L&G Half Year Results 2016 Part 3

RNS Number : 5968G

Legal & General Group Plc

09 August 2016

Legal & General Group Plc

Half Year Results 2016 Part 3

Capital and Investments Page 71

4.01 Group regulatory capital - Solvency II Directive

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

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

The table below shows the estimated Eligible Own Funds, Solvency Capital Requirement (SCR) and Surplus own funds of the group, based on the Internal Model, Matching Adjustment and Transitional Measures on Technical Provisions (TMTP), approved by the PRA in December 2015 (together with the recalculation of TMTP approved by the PRA in July 2016).

(a) Capital position

As at 30 June 2016, the group had a Solvency II surplus of £5.3bn (FY 15: £5.5bn) over its Solvency Capital Requirement, corresponding to a coverage ratio of 158% (FY 15: 169%). The pro-forma Solvency II capital position is as follows:
	30.06.16	31.12.15
	£bn	£bn


Core tier 1 own funds	11.6	11.3
Tier 1 subordinated liabilities	0.6	0.6
Tier 2 subordinated liabilities	2.2	2.0
Eligibility restrictions	(0.1)	(0.4)
Eligible Own Funds¹	14.3	13.5
Solvency Capital Requirement (SCR)	9.0	8.0


Surplus	5.3	5.5


SCR coverage ratio²	158%	169%


1. Eligible Own Funds do not include an accrual for the dividend of £238m (FY 15: £592m) declared after the balance sheet date.
2. Coverage ratio is calculated on unrounded values.

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

(b) Methodology

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

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

Liabilities are valued on a best estimate market consistent basis, with the application of a Solvency II Matching Adjustment for valuing annuity liabilities, and include recognition of the benefit relating to the TMTP for firms moving from the Solvency I to the Solvency II regime. The TMTP has been calculated on a basis approved by the PRA which seeks to encapsulate the difference between the total Financial Resources Requirement under the previous Solvency I regime and the new Solvency II regime.

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

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

All material EEA insurance firms, including Legal & General Assurance Society Limited, Legal & General Insurance Limited, and Legal & General Assurance (Pensions Management) Limited (LGIM's insurance subsidiary) are incorporated into the group's Solvency II Internal Model assessment of required capital, assuming diversification of the risks between and within those firms. These firms contribute over 95% of the group's SCR.

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

Capital and Investments Page 72

4.01 Group regulatory capital - Solvency II Directive (continued)

(b) Methodology (continued)

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

All non-insurance regulated firms are included using their current regulatory surplus. At the half year, unaudited profits earned in the year to date have been included, allowing for any restrictions on fungibility or transferability, without allowing for any diversification with the rest of the group.

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

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

(i) assumptions required to derive the present value of best estimate liability cash flows. Non-market assumptions are broadly the same as those used to derive the group's IFRS disclosures. Future investment returns and discount rates are those defined by EIOPA, which means that the risk free rates used to discount liabilities are market swap rates, with a 14 basis point deduction to allow for a credit risk adjustment. For annuities that are eligible, the liability discount rate includes a Matching 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. Assumptions have been set using a combination of historic market, demographic and operating experience data. In areas where data is not considered robust, expert judgement has been used; and

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

(d) Analysis of change

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


					Solvency II
					surplus
Analysis of movement in the period					£bn


Solvency II surplus as at 1 January 2016					5.5
Operating experience expected release¹					0.5
Operating experience new business					-
Market movements					(0.6)
Other capital movements²					0.5
Dividends declared in the period					(0.6)
Solvency II surplus as at 30 June 2016					5.3


1. Release of surplus generated by in-force business. 2. Other capital movements comprise model and assumption changes, including changes to eligibility restrictions over the period.

Capital and Investments Page 73

4.01 Group regulatory capital - Solvency II Directive (continued)
(e) Reconciliation of IFRS shareholders' equity to Solvency II Eligible Own Funds

The table below gives a reconciliation of the group's IFRS shareholders' equity to the Eligible Own Funds on a Solvency II basis.


	30.06.16	31.12.15
	£bn	£bn


IFRS shareholders' equity	6.6	6.4
Remove DAC, goodwill and other intangible assets and liabilities	(2.1)	(2.0)
Add subordinated debt treated as available capital¹	2.5	2.5
Insurance contract valuation differences²	8.2	7.5
Add value of shareholder transfers	0.2	0.2
Difference in value of net deferred tax liabilities (resulting from valuation differences)	(0.7)	(0.5)
Other³	(0.3)	(0.2)
Eligibility restrictions⁴	(0.1)	(0.4)


Eligible Own Funds	14.3	13.5


1. Treated as available capital on the Solvency II Balance Sheet as the liabilities are subordinate to policyholder claims. 2. Differences in the measurement of liabilities between IFRS and Solvency II, offset by the inclusion of the Risk Margin net of TMTP. 3. Reflects the valuation differences on other assets and liabilities, predominately in respect of borrowings measured at fair value under Solvency II. 4. Relating to the own funds of non-insurance regulated entities, subject to local regulator rules. The figures that appear in this note are all pre-accrual for the 2016 interim dividend of £238m (FY 15: 2015 final dividend of £592m).

(f) Sensitivity analysis The following sensitivities are provided to give an indication of how the group's Solvency II surplus as at 30 June 2016 would have changed in a variety of adverse events. These are all independent stresses to a single risk. In practice, the balance sheet is impacted by combinations of stresses and the combined impact can be larger than adding together the impacts of the same stresses in isolation. It is expected that, particularly for market risks, adverse stresses will happen together. Only key sensitivities have been updated for the half-year process, and only on a Solvency II basis.

