L&G Full Year Results 2017 Part 3

RNS Number : 9080G

Legal & General Group Plc

07 March 2018

Legal & General Group Plc

Full year results 2017 Part 3

Capital and Investments Page 69

5.01 Group regulatory capital - Solvency II

The group complies 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 and unaudited. Further explanation of the underlying methodology and assumptions are 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 of applications for major model change in December 2016 and December 2017). 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 few 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 to use the Deduction and Aggregation method of including these businesses in the group solvency calculation.

The table below shows the "shareholder view" of the group Own Funds, Solvency Capital Requirement (SCR) and Surplus Own Funds, based on the Partial Internal Model, Matching Adjustment and Transitional Measures on Technical Provisions (recalculated as at end December 2017 in line with the PRA guidance).

(a) Capital position

As at 31 December 2017 the group had a Solvency II surplus of £6.9bn (31 December 2016: £5.7bn) over its Solvency Capital Requirement, corresponding to a coverage ratio on a "shareholder view" basis of 189% (31 December 2016: 171%). The shareholder view of the Solvency II capital position is as follows:
	2017	2016
	£bn	£bn


Core tier 1 Own Funds	11.6	11.0
Tier 1 subordinated liabilities¹	-	0.6
Tier 2 subordinated liabilities²	3.1	2.1
Eligibility restrictions	(0.1)	(0.1)
Solvency II Own Funds^3,4	14.6	13.6
Solvency Capital Requirement⁵	(7.7)	(7.9)


Solvency II surplus	6.9	5.7


SCR coverage ratio⁶	189%	171%

1. Tier 1 subordinated liabilities of £0.6bn were redeemed on 2 May 2017.
2. Tier 2 subordinated liabilities include $1.35bn of USD subordinated notes issued in 2017.
3. Own Funds do not include an accrual for the dividend of £658m (2016: £616m) declared after the balance sheet date.
4. Solvency II Own Funds allow for a risk margin of £5.9bn (2016: £6.4bn) and TMTP of £6.2bn (2016: £7.0bn).
5. The SCR is not subject to audit.
6. Coverage ratio is based on unrounded inputs.

The "shareholder view" basis excludes the contribution that the with-profits fund and the final salary pension scheme would normally make to the group position. This is reflected by reducing the group's Own Funds and the group's SCR by the amount of the SCR for the with-profits fund and the final salary pension schemes.

On a proforma basis, which includes the contribution of with-profits fund and the final salary pension scheme in the group's Own Funds and corresponding SCR in group's SCR, the coverage ratio at 31 December 2017 is 181% (31 December 2016: 165%).

On 6 December 2017 the group announced its intention to sell the Mature Savings business to the ReAssure division of Swiss Re. Swiss Re assumed the economic exposure of the business from 1 January 2018 via a risk transfer agreement. It is expected that the formal transfer of the business will be completed in mid-2019, subject to satisfaction of normal conditions for a transaction including court sanction. The transfer will be effected by way of a Part VII transfer under the Financial Services Markets Act 2000. The impact of the risk transfer agreement has been reflected in the 2017 Own Funds. Due to the proximity of the transaction to the year end, the model change to make an allowance on the SCR will take place during 2018 and therefore the SCR in 2017 does not include any impact of the risk transfer agreement.

Capital and Investments Page 70

5.01 Group regulatory capital - Solvency II (continued)

(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 changes to the Internal Model and Matching Adjustment during 2017 and the impacts of a recalculation of the TMTP as at end December 2017. In line with the requirements to recalculate the TMTP every two years we applied to recalculate and the PRA granted approval in December 2017, but the PRA will not review our detailed methodology until later in 2018. The recalculated TMTP of £6.2bn (2016: £7.0bn) is net of amortisation to 31 December 2017.

The liabilities include a Risk Margin of £5.9bn (2016: £6.4bn) which represents an allowance for the cost of capital for a purchasing insurer to take on the portfolio of liabilities and residual risks that are deemed to be not hedgeable under Solvency II. 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.

All material EEA insurance firms, including Legal & General Assurance Society Limited (the LGAS), Legal & General Insurance Limited, and Legal & General Assurance (Pensions Management) Limited 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 (LGRe) based in Bermuda) contribute over 97% 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 the group's 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 (LGA) 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 Company Action Level RBC (CAL RBC). The contribution to group's Own Funds is the SCR together with any surplus capital in excess of 250% of CAL RBC.

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

Allowance is made within the Solvency II balance sheet for the group's defined benefit pension schemes using results on an IFRS basis. Within the SCR an allowance is made by stressing the IFRS result position using the same Internal Model basis as for the insurance firms.

The impact of the risk transfer agreement with the ReAssure division of Swiss Re has been reflected in the calculation of Own Funds. Due to the proximity of the transaction to the year end the model change required to reflect the impact of the agreement on the SCR has not been made. The change is expected in H1 2018. The impact of recognising the risk transfer in Own Funds is to reduce the reported coverage ratio by 2%. Once the model change is implemented the coverage ratio is expected to improve by an estimated 2%. It is expected that there will be a further improvement in the group's coverage ratio in 2019 when the Part VII transfer is finalised.

Capital and Investments Page 71

5.01 Group regulatory capital - Solvency II (continued)

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 10 basis points (2016: 17 basis points) 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 between LGAS and LGRe and by the currency of the relevant liabilities.

At 31 December 2017 the Matching Adjustment for UK GBP was 106 basis points (31 December 2016: 124 basis points) after deducting an allowance for the EIOPA fundamental spread equivalent to 51 basis points (31 December 2016: 58 basis points). The reduction in Fundamental Spread is driven by change in the factors supplied by EIOPA and changes in the asset portfolio which have improved the overall credit quality.

(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

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 is the cost of acquiring, and setting up Technical Provisions and SCR capital (net of any premium income), on actual new business written over the year. It is based on economic conditions at the point of sale.


