L&G H1 2014 Results Part 3

RNS Number : 3773O

Legal & General Group Plc

06 August 2014

Capital and Investments 75

4.01 Group regulatory capital
(a) Insurance Group's Directive (IGD)

The Group is required to measure and monitor its capital resources on a regulatory basis and to comply with the minimum capital requirements of regulators in each territory in which it operates. At a Group level, Legal & General must comply with the requirements of the IGD. The table below shows the estimated total Group capital resources, Group capital resources requirement and the Group surplus.

	At	At			At
	30.06.14	30.06.13			31.12.13
	£bn	£bn			£bn


Core tier 1	6.7	6.6			6.3
Innovative tier 1	0.6	0.6			0.6
Tier 2¹	1.8	1.2			1.2
Deductions	(0.9)	(1.0)			(0.8)


Group capital resources	8.2	7.4			7.3


Group capital resources requirement²	3.5	3.3			3.3


IGD surplus	4.7	4.1			4.0



Coverage ratio (Group capital resources /	2.36	2.26			2.21
Group capital resources requirement)³	times	times			times


1. The Group has issued £0.6bn subordinated notes constituting Lower Tier 2 Capital in H1 14. 2. The Group capital resources requirement includes a With-profits Insurance Capital Component (WPICC) of £0.3bn (H1 13: £0.3bn; FY 13: £0.2bn). 3. Coverage ratio is calculated on unrounded values.

A reconciliation of the Group capital resources on an IGD basis to the capital and reserves attributable to the equity holders of the Company on an IFRS basis is given below.

	At		At			At
	30.06.14		30.06.13			31.12.13
	£bn		£bn			£bn


Capital and reserves attributable to equity holders on an IFRS basis	5.7		5.5			5.6
Innovative tier 1	0.6		0.6			0.6
Tier 2	1.8		1.2			1.2
UK unallocated divisible surplus	1.0		1.0			1.1
Proposed dividends	(0.2)		(0.1)			(0.4)
Intangibles	(0.4)		(0.4)			(0.4)
Other regulatory adjustments¹	(0.3)		(0.4)			(0.4)


Group capital resources	8.2		7.4			7.3


1. Other regulatory adjustments include differences between accounting and regulatory bases.
The table below demonstrates how the Group's net cash generation flows to the IGD capital surplus position.¹

				At
				30.06.14
				£bn


IGD surplus at 1 January				4.0
Net cash generation				0.6
New subordinated debt issued				0.6
Dividends				(0.2)
New business capital required				(0.3)
Existing business capital release				0.1
Capital impact of acquisitions				0.1
Other variances and regulatory adjustments				(0.2)


IGD surplus at 30 June				4.7



1. All IGD amounts are estimated, unaudited and after accrual of the interim dividend of £172m.

Capital and Investments 76

4.01 Group regulatory capital (continued)
(b) Legal & General Assurance Society Limited capital surplus


Legal & General Assurance Society Limited is the principal insurance regulated entity in the Group. The society is required to measure and monitor its capital resources on a regulatory basis.

	At	At	At		At	At		At
	30.06.14	30.06.14	30.06.13		30.06.13	31.12.13		31.12.13
	Long	General	Long		General	Long		General
	term	insu-	term		insu-	term		insu-
	business	rance	business		rance	business		rance
	£bn	£bn	£bn		£bn	£bn		£bn


Available capital resources - Tier 1	6.1	0.2	6.1		0.2	5.8		0.1


Insurance capital requirement	2.8	0.1	2.5		0.1	2.6		0.1
Capital requirements of regulated related undertakings	0.2	-	0.2		-	0.3		-
With-profits Insurance Capital Component	0.3	-	0.3		-	0.2		-


Capital resources requirement	3.3	0.1	3.0		0.1	3.1		0.1


Regulatory capital surplus	2.8	0.1	3.1		0.1	2.7		-


The table below shows the breakdown of Legal & General Assurance Society Limited's long term insurance capital requirement.

				At			At		At
				30.06.14			30.06.13		31.12.13
Pillar 1 capital requirement				£bn			£bn		£bn


Protection				0.8			0.7		0.7
LGR				1.4			1.2		1.2
Non profit pensions and unit linked bonds				0.1			0.1		0.1


Non profit				2.3			2.0		2.0
With-profits				0.5			0.5		0.6


Long term insurance capital requirement				2.8			2.5		2.6



On a regulatory basis (Peak 1), Society long term business regulatory capital surplus of £2.8bn (H1 13: £3.1bn; FY 13: £2.7bn) comprises capital
resources within the long term fund of £3.0bn (H1 13: £2.9bn; FY 13: £3.0bn) and capital resources outside the long term fund of £3.1bn (H1 13: £3.2bn; FY 13: £2.8bn) less the capital resources requirement of £3.3bn (H1 13: £3.0bn; FY 13: £3.1bn).

The With-profits Insurance Capital Component (WPICC) is an additional capital requirement calculated if the surplus in the with-profits fund on a Peak 2 basis is lower than on a Peak 1 basis and represents the difference in the surplus between the two bases. It is calculated based on the most onerous risk capital margin stress referred to in 4.01(c).

(c) With-profits realistic balance sheet

The table below summarises the realistic position of the with-profits part of Legal & General Assurance Society Limited's long term fund.

	At	At	At
	30.06.14	30.06.13	31.12.13
	£bn	£bn	£bn


With-profits surplus	0.7	0.7	0.8
Risk capital margin	(0.1)	(0.1)	(0.1)


Surplus	0.6	0.6	0.7


Legal & General Assurance Society Limited is required to maintain a surplus in the with-profits part of the fund on a realistic basis (Peak 2). The risk capital margin is calculated based on the most onerous capital requirement calculated after performing five stresses specified by the PRA. The surplus includes the present value of future shareholder transfers of £0.3bn (H1 13: £0.3bn; FY 13: £0.3bn) as a liability in the calculation.

Capital and Investments 77

4.02 Group Economic Capital

Economic capital is the amount of capital that the Board believes the Group needs to hold, over and above its liabilities, in order to meet the Group's 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 its investors, rating agencies, customers and intermediaries that this will be the case.

Over the past few years Legal & General has invested considerable time and resource in developing 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. The Group continues to develop the economic capital model in light of developments in the Group's business model, refinements in modelling and the analysis of experience, emerging market practice and feedback from independent reviewers. The Group's economic capital position will reflect these changes as they are implemented.It is intended that this modelling framework, suitably adjusted, should also meet the needs of the Solvency II regime, due to come in to force on 1 January 2016. Our Economic Capital model has not been reviewed by the Prudential Regulatory Authority ("PRA"), nor will it be.

The economic capital numbers presented here do not represent our view of the Solvency II outcome for the Group. Solvency II has elements which are considered to be inconsistent with the Group's definition of economic capital, so there will be differences between the two balance sheets.

The Group has been discussing progress on Solvency II with the PRA and in 2015 it will make a formal application for approval of an internal model. As yet the Group's Solvency II internal model has not been reviewed or approved by the PRA.

(a) Capital position

As at 31 December 2013 the Group had an economic capital surplus of £6.9bn, corresponding to an economic capital coverage ratio of 251%. The economic capital position is as follows:

					At
					31.12.13
					£bn


Eligible own funds					11.4
Economic capital requirement					4.5


Surplus/ (deficit)					6.9


1-in-200 coverage ratio (%)¹					251


1. Coverage ratio is calculated on unrounded values.

The figures that appear in this note are all pre-accrual for any dividend.
Further explanation of the underlying methodology and assumptions are set out in the sections below.

(b) Methodology

Eligible 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.

Assets are valued at IFRS fair value with certain elements adjusted to move to an economic capital basis. 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 subsidiaries 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 the Group's 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 capital and allows for diversification between all Group entities.

All material insurance subsidiaries, including Legal & General Assurance Society Limited, Legal & General Pensions Management Limited and LGA operating subsidiaries are incorporated into the Group's economic capital model assessment of required capital, assuming diversification of the risks between those subsidiaries.

Insurance subsidiaries for which the capital requirements are less material, for example LGF, LGN and Suffolk Life, are valued on the Group's latest interpretation of the Solvency II Standard Formula basis. The business ceded to Legal & General Pensions Limited, an internal Insurance Special Purpose Vehicle, has been valued on a "look through" basis and capital requirements calculated as if the business was not internally reassured. Non-insurance subsidiaries are included using their current regulatory surplus, without allowing for any diversification with the rest of the Group.

The allowance for the Group's defined benefit pension scheme in the base balance sheet is made on the scheme's funding basis, and the allowance within the capital requirement is made by stressing the funding position using the same economic capital basis as for the insurance subsidiaries.

The results and the model are unaudited but certain elements of the methodology, assumptions and processes have been reviewed for the Group by PricewaterhouseCoopers LLP. As stated previously this model has not been reviewed by the PRA.

Capital and Investments 78

4.02 Group Economic Capital (continued)

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

(i) assumptions required to derive the present value of best estimate liability cash flows. Non market assumptions are broadly the same as those used to derive the Group's EEV disclosures. 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 10 basis point deduction to allow for a 'credit risk adjustment';

(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 to are used to calculate the economic capital requirement. Assumptions have been set using a combination of historic market, demographic and operating experience data. In areas where data is not considered robust, judgement has been used; and

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

As stated above, for annuities the liability discount rate includes an economic matching adjustment. This uses the same approach as the Solvency II matching adjustment but any constraints the Group considers economically artificial, such as capping the yield on assets with a credit rating below BBB and any ineligibility of certain assets, have not been applied.

The other key assumption relating to the annuity business is the modelling of stresses to longevity. As for IFRS and EEV, the Group models base mortality and future improvements separately. For the Group's economic capital assessment, the Group believes 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) Sensitivity analysis The following sensitivities are provided to give an indication of how the Group's economic capital surplus as at 31 December 2013 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	capital
	capital	coverage
	surplus	ratio
	31.12.13	31.12.13
	£bn	%


Credit spread widens by 100bps with no change in long term default expectations	(0.3)	(8)
A 3 notch downgrade, e.g. AA- to A-, of 20% of the corporate bond portfolio backing annuity business,	(0.5)	(11)
with no change to the assumed spread sensitivity or long term default expectations
20% fall in equity market	(0.3)	(3)
40% fall in equity markets	(0.6)	(6)
15% fall in property markets	(0.2)	(4)
100bps increase in risk free rates	(0.3)	1
100bps fall in risk free rates	0.1	-
1% reduction in annuitant base mortality	(0.1)	(3)

Capital and Investments 79

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 Eligible own funds on an EC basis and the Group's IFRS shareholders' equity.

