L&G Full Year Results 2020 Part 3

 

 

Capital                                                                                                                                                    Page 72

 

5.01 Group regulatory capital - Solvency II

 

The group complies with the requirements established by the Solvency II Framework Directive, as adopted by the Prudential Regulation Authority (PRA) in the UK and measures and monitors its capital resources on this basis.

 

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

 

The group calculates 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 Partial Internal Model basis approved by the PRA. Capital requirements for a few smaller entities are assessed using the Standard Formula basis on materiality grounds. The group's US insurance businesses are valued on a local statutory basis following the PRA's approval to use the Deduction and Aggregation method of including these businesses in the group solvency calculation.

 

The table below shows the "shareholder view" of the group Own Funds, Solvency Capital Requirement (SCR) and Surplus Own Funds, based on the Partial Internal Model, Matching Adjustment and Transitional Measures on Technical Provisions (TMTP) (recalculated as at 31 December 2020 as agreed with the PRA). The TMTP incorporates estimated impacts of end December 2020 economic conditions and changes during 2020 to the Internal Model and Matching Adjustment. This is in line with group's management of the capital position on a dynamic TMTP basis.

 

(a) Capital position
As at 31 December 2020, and on the above basis, the group had a surplus of £7.4bn (2019: £7.3bn) over its Solvency Capital Requirement, corresponding to a Solvency II capital coverage ratio on a "shareholder view" basis of 177% (2019: 184%). The shareholder view of the Solvency II capital position is as follows:
						2020		2019
						£bn		£bn
Unrestricted Tier 1 Own Funds						12.3		12.4
Restricted Tier 1 Own Funds1						0.5		-
Tier 2 Subordinated liabilities2						4.5		3.9
Eligibility restrictions						(0.2)		(0.2)
Solvency II Own Funds3						17.1		16.1
Solvency Capital Requirement						(9.7)		(8.8)
Solvency II surplus						7.4		7.3
-
SCR Coverage ratio4						177%		184%
1. Restricted Tier 1 Own Funds represent Perpetual Restricted Tier 1 Contingent Convertible Notes issued during the year. See Note 3.09 for details.
2. Tier 2 subordinated liabilities include new debt issue of £0.5bn during the year.
3. Solvency II Own Funds allow for a Risk Margin of £6.1bn (2019: £5.9bn) and TMTP of £5.6bn (2019: £5.7bn).
4. SCR Coverage ratio is based on unrounded inputs.

 

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

 

On a "proforma basis", which includes the contribution of the With-profits fund (2019 only) and the final salary pension schemes, the coverage ratio at 31 December 2020 is 175% (31 December 2019: 179%).

 

On 6 December 2017, the group announced the sale of its Mature Savings business to ReAssure Limited. ReAssure Limited assumed the economic exposure of the business from 1 January 2018 via a risk transfer agreement. The formal transfer of the business completed on 7 September 2020. The transfer was effected by way of a Part VII transfer under the Financial Services and Markets Act 2000.

 

 

Capital                                                                                                                                                    Page 73

 

5.01 Group regulatory capital - Solvency II (continued)

 

 (b) Methodology

 

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

 

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

 

Liabilities are valued on a best estimate market consistent basis, with the application of a Solvency II Matching Adjustment for valuing annuity liabilities. Own Funds incorporate changes to the Internal Model and Matching Adjustment during 2020 and the impacts of a recalculation of the TMTP as at end December 2020 as approved by the PRA. The recalculated TMTP of £5.6bn (31 December 2019: £5.7bn) is net of amortisation to 31 December 2020.

 

The liabilities include a Risk Margin of £6.1bn (31 December 2019: £5.9bn) which represents an allowance for the cost of capital for a purchasing insurer to take on the portfolio of liabilities and residual risks that are deemed to be not hedgeable under Solvency II. This is calculated using a cost of capital of 6% as prescribed by the European Insurance and Occupational Pensions Authority (EIOPA).

 

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

 

All material EEA insurance firms, including Legal and General Assurance Society Limited (LGAS) and Legal and General Assurance (Pensions Management) Limited, are incorporated into the group's Solvency II Internal Model assessment of required capital, assuming diversification of the risks between and within those firms. These firms, as well as the non-EEA insurance firm (Legal & General Reinsurance Company Limited (LGRe) based in Bermuda) contribute over 93% of the group's SCR.

 

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

 

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

 

All non-insurance regulated firms are included using their regulatory surplus on 31 December 2020.

