L&G Full Year Results 2016 Part 3

RNS Number : 8036Y

Legal & General Group Plc

08 March 2017

Legal & General Full Year Results 2016 Part 3

Capital and Investments Page 63

4.01 Group regulatory capital - Solvency II Directive

From 1 January 2016, the group has been required to comply with the requirements established by the Solvency II Framework Directive, as adopted by the Prudential Regulation Authority (PRA) in the UK and to measure and monitor its capital resources on this basis.

The Solvency II results are estimated. Further explanation of the underlying methodology and assumptions is set out in the sections below.

In December 2015, the group received approval to calculate its Solvency II capital requirements using a Partial Internal Model (together with the approval by the PRA in December 2016 of an application for major model change). The vast majority of the risk to which the group is exposed is assessed on the Internal Model basis approved by the PRA. Capital requirements for a handful of smaller entities are assessed using the Standard Formula basis on materiality grounds. The group's US insurance businesses are valued on a local statutory basis, following the PRA's approval of the group's application to use the Deduction and Aggregation method of including these businesses in the group solvency calculation.

The table below shows the estimated group Own Funds, Solvency Capital Requirement and Surplus Own Funds of the group, based on the Internal Model and Matching Adjustment approved by the PRA. This incorporates the estimated impacts of a recalculation of the Transitional Measures for Technical Provisions (Estimated TMTP) recalculated based on end 2016 economic conditions and changes during 2016 to the Internal Model and Matching Adjustment. The Estimated TMTP has been amortised to end 2016. The conditions for the PRA to allow a formal recalculation of the group's TMTP were not met as at end 2016. In line with PRA guidance, we expect to undertake a formal recalculation of the TMTP on or before 1 January 2018, i.e. when PRA conditions are met or two years from the date of commencement of the Solvency II regime.

(a) Capital position

As at 31 December 2016, and on the above basis, the group had a Solvency II surplus of £5.7bn (2015: £5.5bn) over its Solvency Capital Requirement, corresponding to a coverage ratio on a "shareholder view" basis of 171% (2015: 176%). The shareholder view of Solvency II capital position is as follows:

	2016	2015
	£bn	£bn


Core tier 1 Own Funds	11.0	10.6
Tier 1 subordinated liabilities	0.6	0.6
Tier 2 subordinated liabilities	2.1	2.0
Eligibility restrictions	(0.1)	(0.4)
Own Funds¹	13.6	12.8
Solvency Capital Requirement (SCR)²	(7.9)	(7.3)


Solvency II surplus	5.7	5.5


SCR coverage ratio³	171%	176%

1. Own Funds do not include an accrual for the dividend of £616m (2015: £592m) declared after the balance sheet date.
2. The SCR is not subject to audit.
3. Coverage ratio is on an unrounded basis.

The "shareholder view" basis excludes the SCR for the with-profits fund and the final salary pension schemes from both Own Funds and SCR. The 2015 comparatives have been restated from the originally reported pro-forma basis to be on a "shareholder view". On the pro-forma basis as reported at end 2015 the coverage ratio at end 2016 would have been 165% (2015: 169%).

(b) Methodology

Own Funds comprise the excess of the value of assets over the liabilities, as valued on a Solvency II basis. Subordinated debt issued by the group is considered to be part of available capital, rather than a liability, as it is subordinate to policyholder claims. Own Funds include deductions in relation to fungibility and transferability restrictions, where the surplus Own Funds of a specific group entity cannot be freely transferred around the group due to local legal or regulatory constraints.

Assets are valued at IFRS fair value with adjustments to remove intangibles and deferred acquisition costs, and to value reassurers' share of technical provisions on a basis consistent with the liabilities on the Solvency II balance sheet.

Liabilities are valued on a best estimate market consistent basis, with the application of a Solvency II Matching Adjustment for valuing annuity liabilities. This incorporates the estimated impacts of a recalculation of the Transitional Measures for Technical Provisions (Estimated TMTP) recalculated based on end 2016 economic conditions and changes during 2016 to the Internal Model and Matching Adjustment. The Estimated TMTP has been amortised to end 2016.

The liabilities include the Risk Margin which represents an allowance for the cost of capital for a purchasing insurer taking on the portfolio of liabilities and residual risks that are deemed to be not hedgeable under Solvency II, following the 1-in-200 stress event. This is calculated using a cost of capital of 6% as prescribed by the European Insurance and Occupational Pensions Authority (EIOPA).

The Solvency Capital Requirement is the amount of capital required to cover the 1-in-200 worst projected future outcome in the year following the valuation, allowing for realistic management and policyholder actions and the impact of the stress on the tax position of the group. This allows for diversification between the different firms within the group and between the risks to which they are exposed.

Capital and Investments Page 64

4.01 Group regulatory capital - Solvency II Directive (continued)

(b) Methodology (continued)

All material EEA insurance firms, including Legal & General Assurance Society Limited, Legal & General Insurance Limited, and Legal & General Assurance (Pensions Management) Limited (LGIM's insurance subsidiary) are incorporated into the group's Solvency II Internal Model assessment of required capital, assuming diversification of the risks between and within those firms. These firms, as well as the non-EEA insurance firm (Legal & General Reinsurance Company Limited (L&G Re) based in Bermuda) contribute over 90% of the group's SCR.

Firms for which the capital requirements are less material are valued on a Solvency II Standard Formula basis. Firms which are not regulated but which carry material risks to group solvency are modelled in the Internal Model on the basis of applying an appropriate stress to their net asset value.

Legal & General America's Banner Life and its subsidiaries are incorporated into the calculation of group solvency using a Deduction and Aggregation basis. All risk exposure in these firms is valued on a local statutory basis, with capital requirements set to a multiple of local statutory Risk Based Capital (RBC) and further restrictions on the surplus contribution to the group. The US regulatory regime is considered to be equivalent to Solvency II by the European Commission. The contribution to group SCR is 150% of the local RBC Capital Adequacy Level (CAL). The contribution to group's Own Funds is the SCR together with any surplus capital in excess of 250% of RBC CAL.

All non-insurance regulated firms are included using their current regulatory surplus.

The group completed the sale of Cofunds in January 2017 and has announced the sale of Legal & General Netherlands (subject to regulatory approval). The shareholder view of Solvency II capital position as at 31 December 2016 does not reflect the expected impacts of these sales.

Allowance is made within the Solvency II balance sheet for the group's defined benefit pension schemes using results on an IFRS basis.

Allowance is made within the SCR by stressing the IFRS result position using the same Internal Model basis as for the insurance firms.

The calculation of the Solvency II balance sheet and associated capital requirements requires a number of assumptions, including:

(i) assumptions required to derive the present value of best estimate liability cash flows. Non-market assumptions are consistent with those underlying the group's IFRS disclosures, but with the removal of any prudence margins. Future investment returns and discount rates are those defined by EIOPA, which means that the risk free rates used to discount liabilities are market swap rates, with a 17 basis point deduction to allow for a credit risk adjustment for sterling denominated liabilities. For annuities that are eligible, the liability discount rate includes a Matching Adjustment. This Matching Adjustment varies as between LGAS / L&G Re and by currency.

At end 2016 the Matching Adjustment for UK GBP was 124bps after allowing for the EIOPA specified Fundamental Spread 58bps.

(ii) assumptions regarding management actions and policyholder behaviour across the full range of scenarios. The only management actions allowed for are those that have been approved by the Board and are in place at the balance sheet date;

(iii) assumptions regarding the volatility of the risks to which the group is exposed. Assumptions have been set using a combination of historic market, demographic and operating experience data. In areas where data is not considered robust, expert judgement has been used; and

(iv) assumptions on the dependencies between risks, which are calibrated using a combination of historic data and expert judgement.

(d) Analysis of change

The table below shows the movement (net of tax) during the financial year in the group's Solvency II surplus.


					31.12.16
					surplus
					£bn


Operational Surplus Generation¹					1.2
New Business Strain					(0.1)
Net Surplus Generation					1.1
Dividends paid²					(0.8)
Operating variances³					0.2
Market Movements⁴					(0.3)
Total Surplus movement (after dividends paid in the year)					0.2

1. Release of surplus generated by in-force business and includes management actions which at the start of the year could have been reasonably expected to take place. For 2016 these were limited to those to deliver further eligible assets into the Matching Adjustment portfolio in respect of a small amount of pension risk transfer business.
2. Dividends paid are the amounts from the declarations at end 2015 and HY2016.
3. Operating variances include the impact of experience variances, changes to valuation and capital calibration assumptions, changes to planned volumes of new business, tax rate changes, PRA approval of changes to the Internal Model and Matching Adjustment, (in particular the inclusion of Lifetime Mortgages as assets eligible for Matching Adjustment), and other management actions including changes in asset mix and hedging strategies. This incorporates an Estimated TMTP recalculated on a basis as described at the start of 4.01.
4. Market Movements is the impact of market movements over the year and changes to future economic assumptions. It includes the capital impact of investment portfolio changes implemented by LGC.