	Impact on	Impact on	Impact on	Impact on
	net of tax	net of tax	net of tax	net of tax
	Solvency II	Solvency II	Solvency II	Solvency II
	capital	coverage	capital	coverage
	surplus	ratio	surplus	ratio
	30.06.16	30.06.16	31.12.15	31.12.15
	£bn	%	£bn	%


Credit spreads widen by 100bps assuming an escalating addition to ratings^1,2	(0.5)	(6)	(0.6)	(8)
A worsening in our expectation of future default and downgrade to 115% of our assumed best estimate level³	(0.6)	(9)	(0.5)	(11)
15% fall in property markets	(0.3)	(3)	(0.3)	(3)
100bps increase in risk free rates	0.7	14	0.6	19
100bps fall in risk free rates	(0.9)	(14)	(0.4)	(11)

1. The spread sensitivity applies to Legal & General's corporate bond (and similar) holdings, with no change in the firm's long term default expectations. 2. The stress for AA bonds is twice that for AAA bonds, for A bonds it is three times, for BBB four times and so on, such that the weighted average spread stress for the portfolio is 100bps. 3. Downgrade stress covers the cost of an immediate big letter downgrade on c.20% of annuity portfolio bonds, or 3 times level expected in the next 12 months.

The above sensitivity analysis does not reflect all management actions which could be taken to reduce the impacts. In practice, the group actively manages its asset and liability positions to respond to market movements. These results all allow (on an approximate basis) for the recalculation of TMTP as at 30 June 2016 where the impact of the stress would cause this to change materially.

The impacts of these stresses are not linear therefore these results should not be used to interpolate or extrapolate the impact of a smaller or larger stress. The results of these tests are indicative of the market conditions prevailing at the balance sheet date. The results would be different if performed at an alternative reporting date.

Capital and Investments Page 74

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

	30.06.16	31.12.15
	%	%


Interest Rate	3	4
Equity	9	11
Property	4	5
Credit¹	54	48
Currency	1	3
Inflation	3	2
Total Market Risk²	74	73
Counterparty Risk	1	1
Life Mortality	-	-
Life Longevity³	12	11
Life Lapse	1	1
Life Catastrophe	2	2
Non-life underwriting	1	1
Health underwriting	-	-
Expense	-	-
Total Insurance Risk	16	15
Operational Risk	5	5
Miscellaneous⁴	4	6


Total SCR	100	100


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

Capital and Investments Page 75

4.02 Group Economic Capital

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

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

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

(a) Capital position

As at 30 June 2016, the group had an economic capital surplus of £8.1bn (H1 15: £6.4bn; FY 15: £7.6bn), corresponding to an economic capital coverage ratio of 235% (H1 15: 220%; FY 15: 230%). The economic capital position is as follows:
	30.06.16	30.06.15	31.12.15
	£bn	£bn	£bn


Core tier 1 own funds	11.2	9.7	10.8
Tier 1 subordinated liabilities	0.6	0.7	0.7
Tier 2 subordinated liabilities	2.2	1.7	2.3
Eligibility restrictions	-	(0.3)	(0.3)
Eligible Own Funds¹	14.0	11.8	13.5
Economic Capital Requirement (ECR)	5.9	5.4	5.9


Surplus	8.1	6.4	7.6


ECR coverage ratio²	235%	220%	230%


1. Eligible Own Funds do not include an accrual for the dividend of £238m (H1 15: £205m; FY 15: £592m) declared after the balance sheet date.
2. Coverage ratio is calculated on unrounded values.

Further explanation of the underlying methodology and assumptions is 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.

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

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

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

All material insurance firms, including Legal & General Assurance Society Limited, Legal & General Insurance Limited, Legal & General Assurance (Pensions Management) Limited (LGIM's insurance subsidiary) and Legal & General America (LGA) are incorporated into the group's Economic Capital model assessment of required capital, assuming diversification of the risks between the different firms within the group and between the risks to which they are exposed.

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

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

Capital and Investments Page 76

4.02 Group Economic Capital (continued)

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

(i) assumptions required to derive the present value of best estimate liability cash flows. Non-market assumptions are broadly the same as those used to derive the group's IFRS 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 14 basis point deduction to allow for a credit risk adjustment;

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

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

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

(d) Analysis of change

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


								Economic
								Capital
								surplus
Analysis of movement in the period								£bn


Economic solvency position as at 1 January 2016								7.6
Operating experience expected release¹								0.5
Operating experience new business								0.2
Market movements								0.1
Other capital movements²								0.3
Dividends declared in the period								(0.6)
Economic solvency position as at 30 June 2016								8.1


1. Release of surplus generated by in-force business.
2. Other capital movements comprise model and assumption changes.

Capital and Investments Page 77

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

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


	30.06.16	30.06.15	31.12.15
	£bn	£bn	£bn


IFRS shareholders' equity	6.6	6.0	6.4
Remove DAC, goodwill and other intangible assets and liabilities	(2.1)	(2.0)	(2.0)
Add subordinated debt treated as economic available capital¹	2.5	1.9	2.5
Insurance contract valuation differences²	7.6	6.2	7.0
Add value of shareholder transfers	0.2	0.3	0.2
Difference in value of net deferred tax liabilities (resulting from valuation differences)	(0.6)	(0.5)	(0.5)
Other	(0.2)	0.2	0.2
Eligibility restrictions³	-	(0.3)	(0.3)


Eligible Own Funds	14.0	11.8	13.5


1. Treated as available capital on the Economic Capital balance sheet as the liabilities are subordinate to policyholder claims. 2. Differences in the measurement of liabilities between IFRS and Economic Capital, offset by the inclusion of the recapitalisation cost. 3. Relating to the own funds of US captive reassurers and the UK with-profits fund. The figures that appear in this note are all pre-accrual for the 2016 interim dividend of £238m (H1 15: £205m; FY 15: £592m).

(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.

