiplying this percentage (67%) by the number of shares subject to the original 2011 awards (plus additional shares in respect of estimated accrued dividends in the period until vesting) by the average share price between 1 October 2013 and 31 December 2013 (732.3p). For James McConville, the value of his 2013 long-term incentives is a value in respect of the intrinsic gain on SAYE option grant made in 2013 (£2,769).
The aggregate remuneration of all directors under salary, fees, benefits, cash supplements in lieu of pensions and annual incentive was £3.803 million (2012: £3.226 million).
Name As a % of max KPI element As a % of salary
Against the individual financial and non-financial metrics, before discretionary adjustment, out-turns were as follows: Performance metric
% of 80% of incentive potential based on KPIs % achieved
Operating companies’ cash generation 24% 13.5% Group MCEV 24% 24.0% Expense management 16% 16.0% Group MCEV operating earnings after tax 16% 16.0% Customer satisfaction 10% 8.1% Employee engagement 10% 5.0% Total (before moderation) 100% 82.6%
While the Remuneration Committee concluded that the Company had performed very well against the pre-set targets, consistent with prior years, it considered the indicative out-turn against its broader assessment of performance and specifically considered that, while good progress was made on strategic and risk initiatives set by the Board, it was appropriate to moderate the overall score down to 75% of maximum.
Given the closed fund nature of the Company and that the Board periodically looks at other transactions to enhance value for shareholders, whilst the performance measures for AIP and details of the overall out-turn are disclosed, the detailed targets for the performance measures are considered commercially sensitive (and are likely to remain so) and are accordingly not further disclosed.
LTIP OUTCOMES FOR 2011 AWARDS Performance metric % of award subject to metric Target range Performance achieved Vesting outcome
In addition to the above targets, the Remuneration Committee confirmed that the underpin performance condition relating to management of debt within the Group (as described more fully below) had been achieved in the performance period. As previously mentioned, Clive Bannister decided to voluntarily waive any vesting under this award in excess of two-thirds of the maximum. This related to the 2011 LTIP only and is not indicative of any intent in respect of future awards.
NON-EXECUTIVE FEES The emoluments of the Non-Executive Directors for 2013 based on the current disclosure requirements were as follows: Name
During the year to 31 December 2013, the Group has made the following GPP payments: Group contribution
Clive Bannister LTIP1, 2 12 April 2011 657.5p 212,927 – – – – 218,4083 12 April 2014 460,058 196,629 1,399,998 – – 668,530 James McConville LTIP1, 2 23 August 2012 485p 164,948 – – – 169,1943 23 August 2015 1 In addition to the shares awarded under the LTIP presented above, participants receive an additional number of shares (based on the number of LTIP awards which actually vest) to reflect the dividends paid during the vesting period.
2 Aggregate gains of Directors from share options exercised and vesting shares in 2013 was £nil (2012: £nil). The 2013 long-term incentive value shown in the single figure will only vest in April 2014.
4 The face value of awards granted in 2013 represents the maximum vesting of awards (but before any credit for dividends over the period to vesting) and is calculated using a share price of 712p being the closing middle market price on the award date. The vesting % at threshold performance (2013 awards) for Clive Bannister and James McConville is 25%.
Following the year-end, the Group Chief Executive Officer elected to waive his entitlement to any vesting of the 2011 LTIP in excess of two-thirds of the maximum.
Target range between MCEV growth in excess of the risk-free rate by 2.5% per annum and MCEV growth in excess of the risk-free rate by 6% per annum
Target range between MCEV growth in excess of the risk-free rate by 4% per annum and MCEV growth in excess of the risk-free rate by 6% per annum
TSR 25% of this part vests at threshold performance rising on a pro rata basis until 100% vests
N/A Target range between median performance against the constituents of the FTSE 250 (excluding investment trusts) rising on a pro rata basis until full vesting for upper quintile performance
As noted in the Directors’ Remuneration Policy report, LTIP awards to be made in 2014 will be subject to performance measures similar to those described in the table above, and the exact performance targets will be determined by the Remuneration Committee shortly before the awards are made.
1 DBSS awards granted prior to 2013 were increased as a result of the placing and open offer of 50,000,000 shares on 21 February 2013. The increases were made on the basis of the standard formula of share plan adjustments on such event. The aggregate figure shown in the column ‘As at 31 Dec 2013’ reflects this increase in options for Clive Bannister.
This is the arrangement pursuant to which one-third of the AIP for any year is deferred into the Company’s shares. No performance conditions apply therefore other than generally being subject to continued employment. In addition to the shares awarded under the DBSS presented above, participants received an additional number of shares to reflect the dividends paid during the vesting period (or until transfer of shares for DBSS awards made before 2014).
As at 31 December 2013 or retirement if earlier and as at
Ian Ashken1 1,263,698 1,509,796 – – – René-Pierre Azria 28,869 34,491 – – – Alastair Barbour – – – – – David Barnes 2,300 2,747 – – – Charles Clarke2 2,000 2,389 – – – Ian Cormack – 3,650 – – – Tom Cross Brown 1,664 1,988 – – – Manjit Dale3 – – – – – Howard Davies – 3,623 – – – Isabel Hudson 3,249 3,880 – – – Alastair Lyons4 7,500 8,961 – – – Hugh Osmond5 11,072,825 13,229,201 – – – David Woods – 3,500 – – –
2 Charles Clarke’s share interests are shown as at his date of leaving on 2 May 2013.
The Group Chief Executive Officer has confirmed that he will, net of taxes, retain all the shares which vest in April 2014 in respect of the 2011 LTIP which will then count towards these guidelines.
ADDITIONAL FCA DISCLOSURES CODE STAFF The Remuneration Committee has identified the Group’s asset management subsidiary, Ignis Asset Management, as a Code firm. By virtue of its influence over Ignis, the Remuneration 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 Remuneration Committee has determined that 14 staff within Ignis qualify as Code Staff. The Remuneration Committee has also determined that a further 27 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
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 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.
Performance measurement/assessment For Group and Life company employees, performance assessment is normally based upon a balanced scorecard of measures related to Group and individual targets. These targets typically include financial performance, risk, people and customer measures. Overall AIP costs are reviewed by the Remuneration Committee at the year-end having regard to the Group’s financial and non-financial measures.
With the exception of one individual, for all Code Staff in control functions (Internal Audit, Regulatory Compliance and Risk) reward is linked to achievement against individual objectives and excludes any direct link to financial performance. A similar approach is also adopted in respect of the with-profits actuary.
All incentive awards to Code Staff are subject to the review and support of the Remuneration Committee.
Deferral and vesting The Remuneration Committee requires that one-third of annual incentives for the senior Group employees be deferred into Phoenix Group Holdings shares. Equivalent rules apply to Ignis employees who are required to defer part of their annual incentive into phantom shares where the value of the outcome is determined by Ignis’ financial performance. This extends to the majority of Code Staff.
INTRODUCTION Phoenix Group Holdings is incorporated in the Cayman Islands (registered no. 202172) and has a Premium Listing on the London Stock Exchange. The Company is not required to comply with the requirements of the UK Companies Act 2006. However, the directors support these enhanced standards for disclosure and have sought to comply voluntarily with these requirements.
Paid interim dividend 26.7p per share (2012: 21p per share) Recommended final dividend 26.7p per share (2012: 26.7p per share) Total ordinary dividend 53.4p per share (2012: 47.7p per share)
Full details of the authorised, issued and fully paid share capital as at 31 December 2013 and movements in share capital during the period are presented in note 16 to the IFRS consolidated financial statements.
RESTRICTIONS ON TRANSFER OF SHARES Under the Company’s 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 Company’s Articles).
SUBSTANTIAL SHAREHOLDINGS Information provided to the Company pursuant to the FCA’s Disclosure and Transparency Rules is published on a Regulatory Information Service and on the Company’s website. As at 25 March 2014, the Company had been notified or was aware of the following significant holdings of voting rights in its shares.
TDR Capital Nominees Limited1 13,923,409 6.19 Xercise2 Limited 11,452,611 5.09 Henderson Global Investors 11,427,356 5.08 Artemis Investment Management LLP 11,347,387 5.05 FIL Limited 11,322,184 5.03 William Alan McIntosh 9,597,493 4.27 Nicholas Berggruen Charitable Trust 8,906,712 3.96 Hugh Edward Osmond 8,823,352 3.92 1 TDR Capital Nominees Limited is controlled by TDR Capital LLP, of which Manjit Dale is a Partner. The stated shareholding includes ordinary shares also held by Jambright Limited, Jambright Midco Limited.
BOARD BOARD OF DIRECTORS The membership of the Board of Directors during 2013 is given within the Corporate Governance Report on pages 56 to 57 which 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.
During 2013 and up to the date of this report, the following changes to the Board took place: − Ian Ashken and Charles Clarke ceased to be directors of the Company with effect from 2 May 2013, having decided not to stand for re-election at the AGM
− Hugh Osmond resigned from the Board on 21 August 2013
− Alastair Lyons resigned from the Board on 30 September 2013
− Ian Cormack succeeded Alastair Lyons as Senior Independent Director with effect from 1 October 2013.