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

	2017	2016
	£bn	£bn


Surplus arising from back-book (including release of SCR)	1.3	1.2
Release of Risk Margin¹	0.4	0.3
Amortisation of TMTP²	(0.4)	(0.3)
Operational Surplus Generation³	1.3	1.2
New Business Strain	(0.1)	(0.1)
Net Surplus Generation	1.2	1.1
Dividends paid⁴	(0.9)	(0.8)
Operating variances⁵	0.4	0.2
Market movements⁶	-	(0.3)
Subordinated debt⁷	0.5	-

Total Surplus movement (after dividends paid in the year)	1.2	0.2

1. Based on the risk margin in force at the end of 2017 and does not include the release of any risk margin added by new business written in 2017.
2. TMTP amortisation based on a linear run down of the end-2016 TMTP of £5.9bn (net of tax, £7.0bn before tax) which was management's estimate of the TMTP on end-2017 market conditions.
3. 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 2017 these are to deliver further eligible assets and liabilities into the Matching Adjustment portfolio in respect of a small amount of pension risk transfer business and an increase in direct investments allocation to the annuity back-book.
4. Dividends paid are the amounts from the 2016 final and 2017 interim dividend declarations paid in 2017 (2016: 2015 final and 2016 interim dividend declarations).
5. 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 and other management actions including changes in asset mix, Matching Adjustment optimisation, hedging strategies, M&A activities (sale of Mature Savings, Legal & General Netherlands and Cofunds) and update to the longevity assumptions.
6. Market movements represents the impact of changes in investment market conditions over the period and changes to future economic assumptions. It also includes the capital impact of investment portfolio changes implemented by LGC. Market movements in 2017 include a reduction in the Risk Margin of £0.2bn (net of tax). 31 December 2016 included an increase in the Risk Margin of £1.1bn (net of tax) offset by an increase in the estimated TMTP of £1.0bn (net of tax).
7. Movement in subordinated debt includes $1.35bn US Dollar subordinated notes issued and £0.6bn of sub-debt redeemed.

Capital and Investments Page 72

5.01 Group regulatory capital - Solvency II (continued)

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

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

	2017	2016
	£bn	£bn


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

Solvency II Operational Surplus Generation	1.3	1.2

1. Release of prudence from IFRS specific reserves which are not included in Solvency II (e.g. long term expenses and longevity margins).
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 2017.
4. Solvency II Operational Surplus Generation includes management actions which at the start of 2017 were expected to take place within the group plan.

(ii) The table below provides a reconciliation of the group's IFRS New Business Surplus to Solvency II New Business Strain.
	2017	2016
	£bn	£bn
IFRS New Business Surplus	0.2	0.2
Removal of requirement to set up prudential margins above best estimate on New Business¹	0.2	0.5
Set up of Solvency II Capital Requirement on New Business²	(0.3)	(0.7)
Set up of Risk Margin on New Business³	(0.2)	(0.1)
Solvency II New Business Strain	(0.1)	(0.1)
1. Release of margin was higher in 2016 primarily due to the acquisition of bulk-annuity liabilities from Aegon.
2. The lower SCR for 2017 new business strain reflects both premiums written and the success of our strategy to source direct investments (including lifetime mortgages) to back new annuity sales.
3. Risk Margin in 2016 is net of Estimated TMTP attached to the acquisition of bulk-annuity liabilities from Aegon.

(f) Reconciliation of IFRS shareholders' equity to Solvency II Own Funds


A reconciliation of the group's IFRS shareholders' equity to Own Funds is given below:
	2017	2016
	£bn	£bn
IFRS shareholders' equity	7.8	6.9
Remove DAC, goodwill and other intangible assets and liabilities	(1.9)	(2.1)
Add IFRS carrying value of subordinated debt treated as available capital under Solvency II¹	2.9	2.5
Insurance contract valuation differences²	7.4	7.9
Difference in value of net deferred tax liabilities	(0.6)	(0.5)
SCR for with-profits fund and final salary pension schemes	(0.7)	(0.7)
Other³	(0.2)	(0.3)
Eligibility restrictions⁴	(0.1)	(0.1)
Own Funds⁵	14.6	13.6
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 technical provisions between IFRS and Solvency II.
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 that are subject to local regulatory rules.
5. Own Funds do not include an accrual for the dividend of £658m (2016: £616m) declared after the balance sheet date.

Capital and Investments Page 73

5.01 Group regulatory capital - Solvency II (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 2017 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	Impact on	Impact on
	net of tax	net of tax	net of tax	net of tax
	Solvency II	Solvency II	Solvency II	Solvency II
	capital	coverage	capital	coverage
	surplus⁷	ratio⁷	surplus	ratio
	2017	2017	2016	2016
	£bn	%	£bn	%


Credit spreads widen by 100bps assuming an escalating addition to ratings^1,2	0.2	8	0.2	7
Credit spreads narrow by 100bps assuming an escalating addition to ratings^1,2	(0.3)	(9)	(0.2)	(7)
Credit migration³	(0.5)	(6)	(0.6)	(8)
25% rise in equity markets⁴	0.5	5	0.5	6
25% fall in equity markets⁴	(0.5)	(5)	(0.5)	(6)
15% fall in property markets	(0.4)	(4)	(0.2)	(3)
15% rise in property markets	0.3	4	0.2	3
100bps increase in risk free rates	0.8	20	1.0	22
50bps decrease in risk free rates⁵	(0.5)	(10)	(0.5)	(10)
Substantially reduced Risk Margin⁶	0.1	1	0.1	1
1. The spread sensitivity applies to all assets within the group's holdings where the capital treatment depends on a credit rating (for example corporate bonds and income strips), 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 100 basis points.
3. Credit migration stress covers the cost of an immediate big letter downgrade on 20% of all assets where the capital treatment depends on a credit rating (including corporate bonds and income strips).
4. The +/-25% equity impacts from 2016 were approximated using existing sensitivities.
5. In the interest rate down stress negative rates are allowed, i.e. there is no floor at zero rates.
6. This represents a reduction of two-thirds in Risk Margin and subsequent recalculation of TMTP.
7. The 2017 sensitivities ignore the impact of the Mature Savings business (including the With-Profits fund) as the risks have been transferred to ReAssure division of Swiss Re from 1 January 2018.