	30.06.16	30.06.15	31.12.15
	%	%	%


Interest Rate	3	6	4
Equity	11	14	13
Property	6	4	6
Credit¹	48	44	48
Currency	-	2	-
Inflation	4	(1)	3
Total Market Risk²	72	69	74
Counterparty Risk	2	2	1
Life Mortality	-	-	-
Life Longevity³	6	9	4
Life Lapse	4	5	4
Life Catastrophe	4	3	4
Non-life underwriting	1	1	1
Health underwriting	-	1	-
Expense	1	1	1
Total Insurance Risk	16	20	14
Operational Risk	7	7	7
Miscellaneous⁴	3	2	4


Total Economic Capital Requirement	100	100	100


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

Capital and Investments Page 78

4.02 Group Economic Capital (continued)
(g) Reconciliation from Economic Capital surplus to Solvency II surplus

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

	30.06.16	31.12.15
	£bn	£bn


Economic Capital surplus	8.1	7.6
Different matching adjustment¹	(2.2)	(1.4)
Risk margin vs Recapitalisation cost²	-	-
Longevity calibration³	(0.6)	(0.3)
Eligibility of group own funds⁴	(0.1)	(0.5)
LGA on a D&A basis⁵	0.1	0.1


Solvency II surplus⁶	5.3	5.5


1. This is the difference between the Economic Matching Adjustment and the Solvency II Matching Adjustment. 2. The risk margin represents the amount a third party insurance company would require to take on the obligations of a given insurance company. It is equal to the cost of capital on the SCR necessary to support insurance risks that cannot be hedged over the lifetime of the business. This is presented net of TMTP. The recapitalisation cost is an equivalent measure under economic capital, but represents the cost of recapitalising the balance sheet following a stress event. It also removes elements of Solvency II specifications that are, in Legal & General's view, uneconomic. 3. Economic Capital and Solvency II balance sheets use different calibrations for longevity risk. 4. Deductions for regulatory restrictions in respect of fungibility and transferability restrictions. These do not apply to the Economic Capital balance sheet. 5. To ensure consistency of risk management across the group, L&G America remains within the Internal Model for Economic Capital purposes. 6. There are also differences in the valuation of with-profits business and the group pension scheme that have lower order impacts on the difference between the surpluses.

Capital and Investments Page 79

4.03 Estimated Solvency II new business contribution
(a) New business by product¹
		Contri-
		bution
		from new
	PVNBP	business²	Margin
For the six months ended 30 June 2016	£m	£m	%


LGR - UK annuity business	3,743	382	10.2

UK Insurance Total	727	81	11.1
- Retail protection	565	69	12.2
- Group protection	162	12	7.4

LGA³	325	40	12.4


	4,795	503	10.5



1. Selected lines of business only.
2. The contribution from new business is defined as the present value at the point of sale of expected future Solvency II surplus emerging from new business written in the period using the risk discount rate applicable at the end of the reporting period. 3. In local currency, LGA reflects PVNBP of $435m and a contribution from new business of $54m.

(b) Assumptions

The key economic assumptions as at 30 June 2016 are as follows:

		%
Risk margin		3.5
Risk free rate
- UK		1.1
- US		1.3
Risk discount rate (net of tax)
- UK		4.6
- US		4.8

Long-term rate of return on non profit annuities in LGR		3.2

The cashflows are discounted using duration-based discount rates, which is the sum of a duration-based risk free rate and a flat risk margin. The risk free rates have been based on a swap curve net of the EIOPA-specified Credit Risk Adjustment. The risk free rate shown above is a weighted average based on the projected cash flows. Using the previous methodology the risk free rate as at 30 June 2016 (for both the UK and the US) would be 1.5% and the risk discount rate would be 5.0%.

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

· The assumed future pre-tax returns on fixed interest and RPI linked securities are set by reference to the portfolio yield on the relevant backing assets held at market value at the end of the reporting period. The calculated return takes account of derivatives and other credit instruments in the investment portfolio. The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account of the credit rating and the outstanding term of the securities. The allowance for corporate defaults within the new business contribution is based on a level rate deduction from the expected returns for the overall annuities portfolio of 20bps.

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

Tax

The profits on the new business are calculated on an after tax basis and are grossed up by the notional attributed tax rate. For the UK, the after tax basis assumes the annualised current rate of 20% and subsequent planned future reductions in corporation tax to 19% from 1 April 2017 and 18% from 1 April 2020 onwards. The tax rate used for grossing up is the long term corporate tax rate in the territory concerned, which for the UK is 18%.

US, covered business profits are also grossed up using the long term corporate tax rates i.e. 35%.

Capital and Investments Page 80

4.03 Estimated Solvency II new business contribution (continued)

Basis of preparation

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

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

Description of methodology

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

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

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

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

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

Comparison to EEV new business contribution

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

Capital and Investments Page 81

4.03 Estimated Solvency II new business contribution (continued)

Projection assumptions

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

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

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

Tax

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

Risk discount rate

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

The risk free rates have been based on a swap curve net of the EIOPA-specified Credit Risk Adjustment (30 June 2016: 14bps for UK and 10bps for US).

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

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

The cost of debt used in the WACC calculations takes account of the actual locked-in rates for our senior and subordinated long term debt. All debt interest attracts tax relief at a time adjusted rate of 18.4%.

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

(d) PVNBP to gross written premium reconciliation
		30.06.16	30.06.15	31.12.15
	Notes	£bn	£bn	£bn


PVNBP	4.03(a)	4.8
Effect of capitalisation factor		(0.9)


New business premiums from selected lines		3.9
Other¹		0.3


Total LGR, Insurance and LGA new business	3.07/ 3.08	4.2	1.6	3.3

Annualisation impact of regular premium long-term business		(0.1)	(0.1)	(0.2)
IFRS gross written premiums from existing long-term insurance business		1.3	1.3	2.6
IFRS gross written premiums from Savings business		0.1	0.2	0.5
Deposit accounting for lifetime mortgage advances		(0.2)	-	(0.2)
General insurance gross written premiums	3.09	0.2	0.2	0.3


Total gross written premiums		5.5	3.2	6.3


1. Other principally includes annuity sales in the US and lifetime mortgage advances.

Capital and Investments Page 82

4.04 Investment portfolio

	Market	Market	Market
	value	value	value
	30.06.16	30.06.15	31.12.15
	£m	£m	£m


Worldwide total assets	846,140	717,034	747,944
Client and policyholder assets	(766,397)	(649,882)	(679,831)
Non-unit linked with-profits assets	(12,478)	(12,216)	(11,644)


Investments to which shareholders are directly exposed	67,265	54,936	56,469

Analysed by investment class:

			Other
			non profit		Other
		LGR	insurance	LGC	shareholder
		investments	investments	investments¹	investments	Total	Total	Total
		30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.15	31.12.15
	Note	£m	£m	£m	£m	£m	£m	£m