 

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

 

 

Capital                                                                                                                                                    Page 74

 

5.01 Group regulatory capital - Solvency II (continued)

 

 (c) Assumptions

 

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

 

(i)         assumptions required to derive the present value of best estimate liability cash flows. Non-market assumptions are consistent with those underlying the group's IFRS disclosures, but with the removal of any prudence margins. Future investment returns and discount rates are those defined by EIOPA, which means that the risk-free rates used to discount liabilities are market swap rates, with an 11 basis point (2019: 11 basis points) deduction to allow for a credit risk adjustment for sterling denominated liabilities. For annuities that are eligible, the liability discount rate includes a Matching Adjustment. This Matching Adjustment varies between LGAS and LGRe and by the currency of the relevant liabilities.

 

At 31 December 2020 the Matching Adjustment for the UK GBP portfolio was 103 basis points (31 December 2019: 110 basis points) after deducting an allowance for the EIOPA fundamental spread equivalent to 55 basis points (31 December 2019: 53 basis points).

 

(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 year ended 31 December 2020 in the group's Solvency II surplus.
	2020	2019
	£bn	£bn
Surplus arising from back-book (including release of SCR)	1.3	1.5
Release of Risk Margin1	0.6	0.4
Amortisation of TMTP2	(0.4)	(0.3)
Total operational surplus generation3	1.5	1.6
Operational surplus generation - continuing operations	1.5	1.5
Operational surplus generation - discontinued operations	-	0.1
Total operational surplus generation3	1.5	1.6
New business strain - continuing operations	(0.3)	(0.5)
New business strain - discontinued operations	-	(0.1)
New business strain	(0.3)	(0.6)
Net surplus generation	1.2	1.0
Operating variances4	0.4	0.3
Mergers, acquisitions and disposals5	(0.1)	0.1
Market movements6	(1.4)	(0.2)
Restricted Tier 1 convertible notes7	0.5	-
Subordinated liabilities8	0.5	0.2
Dividends paid9	(1.0)	(1.0)
Total surplus movement (after dividends paid in the year)	0.1	0.4
1. Based on the Risk Margin in force at 31 December 2019 and does not include the release of any Risk Margin added by new business written in 2020.
2. TMTP amortisation based on a linear run down of the 31 December 2019 TMTP.
3. Release of surplus generated by in-force business and includes management actions which at the start of the year could have been reasonably expected to take place. For 2020 these are primarily related to the optimisation of structures used to make assets Matching Adjustment eligible and the planned reinsurance of back-book liabilities.
4. Operating variances include the impact of experience variances, changes to valuation and capital calibration assumptions, other management actions including changes in asset mix, hedging strategies, and Matching Adjustment optimisation.
5. Mergers, acquisitions and disposals include the impacts of the sale of the Mature Savings business, which completed in H2 20.
6. Market movements represent the impact of changes in investment market conditions over the year and changes to future economic assumptions. Market movements in 2020 include an increase in the Risk Margin of £0.7bn (net of tax) and an increase to TMTP of £0.7bn (net of tax).
7. Restricted Tier 1 convertible notes represent an issuance of £0.5bn in the year (2019: nil).
8. Subordinated liabilities includes an issuance of £0.5bn in the year (2019: redemption of £0.4bn and an issuance of £0.6bn).
9. Dividends paid are the amounts from the 2019 final and 2020 interim dividend declarations (2019: 2018 final and 2019 interim dividend declarations).

 

 

Capital                                                                                                                                                    Page 75

 

5.01 Group regulatory capital - Solvency II (continued)

 

 (d) Analysis of change (continued)

 

 

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

 

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

 

(e) Reconciliation of IFRS Release from operations to Solvency II Operational surplus generation
(i) The table below provides a reconciliation of the group's IFRS Release from operations to Solvency II Operational surplus generation.
			2020	2019
			£bn	£bn
IFRS Release from operations			1.3	1.3
Expected release of IFRS prudential margins			(0.5)	(0.5)
Releases of IFRS specific reserves1			(0.2)	(0.1)
Solvency II investment margin2,3			0.3	0.2
Release of Solvency II Capital Requirement and Risk Margin less TMTP amortisation			0.6	0.7
Solvency II Operational surplus generation4			1.5	1.6
1. Release of prudence from IFRS specific reserves which are not included in Solvency II (e.g. long term longevity and expense margins).
2. Release of prudence related to differences between the EIOPA-defined Fundamental Spread and Legal & General's best estimate default assumption.
3. Expected market returns earned on LGR's free assets in excess of risk-free rates over 2020.
4. Solvency II Operational Surplus Generation includes management actions which at the start of 2020 were reasonably expected to be implemented over the year.
(ii) The table below provides a reconciliation of the group's IFRS New business surplus to Solvency II New business strain.
			2020	2019
			£bn	£bn
IFRS New business surplus			0.3	0.3
Removal of requirement to set up prudential margins above best estimate on new business			0.3	0.2
Set up of SCR on new business			(0.7)	(0.9)
Set up of Risk Margin on new business			(0.2)	(0.2)
Solvency II New business strain1			(0.3)	(0.6)
1. UK PRT new business volume during 2020 was £7.6bn, compared to £10.3bn over 2019.