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 TMTP as at 31 December 2017 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 74

5.01 Group regulatory capital - Solvency II (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 before the effects of diversification and tax.

	2017	2016
	%	%


Interest Rate	2	4
Equity	6	5
Property	5	5
Credit¹	26	25
Currency	3	3
Inflation	4	2
Total Market Risk²	46	44
Counterparty Risk	1	1
Life Mortality	2	3
Life Longevity³	31	32
Life Mass Lapse	2	2
Life Non-Mass Lapse	3	3
Life Catastrophe	3	4
Expense	3	3
Total Insurance Risk	44	47
Non-life underwriting	2	2
Operational Risk	4	4
Miscellaneous⁴	3	2


Total SCR	100	100

1. Credit risk is one of the group's most significant exposures, 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 the group'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 75

5.02 Estimated Solvency II new business contribution

(a) New business by product¹
Management estimates of the present value of new business premium (PVNBP) and the margin for selected lines of business are provided below:
		Contri-			Contri-
		bution			bution
		from new			from new
	PVNBP	business²	Margin³	PVNBP	business²	Margin
	2017	2017	2017	2016	2016	2016
	£m	£m	%	£m	£m	%


LGR - UK annuity business	4,083	346	8.5	6,661	693	10.4

UK Protection Total	1,496	129	8.6	1,466	153	10.4
- Retail Protection	1,293	111	8.6	1,255	139	11.1
- Group Protection	203	18	8.7	211	14	6.6

US Protection⁴	764	89	11.7	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. Margin is based on unrounded inputs.
4. In local currency, US Protection reflects PVNBP of $985m (2016: $855m) and a contribution from new business of $115m (2016: $106m).
The change in LGR margin reflects differences in the mix of new business. In particular, 2017 margin includes a £250m scheme where the group passes on all of the risk and retains a small facilitation fee. We have maintained a strong pricing discipline in a competitive market. In the UK Protection business, the increase in the Solvency II new business margin on Group Protection is more than offset by a reduction in the margin on new Retail Protection products, which is caused by competitive pressure and a change in mix towards lower margin products. The new business contribution from US Protection has increased by 14% following a significant increase in new business sales. The Solvency II new business margin has reduced in the year as a result of competitive pricing movements during the year resulting in the higher new business volumes.

Capital and Investments Page 76

5.02 Estimated Solvency II new business contribution (continued)

(b) Assumptions

The key economic assumptions as at 31 December 2017 are as follows:

		%


Margin for risk		3.0

Risk free rate
- UK		1.6
- US		2.4
Risk discount rate (net of tax)
- UK		4.6
- US		5.4

Long-term rate of return on non-profit annuities in LGR		3.0

The future earnings are discounted using duration-based discount rates, which is the sum of a duration-based risk free rate and a flat Margin for Risk. 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.

Other than updating for recent experience, 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 previously used by the group for its European Embedded Value reporting, 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 18 basis points.

· 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 19.25% 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 grossed up using the long term corporate tax rate of 21%.

Capital and Investments Page 77

5.02 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 European Embedded Value (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 the period, recognising that the statutory solvency in the UK is now on a Solvency II basis. It has been calculated in a manner consistent with EEV principles.

Solvency II new business contribution has been calculated for the group's most material insurance-related businesses, namely, LGR, LGI 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 2017.

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. 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 expected impact of LGA directly-written business at group level (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 Margin for Risk, 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 10 basis points for GBP and for USD (2016: 17 basis points for GBP and 15 basis points for USD).

The Margin for Risk 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.

Capital and Investments Page 78

5.02 Estimated Solvency II new business contribution (continued)

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.

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 17.5% (2016: 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) Reconciliation of PVNBP to gross written premium

A reconciliation of PVNBP and gross written premium is given below:
	2017	2016
	£bn	£bn


PVNBP	6.3	8.8
Effect of capitalisation factor	(2.0)	(1.8)


New business premiums from selected lines	4.3	7.0
Other	2.4	1.9


Total LGR and LGI new business	6.7	8.9
Annualisation impact of regular premium long-term business	(0.2)	(0.1)
IFRS gross written premiums from existing long-term insurance business	2.8	2.5
IFRS gross written premiums from Savings business²	-	0.1
Deposit accounting for lifetime mortgage advances	(1.0)	(0.6)
General Insurance gross written premiums	0.4	0.3
Future premiums on longevity swap new business	(0.8)	(0.9)


Total gross written premiums	7.9	10.2


1. Other principally includes annuity sales in the US, lifetime mortgage advances and discounted future cash flows on longevity swap new business.
2. This excludes gross written premiums from discontinued operations.

Capital and Investments Page 79

5.03 Group Economic Capital

The group 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.

The Economic Capital results are estimated and unaudited.

The table below shows the group Own Funds, Economic Capital Requirement (ECR) and Surplus Own Funds based on group's Economic Capital model.

(a) Capital position

As at 31 December 2017, the group had an Economic Capital surplus of £9.3bn (31 December 2016: £8.3bn), corresponding to an Economic Capital coverage ratio of 254% (31 December 2016: 230%). The Economic Capital position is as follows:
	2017	2016
	£bn	£bn


Core tier 1 Own Funds	12.2	11.9
Tier 1 subordinated liabilities¹	-	0.6
Tier 2 subordinated liabilities²	3.1	2.1
Own Funds³	15.3	14.6
Economic Capital Requirement⁴	(6.0)	(6.3)


Surplus Own Funds	9.3	8.3
		-

ECR coverage ratio⁵	254%	230%


1. Tier 1 subordinated liabilities of £0.6bn were redeemed on 2 May 2017.
2. Tier 2 subordinated liabilities include $1.35bn of USD subordinated notes issued in 2017.
3. Economic Capital Own Funds do not include an accrual for the dividend of £658m (2016: £616m) declared after the balance sheet date.
4. The Economic Capital balance sheet and ECR are not subject to audit.
5. Coverage ratio uses unrounded inputs.