						At
						31.12.13
						£bn


IFRS shareholders' equity at 31 December 2013						5.6
Remove DAC, goodwill and other intangible assets and liabilities						(1.7)
Add subordinated debt treated as economic available capital						1.9
Insurance contract valuation differences						6.2
Add value of shareholder transfers						0.3
Increase in value of net deferred tax liabilities (resulting from valuation differences)						(0.7)
Other						0.4
Adjustment - Basic own funds to Eligible own funds						(0.6)


Eligible own funds at 31 December 2013						11.4



The figures that appear in this note are all pre-accrual for any dividend.

(f) 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.

					At
					31.12.13
					%


Interest Rate					5
Equity					16
Credit					44
Property					8
Currency					(3)
Inflation					(1)
Total Market Risk					69
Counterparty Risk					1
Life Mortality & Life Catastrophe					5
Life Longevity					12
Life Lapse					7
Non-life underwriting					2
Health underwriting					-
Total Insurance Risk					26
Operational Risk					4


Total Economic Capital Requirement					100



- Credit risk is the Group's most significant exposure, predominantly arising from corporate bond exposure backing the Group's annuity portfolio. - The Group also has significant exposure to other market risks, predominantly due to the investment holdings within the shareholder funds but also the risk to fee income from assets backing unit linked and with-profit Savings businesses. - Longevity risk is the Group's most significant insurance risk exposure, again arising from the annuity book on which the majority of the longevity risk is retained. - Lapse risk arises through the risk of mass lapse on investment management and savings businesses and the risk of non-renewal on the Group's protection businesses.

Capital and Investments 80

4.02 Group Economic Capital (continued)

(g) Solvency II

As indicated above, the economic capital results set out above do not reflect the Solvency II regime. They have been derived using the same modelling framework that the Group intends to use for Solvency II. The Solvency II internal model has not, as yet, been reviewed or approved by the PRA. The Group intends to submit its internal model to the PRA in 2015 to gain approval to use the model from Solvency II go live on 1 January 2016. The Group expects the final outcome on Solvency II to result in a lower Group solvency ratio than the economic capital coverage ratio shown above.

(h) Half-Year 2014 surplus

The economic capital surplus as at 30 June 2014 has increased from 31 December 2013 to a surplus of £7.6bn (FY 13: £6.9bn) and coverage ratio of 261% (FY 13: 251%), with the increase in surplus supported by the raising of £0.6bn of subordinated debt in June 2014.

Capital and Investments 81

4.03 Investment portfolio

	Market	Market	Market
	value	value¹	value¹
	At	At	At
	30.06.14	30.06.13	31.12.13
	£m	£m	£m


Worldwide assets under management	467,176	440,152	452,260
Client and policyholder assets	(401,874)	(380,388)	(391,151)
Non-unit linked with-profits assets²	(17,061)	(17,906)	(17,391)


Investments to which shareholders are directly exposed	48,241	41,858	43,718


1. Comparatives have been restated following the adoption of IFRS 10.
2. Includes assets backing participating business in LGF of £2,378m (H1 13: £2,434m; FY 13: £2,347m).

Analysed by investment class:

			Other
			non profit		Other
		LGR	insurance	LGC	shareholder
		investments¹	investments	investments	investments	Total	Total	Total
		At	At	At	At	At	At	At
		30.06.14	30.06.14	30.06.14	30.06.14	30.06.14	30.06.13	31.12.13
	Note	£m	£m	£m	£m	£m	£m	£m


Equities²		84	-	1,592	9	1,685	1,507	1,760
Bonds	4.05	34,062	2,401	1,538	1,241	39,242	34,647	35,697
Derivative assets³		2,184	28	125	-	2,337	2,314	2,307
Property		1,692	-	324	4	2,020	1,065	1,447
Cash (including cash
equivalents), loans & receivables		582	252	1,602	366	2,802	2,184	2,331


Financial investments		38,604	2,681	5,181	1,620	48,086	41,717	43,542


Other assets⁴		155	-	-	-	155	141	176


Total investments		38,759	2,681	5,181	1,620	48,241	41,858	43,718


1. LGR Investments includes all business written in LGPL and excludes with-profits non-participating business.
2. Includes equity investment in CALA Group Limited.
3. Derivative assets are shown gross of derivative liabilities. 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. Other assets include finance lease debtors and properties under construction.

Capital and Investments 82

4.04 Direct Investments¹
(a) Analysed by asset class

	Direct¹	Traded²		Direct¹	Traded²
	Investments	securities	Total	Investments	securities	Total
	At	At	At	At	At	At
	30.06.14	30.06.14	30.06.14	31.12.13	31.12.13	31.12.13
	£m	£m	£m	£m	£m	£m


Equities	298	1,387	1,685	202	1,558	1,760
Bonds	2,036	37,206	39,242	1,048	34,649	35,697
Derivative assets	-	2,337	2,337	-	2,307	2,307
Property	2,020	-	2,020	1,447	-	1,447
Cash (including cash
equivalents), loans & receivables	75	2,727	2,802	6	2,325	2,331
Other assets	155	-	155	176	-	176


	4,584	43,657	48,241	2,879	40,839	43,718


1. Direct Investments constitute an agreement with another party and represent an exposure to untraded and often less liquid asset classes. Direct Investments 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.

(b) Analysed by segment

	LGR	LGC	LGA	LGAS	Total
	At	At	At	At	At
	30.06.14	30.06.14	30.06.14	30.06.14	30.06.14
	£m	£m	£m	£m	£m


Equities	-	298	-	-	298
Bonds	1,885	-	151	-	2,036
Property	1,692	324	-	4	2,020
Cash (including cash
equivalents), loans & receivables	-	-	75	-	75
Other assets	155	-	-	-	155


	3,732	622	226	4	4,584


	LGR	LGC	LGA	LGAS	Total
	At	At	At	At	At
	31.12.13	31.12.13	31.12.13	31.12.13	31.12.13
	£m	£m	£m	£m	£m


Equities	-	202	-	-	202
Bonds	997	-	51	-	1,048
Property	1,294	149	-	4	1,447
Cash (including cash
equivalents), loans & receivables	-	-	6	-	6
Other assets	176	-	-	-	176


	2,467	351	57	4	2,879

Capital and Investments 83

4.05 Bond portfolio summary
(a) Analysed by sector
		LGR	LGR	Total	Total
		At	At	At	At
		30.06.14	30.06.14	30.06.14	30.06.14
	Note	£m	%	£m	%


Sovereigns, Supras and Sub-Sovereigns	4.05(b)	6,578	19	8,257	21
Banks:
- Tier 1		60	-	66	-
- Tier 2 and other subordinated		590	2	649	2
- Senior		1,359	4	1,901	5
Financial Services:
- Tier 1		4	-	6	-
- Tier 2 and other subordinated		136	-	174	1
- Senior		882	3	1,153	3
Insurance:
- Tier 1		146	-	156	-
- Tier 2 and other subordinated		544	2	581	2
- Senior		493	2	565	2
Utilities		4,456	13	4,764	12
Consumer Services and Goods & Health Care		3,246	10	3,795	10
Technology and Telecoms		2,099	6	2,382	6
Industrials & Oil and Gas		3,333	10	3,879	10
Property		998	3	1,073	3
Asset backed securities:¹
- Traditional		703	2	1,222	3
- Securitisations and debentures		7,337	21	7,521	18
CDOs²		1,098	3	1,098	2


Total		34,062	100	39,242	100


1. Traditional asset backed securities are securities, often with variable expected redemption profiles issued by Special Purpose Vehicles and typically backed by pools of receivables from loans or personal credit. Securitisations are securities with fixed redemption profiles that are issued by Special Purpose Vehicles and secured on revenues from specific assets or operating companies and Debentures are securities with fixed redemption profiles issued by firms typically secured on property.
2. The underlying reference portfolio has had no reference entity defaults during the period ended 30 June 2014. 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 84

4.05 Bond portfolio summary (continued)
(a) Analysed by sector (continued)
		LGR	LGR	Total	Total
		At	At	At	At
		30.06.13	30.06.13	30.06.13	30.06.13
	Note	£m	%	£m	%


Sovereigns, Supras and Sub-Sovereigns	4.05(b)	4,292	15	6,573	19
Banks:
- Tier 1		180	1	189	1
- Tier 2 and other subordinated		482	2	549	2
- Senior		1,508	5	2,304	7
Financial Services:
- Tier 1		1	-	2	-
- Tier 2 and other subordinated		40	-	69	-
- Senior		925	3	1,137	3
Insurance:
- Tier 1		128	-	132	1
- Tier 2 and other subordinated		319	1	345	1
- Senior		726	3	804	2
Utilities		3,902	14	4,155	12
Consumer Services and Goods & Health Care		3,177	11	3,674	10
Technology and Telecoms		1,961	7	2,301	6
Industrials & Oil and Gas		3,160	11	3,659	11
Property		636	2	703	2
Asset backed securities:¹
- Traditional		754	3	1,451	4
- Securitisations and debentures		5,325	18	5,481	16
CDOs²		1,119	4	1,119	3


Total		28,635	100	34,647	100


1. Traditional asset backed securities are securities, often with variable expected redemption profiles issued by Special Purpose Vehicles and typically backed by pools of receivables from loans or personal credit. Securitisations are securities with fixed redemption profiles that are issued by Special Purpose Vehicles and secured on revenues from specific assets or operating companies and Debentures are securities with fixed redemption profiles issued by firms typically secured on property.
2. The underlying reference portfolio has had no reference entity defaults during the period ended 30 June 2013. 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 CDO's are valued using an external valuation which is based on observable market inputs. This is then validated against the market valuation.