Capital and Investments Page 65

4.01 Group regulatory capital - Solvency II Directive (continued)

(d) Analysis of change (continued)

Operational Surplus Generation is the expected surplus generated from the assets and liabilities in-force at the start of the year. It is based on real world assumed returns and best estimate non-market assumptions. It includes the impact of management actions to the extent that, at the start of the year, these were reasonably expected to be implemented over the year.

New Business Strain/Surplus is the cost of acquiring, and setting up Technical Provisions and SCR capital, on actual new business written over the year. It is based on economic conditions at the point of sale.

(e) Reconciliation of IFRS Net Release from Operations to Solvency II Net Surplus Generation

(i) The table below gives a reconciliation of the group's IFRS Release from Operations to Solvency II Operational Surplus Generation.

					2016
					£bn


IFRS Release from Operations					1.3
Expected release of IFRS prudential margins					(0.5)
Releases of IFRS specific reserves¹					(0.1)
Solvency II investment margin^2,3					0.2
Release of Solvency II Capital Requirement and Risk Margin less TMTP amortisation⁴					0.4
Other Solvency II items and presentational differences					(0.1)

Solvency II Operational Surplus Generation					1.2

1. Release of prudence from IFRS specific reserves which are not included in Solvency II (e.g. long term expense margin or new business closure reserves).
2. Release of prudence related to differences between the EIOPA-defined Fundamental Spread and L&G's best estimate default assumption.
3. Expected market returns earned on LGR's free assets in excess of risk free rates over 2016.
4. Solvency II Operational Surplus Generation includes management actions which at the start of 2016 were expected to take place within the group plan. These were limited to actions by LGR to deliver further eligible assets into the Matching Adjustment portfolio in respect of a small amount of pension risk transfer business.

(ii) The table below gives a reconciliation of the group's IFRS New Business Surplus to Solvency II New Business Strain.
					2016
					£bn
IFRS New Business Surplus					0.2
Removal of requirement to set up prudential margins above best estimate on New Business					0.5
Set up of Solvency II Capital Requirement on New Business					(0.7)
Set up of Risk Margin on New Business¹					(0.1)
Solvency II New Business Strain					(0.1)
1. Shown net of the TMTP attached to the back book acquisition of liabilities from Aegon.

(f) Reconciliation of IFRS shareholders' equity to Solvency II Own Funds
The table below gives a reconciliation of the group's IFRS shareholders' equity to the Solvency II Own Funds.

	2016	2015⁶
	£bn	£bn
IFRS shareholders' equity	6.9	6.4
Remove DAC, goodwill and other intangible assets and liabilities	(2.1)	(2.0)
Add subordinated debt treated as available capital¹	2.5	2.5
Insurance contract valuation differences²	7.7	7.5
Add value of shareholder transfers	0.2	0.2
Difference in value of net deferred tax liabilities (resulting from valuation differences)	(0.5)	(0.5)
SCR for with-profits fund and final salary pension schemes	(0.7)	(0.7)
Other³	(0.3)	(0.2)
Eligibility restrictions⁴	(0.1)	(0.4)
Own Funds⁵	13.6	12.8
1. Treated as available capital on the Solvency II balance sheet as the liabilities are subordinate to policyholder claims.
2. Differences in the measurement of liabilities between IFRS and Solvency II, offset by the inclusion of the Risk Margin net of TMTP. This also allows for a recalculation of TMTP using management's estimate.
3. Reflects valuation differences on other assets and liabilities, predominately in respect of borrowings measured at fair value under Solvency II.
4. Relating to the Own Funds of non-insurance regulated entities, subject to local regulator rules.
5. Own Funds do not include an accrual for the dividend of £616m (2015: £592m) declared after the balance sheet date.
6. The 2015 comparatives are restated on the shareholder view basis.

Capital and Investments Page 66

4.01 Group regulatory capital - Solvency II Directive (continued)

(g) Sensitivity analysis The following sensitivities are provided to give an indication of how the group's Solvency II surplus as at 31 December 2016 would have changed in a variety of adverse events. These are all independent stresses to a single risk. In practice, the balance sheet is impacted by combinations of stresses and the combined impact can be larger than adding together the impacts of the same stresses in isolation. It is expected that, particularly for market risks, adverse stresses will happen together.

	Impact on	Impact on
	net of tax	net of tax
	Solvency II	Solvency II
	capital	coverage
	surplus	ratio
	2016	2016
	£bn	%


Credit spreads widen by 100bps assuming a level addition to all ratings¹	0.4	10
Credit spreads widen by 100bps assuming an escalating addition to ratings^1,2	0.2	7
Credit spreads narrow by 100bps assuming a level addition to all ratings¹	(0.4)	(9)
Credit spreads narrow by 100bps assuming an escalating addition to ratings^1,2	(0.2)	(7)
Credit migration³	(0.6)	(8)
20% fall in equity markets	(0.4)	(5)
40% fall in equity markets	(0.8)	(9)
20% rise in equity markets	0.5	5
15% fall in property markets	(0.2)	(3)
15% rise in property markets	0.2	3
100bps increase in risk free rates	1.0	22
50bps fall in risk free rates⁴	(0.5)	(10)
Future inflation expectation increase by 50bps	(0.1)	(3)
1% reduction in annuitant base mortality	(0.2)	(2)
1% increase in annuitant base mortality	0.2	2
Substantially reduced Risk Margin⁵	0.1	1
1. The spread sensitivity applies to Legal & General's corporate bond (and similar) holdings, with no change in the firm's long term default expectations.
2. The stress for AA bonds is twice that for AAA bonds, for A bonds it is three times, for BBB four times and so on, such that the weighted average spread stress for the portfolio is 100bps.
3. Credit migration stress covers the cost of an immediate big letter downgrade on c.20% of annuity portfolio bonds, or 3 times level expected in the next 12 months.
4. In the interest rate down stress negative rates are allowed, i.e. there is no floor at zero.
5. This represents a reduction of two-thirds in Risk Margin and subsequent recalculation of Estimated TMTP.

The above sensitivity analysis does not reflect all management actions which could be taken to reduce the impacts. In practice, the group actively manages its asset and liability positions to respond to market movements. These results all allow (on an approximate basis) for the recalculation of Estimated TMTP as at 31 December 2016 where the impact of the stress would cause this to change materially. The impacts of these stresses are not linear therefore these results should not be used to interpolate or extrapolate the impact of a smaller or larger stress. The results of these tests are indicative of the market conditions prevailing at the balance sheet date. The results would be different if performed at an alternative reporting date.

Capital and Investments Page 67

4.01 Group regulatory capital - Solvency II Directive (continued)

(h) Analysis of Group Solvency Capital Requirement
The table below shows a breakdown of the group's SCR by risk type. The split is shown after the effects of diversification.

					2016
					%


Interest Rate					1
Equity					4
Property					4
Credit¹					40
Currency					1
Inflation					3
Total Market Risk²					53
Counterparty Risk					1
Life Mortality					(1)
Life Longevity³					33
Life Lapse					2
Life Catastrophe					2
Non-life underwriting					1
Expense					1
Total Insurance Risk					38
Operational Risk					5
Miscellaneous⁴					3


Total SCR					100

1. Credit risk is Legal & General's most significant exposure, arising predominantly from the portfolio of bonds and bond-like assets backing the group's annuity business.
2. In addition to credit risk the group also has significant exposure to other market risks, primarily due to the investment holdings within the shareholder funds but also the risk to fee income from assets backing unit linked Savings business.
3. Longevity risk is Legal & General's most significant insurance risk exposure, arising from the annuity book on which the majority of the longevity risk is retained.
4. Miscellaneous includes LGA on a Deduction and Aggregation basis and the sectoral capital requirements for non-insurance regulated firms.

Capital and Investments Page 68

4.02 Group Economic Capital

Legal & General defines Economic Capital to be the amount of capital that the Board believes the group needs to hold, over and above its liabilities, in order to meet its strategic objectives. This is not the same as regulatory capital which reflects regulatory rules and constraints. The group's objectives include being able to meet its liabilities as they fall due whilst maintaining the confidence of our investors, rating agencies, customers and intermediaries.

Further explanation of the underlying methodology and assumptions is set out in the sections below.

Legal & General maintains a risk-based capital model that is used to calculate the group's Economic Capital balance sheet and support the management of risk within the group. This modelling framework, suitably adjusted for regulatory constraints, also meets the needs of the Solvency II regime. Our Economic Capital model has not been reviewed by the Prudential Regulatory Authority (PRA), nor will it be.

Solvency II has elements which are considered to be inconsistent with the group's definition of Economic Capital, so there are differences between the two balance sheets. A reconciliation between the two bases is provided in section 4.02(g).