In accordance with the UK Corporate Governance Code, directors must stand for re-election annually. The Board of Directors will be unanimously recommending that all of the directors should be put forward for election/re-election at the forthcoming AGM to be held on 30 April 2014 (except for Manjit Dale, who is not standing for re-election).
At the Company’s AGM held on 2 May 2013, 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 by operation of law or held in treasury. These authorities were not used during the year or up to the date of this report.
DIRECTORS’ REPORT CONTINUED Subject to obtaining shareholder approval for the renewal of this authority at the forthcoming AGM, the Company is authorised to make purchases of its own shares under Article 20 and make payment for the redemption or purchase of its own shares in any manner permitted by the Cayman Islands Companies Law (as amended), applicable law or regulation, including without limitation, out of capital, profits, share premium or the proceeds of a new issue of shares. The Company held no treasury shares during the year or up to the date of this report.
DIRECTORS’ REMUNERATION AND INTERESTS A report on Directors’ remuneration is presented within the Directors’ Remuneration Report including details of their interests in shares and share options or any rights to subscribe for shares in the Company.
FINANCIAL RISK MANAGEMENT The Group operates a Risk Management Framework (‘RMF’) consisting of several components, as detailed in the Risk management section of the Strategic Report. 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.
MEMORANDUM AND ARTICLES Changes to the Company’s Memorandum and Articles require prior shareholder approval and in some cases, approval of the Group’s main lenders.
DIRECTORS’ REPORT CONTINUED CONTRACTUAL/OTHER SIGNIFICANT AGREEMENTS IMPACTED BY A CHANGE OF CONTROL OF THE COMPANY There are change of control clauses contained in certain of the Group’s financing agreements. Upon a change of control of the Company, the principal amounts outstanding and the accrued interest under the Pearl and Impala facility agreements, the Pearl loan notes, the Royal London PIK facility and Royal London PIK notes would become immediately repayable or be required to be immediately redeemed.
The Group recognises the need to treat people with disabilities fairly and equally including where an employee becomes disabled during their employment. Full and fair consideration is given to internal and external applications from disabled people for employment and further career opportunities, including training and development. Internal and external applicants are asked if they have any special requirements when invited to attend an interview and reasonable provisions are made to meet the applicant’s request. Applicants are considered on the basis of the job requirements and their ability and competencies, also taking into consideration any appropriate reasonable workplace adjustments. The Group also provides the opportunity for employees to participate in the Company’s all-employee share schemes, SAYE and Share Incentive Plan, to facilitate share ownership in the Company.
BOTHWELL STREET, GLASGOW The Bothwell Street office is home to several of Ignis’ investment desks as well as distribution and key support functions.
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITOR As explained more fully in the Directors’ Statement of Responsibilities set out on page 98, the Directors are responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards as adopted by the European Union and with Part 9 of Book 2 of the Dutch Civil Code, and for the preparation of the Directors’ Report in accordance with Part 9 of Book 2 of the Dutch Civil Code. Furthermore, the Board of Directors is responsible for such internal control as it determines is necessary to enable the preparation of the financial statements that are free from material misstatement, whether due to fraud or error.
SCOPE OF THE AUDIT OF THE FINANCIAL STATEMENTS An audit involves obtaining evidence about the amounts and disclosures in the financial statements to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the Directors; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the Annual Report and Accounts 2013 to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
OPINION WITH RESPECT TO THE FINANCIAL STATEMENTS In our opinion, the accompanying financial statements give a true and fair view of the financial position of Phoenix Group Holdings as at 31 December 2013, and of its result and its cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the European Union and with Part 9 of Book 2 of the Dutch Civil Code.
OUR ASSESSMENT OF RISKS OF MATERIAL MISSTATEMENT We identified the following risks that have had the greatest effect on the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team: −reasonableness of IFRS actuarial assumptions including persistency, expenses, longevity and credit default assumptions; −accuracy and completeness of actuarial data and robustness of actuarial modelling processes; −valuation of complex and illiquid assets; and
INDEPENDENT AUDITOR’S REPORT CONTINUED OUR APPLICATION OF MATERIALITY We apply the concept of materiality in both planning and performing the audit, and in evaluating the effect of misstatements on our audit and of uncorrected misstatements, if any, on the financial statements and in forming our opinion in the Audit Report. For the purposes of determining whether the financial statements are free from material misstatement, we define materiality as the magnitude of an omission or misstatement that, individually or in aggregate, in light of the surrounding circumstances, could reasonably be expected to influence the economic decisions of the users of the financial statements.
When establishing our overall audit strategy, we determined the magnitude of uncorrected misstatements that we judged would be material for the financial statements as a whole. We determined materiality for the Group to be £36 million, which is approximately 2% of equity. This provided a basis for determining the nature, timing and extent of risk assessment procedures, identifying and assessing the risk of material misstatement and determining the nature, timings and extent of further audit procedures.
On the basis of our risk assessments, together with our assessment of the Group’s overall control environment, our judgement was that overall performance materiality (i.e. our tolerance for misstatement in an individual account or balance) for the Group should be 50% of materiality, namely £18 million. Our objective in adopting this approach was to ensure that total detected and undetected audit differences do not exceed our materiality level of £36 million for the financial statements as a whole.
The Group audit team continued to follow a programme of planned visits and regular communication that has been designed to ensure that the Group audit team visits each of the locations where the Group audit scope was focused at least once every year. In addition to the location visit, the Group audit team reviewed key working papers and participated in key meetings involving the component teams.
OUR RESPONSE TO THE RISKS IDENTIFIED ABOVE WAS AS FOLLOWS: −In respect of the actuarial assumptions, we evaluated management’s processes and controls over assumption setting and validated the reserving methodologies and assumptions by comparing the valuation assumptions against the Group’s own experience investigations, regulatory requirements and industry benchmarks.
−We tested management’s control over data extraction process and key actuarial models. We have performed substantive testing on a sample basis to assess the accuracy and completeness of the data extraction process and tested that the key actuarial models represent an effective implementation of the approved methodology and operate as intended.
−We engaged valuations specialists to challenge the methodology and assumptions used in the valuation of complex and illiquid assets. We performed substantive procedures to test the appropriateness of the valuation of these assets.
You have asked us to consider whether we have identified any inconsistencies between our knowledge acquired during the audit and the Directors’ statement that they consider the Annual Report is fair, balanced and understandable and whether the Annual Report appropriately discloses those matters that we communicated to the Audit Committee which we consider should have been disclosed.
MATTERS ON WHICH WE REPORT BECAUSE OF VOLUNTARY COMPLIANCE WITH THE UK COMPANIES ACT 2006 We have nothing to report in respect of the following items: −adequate accounting records have not been kept by the Group, or returns adequate for our audit have not been received from branches not visited by us; or
− the consolidated financial statements and the part of the Directors’ Remuneration Report to be audited is not in agreement with the accounting records and returns; or
In our opinion the part of the Remuneration Report of the Company that has been described as audited as been properly prepared in accordance with the basis of preparation as described therein.
