Good morning, everyone. It's really, really thrilling to see everyone today here at Legal & General. Welcome to our results presentation for the first half of 2022. Please silence mobile phones, and the usual disclaimers about forward-looking statements apply. Consistent strength and growth are very apparent in today's numbers. Strength in our balance sheet, which consistently proves itself highly resilient in the face of external economic and political shocks, and profitable growth delivered by all our businesses. We are performing ahead of our 5-year plan for cash and capital generation, delivering unique synergies across divisions, and we have a terrific collaborative management team. I'd like to thank all of our people for today's results, while still encouraging them to be even more ambitious. Here are the headline numbers. Operating profit from divisions up 7% to GBP 1.35 billion.
EPS of 19.28 pence. That's up 8% as well. This is more than the 18.16 pence we achieved in the whole of 2015, when the share price was the same as it is today. The ROE of 21.3% and a Solvency II ratio of 212%. Solvency II operational surplus generation GBP 0.9 billion. That's up 14%. An interim dividend of 5.44 pence, up by 5%. Our four business divisions deliver balanced, high-quality earnings. Across LGC, LGIM, LGRI, and Retail, we cover alternative asset origination, asset management, global pension risk transfer, and U.K. Retail Retirement and Protection. We are the market leader in at least ten of the market segments where we participate.
Indeed, we participate in scale markets, where we have leadership, and growth markets, where we can both lead and deliver scale. Our strategy is very clear and our focus is relentless. These businesses work together to deliver the synergies which underpin our consistent 20% ROE. This should be a familiar slide, but the extent of the positive interplay between the divisions is a unique feature for Legal & General. Asset origination in LGC enables us to win business and optimize the annuity back book. Retail is a source of capital and further assets through lifetime mortgages. Our principal balance sheet in LGRI is a source of business for LGIM, and LGIM brings investment management scale and access to 3,000 institutional clients, a potential source of third-party capital for LGC. Our four divisions each contribute. LGRI, GBP 560 million, up by 7%.
LGC, GBP 263 million, up by 5%. LGIM, GBP 200 million, down only 2%, despite the market shocks of recent months. Retail, up GBP 332 million, up 14%. The six strategic growth drivers to which we align our businesses have not changed. In fact, they are more relevant today than they have ever been, and the market opportunities they drive are immense. Demographics is now trendy. The world continues to get older, driving demand for pension de-risking and retirement solutions, a global $57 trillion opportunity. Only 10% of available DB schemes have completed buyouts, so we've just scratched the surface. Asset management continues to globalize and consolidate. The tough space is in the middle, but LGIM is in the global top dozen and internationalizing fast in this $129 trillion global marketplace.
Real economy investment is supported politically. We are likely to see positive change in this area, and the market favors alternative assets. We have a unique capability to deliver and a trusted track record. Constrained government spending and economic insecurity drive welfare reform and the need for personal provision. Technology is advancing faster than at any point since the 1860s. We have invested directly and indirectly in over 500 startups. Climate change or possibly climate catastrophe creates a $20 trillion liability, and with it, for us, a series of huge investment opportunities. There's a great deal more to do as we tackle the planet's most pressing crisis. Turning to the current economic and market environment, this slide captures the three current trends of normalizing interest rates, widening credit spreads, and rising inflation and their respective impacts on Legal & General. First, normalizing interest rates.
This is a net positive for us as a group. You see the positive effects on the Solvency II ratio. This gives us greater capital optionality and creates more favorable conditions for PRT transactions. Normalizing rates also helps EPS as they drive positive insurance investment variances. Against this, you see the higher rates reducing LGIM's fixed income revenue. However, the shape and balance of our group is such that normalizing interest rates is a net tailwind. Widening credit spreads similarly support the PRT market by reducing DB scheme deficits and improving bulk annuity pricing with positive consequential effects for both volumes and margins. Our credit portfolio has seen no defaults since 2008.
Concerns about the impact of widening spreads are simply not borne out by the facts, as Jeff will explain in some detail. Inflation, which is a challenge for so many people across the U.K., has a minimal second-order impact on us . In short, L&G's mix of business and its resilient business balance sheet again put us in a very strong position to manage headwinds from the broader economy. We're on track to achieve or indeed beat our cumulative cash and capital ambitions for the 5-year period, 2020 to 2024. Here you see the 0%, 5%, and 10% growth assumptions for both cash and capital. The key takeaway is that even if we have zero growth in cash and capital from here through to 2024, we will achieve our target. This is a good underpin, but we will not rest on our laurels.
We are confident that we can grow cash and capital faster than our dividend commitment. Widening jaws over the dividend creates positive optionality for us. We expect our annuity portfolio to be self-sustaining again in 2022, as it was in 2020 and 2021. The driver is growing operational surplus or capital generation, which we expect to see at GBP 1.8 billion in 2022. This grows year on year as the annuity portfolio grows, and we exercise consistent discipline around new business strain. Our newly created retail division has multiple growth opportunities. In Retail Retirement, we have strong market shares in growing markets, in workplace savings, in retirement income, and in home finance. We also have strong positions in the U.K. Protection and a smaller market share in the larger U.S. Protection market, where we are bringing to bear our digital expertise, disrupting the market, and gaining market share.
In Fintech, we have made nine strategic investments in growing and exciting businesses that complement or are adjacent to our own business. L&G has always been a purpose-led company. We think this is entirely consistent with the delivering value for our shareholders. Aligning purpose and profit makes purpose scalable. We believe in applying the principles of ESG. We include health as a socially beneficial impact. Tackling health inequalities is explicitly part of our levelling-up policy. We have started already through our partnership with Sir Michael Marmot to narrow the widening inequalities in health outcomes. ESG and a commitment to sustainability strengthens our business for the long term, attracting new customers and existing customers, and also motivating our employees.