(a) Capital position

As at 31 December 2016, the group had an Economic Capital surplus of £8.3bn (2015: £7.6bn), corresponding to an Economic Capital coverage ratio of 230% (2015: 230%). The Economic Capital position is as follows:
	2016	2015
	£bn	£bn


Core tier 1 Own Funds	11.9	10.8
Tier 1 subordinated liabilities	0.6	0.7
Tier 2 subordinated liabilities	2.1	2.3
Eligibility restrictions	-	(0.3)
Own Funds¹	14.6	13.5
Economic Capital Requirement (ECR)²	(6.3)	(5.9)


Surplus	8.3	7.6


ECR coverage ratio³	230%	230%


1. Economic Capital Own Funds do not include an accrual for the dividend of £616m (2015: £592m) declared after the balance sheet date.
2. The ECR is not subject to audit.
3. Coverage ratio is calculated on unrounded values.

The Economic Capital position does not exclude the ECR for with-profits fund and the final salary pension schemes for both Own Funds and ECR.

(b) Methodology

Own Funds are defined to be the excess of the value of assets over the liabilities. Subordinated debt issued by the group is considered to be part of available capital, rather than a liability, as it is subordinate to policyholder claims.

Liabilities are valued on a best estimate market consistent basis, with the application of an Economic Matching Adjustment for valuing annuity liabilities.

The Economic Capital Requirement is the amount of capital required to cover the 1-in-200 worst projected future outcome in the year following the valuation, allowing for realistic management and policyholder actions and the impact of the stress on the tax position of the group. This allows for diversification between the different firms within the group and between the risks that they are exposed to.

The liabilities include a Recapitalisation Cost to allow for the cost of recapitalising the balance sheet following the 1-in-200 stress in order to maintain confidence that our future liabilities will be met. This is calculated using a cost of capital that reflects the long term average rates at which it is expected that the group could raise debt and allowing for diversification between all group entities.

All material insurance firms, including Legal & General Assurance Society Limited, Legal & General Insurance Limited, Legal & General Assurance (Pensions Management) Limited (LGIM's insurance subsidiary) and Legal & General America (LGA) are incorporated into the group's Economic Capital model assessment of required capital, assuming diversification of the risks between the different firms within the group and between the risks to which they are exposed. These firms, as well as the non-EEA insurance firm (Legal and General Reinsurance Company Limited based in Bermuda) contribute over 90% of the group's ECR.

Firms for which the capital requirements are less material, are valued on the Solvency II Standard Formula basis. Non-insurance firms are included using their current regulatory surplus, without allowing for any diversification with the rest of the group.

The group completed the sale of Cofunds in January 2017 and has announced the sale of Legal & General Netherlands (subject to regulatory approval). The Economic Capital result as at 31 December 2016 does not reflect the expected impacts of these sales.

Allowance is made within the Economic Capital balance sheet for the group's defined benefit pension schemes based upon the scheme's funding basis, and allowance is made within the capital requirement by stressing the funding position, using the same Economic Capital basis as for the insurance firms.

Capital and Investments Page 69

4.02 Group Economic Capital (continued)

The calculation of the Economic Capital balance sheet and associated capital requirement requires a number of assumptions, including:

(i) assumptions required to derive the present value of best estimate liability cash flows. Non-market assumptions are consistent with those used to derive the group's IFRS disclosures, but with the removal of any prudence margins. Future investment returns and discount rates are based on market data where a deep and liquid market exists or using appropriate estimation techniques where this is not the case. The risk-free rates used to discount liabilities are market swap rates, with a 17 basis point deduction to allow for a credit risk adjustment;

(iv) assumptions on the dependencies between risks, which are calibrated using a combination of historic data and expert judgement.

For annuities the liability discount rate includes an Economic Matching Adjustment, which is derived using the same approach as the Solvency II matching adjustment, but any constraints we consider economically artificial, such as capping the yield on assets with a credit rating below BBB and any ineligibility of certain assets and liabilities, have not been applied. The Economic Matching Adjustment was 146bps after allowing for future defaults and downgrades totalling 61bps.

The other key assumption relating to the annuity business is the assumption of longevity. As for IFRS, Legal & General models base mortality and future improvement of mortality separately. For our Economic Capital assessment we believe it is appropriate to ensure that the balance sheet makes sufficient allowance to meet the 1-in-200 stress to longevity over the run-off of the liabilities rather than just over a 1 year timeframe as required by Solvency II.

(d) Analysis of change

The table below shows the movement (net of tax) during the financial year in the group's Economic Capital surplus.

								31.12.16
								surplus
								£bn


Operational Surplus Generation¹								0.8
New Business Surplus								0.5
Net Surplus Generation								1.3
Dividends paid²								(0.8)
Operating variances³								-
Market Movements⁴								0.2
Total Surplus (after dividends)								0.7

1. Release of surplus generated by in-force business. It may include management actions which at the start of the year could have been reasonably expected to take place. For 2016, no management actions were included which impacted the Economic Capital balance sheet.
2. Dividends paid are the amounts from the declarations at year-end 2015 and HY2016.
3. Operating variances comprise of model and assumption changes and changes in asset mix across the group (with corresponding increase in Economic Capital Requirement).
4. Market Movements is the impact of market movements over the year and changes to future economic assumptions. It includes the capital impact of investment portfolio changes implemented by LGC.

Capital and Investments Page 70

4.02 Group Economic Capital (continued)

(e) Reconciliation of IFRS shareholders' equity to Economic Capital Eligible Own Funds


The table below gives a reconciliation of the group's IFRS shareholders' equity to the Own Funds on an Economic Capital basis.


	2016	2015
	£bn	£bn


IFRS shareholders' equity	6.9	6.4
Remove DAC, goodwill and other intangible assets and liabilities	(2.1)	(2.0)
Add subordinated debt treated as available capital¹	2.5	2.5
Insurance contract valuation differences²	7.9	7.0
Add value of shareholder transfers	0.2	0.2
Difference in value of net deferred tax liabilities (resulting from valuation differences)	(0.5)	(0.5)
Other	(0.3)	0.2
Eligibility restrictions³	-	(0.3)


Own Funds⁴	14.6	13.5


1. Treated as available capital on the Economic Capital balance sheet as the liabilities are subordinate to policyholder claims.
2. Differences in the measurement of liabilities between IFRS and Economic Capital, offset by the inclusion of the recapitalisation cost.
3. Relating to the Own Funds of US captive reassurers and the UK with-profits fund.
4. Own Funds do not include an accrual for the dividend of £616m (2015: £592m) declared after the balance sheet date.

(f) Sensitivity analysis The following sensitivities are provided to give an indication of how the group's Economic Capital surplus as at 31 December 2016 would have changed in a variety of adverse events. These are all independent stresses to a single risk. In practice the balance sheet is impacted by combinations of stresses and the combined impact can be larger than adding together the impacts of the same stresses in isolation. It is expected that, particularly for market risks, adverse stresses will happen together.

		Impact on
	Impact on	economic
	net of tax	capital
	capital	coverage
	surplus	ratio
	2016	2016
	£bn	%


Credit spreads widen by 100bps assuming a level addition to all ratings¹	0.2	9
Credit spreads widen by 100bps assuming an escalating addition to ratings^1,2	0.1	6
Credit migration	(0.6)	(10)
20% fall in equity markets	(0.4)	(5)
40% fall in equity markets	(0.8)	(10)
20% rise in equity markets	0.5	5
15% fall in property markets	(0.2)	(3)
100bps increase in risk free rates	0.6	21
50bps fall in risk free rates³	(0.3)	(11)
1% reduction in annuitant base mortality	(0.2)	(3)
1% increase in annuitant base mortality	0.2	3

1. All spread sensitivities apply to Legal & General's corporate bond (and similar) holdings, with no change in the firm's long term default expectations.
2. The stress for AA bonds is twice that for AAA bonds, for A bonds it is three times, for BBB four times and so on, such that the weighted average spread stress for the portfolio is 100bps.
3. In the interest rate down stress negative rates are allowed, i.e. there is no floor at zero.
The above sensitivity analysis does not reflect management actions which could be taken to reduce the impacts. In practice, the group actively manages its asset and liability positions to respond to market movements. The impacts of these stresses are not linear therefore these results should not be used to extrapolate the impact of a smaller or larger stress. The results of these tests are indicative of the market conditions prevailing at the balance sheet date. The results would be different if performed at an alternative reporting date.

Capital and Investments Page 71

4.02 Group Economic Capital (continued)

(g) Analysis of Group Economic Capital Requirement


The table below shows a breakdown of the group's Economic Capital Requirement by risk type. The split is shown after the effects of diversification.

					2016
					%


Interest Rate					2
Equity					10
Property					6
Credit¹					45
Currency					1
Inflation					2
Total Market Risk²					66
Counterparty Risk					2
Life Longevity³					14
Life Lapse					3
Life Catastrophe					5
Non-life underwriting					1
Expense					1
Total Insurance Risk					24
Operational Risk					9
Miscellaneous⁴					(1)


Total ECR					100

1. Credit risk is Legal & General's most significant exposure, arising predominantly from the portfolio of bonds backing the group's annuity business.
2. In addition to credit risk the group also has significant exposure to other market risks, primarily due to the investment holdings within the shareholder funds but also the risk to fee income from assets backing unit linked and with-profits Savings business.
3. Longevity risk is Legal & General's most significant insurance risk exposure, arising from the annuity book on which the majority of the longevity risk is retained.
4. Miscellaneous includes the sectoral capital requirements for non-insurance regulated firms.