J.G. Kolsters 101 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Gross premiums written 1,333 1,609 Less: premiums ceded to reinsurers 7 11 (5,173) Net premiums written 1,344 (3,564)
Net investment income 9 2,673 4,600 Total revenue, net of reinsurance payable 4,197 1,193
Policyholder claims (4,830) (5,166) Less: reinsurance recoveries 464 364 Change in insurance contract liabilities 3,411 645 Change in reinsurers’ share of insurance contract liabilities (710) 5,142 Transfer to unallocated surplus 22 (77) (45) Net policyholder claims and benefits incurred (1,742) 940
Change in investment contract liabilities (1,156) (750) Acquisition costs (10) (3) Change in present value of future profits 31 9 – Amortisation of acquired in-force business 31 (111) (122) Amortisation of customer relationships and other intangibles 31 (19) (18)
Add: tax attributable to policyholders’ returns 13 (27) 33 Tax (charge)/credit attributable to owners 13 (10) 115 Profit for the year attributable to owners 207 424
Attributable to: Owners of the parent 145 407 Non-controlling interests 20 62 17
Attributable to: Owners of the parent 141 72 Non-controlling interests 62 17
Equity attributable to owners of the parent Share capital 16 – – Share premium 1,097 982 Other reserves 17 – 5 Shares held by employee trust and Group entities 18 (13) (10) Foreign currency translation reserve 93 85 Retained earnings 732 596
Net asset value attributable to unitholders 5,309 4,671 Obligations for repayment of collateral received 7,284 10,458
Reinsurance payables 12 47 Payables related to direct insurance contracts 27 395 393
Acquired in-force business 1,511 1,622 Customer relationships and other intangibles 368 384 Present value of future profits 32 23
Cash and cash equivalents 36 9,224 9,028 Assets classified as held for sale 4 66 5,310
Total assets 74,073 86,094 105 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Cash flows from financing activities Proceeds from issuing ordinary shares, net of associated commission and expenses 233 – Proceeds from issuing shares in subsidiaries to non-controlling interests 37 33 Proceeds of new policyholder borrowings – 90 Ordinary share dividends paid (120) (72) Coupon on Perpetual Reset Capital Securities paid (26) (26) Dividends paid to non-controlling interests (25) (23) Arrangement and structuring fees associated with the re-terming of the Impala loan facility (21) – Repayment of policyholder borrowings (33) (43) Repayment of shareholder borrowings (694) (172) Interest paid on policyholder borrowings (18) (18) Interest paid on shareholder borrowings (136) (103)
Net increase/(decrease) in cash and cash equivalents 196 (2,695) Cash and cash equivalents at the beginning of the year 9,028 11,723 Cash and cash equivalents at the end of the year 36 9,224 9,028 106 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Issue of ordinary share capital, net of associated commissions and expenses – 233 – – – – 233 – 233 Dividends paid on ordinary shares – (120) – – – – (120) – (120) Dividends paid on shares held by the employee trust and Group entities – 2 – – – – 2 – 2 Dividends paid to non-controlling interests – – – – – – – (25) (25) Coupon paid to non-controlling interests, net of tax relief – – – – – – – (20) (20) Credit to equity for equity-settled share-based payments – – – – – 6 6 – 6 Shares in subsidiaries subscribed for by noncontrolling interests – – – – – – – 37 37 Shares distributed by employee trust – – – 8 – (8) – – – Shares acquired by employee trust – – – (11) – – (11) – (11) Expired contingent rights – – (5) – – 5 – – –
Profit for the year – – – – – 407 407 17 424 Other comprehensive income for the year – – – – (8) (327) (335) – (335) Total comprehensive income for the year – – – – (8) 80 72 17 89
1. ACCOUNTING POLICIES (a) Basis of preparation The consolidated financial statements for the year ended 31 December 2013 comprise the financial statements of Phoenix Group Holdings (‘the Company’) and its subsidiaries (together referred to as ‘the Group’).
Basis of consolidation The consolidated financial statements include the financial statements of the Company and its subsidiary undertakings including collective investment schemes where the Group exercises overall control. In accordance with the principles set out in IAS 27 Consolidated and Separate Financial Statements and SIC-12 Consolidation – Special Purpose Entities, collective investment schemes which are managed by the Group and where more than 50% of the units in issue are directly held by Group entities at the end of the accounting period, are included in the consolidated financial statements, with the interests of external third parties recognised as a liability, see policy (j). Certain of the collective investment schemes have non-coterminous period ends and are consolidated on the basis of additional financial statements prepared to the period end. Intragroup balances and income and expenses arising from intragroup transactions are eliminated in preparing the consolidated financial statements.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 1. ACCOUNTING POLICIES CONTINUED (b) Critical accounting estimates and judgements CONTINUED Insurance and investment contract liabilities Insurance and investment contract liability accounting is discussed in more detail in accounting policies (e) and (f) with further detail of the key assumptions made in determining insurance and investment contract liabilities included in note 39.
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 30.
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
− in the periods where guaranteed surrender values do not apply even though guaranteed surrender values are applicable after a specified period of time.
The with-profit bonus reserve for an individual contract is determined by either a retrospective calculation of ‘accumulated asset share’ approach or by way of a prospective ‘bonus reserve valuation’ method. The cost of future policy related liabilities is determined using a market consistent approach, mainly based on a stochastic model calibrated to market conditions at the end of the reporting period. Nonmarket related assumptions (for example, persistency, mortality and expenses) are based on experience adjusted to take into account of future trends.
The realistic liability for any contract is equal to the sum of the with-profit bonus reserve and the cost of future policy related liabilities.
The principal assumptions employed in respect of insurance liabilities are given in note 39.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 1. ACCOUNTING POLICIES CONTINUED (e) Insurance contracts and investment contracts with DPF CONTINUED Where the value of future profits can be shown to be due to policyholders, this amount is recognised as a reduction in the liability rather than as an intangible asset. This is then apportioned between the amounts that have been taken into account in the measurement of liabilities and other amounts which are shown as an adjustment to the unallocated surplus.
The value of the PVFP is determined in a manner consistent with realistic measurement of liabilities. In particular, the methodology and assumptions involve adjustments to reflect risk and uncertainty, are based on current estimates of future experience and current market yields and allow for market consistent valuation of any guarantees or options within the contracts. The value is also adjusted to remove the value of capital backing the non-profit business if this is included in the realistic calculation of PVFP. The principal assumptions used to calculate the PVFP are the same as those used in calculating the insurance contract liabilities given in note 39.
The valuation of liabilities on unit-linked contracts is held at fair value of the related assets and liabilities. The liability is the sum of the unitlinked liabilities plus an additional amount to cover the present value of the excess of future policy costs over future charges.
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 and where 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 (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.
The Group determines the net interest expense or income on the net defined benefit asset/liability for the period by applying the discount rate used to measure the defined benefit obligation at the beginning of the annual period to the net defined benefit asset/liability. The discount rate is the yield at the period end on AA credit rated bonds that have maturity dates approximating to the terms of the Group’s obligations. The calculation is performed by a qualified actuary using the projected unit credit method.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 1. ACCOUNTING POLICIES CONTINUED (r) Financial assets Purchases and sales of financial assets are recognised on the trade date, which is the date that the Group commits to purchase or sell the asset.
For units in unit trusts and shares in open-ended investment companies, fair value is determined by reference to published bid-values. The fair value of receivables and floating rate and overnight deposits with credit institutions is their carrying value. The fair value of fixed interestbearing deposits is estimated using discounted cash flow techniques.
(z) Share capital and shares held by the employee trust and Group entities Ordinary share capital The Group has issued ordinary shares which are classified as equity. Incremental external costs that are directly attributable to the issue of these shares are recognised in equity, net of tax.
(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.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 2. FINANCIAL INFORMATION The consolidated financial statements for the year ended 31 December 2013, set out on pages 102 to 196, were authorised by the Board of Directors for issue on 25 March 2014.
−Presentation of Items of Other Comprehensive Income (Amendments to IAS 1 Presentation of Financial Statements) (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 and disclose them separately from those that will not be reclassified.
− IAS 19 Employee Benefits (Amendment) (2013). The IASB has issued numerous amendments to IAS 19. These range from fundamental changes like removing the corridor mechanism and the concept of expected returns on plan assets to simple clarifications and re-wording. The Group has consequently changed its basis for determining the income or expense related to defined benefit pension schemes. The effect of this change in accounting policy is outlined in note 3.
− IFRS 13 Fair Value Measurement (2013) defines fair value and sets out in a single IFRS a framework for measuring fair value. The impact of adopting this new standard is outlined in note 3.
−Annual Improvements to IFRS 2009–2011 cycle (2013). This makes a number of minor improvements to existing standards and interpretations.
− IFRS 11 Joint Arrangements (2014) establishes principles for financial reporting by parties to a joint arrangement.
− IFRS 12 Disclosure of Interests in Other Entities (2014) combines, enhances and replaces the disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities.
− IAS 28 Investments in Associates and Joint Ventures (Revised) (2014). 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.
−Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32) (2014). The amendments address inconsistencies in current practice when applying the offsetting criteria in IAS 32.
−Recoverable Amount Disclosures for Non-Financial Assets (Amendments to IAS 36 Impairment of Assets) (2014). Modifications to the disclosures required by IAS 36 have been made as a result of the requirements of IFRS 13.
(a) Fair value measurement The Group has adopted IFRS 13 Fair Value Measurement from 1 January 2013. As a result of adopting this standard for financial instruments that are recognised at fair value on a recurring basis, the Group will now determine whether transfers have occurred between levels in the hierarchy by re-assessing categorisation (based on the lowest level input that is significant to the fair value measurement as a whole) at the start of each reporting period. The adoption of IFRS 13 has not had a significant impact on the measurement of the assets and liabilities included within the consolidated financial statements.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 3. CHANGE IN ACCOUNTING POLICIES CONTINUED This change in accounting policy has been applied retrospectively. The change has decreased the defined benefit expense recognised in the consolidated income statement and correspondingly increased the loss on remeasurements of the net defined benefit asset/liability recognised in other comprehensive income by £15 million for the year ended 31 December 2012.
The following table summarises the financial effects on the consolidated income statement and the statement of consolidated comprehensive income as a result of the implementation of the new accounting policy: Year ended 31 December 2012
Consolidated income statement: Increase in net investment income 5 14 Increase in deferred tax expense (1) (3)
The balances transferred to assets and liabilities classified as held for sale in the statement of consolidated financial position as at December 2013 relate to BA(GI) Limited (‘BAGI’). The balances as at 31 December 2012, related to the Part VII transfer of a portfolio of wholly reinsured annuity liabilities to Guardian Assurance Limited (‘Guardian’) which completed in September 2013 and the proposed sale of BAGI.
