Throughout the Annual Report and Accounts 2009, Phoenix Group Holdings and its subsidiaries are referred to as “Phoenix Group” or “the Group”. When referring to Phoenix Group Holdings, the parent company, “Phoenix Group Holdings” or “the Company” is used.
Operational – Scottish Mutual and Scottish Provident funds merged into Phoenix Life Limited – Progressed closure of Glasgow and Peterborough life company offices and associated transfer of operations to Wythall – Consolidation and rebranding of asset management business under Ignis
We achieved this strong cash flow by identifying and implementing a number of management actions during 2009, including the transfer of the Scottish Provident and Scottish Mutual life funds into Phoenix Life Limited, the restructuring of Phoenix & London Assurance, the renegotiation of certain outsourcer contracts and the resolution of other legacy issues. We are targeting £2.7 billion of cash generation over the next five years.
We believe Phoenix Life and Ignis Asset Management manage our key risks effectively but recognise that we have further work ahead to both enhance and fully embed the Group-wide risk governance, monitoring and reporting framework. In support of this risk agenda we recruited as Group Chief Risk Officer, Jean Park, in November 2009 and have established a Board level Risk Committee that will assist the Group in driving this agenda forward. All our future governance, risk and capital management initiatives will be aligned to the Solvency II directive.
To implement our model we have invested heavily in our employees, infrastructure and outsourcer partnerships, providing us with a scalable platform for acquisitions, their integration and hence the opportunity to benefit from synergies. This is key for the sustainability of our business, while providing policyholder protection and shareholder returns.
Key 2009 achievements Pro forma – UK holding company cash inflows of £716 million Management actions generated – £155 million of added Embedded Value First phase of – life company fund mergers completed Pro forma – Ignis Asset Management third party asset inflows of £1.3 billion Agreed plans to repatriate life company – asset management and to establish new fund structures within Ignis Asset Management 2010 priorities Drive – further cash flow acceleration and value creation within Phoenix Life Continue programme to – rationalise life companies Enhance the Group-wide risk and – capital management frameworks Increase – third party asset management business
– the value of the asset management and management service companies are calculated on an IFRS basis.
Favourable experience and other operating variances of £83 million primarily related to several management actions including the resolution of certain legacy issues, partially offset by the strengthening of regulatory capital requirements and capital policy in the life companies following the acquisition of the Pearl businesses by Phoenix Group Holdings. Favourable assumption changes of £73 million mainly relates to harmonisation of longevity assumptions across the Group and the results of an annuitant survival investigation.
Profits in the first half of the year were impacted by a number of factors, including significantly lower equity market levels and the depressed conditions of the commercial property market which resulted in a reduction in average funds under management and consequently lower fees. Equity markets improved significantly in the second half of the year and the commercial property market is also showing signs of recovery.
Restatement of the pro forma 31 December 2008 Embedded Value Certain changes have been made to the previously reported embedded value of the Pearl businesses. These changes have been implemented to align the methodology more closely with the CFO Forum principles.
Vesting annuities The MCEV places a value on the profits expected to be earned on annuities arising from policies vesting with guaranteed annuity terms. These policies are excluded from the definition of new business on the basis that the annuity being provided is an obligation under an existing policy and the life companies are already reserving for the cost of these guarantees.
The owners’ one-ninth share of policyholder with profit bonus of £20 million in the four-month post-acquisition period reflects the impact of lower terminal bonuses in 2009 following difficult market conditions. The market recovery in the financial investments backing the with profit business experienced in the latter half of the year is expected to be considered in bonus rates in 2010 along with the market performance for the first half of 2010.
2 Operating profit is presented before adjusting items. 3 Operating profit for Phoenix Life is based on expected investment returns on financial investments backing owners and policyholder funds over the reporting period, with consistent allowance for the corresponding expected movements in liabilities. Operating profit includes the effect of variances in experience for non-economic items, such as mortality, persistency and expenses, and the effect of changes in non-economic 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 disclosed separately outside operating profit. Phoenix Life operating profit is net of policyholder finance charges and policyholder tax.
A further test is required under Pillar 1 in respect of with profit funds which may result in an additional capital requirement referred to as the With profit Insurance Capital Component (“WPICC”).
 How we continue to attract, develop and retain the best people is a key focus for us.
Restructuring and site consolidation In common with many other firms, we have been affected by the impact of the global recession and the turmoil in financial markets. These issues, combined with the legacy of acquisitions, have placed considerable demands on our employees, particularly as we create the organisational foundations to achieve significant and maintainable economies of scale throughout our operations, on which to build a profitable and sustainable future.
Providing relevant and timely information to our customers is key to us, keeping them informed throughout the product lifecycle, including posting any unclaimed funds to the Unclaimed Assets Register.
Sponsorship The Group is committed to playing an active role in the wider community through supporting local initiatives.