(h) Reconciliation from Economic Capital surplus to Solvency II surplus

The Economic Capital position does not reflect regulatory constraints. The regulatory constraints imposed by the Solvency II regime result in a lower surplus. The table below provides an analysis of the key differences between the two bases. The Solvency II results are reported net of Estimated TMTP.

	2016	2015
	£bn	£bn


Economic Capital surplus	8.3	7.6
LGA on a D&A basis¹	0.1	0.1
Different annuity capital requirements²	(2.6)	(1.7)
Risk margin vs. Recapitalisation cost³	-	-
Eligibility of group Own Funds⁴	(0.1)	(0.5)


Solvency II surplus⁵	5.7	5.5
1. To ensure consistency of risk management across the group, L&G America remains within the Internal Model for Economic Capital purposes.
2. This includes the difference between the Economic Matching Adjustment and the Solvency II Matching Adjustment as well as the fact that Economic Capital and Solvency II balance sheets use different calibrations for longevity risk.
3. The Risk Margin represents the amount a third party insurance company would require to take on the obligations of a given insurance company. It is equal to the cost of capital on the SCR necessary to support insurance risks that cannot be hedged over the lifetime of the business. This is presented net of Estimated TMTP. The recapitalisation cost is an equivalent measure under Economic Capital, but represents the cost of recapitalising the balance sheet following a stress event. It also removes elements of Solvency II specifications that are, in Legal & General's view, uneconomic.
4. Deductions for regulatory restrictions in respect of fungibility and transferability restrictions. These do not apply to the Economic Capital balance sheet.
5. There are also differences in the valuation of with-profits business and the group pension schemes that have lower order impacts on the difference between the surpluses.

Capital and Investments Page 72

4.03 Estimated Solvency II new business contributions

(a) New business by product

		Contri-
		bution
		from new
	PVNBP	business²	Margin
For the year ended 31 December 2016	£m	£m	%


LGR - UK annuity business	6,661	693	10.4

UK Insurance Total	1,466	153	10.4
- Retail protection	1,255	139	11.1
- Group protection	211	14	6.6

LGA³	631	78	12.4



1. Selected lines of business only.
2. The contribution from new business is defined as the present value at the point of sale of expected future Solvency II surplus emerging from new business written in the period using the risk discount rate applicable at the end of the reporting period.
3. In local currency, LGA reflects PVNBP of $855m and a contribution from new business of $106m.

(b) Assumptions

The key economic assumptions as at 31 December 2016 are as follows:

Risk Margin		3.1
Risk free rate
- UK		1.7
- US		2.1
Risk discount rate (net of tax)
- UK		4.8
- US		5.2

Long-term rate of return on non-profit annuities in LGR		3.1

The cashflows are discounted using duration-based discount rates, which is the sum of a duration-based risk free rate and a flat Risk Margin. The risk free rates have been based on a swap curve net of the EIOPA-specified Credit Risk Adjustment. The risk free rate shown above is a weighted average based on the projected cash flows.

All other economic and non-economic assumptions and methodologies that would have a material impact on the margin for these contracts are unchanged from those used for the European Embedded Value reporting at end 2015 other than the cost of currency hedging which has been updated to reflect current market conditions and hedging activity in light of Solvency II. In particular:

· The assumed future pre-tax returns on fixed interest and RPI linked securities are set by reference to the portfolio yield on the relevant backing assets held at market value at the end of the reporting period. The calculated return takes account of derivatives and other credit instruments in the investment portfolio. The returns on fixed and index-linked assets are calculated net of an allowance for default risk which takes account of the credit rating and the outstanding term of the assets. The allowance for corporate and other unapproved credit asset defaults within the new business contribution is based on a level rate deduction from the expected returns for the overall annuities portfolio of 19bps.

· Non-economic assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses (excluding development costs). An allowance is made for future mortality improvement. For new business, mortality assumptions may be modified to take certain scheme specific features into account. These are normally reviewed annually.

Tax

The profits on the new business are calculated on an after tax basis and are grossed up by the notional attributed tax rate. For the UK, the after tax basis assumes the annualised current rate of 20% and subsequent enacted future reductions in corporation tax to 19% from 1 April 2017 and 17% from 1 April 2020 onwards. The tax rate used for grossing up is the long term corporate tax rate in the territory concerned, which for the UK is 17%.

US covered business profits are also grossed up using the long term corporate tax rate of 35%.

Capital and Investments Page 73

4.03 Estimated Solvency II new business contribution (continued)

Basis of preparation

The group is required to comply with the requirements established by the EU Solvency II Directive. Consequently, a Solvency II value reporting framework, which incorporates a best estimate of cash flows in relation to insurance assets and liabilities, has replaced EEV reporting in the management information used internally to measure and monitor capital resources. Solvency II new business contribution reflects the portion of Solvency II value added by new business written in 2016, recognising that the statutory solvency in the UK is now on a Solvency II basis. It has been calculated in a manner consistent with European Embedded Value (EEV) principles.

Solvency II new business contribution has been calculated for the group's most material insurance-related businesses, namely, LGR, UK Insurance and LGA.

Description of methodology

The objective of the Solvency II new business contribution is to provide shareholders with information on the long term contribution of new business written in 2016.

With the exception of the discount rate, cost of currency hedging and the statutory solvency basis, new business contribution arising from the new business premiums written during the reporting period has been calculated on the same economic and operating assumptions as would have been used under the EEV methodology.

The PVNBP is equivalent to total single premiums plus the discounted value of annual premiums expected to be received over the term of the contracts using the same economic and operating assumptions used for the calculation of the new business contribution for the financial period.

The new business margin is defined as new business contribution divided by the PVNBP. The premium volumes used to calculate the PVNBP are the same as those used to calculate new business contribution.

LGA is consolidated into the group solvency balance sheet on a US Statutory solvency basis. Therefore, the LGA margin is largely unchanged from the EEV basis, where new business profitability was also based on the US Statutory solvency basis. Intra-group reinsurance arrangements are in place between the US and UK businesses, and it is expected that these arrangements will be periodically extended to cover recent new business. LGA new business premiums and contribution reflect the groupwide expected impact of LGA directly-written business (i.e. looks through any intra-group reinsurance arrangements).

Comparison to EEV new business contribution

The key difference between Solvency II and EEV new business contribution is the Statutory solvency basis used for UK business. Due to the different reserving and capital bases under Solvency II compared to Solvency I, the timing of profit emergence changes. The impact on new business contribution therefore largely reflects the cost of capital effect of this change in profit timing. The impact on new business contribution of moving to a Solvency II basis will differ by type of business. Products which are more capital consumptive under Solvency II will have a lower new business value and vice versa for less capital consumptive products.

Projection assumptions

Cash flow projections are determined using best estimate assumptions for each component of cash flow for each line of business. Future economic and investment return assumptions are based on conditions at the end of the financial period.

Detailed projection assumptions including mortality, morbidity, persistency and expenses reflect recent operating experience and are normally reviewed annually. Allowance is made for future improvements in annuitant mortality based on experience and externally published data. Favourable changes in operating experience are not anticipated until the improvement in experience has been observed.

All costs relating to new business, even if incurred elsewhere in the group, are allocated to the new business. The expense assumptions used for the cash flow projections therefore include the full cost of servicing this business.

Tax

The projections take into account all tax which is expected to be paid, based on best estimate assumptions, applying current legislation and practice together with substantively enacted future changes.

Risk discount rate

The risk discount rate (RDR) is duration-based and is a combination of the risk free curve and a flat Risk Margin, which reflects the residual risks inherent in the group's businesses, after taking account of margins in the statutory technical provisions, the required capital and the specific allowance for financial options and guarantees.

The risk free rates have been based on a swap curve net of the EIOPA-specified Credit Risk Adjustment (31 December 2016: 17bps for UK and 15bps for US).

The Risk Margin has been determined based on an assessment of the group's weighted average cost of capital (WACC). This assessment incorporates a beta for the group, which measures the correlation of movements in the group's share price to movements in a relevant index. Beta values therefore allow for the market's assessment of the risks inherent in the business relative to other companies in the chosen index.

The WACC is derived from the group's cost of equity and debt, and the proportion of equity to debt in the group's capital structure measured using market values. Each of these three parameters is forward looking, although informed by historic information and appropriate judgements where necessary. The cost of equity is calculated as the risk free rate plus the equity risk premium for the chosen index multiplied by the company's beta.

Capital and Investments Page 74

4.03 Estimated Solvency II new business contribution (continued)

The cost of debt used in the WACC calculations takes account of the actual locked-in rates for our senior and subordinated long term debt. All debt interest attracts tax relief at a time adjusted rate of 17.7%.