Liabilities classified as held for sale: Liabilities under insurance contracts – 5,404 Deferred tax liabilities – 23 Payables related to direct insurance contracts 48 42 Other liabilities 1 10 122 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
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. The business was transferred to Guardian on 30 September 2013 using a scheme under Part VII of the Financial Services and Markets Act 2000 approved by the High Court on 12 September 2013.
As part of the Part VII transfer, the Group paid £78 million consideration to Guardian in connection with the ongoing servicing of the transferred policies. Net liabilities disposed of were £143 million and the Group recognised a gain on transfer of £65 million, comprising £42 million within gain on transfer of business and £23 million within tax (charge)/credit attributable to owners in the consolidated income statement.
GENERAL INSURANCE During 2012, the Group made considerable progress with its strategy to exit from its residual, non-core general insurance business. In April 2012, the general insurance business of Phoenix Life Assurance Limited (formerly Pearl Assurance Limited) was transferred under a Part VII scheme to BAGI, a fellow group company – which resulted in all of the Group’s residual general insurance liabilities being held in the same entity. The Group completed the sale of its entire interest in BAGI on 18 March 2014 and accordingly its assets and liabilities were classified as held for sale as at 31 December 2013.
5. SEGMENTAL ANALYSIS The Group defines and presents operating segments based on the information which is provided to the Board, and therefore segmental information in this note is presented on a different basis from profit or loss in the consolidated financial statements. The accounting policy adopted in the preparation of this note is detailed in note 1 (dd).
For management purposes, the Group is organised into business units based on their products and services and has two operating segments as follows: −Phoenix Life – this segment manages a range of whole life, term assurance and pension products; and
− Ignis Asset Management – this segment provides investment management services to the life companies within the Group and to third parties, covering both retail and institutional investors.
Net policyholder claims and benefits incurred: Depreciation, impairment and amortisation: Depreciation of property, plant and equipment – (3) – – (3) Amortisation of acquired in-force business (111) – – – (111) Amortisation of customer relationships and other intangibles (16) (3) – – (19)
Profit/(loss) before tax 300 51 (161) – 190 Tax attributable to policyholders’ returns 27 – – – 27 Segmental result before the tax attributable to owners 327 51 (161) – 217 124 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Depreciation, impairment and amortisation: Depreciation of property, plant and equipment – (3) – – (3) Impairment losses on property, plant and equipment (4) – – – (4) Amortisation of acquired in-force business (122) – – – (122) Amortisation of customer relationships (15) (3) – – (18)
Other operating expenses: Profit before finance costs and tax 517 38 2 – 557
Profit/(loss) before tax 413 38 (109) – 342 Tax attributable to policyholders’ returns (33) – – – (33) Segmental result before the tax attributable to owners 380 38 (109) – 309 125 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Operating profit/(loss) before adjusting items 414 49 (24) 439 Investment return variances and economic assumption changes on long-term
Financing costs attributable to owners – – (126) (126) Segmental result before the tax attributable to owners 327 51 (161) 217
Non-recurring items include: −arrangement and structuring fees of £21 million associated with the extinguishment and re-terming of the Impala loan facility; −gain on transfer of business of £42 million (see note 4); − regulatory change and systems transformation costs of £25 million; −net settlement cost of pension liability management initiatives of £9 million (see note 30); and
−net other items of positive £2 million include a gain on the reinsurance agreement with Guardian offset by corporate project costs.
Operating profit/(loss) before adjusting items 399 43 (13) 429 Investment return variances and economic assumption changes on long-term
Non-recurring items include: −a gain of £177 million recognised upon entering into the reinsurance agreement with Guardian to transfer certain portfolios of annuity liabilities; − regulatory change and systems transformation costs of £28 million; and
Variances on owners’ funds of: Subsidiary undertakings (29) (13) The Company (2) –
The negative variance on owners’ funds of subsidiary undertakings of £29 million primarily relates to fair value losses on swap and equity hedging positions held within the shareholder funds. The variances on owners’ funds of the Company of £2 million (2012: £nil) comprise fair value gains arising from movements in the fair value of warrants in issue over the Company’s shares.
6.3 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) 2.4 2.6 Other fixed interest 3.4 3.6 127 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 7. REINSURANCE No significant new reinsurance agreements were entered into during the year. In 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.
Where the Group receives collateral on 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 ‘Deposits received from reinsurers’. The amounts recognised as financial assets and liabilities from cash collateral received at 31 December 2013 are set out below.
Financial assets 379 445 Financial liabilities 379 445 8. FEES This note analyses the Group’s fees and commission income. The accounting policy adopted in the preparation of this note is detailed in note 1(x).
Investment income Interest income on loans and receivables 11 40 Interest income on impaired financial assets – 1 Interest income on financial assets designated at fair value through profit or loss on initial recognition 1,552 2,433 Dividend income 687 674 Rental income 80 88 Net interest (expense)/income on Group defined benefit pension scheme asset/liability (1) 15
Loans and receivables 10 – Financial assets at fair value through profit or loss
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 10. ADMINISTRATIVE EXPENSES This note gives further details on the items included within administrative expenses in the consolidated income statement and an analysis of which operating segment our employees work within.
Average number of persons employed Phoenix Life 807 809 Ignis Asset Management 393 456 11. AUDITOR’S REMUNERATION This note shows the total remuneration payable by the Group to our auditors.
The remuneration of the Company’s auditors, including their associates, in respect of services supplied to members of the Group was £7.6 million (2012: £7.6 million). No services were provided by the Company’s auditors to the Group’s pension schemes in either 2013 or 2012.
Audit of the consolidated financial statements 0.5 0.4 Audit of the Company’s subsidiaries 2.3 2.7 Audit of MCEV supplementary information 0.4 0.5
Corporate finance services 2.7 – Tax advisory services – 0.1 Other non-audit services – 0.5 Total fees for other services 2.7 0.6
12. FINANCE COSTS This note analyses the interest costs on the Group’s borrowings which are described in note 23 and is based upon the accounting policy detailed in note 1(y).
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 (benefit)/charge attributable to policyholder earnings was £(27) million (2012: £33 million).
Deferred tax on remeasurement losses/gains of defined benefit schemes 12 (114)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 13. TAX (CREDIT)/CHARGE CONTINUED 13.3 RECONCILIATION OF TAX (CREDIT)/CHARGE
Policyholder tax (credit)/charge (27) 33 Total tax credit for the year (17) (82)
1 The Group’s two operating segments operate predominantly in the UK. The reconciliation of the tax credit has, therefore, been completed by reference to the standard rate of UK tax rather than by reference to the Jersey income tax rate of 0% which is applicable to Phoenix Group Holdings.
18. SHARES HELD BY THE EMPLOYEE TRUST AND GROUP ENTITIES This note gives details of the value of the shares held by the Phoenix Group Holdings Employee Benefit Trust (‘PGH EBT’) to satisfy awards granted to employees under the Group’s share-based payment schemes and shares issued to Phoenix Life Assurance Limited. The accounting policy adopted in the preparation of this note is detailed in note 1(z).
19. SHARE-BASED PAYMENT This note describes the various share-based payment schemes used within the Group and how the options and awards of shares are valued. The accounting policy adopted in the preparation of this note is detailed in note 1(y).
19.1 SHARE-BASED PAYMENT EXPENSE The expense recognised for employee services receivable during the year is as follows: £m £m
The fair value of these awards is estimated at the share price at the grant date, taking into account the terms and conditions upon which the instruments were granted.
The weighted average fair value of options granted during the year was £5.93 (2012: £4.53).
The weighted average remaining contractual life for the rewards outstanding as at 31 December 2013 is 1.5 years (2012: 1.6 years).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 20. NON-CONTROLLING INTERESTS CONTINUED 20.1 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.
The Notes have no fixed maturity date and coupon payments may be deferred at the option of PGH1; accordingly the Notes meet the definition of equity for financial reporting purposes. Under the rules of the PRA, the Notes also meet the conditions to be included in Tier 1 capital in the calculation of the group capital resources. As the Notes are not held by the Company, these are disclosed as a non-controlling interest in the consolidated financial statements.
For so long as a deferred coupon payment has not been satisfied, PGH1 may not declare, pay or distribute a dividend on any of its securities in issue ranking junior to the Notes, including the ordinary shares of PGH1 or any parity securities or, except in particular circumstances, redeem, purchase or otherwise acquire any of its securities in issue ranking junior to the Notes, including its ordinary shares or any parity securities. These restrictions would also apply to the Company until the deferred coupon payment is satisfied.
On 25 April 2013, the 2013 coupon was settled in full by PGH1, other than to two companies within the Group which waived their right to receive that coupon.
22. UNALLOCATED SURPLUS This note shows the movement in the excess of the assets over the policyholder liabilities of the with-profit business of the Group’s life operations. The accounting policy adopted in the preparation of this note is detailed in note 1(e).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 23. BORROWINGS This note shows the carrying values and fair values of each of the Group’s borrowings and explains their main features and movements during the year. The accounting policy adopted in the preparation of this note is detailed in note 1(h).