Capital and Investments 85

4.05 Bond portfolio summary (continued)
(a) Analysed by sector (continued)
		LGR	LGR	Total	Total
		At	At	At	At
		31.12.13	31.12.13	31.12.13	31.12.13
	Note	£m	%	£m	%


Sovereigns, Supras and Sub-Sovereigns	4.05(b)	4,772	16	6,502	18
Banks:
- Tier 1		100	-	105	-
- Tier 2 and other subordinated		637	2	698	2
- Senior		1,406	5	2,169	6
Financial Services:
- Tier 1		2	-	5	-
- Tier 2 and other subordinated		206	1	251	1
- Senior		800	3	1,041	3
Insurance:
- Tier 1		144	1	152	-
- Tier 2 and other subordinated		579	2	625	2
- Senior		481	2	552	2
Utilities		4,013	13	4,329	12
Consumer Services and Goods & Health Care		3,128	10	3,716	10
Technology and Telecoms		1,995	7	2,333	7
Industrials & Oil and Gas		3,074	10	3,626	10
Property		981	3	1,053	3
Asset backed securities:¹
- Traditional		763	3	1,395	4
- Securitisations and debentures		5,839	19	6,047	17
CDOs²		1,098	3	1,098	3


Total		30,018	100	35,697	100


1. Traditional asset backed securities are securities, often with variable expected redemption profiles issued by Special Purpose Vehicles and typically backed by pools of receivables from loans or personal credit. Securitisations are securities with fixed redemption profiles that are issued by Special Purpose Vehicles and secured on revenues from specific assets or operating companies and Debentures are securities with fixed redemption profiles issued by firms typically secured on property.
2. The underlying reference portfolio has had no reference entity defaults in 2013. 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 CDO's are valued using an external valuation which is based on observable market inputs. This is then validated against the market valuation.

Capital and Investments 86

4.05 Bond portfolio summary (continued)
(b) Analysed by domicile

The tables below are based on the legal domicile of the security.
	LGR	Total	LGR	Total	LGR	Total
	30.06.14	30.06.14	30.06.13	30.06.13	31.12.13	31.12.13
	£m	£m	£m	£m	£m	£m


Market value by region:
United Kingdom	16,299	17,224	11,696	12,708	13,099	14,178
USA	7,747	10,034	7,834	10,555	7,237	9,779
Netherlands	1,778	2,119	1,671	2,289	1,736	2,164
France	1,289	1,642	1,190	1,581	1,382	1,681
Germany	378	737	337	650	411	791
GIIPS:
- Greece	-	5	-	3	-	-
- Ireland¹	225	264	249	287	234	271
- Italy	485	636	644	792	636	786
- Portugal	3	14	15	28	15	31
- Spain	158	224	195	290	178	263
Rest of Europe	1,643	2,013	1,175	1,583	1,299	1,721
Rest of World	2,959	3,232	2,510	2,762	2,693	2,934
CDOs	1,098	1,098	1,119	1,119	1,098	1,098


Total	34,062	39,242	28,635	34,647	30,018	35,697


1. Within LGR, out of the £225m of bonds domiciled in Ireland, £223m relate to financing vehicles where the underlying exposure lies outside Ireland.

Additional analysis of sovereign debt exposures

	Sovereigns, Supras and Sub-Sovereigns

	LGR	Total	LGR	Total	LGR	Total
	30.06.14	30.06.14	30.06.13	30.06.13	31.12.13	31.12.13
	£m	£m	£m	£m	£m	£m


Market value by region:
United Kingdom	4,768	5,102	2,884	3,279	3,340	3,725
USA	407	830	325	889	282	664
Netherlands	13	167	1	387	10	194
France	118	246	89	312	90	220
Germany	195	437	189	382	212	472
GIIPS:
- Greece	-	5	-	3	-	-
- Ireland	-	12	-	14	-	7
- Italy	109	192	253	368	236	323
- Portugal	-	6	-	12	-	16
- Spain	-	6	1	58	-	14
Rest of Europe	793	989	453	691	474	661
Rest of World	175	265	97	178	128	206


Total	6,578	8,257	4,292	6,573	4,772	6,502

Capital and Investments 87

4.05 Bond portfolio summary (continued)
(c) Analysed by credit rating

	LGR	LGR	Total	Total
	At	At	At	At
	30.06.14	30.06.14	30.06.14	30.06.14
	£m	%	£m	%


AAA	1,711	5	3,376	9
AA	8,471	25	9,217	23
A	11,082	32	12,333	31
BBB	8,716	26	9,891	25
BB or below	566	2	761	2
Unrated: Bespoke CDOs²	983	3	983	3
Other³	2,533	7	2,681	7


	34,062	100	39,242	100



	LGR	LGR	Total	Total
	At	At	At	At
	30.06.13	30.06.13	30.06.13	30.06.13
	£m	%	£m	%


AAA¹	1,235	4	3,502	10
AA	6,263	22	7,373	21
A	10,080	35	11,507	33
BBB	8,321	29	9,422	27
BB or below	448	2	528	2
Unrated: Bespoke CDOs²	991	3	991	3
Other³	1,297	5	1,324	4


	28,635	100	34,647	100


	LGR	LGR	Total	Total
	At	At	At	At
	31.12.13	31.12.13	31.12.13	31.12.13
	£m	%	£m	%


AAA¹	1,378	5	3,144	9
AA	6,743	22	7,599	21
A	10,236	34	11,703	34
BBB	8,326	28	9,456	26
BB or below	603	2	874	2
Unrated: Bespoke CDOs²	983	3	983	3
Other³	1,749	6	1,938	5


	30,018	100	35,697	100


1. During 2013, UK sovereign debt was downgraded from AAA to AA+.
2. The CDOs are termed as super senior since default losses have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. The underlying reference portfolio has had no reference entity defaults in 2013 or 2014. Losses are limited under the terms off the CDOs to assets and collateral invested.
3. Other unrated bonds have been assessed and rated internally. Over £1.5bn at H1 14 (H1 13: £0.6bn; FY 13: £0.7bn) relates to secured asset backed securities.

4.06 Value of policyholder assets held in Society and LGPL

	At	At	At
	30.06.14	30.06.13	31.12.13
	£m	£m	£m


With-profits business	23,475	24,027	23,959
Non profit business	54,272	47,150	49,949


	77,747	71,177	73,908

Capital and Investments 88

Blank page

European Embedded Value 89

Group embedded value - summary
	Covered business
		LGAS		Non-
	UK	overseas		covered
	business	business	LGA	business	Total
For the six months ended 30 June 2014	£m	£m	£m	£m	£m


At 1 January 2014
Value of in-force business (VIF)	4,693	197	699	-	5,589
Shareholder net worth (SNW)	3,249	315	234	199	3,997


Embedded value at 1 January 2014	7,942	512	933	199	9,586
Exchange rate movements	-	(19)	(30)	12	(37)

Operating profit after tax for the period	539	11	47	68	665
Non-operating profit/(loss) for the period	59	3	(1)	(7)	54


Profit for the period	598	14	46	61	719
Intra-group distributions¹	18	(15)	(44)	41	-
Dividends to equity holders of the Company	-	-	-	(408)	(408)
Transfer to non-covered business²	(15)	-	-	15	-
Other reserve movements including pension deficit³	12	-	-	(29)	(17)


Embedded value at 30 June 2014	8,555	492	905	(109)	9,843


Value of in-force business	4,928	167	717	-	5,812
Shareholder net worth	3,627	325	188	(109)	4,031



Embedded value per share (p)⁴					166


1. UK intra-group distributions primarily reflect €18m (H1 13: €nil; FY 13: €16m) dividend from LGN and £4m dividend from Nationwide Life (H1 13: £10m; FY 13: £10m) paid to Society. Dividends of $73m (H1 13: $66m; FY 13: $69m) from LGA and €2m (H1 13: €1m; FY 13: €2m) from LGF were paid to the group.
2. The transfer to non-covered business represents the IFRS profits arising in the period from the provisions of investment management services by LGIM to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
3. The other reserve movements of UK covered business primarily reflects the effect of reinsurance arrangement transactions between UK and US covered business. Non-covered business mainly reflects the movement in the savings related share options scheme and the actuarial loss on the pension deficit movement.
4. The number of shares in issue at 30 June 2014 was 5,935,497,507 (30 June 2013: 5,915,445,369; 31 December 2013: 5,917,066,636).

Further analysis of the LGAS and LGR covered business can be found in Note 5.01.

European Embedded Value 90

Group embedded value - summary (continued)
	Covered business
		LGAS		Non-
	UK	overseas		covered
	business	business	LGA	business	Total
For the six months ended 30 June 2013	£m	£m	£m	£m	£m


At 1 January 2013
Value of in-force business (VIF)	4,402	146	735	-	5,283
Shareholder net worth (SNW)	3,178	296	239	(96)	3,617


Embedded value at 1 January 2013	7,580	442	974	(96)	8,900
Exchange rate movements	-	23	72	(74)	21

Operating profit after tax for the period	392	4	35	73	504
Non-operating profit/(loss) for the period	282	34	(31)	(4)	281


Profit for the period	674	38	4	69	785
Intra-group distributions¹	10	(1)	(43)	34	-
Dividends to equity holders of the Company	-	-	-	(337)	(337)
Transfer to non-covered business²	(12)	-	-	12	-
Other reserve movements including pension deficit³	(44)	-	-	4	(40)


Embedded value at 30 June 2013	8,208	502	1,007	(388)	9,329


Value of in-force business	4,570	178	890	-	5,638
Shareholder net worth	3,638	324	117	(388)	3,691



Embedded value per share (p)⁴					158


1. UK intragroup distributions reflect dividends of £10m paid to Society from subsidiaries (primarily Nationwide Life). Dividends of $66m from LGA, €nil from LGN and €1m from LGF were also paid to the group.
2. The transfer to non-covered business represents the IFRS profits arising in the period from the provisions of investment management services by Legal & General Investment Management to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
3. The other reserve movements reflect the pension deficit movement, the movement of investment project costs from covered to non-covered business and the effect of reinsurance arrangement transactions between UK and US covered business.
4. The number of shares in issue at 30 June 2013 was 5,915,445,369.

Further analysis of the LGAS and LGR covered business can be found in Note 5.01.