Inclusive capitalism, that is investing our capital and our customer savings to benefit society as well as delivering good returns, is a purpose we have been leaning into for over a decade, including our 20 U.K. cities and now the GBP 4 billion investment in the West Midlands, the GBP 2.2 billion deal with British Steel Pension, and a $4 billion deal with Ancora in the United States. To sum up, our strategic drivers are more valid than ever. We have made a strong start to 2022. LGIM experienced GBP 65 billion of inflows. The market environment is accelerating global demand for PRT. LGC is on track for our 2025 ambitions to deliver at least GBP 600 million-GBP 700 million of operating profit and attract GBP 25 billion-GBP 30 billion of external capital. These are strong half-year results, and the outlook for the full year is positive.
I'll now hand over to Jeff to take you through the numbers in more detail. Jeff?
Go on. We'll switch , just in case I start coughing. Morning, everyone. Hope you're keeping well, if not a little warm. In the first half of 2022, Legal & General continued to prove its resilience by delivering another set of strong results. Year-to-date operating performance is in line with our expectations, notwithstanding market volatility, with operating profit up 8% to GBP 1.2 billion. Investment variance was positive, reflecting the impact of increasing interest rates on protection reserves and strong performance in the annuity portfolio. This was partially offset by volatile global equity markets impacting LGC's traded equities. As Nigel mentioned earlier, we are well-positioned to navigate prevailing market conditions, and our diversified business model allows us to continue to deliver dependable and consistent value generation to our shareholders.
In the first half, profit before tax was up on the prior year at GBP 1.4 billion, with earnings per share at 19.28 pence, up 8%, and our ROE was once again above 20%. Solvency II operational surplus generation was GBP 0.9 billion, up 14%. Finally, the coverage ratio at 212%. This very strong ratio demonstrates the strength of our balance sheet and provides the group with optionality for future growth opportunities. Turning to our divisions. In the first half, LGRI delivered an operating profit of GBP 560 million. This performance was driven by the ongoing predictable delivery of prudential margin releases from our growing back book, an effective ongoing asset strategy that is increasing the total yield on our portfolio. A new business surplus was generated from robust volumes of PRT business.
Investment variance was positive, reflecting the continued strength of LGRI's defensively managed and well-diversified asset portfolio. The H1 2021 results included positive variances driven by COVID-related deaths, which have not been repeated at the same scale in this period. In the first half, LGRI wrote GBP 4.4 billion of global PRT across 25 transactions. These volumes were written at attractive margins, and capital strain levels were below 4%, the result of good asset origination and favorable reinsurance pricing. We were pleased to announce a follow-on transaction of over GBP 2 billion with British Steel Pension Scheme in the U.K., executed under an umbrella agreement. In the U.S., we wrote our biggest ever transaction at over $550 million. We continue to be excited by our growth prospects in the U.S. PRT market.
We wrote another Canadian deal for CAD 230 million, building on our strategic partnerships in that market. Market volumes in 2022 are expected to be higher than in 2021, and our pipeline is strong. We're confident in delivering against our 5-year ambition of GBP 40 billion-GBP 50 billion of U.K. PRT and $10 billion of international PRT. As always, we will remain disciplined in our pricing to ensure we achieve our target financial metrics. Moving to the annuity asset portfolio. As usual, we provide an overview of our A-minus rated annuity portfolio. The diversified GBP 73.2 billion bond portfolio, down in value because of rising interest rates, is defensively positioned and actively managed to optimize performance and mitigate downgrades. We've maintained high credit quality with two-thirds of our bond portfolio rated A or better, with 14% in sovereign-like assets.
Our portfolio is geographically diverse, and we have minimal lower-rated cyclical exposures. During the first half, we originated GBP 1.6 billion of new direct investments. The DI portfolio now stands at GBP 20.5 billion, approximately 26% of total assets. 100% of scheduled cash flows were paid in the period, and around two-thirds of our DI portfolio exposure is from counterparties rated A or above, often secured, making it very resilient to market stresses. We provided our top 10 triple B exposures in the appendix. It includes names such as National Grid and Bayer. Our ambition is to continue to strengthen our asset sourcing capabilities with a strong ESG focus.
Working alongside LGIM and LGC, our ability to self-manufacture attractive long-term assets to back annuities, for example, affordable housing built to rent and urban regeneration, is a differentiating feature of our annuity business and remains a key competitive advantage. Investment-grade credit, which very rarely defaults, represents 99% of our annuity bond portfolio. Even so, we adopt a prudent annual IFRS default allowance of 43 basis points based on assumptions that have been broadly unchanged for almost a decade. This is equivalent to the GBP 2.7 billion default reserve held on the Group's balance sheet. To illustrate the level of prudence in this assumption, the IFRS base default assumption for the portfolio is just 18 basis points, which in itself has proven to be conservative. Our actual default experience has been much lower, with an annualized default rate since 2007 of less than one basis point.
While we are, of course, proud of our track record of low defaults, the key point is that we adopt prudent default assumptions that we expect to be significantly greater than our experience over time, and which provide us with optionality as margins unwind to rebalance the portfolio if and as required. The outcome of our careful approach to managing credit risk can be seen clearly on this slide. Since 2007, the annuity book has more than quadrupled in size. Actual default losses in the book have been just GBP 25 million, and the majority of these were back in 2008. The difference between the base default assumption and our actual default experience is reported through investment variance together with other trading profits. Year-on-year, this variance has been positive even after allowing for the cost of selectively trading out of any assets.
To further demonstrate the resilience of our balance sheet, we've run a severe potential credit stress scenario broadly consistent with 2001-2 credit event, the worst period in 30 years for downgrades and defaults. In this scenario, we assume 1% of our credit assets default pre-recoveries, with 1.4% of triple-B assets defaulted and 7% of sub-investment grade assets defaulting. We assume an immediate big letter downgrade on 20% of all assets and haven't recognized any benefit from widening credit spreads. In this scenario, the primary impact on our solvency ratio is from downgrades. We would expect downgrades to reduce the ratio by around 29% without taking any management action. However, experience shows we could take action to rebalance the portfolio.