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 2013 and 2012.
d. On 19 May 2011, UKCPT entered into a £150 million investment term loan facility agreement. The £150 million investment term loan facility agreement accrues interest at LIBOR plus a variable margin of 1.60% to 2.00% per annum. The lender holds security over the assets of UK Commercial Property Estates Holdings Limited and UK Commercial Property Estates Limited, both of which are subsidiaries of UKCPT. The repayment date for this facility is 19 May 2018. As at 31 December 2013, the facility was fully drawn down (2012: Fully drawn down).
f. 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. On 22 February 2013, Tranche A, Tranche B and Tranche C of the Impala Facility were converted into a £1,851 million single tranche term loan facility and an initial prepayment of £450 million was paid. The original financial liability has been treated as an extinguishment and has been replaced in the statement of consolidated financial position by a new financial liability. Arrangement and structuring fees of £21 million associated with this new financial liability have been shown in the consolidated income statement.
The terms of this new facility are: −Repayment instalments of £30 million are due semi-annually on 30 June and 31 December each year; −The facility maturity date is 31 December 2017, with the option for the Group to extend this date to 30 June 2019; −The facility bears interest at LIBOR plus a margin of 4.75% per annum which would increase by: (i) 2.25% per annum after 31 December 2017 if the option to extend the final maturity date to 30 June 2019 is exercised; and (ii) 0.5% per annum if additional target repayments of £60 million per annum do not occur. The additional interest charge applies from the end of the period when the repayment was due until the repayment has been made.
g. On 14 May 2008, PGH (MC1) Limited issued PIK notes to the value of £154.5 million to Royal London and PGH (MC2) Limited obtained a £154.5 million PIK facility from Royal London. The PIK notes and facility were subsequently amended on 2 September 2009, leaving a total of £100 million outstanding. Interest accrues on the PIK notes and facility at LIBOR plus a margin of 2% unless an election is made by PGH (MC1) Limited or PGH (MC2) Limited to capitalise the interest, in which case the margin increases to 3.5%. During 2013, interest of £5 million (2012: £5 million) was capitalised on the PIK notes and facility. The final maturity date on the PIK notes and facility is 30 June 2019.
Credit linked note – – 32 – Contract for differences – – 2 –
IPO WARRANTS The IPO warrants originally entitled the holder to purchase one ordinary share at a price of €7.00 per share, subject to adjustment, at any time commencing on the consummation of a business combination. On 2 September 2009 the exercise price was increased to €11. At 31 December 2013, the terms of the IPO warrants entitled the holder to purchase 1.027873 (2012: 1.027873) ordinary shares per IPO warrant, for an exercise price of €10.70 (2012: €10.70).
On 5 July 2010, the IPO warrants were admitted to trading on the LSE. The IPO warrants were subsequently delisted from Euronext on 17 November 2010.
−the foregoing conditions are satisfied and the Company issues notice of redemption of the warrants, each warrant holder shall be entitled to exercise their warrant prior to the scheduled redemption date. However, the price of the shares may fall below the redemption trigger price or the warrant exercise price after the redemption notice is issued.
At 31 December 2013, the IPO warrants were valued at £2 million (2012: £1 million).
All outstanding Lenders’ warrants may be redeemed at the option of the Company at any time after they become exercisable and prior to their expiration at a price of €0.01 per warrant provided that the last closing bid price of the ordinary shares is equal to or exceeds £18.97 (2012: £18.97) on each of 20 consecutive trading days. The Company must give not less than 30 days’ notice of the redemption date. Each warrant may then be exercised by the warrant holder (in whole or any part) at its option.
The holders are entitled to exercise their warrants for cash, assignment of an amount of outstanding principal/accrued interest of any Global Debt (i.e. any debt owed to the registered holder by any Group company) 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.
These Lenders’ warrants are not traded in an active market and have therefore been valued using an extended Black-Scholes valuation model to capture the embedded barrier feature. The key assumptions used to ascertain a value are the same as for the IPO warrants (see above). The value of the warrants at the year end was £300,000 (2012: £200,000).
All outstanding warrants may be redeemed at the option of the Company at any time after they become exercisable and prior to their expiration at a price of €0.01 per warrant, provided that the last closing bid price of the ordinary shares is equal to or exceeds €16.50 on each of 20 consecutive trading days. At 31 December 2012, the threshold was reduced to €16.05 following an issue of ordinary shares by the Company under a scrip dividend in 2012. The Company must give not less than 30 days’ notice of the redemption date. Each warrant may then be exercised by the warrant holder (in whole or any part) at its option.
The holders are entitled to exercise their warrants for cash, assignment of an amount of outstanding principal plus accrued interest of any Global Debt (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.
The leasehold properties provision has been made for amounts in respect of the excess of lease rentals and other payments on properties that are currently vacant or are expected to become vacant, over the amounts to be recovered from subletting these properties. The discount rate used was 1.7% (2012: between 2.6% and 5.5%) and it is expected that the provision will be utilised over the next five years (2012: 12 years).
The known incidents provision was created for historical data quality, administration systems problems and process deficiencies on the policy administration, financial reconciliations and operational finance aspects of business outsourced.
26. TAX ASSETS AND LIABILITIES This note analyses the tax assets and liabilities that appear in the statement of consolidated financial position, and explains the movements in these balances during the year. The accounting policy adopted in the preparation of this note is detailed in note 1(l).
Current tax: Current tax receivables 6 6 Current tax payable (107) (71)
Deferred tax: The balances at 31 December comprise: Deferred tax liabilities (373) (409)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 26. TAX ASSETS AND LIABILITIES CONTINUED MOVEMENT IN DEFERRED TAX ASSETS/(LIABILITIES)
Surplus within the non-profit funds (62) 62 – – – IFRS transitional adjustments – (88) – – (88) Adjustment for insurance policies held with related parties in respect of the PGL pension scheme (24) – 1 – (23)
Payables related to direct insurance contracts 443 435 Less amounts classified as held for sale (note 4) (48) (42)
Accruals and deferred income 139 171 Less amounts classified as held for sale (note 4) – (5)
Amount due for settlement after 12 months – 3 29. OTHER PAYABLES This note analyses the Group’s other payables at the end of the year.
Less amounts classified as held for sale (note 4) (1) (5)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 30. PENSION SCHEMES This note describes the Group’s two main staff pension schemes for its employees, the Pearl Group Staff Pension Scheme and the PGL Pension Scheme and explains how the pension asset/liability is calculated. The accounting policy adopted in the preparation of this note is detailed in note 1(m).
An analysis of the defined benefit asset/liability for each pension scheme is set out below: £m £m
Pearl Group Staff Pension Scheme Economic deficit (53) (114) Minimum funding requirement obligation (84) (83) Net defined benefit liability (137) (197)
The Group defined benefit schemes typically expose the Group to a number of risks, the most significant of which are: Asset volatility – the value of the scheme’s assets will vary as market conditions change and as such is subject to considerable volatility. The volatility in the scheme’s assets can be caused by both volatility within the markets or variations in the return achieved by the schemes’ investment managers relative to market performance. In particular, there is the risk that the variation in asset values will not be in line with the variation in pension liability values, and as such differences in the nature and duration of the assets and liabilities can cause difference in the way that the assets and liabilities vary.
30.1 PEARL GROUP STAFF PENSION SCHEME Scheme details The Pearl Group Staff Pension Scheme (‘the Pearl Scheme’) comprises a final salary section, a money purchase section and a hybrid section (a mix of final salary and money purchase). The final salary and hybrid sections of the Pearl Scheme are closed to new members, and since 1 July 2011 are also closed to future accrual by active members.
Defined contribution scheme Contributions in the year amounted to £1 million (2012: £1 million).
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: − annual cash payments into the scheme of £70 million in 2013 and 2014, payable on 30 September, followed by payments of £40 million each year from 2015 to 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
−covenant tests relating to the embedded value of certain companies within the Group.
Contributions totalling £68 million are expected to be paid into the scheme in 2014. The £70 million due by 30 September 2014 has been reduced by £2 million in respect of accelerated deficit funding contributions which were paid in 2013 as a result of the enhanced transfer value (‘ETV’) exercise, further details of which are included on page 151.
Gains and losses on settlements (72) 63 – (9) Included in profit or loss 10 (24) (3) (17)
Loss from change in demographic assumptions – (66) – – (66) Loss from change in financial assumptions – (91) – – (91) Experience losses – (24) – – (24) Change in provision for tax on economic surplus available as a refund – – 20 – 20 Change in minimum funding requirement obligation – – – (83) (83)
Employer’s contributions 26 – – – 26 Benefit payments (89) 89 – – –
In May 2013, the Group commenced an enhanced transfer value (‘ETV’) exercise which offered in-scope deferred members of the Pearl Scheme the option to take an equivalent cash transfer value to exit the scheme, thereby extinguishing any future liability and risk for the Group with respect of these members. The financial effect of all completed transfers has been recognised in the consolidated financial statements in 2013. As at 31 December 2013, ETVs of £72 million have been paid out, reducing scheme assets, and there was a resultant reduction in scheme liabilities of £63 million. The net settlement cost of £9 million has been recognised in the consolidated income statement.