 

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

A reconciliation of the group's IFRS equity to Solvency II Own Funds is given below:
			2020	20194
			£bn	£bn
IFRS equity			10.0	9.1
Remove DAC, goodwill and other intangible assets and associated liabilities			(0.4)	(0.5)
Add IFRS carrying value of subordinated borrowings1			4.0	3.5
Insurance contract valuation differences2			4.5	5.6
Difference in value of net deferred tax liabilities			(0.6)	(0.6)
SCR for with-profits fund and final salary pension schemes			(0.2)	(0.8)
Eligibility restrictions3			(0.2)	(0.2)
Solvency II Own Funds			17.1	16.1
1. Treated as available capital on the Solvency II balance sheet as the liabilities are subordinate to policyholder claims.
2. Differences in the measurement of technical provisions between IFRS and Solvency II.
3. Relating to the Own Funds of non-insurance regulated entities that are subject to local regulatory rules.
4. Following the change in accounting policy for LGIA universal life and annuity IFRS reserves, the 2019 reconciliation has been restated. Further details on the change in accounting policy are provided in Note 3.01.

 

 

Capital                                                                                                                                                    Page 76

 

5.01 Group regulatory capital - Solvency II (continued)

 

(g) Sensitivity analysis   The following sensitivities are provided to give an indication of how the group's Solvency II surplus as at 31 December 2020 would have changed in a variety of adverse events. These are all independent stresses to a single risk. In practice, the balance sheet is impacted by combinations of stresses and the combined impact can be larger than adding together the impacts of the same stresses in isolation. It is expected that, particularly for market risks, adverse stresses will happen together.
			Impact on	Impact on	Impact on	Impact on
			net of tax	net of tax	net of tax	net of tax
			Solvency II	Solvency II	Solvency II	Solvency II
			capital	coverage	capital	coverage
			surplus1	ratio1	surplus1	ratio1
			2020	2020	2019	2019
			£bn	%	£bn	%
Credit spreads widen by 100bps assuming an escalating addition to ratings2,3			0.5	11	0.3	8
Credit spreads narrow by 100bps assuming an escalating addition to ratings2,3			(0.7)	(12)	(0.4)	(9)
Credit spreads widen by 100bps assuming a level addition to ratings2			0.7	13	0.5	11
Credit spreads of sub investment grade assets widen by 100bps assuming a level addition to ratings2,4			(0.4)	(5)	(0.3)	(6)
Credit migration5			(1.2)	(13)	(0.8)	(9)
25% fall in equity markets6			(0.5)	(4)	(0.5)	(5)
15% fall in property markets7			(0.6)	(6)	(0.7)	(6)
100bps increase in risk-free rates8			1.0	20	1.0	22
50bps decrease in risk-free rates8,9			(0.7)	(11)	(0.6)	(11)
10% increase in maintenance expenses10			(0.3)	(3)	(0.2)	(3)
Substantially reduced Risk Margin11			0.5	5	0.6	6
1. Both the 2020 and 2019 sensitivities exclude the impact from the Mature Savings business (including the With-Profits fund) as the risks were transferred to ReAssure Limited from 1 January 2018.
2. The spread sensitivity applies to the group's corporate bond (and similar) holdings, with no change in long-term default expectations. Restructured lifetime mortgages are excluded as the underlying exposure is mostly to property.
3. The stress for AA bonds is twice that for AAA bonds, for A bonds it is three times, for BBB four times and so on, such that the weighted average spread stress for the portfolio is 100 basis points. To give a 100bps increase on the total portfolio, the spread stress increases in steps of 32bps, i.e. 32bps for AAA, 64bps for AA etc.
4. No stress for bonds rated BBB and above. For bonds rated BB and below the stress is 100bps.  The spread widening on the total portfolio is 2bps as the group holds only 2% in bonds rated BB and below. The impact is primarily an increase in SCR arising from the modelled cost of trading downgraded bonds back to a higher rating in the stress scenarios in the SCR calculation.
5. Credit migration stress covers the cost of an immediate big letter downgrade on 20% of all assets where the capital treatment depends on a credit rating (including corporate bonds, and sale and leaseback rental strips; lifetime mortgage senior notes are excluded). Downgraded assets are assumed to be traded to their original credit rating, so the impact is primarily a reduction in Own Funds from the loss of value on downgrade.  The impact of the sensitivity will depend upon the market levels of spreads at the balance sheet date.
6. This relates primarily to equity exposure in LGC but will also include equity-based mutual funds and other investments that receive an equity stress (for example, certain investments in subsidiaries). Some assets have factors that increase or decrease the stress relative to general equity levels via a beta factor.
7. Assets stressed include residual values from sale and leaseback, the full amount of lifetime mortgages and direct investments treated as property.
8. Assuming a recalculation of the Transitional Measure on Technical Provisions that partially offsets the impact on Risk Margin.
9. In the interest rate down stress negative rates are allowed, i.e. there is no floor at zero rates.
10. A 10% increase in the assumed unit costs and future costs of investment management across all long term insurance business lines.
11. Assuming a 2/3 reduction in the Risk Margin, allowing for offset from an equivalent reduction in the Transitional Measure on Technical Provisions.
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. Other than in the interest rate stresses, we have not allowed for the recalculation of TMTP.   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                                                                                                                                                    Page 77