We would add around 10% points from a partial rebalancing of sub-investment grade assets, which in itself is prudent compared to our standard sensitivity. We could therefore reasonably expect the solvency ratio to be around 190% shortly after this scenario, given the current starting point. This demonstrates that our balance sheet is well positioned to absorb a significant credit event should it occur. Moving on to LGC. Operating profit was up 5% at GBP 263 million. This reflects increased profits from our alternative asset portfolio and strong trading performances in CALA and Affordable Homes, as well as valuation increases in our VC portfolio and in Pemberton, which was driven by strong growth in revenues and committed AUM.
The alternatives portfolio now stands at GBP 3.7 billion. We also now have GBP 15.6 billion of third-party capital, which positions us well to exceed our ambition in managing over 30 billion of alternative assets by 2025, and delivering at least GBP 600 million-GBP 700 million of operating profit. As part of LGC's growth strategy, we recently announced our first U.S. investment, a 50-50 partnership with U.S. real estate developer Ancora, delivering life science and research facilities in this fast-growing market. This is the first step in replicating the synergistic model we have in the U.K., and will produce investment opportunities for both third parties as well as the annuity portfolio. Moving on to our investment management division. In LGIM, operating profit was down 2% to GBP 200 million.
A resilient result in tough market conditions, where interest rates, inflation, and equities impacted asset values across the portfolio. Second half revenues will be challenged if these conditions continue. Expenses were up, reflecting ongoing investment in the business and inflation, offset by careful cost management, resulting in a stable cost income ratio of 59%. Total AUM was down slightly at GBP 1.3 trillion, with international assets accounting for approximately 36% of GBP 468 billion. We remain a market leader in U.K. DC, where our strong customer focus has helped grow AUM to GBP 109-129 billion, covering over 4.7 million workplace members. Our wholesale business continues to make good progress, with AUM reaching GBP 46 billion. We continue to make strategic progress to modernize, diversify, and internationalize the business.
For example, we are expanding our ESG product range. This includes ongoing preparations for the launch of a new renewable infrastructure equity offering in partnership with NTR. In Europe, we've expanded our product range through the development of thematic equity and fixed income ETF products, and extended our distribution reach. In the U.S., we expanded our product proposition through the launch of 5 new mutual funds, which provide the building blocks for our U.S., DC retirement income solution. We also added to our U.S. real estate investment capability. Despite market volatility, we delivered record external net flows of GBP 65.6 billion, equivalent to 10% of opening external AUM on an annualized basis. The flows were diversified across the business and driven by strong international growth, reflecting deep relationships with our clients. International net flows represented over half of LGIM's total.
U.K. DB flows were also strong as clients seek to de-risk in volatile markets, with ongoing demand for LDI solutions. U.K. DC also produced solid results where we had 22 scheme wins, many of which use our multi-asset or target date funds as their default strategy. Our ETF business has shown a resilient performance against a challenging market backdrop, contributing to overall growth in LGIM's annualized net new revenue of GBP 13 million, up 14% compared to the first half of last year. Now moving on to our retail division. Operating profit increased 14% to GBP 332 million, driven by ongoing releases from our growing protection and individual annuity portfolios. We also experienced valuation uplifts in two of our retail fintech businesses, where there was external funding and strong business growth.
In the U.S., we continue to experience adverse mortality consistent with the broader market. COVID-related claims were concentrated in Q1, and in line with the GBP 57 million provision set up at the year-end. Solvency II new business value generated was down on the prior year at GBP 124 million, reflecting some margin pressure and lower retail protection volumes compared to the very strong market we saw in the first half of 2021. Moving on to capital. Our balance sheet remains well capitalized, with the group Solvency II surplus at GBP 9.2 billion. As at the end of June, the coverage ratio was 212%, as we've said, following positive market movements, partially offset by payment of the 2021 final dividend.
Operational surplus generation from the growing back book was up 14%, demonstrating the predictable nature of our capital generation. After allowing for efficient new business strain of just GBP 0.1 billion, net surplus generation was GBP 0.8 billion. Market movements were GBP 1.2 billion, predominantly driven by the higher interest rates. As a reminder, we hedge inflation and so are not materially exposed to this risk, as can be seen by our sensitivities. A 50 basis points increase in future inflation expectations reduces the solvency ratio by just three percentage points. To conclude, we have delivered another strong set of financial results, with operating profit up 8% and an ROE of 21.3%. Our carefully managed annuity portfolio continues to perform as expected, with no defaults, and we are well positioned to absorb a significant credit event should it occur.
As noted, assuming no change in market conditions in the second half, we expect LGIM revenues to be down year-over-year due to the reduced level of AUM. However, given our diversified businesses, we still expect the group to deliver full-year operating profit growth in line with the first half. Our unique business model drives predictable levels of cash and capital, and funds our progressive dividend. As guided previously, we expect to deliver GBP 1.8 billion of capital generation at the full year. We continue to make significant progress on our 5-year ambition, and our solvency position is stronger than ever, allowing us to capitalize on the significant growth opportunities across our businesses. Thank you. Nigel?
Thanks, Jeff. The investment case for Legal & General can be summarized in these six points. A track record of growth which has been consistent through changing economic environments, driven by a proven synergistic business model, delivering 20% ROE, delivering predictable value across the long term, a resilient balance sheet and a clear purpose. This is a standout proposition in a challenging economic and political environment. We have delivered again in H1 2022 and are positive and ambitious in our outlook for the second half of the year and beyond. Thank you. We're now very happy to take questions. Before each question, can people state their name and the organization they're representing. Why don't we start with Andy.
Thanks. It's Andy Sinclair from Bank of America. Three for me, please. Firstly, it was just on LGC. Just wonder if you could give us an idea of the actual cash generated within LGC, and if possible, just to give an idea of that by mature businesses, disposal proceeds, and margins on third party capital. That's question one. Second was just on the bond portfolio. I think for the first time, correct me if I'm wrong, under 50% of the portfolio is now in the U.K., with over 50% international. Just wondering, are you looking to further internationalize that portfolio? And does the average credit rating differ by geography? Thirdly was just on LGIM.
Just with the slightly lower AUM base, just if you could give us an update on outlook for costs and cost income ratio, for the rest of the year and beyond. Thanks.