In November 2011, following formal consultation, the Group carried out a pension increase exchange (‘PIE’) exercise where existing inscope pensioners were offered the option to exchange future non-statutory pension increases for benefits accrued before 6 April 1997 for a higher, non-increasing pension, thereby reducing longevity and inflation risk for the Group. The exercise was completed in 2012 and in that year a reduction in scheme liabilities of £3 million was recognised in the consolidated financial statements as a negative past service cost in the consolidated income statement. There is no financial impact in the current year.
The Pearl Scheme uses swaps, UK Government bonds and UK Government stock lending to hedge the interest rate and inflation exposure arising from the liabilities and are disclosed in the table above as ‘Hedging Portfolio’ assets. Under the Scheme’s stock lending programme, the Scheme lends a Government bond to an approved counterparty and receives a similar value in the form of cash in return which is typically reinvested into other Government bonds. The Scheme retains economic exposure to the Government bond, hence the bonds continue to be recognised as scheme assets with a corresponding liability to repay the cash received as disclosed in the table above.
The weighted average duration of the defined benefit obligation at 31 December 2013 is 17 years (2012: 16 years).
Rate of increase for pensions in payment (5% per annum or RPI if lower) 3.15 2.90 Rate of increase for deferred pensions (CPI) 2.35 2.25 Discount rate 4.50 4.50 Inflation – RPI 3.35 3.00 Inflation – CPI 2.35 2.25
Sensitivity level 25bps increase 25bps decrease 25bps increase 25bps decrease 1 year increase decrease
The above sensitivity analyses are based on a change in an assumption while holding all other assumptions constant. In practice, this is unlikely to occur, and changes in some of the assumptions may be correlated. When calculating the sensitivity of the defined benefit obligation to significant actuarial assumptions, the same method has been applied as when calculating the pension liability recognised within the statement of financial position.
The UK Government currently intends to equalise benefits between males and females arising from the accrual of Guaranteed Minimum Pension (‘GMP’) requirements. Legislation will be implemented following completion of the current consultation on this matter. Once this consultation process has reached a conclusion, the Group will be able to quantify the impact of this change.
30.2 PGL PENSION SCHEME The PGL Pension Scheme comprises a final salary section and a defined contribution section.
Scheme details Defined contribution scheme Contributions in the year amounted to £5 million (2012: £4 million).
An additional liability has been recognised of £17 million (2012: £25 million) reflecting a charge on any refund of the resultant IAS 19 surplus of £51 million (2012: £71 million) that would arise as a result of the minimum funding requirement. A deferred tax asset of £10 million (2012: £16 million) has also been recognised to reflect tax relief at a rate of 20% (2012: 23%) that is expected to be available on the contributions, once paid into the scheme.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 30. PENSION SCHEMES CONTINUED 30.2 PGL PENSION SCHEME CONTINUED Summary of amounts recognised in the consolidated financial statements The amounts recognised in the consolidated financial statements are as follows: Fair value of scheme assets £m
Remeasurements: Return on plan assets excluding amounts included in interest income (6) – – – (6)
Gain from change in demographic assumptions – 42 – – 42 Loss from change in financial assumptions – (43) – – (43) Experience losses – (1) – – (1) Change in provision for tax on economic surplus available as a refund – – (5) – (5) Change in minimum funding requirements obligation – – – 9 9
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 exercise was completed in 2012 and in that year a reduction in scheme liabilities of £2 million was recognised in the consolidated financial statements as a negative past service cost in the consolidated income statement. There was no financial impact of this exercise in the current year.
In November 2011, the Group commenced an Enhanced Transfer Value (‘ETV’) exercise which offered in-scope deferred members of the PGL Pension Scheme the option to take an Equivalent Cash Transfer Value to exit the Scheme. The financial effect of all completed transfers was recognised in the consolidated financial statements in 2012. As at 31 December 2012, ETVs of £36 million had been paid out, reducing scheme assets, and there was a resulting reduction in the scheme liabilities of £29 million. A net settlement cost of £7 million was recognised in the consolidated income statement. There was no financial impact of this exercise in the current year.
The actual return on plan assets was £66 million (2012: £15 million).
The economic value of the PGL Pension Scheme assets as at 31 December 2013, amounted to £1,734 million (2012: £1,704 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 2013 of £1,639 million (2012: £1,609 million).
The Group ensures that the investment positions are managed within an asset liability matching (ALM) framework that has been developed to achieve long-term investments that are in line with the obligations under the pension scheme. Within this framework, an allocation of 85% of the scheme assets is invested in a combination of supranational debt and a liability hedging portfolio. The Liability Driven Investment (‘LDI’) portfolio is actively managed against a liability benchmark in order to hedge the duration and inflation risks.
The weighted average duration of the defined benefit obligation at 31 December 2013 is 16 years (2012: 16 years).
Principal assumptions The principal financial assumptions of the PGL Pension Scheme are set out in the table below: %
Rate of increase for pensions in payment (7.5% per annum or RPI if lower) 3.35 3.00 Rate of increase for deferred pensions (‘CPI’) 2.35 2.25 Discount rate 4.50 4.50 Inflation – RPI 3.35 3.00 Inflation – CPI 2.35 2.25
A quantitative sensitivity analysis for significant actuarial assumptions as at 31 December 2013 is shown below: 2013 Assumptions Base Discount rate RPI Life expectancy
31. INTANGIBLE ASSETS This note analyses the changes to the carrying value of the Group’s intangible assets during the year and details the results of the impairment testing on goodwill and the intangible assets with an indefinite life. The accounting policy adopted in the preparation of this note is detailed in note 1(n).
At 1 January Amounts classified as held for sale (note 4) (19) (165) – – (184)
Charge for the year – 122 18 – 140 Amounts classified as held for sale (note 4) – (27) – – (27)
The carrying amount of goodwill allocated to the Phoenix Life segment is £39 million (2012: £39 million) and to the Ignis Asset Management segment is £57 million (2012: £57 million).
CUSTOMER RELATIONSHIPS AND OTHER The first part of the customer relationships intangible relates to vesting pension premiums which captures the new business arising from policies in-force at the acquisition date, specifically top-ups made to existing policies and annuities vested from matured pension policies. The total value of this customer relationship intangible at acquisition was £297 million and has been allocated to the Phoenix Life segment. This intangible is being amortised over a 20 year period.
The second part of the customer relationships intangible relates to the investment management contracts (‘IMCs’) held within Ignis Asset Management. These are further split into IMCs held with open-ended funds and institutional mandates. The open-ended IMCs had a value at acquisition of £130 million and an indefinite useful economic life (‘UEL’). The reason for the indefinite UEL is that funds are open ended and indefinite in nature. An impairment review has been completed for these intangibles at the period end with an indefinite life and no impairment has arisen. Under this impairment review, value in use has been determined as the present value of future cash flows associated with the open-ended IMCs. The cash flows used in this calculation are consistent with those adopted by management in the Group’s operating plan, with a declining growth rate assumed for the extended forecast period beyond the period of this plan. Future cash flows have been valued using a discount rate of 10.8% (2012: 10.1%). The institutional mandate IMCs had a value at acquisition of £18 million and a UEL of between five and seven years.
Depreciation and impairment At 1 January (22) (16) Charge for the year (3) (3)
Keppie Massie, an accredited independent valuer, completed a valuation of the land and buildings at 31 December 2013 on an open market basis in accordance with the Royal Institution of Chartered Surveyors’ requirements, which is deemed to equate to fair value. The fair value measurement for the land and buildings of £15 million has been categorised as a Level 3 fair value based on the non-observable inputs to the valuation technique used.
The property portfolio consists of a mix of commercial sectors, held by the life companies, £366 million (2012: £512 million), and by the Group’s UK Commercial Property Trust, £1,046 million (2012: £1,016 million). The portfolio is spread geographically throughout the UK. Investment properties also include £191 million (2012: £199 million) of property reversions arising from sales of the NPI Extra Income Plan.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 33. INVESTMENT PROPERTY CONTINUED The fair value measurement of the investment properties has been categorised as a Level 3 fair value based on the inputs to the valuation techniques used. The following table shows the valuation techniques used in measuring the fair value of the investment properties, the significant non-observable inputs used, the inter-relationship between the key non-observable inputs and the fair value measurement of the investment properties: Description Valuation techniques Significant non-observable inputs Range (weighted average)
Yield methodology Expected income per sq. ft. Retail: £10 – £310 (£80)
Direct operating expenses (offset against rental income in the income statement) in respect of investment properties that generated rental income during the year amounted to £10 million (2012: £8 million). The direct operating expenses arising from investment property that did not generate rental income during the year amounted to £2 million (2012: £2 million).
Total financial liabilities 26,071 18,808 1 These assets and liabilities have no expected settlement date.