European Embedded Value 91

Group embedded value - summary (continued)
	Covered business
		LGAS		Non-
	UK	overseas		covered
	business	business	LGA	business	Total
For the year ended 31 December 2013	£m	£m	£m	£m	£m


At 1 January 2013
Value of in-force business (VIF)	4,402	146	735	-	5,283
Shareholder net worth (SNW)	3,178	296	239	(96)	3,617


Embedded value at 1 January 2013	7,580	442	974	(96)	8,900
Exchange rate movements	-	9	(14)	(10)	(15)

Operating profit after tax for the year	804	16	70	168	1,058
Non-operating profit/(loss) for the year	222	60	(24)	(17)	241


Profit for the year	1,026	76	46	151	1,299
Intra-group distributions¹	(602)	(15)	(44)	661	-
Dividends to equity holders of the Company	-	-	-	(479)	(479)
Transfer to non-covered business²	(27)	-	-	27	-
Other reserve movements including pension deficit³	(35)	-	(29)	(55)	(119)


Embedded value at 31 December 2013	7,942	512	933	199	9,586


Value of in-force business	4,693	197	699	-	5,589
Shareholder net worth	3,249	315	234	199	3,997



Embedded value per share (p)⁴					162


1. UK intra-group distributions reflect a £625m dividend paid from Society to Group, and dividends of £10m paid to Society from subsidiaries (primarily Nationwide Life). Dividends of €16m from LGN are also paid to Society. Dividends of $69m from LGA and €2m from LGF were paid to the group.
2. The transfer to non-covered business represents the IFRS profits arising in the period from the provisions of investment management services by LGIM to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
3. The other reserve movements reflect the pension deficit movement, the movement of investment project costs from covered to non-covered business and the effect of reinsurance arrangement transactions between UK and US covered business.
4. The number of shares in issue at 31 December 2013 was 5,917,066,636.

Further analysis of the LGAS and LGR covered business can be found in Note 5.01.

European Embedded Value 92

5.01 LGAS and LGR embedded value reconciliation

	Shareholder net worth				Total
	Free	Required		Value of	embedded
	surplus	capital	Total	in-force	value
For the six months ended 30 June 2014	£m	£m	£m	£m	£m


At 1 January 2014¹	1,174	2,390	3,564	4,890	8,454
Exchange movement	(15)	4	(11)	(8)	(19)

Operating profit/(loss) after tax - UK business:
- New business contribution²	(195)	184	(11)	305	294
- Expected return on VIF	-	-	-	157	157
- Expected transfer from VIF to SNW³	457	(113)	344	(344)	-
- Expected return on SNW	26	62	88	-	88
Generation of embedded value	288	133	421	118	539
- Experience variances	(6)	3	(3)	34	31
- Operating assumption changes	11	-	11	(31)	(20)
- Development costs	(11)	-	(11)	-	(11)
Variances	(6)	3	(3)	3	-
Operating profit/(loss) after tax - LGAS overseas	12	4	16	(5)	11


Operating profit after tax - LGAS & LGR	294	140	434	116	550
Non-operating profit/(loss) after tax - UK business:
- Economic variances	(30)	42	12	26	38
- Other taxation impacts⁴	(12)	-	(12)	33	21

Non-operating profit/(loss) after tax - LGAS overseas	13	8	21	(18)	3
Non-operating profit/(loss) after tax - LGAS & LGR	(29)	50	21	41	62


Profit for the period - LGAS & LGR	265	190	455	157	612
Intra-group distributions⁵	3	-	3	-	3
Transfer to non-covered business⁶	(15)	-	(15)	-	(15)
Other reserve movements including pension deficit⁷	(44)	-	(44)	56	12


Embedded value at 30 June 2014	1,368	2,584	3,952	5,095	9,047


1. Opening balances at 1 January 2014 include LGF and LGN.
2. The UK free surplus reduction of £195m to finance new business includes £11m new business strain and £184m additional required capital.
3. The increase in UK free surplus of £457m from the expected transfer from the in-force non profit business includes £344m of operational cash generation and a £113m reduction in required capital.The £383m operational cash generation from LGAS and LGR per Note 2.01 also includes £14m dividend from LGN, £1m dividend from LGF and £24m primarily reflecting profit from non-covered business.
4. Reflects the impact of change in treatment in deferred tax to align with IFRS by removing the effect of discounting.
5. Intra-group distributions primarily reflect £4m dividend from the non-covered subsidiary, Nationwide Life, to Society.
6. The transfer to non-covered business represents the IFRS profits arising in the period from the provisions of investment management services by LGIM to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
7. The other reserve movements reflects the pension deficit movement and the effect of reinsurance arrangement transactions between UK and US covered business.

The value of in-force business of £5,095m is comprised of £4,676m of non profit business and £419m of with-profits business.

European Embedded Value 93

5.01 LGAS and LGR embedded value reconciliation (continued)

	Shareholder net worth				Total
	Free	Required		Value of	embedded
	surplus	capital	Total	in-force	value
For the six months ended 30 June 2013¹	£m	£m	£m	£m	£m


At 1 January 2013	1,259	2,215	3,474	4,548	8,022
Exchange movement	9	6	15	8	23

Operating profit/(loss) after tax - UK business:
- New business contribution²	(132)	95	(37)	205	168
- Expected return on VIF	-	-	-	132	132
- Expected transfer from VIF to SNW³	429	(89)	340	(340)	-
- Expected return on SNW	22	36	58	-	58
Generation of embedded value	319	42	361	(3)	358
- Experience variances	(2)	3	1	35	36
- Operating assumption changes	21	-	21	(9)	12
- Development costs	(14)	-	(14)	-	(14)
Variances	5	3	8	26	34
Operating profit/(loss) after tax - LGAS overseas	6	2	8	(4)	4


Operating profit after tax - LGAS & LGR	330	47	377	19	396
Non-operating profit/(loss) after tax - UK business:
- Economic variances	166	(34)	132	109	241
- Effect of tax rate changes and other taxation impacts⁴	-	-	-	41	41

Non-operating profit/(loss) after tax - LGAS overseas	8	(2)	6	28	34
Non-operating profit/(loss) after tax - LGAS & LGR	174	(36)	138	178	316


Profit for the period - LGAS & LGR	504	11	515	197	712
Intra-group distributions⁵	9	-	9	-	9
Transfer to non-covered business⁶	(12)	-	(12)	-	(12)
Other reserve movements including pension deficit⁷	(39)	-	(39)	(5)	(44)


Embedded value at 30 June 2013	1,730	2,232	3,962	4,748	8,710


1. Opening balances at 1 January 2013 include LGF and LGN.
2. The free surplus reduction of £132m to finance new business includes £37m new business strain and £95m additional required capital.
3. The increase in free surplus of £429m from the expected transfer from the in-force covered business includes £340m of operational cash generation and a £89m reduction in required capital. The £361m operational cash generation from LGAS and LGR per Note 2.01 also includes £1m dividend from LGF and £20m primarily reflecting IFRS profit from non covered business.
4. Reflects the implementation of the UK planned future reductions in corporation tax to 20% on 1 April 2015.
5. UK intra-group dividends reflect dividends of £10m paid to Society from subsidiaries (primarily Nationwide Life) and €1m from LGF paid to Group.
6. The transfer to non-covered business represents the IFRS profits arising in the period from the provisions of investment management services by Legal & General Investment Management to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
7. The other reserve movements reflects the pension deficit movement, the movement of investment project costs from covered to non-covered business and the effect of reinsurance arrangement transactions between UK and US covered business.

The UK value of in-force business of £4,748m is comprised of £4,330m of non profit business and £418m of with-profits business.

European Embedded Value 94

5.01 LGAS and LGR embedded value reconciliation (continued)

	Shareholder net worth				Total
	Free	Required		Value of	embedded
	surplus	capital	Total	in-force	value
For the year ended 31 December 2013	£m	£m	£m	£m	£m


At 1 January 2013¹	1,259	2,215	3,474	4,548	8,022
Exchange movement	3	3	6	3	9

Operating profit/(loss) after tax - UK business:
- New business contribution²	(324)	284	(40)	484	444
- Expected return on VIF	-	-	-	266	266
- Expected transfer from VIF to SNW³	869	(181)	688	(688)	-
- Expected return on SNW	40	76	116	-	116
Generation of embedded value	585	179	764	62	826
- Experience variances	5	(9)	(4)	14	10
- Operating assumption changes	(24)	2	(22)	21	(1)
- Development costs	(31)	-	(31)	-	(31)
Variances	(50)	(7)	(57)	35	(22)
Operating profit after tax - LGAS overseas	7	1	8	8	16


Operating profit after tax - LGAS & LGR	542	173	715	105	820
Non-operating profit/(loss) after tax - UK business:
- Economic variances	109	(8)	101	80	181
- Effect of tax rate changes and other taxation impacts⁴	-	-	-	41	41

Non-operating profit after tax - LGAS overseas	20	-	20	40	60
Non-operating profit/(loss) after tax - LGAS & LGR	129	(8)	121	161	282


Profit for the year - LGAS & LGR	671	165	836	266	1,102
Intra-group distributions⁵	(617)	-	(617)	-	(617)
Transfer to non-covered business⁶	(27)	-	(27)	-	(27)
Other reserve movements including pension deficit⁷	(115)	7	(108)	73	(35)


Embedded value at 31 December 2013	1,174	2,390	3,564	4,890	8,454


1. Opening balances at 1 January 2013 include LGF and LGN.
2. The UK free surplus reduction of £324m to finance new business includes £40m new business strain and £284m additional required capital.
3. The increase in UK free surplus of £869m from the expected transfer from the in-force covered business includes £688m of operational cash generation and a £181m reduction in required capital. The £734m operational cash from LGAS and LGR per Note 2.01 also includes £2m and £14m remitted from LGF and LGN respectively, and £30m primarily reflecting IFRS profit from non covered business.
4. Reflects the implementation of the UK planned future reductions in corporation tax to 20% on 1 April 2015.
5. UK intra-group dividends reflect a £625m dividend paid from Society to Group and dividends of £10m paid to Society from subsidiaries (primarily Nationwide Life). Dividends of €16m from LGN were also paid to Society.
6. The transfer to non-covered business represents the IFRS profits arising in the period from the provisions of investment management services by LGIM to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
7. The other reserve movements reflects the pension deficit movement, the movement of investment project costs from covered to non-covered business and the effect of reinsurance arrangement transactions between UK and US covered business.

The value of in-force business of £4,890m is comprised of £4,454m of non profit business and £436m of with-profits business.