Okay, Jeff, do you wanna take the first one? I'll do the second one, then Michelle, you're happy with the third one.
Sure, yeah. The cash around LGC for the first half was round about our profit. I think you'd said before, sometimes it'll be less than our profit, sometimes it'll be more, some will be significantly more, as it was last year with sale of MediaCityUK, for example. There were no large transactions as such in the first half, so it was good, steady cash emergence. Round about, just higher than the profit number.
It was very observant of you on the bond portfolio 'cause that was in the appendix in one of the slides. Well done, Andy. It is indeed the case that we've invested more of the assets in outside the U.K. than in the U.K., 51-49. That's one of the arguments we've been having with both the government and the regulator, because clearly, ideally we'd like to invest more of those in the U.K. Giving us a mandate where we have more opportunities and more asset classes in the U.K. would undoubtedly result in a better outcome for the U.K. Unfortunately, I mean, America is very open for business as my colleagues will tell you.
Therefore we are getting some pull from America and in one sense, the attractiveness of America is going up a bit and the U.K. is going down a bit under the current political and regulatory environment over here. We'd like to reverse that. We're hoping one of the things that the new prime minister does is indeed reverse that, to give us more opportunities to invest here in the U.K. Plus, ironically, they've got a bit ahead of us in things like retrofitting, where retrofitting of housing and offices already produces a matching adjustment asset class. we'd like the U.K. to at least keep up with the U.S. and indeed Europe. Michelle.
Look, on costs. I mean, just to say, clearly it's a challenging time. I'm not going to lie about that. In terms of what we said. What we said at the Capital Markets Event in November 2020 was that we would expect to see the cost income ratio go up towards the mid- to high-50s%, given that we're going to invest in the business. That hasn't changed. What's happened is, Jeff has also indicated, is that we would expect that to probably drift up a little bit actually in the next year or so. That's not gonna be the norm. It'll normalize once markets settle, and we'd expect that to come down again over time.
Thank you, Michelle. We do three there, then we'll
Hi. Thank you. Ashik Musaddi from Morgan Stanley. First of all, great set of results and pretty clean this time, I really appreciate that. Not many one-offs, so that's good news. Just three questions. One, I saw somewhere in the table at the end of the presentation that the credit default reserve was GBP 3.4 billion last year. It's GBP 2.7 billion this year. I mean, can we just get the big mechanics? I think it has to do with the level of assets. But would be good to get a bit of mechanics as to how you decide on this number, would be good. Thank you. The second one is around the solvency ratio. Now, 212% is a number, which looks pretty good.
I guess you would agree that there is a lot of buffer to absorb shocks here, but how are you viewing this? I mean, would you like to capitalize on this through some extra capital return or some accelerated growth? Are you looking to do that or you're just waiting for markets to settle and then take a call at that point? The third one is, I mean, one of the sensitivities that you have is around interest rates and a bit of benefit that has come through in the solvency ratio is rates. Is there any way you can hedge that out?
At a reasonable cost so that the solvency ratio doesn't go down, even if the interest rate drops again? Thank you.
Jeff, do you wanna take the first and the third question? I'll go on the second one.
Sure. The first one is reasonably straightforward. It is just a discount. The methodology is still the same. It's the 43 basis points applied to the same assets as it was before, basically. But I think Tim sent me an email. I think our discount rate had gone up by something like 170 basis points. It's literally just discounting at a higher rate for the same cash flows. Gives you a much smaller number. if we put it back to the old, it would be virtually the same. There's no big change there.
On the third one.
Sure. Rates hedging, we constantly look at this. It is a, it's a big question. We have our smartest people on it all the time to think. We try to balance solvency versus IFRS. Of course with change coming in IFRS, we're looking at what's possible there. You shouldn't confuse solvency ratio movements with whether we're matched or not. A bit like inflation, we're matched, cash flow matched, we're rates matched on the annuity portfolio. It is the fact that you've got an SCR, which has got a big stress, which brings in more duration to that. We constantly look at it. We balance, using derivatives to do that, spend some money or use the liquidity in a stress, up by putting more derivatives on. We're pretty happy. We wouldn't want.
We don't want it to get higher. We try and balance the two. We will be making changes as we go into IFRS 17, and we'll see, try and optimize between the different metrics.
We want an investment-led recovery here in the U.K. In fact, everywhere. We fundamentally believe that's the right thing to do. We would like to be given a bigger mandate to allow to invest. The fact that the Solvency II ratio is well over 200 is very comforting, and it does bring into question of buybacks, which so we made a comment on that in the RNS. Our preference, if we can still deliver a 20-odd% return on equity, is to continue investing in our very attractive high growth businesses and just relentlessly pursue that. We've hired some great new people into our organization who are globally dispersed, looking at investment opportunities everywhere.
We've got a great track record in pretty much all of the businesses, right now. These 500 startups, our activity in new and attractive sectors like renewables, give us lots and lots of opportunities to invest and to grow the business, and in fact accelerate the growth of the business. One of the things we're looking forward to is explaining why we're accelerating growth in 2023 and 2024 and beyond. We're not gonna go along the 0% line that I had in my slide. Okay. Next questions. Can we just pass the microphone and just try and be a bit easier?
Hi. Thanks. Nasib Ahmed from UBS. Thanks for taking my question. First one, on your capital generation target for 2022 of GBP 1.8 billion. If I double the H1 number, I get to 1.9, and you've got management actions coming in the second half, presumably. Are there any offsets that bring you down to GBP 1.8 billion? And then on the GBP 25 billion of pipeline, what percentage are you exclusive on? I didn't see that in the release. Apologies if I missed that. And then on the credit migration sensitivity, it was a little bit higher. What's driving that? And what's the difference between the minus 19 on the slide and the minus 14 in the-
Okay
press release? Thanks.