Less amounts classified as held for sale (note 4) (61) – (61) Total financial assets 63,520 63,518
Financial liabilities measured at carrying and fair values Financial liabilities at fair value through profit or loss: Designated upon initial recognition: Borrowings 194 194 194 Net asset value attributable to unitholders1 4,671 – 4,671 Investment contract liabilities1 8,096 – 8,096
Financial instruments traded in active markets with less depth or wider bid-ask spreads which do not meet the classification as Level 1 inputs, are classified as Level 2. The fair values of financial instruments not traded in active markets are determined using broker quotes or valuation techniques with observable market inputs. Financial instruments valued using broker quotes are classified at Level 2, only where there is a sufficient range of available quotes. The fair value of unquoted equities, over-the-counter derivatives, loans and deposits and collective investment schemes, where published bid prices are not available, are estimated using pricing models or discounted cash flow techniques. Where pricing models are used, inputs are based on market related data at the period end. Where discounted cash flows 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.
Financial liabilities measured at fair value Derivatives 40 2,113 3 2,156 Financial liabilities designated at fair value through profit or loss upon initial recognition: Investment contract liabilities – 8,578 – 8,578
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 34. FINANCIAL INSTRUMENTS CONTINUED 34.2 FAIR VALUE HIERARCHY CONTINUED 2012 £m £m
Financial assets measured at fair value Derivatives 37 3,616 12 3,665 Financial assets designated at fair value through profit or loss upon initial recognition: Fixed and variable rate income securities 28,997 11,448 500 40,945
Both investments have been valued by taking the fair value of the property within the structures, which have been independently valued, less the fair value of the debt within the structures. The valuations are sensitive to movements in yields on the underlying property portfolio. An increase in yields of 25bps would reduce the value of the first investment by £8 million (2012: £6 million) and the second investment by £23 million (2012: £25 million). A reduction in yields of 25bps would increase the value of the first investment by £9 million (2012: £9 million) and the second investment by £25 million (2012: £22 million).
34.2.4 Transfers of financial instruments between Level 1 and Level 2
Financial assets measured at fair value Financial assets designated at fair value through profit or loss upon initial recognition
Unrealised (losses)/ gains on assets held at end of period £m
Financial assets Derivatives 12 (12) – – – – – (12) Financial assets designated at fair value through profit or loss upon initial recognition: Equities 810 (15) 50 (131) 39 – 753 2 Fixed and variable rate income securities 500 104 827 (665) 390 (24) 1,132 70 £m
Financial liabilities designated at fair value through profit or loss upon initial recognition: Borrowings – 14 – (22) 194 – 186 (15) Net asset value attributable to unitholders 70 7 94 (74) – – 97 3
During 2013, updates to the Group’s observations with regard to the liquidity of certain equity and fixed and variable rate income securities resulted in a net transfer into Level 3 from Levels 1 and 2.
Where the Group receives collateral in the form of marketable financial instruments which it is not permitted to sell or re-pledge except in the case of default, it is not recognised in the statement of consolidated financial position. The fair value of financial assets accepted as collateral for OTC derivatives but not recognised in the statement of consolidated financial position amounts to £35 million (2012: £245 million).
The maximum exposure to credit risk in respect of OTC derivative assets is £1,890 million (2012: £3,619 million) of which credit risk of £1,856 million (2012: £3,492 million) is mitigated by use of collateral arrangements (which are settled net after taking account of any OTC derivative liabilities owed to the counterparty).
Credit risk on exchange traded derivative assets of £58 million (2012: £46 million) is mitigated through regular margining and the protection offered by the exchange.
Where the Group pledges collateral in the form of marketable financial instruments and retains all the risks and rewards of the transferred assets, it continues to be recognised in the statement of consolidated financial position. Cash collateral pledged where the counterparty retains the risks and rewards it is derecognised from the statement of consolidated financial position and a corresponding receivable is recognised for its return. The value of assets pledged at 31 December 2013, in respect of OTC derivative liabilities of £2,116 million (2012: £3,002 million), amounted to £788 million (2012: £1,048 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 £64 million (2012: £83 million).
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 2013, is £6,743 million (2012: £9,269 million) and £6,743 million (2012: £9,249 million) respectively.
34.3.5 Other collateral arrangements Collateral has also been pledged and charges granted in respect of certain of the Group’s borrowings. The details of these arrangements are set out in note 23.
During the year, the Group updated its presentation of cash collateral pledged where the Group does not retain the right to receive contractual cash flows and now discloses all such balances in other receivables. Cash collateral pledged was previously included in cash or offset against obligations for repayment of collateral received.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 37. CASH FLOWS FROM OPERATING ACTIVITIES This note gives further details behind the ‘cash generated/(utilised) by operations’ figure in the statement of consolidated cash flows.
Profit for the year before tax 190 342 Non-cash movements in profit for the year before tax
Fair value (gains)/losses on: Investment property (72) 85 Financial assets (299) (1,445)
Change in fair value of borrowings 36 11 Depreciation of property, plant and equipment 3 3 Impairment of owner occupied property – 4 Amortisation of intangible assets 130 140 Change in present value of future profits (9) – Change in unallocated surplus 77 45 Share-based payment charge 6 5 Interest expense on borrowings 230 215 Net interest expense/(income) on Group defined benefit pension scheme asset/liability 1 (17) Gain on transfer of business (42) – Other losses on pension schemes 12 7
38. CAPITAL STATEMENT This note sets out the Group’s approach to managing capital, provides an analysis of available capital resources and explains the different regulatory capital requirements of the Group and its life companies.
CAPITAL MANAGEMENT FRAMEWORK The Group’s Capital Management Framework is designed to achieve the following objectives: −provide appropriate security for policyholders and meet all regulatory capital requirements whilst not retaining unnecessary excess capital; −ensure sufficient liquidity to meet obligations to policyholders and other creditors; and
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 (previously FSA).
Total IFRS equity attributable to owners of the parent1 1,909 1,658 Adjustments between IFRS equity attributable to owners of the parent and MCEV net worth2 (1,788) (1,913) MCEV value of in-force business2 2,257 2,377 Group MCEV 2,378 2,122 Gross shareholder debt: 50% of the Perpetual Reset Capital Securities given their hybrid nature 20 204 204
Difference between IFRS and MCEV carrying values of shareholder borrowings 200 112 Gross MCEV 4,639 4,975 1 As shown in the consolidated statement of financial position.
Leverage In managing capital the Group seeks to optimise the level of debt on its balance sheet. The Group’s closed book business model allows it to operate with higher leverage than life companies that are still writing new business, as it does not need to fund upfront capital requirements and new business acquisition expenses.
For this measure the capital resources include the surplus over capital policy in the life companies, a prudent assessment of the present value of future profits of Ignis Asset Management and the net assets of the holding companies, less 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. Further detail of the PLHL ICA position is provided in the business review (unaudited) on page 40.
Non-participating funds – any available surplus held in these funds is attributable to owners. Capital within the non-participating funds may be made available to meet capital requirements elsewhere in the Group subject to meeting regulatory and legal requirements, and after consideration of the internal capital requirements of the relevant fund and company. Any transfer of surplus may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
Other qualifying capital: Subordinated debt3 – – 450 450 Contingent loans 272 – (272) –
2 Regulatory adjustments to liabilities primarily reflect differences between the realistic valuation basis for the with-profit business used in calculating owners’ funds on an IFRS basis, and the regulatory valuation basis used to calculate the PRA peak 1 capital resources.
3 Of the £450 million (2012: £645 million) subordinated debt attributed to the Phoenix Life segment of the Group, £250 million (2012: £445 million) is internal to the Group, comprising £250 million (2012: £250 million) provided to Phoenix Life Assurance Limited and £nil (2012: £195 million) provided to Phoenix & London Assurance Limited which was transferred to PLL on 1 January 2011 following a Part VII transfer. The remaining £200 million (2012: £200 million) is external subordinated debt, see note 23 for details.
4 ‘Other activities and consolidation adjustments’ represent the consolidated owners’ funds arising outside of the Phoenix Life business. This includes the owners’ funds of Ignis Asset Management and the holding companies of the Group plus the value of the acquired in-force business net of the consolidation adjustments to eliminate the cost of the Group’s investment in the Phoenix Life business in the form of equity capital and subordinated loans.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 38. CAPITAL STATEMENT CONTINUED GROUP CAPITAL CONTINUED
Adjustments onto a regulatory basis: Unallocated surplus 883 10 – 893 Adjustments to assets1 (31) (214) (604) (849)
Adjustments onto a regulatory basis: Other qualifying capital: Contingent loans – – – – – 350 350 176 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Intragroup Loan Interest – – – – – – 10 (2) 8 Changes in methodology and assumptions: Longevity 3 7 1 4 3 (8) – – 10
Distributions made by Phoenix Life – – – – – – – (494) (494) New business and other factors: Intragroup capital movement – – – – – (107) (383) 479 (11)
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 year to 31 December 2013, are dividend payments to Group entities and restructuring activities, notably the Part VII transfer to Guardian.