2009 was the 13th successive year that Ignis Asset Management was the title sponsor of the annual Women’s 10k Road Race in Glasgow, with approximately 12,000 women involved, raising money for numerous charitable causes. The Group has also been the proud sponsor, since 2007, of Partick Thistle Football Club and in 2009 agreed a three-year sponsorship deal with Middlesex County Cricket Club.
Simon Smith (age 45) Group Finance Director Simon Smith became Group Finance Director of the Pearl businesses in 2006, having joined in 2005 following the acquisition of the Pearl life companies from Henderson. He is a Chartered Accountant with 18 years’ experience in the fund management and life insurance sectors, initially in tax management and structuring. Mr Smith was appointed to the Board of Directors of the Company on 2 September 2009.
The Board, chaired by Ron Sandler, is responsible for the strategy of the Group and its strength reflects the Group’s ambitions to remain the leading UK life assurer for closed fund business. The Board contains a majority of independent Non-Executive Directors, and its balance of complementary skills and experience is reflected in the Director profiles. Please see the Corporate governance report for details of the operations of the Board and its Committees.
The Company was not, by virtue of its secondary listing, required during 2009 or to date in 2010, to comply with the June 2008 UK Combined Code on Corporate Governance (“the Combined Code”). However, the Directors support the high standards of corporate governance contained in the Combined Code and, in line with the Company’s intention to seek the Premium Listing, this report outlines the Company’s position with regard to the Combined Code as at 30 March 2010.
For 2010, bonus potential for the Executive Directors will be as follows: Target*
Jonathan Moss 75 150 Simon Smith 75 150 * Assumes “on target” financial and personal performance
Net expense attributable to unitholders 43 – Total operating expenses (1,536) (2)
1. Accounting policies (a) Basis of preparation The consolidated financial statements for the year ended 31 December 2009 comprise the financial statements of Phoenix Group Holdings (“the Company”) and its subsidiaries (together referred to as “the Group”). Following the completion of the acquisition of the Pearl businesses on 2 September 2009, Liberty Acquisition Holdings (International) Company changed its name to Pearl Group. Subsequently, on 15 March 2010, Pearl Group changed its name to Phoenix Group Holdings.
(o) Property, plant and equipment Owner-occupied property is stated at fair value, being the estimated amount for which the property could be exchanged on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction. Owner-occupied property is depreciated over its estimated useful life, which is taken as 50 years, except where the residual value is greater than its carrying value in which case, no depreciation is charged to profit or loss. Land is not depreciated. Gains and losses on owner-occupied property are recognised in the statement of consolidated comprehensive income.
Fair value estimation The fair value of financial instruments traded in active markets such as publicly traded securities and derivatives are based on quoted market prices at the period end. The quoted market price used for financial assets is the current bid price on the trade date. The fair value of investments that are not traded in an active market is determined using valuation techniques such as broker quotes, 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 flow techniques are used, estimated future cash flows are based on management’s best estimates and the discount rate used is a market related rate for a similar instrument.
(s) Reinsurance The Group cedes insurance risk in the normal course of business. Reinsurance assets represent balances due from reinsurance companies. Reinsurers’ share of insurance contract liabilities are dependent on expected claims and benefits arising under the related reinsured policies.
Net policyholder claims and benefits incurred: Non-recurring (74) – – – (74)
Total £m 4.4 2008 segmental analysis In 2008 the results and net assets relate to unallocated corporate items.
Fund management based fees 30 – Investment contract income 71 –
Net investment income 1,032 33 8. Other operating income 2009 £m
Amounts due for settlement after 12 months 40,150 2,722 – –
Fair value Debenture loans Limited recourse bonds 2012 7.39% (note a) 45 – Limited recourse bonds 2022 7.59% (note a) 93 – Unsecured loan notes (note b) 18 – £200 million 7.25% unsecured subordinated loans (note c) 156 – £779 million loan (note d) 751 – £15 million loan (note e) 14 – £2,260 million syndicated loan (note f) 2,260 – £80 million facility agreement (note g) 42 – £100 million PIK notes and facility (note h) 102 – £75 million secured loan note (note i) 70 – £425 million loan facility (note i) 399 –
(c) Scottish Mutual Assurance Limited (“SMA”) issued £200 million 7.25% undated, unsecured subordinated loan notes on 23 July 2001. The earliest repayment date of the notes is 25 March 2021 and thereafter on each fifth anniversary so long as the notes are outstanding. With effect from 1 January 2009, as a part of a Part VII transfer, these loan notes were transferred into the shareholder fund of Phoenix Life Limited (“PLL”). PLL has entered into interest rate swap agreements with Abbey National Treasury Services plc, the effect of which is to convert the fixed interest expense on the notes to a floating rate expense. In the event of the winding up of PLL, the right of payment under the notes is subordinated to the rights of the higher-ranking creditors (principally policyholders). Phoenix Group Holdings acquired these loan notes as part of the acquisition of the Pearl businesses and they were recognised at their fair value.