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

The impact of the risk transfer agreement with the ReAssure division of Swiss Re has been reflected in the calculation of Economic Capital Own Funds. Due to the proximity of the transaction to the year end the model change required to reflect the impact of the risk transfer agreement on the ECR has not been made. The model change is expected during 2018. It is expected that there will be a further improvement in the group's Economic Capital coverage ratio in 2019 when the Part VII transfer is finalised.

(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 and Legal & General Assurance (Pensions Management) Limited 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 firms (Legal & General America and Legal & General Reinsurance Company Limited based in Bermuda) contribute over 97% 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.

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 80

5.04 Investment portfolio

	Market	Market¹
	value	value
	2017	2016
	£m	£m


Worldwide total assets under management	984,120	903,886
Client and policyholder assets	(900,904)	(821,978)
Non-unit linked with-profits assets	(11,113)	(11,924)


Investments to which shareholders are directly exposed	72,103	69,984

Analysed by investment class:

			Other
			non profit		Other
		LGR	insurance	LGC	shareholder
		investments	investments	investments	investments	Total	Total¹
		2017	2017	2017	2017	2017	2016
	Notes	£m	£m	£m	£m	£m	£m


Equities²		282	-	2,522	156	2,960	2,558
Bonds	5.06	52,476	1,619	2,501	479	57,075	54,852
Derivative assets³		4,018	-	44	-	4,062	4,693
Property	5.07	2,722⁴	-	110⁵	-	2,832	2,604
Cash, cash equivalents and loans¹		1,711	505	1,648	220	4,084	3,362


Financial investments		61,209	2,124	6,825	855	71,013	68,069


Other assets⁶		455	-	548	87	1,090	1,915


Total investments		61,664	2,124	7,373	942	72,103	69,984


1. Following a review of short dated instruments, certain assets have been reclassified from Cash, cash equivalents and loans to Bonds as their maturity at the balance sheet date was greater than 3 months. These amounts totalled £1,489m and the analysis above has been restated to reflect this reclassification.
2. Equity investments include a total of £260m in respect of CALA Group Limited, Peel Media Holdings Limited (MediaCityUK), NTR Wind Management Ltd and Access Development Partnership (2016: £237m).
3. Derivative assets are shown gross of derivative liabilities of £2.3bn (2016: £2.9bn). 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.
4. Included within other assets outside of Financial investments, LGR has a further £419m of property-related assets. Within the group's Solvency II capital calculations, these are combined with the £2,722m of property assets within Financial investments to give a total of £3,141m (2016: £2,872m), which are designated within those calculations as £1,987m (2016: £1,883m) of bonds and £1,154m (2016: £989m) of investment property.
5. LGC property includes £23m of shareholder investment property.
6. Other assets include reverse repurchase agreements of £679m (2016: £1,883m).

Capital and Investments Page 81

5.05 Direct Investments

(a) Analysed by asset class


	Direct¹	Traded²		Direct¹	Traded^2,3
	Investments	securities	Total	Investments	securities	Total
	2017	2017	2017	2016	2016	2016
	£m	£m	£m	£m	£m	£m


Equities	930	2,030	2,960	595	1,963	2,558
Bonds⁴	9,726	47,349	57,075	6,256	48,596	54,852
Derivative assets	-	4,062	4,062	-	4,693	4,693
Property⁵	2,832	-	2,832	2,604	-	2,604
Cash, cash equivalents and loans	474	3,610	4,084	518	2,844	3,362
Other assets	411	679	1,090	32	1,883	1,915


	14,373	57,730	72,103	10,005	59,979	69,984


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. Traded securities are defined by exclusion. If an instrument is not a Direct Investment, then it is classed as a traded security.
3. Following a review of short dated instruments, certain assets have been reclassified from Cash, cash equivalents and loans to Bonds as their maturity at the balance sheet date was greater than 3 months. These amounts totalled £1,489m and the analysis above has been restated to reflect this reclassification.
4. Direct Investment bonds include lifetime mortgages of £2,023m (2016: £852m).
5. A further breakdown of property is provided in note 5.07.

(b) Analysed by segment

		LGR	LGC¹	LGI²	Total
		2017	2017	2017	2017
		£m	£m	£m	£m
	-

Equities		-	922	8	930
Bonds³		9,272	22	432	9,726
Property⁴		2,722	110	-	2,832
Cash, cash equivalents and loans⁵		88	150	236	474
Other assets⁶		92	319	-	411


		12,174	1,523	676	14,373


1. LGI includes £8m of equity investments in LGI UK. The bonds and loans and receivables are in the US business.
2. LGC includes £30m of equities, £19m of bonds and £23m of property that belong to other shareholder funds.
3. Direct Investment bonds include lifetime mortgages of £2,023m (2016: £852m).
4. A further breakdown of property is provided in note 5.07.
5. Cash, cash equivalents and loans only include loans.
6. Other assets include finance leases of £92m and property under construction of £270m.


	LGR	LGC	LGI	Total
	2016	2016	2016	2016
	£m	£m	£m	£m


Equities	-	595	-	595
Bonds¹	5,655	228	373	6,256
Property²	2,442	162	-	2,604
Cash, cash equivalents and loans³	33	120	365	518
Other assets	-	32	-	32


	8,130	1,137	738	10,005


1. Direct Investments bonds include lifetime mortgages of £852m.
2. A further breakdown of property is provided in note 5.07.
3. Cash, cash equivalents and loans only include loans.