European Embedded Value 95

5.02 Analysis of shareholders' equity

			LGC
	LGAS and		and group
	LGR	LGIM	expenses	LGA	Total
As at 30 June 2014	£m	£m	£m	£m	£m


Analysed as:
IFRS basis shareholders' equity¹	820	566	3,538	787	5,711
Additional retained profit/(loss) on an EEV basis	5,041	-	(1,027)	118	4,132


Shareholders' equity on an EEV basis	5,861	566	2,511	905	9,843


Comprising:
Business reported on an IFRS basis	441	566	(1,116)	-	(109)

Business reported on an EEV basis:
Shareholder net worth
- Free surplus²	74		1,294	139	1,507
- Required capital to cover solvency margin	251		2,333	49	2,633
Value of in-force
- Value of in-force business³	5,611			729	6,340
- Cost of capital	(516)			(12)	(528)



			LGC
	LGAS and		and group
	LGR	LGIM	expenses	LGA	Total
As at 30 June 2013	£m	£m	£m	£m	£m


Analysed as:
IFRS basis shareholders' equity¹	772	522	3,276	935	5,505
Additional retained profit/(loss) on an EEV basis	4,672	-	(920)	72	3,824


Shareholders' equity on an EEV basis	5,444	522	2,356	1,007	9,329


Comprising:
Business reported on an IFRS basis	372	522	(1,282)	-	(388)

Business reported on an EEV basis:
Shareholder net worth
- Free surplus²	71		1,659	64	1,794
- Required capital to cover solvency margin	253		1,979	53	2,285
Value of in-force
- Value of in-force business³	5,228			903	6,131
- Cost of capital	(480)			(13)	(493)


1. Shareholders' equity supporting the UK non profit LGAS and LGR businesses is held within Legal & General Assurance Society Limited and Legal & General Pensions Limited and is managed on a groupwide basis within the LGC and group expenses segment.
2. Free surplus is the value of any capital and surplus allocated to, but not required to support, the in-force covered business at the valuation date.
3. Value of in-force business includes a deduction for the time value of options and guarantees of £14m (H1 13: £27m; FY13: £23m).

Further analysis of shareholders' equity is included in Note 5.03.

European Embedded Value 96

5.02 Analysis of shareholders' equity (continued)

			LGC
	LGAS and		and group
	LGR	LGIM	expenses	LGA	Total
As at 31 December 2013	£m	£m	£m	£m	£m


Analysed as:
IFRS basis shareholders' equity¹	783	421	3,622	816	5,642
Additional retained profit/(loss) on an EEV basis	4,830	-	(1,003)	117	3,944


Shareholders' equity on an EEV basis	5,613	421	2,619	933	9,586


Comprising:
Business reported on an IFRS basis	408	421	(630)	-	199

Business reported on an EEV basis:
Shareholder net worth
- Free surplus²	67		1,107	192	1,366
- Required capital to cover solvency margin	248		2,142	42	2,432
Value of in-force
- Value of in-force business³	5,398			711	6,109
- Cost of capital	(508)			(12)	(520)


1. Shareholders' equity supporting the UK non profit LGAS and LGR businesses is held within Legal & General Assurance Society Limited and Legal & General Pensions Limited and is managed on a groupwide basis within the LGC and group expenses segment.
2. Free surplus is the value of any capital and surplus allocated to, but not required to support, the in-force covered business at the valuation date.
3. Value of in-force business includes a deduction for the time value of options and guarantees of £23m.

Further analysis of shareholders' equity is included in Note 5.03.

European Embedded Value 97

5.03 Segmental analysis of shareholders' equity

	Covered	Other		Covered	Other
	business	business		business	business
	EEV	IFRS		EEV	IFRS
	basis	basis	Total	basis	basis	Total
	30.06.14	30.06.14	30.06.14	30.06.13	30.06.13	30.06.13
	£m	£m	£m	£m	£m	£m


LGAS
- LGAS UK Protection and Savings	2,290	-	2,290	2,268	-	2,268
- LGAS overseas business	492	-	492	502	-	502
- General insurance and other	-	441	441	-	372	372


Total LGAS	2,782	441	3,223	2,770	372	3,142



LGR	2,638	-	2,638	2,302	-	2,302



LGIM	-	566	566	-	522	522




LGC and group expenses	3,627	(1,116)	2,511	3,638	(1,282)	2,356



LGA	905	-	905	1,007	-	1,007



Total	9,952	(109)	9,843	9,717	(388)	9,329

	Covered	Other
	business	business
	EEV	IFRS
	basis	basis	Total
	31.12.13	31.12.13	31.12.13
	£m	£m	£m


LGAS
- LGAS UK Protection and Savings	2,331	-	2,331
- LGAS overseas business	512	-	512
- General insurance and other	-	408	408


Total LGAS	2,843	408	3,251



LGR	2,362	-	2,362



LGIM	-	421	421




LGC and group expenses	3,249	(630)	2,619



LGA	933	-	933



Total	9,387	199	9,586

European Embedded Value 98

5.04 Reconciliation of shareholder net worth

	UK		UK		UK
	covered		covered		covered
	business	Total	business	Total	business	Total
	30.06.14	30.06.14	30.06.13	30.06.13	31.12.13	31.12.13
	£m	£m	£m	£m	£m	£m


SNW of long term operations (IFRS basis)	4,645	5,820	4,603	5,893	4,291	5,443
Other (liabilities)/assets (IFRS basis)	-	(109)	-	(388)	-	199


Shareholders' equity on the IFRS basis	4,645	5,711	4,603	5,505	4,291	5,642
Purchased interest in long term business	(51)	(54)	(58)	(60)	(52)	(59)
Deferred acquisition costs/deferred income liabilities	(212)	(1,140)	(267)	(1,213)	(223)	(1,129)
Deferred tax¹	(123)	282	(165)	195	(162)	232
Other²	(632)	(768)	(475)	(736)	(605)	(689)


Shareholder net worth on the EEV basis	3,627	4,031	3,638	3,691	3,249	3,997


1. Deferred tax represents all tax which is expected to be paid under current legislation. 2. Other primarily relates to the different treatment of annuities and LGA Triple X securitisation between the EEV and IFRS basis.

European Embedded Value 99

5.05 Profit/(loss) for the period

				LGC
		LGAS and		and group
		LGR	LGIM	expenses	LGA	Total
For the six months ended 30 June 2014	Note	£m	£m	£m	£m	£m


Business reported on an EEV basis:
Contribution from new business after cost of capital	5.06	370			51	421
Contribution from in-force business:
- expected return¹		210			28	238
- experience variances ²		42			(10)	32
- operating assumption changes³		(23)			-	(23)
Development costs		(14)			-	(14)
Contribution from shareholder net worth		3		87	3	93


Operating profit on covered business		588	-	87	72	747

Business reported on an IFRS basis^4,5,6		27	140	(64)	-	103


Total operating profit		615	140	23	72	850
Economic variances⁷		97	(5)	(82)	(2)	8
Gains on non-controlling interests		-	-	6	-	6


Profit/(loss) before tax		712	135	(53)	70	864
Tax (expense)/credit on profit from ordinary activities		(145)	(30)	33	(24)	(166)
Other taxation impacts⁸		21	-	-	-	21


Profit/(loss) for the period		588	105	(20)	46	719



Operating profit attributable to:
LGAS		185
LGR		430



						p


Earnings per share
Based on profit attributable to equity holders of the Company						12.12

Diluted earnings per share
Based on profit attributable to equity holders of the Company						11.99


1. The expected return on in-force for LGAS and LGR is based on the unwind of the risk discount rate on the opening, adjusted base value of in-force (VIF). The opening base VIF of the UK LGAS and LGR business was £4,693m in 2014 (£4,402m in 2013). This is adjusted for the effects of opening model changes of £4m (H1 13: £50m; FY 13: £27m) to give an adjusted opening base VIF of £4,697m (H1 13: £4,452m; FY 13: £4,429m). This is then multiplied by the opening risk discount rate of 6.8% (H1 13: 6.0%; FY 13: 6.0%) and the result grossed up at the notional attributed tax rate of 20% (H1 13: 20%; FY 13: 20%) to give a return of £196m (H1 13: £165m; FY 13: £331m). The same approach has been applied for the LGAS overseas businesses
2. LGAS and LGR variance primarily reflects UK cost of capital unwind, bulk purchase annuity data loading and fewer retail protection lapses. LGA experience variance primarily relates to adverse mortality experience within term assurance and universal life products.
3. LGAS and LGR assumption changes primarily reflect mortality reserves strengthening partly offset by a reduction in prudence margin in the regulatory morbidity reserves within retail protection.
4. LGAS and LGR non-covered business primarily reflects GI operating profit of £28m (H1 13: £39m; FY 13: £69m).
5. LGIM operating profit includes Retail Investments and excludes £19m (H1 13: £15m; FY 13: £34m) of profits arising from the provision of investment management services at market referenced rates to the covered business on a look through basis and as a consequence are included in the LGAS and LGR covered business on an EEV basis.
6. LGC and group expenses non-covered business primarily reflects Group debt costs and investment projects and expenses, partly offset by investment returns from non-covered shareholder assets.
7. The LGAS and LGR positive variance has resulted from a number of factors including lower risk discount rate and enhanced yield on annuity assets offset by a lower risk free rate and a narrowing credit spread. LGC and group expenses primarily reflects lower equity return from shareholder funds.
8. Other taxation impacts reflects the change in the treatment of deferred tax on in-force business to align with IFRS by removing the effect of discounting.