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. 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.
Expected return on scheme assets 17 – Actuarial gains on scheme assets 23 –
The financial assets do not qualify for derecognition as the Group retains all the risks and rewards of the transferred assets except for the voting rights. The carrying value of listed financial assets lent at 31 December 2009 that have not been derecognised amounted to £8,612 million (2008: £nil).
It is the Group’s practice to obtain collateral in stock lending transactions, usually in the form of cash or marketable securities. Certain cash collateral is available to the Group for investment purposes and is therefore recognised as a financial asset and a financial liability. The amount recognised as a financial assets and a financial liability at 31 December 2009 is £2,780 million (2008: £nil) and £3,007 million (2008: £nil) respectively. Other collateral is held on behalf of the Group and is not recognised in the statement of consolidated financial position as the Group is not permitted to sell or re-pledge the collateral in the absence of default.
42.1 Risk and capital management objectives The risk management objectives and policies of the Group are based on the requirement to protect the Group’s regulatory capital position, thereby safeguarding policyholders’ guaranteed benefits whilst also ensuring the Group can meet various cash flow requirements. Subject to this, the Group seeks to use available capital to achieve increased investment returns, balancing risk and reward, to generate additional value for policyholders and shareholders.
Price risk The Group’s price risk exposure relates to financial assets and liabilities whose values will fluctuate as a result of changes in market prices other than from interest rate and currency fluctuations. This is due to factors specific to individual instruments, their issuers or factors affecting all instruments traded in the market. Accordingly, the Group limits its exposure to any one counterparty in its investment portfolios and to any one foreign market.
Equity and property price risk is managed through the agreement and monitoring of financial risk profiles that are appropriate for each of the Group’s life funds in respect of maintaining adequate regulatory capital and Treating Customers Fairly. This is largely achieved through asset class diversification.
A 10% decrease in equity/property prices, with all other variables held constant, would result in a decrease in the profit after tax in respect of a full financial year and in equity of £17 million (2008: £nil).
Also on 2 September 2009, 50% of the Sponsors warrants’ were converted into ordinary shares as follows: Units Number of ordinary shares
The MCEV methodology adopted by the Group is in accordance with these MCEV principles with the exception of: – Risk‑free rates have been defined as the annually compounded UK government bond nominal spot curve plus ten basis points rather than as the swap rate curve; – The value of the asset management and management service companies has been included on an IFRS basis; and – No allowance for the costs of residual non‑hedgeable risk has been made.
Pro forma MCEV earnings per ordinary share For the year ended 31 December 2009
Issue of share capital 275 Conversion of warrants into ordinary shares 51 Redemption of shares (41) Credit to equity for equity‑settled share‑based payments 5
MCEV methodology The embedded value of covered business is based on a market‑consistent methodology. Under this methodology, assets and liabilities are valued in line with market prices and consistently with each other. Details of the key components of the MCEV are discussed below.
Frictional cost of capital (“COC”) COC is defined as the difference between the market value of shareholder‑owned assets backing required capital and the present value of future releases of those assets allowing for future investment returns on that capital, investment expenses and taxes.
Years 2009 1–5 £m 6–10 £m 11–15 £m 16–20 £m 20+ £m
The swaps rates above are only applicable to sensitivity (12) as disclosed in note 7.
(2) 1% decrease in risk‑free rates 135 (3) 1% increase in risk‑free rates (167) (4) 10% decrease in equity/property market values (156) (5) 100 bps increase in credit spreads1 (365) (6) 25% increase in equity/property implied volatilities (19) (7) 25% increase in swaption implied volatilities (57) (8) 10% decrease in lapse rates and paid‑up rates (19) (9) 5% decrease in annuitant mortality (183) (10) 5% decrease in non‑annuitant mortality 20 (11) Required capital equal to the minimum regulatory capital 81 (12) Swap curve as reference rate, retaining appropriate liquidity premiums (160) 1 25 bps is assumed to relate to default risk.
Forward‑looking statements The 2009 Annual Report and Accounts contains forward‑looking statements about the Group’s current plans, goals and expectations relating to future financial conditions, performance, results, strategy and objectives.
Glossary ABI Association of British Insurers – Represents the collective interests of the UK’s insurance industry.
CEIOPS The Committee of European Insurance and Occupational Pensions Supervisors – the Committee is composed of high level representatives from the insurance and occupational pensions supervisory authorities of European Union member states and is currently consulting with the industry on the technical requirements of Solvency II.
IMMFA Institutional Money Market Funds Association – The trade association which represents the European triple‑A rated money market funds industry.
RCR Resilience Capital Requirement – additional amounts of capital required to be held for regulatory purposes as a result of two stress tests.
WPICC With profit insurance capital component. The WPICC is the amount by which the regulatory surplus exceeds the realistic surplus.