Jeff, do you wanna take the first and the third question? Andrew, do you wanna take the pipeline and the opportunities and why you're so confident that we're gonna outperform?
no problem. The capital generation, I mean, to be honest, there's not a lot going in there. It's pretty much the same. It just doubles up. There's a bit of rounding in 0.9s and 1.8s, but there isn't much there. We expect double-digit growth in the OSG. It's obviously dependent what was in the previous period when you're only looking at a half year, what's in the full year. We expect that 1.8 roundabout double-digit growth in OSG. There's nothing major going on within that. I'll do the last one if you like. I mean, again, a lot of it is math. The credit migration one is very simple, and we saw this in the pandemic in our numbers.
It's very simply because the sub-investment grade spreads have widened. When we formulaically model our stress, we say, "Well, triple-Bs downgrade," and then we sell them and we go back. We make a bigger loss at the point we sell them in our model because the spreads are wider that they're migrating to. We saw exactly that in the pandemic. It's just the math of having wider spreads as a starting point. There's nothing. We haven't strengthened it or anything. It's just the market conditions, the way it flows through. On the 19%-14%, yes, we showed 19% was the net impact of 20% downgrade. We showed 14% in our sensitivities. As I said, we've taken a slightly more prudent view, so we've only rebalanced sub-investment grade and not quite all of it, partially.
It's, let's call it 75% or so of the sub-investment grade. If we rebalanced all the sub-investment-grade , that would give you another couple of percent. If we rebalanced the investment grade, which we also haven't done in the sense that in the slide, that would give you another 3%, which gets close to the 5. We've just taken a more prudent view on what we would rebalance to show in the sensitivity on the slide.
Morning, everybody. On the GBP 25 billion, we haven't disclosed the number we're exclusive on. That's a relatively small number at this stage. The GBP 25 billion would cover the transactions that were in active conversations through to pricing across the U.K., U.S., and Canadian markets. As Nigel said, and Jeff said, very buoyant markets, both in the U.K. and the U.S. As with other commentators, we'd expect 2022 to be, a higher level of transacted volumes than we saw in the previous year. We are in the final stages of some very significant pricing conversations, but we're not exclusive at that stage?
I think we can be fair to say we've got more active conversations than we've ever had in the history of 35 years that we've been doing this business. The sales teams are very busy at the moment pricing up various things. People are pulling forward deals that they might have been thinking about doing 3, 4, even 5 years' time because rates have moved up, deficits have gone. Chairman of the trustees is pretty anxious now that they've got a window of opportunity to do things, and so they're kind of getting on with it. I think the other thing, Jeff, about our portfolio is we don't have very much triple B -.
In our portfolio as well, which I think is a good thing. Chris is sitting at the back there, and he's always commenting on the fact that we've got so little cyclical BBB- as well. The clever team who construct the portfolio spend a lot of time figuring out what's the right portfolio for us to have as a business. Don't know whether. Just. Can we just. If you just put the mic there, and you guys just. Oh. Sorry.
Larissa van Deventer from Barclays. Congratulations on a good set of results. Two questions, please. The first one on LGC. How should we think about growth and the sustainability of growth to the end of your 5-year plan? Specifically which areas do you see expect most aggressive growth, and what would put that at risk? With respect to bulk annuities, you mentioned the active discussions. On margin, what are those margins most sensitive to, and what would the biggest risk be to the margin compressing?
Could you?
Thank you.
Laura unfortunately is not here. We don't have all of the executive team here today. I'll have a go on LGC, and if you take the second question.
sure.
That'd be great. I think we're very fortunate now. We've created lots of optionality for ourselves across the whole of the LGC business. We really started that in 2013, 2014. Lots of those businesses, which were tiny in those days have really become quite substantial businesses already and are in structurally growing markets. I think the GBP 600 million-GBP 700 million target, which I know from some of your papers you think is very conservative, I might well agree with that myself. In fact I certainly agree with it myself. That's kind of the targets we've set at the moment. I think if you talk to the management team and Gareth here, who's the CFO. Just stand up, Gareth, just so people know who you are.
If you catch Gareth afterwards, he can go through some of the more detail about it and why we're very excited about the American opportunity, which has really opened up for us, and the renewables opportunity. Again, Simon Gadd, here sitting at the front. He can go through some of the more of the detail around what are the opportunities. We've done sort of tactical equity and a small amount of debt investment so far, but the universe of opportunities is this wide, which goes back to this point about Solvency II. There's a lot of that we have to do outside the Solvency II buckets at the moment. We'd like to push a lot more of that into Solvency II and get rid of the fixed cash flows and come around to highly predictable cash flows.
Hopefully, our regulator and the Treasury can see eye to eye on that. That just makes a huge amount of sense here in the U.K. and indeed elsewhere. Do you have Jeff?
The second question was on margins and.
Sure. no, the PRT margins. I mean, you'll see, first half, last year, pretty consistent sums to the new business margin. we absolutely will only deploy capital if we believe the margin is there. The big thing that drives that for us, I talked about it, is obviously the asset management that gives us a big competitive advantage. Spreads widening also make it easier to achieve those margins with traded credit, which gives us a bit more optionality in the investment. we are able to get very good reinsurance terms. We then make a decision about how much capital, how much to reinsure, pending Solvency II discussions and everything else out of capital headroom, how much do we want to maintain.
We have a model that works extremely well to deliver that margin. with a really good team that can deliver the hedging required on day one and source the assets, you know. We're very careful to make sure we've got a sight on those assets, what are the spreads, what are we gonna achieve. That's the main thing that drives the margin in conjunction with the reinsurance.
Thank you.
Oh.
Echo. Thanks. Alan Devlin.
If you just keep passing it would be. You'll save something hard.
Alan Devlin, Goldman Sachs. Two questions. First of all, on capital. how are you thinking about capital, given your strong solvency ratio and the comments about the jaws of capital generation, increasing above the dividend? I think on your press release you included for the first time that you wouldn't sit on excess capital if it was in the best interest of returning to shareholders. Obviously, given the very strong bulk annuity volumes and your comments that things you're expecting to see in three or four years coming through potentially earlier, you would use that excess capital to take advantage of that market if you could Secondly, a related question.