Capital and Investments Page 82

5.05 Direct Investments (continued)

(c) Movement in the period

	Carrying			Change in	Carrying
	value			market	value
	1 January 2017	Additions	Disposals	value	31 December 2017
	£m	£m	£m	£m	£m


Equities	595	424	(169)	80	930
Bonds	6,256	3,464	(265)	271	9,726
Property	2,604	753	(664)	139	2,832
Cash, cash equivalents and loans	518	32	(43)	(33)	474
Other assets	32	379	-	-	411


	10,005	5,052	(1,141)	457	14,373

Capital and Investments Page 83

5.06 Bond portfolio summary

(a) LGR analysed by sector

Sectors analysed by credit rating

					BB or
	AAA	AA	A	BBB	below	LGR	LGR
	2017	2017	2017	2017	2017	2017	2017
	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,220	8,604	186	238	10	10,258	20
Banks:
- Tier 1	-	-	-	-	-	-	-
- Tier 2 and other subordinated	142	-	63	31	-	236	1
- Senior	-	682	1,740	47	-	2,469	5
- Covered	193	-	-	-	-	193	-
Financial Services:
- Tier 2 and other subordinated	-	123	113	9	-	245	1
- Senior	-	307	348	187	-	842	2
Insurance:
- Tier 1	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	124	1	46	-	171	-
- Senior	-	116	458	65	-	639	1
Consumer Services and Goods:
- Cyclical	-	271	798	1,510	213	2,792	5
- Non-cyclical	201	574	1,239	2,031	126	4,171	8
- Health care	3	32	232	176	-	443	1
Infrastructure:
- Social	93	708	3,442	1,111	21	5,375	10
- Economic	179	30	937	2,179	43	3,368	6
Technology and Telecoms	60	148	777	1,941	26	2,952	6
Industrials	-	-	774	274	9	1,057	2
Utilities	-	107	4,800	3,666	11	8,584	17
Energy	-	-	106	538	16	660	1
Commodities	-	-	246	490	19	755	1
Oil and Gas	-	304	616	541	170	1,631	3
Real estate	-	22	1,044	1,166	49	2,281	4
Structured finance ABS / RMBS / CMBS / Other	176	681	172	151	55	1,235	2
Lifetime mortgage loans¹	-	1,972	51	-	-	2,023	4
CDOs	-	22	60	14	-	96	-


Total	2,267	14,827	18,203	16,411	768	52,476	100


Total %	4	28	36	31	1	100



1. The credit ratings attributed to lifetime mortgages are allocated in accordance with the internal Matching Adjustment structuring.

Capital and Investments Page 84

5.06 Bond portfolio summary (continued)

(a) LGR analysed by sector (continued)

Sectors analysed by credit rating (continued)
					BB or
	AAA¹	AA¹	A¹	BBB¹	below¹	LGR¹	LGR¹
	At	At	At	At	At	At	At
	2016	2016	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	912	9,961	285	229	34	11,421	24
Banks:
- Tier 1	-	-	-	-	12	12	-
- Tier 2 and other subordinated	211	49	62	41	-	363	1
- Senior	8	436	1,201	59	-	1,704	3
- Covered	259	-	16	-	-	275	1
Financial Services:
- Tier 2 and other subordinated	-	87	59	56	-	202	-
- Senior	-	371	125	110	-	606	1
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	-	389	1,088	1,755	165	3,397	7
- Non-cyclical	260	647	1,380	1,373	115	3,775	8
- Health care	3	13	15	10	1	42	-
Infrastructure:
- Social	-	624	3,259	926	148	4,957	10
- Economic	-	-	873	1,313	44	2,230	4
Technology and Telecoms	57	203	610	2,104	84	3,058	6
Industrials	-	142	741	362	37	1,282	3
Utilities	-	101	4,903	3,142	12	8,158	16
Energy	-	-	106	554	31	691	1
Commodities	-	-	304	475	77	856	2
Oil and Gas	-	281	544	633	180	1,638	3
Property	-	-	1	6	-	7	-
Real estate	-	305	628	1,063	48	2,044	4
Structured finance ABS / RMBS / CMBS / Other	121	671	572	46	49	1,459	3
Lifetime mortgage loans²	388	322	91	51	-	852	2
CDOs	-	-	59	14	-	73	-


Total¹	2,227	14,735	17,410	14,467	1,037	49,876	100


Total %	4	30	35	29	2	100


1. Following a review of short dated instruments, certain assets have been reclassified from Cash and cash equivalents to Financial investments as their maturity at the balance sheet date was greater than 3 months. These amounts totalled £406m and the analysis above has been restated to reflect this reclassification.
2. The credit ratings attributed to lifetime mortgages are allocated in accordance with the internal Matching Adjustment structuring.

Capital and Investments Page 85

5.06 Bond portfolio summary (continued)

(a) LGR analysed by sector (continued)

Sectors analysed by domicile
			EU	Rest of
	UK	US	excluding UK	the World	LGR
	2017	2017	2017	2017	2017
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	8,052	925	978	303	10,258
Banks	1,351	690	662	195	2,898
Financial Services	364	68	655	-	1,087
Insurance	135	531	91	53	810
Consumer Services and Goods:
- Cyclical	597	1,919	210	66	2,792
- Non-cyclical	1,298	2,553	314	6	4,171
- Health care	1	442	-	-	443
Infrastructure:
- Social	5,051	287	-	37	5,375
- Economic	2,658	310	34	366	3,368
Technology and Telecoms	686	1,300	556	410	2,952
Industrials	195	523	263	76	1,057
Utilities	3,997	1,233	2,280	1,074	8,584
Energy	-	583	5	72	660
Commodities	8	263	34	450	755
Oil and Gas	259	418	429	525	1,631
Real estate	1,600	359	44	278	2,281
Structured finance ABS / RMBS / CMBS / Other	1,011	192	10	22	1,235
Lifetime mortgages	2,023	-	-	-	2,023
CDOs	-	22	-	74	96


Total	29,286	12,618	6,565	4,007	52,476

Capital and Investments Page 86

5.06 Bond portfolio summary (continued)

(a) LGR analysed by sector (continued)