Equities		56	-	2,350	188	2,594	2,409	2,252
Bonds	4.06	47,908	2,505	1,651	666	52,730	43,917	43,916
Derivative assets²		5,661	-	62	-	5,723	3,730	3,663
Property	4.07	2,257	-	196	4	2,457	2,220	2,347
Cash, cash equivalents,
loans & receivables		878	556	1,313	504	3,251	2,527	4,168


Financial investments		56,760	3,061	5,572	1,362	66,755	54,803	56,346


Other assets³		157	-	331	22	510	133	123


Total investments		56,917	3,061	5,903	1,384	67,265	54,936	56,469


1. Equity investments include a total of £323m in respect of CALA Group Limited, Peel Media Holdings Limited (MediaCityUK) and NTR Wind Management Ltd (30 June 2015: £280m; 31 December 2015: £295m).
2. Derivative assets are shown gross of derivative liabilities of £5.0bn (HY15: £2.0bn; FY15: £2.7bn). Exposures arise from the use of derivatives for efficient portfolio management, especially the use of interest rate swaps, inflation swaps, credit default swaps and foreign exchange forward contracts for asset and liability management.
3. Other assets include reverse repurchase agreements of £464m (HY15: £nil; FY15: £82m).

Capital and Investments Page 83

4.05 Direct Investments
(a) Analysed by asset class


	Direct^{1, 2}	Traded³		Direct^{1, 2}	Traded³		Direct^{1, 2}	Traded³
	Investments	securities	Total	Investments	securities	Total	Investments	securities	Total
	30.06.16	30.06.16	30.06.16	30.06.15	30.06.15	30.06.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	£m	£m	£m	£m	£m


Equities	508	2,086	2,594	410	1,999	2,409	432	1,820	2,252
Bonds	4,474	48,256	52,730	3,050	40,867	43,917	3,722	40,194	43,916
Derivative assets	-	5,723	5,723	-	3,730	3,730	-	3,663	3,663
Property	2,457	-	2,457	2,220	-	2,220	2,347	-	2,347
Cash, cash equivalents,
loans & receivables	466	2,785	3,251	380	2,147	2,527	425	3,743	4,168
Other assets	46	464	510	133	-	133	41	82	123


	7,951	59,314	67,265	6,193	48,743	54,936	6,967	49,420	56,469


1. Direct Investments constitute an agreement with another party and represent an exposure to untraded and often less volatile assets. Direct Investments include physical assets, bilateral loans and private equity but exclude hedge funds.
2. A further breakdown of property is provided in note 4.07.
3. Traded securities are defined by exclusion. If an instrument is not a Direct Investment, then it is classed as a traded security.

(b) Analysed by segment
	LGR	LGC	LGA	Insurance	Total
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16
	£m	£m	£m	£m	£m


Equities	-	508	-	-	508
Bonds	3,932	197	345	-	4,474
Property	2,257	196	-	4	2,457
Cash, cash equivalents, loans & receivables	20	117	329	-	466
Other assets	-	46	-	-	46


	6,209	1,064	674	4	7,951

	LGR	LGC	LGA	Insurance	Total
	At	At	At	At	At
	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15
	£m	£m	£m	£m	£m


Equities	-	410	-	-	410
Bonds	2,737	61	252	-	3,050
Property	2,037	180	-	3	2,220
Cash, cash equivalents, loans & receivables	-	112	268	-	380
Other assets	118	15	-	-	133


	4,892	778	520	3	6,193

Capital and Investments Page 84

4.05 Direct Investments (continued)
(b) Analysed by segment (continued)

	LGR	LGC	LGA	Insurance	Total
	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	£m


Equities	-	432	-	-	432
Bonds	3,336	93	293	-	3,722
Property	2,157	186	-	4	2,347
Cash, cash equivalents, loans & receivables	-	115	310	-	425
Other assets	-	41	-	-	41


	5,493	867	603	4	6,967

(c) Movement in the period

	Carrying			Change in	Carrying
	value			market	value
	01.01.16	Additions	Disposals	value	30.06.16
	£m	£m	£m	£m	£m


Equities	432	65	(9)	20	508
Bonds	3,722	580	(182)	354	4,474
Property	2,347	198	(60)	(28)	2,457
Cash, cash equivalents, loans & receivables	425	29	(23)	35	466
Other assets	41	3	-	2	46


	6,967	875	(274)	383	7,951

Capital and Investments Page 85

4.06 Bond portfolio summary
(a) LGR analysed by sector
Sectors analysed by credit rating

					BB or
	AAA	AA	A	BBB	below	LGR	LGR
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16
	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	898	6,747	114	200	58	8,017	17
Banks:
- Tier 1	-	-	-	-	21	21	-
- Tier 2 and other subordinated	-	-	159	265	-	424	1
- Senior	100	564	1,046	85	-	1,795	4
Financial Services:
- Tier 1	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	-	31	10	-	41	-
- Senior	78	420	210	125	-	833	2
Insurance:
- Tier 1	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	-	136	60	26	222	-
- Senior	-	15	418	184	-	617	1
Utilities	63	7	2,324	2,834	24	5,252	11
Consumer Services and Goods
& Health Care	174	1,181	2,041	2,407	124	5,927	12
Technology and Telecoms	46	156	550	2,181	115	3,048	6
Industrials¹	-	24	1,082	967	103	2,176	5
Oil and Gas	-	169	683	1,146	273	2,271	5
Property	-	579	323	969	1	1,872	4
Asset backed securities	134	745	292	95	48	1,314	3
Securitisations and debentures²	252	2,335	6,948	2,151	850	12,536	26
Lifetime mortgage loans³	-	-	-	440	-	440	1
CDOs⁴	-	722	366	14	-	1,102	2


Total £m	1,745	13,664	16,723	14,133	1,643	47,908	100


Total %	4	29	34	30	3	100


1. Included within Industrials is a £599m exposure to Basic Resources.
2. Securitisations and debentures have been reanalysed in note 4.06(c).
3. Lifetime mortgage loans have increased in value since inception predominantly due to the accrual of interest on the loans.
4. The underlying reference portfolio has had no reference entity defaults during the period. The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the counterparty valuation.