Whilst the WACC approach is a relatively simple and transparent calculation to apply, subjectivity remains within a number of the assumptions. Management believes that the chosen margin, together with the levels of required capital, the inherent strength of the group's regulatory reserves and the explicit deduction for the cost of options and guarantees, is appropriate to reflect the risks within the covered business.

(d) PVNBP to gross written premium reconciliation
		2016	2015
	Notes	£bn	£bn


PVNBP	4.03(a)	8.8
Effect of capitalisation factor		(1.8)


New business premiums from selected lines		7.0
Other¹		1.9


Total LGR, Insurance and LGA new business	3.07/3.08	8.9	3.3
Annualisation impact of regular premium long-term business		(0.1)	(0.2)
IFRS gross written premiums from existing long-term insurance business		2.5	2.6
IFRS gross written premiums from Savings business		0.2	0.5
Deposit accounting for lifetime mortgage advances		(0.6)	(0.2)
General Insurance gross written premiums	3.09	0.3	0.3
Future premiums on longevity swap new business		(0.9)	-


Total gross written premiums		10.3	6.3


1. Other principally includes annuity sales in the US, lifetime mortgage advances and discounted future cash flows on longevity swap new business.

Capital and Investments Page 75

4.04 Investment portfolio


	Market	Market
	value	value
	2016	2015
	£m	£m


Worldwide total assets	903,886	747,944
Client and policyholder assets¹	(821,978)	(679,831)
Non-unit linked with-profits assets	(11,924)	(11,644)


Investments to which shareholders are directly exposed	69,984	56,469


1. Prior year figures for client and policyholder assets have been restated to include £82m of reverse repurchase agreements. The total investments to which shareholders are directly exposed to has increased to reflect the change.

Analysed by investment class:

			Other
			non profit		Other
		LGR	insurance	LGC	shareholder
		investments	investments	investments¹	investments	Total	Total
		2016	2016	2016	2016	2016	2015
	Note	£m	£m	£m	£m	£m	£m


Equities¹		393	-	2,034	131	2,558	2,252
Bonds	4.06	49,470	1,769	1,689	435	53,363	43,916
Derivative assets²		4,611	-	82	-	4,693	3,663
Property	4.07	2,442	-	162	-	2,604	2,347
Cash, cash equivalents, loans & receivables		1,589	544	2,194	524	4,851	4,168


Financial investments		58,505	2,313	6,161	1,090	68,069	56,346


Other assets³		1,883	-	32		1,915	123


Total investments		60,388	2,313	6,193	1,090	69,984	56,469


1. Equity investments include a total of £237m (2015: £180m) in respect of CALA Group Limited, Peel Media Holdings Limited (MediaCityUK), NTR Wind Management Ltd and Access Development Partnership, the latter being acquired in 2016.
2. Derivative assets are shown gross of derivative liabilities of £2.9bn (2015: £2.7bn). Exposures arise from the use of derivatives for efficient portfolio management, especially the use of interest rate swaps, inflation swaps, credit default swaps and foreign exchange forward contracts for asset and liability management.
3. Other assets include reverse repurchase agreements of £1,883m (2015: £82m).

Capital and Investments Page 76

4.05 Direct Investments

(a) Analysed by asset class


	Direct^{1, 2}	Traded³		Direct^{1, 2}	Traded³
	Investments	securities	Total	Investments	securities	Total
	2016	2016	2016	2015	2015	2015
	£m	£m	£m	£m	£m	£m


Equities	595	1,963	2,558	432	1,820	2,252
Bonds⁴	6,256	47,107	53,363	3,929	39,987	43,916
Derivative assets	-	4,693	4,693	-	3,663	3,663
Property	2,604	-	2,604	2,347	-	2,347
Cash, cash equivalents, loans & receivables	518	4,333	4,851	425	3,743	4,168
Other assets	32	1,883	1,915	41	82⁵	123


	10,005	59,979	69,984	7,174	49,295	56,469


1. Direct investments, which generally constitute an agreement with another party, represent an exposure to untraded and often less volatile asset classes. Direct investments also include physical assets, bilateral loans and private equity, but exclude hedge funds.
2. A further breakdown of property is provided in note 4.07.
3. Traded securities are defined by exclusion. If an instrument is not a Direct Investment, then it is classed as a traded security.
4. Direct Investment bonds now include lifetime mortgages of £852m. Prior year figures have been adjusted, showing an increase of £207m in Direct Investments bonds.
5. 2015 traded securities now include £82m of reverse repurchase agreements.

(b) Analysed by segment
				LGI
			LGI	(UK and
	LGR	LGC	(US)	Other)	Total
	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m


Equities	-	595	-	-	595
Bonds¹	5,655	228	373	-	6,256
Property²	2,442	162	-	-	2,604
Cash, cash equivalents, loans & receivables	33	120	365	-	518
Other assets	-	32	-	-	32


	8,130	1,137	738	-	10,005


1. Direct Investments bonds now include lifetime mortgages of £852m. Prior year figures have been adjusted, showing an increase of £207m in Direct Investments bonds.
2. A further breakdown of property is provided in note 4.07.

Capital and Investments Page 77

4.05 Direct Investments

(a) Analysed by segment (continued)

				LGI
			LGI	(UK and
	LGR	LGC	(US)	Other)	Total
	2015	2015	2015	2015	2015
	£m	£m	£m	£m	£m


Equities	-	432	-	-	432
Bonds¹	3,543	93	293	-	3,929
Property²	2,157	186	-	4	2,347
Cash, cash equivalents, loans & receivables	-	115	310	-	425
Other assets	-	41	-	-	41


	5,700	867	603	4	7,174


1. Direct Investments bonds now include lifetime mortgages of £852m. Prior year figures have been adjusted, showing an increase of £207m in Direct Investments bonds.
2. A further breakdown of property is provided in note 4.07.

(c) Movement in the period

	Carrying			Change in	Carrying
	value			market	value
	01.01.16	Additions	Disposals¹	value	31.12.16
	£m	£m	£m	£m	£m


Equities	432	202	(74)	35	595
Bonds	3,929	2,121	(286)	492	6,256
Property	2,347	596	(328)	(11)	2,604
Cash, cash equivalents, loans & receivables	425	60	(33)	66	518
Other assets	41	6	-	(15)	32


	7,174	2,985	(721)	567	10,005



1. Disposals include £91m of assets transferred to held for sale.

Capital and Investments Page 78

4.06 Bond portfolio summary

(a) LGR analysed by sector

Sectors analysed by credit rating


					BB or
	AAA	AA	A	BBB	below	LGR	LGR
	2016	2016	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	888	9,874	285	230	34	11,311	23
Banks:
- Tier 1	-	-	-	-	12	12	-
- Tier 2 and other subordinated	211	49	61	41	-	362	1
- Senior	6	330	1,019	58	-	1,413	3
- Covered	259	-	16	-	-	275	1
Financial Services:
- Tier 1	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	-	13	11	-	24	-
- Senior	-	458	171	155	-	784	2
Insurance:
- Tier 1	-	-	-	1	-	1	-
- Tier 2 and other subordinated	-	45	3	68	-	116	-
- Senior	8	88	485	76	-	657	1
Consumer Services and Goods:
- Cyclical	-	387	1,088	1,755	164	3,394	7
- Non-cyclical	260	647	1,380	1,290	116	3,693	7
- Health care	3	12	16	10	-	41	-
Infrastructure:
- Social	-	346	3,161	675	148	4,330	9
- Economic	-	-	873	1,313	45	2,231	5
Technology and Telecoms	57	202	610	2,104	84	3,057	6
Industrials	-	142	741	362	37	1,282	3
Utilities	-	101	4,903	3,142	12	8,158	16
Energy	-	171	617	1,134	211	2,133	4
Commodities	-	-	304	475	77	856	2
Oil and Gas	-	111	32	53	-	196	-
Property	-	278	99	339	-	716	1
Property backed securities	-	305	628	1,063	48	2,044	4
Structured finance ABS / RMBS / CMBS / Other	121	671	572	46	49	1,459	3
Lifetime mortgage loans	388	322	91	51	-	852	2
CDOs¹	-	-	59	14	-	73	-


Total £m	2,201	14,539	17,227	14,466	1,037	49,470	100


Total %	4	30	35	29	2	100


1. In October 2016 the Lagoon CDOs were restructured effectively unwinding the levered super senior swaps. As the notes are now unlevered they have been reclassified to reflect the nature of the exposure.