European Embedded Value 100

5.05 Profit/(loss) for the period (continued)

				LGC
		LGAS and		and group
		LGR	LGIM	expenses	LGA	Total
For the six months ended 30 June 2013	Note	£m	£m	£m	£m	£m


Business reported on an EEV basis:
Contribution from new business after cost of capital	5.06	213			44	257
Contribution from in-force business:
- expected return¹		178			33	211
- experience variances ²		42			(27)	15
- operating assumption changes³		14			-	14
Development costs		(18)			-	(18)
Contribution from shareholder net worth		2		65	4	71


Operating profit on covered business		431	-	65	54	550

Business reported on an IFRS basis^4,5,6		18	137	(65)	-	90


Total operating profit		449	137	-	54	640
Economic variances⁷		302	(2)	11	(47)	264
Gains on non-controlling interests		-	-	7	-	7


Profit before tax		751	135	18	7	911
Tax (expense)/credit on profit from ordinary activities		(152)	(28)	16	(3)	(167)
Effect of tax rate changes and other taxation impacts⁸		41	-	-	-	41


Profit for the period		640	107	34	4	785



Operating profit attributable to:
LGAS		167
LGR		282



						p


Earnings per share
Based on profit attributable to equity holders of the Company						13.24

Diluted earnings per share
Based on profit attributable to equity holders of the Company						13.09


1. The expected return on in-force is based on the unwind of the risk discount rate on the opening, adjusted base value of in-force (VIF). The opening base VIF of the UK LGAS and LGR business was £4,402m. This is adjusted for the effects of opening model changes of £50m to give an adjusted opening base VIF of £4,452m. This is then multiplied by the opening risk discount rate of 6.0% and the result grossed up at the notional attributed tax rate of 20% to give a return of £165m. The same approach has been applied for the LGAS overseas business.
2. LGAS and LGR reflects UK cost of capital unwind and bulk purchase annuity data loading and model changes. LGA reflects a higher than anticipated lapses in the period.
3. LGAS and LGR primarily reflects mortality assumption changes in retail protection.
4. LGAS and LGR non-covered business primarily reflects GI operating profit of £39m.
5. LGIM operating profit excludes £15m of profits arising from the provision of investment management services at market referenced rates to the covered business. These are reported on a look through basis and as a consequence are included in the LGAS and LGR covered business on an EEV basis.
6. LGC and group expenses non-covered business primarily reflects Group debt costs and investment projects and expenses, partly offset by investment returns from non-covered shareholder assets.
7. LGAS and LGR positive variance primarily reflects equity market outperformance, actions to improve the yield on annuities assets and a lower risk margin.
8. Primarily reflects the implementation of the UK planned future reductions in the corporation tax rate to 20% on 1 April 2015.

European Embedded Value 101

5.05 Profit/(loss) for the year (continued)

				LGC
		LGAS and		and group
		LGR	LGIM	expenses	LGA	Total
For the year ended 31 December 2013	Note	£m	£m	£m	£m	£m


Business reported on an EEV basis:
Contribution from new business after cost of capital	5.06	544			107	651
Contribution from in-force business:
- expected return¹		358			68	426
- experience variances ²		52			(23)	29
- operating assumption changes³		(9)			(52)	(61)
Development costs		(40)			-	(40)
Contribution from shareholder net worth		5		113	7	125


Operating profit on covered business		910	-	113	107	1,130

Business reported on an IFRS basis^4,5,6		47	270	(106)	-	211


Total operating profit		957	270	7	107	1,341
Economic variances⁷		250	(6)	8	(37)	215
Gains on non-controlling interests		-	-	13	-	13


Profit before tax		1,207	264	28	70	1,569
Tax (expense)/credit on profit from ordinary activities		(251)	(57)	21	(24)	(311)
Effect of tax rate changes and other taxation impacts⁸		41	-	-	-	41


Profit for the year		997	207	49	46	1,299



Operating profit attributable to:
LGAS		360
LGR		597



						p


Earnings per share
Based on profit attributable to equity holders of the Company						21.91

Diluted earnings per share
Based on profit attributable to equity holders of the Company						21.61


1. The expected return on in-force is based on the unwind of the risk discount rate on the opening, adjusted base value of in-force (VIF). The opening base VIF of the UK LGAS and LGR business was £4,402m in 2013. This is adjusted for the effects of opening model changes of £27m to give an adjusted opening base VIF of £4,429m. This is then multiplied by the opening risk discount rate of 6.0% and the result grossed up at the notional attributed tax rate of 20% to give a return of £331m. The same approach has been applied for the LGAS overseas businesses.
2. LGAS and LGR variance primarily reflects UK cost of capital unwind, bulk purchase annuity data loading, fewer retail protection lapses and better longevity experience. LGA experience variance primarily relates to adverse persistency experience and mortality experience within term assurance and universal life products respectively.
3. LGAS and LGR assumption changes primarily reflects mortality assumption changes in LGR. LGA assumption changes primarily relate to improved modelling of term business in the period after the end of the guaranteed level premium period.
4. LGAS and LGR non-covered business primarily reflects GI operating profit of £69m.
5. LGIM operating profit includes Retail Investments and excludes £34m of profits arising from the provision of investment management services at market referenced rates to the covered business on a look through basis and as a consequence are included in the LGAS and LGR covered business on an EEV basis.
6. LGC and group expenses non-covered business primarily reflects Group debt costs and investment projects and expenses, partly offset by investment returns from non-covered shareholder assets.
7. The LGAS and LGR positive variance has resulted from a number of factors including equity market outperformance, favourable default experience, actions to improve the yield on annuity assets and a lower risk margin offset by a higher risk free rate. The higher risk free rate has contributed to a negative variance in LGA.
8. Primarily reflects the implementation of the UK planned future reductions in the corporation tax rate to 20% on 1 April 2015.

European Embedded Value 102

5.06 New business by product¹

		Present				Contri-
		value of	Capital-			bution
	Annual	annual	isation	Single		from new
	premiums	premiums	factor²	premiums	PVNBP	business³	Margin
For the six months ended 30 June 2014	£m	£m		£m	£m	£m	%


UK Protection	123	668	5.4	-	668	62	9.3
Overseas business	38	266	7.0	180	446	2	0.4
UK Savings	341	1,212	3.6	1,420	2,632	11	0.4


Total LGAS	502	2,146	4.3	1,600	3,746	75	2.0


LGR	n/a	-	n/a	3,518	3,518	295	8.4


LGA	47	474	10.1	-	474	51	10.8


Total new business	549	2,620	4.8	5,118	7,738	421	5.4
Cost of capital						82


Contribution from new business before cost of capital						503




		Present				Contri-
		value of	Capital-			bution
	Annual	annual	isation	Single		from new
	premiums	premiums	factor²	premiums	PVNBP	business³	Margin
For the six months ended 30 June 2013	£m	£m		£m	£m	£m	%


UK Protection	105	528	5.0	-	528	35	6.7
Overseas business	30	230	7.7	183	413	3	0.8
UK Savings	314	1,162	3.7	1,203	2,365	(2)	(0.1)


Total LGAS	449	1,920	4.3	1,386	3,306	36	1.1


LGR⁴	n/a	692	n/a	1,424	2,116	177	8.4


LGA	45	440	9.7	-	440	44	10.0


Total new business	494	3,052	6.2	2,810	5,862	257	4.4
Cost of capital						30


Contribution from new business before cost of capital						287


1. Covered business only.
2. The capitalisation factor is the present value of annual premiums divided by the amount of annual premiums.
3. The contribution from new business is defined as the present value at the point of sale of assumed profits from new business written in the period and then rolled forward to the end of the financial period using the risk discount rate applicable at the end of the reporting period.
4. LGR for H1 13 and FY 13 includes present value of annual premiums for longevity insurance on a net of reinsurance basis to enable a more representative margin figure. The gross of reinsurance longevity insurance annual premium for H1 13 is £175m; FY 13: £270m. The LGR PVNBP contribution from new business and margin for H1 13 and FY 13 are also inclusive of longevity insurance. There has been no longevity insurance sales during H1 14.

European Embedded Value 103

5.06 New business by product (continued)¹

		Present				Contri-
		value of	Capital-			bution
	Annual	annual	isation	Single		from new
	premiums	premiums	factor²	premiums	PVNBP	business³	Margin
For the year ended 31 December 2013	£m	£m		£m	£m	£m	%


UK Protection	218	1,141	5.2	-	1,141	101	8.9
Overseas business	30	229	7.6	371	600	5	0.8
UK Savings	724	2,516	3.5	2,495	5,011	2	-


Total LGAS	972	3,886	4.0	2,866	6,752	108	1.6


LGR⁴	n/a	939	n/a	4,089	5,028	436	8.7


LGA	99	926	9.4	-	926	107	11.6


Total new business	1,071	5,751	5.4	6,955	12,706	651	5.1
Cost of capital						72


Contribution from new business before cost of capital						723


1. Covered business only.
2. The capitalisation factor is the present value of annual premiums divided by the amount of annual premiums.
3. The contribution from new business is defined as the present value at the point of sale of assumed profits from new business written in the period and then rolled forward to the end of the financial period using the risk discount rate applicable at the end of the reporting period.
4. LGR includes present value of annual premiums for longevity insurance on a net of reinsurance basis to enable a more representative margin figure. The gross of reinsurance longevity insurance annual premium is £270m. The LGR PVNBP contribution from new business and margin are also inclusive of longevity insurance.

European Embedded Value 104

5.07 Assumptions

UK assumptions

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. Indicative yields on the portfolio, excluding annuities within LGR, but after allowance for long term default risk, are shown below.

For LGR, separate returns are calculated for new and existing business. Indicative combined yields, after allowance for long term default risk and the following additional assumptions, are also shown below. These additional assumptions are:

i. Where cash balances and debt securities are held at the reporting date in excess of, or below strategic investment guidelines, then it is assumed that these cash balances or debt securities are immediately invested or disinvested at current yields.

ii. Where interest rate swaps are used to reduce risk, it is assumed that these swaps will be sold before expiry and the proceeds reinvested in corporate bonds with a redemption yield 0.70% p.a. (0.70% p.a. at 30 June 2013; 0.70% p.a. at 31 December 2013) greater than the swap rate at that time (i.e. the long term credit rate).

iii. Where reinvestment or disinvestment is necessary to rebalance the asset portfolio in line with projected outgo, this is also assumed to take place at the long term credit rate above the swap rate at that time.

The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account of the credit rating, outstanding term of the securities, and increase in the expectation of credit defaults over the economic cycle. The allowance for corporate securities expressed as a level rate deduction from the expected returns for annuities was 26bps at 30 June 2014 (26bps at 30 June 2013; 27bps at 31 December 2013).

UK covered business

i. Assets are valued at market value.

ii. Future bonus rates have been set at levels which would fully utilise the assets supporting the policyholders' portion of the with-profits business in accordance with established practice. The proportion of profits derived from with-profits business allocated to shareholders amounts to almost 10% throughout the projection.

iii. The value of in-force business reflects the cost, including administration expenses, of providing for benefit enhancement or compensation in relation to certain products.

iv. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses (excluding the development costs referred to below). These are normally reviewed annually.

An allowance is made for future mortality improvement. For new business, mortality assumptions may be modified to take certain scheme specific features into account.

v. Development costs relate to investment in strategic systems and development capability that are charged to the covered business. Projects charged to the non-covered business are included within Group Investment projects in LGC and group expenses.

Overseas covered business

vi. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses.