Capital and Investments Page 86

4.06 Bond portfolio summary (continued)
(a) LGR analysed by sector (continued)
Sectors analysed by credit rating (continued)

					BB or
	AAA	AA	A	BBB	below	Other	LGR	LGR
	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	921	5,458	126	208	8	1	6,722	17
Banks:
- Tier 1	-	-	55	6	33	-	94	-
- Tier 2 and other subordinated	41	2	231	149	11	-	434	1
- Senior	73	383	891	137	3	-	1,487	4
Financial Services:
- Tier 1	-	4	-	-	-	-	4	-
- Tier 2 and other subordinated	4	1	43	8	-	-	56	-
- Senior	52	386	89	121	1	-	649	2
Insurance:
- Tier 1	-	4	10	71	-	-	85	-
- Tier 2 and other subordinated	4	6	147	138	-	-	295	1
- Senior	-	49	346	138	-	-	533	1
Utilities	3	5	2,154	2,329	24	-	4,515	11
Consumer Services and Goods
& Health Care	161	735	1,434	1,518	140	1	3,989	11
Technology and Telecoms	24	98	436	1,669	158	1	2,386	6
Industrials¹	3	20	866	857	36	1	1,783	5
Oil and Gas	19	345	473	1,011	278	-	2,126	5
Property	2	364	231	814	-	2	1,413	4
Asset backed securities	296	671	197	73	33	-	1,270	3
Securitisations and debentures²	272	2,186	5,437	2,149	292	-	10,336	26
Lifetime mortgage loans³	-	-	-	38	-	-	38	-
CDOs⁴	-	537	464	54	47	-	1,102	3


Total £m	1,875	11,254	13,630	11,488	1,064	6	39,317	100


Total %	5	29	34	29	3	-	100


1. Included within Industrials is a £507m exposure to Basic Resources.
2. Securitisations and debentures have been reanalysed in note 4.06(c).
3. Lifetime mortgage loans have increased in value since inception predominantly due to the accrual of interest on the loans.
4. The underlying reference portfolio has had no reference entity defaults during the period. The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the counterparty valuation.

Capital and Investments Page 87

4.06 Bond portfolio summary (continued)
(a) LGR analysed by sector (continued)
Sectors analysed by credit rating (continued)

					BB or
	AAA	AA	A	BBB	below	LGR	LGR
	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	956	4,774	64	154	30	5,978	14
Banks:
- Tier 1	17	35	-	-	26	78	-
- Tier 2 and other subordinated	-	-	92	138	2	232	1
- Senior	49	421	859	77	1	1,407	4
Financial Services:
- Tier 1	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	3	33	8	4	48	-
- Senior	63	396	106	140	-	705	2
Insurance:
- Tier 1	-	-	-	6	-	6	-
- Tier 2 and other subordinated	-	-	144	64	-	208	1
- Senior	-	14	316	118	-	448	1
Utilities	43	8	1,847	2,593	27	4,518	11
Consumer Services and Goods
& Health Care	136	969	1,572	1,830	130	4,637	12
Technology and Telecoms	48	138	409	1,940	129	2,664	7
Industrials¹	-	21	934	899	30	1,884	5
Oil and Gas	24	321	482	901	247	1,975	5
Property	-	516	269	868	-	1,653	4
Asset backed securities	123	657	167	74	38	1,059	3
Securitisations and debentures²	258	2,152	5,489	2,349	331	10,579	26
Lifetime mortgage loans³	-	-	-	207	-	207	1
CDOs⁴	-	552	469	14	47	1,082	3


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


Total %	4	28	34	31	3	100


1. Included within Industrials is a £455m exposure to Basic Resources.
2. Securitisations and debentures have been reanalysed in note 4.06(c).
3. Lifetime mortgage loans have increased in value since inception predominantly due to the accrual of interest on the loans.
4. The underlying reference portfolio has had no reference entity defaults during the period . The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the counterparty valuation.

Capital and Investments Page 88

4.06 Bond portfolio summary (continued)
(a) LGR analysed by sector (continued)
Sectors analysed by domicile
			EU	Rest of
	UK	US	excluding UK	the World	LGR
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	6,133	571	635	678	8,017
Banks	638	780	635	187	2,240
Financial Services	270	229	277	98	874
Insurance	312	481	46	-	839
Utilities	2,673	390	2,125	64	5,252
Consumer Services and Goods & Health Care	1,214	4,054	464	195	5,927
Technology and Telecoms	508	1,267	879	394	3,048
Industrials	119	1,129	323	605	2,176
Oil and Gas	181	1,106	345	639	2,271
Property	1,410	385	12	65	1,872
Asset backed securities, securitisations and debentures¹	11,539	1,086	462	1,203	14,290
CDOs	-	-	1,031	71	1,102


Total	24,997	11,478	7,234	4,199	47,908


1. Includes lifetime mortgage loans.

			EU	Rest of
	UK	US	excluding UK	the World	LGR
	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	4,963	519	638	602	6,722
Banks	662	795	453	105	2,015
Financial Services	186	330	140	53	709
Insurance	463	341	91	18	913
Utilities	2,347	252	1,857	59	4,515
Consumer Services and Goods & Health Care	792	2,786	336	75	3,989
Technology and Telecoms	389	973	841	183	2,386
Industrials	199	735	266	583	1,783
Oil and Gas	193	1,088	354	491	2,126
Property	1,054	316	17	26	1,413
Asset backed securities, securitisations and debentures¹	9,013	1,075	378	1,178	11,644
CDOs	-	-	1,026	76	1,102


Total	20,261	9,210	6,397	3,449	39,317


1. Includes lifetime mortgage loans.

Capital and Investments Page 89

4.06 Bond portfolio summary (continued)
(a) LGR analysed by sector (continued)
Sectors analysed by domicile (continued)
			EU	Rest of
	UK	US	excluding UK	the World	LGR
	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	4,305	455	647	571	5,978
Banks	568	582	441	126	1,717
Financial Services	217	373	159	4	753
Insurance	337	284	41	-	662
Utilities	2,355	313	1,796	54	4,518
Consumer Services and Goods & Health Care	870	3,212	391	164	4,637
Technology and Telecoms	462	1,217	787	198	2,664
Industrials	220	854	272	538	1,884
Oil and Gas	197	995	326	457	1,975
Property	1,286	324	12	31	1,653
Asset backed securities, securitisations and debentures¹	9,570	884	355	1,036	11,845
CDOs	-	-	1,047	35	1,082