Sectors analysed by domicile (continued)
			EU	Rest of
	UK¹	US¹	excluding UK¹	the World¹	LGR¹
	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	9,128	782	1,003	508	11,421
Banks	948	680	537	189	2,354
Financial Services	389	76	342	1	808
Insurance	176	528	15	55	774
Consumer Services and Goods:
- Cyclical	783	2,229	255	130	3,397
- Non-cyclical	1,142	2,419	201	13	3,775
- Health care	4	37	1	-	42
Infrastructure:
- Social	4,785	137	-	35	4,957
- Economic	1,934	74	.	222	2,230
Technology and Telecoms	582	1,305	746	425	3,058
Industrials	148	656	301	177	1,282
Utilities	3,673	1,191	2,387	907	8,158
Energy	-	589	6	96	691
Commodities	16	290	27	523	856
Oil and Gas	183	485	417	553	1,638
Property	-	7	-	-	7
Real estate	1,629	340	17	58	2,044
Structured finance ABS / RMBS / CMBS / Other	1,016	50	375	18	1,459
Lifetime mortgages	852	-	-	-	852
CDOs	-	-	-	73	73


Total	27,388	11,875	6,630	3,983	49,876


1. Following a review of short dated instruments, certain assets have been reclassified from Cash and cash equivalents to Financial investments as their maturity at the balance sheet date was greater than 3 months. These amounts totalled £406m and the analysis above has been restated to reflect this reclassification.

Capital and Investments Page 87

5.06 Bond portfolio summary (continued)

(b) Total group analysed by sector (continued)

Sectors analysed by credit rating

					BB or
	AAA	AA	A	BBB	below	Other	Total	Total
	2017	2017	2017	2017	2017	2017	2017	2017
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,477	9,376	210	328	59	-	11,450	20
Banks:
- Tier 1	-	-	-	1	1	2	4	-
- Tier 2 and other subordinated	142	-	74	42	2	-	260	-
- Senior	-	1,366	2,782	90	-	-	4,238	8
- Covered	221	-	-	-	-	-	221	-
Financial Services:
- Tier 1	1	-	-	-	-	-	1	-
- Tier 2 and other subordinated	-	123	118	10	-	-	251	-
- Senior	-	323	368	205	9	-	905	2
Insurance:
- Tier 1	-	-	-	1	-	-	1	-
- Tier 2 and other subordinated	-	127	4	51	-	-	182	-
- Senior	-	128	464	68	-	-	660	1
Consumer Services and Goods:
- Cyclical	-	289	841	1,542	271	2	2,945	5
- Non-cyclical	215	601	1,313	2,114	165	1	4,409	8
- Health Care	3	32	262	189	4	-	490	1
Infrastructure:
- Social	93	708	3,445	1,111	21	-	5,378	9
- Economic	179	30	949	2,182	44	-	3,384	6
Technology and Telecoms	73	167	833	1,988	57	2	3,120	6
Industrials	-	3	851	376	52	1	1,283	2
Utilities	-	115	4,860	3,725	21	-	8,721	16
Energy	-	-	106	567	31	-	704	1
Commodities	-	-	260	494	39	-	793	1
Oil and Gas	-	322	640	566	213	1	1,742	3
Real estate	-	22	1,053	1,221	59	-	2,355	4
Structured finance ABS / RMBS / CMBS / Other	318	717	208	161	55	-	1,459	3
Lifetime mortgage loans¹	-	1,972	51	-	-	-	2,023	4
CDOs	-	22	60	14	-	-	96	-


Total £m	2,722	16,443	19,752	17,046	1,103	9	57,075	100


Total %	5	28	35	30	2	-	100


1. The credit ratings attributed to lifetime mortgages are allocated in accordance with the internal Matching Adjustment structuring.

Capital and Investments Page 88

5.06 Bond portfolio summary (continued)

(b) Total group analysed by sector (continued)

Sectors analysed by credit rating (continued)
					BB or
	AAA¹	AA¹	A¹	BBB¹	below¹	Other¹	Total¹	Total¹
	2016	2016	2016	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,206	10,535	370	387	102	-	12,600	24
Banks:
- Tier 1	-	-	-	1	12	-	13	-
- Tier 2 and other subordinated	211	49	73	54	-	-	387	1
- Senior	16	1,076	2,067	133	12	-	3,304	6
- Covered	259	-	16	-	-	-	275	1
Financial Services:
- Tier 1	-	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	87	59	63	-	-	209	-
- Senior	-	381	147	129	3	112	772	1
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 & Health Care
- Cyclical	-	409	1,167	1,809	244	-	3,629	7
- Non-cyclical	300	665	1,454	1,474	148	-	4,041	7
- Health Care	3	30	45	44	8	-	130	-
Infrastructure:
- Social	-	624	3,262	926	148	-	4,960	9
- Economic	-	-	903	1,318	44	-	2,265	4
Technology and Telecoms	73	238	662	2,162	123	-	3,258	6
Industrials	-	146	840	487	107	-	1,580	3
Utilities	-	108	4,967	3,193	28	-	8,296	15
Energy	-	5	106	575	44	-	730	1
Commodities	-	-	313	478	98	-	889	2
Oil and Gas	-	290	582	692	236	-	1,800	3
Property	-	-	12	60	6	-	78	-
Real estate	-	305	629	1,067	53	-	2,054	4
Structured finance ABS / RMBS / CMBS / Other	341	729	617	90	53	-	1,830	3
Lifetime mortgage loans²	388	322	91	51	-	-	852	2
CDOs³	-	-	59	14	-	-	73	-


Total £m	2,826	16,135	18,946	15,363	1,470	112	54,852	100


Total %	5	29	35	28	3	-	100	-


1. Following a review of short dated instruments, certain assets have been reclassified from Cash and cash equivalents to Financial investments as their maturity at the balance sheet date was greater than 3 months. These amounts totalled £1,489m and the analysis above has been restated to reflect this reclassification.
2. The credit ratings attributed to lifetime mortgages are allocated in accordance with the internal Matching Adjustment structuring.