You know, just given the big move in interest rates and credit spreads you're seeing both in the U.S. and U.K., and you've talked about it in the investment portfolio. Does that change your kind of view on what part of the bulk annuity market that's incrementally more attractive to you to invest capital for Legal's? Obviously, both markets have got more attractive, but in relative terms, has there been any change? Thanks.
Andrew, do you wanna take the second one? Jeff, do you wanna take the first question?
Sure. I mean, we did include some wording. We have had lots of questions over the last few months. Well, ratios are higher, what does that mean? As we don't set a range of solvency ratio because we like to look at economically what's really going on within that. You hit on the right point. It's the jaws. The sort of what is real economic capital projection and generation that we are producing. As those open, that's real generation. If rates go back down, and we've created that capital, and we've either put it to work or we're sitting on it, that's when we have a discussion, not just because rates move around. That gives us great optionality, as Nigel said at the start, to invest.
It's not just c apital for PRT, I mean, that's pretty efficient. It's also capital, whether it's LGC, LGIM, to grow those businesses, create assets for the third parties, create assets for other parts of the business. We luckily don't need too much capital for retail. It's a very efficient business. We balance the two all the time. It's that real economic capital growth that is important for us.
Just on the U.K and U.S. markets. Obviously we have a very different market profile in the U.S. to the U.K. We're typically competing on $500 million and below schemes in planned termination. We do see a difference in margin in the U.K. and U.S. I won't repeat Jeff's comments, but we're very disciplined around how we deploy capital and making sure we achieve the right margins, recognizing our U.S. business is in scale-up . Just like I said in the U.K., the U.S. business volumes and the market opportunities there are significant. We're very active in the U.K., but really disciplined on how we deploy capital, particularly given the different scale of balance sheets and the different capital regimes we have in the U.S.
There are some technical differences around yields and margins in the U.K. and U.S., particularly around duration and local U.S. stats. I think on an economic basis we're very disciplined in how we deploy capital.
The exciting thing is U.S., we're closing on over $500 million deals and winning them. That's a big plus for us. The brand recognition's gone up immeasurably in the United States. Do you know who's got them? Sorry, somebody reach forward or backwards.
I do.
Hi. Just three questions for me, please. I think in the appendix you've got your top quality BBB. So, do you have examples for the BBB-? 'Cause that's also 12% of your total BBB. Second question, your 35% exposure in BBB, that's obviously much higher than your peers on the mid-teens. That's an increase from your 2008 position, which I believe was around 20%. Is there any action or any plans you could do sort of going forward on the new business side as well as the existing book to maybe, like, bring down that 35%? Third question is the widening gap between the capital and dividend. You've talked about optionality.
Could you give a little bit more examples of, what sort of investment in growth you could do? Would you consider any excess return to shareholders? Thank you.
I think that was about 6 questions. Around that. On the credit portfolio, I'll just make a few general comments. I think we're all feeling very relaxed about the composition that we have of it. People wanted triple B, so we give them triple B, and then they come back and say, "Well, can you give us a triple B- one?" We've had no defaults in the portfolios. It's not. It's discussed more by you guys than by our rating agencies and/or our regulators. You're the most sensitive group. Hence, we've given you a lot of information to try and get you over the hurdle that in fact this isn't a high risk portfolio.
The more names we give you, there always seems to be somebody else you want to get access to. We're very comfortable at 35%. Chris, who's the CRO of Allianz, right? If you want to catch up with him afterwards and have a longer discussion about the risk in the portfolio, he'd be very happy to do that. Jeff?
I mean, some of the change there will be that will be FX, because there's a much more active triple B market in the U.S.. With the movement in FX, it proportionally looks a bit bigger. You'll notice the triple A also proportionally has gone up, so no one says that, though. You know. It is just moving around a little, you know. It isn't that it's very active. Some of it also is to do with early stage direct investments when you're developing some of those. A lot of those don't get reviewed and upgraded later. Don't forget, the triple B minus will include some of the sub IG that we've had as upgrades over the last 12 months or so after coming out of the pandemic.
There's a formulaic thing that we do on assets under construction which get upgraded once they stop being under construction. There's some mechanics in there. There's part of the reason that we've got a 35% and not a lower percentage is that we're actually building assets in different parts of the country. Things like affordable housing and stuff like this can get a lower rating, but then get upgraded once the development's finished and income producing over a long period of time. We're very comfortable with the portfolio. We're not complacent. Next question.
I have the mic. Just firstly on, going back to Ming's question and Alan's question. I mean, I think one of the EBCs is saying that next year is gonna be a record year for bulk volumes. Given your capital position, would you consider going over the 40-50 and the 10? Because, it's great value business. Would you also consider asset reinsurance to really, to white label and to grow in that space? Question two is the direct allocations of the back book. Presumably, given LGC and given the opportunities you have, you're looking to expand that. Can you give some more idea about that?
Lastly, on mortality, where are you in the journey to thinking about what is the sustainable kind of picture for mortality improvements, mortality rates and protection, given what just happened? Is there any movement there? Thank you.
I think the answer to the first question is yes and yes. I mean, if our capital is very strong and there are a lot opportunities, then clearly these were guidelines. if the market's poor, then we'll be below targets. If the market's very attractive, then we'd be maybe over targets. I think I don't think it's one EBC thinking, the market's gonna be large next year. I think all of them are thinking that it's gonna be very large next year. That's part of the reason we want the rules changed for Solvency II, is to give us a wider universe of DIs so we're capable of dealing with this issue when it comes our way. Jeff?
I mean, in terms of back book DI, it is back book and obviously putting the better assets against new business, and you can see different examples of that. Part of the positive investment variance in LGR is putting assets to the back book and seeing that come through in returns. But also in the release from operations is some of that is the assets that we've started applying to new business, some of which we'll also be putting to the back book going forward, is prudent allowance for those assets coming through. So the majority of that increase actually comes from what we've done with assets, whether that's build to rent, et cetera. We have very prudent assumptions around those, and those therefore unwind under the IFRS.