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


1. Includes lifetime mortgage loans.

Capital and Investments Page 90

4.06 Bond portfolio summary (continued)
(b) Total group analysed by sector
Sectors analysed by credit rating

					BB or
	AAA	AA	A	BBB	below	Other	Total	Total
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,549	7,355	196	424	113	1	9,638	18
Banks:
- Tier 1	-	-	-	1	21	-	22	-
- Tier 2 and other subordinated	-	-	172	279	-	1	452	1
- Senior	207	865	1,335	102	1	1	2,511	5
Financial Services:
- Tier 1	-	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	-	32	11	-	3	46	-
- Senior	85	504	259	161	2	2	1,013	2
Insurance:
- Tier 1	-	-	1	-	-	-	1	-
- Tier 2 and other subordinated	-	3	140	70	26	1	240	-
- Senior	-	17	426	190	-	-	633	1
Utilities	64	16	2,385	2,931	36	40	5,472	10
Consumer Services and Goods
& Health Care	210	1,218	2,195	2,630	207	11	6,471	13
Technology and Telecoms	58	185	614	2,302	142	3	3,304	6
Industrials¹	-	34	1,194	1,125	158	5	2,516	5
Oil and Gas	-	197	740	1,241	323	2	2,503	5
Property	-	579	344	1,029	10	163	2,125	4
Asset backed securities	335	768	293	95	48	-	1,539	3
Securitisations and debentures²	309	2,337	7,011	2,180	865	-	12,702	24
Lifetime mortgage loans³	-	-	-	440	-	-	440	1
CDOs⁴	-	722	366	14	-	-	1,102	2


Total £m	2,817	14,800	17,703	15,225	1,952	233	52,730	100


Total %	5	28	34	29	4	-	100


1. Included within Industrials is a £605m exposure to Basic Resources.
2. Securitisations and debentures have been reanalysed in note 4.06(d).
3. Lifetime mortgage loans have increased in value since inception predominantly due to the accrual of interest on the loans.
4. The underlying reference portfolio has had no reference entity defaults during the period. The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the market valuation.

Capital and Investments Page 91

4.06 Bond portfolio summary (continued)
(b) Total group analysed by sector (continued)
Sectors analysed by credit rating (continued)

					BB or
	AAA	AA	A	BBB	below	Other	Total	Total
	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,485	5,928	181	399	42	8	8,043	18
Banks:
- Tier 1	-	-	55	9	33	-	97	-
- Tier 2 and other subordinated	133	4	248	183	14	1	583	1
- Senior	271	511	1,031	168	8	1	1,990	5
Financial Services:
- Tier 1	-	4	-	-	-	-	4	-
- Tier 2 and other subordinated	10	5	51	14	1	-	81	-
- Senior	70	418	176	186	9	1	860	2
Insurance:
- Tier 1	-	4	10	72	-	-	86	-
- Tier 2 and other subordinated	9	15	149	150	2	1	326	1
- Senior	1	89	359	146	-	-	595	1
Utilities	7	18	2,235	2,423	33	2	4,718	11
Consumer Services and Goods
& Health Care	211	817	1,636	1,714	209	5	4,592	10
Technology and Telecoms	44	137	512	1,755	189	3	2,640	6
Industrials¹	9	28	1,011	1,023	77	4	2,152	5
Oil and Gas	28	381	512	1,097	312	2	2,332	5
Property	4	367	243	866	11	64	1,555	4
Asset backed securities	670	706	201	75	34	-	1,686	4
Securitisations and debentures²	274	2,199	5,505	2,154	305	-	10,437	24
Lifetime mortgage loans³	-	-	-	38	-	-	38	-
CDOs⁴	-	537	464	54	47	-	1,102	3


Total £m	3,226	12,168	14,579	12,526	1,326	92	43,917	100


Total %	7	28	33	29	3	-	100


1. Included within Industrials is a £520m exposure to Basic Resources.
2. Securitisations and debentures have been reanalysed in note 4.06(d).
3. Lifetime mortgage loans have increased in value since inception predominantly due to the accrual of interest on the loans.
4. The underlying reference portfolio has had no reference entity defaults during the period. The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the market valuation.

Capital and Investments Page 92

4.06 Bond portfolio summary (continued)
(b) Total group analysed by sector (continued)
Sectors analysed by credit rating (continued)

					BB or
	AAA	AA	A	BBB	below	Other	Total	Total
	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	£m	£m	£m	%


Sovereigns, Supras and Sub-Sovereigns	1,981	5,022	112	367	62	5	7,549	17
Banks:
- Tier 1	68	139	5	10	26	-	248	1
- Tier 2 and other subordinated	22	-	100	146	3	1	272	1
- Senior	105	721	992	98	3	1	1,920	4
Financial Services:
- Tier 1	-	-	-	-	-	-	-	-
- Tier 2 and other subordinated	-	3	38	16	-	1	58	-
- Senior	65	415	172	198	7	-	857	2
Insurance:
- Tier 1	-	-	-	6	-	-	6	-
- Tier 2 and other subordinated	-	3	146	68	1	1	219	-
- Senior	1	18	326	126	-	-	471	1
Utilities	42	17	1,900	2,677	42	13	4,691	11
Consumer Services and Goods
& Health Care	170	1,004	1,707	1,993	210	4	5,088	12
Technology and Telecoms	61	169	472	2,027	151	1	2,881	7
Industrials¹	-	38	1,039	1,075	67	2	2,221	5
Oil and Gas	27	342	517	958	280	1	2,125	5
Property	-	516	287	912	9	81	1,805	4
Asset backed securities	511	672	164	74	42	-	1,463	3
Securitisations and debentures²	281	2,157	5,602	2,370	343	-	10,753	25
Lifetime mortgage loans³	-	-	-	207	-	-	207	-
CDOs⁴	-	552	469	14	47	-	1,082	2


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


Total %	8	27	32	30	3	-	100


1. Included within Industrials is a £455m exposure to Basic Resources.
2. Securitisations and debentures have been reanalysed in note 4.06(d).
3. Lifetime mortgage loans have increased in value since inception predominantly due to the accrual of interest on the loans.
4. The underlying reference portfolio has had no reference entity defaults during the period. The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 27.5%, on average across the reference portfolio, before the CDOs incur any default losses. Assuming an average recovery rate of 30%, then over 39% of the reference names would have to default before the CDOs incur any default losses. The CDOs are valued using an external valuation which is based on observable market inputs. This is then validated against the market valuation.