Capital and Investments Page 89

5.06 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
	2017	2017	2017	2017	2017
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	8,689	1,204	1,114	443	11,450
Banks	2,326	794	1,187	416	4,723
Financial Services	365	111	681	-	1,157
Insurance	143	555	92	53	843
Consumer Services and Goods:
- Cyclical	604	2,015	251	75	2,945
- Non-cyclical	1,313	2,752	324	20	4,409
- Health care	10	480	-	-	490
Infrastructure:
- Social	5,054	287	-	37	5,378
- Economic	2,661	321	34	368	3,384
Technology and Telecoms	692	1,435	563	430	3,120
Industrials	209	714	274	86	1,283
Utilities	4,008	1,334	2,296	1,083	8,721
Energy	-	626	5	73	704
Commodities	10	287	38	458	793
Oil and Gas	265	462	458	557	1,742
Real estate	1,602	422	48	283	2,355
Structured Finance ABS / RMBS / CMBS / Other	1,017	366	54	22	1,459
Lifetime mortgages	2,023	-	-	-	2,023
CDOs	-	22	-	74	96


Total	30,991	14,187	7,419	4,478	57,075

Capital and Investments Page 90

5.06 Bond portfolio summary (continued)

(b) Total group analysed by sector (continued)

Sectors analysed by domicile (continued)

			EU
			excluding	Rest of
	UK¹	US¹	UK¹	the World¹	Total¹
	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	9,569	1,038	1,264	729	12,600
Banks	1,625	803	1,005	546	3,979
Financial Services	500	124	355	2	981
Insurance	189	566	17	55	827
Consumer Services and Goods:
- Cyclical	794	2,410	272	153	3,629
- Non-cyclical	1,155	2,650	208	28	4,041
- Health care	18	106	6	-	130
Infrastructure:
- Social	4,788	137	-	35	4,960
- Economic	1,937	102	1	225	2,265
Technology and Telecoms	589	1,467	753	449	3,258
Industrials	166	904	312	198	1,580
Utilities	3,687	1,293	2,401	915	8,296
Energy	1	598	14	117	730
Commodities	16	292	33	548	889
Oil and Gas	190	574	450	586	1,800
Property	-	71	4	3	78
Real estate	1,631	345	17	61	2,054
Structured Finance ABS / RMBS / CMBS / Other	1,020	323	469	18	1,830
Lifetime mortgages	852	-	-	-	852
CDOs	-	-	-	73	73


Total	28,727	13,803	7,581	4,741	54,852


1. Following a review of short dated instruments, certain assets have been reclassified from Cash and cash equivalents to Financial investments as their maturity at the balance sheet date was greater than 3 months. These amounts totalled £1,489m and the analysis above has been restated to reflect this reclassification.

Capital and Investments Page 91

5.06 Bond portfolio summary (continued)

(c) LGR and total group analysed by credit rating

	Externally	Internally		Externally	Internally	Total
	rated	rated²	LGR	rated	rated^{2, 3}	group
	2017	2017	2017	2017	2017	2017
	£m	£m	£m	£m	£m	£m


AAA	1,783	484	2,267	2,238	484	2,722
AA	11,617	3,210	14,827	13,024	3,419	16,443
A	15,174	3,029	18,203	16,609	3,143	19,752
BBB	12,979	3,432	16,411	13,389	3,657	17,046
BB or below	690	78	768	965	138	1,103
Other	-	-	-	9	-	9


	42,243	10,233	52,476	46,234	10,841	57,075





	Externally	Internally		Externally	Internally	Total
	rated¹	rated^{1, 2}	LGR¹	rated¹	rated^{1, 2, 3}	group ¹
	2016	2016	2016	2016	2016	2016
	£m	£m	£m	£m	£m	£m


AAA	1,839	388	2,227	2,438	388	2,826
AA	13,499	1,236	14,735	14,632	1,503	16,135
A	14,637	2,773	17,410	16,063	2,883	18,946
BBB	12,405	2,062	14,467	13,068	2,295	15,363
BB or below	960	77	1,037	1,322	148	1,470
Other	-	-	-	-	112	112


	43,340	6,536	49,876	47,523	7,329	54,852


1. Following a review of short dated instruments, certain assets have been reclassified from Cash and cash equivalents to Financial investments as their maturity at the balance sheet date was greater than 3 months. These amounts totalled £1,489m and the analysis above has been restated to reflect this reclassification.
2. Where external ratings are not available an internal rating has been used where it is practicable to do so.
3. The increase in internally rated assets is due to £2.5bn of new direct investments and an increase in the value of lifetime mortgages of £1.2bn.

Capital and Investments Page 92

5.07 Property analysis

(a) Property exposure within Direct Investments

(i) Group property Direct Investments by status



	LGR¹	LGC²	Total
	2017	2017	2017	2017
	£m	£m	£m	%


Fully let	2,722	30	2,752	97%
Development	-	32	32	1%
Land	-	48	48	2%

	2,722	110	2,832	100%


1. The fully let LGR property includes £2.4bn let to investment grade tenants.
2. Development includes £23m of shareholder investment property.



	LGR¹	LGC	Total
	2016	2016	2016	2016
	£m	£m	£m	%

Fully let	2,442	16	2,458	94
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.

Glossary Page 93

* These items represent an alternative performance measure (APM)

Ad valorem fees

Ongoing management fees earned on assets under management, overlay assets and advisory assets as defined below.

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 continuing 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 on-going 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.

Annuity

Regular payments from an insurance company made for an agreed period of time (usually up to the depth of the recipient) in return for either cash lump sum or a series of premiums which the policyholder has paid to the insurance company during their working lifetime.

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 and are therefore not reported on the Consolidated Balance Sheet. 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)*

Funds which are managed by our fund managers on behalf of investors. It represents the total amount of money investors have trusted with our fund managers to invest across our investment products.

Back book 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.

Glossary Page 94

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.

Credit rating

A measure of the ability of an individual, organisation or country to repay debt. The highest rating is usually AAA and the lowest Unrated. Ratings are usually issued by a credit rating agency (e.g. Moody's or Standard & Poor's) or a credit bureau.

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 LGI US on this basis.

Defined benefit pension scheme (DB scheme)

A type of pension plan in which an employer/sponsor promises a specified monthly benefit on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns.