You see that in the release from operations. Economically, we think absolutely it makes sense. We have however you wanna measure it, GBP 10 billion, GBP 13 billion, GBP 15 billion of headroom to put these assets against. We believe we can produce more than we need for new business, even with these large volumes. At the same time, we can direct some to the back book. We have still significant gilt holdings in the back book. We don't believe we need those all the time. We're constantly managing the flow and how much we can put to the back book. Then it goes back to would we use asset reinsurance as well, et cetera, to optimize the economics of the whole thing.
On assets, I mean, we'd like to do more affordable housing and social housing. there's the housing list in the U.K. is, we think, there's over 1 million houses. There were 90,000 children in London in temporary accommodation last night. These are sort of shocking statistics for a modern economy. All the capital is available, all the land is available, all the people are available to produce, a massive change in that. Again, that's something we think, between the government and the regulators, they've got to get these things sorted out so that firms like ours can step up.
We're really excited about projects, not just here, but in the United States, 'cause pretty much everything we've done in cities and towns over here, there's a mirror image somewhere in America of a town or city that looks a lot like what we're doing in the U.K. The universities themselves have realized they all need to modernize and compete. even the mighty Oxford University is in that position. We have great partnerships with about 10 or 12 of the U.K. universities right now. They're all recognizing this, the world's changing. Online teaching is changing. The customer proposition for the students is changing. How much research and how much commercialization you can do in the U.K. is changing.
Everywhere there's change and disruption going on, and we're sitting at the heart of the debate and discussion on more of those things. Yes, we will deploy capital to help you go on this transitional journey with us. I know if the renewables team were here, they've got a very long list of new opportunities that are coming our way that we want to invest our capital in. In part to produce returns for normal service, but also to back our annuity liabilities, if we're growing the annuity liabilities.
I've got a very quick answer on the mortality rates, 'cause basically it's too early to tell. That's the quick answer. we look at that. We think it will be a probably slightly negative impact going forward, probably impact the annuity portfolio, the older ages more than, say, the retained book in the U.S. It is too early. I mean, you will have some form of endemic COVID, but of course you've got vaccines and medical treatment improving. We've been monitoring Australia, where you have had a flu season again, but we haven't had. There's been some hospitalization, but you haven't had a huge number of deaths. You can definitely say flu is back. We will have both endemic COVID and the flu season. What will the impact be on that?
It's quite subjective at the moment, and that doesn't change our long-term view. At the moment, we remain prudent on that and we would assume we'll see, again, releases coming through in the P&L year on year at the moment, unless we make changes to the assumptions.
Thanks. Dominic O'Mahony, BNP Paribas Exane. I've got two detailed questions and one broader. The first is just on the fintech revaluations. I couldn't see a value or an impact on the operating profit. If you could just share that'd be very helpful. And clarify whether. Would that have been in the operating surplus generation, or would it have been in the variances within the capital movement? Secondly, in the operating surplus generation, were there management actions in there? I couldn't see that in the release, but if there were, it'd be helpful to understand. The broader question is Solvency II reform?
We've now had quite a lot of detailed insight into how the PRA is thinking about this, some scenarios around fundamental spread. The ABI has been quite clear that, actually this isn't the reforms as proposed, don't seem to achieve some of the outcomes that the government suddenly seem to have thought they might get. Could you give us a sense of where you think the impact on your business would be given those reforms as they were laid out, both sort of the stock and the sort of the new business dynamics? I don't really have a sense of whether this is a big thing, a small thing, or positive or negative at the moment. Thank you.
Do you wanna take the first one, Jeff? I'll do the second one.
Sure. The fintech, I mean, a number of you have made a stab at it already. I'd say it's tens of millions. People have had a stab at 30-60, so that's pretty close. We're in the range there. Obviously, we have to be sensitive. There's lots of third parties investing in these businesses, if it isn't public, et cetera. But equally, when we don't make these numbers up. There is either external funding. We go through a rigorous process of are they achieving the business plan. Salary Finance is really moving forward. The U.S. is accelerating. Emma's nodding. She's on the board. You can ask her afterwards if you like. they.
They're really doing well, and dealing very well with the economic environment and then continuing to invest, you know. We look at are they achieving plan, is there funding, you know. And this is part of the model. We said we would be investing in fintech. Nigel mentioned the 9 of them. They will come through. I mean, the IFRS is the base balance sheet for Solvency II, so that will be in there coming through within it. it would be in the surplus generation. Management actions, I mean, very little. You just saw there was a negative investment return. That's more about reinsurance type management actions, and so we hadn't executed.
Same as ever, we hadn't put in place the what used to be called the Triple-X funding for the term life in the U.S. That's not there, so that will be gone by the second half. So, very little in the way of management actions. It continues the theme of clean numbers.
On Solvency II, clearly if all of this PRA recommendations were implemented, our ratio would go down a little bit. That's not something that we think represents a Brexit dividend for the U.K. I think it would force us to look at more asset reinsurance, rather like longevity in reinsurance, given the amount of volume that's out in the marketplace right now. It would encourage us to invest in non-U.K. assets as well. We think those are not good outcomes for the U.K., putting in rules that make us less competitive as an industry doesn't seem like the right thing to do, particularly when we think there's a great need for investment-led recovery.
We're the largest investor in the U.K., and spreading a set of rules which discourage us from investing in the U.K. doesn't seem the right policy outcome. It's not like they're, this room is full of rash and reckless people who bet on red and are busy spread betting all day. They're, some of the most conservative, prudent people we have. That's one of the reasons I can sleep well at night, is I have so many people worrying about these sorts of things across our firm that it's not a worry for me. We've given you more data, as much data as we can with, the public.
We have to ask for everybody's name, we have to ask for permission of S&P to get all this data to you guys so you can do a better job analyzing what's really going on in our credit portfolio. We always want to do the right thing for the right reasons, deliver the right outcomes, and we're not suddenly gonna go change our spots and actually go around and do all sorts of reckless things, because we take our prudent principles very seriously. Tim and I have worked very unsuccessfully together for six years on trying to get reform in Solvency II. He is reassuring me that at some point in the next ten years that we will resolve it.
If you really want the grimy details on the lack of success that Tim Stedman and I have had, then you can talk to Tim afterwards. If that's okay. Oliver Steel, how did you think?