Capital and Investments Page 93

4.06 Bond portfolio summary (continued)
(b) Total group analysed by sector (continued)
Sectors analysed by domicile
			EU
			excluding	Rest of
	UK	US	UK	the World	Total
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	6,503	881	1,398	856	9,638
Banks	676	941	935	433	2,985
Financial Services	279	287	293	200	1,059
Insurance	322	497	55	-	874
Utilities	2,723	474	2,206	69	5,472
Consumer Services and Goods & Health Care	1,261	4,446	535	229	6,471
Technology and Telecoms	521	1,419	942	422	3,304
Industrials	153	1,354	374	635	2,516
Oil and Gas	205	1,202	404	692	2,503
Property	1,575	459	22	69	2,125
Asset backed securities, securitisations and debentures¹	11,586	1,394	478	1,223	14,681
CDOs	-	-	1,031	71	1,102


Total	25,804	13,354	8,673	4,899	52,730


1. Includes lifetime mortgage loans.

			EU
			excluding	Rest of
	UK	US	UK	the World	Total
	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	5,309	735	1,271	728	8,043
Banks	757	925	687	301	2,670
Financial Services	200	443	212	90	945
Insurance	486	399	102	20	1,007
Utilities	2,365	344	1,933	76	4,718
Consumer Services and Goods & Health Care	861	3,221	392	118	4,592
Technology and Telecoms	405	1,147	884	204	2,640
Industrials	247	952	331	622	2,152
Oil and Gas	208	1,186	399	539	2,332
Property	1,129	369	22	35	1,555
Asset backed securities, securitisations and debentures¹	9,081	1,515	388	1,177	12,161
CDOs	-	-	1,026	76	1,102


Total	21,048	11,236	7,647	3,986	43,917


1. Includes lifetime mortgage loans.

Capital and Investments Page 94

4.06 Bond portfolio summary (continued)
(b) Total group analysed by sector (continued)
Sectors analysed by domicile (continued)

			EU
			excluding	Rest of
	UK	US	UK	the World	Total
	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	4,665	775	1,374	735	7,549
Banks	674	703	655	408	2,440
Financial Services	227	460	208	20	915
Insurance	343	305	47	1	696
Utilities	2,376	387	1,859	69	4,691
Consumer Services and Goods & Health Care	904	3,565	428	191	5,088
Technology and Telecoms	468	1,377	822	214	2,881
Industrials	257	1,064	330	570	2,221
Oil and Gas	206	1,060	357	502	2,125
Property	1,375	374	19	37	1,805
Asset backed securities, securitisations and debentures¹	9,578	1,440	364	1,041	12,423
CDOs	-	-	1,047	35	1,082


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


1. Includes lifetime mortgage loans.

Capital and Investments Page 95

4.06 Bond portfolio summary (continued)
(c) Analysis of LGR securitisations and debentures

					BB or
	AAA	AA	A	BBB	below	LGR	LGR	LGR
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.15	31.12.15
	£m	£m	£m	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	-	743	5	-	-	748	702	682
Financial Services	-	636	1,392	249	150	2,427	2,145	2,166
Insurance	-	43	106	-	-	149	110	130
Utilities	-	103	1,797	129	-	2,029	1,722	1,765
Consumer Services and Goods
& Health Care	-	-	286	69	21	376	408	355
Technology and Telecoms	-	-	-	-	-	-	1	1
Industrials	-	43	455	300	5	803	700	711
Oil and Gas	-	-	14	32	19	65	64	65
Property	-	204	586	1	-	791	411	402
Infrastructure / PFI / Social housing	-	186	664	715	64	1,629	1,259	1,232
Covered Bonds¹	251	2	-	16	-	269	285	273
Whole Business Securitised	-	67	390	345	105	907	847	624
Commercial Property Backed Bonds	-	188	505	14	464	1,171	679	1,092
Secured Bonds²	1	120	748	281	22	1,172	1,003	949
Other	-	-	-	-	-	-	-	132


Total	252	2,335	6,948	2,151	850	12,536	10,336	10,579


1. Covered bonds are typically issued by banks and are secured on pools of residential mortgages.
2. Secured bonds are typically issued by Special Purpose Vehicles and are secured on various assets and/or cashflows within the issuer's business.

(d) Analysis of total group securitisations and debentures

					BB or
	AAA	AA	A	BBB	below	Total	Total	Total
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.15	31.12.15
	£m	£m	£m	£m	£m	£m	£m	£m


Sovereigns, Supras and Sub-Sovereigns	-	743	5	-	-	748	702	682
Financial Services	-	636	1,392	249	150	2,427	2,145	2,166
Insurance	-	43	106	-	-	149	114	132
Utilities	-	103	1,799	130	-	2,032	1,727	1,768
Consumer Services and Goods
& Health Care	-	-	332	86	24	442	410	416
Technology and Telecoms	-	-	-	-	-	-	1	1
Industrials	-	43	456	300	6	805	701	711
Oil and Gas	-	-	14	32	19	65	64	65
Property	-	204	586	1	-	791	411	403
Infrastructure / PFI / Social housing	-	186	667	715	64	1,632	1,259	1,234
Covered Bonds¹	307	2	-	16	-	325	286	279
Whole Business Securitised	-	67	390	347	105	909	847	626
Commercial Property Backed Bonds	-	189	505	14	464	1,172	679	1,092
Secured Bonds²	1	121	749	289	33	1,193	1,034	959
Other	1	-	10	1	-	12	57	219


Total	309	2,337	7,011	2,180	865	12,702	10,437	10,753


1. Covered bonds are typically issued by banks and are secured on pools of residential mortgages.
2. Secured bonds are typically issued by Special Purpose Vehicles and are secured on various assets and/or cashflows within the issuer's business.