Capital and Investments Page 79

4.06 Bond portfolio summary (continued)

(a) LGR analysed by sector (continued)

Sectors analysed by credit rating (continued)


					BB or
	AAA	AA	A	BBB	below	LGR	LGR
	2015	2015	2015	2015	2015	2015	2015
	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,041	6,396	275	206	31	7,949	21
Banks:
- Tier 1	-	-	-	5	30	35	-
- Tier 2 and other subordinated	-	-	91	137	-	228	1
- Senior	25	296	869	111	-	1,301	3
- Covered	258	-	-	15	-	273	1
Financial Services:
- Tier 1	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	3	45	7	-	55	-
- Senior	-	360	200	246	4	810	2
Insurance:
- Tier 1	-	-	-	6	-	6	-
- Tier 2 and other subordinated	-	-	93	103	-	196	-
- Senior	-	70	422	76	-	568	1
Consumer Services and Goods:
- Cyclical	-	292	582	1,475	141	2,490	6
- Non-cyclical	198	489	1,205	939	100	2,931	7
- Health care	2	1	24	3	-	30	-
Infrastructure:
- Social	-	518	2,086	412	131	3,147	8
- Economic	-	-	729	735	19	1,483	4
Technology and Telecoms	47	137	404	1,991	110	2,689	7
Industrials	-	82	504	345	28	959	2
Utilities	-	76	3,886	2,681	28	6,671	17
Energy	22	315	471	897	268	1,973	5
Commodities	-	-	262	361	23	646	2
Oil and Gas	1	6	15	4	-	26	-
Property	-	257	93	343	-	693	2
Property backed securities	-	414	291	989	12	1,706	4
Structured finance ABS / RMBS / CMBS / Other	123	713	237	72	70	1,215	3
Lifetime mortgage loans	-	-	-	207	-	207	1
CDOs¹	-	552	468	14	47	1,081	3


Total £m	1,717	10,977	13,252	12,380	1,042	39,368	100


Total %	4	28	34	31	3	100


1. The underlying reference portfolio has had no reference entity defaults during the period . The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the counterparty valuation.

Capital and Investments Page 80

4.06 Bond portfolio summary (continued)

(a) LGR analysed by sector (continued)

Sectors analysed by domicile

			EU	Rest of
	UK	US	excluding UK	the World	LGR
	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	9,071	782	950	508	11,311
Banks	816	682	388	176	2,062
Financial Services	389	76	342	1	808
Insurance	176	528	15	55	774
Consumer Services and Goods:
- Cyclical	783	2,229	255	127	3,394
- Non-cyclical	1,059	2,420	201	13	3,693
- Health care	4	36	1	-	41
Infrastructure:
- Social	4,158	137	-	35	4,330
- Economic	1,934	74	-	223	2,231
Technology and Telecoms	582	1,306	745	424	3,057
Industrials	148	656	301	177	1,282
Utilities	3,673	1,191	2,387	907	8,158
Energy	176	1,030	303	624	2,133
Commodities	16	290	27	523	856
Oil and Gas	8	43	120	25	196
Property	709	7	-	-	716
Property backed securities	1,629	340	17	58	2,044
Structured finance ABS / RMBS / CMBS / Other	1,016	50	375	18	1,459
Lifetime mortgages	852	-	-	-	852
CDOs¹	-	-	-	73	73


Total	27,199	11,877	6,427	3,967	49,470


1. In October 2016 the Lagoon CDOs were restructured effectively unwinding the levered super senior swaps. As the notes are now unlevered they have been reclassified to reflect the nature of the exposure.

Capital and Investments Page 81

4.06 Bond portfolio summary (continued)

(a) LGR analysed by sector (continued)

Sectors analysed by domicile (continued)

			EU	Rest of
	UK	US	excluding UK	the World	LGR
	2015	2015	2015	2015	2015
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	5,845	557	955	592	7,949
Banks	872	594	243	128	1,837
Financial Services	382	281	198	4	865
Insurance	277	380	40	73	770
Consumer Services and Goods:
- Cyclical	593	1,556	156	185	2,490
- Non-cyclical	905	1,824	138	64	2,931
- Health care	3	26	1	-	30
Infrastructure:	-	-	-	-
- Social	3,065	66	-	16	3,147
- Economic	1,348	29	-	106	1,483
Technology and Telecoms	506	1,200	786	197	2,689
Industrials	139	469	244	107	959
Utilities	3,024	974	1,902	771	6,671
Energy	194	983	325	471	1,973
Commodities	21	187	13	425	646
Oil and Gas	3	14	4	5	26
Property	689	4	-	-	693
Property backed securities	1,342	320	12	32	1,706
Structured finance ABS / RMBS / CMBS / Other	972	29	211	3	1,215
Lifetime mortgages	207	-	-	-	207
CDOs¹	-	-	1,046	35	1,081


Total	20,387	9,493	6,274	3,214	39,368


1. The underlying reference portfolio has had no reference entity defaults during the period . The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the counterparty valuation.

Capital and Investments Page 82

4.06 Bond portfolio summary (continued)

(b) Total group analysed by sector

Sectors analysed by credit rating

					BB or
	AAA	AA	A	BBB	below	Other	Total	Total
	2016	2016	2016	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,115	10,216	370	394	102	-	12,197	23
Banks:
- Tier 1	-	-	-	1	12	-	13	-
- Tier 2 and other subordinated	210	49	73	54	1	-	387	1
- Senior	15	687	1,388	128	12	-	2,230	4
- Covered	259	-	16	-	-	-	275	1
Financial Services:
- Tier 1	-	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	-	13	18	-	-	31	-
- Senior	-	468	193	174	3	112	950	2
Insurance:
- Tier 1	-	-	2	4	-	-	6	-
- Tier 2 and other subordinated	-	48	8	72	1	-	129	-
- Senior	29	88	495	80	-	-	692	1
Consumer Services and Goods:
- Cyclical	-	403	1,167	1,808	244	-	3,622	7
- Non-cyclical	300	665	1,454	1,391	152	-	3,962	7
- Health Care	3	29	46	44	4	-	126	-
Infrastructure:
- Social	-	346	3,164	675	148	-	4,333	8
- Economic	-	-	903	1,318	45	-	2,266	4
Technology and Telecoms	73	238	662	2,162	122	-	3,257	6
Industrials	-	146	840	487	107	-	1,580	3
Utilities	-	108	4,967	3,193	28	-	8,296	16
Energy	-	174	619	1,156	240	-	2,189	4
Commodities	-	-	313	478	98	-	889	2
Oil and Gas	-	120	69	111	39	-	339	1
Property	-	278	109	394	6	-	787	1
Property backed securities	-	305	628	1,066	53	-	2,052	4
Structured finance ABS / RMBS / CMBS / Other	341	729	617	90	53	-	1,830	3
Lifetime mortgage loans	388	322	91	51	-	-	852	2
CDOs¹	-	-	59	14	-	-	73	-


Total £m	2,733	15,419	18,266	15,363	1,470	112	53,363	100


Total %	5	29	34	29	3	-	100


1. In October 2016 the Lagoon CDOs were restructured effectively unwinding the levered super senior swaps. As the notes are now unlevered they have been reclassified to reflect the nature of the exposure.

Capital and Investments Page 83

4.06 Bond portfolio summary (continued)

(b) Total group analysed by sector (continued)

Sectors analysed by credit rating (continued)

					BB or
	AAA	AA	A	BBB	below	Other	Total	Total
	2015	2015	2015	2015	2015	2015	2015	2015
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	2,069	6,645	324	420	63	6	9,527	23
Banks:
- Tier 1	-	-	-	5	30	-	35	-
- Tier 2 and other subordinated	-	-	102	148	1	1	252	1
- Senior	97	698	1,004	140	11	1	1,951	4
- Covered	311	-	-	15	-	-	326	1
Financial Services:
- Tier 1	-	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	3	51	8	-	-	62	-
- Senior	1	380	267	309	7	80	1,044	2
Insurance:
- Tier 1	-	-	-	6	-	-	6	-
- Tier 2 and other subordinated	-	3	93	105	1	1	203	-
- Senior	1	76	435	85	-	-	597	1
Consumer Services and Goods:
- Cyclical	-	304	661	1,521	191	-	2,677	6
- Non-cyclical	231	506	1,259	1,055	125	3	3,179	7
- Health care	4	8	68	22	9	-	111	-
Infrastructure:
- Social	-	519	2,089	413	131	-	3,152	7
- Economic	-	-	729	737	19	14	1,499	3
Technology and Telecoms	61	169	467	2,077	135	1	2,910	7
Industrials	-	99	600	514	66	1	1,280	3
Utilities	1	83	3,939	2,767	39	1	6,830	17
Energy	24	318	472	913	283	-	2,010	5
Commodities	-	-	270	365	23	-	658	1
Oil and Gas	4	24	48	44	19	1	140	-
Property	-	257	111	386	7	1	762	2
Property backed securities	-	414	292	990	15	-	1,711	4
Structured finance ABS / RMBS / CMBS / Other	530	730	299	76	71	-	1,706	4
Lifetime mortgage loans	-	-	-	207	-	-	207	-
CDOs¹	-	552	468	14	47	-	1,081	2


Total £m	3,334	11,788	14,048	13,342	1,293	111	43,916	100


Total %	8	27	32	30	3	-	100


1. The underlying reference portfolio has had no reference entity defaults during the period. The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the market valuation.