 

5.01 Group regulatory capital - Solvency II (continued)

 

(h) Analysis of Group Solvency Capital Requirement
The table below shows a breakdown of the group's SCR by risk type. The split is shown before the effects of diversification and tax.
		2020	2019
		%	%
Interest rate		2	1
Equity		6	6
Property		9	9
Credit1		29	27
Currency		3	4
Inflation		7	6
Total Market risk2		56	53
Counterparty risk		1	2
Life mortality		3	3
Life longevity3		22	22
Life mass lapse		2	2
Life non-mass lapse		2	2
Life catastrophe		4	5
Expense		3	3
Total Insurance risk		36	37
Non-life underwriting		1	1
Operational risk		4	5
Miscellaneous4		2	2
Total SCR		100	100
1. Credit risk is one of the group's most significant exposures, arising predominantly from the portfolio of bonds and bond-like assets backing the group's annuity business.
2. In addition to credit risk the group also has significant exposure to other market risks, primarily due to the investment holdings within the shareholder funds but also the risk to fee income from assets backing unit-linked business.
3. Longevity risk is the group's most significant insurance risk exposure, arising from the annuity book on which the majority of the longevity risk on the back-book is retained. However, we expect this to reduce over time as we continue to reinsure the majority of the exposure on the new business written post the implementation of Solvency II.
4. Miscellaneous includes LGA on a Deduction and Aggregation basis and the sectoral capital requirements for non-insurance regulated firms.

 

 

Capital                                                                                                                                                    Page 78

 

5.02 Estimated Solvency II new business contribution

 

(a) New business by product1
Management estimates of the present value of new business premium (PVNBP) and the margin for selected lines of business are provided below:
			Contribution			Contribution
			from new			from new
		PVNBP	business2	Margin3	PVNBP	business2	Margin3
		Full Year	Full Year	Full Year	Full year	Full year	Full year
		2020	2020	2020	2019	2019	2019
		£m	£m	%	£m	£m	%
LGR - UK annuity business		8,503	901	10.6	11,295	890	7.9
UK Protection Total		1,887	160	8.5	1,604	122	7.6
- Retail Protection		1,359	123	9.1	1,284	98	7.6
- Group Protection		528	37	7.0	320	24	7.5
US Protection4		829	94	11.2	850	94	11.1
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 year using the risk discount rate applicable at the end of the year.
3. Margin is based on unrounded inputs.
4. In local currency, US Protection reflects PVNBP of $1,064m (31 December 2019: $1,085m) and a contribution from new business of $120m (31 December 2019: $120m).
The increase in LGR margin was driven by the longer average duration for the schemes written in 2020, compared to the schemes written in prior year.   For UK Protection new business the increase in profitability was driven by a shift in the product mix combined with continued price optimisation. The margin was further increased by the fall in interest rates during 2020.