That was a quick grab there. You and Barry were going for the light.
I was gonna ask some questions, but extraordinary. Two questions. The first is the gross release from operations in LGRI and LGRR pushed up very strongly, 23%, I think, on the first half. I appreciate that some of that came from increased direct investments and increased yields on direct investments, but I think some of it was also caused by inflation. I'm wondering, is there any element of that that is not sustainable and where we'll find out next year that actually the numbers are coming back down again? That's question one. Question two is, if you hit the top end of your targets on capital generation and cash, is it axiomatic that you should then be at the top end of your targets on dividend growth?
I'll have a go at the second question. Jeff can have a go.
I mean, that's what I was referring to earlier. Of your 23%, 60% plus comes from the assets that we applied to the book last year. Those are fully repeatable. It is just the prudent assumptions. It just unwinds in the same way as the prudence in the default assumption. Some of that is helped by inflation. If it's rental assumptions on build-to-rent , then those will factor through in the model. But those are fully repeatable. It just unwinds over time, and it's just a very prudent assumption. People like Chris and the PRA make sure that we're very prudent on that, and it completely makes sense.
You know, we don't anticipate lots of future increases for 25-40 years, that they would inflate way too much and wouldn't give a fair view of that.
Part of the problem is that we are so prudent that you end up with being so far behind that you've got to have an end-
you get the catch-up, which is why you get the big increase.
Have to really increase.
Over half of that's, 60% or so. Of the 40% left, half of that is then just from having a bigger book, so that's, fully repeatable, and the other half is just noise to be honest. It's going through. There's always, in a massive portfolio, there's always stuff that comes through. We wouldn't see it, dramatically going backwards or anything.
We're clearly ahead of plan and, the plan had 5% dividends and we actually haven't had a debate about anything other than that right now, Oliver. If we continued on the trajectory and the draws open up, then there will be debate at the board about, what's the right dividend policy and what should we do about share buybacks or that. I'm hoping at the moment our colleagues will come up with even more investment ideas on a go-forward basis, so we can continue to kind of, hit, get the sort of results that you guys all like and we like. You still haven't got it, Barry. God, you're not a man of influence.
Good morning. Mandeep Jagpal, RBC Capital Markets. Just one question left for me on the credit portfolio again. I think later this year, we're gonna see the unprecedented event of the Bank of England selling back tens of billions of GBP of corporate bonds back to the market. At the same time, we're expecting potentially record volumes of bulk annuities for the next 12 months. Given the high proportion of corporate bonds used by insurers to back these transactions, do you foresee any risk or opportunities as a result of these bonds being sold back? Could it potentially have a positive impact on margins or pricing?
That's a very insightful question, that one. I'm gonna pass it to Jeff.
I mean, any liquidity in the market clearly helps. I mean, there's a reason why we go to the U.S. dollar market for a lot of our corporates, because it's just way more liquidity. If there are sterling bonds being sold back in. Or we of course don't really invest heavily in financial services, which is a lot of the sterling bond market that you'll be talking about. It's very hard to tell what it does to marginal spreads. I mean, spreads move around anyway. That gets reflected in pricing. If you look back, our margins have been pretty consistent since Solvency II have come in, so we wouldn't be looking at this and hoping that it fundamentally changes things. it's a good question. Anything to help with liquidity definitely help.
It's being settled in. I mean, we may be at the point where we want spreads to come in a bit because they've come out. Who knows?
Well, everyone's apparently bored at last. Just most people have asked my question, to be honest. I'll attack it from a different angle. Obviously you have great opportunities going forward to get there and higher ROEs. You also talk about optionality. What needs to occur for you to start seriously considering returning capital to shareholders? You skirted around it, but what should we be thinking needs to? What sort of hurdle rate? What should we be looking at before we think it might be on the agenda?
We've never really had a serious discussion at the board, I think, about what's the right parameters around it. It's relatively new that we're over 200% solvency ratio. We've been through another test, as it were, and everybody's happy with it. I think we were, the only financial service company with a market cap over, GBP 10-12 billion who paid a dividend during COVID. There's lots of attractive features that we have and how resilient the model is. We don't have a parameterization right now if X, Y, Z happens. Adam will say we did, but we actually don't. Are there any more questions? Kieran, do you wanna say a couple of things about Asia since you're.
He's busy, not in quarantine at the moment?
Well, really good to see you all. It's been 3 years since I've seen a lot of you. So thanks, Nigel, for giving me the opportunity to say a couple of words. I think when we look at Asia, the opportunities there, and you think about our skill sets in incredible skill sets, capabilities that we have in pensions and investment and the strategic growth drivers that we talk about, I'm very enthused about the opportunities we have in Asia, all the way from long-term savings, pensions, addressing climate change and alternative assets more broadly. All of those things are things that we're exploring, actively investigating, and I very much hope that we'll have more to say on progress on those in the near future? Thank you.
There are a number of questions have come through from Andrew Crean and Greg and others on the back, but they tend to, I think, overall, overlap with questions that we've answered here. If Andrew Crean or Greg think that's not the case or anybody else who submitted a question, if they then just call us and we'll answer the questions obviously. Give Ed or Nim a ring, and either Jeff or I'll make ourselves available afterwards for it. I'd like to say thank you to everyone. While it was a really, a really good set of results, I think we have to remember the ongoing struggle. There is a real cost of living crisis out there. People are living in extraordinary times.
They're unable to pay their food bills, their fuel bills, energy pricing, et cetera, et cetera. I know that we as corporates and MSC are heading up. HR for us is you know want to make a difference, both from our investment-led strategy, but actually looking after our people and our customers during these really difficult and challenging times, which are gonna be here for a while, until we get some good resolution on those things. I don't want to leave on a downbeat note, so you know I'd like to say again, we're very confident about 2022, 2023 and beyond. We've got a great team, tremendous collaboration, huge investment appetite and huge investment capabilities.
We're very motivated to continue to deliver great outcomes for our shareholders and our customers, and indeed for you guys as well. Thank you.