European Embedded Value 105

5.07 Assumptions (continued)

Economic assumptions


	As at	As at	As at
	30.06.14	30.06.13	31.12.13
	% p.a.	% p.a.	% p.a.
Risk margin	3.3	3.5	3.4
Risk free rate¹
- UK	3.2	3.0	3.4
- Europe	1.4	2.1	2.2
- US	2.5	2.6	3.1
Risk discount rate (net of tax)
- UK	6.5	6.5	6.8
- Europe	4.7	5.6	5.6
- US	5.8	6.1	6.5
Reinvestment rate (US)	5.0	5.1	5.8
Other UK business assumptions
Equity risk premium	3.3	3.3	3.3
Property risk premium	2.0	2.0	2.0

Investment return (excluding annuities in LGR )
- Gilts:
- Fixed interest	2.5 - 3.2	2.5 - 3.0	2.7 - 3.4
- RPI linked	3.2	3.1	3.6
- Non gilts:
- Fixed interest	2.2 - 3.3	1.9 - 3.4	2.2 - 3.6
- Equities	6.5	6.3	6.7
- Property	5.2	5.0	5.4

Long-term rate of return on non profit annuities in LGR	4.3	4.7	4.6

Inflation
- Expenses/earnings	3.9	3.8	4.1
- Indexation	3.4	3.3	3.6

1. The risk free rate is the gross redemption yield on the 15 year gilt index. The Europe risk free rate is the 10 year ECB AAA-rated euro area central government bond par yield. The LGA risk free rate is the 10 year US Treasury effective yield.

Tax

vii. The profits on the covered business, except for the profits on the Society shareholder capital held outside the long term fund, are calculated on an after tax basis and are grossed up by the notional attributed tax rate for presentation in the income statement. For the UK, the after tax basis assumes the annualised current tax rate of 21.5% and the subsequent enacted future reduction in corporation tax to 20% from 1 April 2015. The tax rate used for grossing up is the long term corporate tax rate in the territory concerned, which for the UK is 20% (30 June 2013: 20%; 31 December 2013: 20%) taking into account the expected further rate reduction to 20% by 1 April 2015. The profits on the Society shareholder capital held outside the long term fund are calculated before tax and therefore tax is calculated on an actual basis.

US, Netherlands and France covered business profits are also grossed up using the long term corporate tax rates of the respective territories i.e. US is 35% (30 June 2013: 35%; 31 December 2013: 35%), France is 34.43% (30 June 2013: 34.43%; 31 December 2013: 34.43%) and Netherlands is 25% (30 June 2013: 25%; 31 December 2013: 25%).

European Embedded Value 106

5.07 Assumptions (continued)

Stochastic calculations

viii. The time value of options and guarantees is calculated using economic and non-economic assumptions consistent with those used for the deterministic embedded value calculations.

A single model has been used for UK and international business, with different economic assumptions for each territory reflecting the significant asset classes in each territory.

Government nominal interest rates are generated using a LIBOR Market Model projecting full yield curves at annual intervals. The model provides a good fit to the initial yield curve.

The total annual returns on equities and property are calculated as the return on 1 year bonds plus an excess return. The excess return is assumed to have a lognormal distribution. Corporate bonds are modelled separately by credit rating using stochastic credit spreads over the risk free rates, transition matrices and default recovery rates. The real yield curve model assumes that the real short rate follows a mean-reverting process subject to two normally distributed random shocks.

The significant asset classes are:

- UK with-profits business - equities, property and fixed rate bonds of various durations;

- UK annuity business - fixed rate and index-linked bonds of various durations; and

- International business - fixed rate bonds of various durations.

The risk discount rate is scenario dependent within the stochastic projection. It is calculated by applying the deterministic risk margin to the risk free rate in each stochastic projection.

European Embedded Value 107

5.08 Methodology

Basis of preparation

The supplementary financial information has been prepared in accordance with the European Embedded Value (EEV) Principles issued in May 2004 by the European Insurance CFO Forum.

The supplementary financial information has been reviewed by PricewaterhouseCoopers LLP and prepared with assistance from our consulting actuary Milliman in the USA.

Changes to accounting policy - IASB consolidation project

On 1st January 2014 the application of IFRS 10, 'Consolidated Financial Statements' became compulsory for entities reporting in the EU.

IFRS 10, 'Consolidated Financial Statements' defines the principal of control and establishes control as the basis for determining which entities are consolidated in the consolidated financial statements. This states that an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The application of IFRS 10 has resulted in the Group consolidating a small number of investment vehicles which were not previously consolidated which impacted the gain attributable to non-controlling interest.

As a result, the prior period disclosure in the Group embedded value summary and Note 5.05 have been restated to reflect the adoption by the Group of IFRS 10, 'Consolidated Financial Statements'. The effect on amounts previously reported at 30 June 2013 and 31 December 2013 is shown below. Embedded value at 30 June 2013 and 31 December 2013 remains unaffected by the adoption.

	30.06.13	31.12.13
	£m	£m


Profit for the period as previously reported	783	1,289
Gains on non-controlling interest
IFRS 10 'Consolidated Financial Statements' amendment	2	10


Revised profit for the period (after tax)	785	1,299

Covered business

The Group uses EEV methodology to value individual and group life assurance, pensions and annuity business written in the UK, Continental Europe and the US. The UK covered business also includes non-insured self invested personal pension (SIPP) business.

The managed pension funds business has been excluded from covered business and is reported on an IFRS basis.

All other businesses are accounted for on the IFRS basis adopted in the primary financial statements.

There is no distinction made between insurance and investment contracts in our covered business as there is under IFRS.

European Embedded Value 108

5.08 Methodology (continued)

Description of methodology

The objective of EEV is to provide shareholders with realistic information on the financial position and current performance of the Group.

The methodology requires assets of an insurance company, as reported in the primary financial statements, to be attributed between those supporting the covered business and the remainder. The method accounts for assets in the covered business on an EEV basis and the remainder of the Group's assets on the IFRS basis adopted in the primary financial statements.

The EEV methodology recognises profit from the covered business as the total of:

i. cash transfers during the relevant period from the covered business to the remainder of the Group's assets; and

ii. the movement in the present value of future distributable profits to shareholders arising from the covered business over the relevant reporting period.

Embedded value

Shareholders' equity on the EEV basis comprises the embedded value of the covered business plus the shareholders' equity of other businesses, less the value included for purchased interests in long term business.

The embedded value is the sum of the shareholder net worth (SNW) and the value of the in-force business (VIF). SNW is defined as those amounts, within covered business (both within the long term fund and held outside the long term fund but used to support long term business), which are regarded either as required capital or which represent free surplus.

The VIF is the present value of future shareholder profits arising from the covered business, projected using best estimate assumptions, less an appropriate deduction for the cost of holding the required level of capital and the time value of financial options and guarantees (FOGs).

Service companies

All services relating to the UK covered business are charged on a cost recovery basis, with the exception of investment management services provided to Legal & General Pensions Limited (LGPL) and to Legal & General Assurance Society Limited (Society). Profits arising on the provision of these services are valued on a look through basis.

As the EEV methodology incorporates the future capitalised cost of these internal investment management services, the equivalent IFRS profits have been removed from the Investment management segment and are instead included in the results of the LGAS and LGR segments on an EEV basis.

The capitalised value of future profits emerging from internal investment management services are therefore included in the embedded value and new business contribution calculations for the LGAS and LGR segments. However, the historical profits which have emerged continue to be reported in the shareholders' equity of the LGIM segment on an IFRS basis. Since the look through into service companies includes only future profits and losses, current intra-group profits or losses must be eliminated from the closing embedded value and in order to reconcile the profits arising in the financial period within each segment with the net assets on the opening and closing balance sheet, a transfer of IFRS profits for the period from the UK SNW is deemed to occur.

New business

New business premiums reflect income arising from the sale of new contracts during the reporting period and any changes to existing contracts, which were not anticipated at the outset of the contract.

In-force business comprises previously written single premium, regular premium, recurrent single premium contracts and payments in relation to existing longevity insurance. Longevity insurance product comprises the exchange of a stream of fixed leg payments for a stream of floating payments, with the value of the income stream being the difference between the two legs. New business annual premiums have been excluded for longevity insurance due to the unpredictable deal flow from this type of business.

New business contribution arising from the new business premiums written during the reporting period has been calculated on the same economic and operating assumptions used in the embedded value at the end of the financial period. This has then been rolled forward to the end of the financial period using the risk discount rate applicable at the end of the reporting period.

The present value of future new business premiums (PVNBP) has been calculated and expressed at the point of sale. The PVNBP is equivalent to total single premiums plus the discounted value of regular premiums expected to be received over the term of the contracts using the same economic and operating assumptions used for the embedded value at the end of the financial period. The discounted value of longevity insurance regular premiums is calculated on a net of reinsurance basis to enable a more representative margin figure.

The new business margin is defined as new business contribution at the end of the reporting period divided by the PVNBP. The premium volumes and projection assumptions used to calculate the PVNBP are the same as those used to calculate new business contribution.

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.

European Embedded Value 109

5.08 Methodology (continued)

Projection assumptions

Cash flow projections are determined using best estimate assumptions for each component of cash flow and for each policy group. Future economic and investment return assumptions are based on conditions at the end of the financial period. Future investment returns are projected by one of two methods. The first method is based on an assumed investment return attributed to assets at their market value. The second, which is used by LGA, where the investments of that subsidiary are substantially all fixed interest, projects the cash flows from the current portfolio of assets and assumes an investment return on reinvestment of surplus cash flows. The assumed discount and inflation rates are consistent with the investment return assumptions.

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 the covered business, whether incurred in the covered business or elsewhere in the Group, are allocated to that 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 known future changes.

Allowance for risk

Aggregate risks within the covered business are allowed for through the following principal mechanisms:

i. setting required capital levels with reference to both the Group's internal risk based capital models, and an assessment of the strength of regulatory reserves in the covered business;

ii. allowing explicitly for the time value of financial options and guarantees within the Group's products; and

iii. setting risk discount rates by deriving a Group level risk margin to be applied consistently to local risk free rates.

Required capital and free surplus

Regulatory capital for the UK LGAS and LGR businesses is provided by assets backing the with-profits business or by the SNW. The SNW comprises all shareholders' capital within Society, including those funds retained within the long term fund and the excess assets in LGPL (collectively Society shareholder capital).

Society shareholder capital is either required to cover EU solvency margin or is free surplus as its distribution to shareholders is not restricted.