Capital and Investments Page 84

4.06 Bond portfolio summary (continued)

(b) Total group analysed by sector (continued)

Sectors analysed by domicile

			EU
			excluding	Rest of
	UK	US	UK	the World	Total
	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	9,362	1,038	1,068	729	12,197
Banks	1,141	810	457	497	2,905
Financial Services	502	125	353	1	981
Insurance	189	566	18	54	827
Consumer Services and Goods:
- Cyclical	795	2,410	272	145	3,622
- Non-cyclical	1,073	2,653	209	27	3,962
- Health care	18	102	6	-	126
Infrastructure:
- Social	4,161	137	-	35	4,333
- Economic	1,937	102	1	226	2,266
Technology and Telecoms	588	1,468	753	448	3,257
Industrials	166	904	312	198	1,580
Utilities	3,687	1,293	2,401	915	8,296
Energy	178	1,044	321	646	2,189
Commodities	16	292	33	548	889
Oil and Gas	13	128	144	54	339
Property	709	71	4	3	787
Property backed securities	1,631	345	17	59	2,052
Structured Finance ABS / RMBS / CMBS / Other	1,020	323	469	18	1,830
Lifetime mortgages	852	-	-	-	852
CDOs¹	-	-	-	73	73


Total	28,038	13,811	6,838	4,676	53,363


1. In October 2016 the Lagoon CDOs were restructured effectively unwinding the levered super senior swaps. As the notes are now unlevered they have been reclassified to reflect the nature of the exposure.

Capital and Investments Page 85

4.06 Bond portfolio summary (continued)

(b) Total group analysed by sector (continued)

Sectors analysed by domicile (continued)

			EU
			excluding	Rest of
	UK	US	UK	the World	Total
	2015	2015	2015	2015	2015
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	6,200	878	1,696	753	9,527
Banks	979	710	455	420	2,564
Financial Services	472	368	252	14	1,106
Insurance	282	404	45	75	806
Consumer Services and Goods
- Cyclical	595	1,724	158	200	2,677
- Non-cyclical	926	2,007	169	77	3,179
- Health care	16	90	4	1	111
Infrastructure
- Social	3,068	67	-	17	3,152
- Economic	1,363	29	-	107	1,499
Technology and Telecoms	513	1,361	822	214	2,910
Industrials	175	678	301	126	1,280
Utilities	3,033	1,049	1,964	784	6,830
Energy	195	993	337	485	2,010
Commodities	22	187	12	437	658
Oil and Gas	11	71	22	36	140
Property	699	52	7	4	762
Property backed securities	1,342	324	11	34	1,711
Structured finance ABS / RMBS / CMBS / Other	975	518	209	4	1,706
Lifetime mortgage loans	207	-	-	-	207
CDOs¹	-	-	1,046	35	1,081


Total	21,073	11,510	7,510	3,823	43,916


1. The underlying reference portfolio has had no reference entity defaults during the period. The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the market valuation.

Capital and Investments Page 86

4.06 Bond portfolio summary (continued)

	Externally	Internally		Externally	Internally	Total
	rated	rated¹	LGR	rated	rated¹	Group
	2016	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m	£m


AAA	1,813	388	2,201	2,345	388	2,733
AA	13,303	1,236	14,539	13,916	1,503	15,419
A	14,454	2,773	17,227	15,384	2,882	18,266
BBB	12,405	2,061	14,466	13,068	2,295	15,363
BB or below	960	77	1,037	1,322	148	1,470
Other	-	-	-	-	112	112


	42,935	6,535	49,470	46,035	7,328	53,363





	Externally	Internally		Externally	Internally	Total
	rated	rated¹	LGR	rated	rated¹	Group
	2015	2015	2015	2015	2015	2015
	£m	£m	£m	£m	£m	£m


AAA	1,711	6	1,717	3,326	8	3,334
AA	9,426	1,551	10,977	10,234	1,554	11,788
A	11,349	1,903	13,252	12,084	1,964	14,048
BBB	10,721	1,659	12,380	11,497	1,845	13,342
BB or below	1,022	20	1,042	1,221	72	1,293
Other	-	-	-	-	111	111


	34,229	5,139	39,368	38,362	5,554	43,916

Capital and Investments Page 87

4.07 Property analysis

Property exposure within Direct Investments


Group property Direct Investments by status



			LGI
			(UK and
	LGR¹	LGC	Other)	Total
	At	At	At	At
	2016	2016	2016	2016
	£m	£m	£m	£m	%


Fully let	2,442	16	-	2,458	94
Part let	-	-	-	-	-
Development	-	101	-	101	4
Land	-	45	-	45	2


	2,442	162	-	2,604	100


1. The fully let LGR property includes £2.1bn let to investment grade tenants.

			LGI
			(UK and
	LGR¹	LGC	Other)	Total
	At	At	At	At
	2015	2015	2015	2015
	£m	£m	£m	£m	%


Fully let	2,157	25	4	2,186	93
Part let	-	-	-	-	-
Development	-	118	-	118	5
Land	-	43	-	43	2


	2,157	186	4	2,347	100

1. The fully let LGR property includes £1.9bn let to investment grade tenants.

Capital and Investments Page 88

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Glossary Page 89

Adjusted earnings per share*

Calculated by dividing profit after tax from continuing operations, attributable to equity holders of the company, excluding recognised gains and losses associated with held for sale and completed business disposals, by the weighted average number of ordinary shares in issue during the period, excluding employee scheme treasury shares. Excluding the impact of anticipated and completed disposals provides an indication of the earnings per share from ongoing operations.

Adjusted return on equity*

ROE measures the return earned by shareholders on shareholder capital retained within the business. Adjusted ROE is calculated as IFRS proﬁt after tax divided by average IFRS shareholders' funds excluding recognised gains and losses associated with held for sale and completed business disposals. Excluding the impact of anticipated and completed disposals provides an indication of the return on equity from ongoing operations.

Adjusted operating profit*

Operating proﬁt measures the pre-tax result excluding the impact of investment volatility, economic assumption changes and exceptional items. Adjusted operating profit further removes exceptional restructuring costs to demonstrate the profitability before these costs which are non-recurring in nature.

Advisory assets

These are assets on which Global Index Advisors (GIA) provide advisory services. Advisory assets are beneﬁcially owned by GIA's clients and all investment decisions pertaining to these assets are also made by the clients. These are different from Assets under Management (AUM) deﬁned below.

Alternative performance measures (APMs)

An alternative performance measure is a financial measure of historic or future financial performance, financial position, or cash flows, other than a financial measure defined under IFRS or the regulations of Solvency II. The group uses a range of these metrics to provide a better understanding of the underlying performance of the group. Where appropriate, reconciliations of alternative performance measures to IFRS measures are provided. All APMs defined within this glossary are marked with an asterisk.

Annual premium

Premiums that are paid regularly over the duration of the contract such as protection policies.

Assets under administration (AUA)*

Assets administered by Legal & General which are beneﬁcially owned by clients. Services provided in respect of assets under administration are of an administrative nature, including safekeeping, collecting investment income, settling purchase and sales transactions and record keeping.

Assets under management (AUM)*

The total amount of money investors have trusted to our fund managers to invest across our investment products i.e. these are funds which are managed by our fund managers on behalf of investors.

Backbook acquisition

New business transacted with an insurance company which allows the business to continue to utilise solvency II transitional measures associated with the business.

Bundled DC solution

Where investment and administration services are provided to a scheme by the same service provider. Typically, all investment and administration costs are passed onto the scheme members.

Bundled pension schemes

Where the fund manager bundles together the investment provider role and third-party administrator role, together with the role of selecting funds and providing investment education, into one proposition.

Deduction and aggregation (D&A)

A method of calculating group solvency on a Solvency II basis, whereby the assets and liabilities of certain entities are excluded from the group consolidation. The net contribution from those entities to group own funds is included as an asset on the group's Solvency II balance sheet. Regulatory approval has been provided to recognise the (re)insurance subsidiaries of LGA on this basis.

Glossary Page 90

Direct investments

Direct investments, which generally constitute an agreement with another party and represent an exposure to untraded and often less volatile asset classes. Direct investments also include physical assets, bilateral loans and private equity, but exclude hedge funds.

Earnings per share (EPS)

EPS is a common ﬁnancial metric which can be used to measure the proﬁtability and strength of a company over time. It is the total shareholder proﬁt after tax divided by the number of shares outstanding. EPS uses a weighted average number of shares outstanding during the year.

Economic capital*

Economic capital is the capital that an insurer holds internally as a result of its own assessment of risk. It differs from regulatory capital, which is determined by regulators. It represents an estimate of the amount of economic losses an insurer could withstand and still remain solvent with a target level of conﬁdence over a speciﬁed time horizon.

Economic Capital Requirement (ECR)

The amount of Economic Capital required to cover the losses occurring in a 1-in-200 year risk event.