Responsibility for agreeing the financial risk profile rests with the Board of each life company, as advised by investment managers, internal committees and the actuarial function. In setting the risk profile, the Board of each life company will receive advice from the appointed investment managers, the relevant with-profit actuary and the relevant actuarial function holder as to the potential implications of that risk profile with regard to the probability of both realistic insolvency and of failing to meet the regulatory minimum capital requirement. The actuarial function holder will also advise the extent to which the investment risk taken is consistent with the Group’s commitment to treat customers fairly.
The Group is also exposed to insurance risk arising from its Phoenix Life segment. Life insurance risk in the Group arises through its exposure to longevity, persistency, mortality and to other variances between assumed and actual experience. These variances can be in factors such as persistency levels and management and administrative expenses. More details on the Group’s exposure to insurance risk are provided in note 39.5 below.
39.3.1 Credit risk Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation. These obligations can relate to both on and off balance sheet assets and liabilities.
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
There is an exposure to spread changes affecting the prices of corporate bonds and derivatives. This exposure applies to with-profit funds, non-profit funds (where risks and rewards fall wholly to shareholders), shareholders’ funds and to unit-linked funds to the extent of management fees generated by the Group.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 39. RISK MANAGEMENT CONTINUED 39.3 FINANCIAL RISK ANALYSIS CONTINUED The Group holds £3,319 million of corporate bonds which are used to back annuity liabilities in non-profit funds (this excludes the liabilities reinsured to Opal Reassurance Limited). These annuity liabilities include an aggregate credit default provision of £238 million to fund against the risk of default.
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 withprofit policies is dependent on the extent to which the underlying insurance fund is relying on shareholder support.
Fixed and variable rate income securities 8,471 16,174 4,907 3,947 486 554 612 111 35,262 Reinsurers’ share of insurance contract
Credit ratings have not been disclosed in the above tables for holdings in collective investment schemes. The credit quality of the underlying debt securities within these vehicles is managed by the safeguards built into the investment mandates for these vehicles.
39.3.2 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).
The Group is mainly exposed to market risk as a result of: − the mismatch between liability profiles and the related asset investment portfolios; − the investment of surplus assets including shareholder reserves yet to be distributed, surplus assets within the with-profit funds and assets held to meet regulatory capital and solvency requirements; and
−the income flow of management charges from the invested assets of the business.
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
The sensitivity analysis for interest rate risk indicates how changes in the fair value or future cash flows of a financial instrument arising from changes in market interest rates at the reporting date result in a change in profit after tax and in equity. It takes into account the effect of such changes in market interest rates on all assets and liabilities that contribute to the Group’s reported profit after tax and in equity (but excludes the impact on the Group’s pension schemes).
In the non-participating funds, policy liabilities’ sensitivity to interest rates are matched primarily with fixed and variable rate income securities, with the result that sensitivity to changes in interest rates is very low. For unit-linked funds this risk is borne by the policyholders and the risk to the Group is limited to the extent of the management fees generated by the Group.
The portfolio of marketable equity securities and property investments which is carried in the statement of consolidated financial position at fair value, has exposure to price risk. The Group’s objective in holding these assets is to earn higher long-term returns by investing in a diverse portfolio of equities and properties. Portfolio characteristics are analysed regularly and price risks are actively managed in line with investment mandates. The Group’s holdings are diversified across industries and concentrations in any one company or industry are limited.
A 10% decrease in equity 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 £36 million (2012: an increase of £12 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 £35 million (2012: a decrease of £12 million).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 39. RISK MANAGEMENT CONTINUED 39.3 FINANCIAL RISK ANALYSIS CONTINUED 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.
Currency risk The Group’s principal transactions are carried out in sterling, and therefore its exchange risk is limited principally to historic business that was written in the Republic of Ireland, where the assets are generally held in the same currency denomination as their liabilities, therefore, any foreign currency mismatch is largely mitigated. Consequently, the foreign currency risk relating to this business mainly arises when the assets and liabilities are translated into sterling.
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
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.
Net asset value attributable to unitholders 5,309 – – – 5,309 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 351 – – – 351 185 PHOENIX GROUP HOLDINGS ANNUAL REPORT AND ACCOUNTS 2013
Net asset value attributable to unitholders 4,671 – – – 4,671 Obligations for repayment of collateral received 9,456 157 845 – 10,458 Reinsurance payables 47 – – – 47 Payables related to direct insurance contracts 393 – – – 393 Accruals and deferred income 163 2 – 1 166 Other payables 509 – – – 509
39.5 INSURANCE RISK Insurance risk refers to the risk that the frequency or severity of insured events may be worse than expected and includes expense risk. The Phoenix Life segment contracts include the following sources of insurance risk: Mortality higher than expected number of death claims on assurance products and occurrence of one or more large claims; Longevity faster than expected improvements in life expectancy on immediate and deferred annuity products; Morbidity higher than expected number of serious illness claims or more sickness claims which last longer on income protection policies; Expenses policies cost more to administer than expected; Lapses the numbers of policies terminating early is different to that expected in a way which increases expected claims costs or expenses or reduces future profits; Options unanticipated changes in policyholder option exercise rates giving rise to increased claims costs; and
The Group has a number of small books of general insurance 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 4.
Due to the historic diversity of issued general insurance policies and taking into account the legal and regulatory environment for hazardous risks, it is possible that additional claims could emerge from long-tail unexpired risks albeit it is not possible to predict the quantum, location or timing of such occurrences.
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 £18 million (2012: £25 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 £44 million (2012: £47 million).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 39. RISK MANAGEMENT CONTINUED 39.5 INSURANCE RISK CONTINUED 39.5.1 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.
Process used to determine assumptions For participating business in realistic basis companies, the assumptions about future demographic trends are intended to be ‘best estimates’. They are determined after considering the companies’ recent experience and/or relevant industry data. Economic assumptions are market consistent.
For other business, demographic assumptions are derived by adding a prudent margin to best estimate assumptions. Economic assumptions are prudent estimates of the returns expected to be achieved on the assets backing the liabilities.
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 £m
Valuation interest rate For realistic basis companies, the liabilities are determined stochastically using an appropriate number of risk-neutral scenarios produced by an economic scenario generator calibrated to market conditions and gilt yields as at the valuation date.
Lapse and surrender rates (persistency) The assumed rates for surrender and voluntary premium discontinuance depend on the length of time a policy has been in force and the relevant company. Surrender or voluntary premium discontinuances are only assumed for realistic basis companies. Withdrawal rates used in the valuation of with-profit policies are based on observed experience and adjusted when it is considered that future policyholder behaviour will be influenced by different considerations than in the past. In particular, it is assumed that withdrawal rates for unitised withprofit contracts will be higher on policy anniversaries on which Market Value Adjustments do not apply.
In common with other life companies in the UK which have written pension transfer and opt-out business, the Group has set up provisions for the review and possible redress relating to personal pension policies. These provisions, which have been calculated from data derived from detailed file reviews of specific cases and using a certainty equivalent approach, which give a result very similar to a market consistent valuation, are included in liabilities arising under insurance contracts. The total amount provided in the with-profit funds and non-profit funds in respect of the review and possible redress relating to pension policies, including associated costs, are £254 million (2012: £338 million) and £15 million (2012: £16 million) respectively.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 39. RISK MANAGEMENT CONTINUED 39.5 INSURANCE RISK CONTINUED 39.5.2 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.
Non-profit funds: Deferred annuities – with guarantees 50 – – – Deferred annuities – without guarantees 615 6 – – Immediate annuities 6,834 – 1,170 –
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 one year.
40. 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(bb).
Not later than 1 year 14 10 Later than 1 year and not later than 5 years 45 41 Later than 5 years 15 28
Transactions with pension schemes During the year, the Group entered into the following transactions with its pension schemes: £m
Information on other transactions with the pension schemes is included in note 30.
43. CONTINGENT LIABILITIES This note considers whether there is any uncertainty around the timing and amount of certain of the Group’s liabilities that would result in their disclosure as a contingent liability. The accounting policy adopted in the preparation of this note is detailed in note 1(u).
44. GROUP ENTITIES As at 31 December 2013, the principal subsidiary undertakings of the Group are as follows: Country of incorporation and principal place of operation
‘B’ ordinary shares of £1 Phoenix Life Limited (life assurance company) UK Ordinary shares of £1 Scottish Mutual International Limited (life assurance company) ROI Ordinary shares of €1.25 Non-insurance companies Ignis Asset Management Limited (holding company) UK Ordinary shares of £1 Ignis Fund Managers Limited (unit trust management company) UK Ordinary shares of £1 Ignis Investment Services Limited (investment management company) UK Ordinary shares of £0.10 Impala Holdings Limited (holding company) UK ‘A’ ordinary shares of £1
ordinary shares of £1 Opal Reassurance Limited (reassurance company)2 Bermuda ‘A’ ordinary shares of £1