 

 

Capital                                                                                                                                                    Page 79

 

5.02 Estimated Solvency II new business contribution (continued)

 

 (b) Assumptions

 

The key economic assumptions are as follows:

 

	2020	2019
	%	%
Margin for Risk	3.9	3.5
Risk-free rate
- UK	0.5	1.1
- US	0.9	1.9
Risk discount rate (net of tax)
- UK	4.4	4.6
- US	4.8	5.4
Long-term rate of return on non-profit annuities in LGR	2.1	2.8

 

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

 

Other than updating for recent experience, all other economic and non-economic assumptions and methodologies that would have a material impact on the margin for these contracts are unchanged from those previously used by the group for its European Embedded Value reporting, other than the cost of currency hedging which has been updated to reflect current market conditions and hedging activity in light of Solvency II. In particular:

 

·      The assumed future pre-tax returns on fixed interest and RPI-linked securities are set by reference to the portfolio yield on the relevant backing assets held at market value at the end of the reporting period. The calculated return takes account of derivatives and other credit instruments in the investment portfolio. The returns on fixed and index-linked assets are calculated net of an allowance for default risk which takes account of the credit rating and the outstanding term of the assets. The allowance for corporate and other unapproved credit asset defaults within the new business contribution is calculated explicitly for each bulk annuity scheme written, and the weighted average deduction for business written in 2020 equates to a level rate deduction from the expected returns for the overall annuities portfolio of 15 basis points.

 

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

 

Tax

 

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

 

The profits on the new business are calculated on an after tax basis and are grossed up by the notional attributed tax rate. For the UK, the after tax basis assumes the annualised current rate of 19%. The tax rate used for grossing up is the long-term corporate tax rate in the territory concerned, which for the UK is 19%.

 

US covered business profits are grossed up using the long-term corporate tax rate of 21%.

 

 

Capital                                                                                                                                                    Page 80

 

5.02 Estimated Solvency II new business contribution (continued)

 

 (c) Methodology

 

Basis of preparation

 

Solvency II new business contribution reflects the portion of Solvency II value added by new business written in the period. It has been calculated in a manner consistent with principles and methodologies as set out in the group's 2020 Annual Report and Accounts and Full Year Results.

 

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

 

Description of methodology

 

The objective of the Solvency II new business contribution is to provide shareholders with information on the long-term contribution of new business written in 2020.

 

The Solvency II new business contribution has been calculated as the present value of future shareholder profits arising from business written in 2020. Cash flow projections are determined using best estimate assumptions for each component of cash flow and for each policy group. Best estimate assumptions including mortality, morbidity, persistency and expenses reflect recent operating experience and are set in accordance with the CFO Forum EEV Principles, dated April 2016.

 

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

 

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

 

LGA is consolidated into the group solvency balance sheet on a US Statutory solvency basis.  Intra-group reinsurance arrangements are in place between US, UK and Bermudan businesses and it is expected that these arrangements will be periodically extended to cover future new business. The LGA new business margin looks through the intra-group arrangements.

 

Projection assumptions

 

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

 

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

 

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

 

Tax

 

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

 

Risk discount rate

 

The risk discount rate (RDR) is duration-based and is a combination of the risk-free curve and a flat Margin for Risk.

 

The risk-free rates have been based on a swap curve net of the EIOPA-specified Credit Risk Adjustment of 11 basis points for GBP and 16 basis points for USD (31 December 2019: 11 basis points for GBP and 13 basis points for USD).

 

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

 

 

Capital                                                                                                                                                    Page 81

 

5.02 Estimated Solvency II new business contribution (continued)

 

 (c) Methodology (continued)

 

The WACC is derived from the group's cost of equity, cost of 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 19% (31 December 2019: 17.17%).

 

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 and the inherent strength of the group's regulatory reserves, is appropriate to reflect the risks within the covered business.

 

(d) Reconciliation of PVNBP to gross written premium
A reconciliation of PVNBP and gross written premium is given below:
		2020	2019
	Notes	£bn	£bn
PVNBP	5.02 (a)	11.2	13.7
Effect of capitalisation factor		(2.3)	(1.9)
New business premiums from selected lines		8.9	11.8
Other1		2.0	1.9
Total LGR and LGI new business	4.07,4.08	10.9	13.7
Annualisation impact of regular premium long-term business		(0.2)	(0.2)
IFRS gross written premiums from existing long-term insurance business		3.0	2.9
Deposit accounting for investment products		(1.2)	(1.2)
Total gross written premiums2	2.01	12.5	15.2
1. Other principally includes annuity sales in the US and lifetime and retirement interest only mortgage advances.
2. Total gross written premiums exclude gross written premiums from discontinued operations, but include £114m of gross written premiums relating to a residual reinsurance treaty following the disposal of the General Insurance business