Defined contribution pension scheme (DC scheme)

A type of pension plan where the pension benefits at retirement are determined by agreed levels of contributions paid into the fund by the member and employer. They provide benefits based upon the money held in each individual's plan specifically on behalf of each member. The amount in each plan at retirement will depend upon the investment returns achieved and on the member and employer contributions.

Derivatives

Derivatives are not a separate asset class but are contracts usually giving a commitment or right to buy or sell assets on specified conditions, for example on a set date in the future and at a set price. The value of a derivative contract can vary. Derivatives can generally be used with the aim of enhancing the overall investment returns of a fund by taking on an increased risk, or they can be used with the aim of reducing the amount of risk to which a fund is exposed.

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.

Dividend cover

Dividend cover measures how many times over the net release from operations in the year could have paid the full year dividend. For example, if the dividend cover is 3, this means that the net release from operations was three times the amount of dividend paid out.

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.

Glossary Page 95

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.

Employee engagement index

The Employee engagement index measures the extent to which employees are committed to the goals of Legal & General and are motivated to contribute to the overall success of the company, whilst at the same time working with their manager to enhance their own sense of development and well-being.

Escape of Water

Escape of water is a type of home insurance claim relating to leakage from fixed water tanks, apparatus (e.g. washing machine) or pipes

Euro Commercial paper

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

FVTPL

Fair value through profit or loss. A financial asset or financial liability that is measured at fair value in the Consolidated Balance Sheet reports gains and losses arising from movements in fair value within the Consolidated Income Statement as part of the profit or loss for the year.

Full year dividend

Full year dividend is the total dividend per share declared for the year (including interim dividend but excluding, where appropriate, any special dividend).

General insurance combined operating ratio

The combined operating ratio is calculated as the sum of incurred losses and expenses, including commission, divided by net earned premium.

Generally accepted accounting principles (GAAP)

These are a widely accepted collection of guidelines and principles, established by accounting standard setters and used

by the accounting community to report financial information.

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.

Index tracker (passive fund)

Index tracker funds invest in most or all of the same shares, and in a similar proportion, as the index they are tracking, for example the FTSE 100 index. Index tracker funds aim to produce a return in line with a particular market or sector, for example, Europe or technology. They are also sometimes known as 'tracker funds'.

International financial reporting standards (IFRS)

These are accounting guidelines and rules that companies and organisations follow when completing financial statements.

They are designed to enable comparable reporting between companies, and they are the standards that all publicly listed

groups in the European Union (EU) are required to use.

Glossary Page 96

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.

LGA

Legal & General America.

LGAS

Legal & General Assurance Society Limited

LGC

Legal & General Capital.

LGI

Legal & General Insurance.

LGIM

Legal & General Investment Management.

LGR

Legal & General Retirement.

LGR new business

Single premiums arising from annuity sales and back book acquisitions (including individual annuity and pension risk transfer), the volume of lifetime mortgage lending and the notional size of longevity insurance transactions, based on the present value of the fixed leg cash flows discounted at the LIBOR curve.

Liability driven investment (LDI)

A form of investing in which the main goal is to gain sufficient assets to meet all liabilities, both current and future. This form of investing is most prominent in final salary pension plans, whose liabilities can often reach into billions of pounds for the largest of plans.

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.

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.

Mortality rate

Rate of death, influenced by age, gender and health, used in pricing and calculating liabilities for future policyholders of life and annuity products, which contain mortality risks.

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.

Glossary Page 97

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 LGIA 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.

Open architecture

Where a company offers investment products from a rang of other companies in addition to its own products. This gives customers a wider choice of funds to invest in and access to a larger pool of money management professionals.

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.

Platform

Online services used by intermediaries and consumers to view and administer their investment portfolios. Platforms usually provide facilities for buying and selling investments (including, in the UK products such as Individual Savings Accounts (ISAs), Self-Invested Personal Pensions (SIPPs) and life insurance) and for viewing an individual's entire portfolio to assess asset allocation and risk exposure.

Profit before tax attributable to equity holders (PBT)

Profit attributable to shareholders incorporating actual investment returns experienced during the year but before

the payment of tax.

Purchased interest in long term business (PILTB)

An estimate of the future profits that will emerge over the remaining term of life and pensions policies that have been

acquired via a business combination.

Recapitalisation Cost*

An additional liability required in the group 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. Release from operations was previously referred to as operational 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.

Glossary Page 98

Risk appetite

The aggregate level and types of risk a company is willing to assume in its exposures and business activities in order

to achieve its business objectives.

SCR coverage ratio

The eligible own funds on a regulatory basis divided by the group solvency capital requirement. This represents the number of times the SCR is covered by eligible own funds.

SCR coverage ratio (proforma basis)*

The proforma basis solvency II SCR coverage ratio incorporates the impacts of a recalculation of the Transitional Measures for Technical Provisions and the contribution of with-profits fund and our defined benefit pension schemes in both Own Funds and the SCR in the calculation of the SCR coverage ratio.

SCR coverage ratio (shareholder view basis)*

In order to represent a shareholder view of group solvency position, the contribution of with-profits fund and our defined benefit pension schemes is excluded from both the group's Own Funds and the group's solvency capital requirement, by the amount of their respective solvency capital requirements, in the calculation of the SCR coverage ratio. This incorporates the impacts of a recalculation of the Transitional Measures for Technical Provisions based on end of period economic conditions. The shareholder view basis does not reflect the regulatory capital position as at 31 December 2017. This will be made public in May 2018.

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.

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.

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.

Glossary Page 99

With-profits funds

Individually identifiable portfolios where policyholders have a contractual right to receive additional benefits based on factors such as the performance of a pool of assets held within the fund, as a supplement to any guaranteed benefits. An insurer may either have discretion as to the timing of the allocation of those benefits to participating policyholders or

may have discretion as to the timing and the amount of the additional benefits.

Yield

A measure of the income received from an investment compared to the price paid for the investment. It is usually expressed as a percentage.

This information is provided by RNS

The company news service from the London Stock Exchange

END

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