For UK with-profits business, the required capital is covered by the surplus within the with-profits part of the fund and no effect is attributed to shareholders except for the burn-through cost, which is described later. This treatment is consistent with the Principles and Practices of Financial Management for this part of the fund.

For UK non profit business, the required capital will be maintained at no less than the level of the EU minimum solvency requirement. This level, together with the margins for adverse deviation in the regulatory reserves, is, in aggregate, in excess of internal capital targets assessed in conjunction with the Individual Capital Assessment (ICA) and the with-profits support account.

The initial strains relating to new non profit business, together with the related EU solvency margin, are supported by releases from existing non profit business and the Society shareholder capital. As a consequence, the writing of new business defers the release of capital to free surplus. The cost of holding required capital is defined as the difference between the value of the required capital and the present value of future releases of that capital. For new business, the cost of capital is taken as the difference in the value of that capital assuming it was available for release immediately and the present value of the future releases of that capital. As the investment return, net of tax, on that capital is less than the risk discount rate, there is a resulting cost of capital which is reflected in the value of new business.

For LGA, the Company Action Level (CAL) of capital has been treated as required capital for modelling purposes. The CAL is the regulatory capital level at which the company would have to take prescribed action, such as submission of plans to the State insurance regulator, but would be able to continue operating on the existing basis. The CAL is currently twice the level of capital at which the regulator is permitted to take control of the business.

For LGN, required capital has been set at 100% of EU minimum solvency margin for all products without FOGs. For those products with FOGs, capital of between 100% and 425% of the EU minimum solvency margin has been used. At total level a check is made to ensure the total requirement meets the 160% Solvency I (both EEV and NBVA) from the capital policy. The level of capital has been determined using risk based capital techniques.

For LGF, 100% of EU minimum solvency margin has been used for EV modelling purposes for all products both with and without FOGs. The level of capital has been determined using risk based capital techniques.

The contribution from new business for our International businesses reflects an appropriate allowance for the cost of holding the required capital.

European Embedded Value 110

5.08 Methodology (continued)

Financial options and guarantees

Under the EEV Principles an allowance for time value of FOGs is required where a financial option exists which is exercisable at the discretion of the policyholder. These types of option principally arise within the with-profits part of the fund and their time value is recognised within the with-profits burn-through cost described below. Additional financial options for non profit business exist only for a small amount of deferred annuity business where guaranteed early retirement and cash commutation terms apply when the policyholders choose their actual retirement date.

Further financial guarantees exist for non profit business, in relation to index-linked annuities where capped or collared restrictions apply. Due to the nature of these restrictions and the manner in which they vary depending on the prevailing inflation conditions, they are also treated as FOGs and a time value cost recognised accordingly.

The time value of FOGs has been calculated stochastically using a large number of real world economic scenarios derived from assumptions consistent with the deterministic EEV assumptions and allowing for appropriate management actions where applicable. The management action primarily relates to the setting of bonus rates. Future regular and terminal bonuses on participating business within the projections are set in a manner consistent with expected future returns available on assets deemed to back the policies within the stochastic scenarios.

In recognising the residual value of any projected surplus assets within the with-profits part of the fund in the deterministic projection, it is assumed that terminal bonuses are increased to exhaust all of the assets in the part of the fund over the future lifetime of the in-force with-profits policies. However, under stochastic modelling, there may be some extreme economic scenarios when the total projected assets within the with-profits part of the fund are insufficient to pay all projected policyholder claims and associated costs. The average additional shareholder cost arising from this shortfall has been included in the time value cost of financial options and guarantees and is referred to as the with-profits burn-through cost.

Economic scenarios have been used to assess the time value of the financial guarantees for non profit business by using the inflation rate generated in each scenario. The inflation rate used to project index-linked annuities will be constrained in certain real world scenarios, for example, where negative inflation occurs but the annuity payments do not reduce below pre-existing levels. The time value cost of FOGs allows for the projected average cost of these constrained payments for the index-linked annuities. It also allows for the small additional cost of the guaranteed early retirement and cash commutation terms for the minority of deferred annuity business where such guarantees have been written.

LGA FOGs relate to guaranteed minimum crediting rates and surrender values on a range of contracts, as well as impacts on no-lapse guarantees (NLG). The guaranteed surrender value of the contract is based on the accumulated value of the contract including accrued interest. The crediting rates are discretionary but related to the accounting income for the amortising bond portfolio. The majority of the guaranteed minimum crediting rates are between 3% and 4%. The assets backing these contracts are invested in US Dollar denominated fixed interest securities.

LGN separately provides for two types of guarantees: interest rate guarantees and maturity guarantees. Certain contracts provide an interest rate guarantee where there is a minimum crediting rate based on the higher of 1-year Euribor and the policy guarantee rate. This guarantee applies on a monthly basis. Certain other linked contracts provide a guaranteed minimum value at maturity where the maturity amount is the higher of the fund value and a guarantee amount. The fund values for both these contracts are invested in Euro denominated fixed interest securities.

For LGF, FOGs which have been separately provided for relate to guaranteed minimum crediting rates and surrender values on a range of contracts. The guaranteed surrender value of the contract is the accumulated value of the contract including accrued bonuses. The bonuses are based on the accounting income for the amortising bond portfolios plus income and releases from realised gains on any equity type investments. Policy liabilities equal guaranteed surrender values. In general, the guaranteed annual bonus rates are between 0% and 4.5%.

Risk free rate

The risk free rate is set to reflect both the pattern of the emerging profits under EEV and the relevant duration of the liabilities where backing assets reflect this assumption (e.g. equity returns). For the UK, it is set by reference to the gross redemption yield on the 15 year gilt index. For LGA, the risk free rate is the 10 year US Treasury effective yield, while the 10 year ECB AAA-rated Euro area central government bond par yield is used for LGN and LGF.

European Embedded Value 111

5.08 Methodology (continued)

Risk discount rate

The risk discount rate (RDR) is a combination of the risk free rate and a risk margin, which reflects the residual risks inherent in the Group's covered businesses, after taking account of prudential margins in the statutory provisions, the required capital and the specific allowance for FOGs.

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. Forward-looking or adjusted betas make allowance for the observed tendency for betas to revert to 1 and therefore a weighted average of the historic beta and 1 tends to be a better estimate of the Company's beta for the future period. We have computed the WACC using an arithmetical average of forward-looking betas against the FTSE 100 index.

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 rate of 20.1%.

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.

Analysis of profit

Operating profit is identified at a level which reflects an assumed longer term level of investment return.

The contribution to operating profit in a period is attributed to four sources:

i. new business;

ii. the management of in-force business;

iii. development costs; and

iv. return on shareholder net worth.

Further profit contributions arise from actual investment return differing from the assumed long term investment return (investment return variances), and from the effect of economic assumption changes.

The contribution from new business represents the value recognised at the end of each period from new business written in that period, after allowing for the actual cost of acquiring the business and of establishing the required technical provisions and reserves and after making allowance for the cost of capital. New business contributions are calculated using closing assumptions.

The contribution from in-force business is calculated using opening assumptions and comprises:

i. expected return - the discount earned from the value of business in-force at the start of the year;

ii. experience variances - the variance in the actual experience over the reporting period from that assumed in the value of business in-force as at the start of the year; and

iii. operating assumption changes - the effects of changes in future assumptions, other than changes in economic assumptions from those used in valuing the business at the start of the year. These changes are made prospectively from the end of the period.

Development costs relate to investment in strategic systems and development capability.

The contribution from shareholder net worth comprises the increase in embedded value based on assumptions at the start of the year in respect of the expected investment return on the Society shareholder capital.

Further profit contributions arise from investment return variances and the effect of economic assumption changes.

Economic variances represent:

i. the effect of actual investment performance and changes to investment policy on SNW and VIF business from that assumed at the beginning of the period; and

ii. the effect of changes in economic variables on SNW and VIF business from that assumed at the beginning of the period, which are beyond the control of management, including associated changes to valuation bases to the extent that they are reflected in revised assumptions.

European Embedded Value 112

Independent review report to Legal & General Group Plc - EEV

Report on the supplementary interim financial information

Our conclusion

We have reviewed the supplementary interim financial information, defined below, in the interim management report of Legal & General Group Plc for the six months ended 30 June 2014. Based on our review, nothing has come to our attention that causes us to believe that the supplementary interim financial information is not prepared, in all material respects, in accordance with the EEV basis set out in Note 5.08.

This conclusion is to be read in the context of what we say in the remainder of this report.

What we have reviewed

The supplementary interim financial information, which is prepared by Legal & General Group Plc, comprises:

· the Group embedded value summary as at 30 June 2014; and

· the explanatory notes to the supplementary interim financial information.

As disclosed in Note 5.08 the supplementary interim financial information has been prepared on the European Embedded Value ("EEV") basis.

What a review of supplementary interim financial information involves

We conducted our review in accordance with International Standard on Review Engagements (UK and Ireland) 2410, 'Review of Interim Financial Information Performed by the Independent Auditor of the Entity' issued by the Auditing Practices Board for use in the United Kingdom. A review of supplementary interim financial information consists of making enquiries, primarily of persons responsible for financial and accounting matters, and applying analytical and other review procedures.

A review is substantially less in scope than an audit conducted in accordance with International Standards on Auditing (UK and Ireland) and, consequently, does not enable us to obtain assurance that we would become aware of all significant matters that might be identified in an audit. Accordingly, we do not express an audit opinion.

We have read the other information contained in the interim management report and considered whether it contains any apparent misstatements or material inconsistencies with the information in the supplementary interim financial information.

Responsibilities for the supplementary interim financial information and the review

Our responsibilities and those of the directors

The interim management report, including the supplementary interim financial information, is the responsibility of, and has been approved by, the directors. The directors are responsible for preparing the supplementary interim financial information in accordance with the EEV basis set out in Note 5.08.

Our responsibility is to express to the company a conclusion on the supplementary interim financial information in the interim management report based on our review. This report, including the conclusion, has been prepared for and only for the company and for no other purpose. We do not, in giving this conclusion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.

PricewaterhouseCoopers LLP

Chartered Accountants

5 August 2014

London

Notes:

(a) The maintenance and integrity of the Legal & General Group Plc website is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial information since it was initially presented on the website.

(b) Legislation in the United Kingdom governing the preparation and dissemination of financial information may differ from legislation in other jurisdictions.

This information is provided by RNS

The company news service from the London Stock Exchange

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