Capital and Investments Page 96

4.06 Bond portfolio summary (continued)
(e) LGR and total group analysed by credit rating
	Externally	Internally		Externally	Internally
	rated	rated¹	LGR	rated	rated¹	Total
	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16	30.06.16
	£m	£m	£m	£m	£m	£m


AAA	1,737	8	1,745	2,809	8	2,817
AA	11,964	1,700	13,664	13,096	1,704	14,800
A	14,422	2,301	16,723	15,325	2,378	17,703
BBB	12,496	1,637	14,133	13,372	1,853	15,225
BB or below	1,102	541	1,643	1,348	604	1,952
Other	-	-	-	233	-	233


	41,721	6,187	47,908	46,183	6,547	52,730


1. Where external ratings are not available an internal rating has been used where it is practicable to do so.


	Externally	Internally		Externally	Internally
	rated	rated¹	LGR	rated	rated¹	Total
	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15	30.06.15
	£m	£m	£m	£m	£m	£m


AAA	1,870	5	1,875	3,149	77	3,226
AA	9,763	1,491	11,254	10,605	1,563	12,168
A	11,996	1,634	13,630	12,915	1,664	14,579
BBB	10,268	1,220	11,488	11,133	1,393	12,526
BB or below	1,008	56	1,064	1,233	93	1,326
Other	-	6	6	-	92	92


	34,905	4,412	39,317	39,035	4,882	43,917


1. Where external ratings are not available an internal rating has been used where it is practicable to do so.


	Externally	Internally		Externally	Internally
	rated	rated¹	LGR	rated	rated¹	Total
	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	£m	£m


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


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


1. Where external ratings are not available an internal rating has been used where it is practicable to do so.

Capital and Investments Page 97

4.07 Property analysis
Group property Direct Investments by status


	LGR¹	LGC	Insurance	Total
	At	At	At	At
	30.06.16	30.06.16	30.06.16	30.06.16
	£m	£m	£m	£m	%


Fully let	2,257	58	4	2,319	94
Part let	-	-	-	-	-
Development	-	95	-	95	4
Land	-	43	-	43	2


	2,257	196	4	2,457	100


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

	LGR¹	LGC	Insurance	Total
	At	At	At	At
	30.06.15	30.06.15	30.06.15	30.06.15
	£m	£m	£m	£m	%


Fully let	2,037	30	3	2,070	93
Part let	-	-	-	-	-
Development	-	108	-	108	5
Land	-	42	-	42	2


	2,037	180	3	2,220	100


1. The fully let LGR property includes £1.7bn let to investment grade tenants.

	LGR¹	LGC	Insurance	Total
	At	At	At	At
	31.12.15	31.12.15	31.12.15	31.12.15
	£m	£m	£m	£m	%


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


	2,157	186	4	2,347	100


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

Capital and Investments Page 98

This page has been left intentionally blank

Glossary Page 99

Adjusted earnings per share*

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

Adjusted return on equity*

ROE measures the return earned by shareholders on shareholder capital retained within the business. Adjusted ROE is calculated as IFRS proﬁt after tax divided by average IFRS shareholders' funds excluding recognised gains and losses associated with held for sale and completed business disposals.

Adjusted operating profit*

Operating proﬁt measures the pre-tax result excluding the impact of investment volatility, economic assumption changes and exceptional items. Adjusted operating profit further removes exceptional restructuring costs.

Advisory assets*

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

Alternative performance measures (APMs)

Measures that are not defined by an accounting or regulatory standard, but used by the group to give shareholders a better understanding of the underlying performance of the group. All APMs defined within this glossary are marked with an asterisk.

Annualised return on equity*

Calculated by taking annualised profit after tax attributable to equity holders of the company, excluding gains and losses associated with held for sale and completed business disposals, as a percentage of the average shareholders' capital employed, being an average of the opening and closing shareholders' equity during the period.

Annual premium*

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

Assets under administration (AUA)*

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

Assets under management (AUM)*

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

Deduction and aggregation (D&A)

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

Direct investments

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

Earnings per share (EPS)

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

Economic capital*

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

* Represents an alternative performance measure.

Glossary Page 100

Economic Capital Requirement (ECR)*

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

Economic Capital Surplus*

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

ECR coverage ratio*

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

Eligible Own Funds

Eligible Own Funds represents the capital available to cover the group's Economic or Solvency II Capital Requirement. Eligible Own Funds comprise the excess of the value of assets over liabilities, as valued on an Economic Capital or Solvency II basis, plus high quality hybrid capital instruments, which are freely available (fungible and transferable) to absorb losses wherever they occur across the group.

Gross written premiums (GWP)

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

IFRS proﬁt before tax (PBT)

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

Key performance indicators (KPIs)

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

Lifetime mortgages

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

Matching adjustment

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

Net cash generation*

Net cash generation is deﬁned as operational cash generation plus new business surplus/(strain).

New business surplus/(strain)*

The net impact of writing new business on the IFRS position, including the benefit/cost of acquiring new business and the setting up of reserves.

Operating proﬁt*

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

* Represents an alternative performance measure.

Glossary Page 101

Operational cash generation*

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

Overlay assets

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

Pension risk transfer (PRT)

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

Present value of future new business profits (PVNBP)*

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

Recapitalisation Cost*

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

Return on equity (ROE)*

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

Single premiums*

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

Solvency II

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

Solvency II Risk Margin

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

Solvency II Surplus

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

Solvency Capital Requirement (SCR)

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

SCR coverage ratio

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

* Represents an alternative performance measure

Glossary Page 102

SCR coverage ratio (shareholder basis)*

In order to represent a shareholder view of group solvency on a regulatory basis, the capital requirement in relation to the ring-fenced LGAS With-profits fund is excluded from both Eligible Own Funds and the SCR in the calculation of the SCR coverage ratio.

Transitional Measures on Technical Provisions (TMTP)

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

* Represents an alternative performance measure.

This information is provided by RNS

The company news service from the London Stock Exchange

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