Economic Capital Surplus*

The excess of Eligible Own Funds on an economic basis over the Economic Capital Requirement. This represents the amount of capital available to the company in excess of that required to sustain it in a 1-in-200 year risk event.

ECR coverage ratio*

The Eligible Own Funds on an economic basis divided by the Economic Capital Requirement (ECR). This represents the number of times that the ECR is covered by Eligible Own Funds.

Eligible Own Funds

Eligible Own Funds represents the capital available to cover the group's Economic or Solvency II Capital Requirement. Eligible Own Funds comprise the excess of the value of assets over liabilities, as valued on an Economic Capital or Solvency II basis, plus high quality hybrid capital instruments, which are freely available (fungible and transferable) to absorb losses wherever they occur across the group. Eligible own funds (shareholder view basis) excludes the contribution to the groups solvency capital requirement of with-profits fund and final salary pension schemes.

Euro Commercial paper

Short term borrowings with maturities of up to 1 year typically issued for working capital purposes.

General insurance combined operating ratio

The combined ratio is calculated as the sum of incurred losses and expenses divided by earned premium.

Gross written premiums (GWP)

GWP is an industry measure of the life insurance premiums due and the general insurance premiums underwritten in the reporting period, before any deductions for reinsurance.

ICAV - Irish Collective Asset-Management Vehicle

A legal structure investment funds, based in Ireland and aimed at European investment funds looking for a simple, tax-efficient investment vehicle.

IFRS proﬁt before tax (PBT)

PBT measures proﬁt attributable to shareholders incorporating actual investment returns experienced during the year but before the payment of tax.

Key performance indicators (KPIs)

These are measures by which the development, performance or position of the business can be measured effectively. The group Board reviews the KPIs annually and updates them where appropriate.

Lifetime mortgages

An equity release product aimed at people aged 60 years and over. It is a mortgage loan secured against the customer's house. Customers do not make any monthly payments and continue to own and live in their house until they move into long term care or on death. A no negative equity guarantee exists such that if the house value on repayment is insufficient to cover the outstanding loan, any shortfall is borne by the lender.

Long dated debt

Debt issued in either subordinated or senior format which forms part of the Group's core borrowings.

Glossary Page 91

Matching adjustment

An adjustment to the discount rate used for annuity liabilities in Economic Capital and Solvency II balance sheets. This adjustment reflects the fact that the profile of assets held is sufficiently well-matched to the profile of the liabilities, that those assets can be held to maturity, and that any excess return over risk-free (that is not related to defaults) can be earned regardless of asset value fluctuations after purchase.

Net release from operations*

Net release from operations is deﬁned as release from operations plus new business surplus/(strain). Net release from operations was previously referred to as Net Cash and provides information on the underlying release of prudent margins from the back book.

New business surplus/(strain)*

The net impact of writing new business on the IFRS position, including the benefit/cost of acquiring new business and the setting up of reserves, for UK non profit annuities, workplace savings, protection and savings, net of tax. This metric provides an understanding of the impact of new contracts on the IFRS profit for the year.

Operating proﬁt*

Operating proﬁt measures the pre-tax result excluding the impact of investment volatility, economic assumption changes and exceptional items. Operating proﬁt therefore reﬂects longer-term economic assumptions and changes in insurance risks such as mortality and longevity for the group's insurance business and shareholder funds, except for LGA which excludes unrealised investment returns to align with the liability measurement under US GAAP. Variances between actual and smoothed assumptions are reported below operating proﬁt. Exceptional income and expenses which arise outside the normal course of business in the period, such as merger and acquisition and start-up costs are excluded from operating proﬁt.

Overlay assets

Overlay assets are derivative assets that are managed alongside the physical assets held by LGIM. These instruments include interest rate swaps, inﬂation swaps, equity futures and options. These are typically used to hedge risks associated with pension scheme assets during the derisking stage of the pension life cycle.

Pension risk transfer (PRT)

PRT represents bulk annuities bought by entities that run ﬁnal salary pension schemes to reduce their responsibilities by closing the schemes to new members and passing the assets and obligations to insurance providers.

Present value of future new business premiums (PVNBP)*

PVNBP is equivalent to total single premiums plus the discounted value of annual premiums expected to be received over the term of the contracts using the same economic and operating assumptions used for the new business value at the end of the financial period. The discounted value of longevity insurance regular premiums and quota share reinsurance single premiums are calculated on a net of reinsurance basis to enable a more representative margin figure. PVNBP therefore provides an estimate of the present value of the premiums associated with new business written in the year.

Recapitalisation Cost*

An additional liability required in the L&G Economic Capital balance sheet, to allow for the cost of recapitalising the balance sheet following a 1-in-200 year risk event, in order to maintain confidence that our future liabilities will be met. This is calculated using a cost of capital that reflects the long term average rates at which it is expected that the group could raise debt and allows for diversification between all group entities.

Real assets

Real assets encompass a wide variety of tangible debt and equity investments, primarily real estate, infrastructure and energy. They have the ability to serve as stable sources of long term income in weak markets, while also providing capital appreciation opportunities in strong markets.

Release from operations*

The expected release of IFRS surplus from in-force business for the UK non-profit Insurance and Savings and LGR businesses, the shareholder's share of bonuses on with-profits business, the post-tax operating profit on other UK businesses, including the medium term expected investment return on LGC invested assets, and dividends remitted from LGA and Legal & General Netherlands. 2015 included dividends remitted from Legal & General France, which was disposed of on 31 December 2015. Release from operations was previously referred to as pperational cash generation.

Return on equity (ROE)*

ROE measures the return earned by shareholders on shareholder capital retained within the business. ROE is calculated as IFRS proﬁt after tax divided by average IFRS shareholders' funds.

Single premiums*

Single premiums arise on the sale of new contracts where the terms of the policy do not anticipate more than one premium being paid over its lifetime, such as in individual and bulk annuity deals.

Glossary Page 92

Solvency II

Taking effect from 1 January 2016, the Solvency II regulatory regime is a harmonised prudential framework for insurance ﬁrms in the EEA. This single market approach is based on economic principles that measure assets and liabilities to appropriately align insurers' risk with the capital they hold to safeguard policyholder.

Solvency II new business contribution

Reflects present value at the point of sale of expected future Solvency II surplus emerging from new business written in the period using the risk discount rate applicable at the end of the reporting period.

Solvency II Risk Margin

An additional liability required in the Solvency II balance sheet, to ensure the total value of technical provisions is equal to the current amount a (re)insurer would have to pay if it were to transfer its insurance and reinsurance obligations immediately to another (re)insurer. The value of the risk margin represents the cost of providing an amount of Eligible Own Funds equal to the Solvency Capital Requirement (relating to non-market risks) necessary to support the insurance and reinsurance obligations over the lifetime thereof.

Solvency II Surplus

The excess of Eligible Own Funds on a regulatory basis over the Solvency Capital Requirement. This represents the amount of capital available to the company in excess of that required to sustain it in a 1-in-200 year risk event.

Solvency Capital Requirement (SCR)

The amount of Solvency II capital required to cover the losses occurring in a 1-in-200 year risk event.

SCR (shareholder view basis)

In order to present a shareholder view of group SCR the Solvency capital requirement of LGAS With-profits fund and defined benefit final salary pension scheme is excluded from SCR.

SCR coverage ratio

The Eligible Own Funds on a regulatory basis divided by the Solvency Capital Requirement (SCR). This represents the number of times that the SCR is covered by Eligible Own Funds.

SCR coverage ratio (proforma basis)

The proforma basis solvency II coverage incorporates the estimated impacts of a recalculation of the Transitional Measures for Technical Provisions recalculated based on end 2016 economic conditions, changes during 2016 to the Internal Model and Matching Adjustment and management's updated Solvency I basis. The proforma basis does not reflect the regulatory capital position as at 31 December 2016. This will be made public in May 2017.

SCR coverage ratio (shareholder view basis)*

In order to represent a shareholder view of group solvency position, the capital requirement in relation to the ring-fenced LGAS With-profits fund and our defined benefit pension schemes is excluded from both Eligible Own Funds and the SCR in the calculation of the SCR coverage ratio. The shareholder view basis does not reflect the regulatory capital position as at 31 December 2016. This will be made public in May 2017.

Total shareholder return (TSR)

TSR is a measure used to compare the performance of different companies' stocks and shares over time. It combines the share price appreciation and dividends paid to show the total return to the shareholder.

Transitional Measures on Technical Provisions (TMTP)

This is an adjustment to Solvency II technical provisions to bring them into line with the pre-Solvency II equivalent as at 1 January 2016 when the regulatory basis switched over, to smooth the introduction of the new regime. This will decrease linearly over the 16 years following Solvency II implementation but may be recalculated to allow for changes impacting the relevant business, subject to agreement with the PRA.

Unbundled DC solution

When investment services and administration services are supplied by separate providers. Typically the sponsoring employer will cover administration costs and scheme members the investment costs.

This information is provided by RNS

The company news service from the London Stock Exchange

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