Good morning. Welcome to our first-ever Virtual Results Presentation: Delivering Value Through Inclusive Capitalism. Let me say at the outset that I hope you and your families have come through COVID and lockdown healthy. This has been a difficult time for many people and many businesses, with more economic and social dislocation to come. I am incredibly proud of the way Legal & General has risen to the operation and market challenges. We have continued to do good business, to serve our customers, and look after our people. We have paid around $1 billion in gross insurance claims, and we did not miss a beat paying annuities and pensions. Paying out in bad times as well as good is simply what we are here to do. We have also paid all of our people 100% of their salaries. We took no government funding.
On the contrary, we supported communities and laid the groundwork to be a key part of the investment-led reconstruction that our economy so badly needs. This includes planning approval for Sky Studios Elstree, the U.K.'s new state-of-the-art film and TV studio, as well as a GBP 150 million commitment to Sheffield City Centre Regeneration Project. Our purpose and our strategy are aligned. L&G is both socially and economically useful. Today is about the economic part of that. First, the usual disclaimers apply to forward-looking statements. In the first half of this year, L&G demonstrated that our balance sheet is robust, our operational earnings are resilient, and our strategy with its six growth drivers is highly relevant, both to weather the storm of a health pandemic and to help build back better.
While in lockdown, we secured several planning permissions to take forward house building, affordable, leisure-like living, build-to-rent, and urban regeneration, while more than 90 colleagues worked together to innovate a commercial project to counter the next crisis: climate change. The first two Rs of robustness and resilience are shown in these financial highlights. Operating profits from divisions were $1.1 billion, down by only 2% versus H1 2019, even as U.K. GDP shrank by 24%. Three out of our five divisions, LGRI, LGRR, and LGIM, delivered increased operating earnings. The balance sheet showed itself once again to be robust. Once again, no defaults. The S2 coverage ratio at the 30th of June was 173%, slightly up against the prior year's 171%, and Solvency II operational surplus generation was GBP 0.8 billion. This H1 performance has enabled us to announce an interim dividend of GBP 4.93.
Setting the interim dividend at this level, flat to the interim dividend for H1 2019, is prudent, consistent with treating all shareholders and stakeholders responsibly, as well as playing our part in the wider pensions landscape. Jeff will take us through results division by division. What you see here is the specific impact of COVID on our business. Two divisions, LGC and LGI, each saw reduced operating profits, an impact of GBP 60 million from site closures for LGC and GBP 80 million from higher claims, and indeed future provisions from LGI. In addition, GBP 21 million of extra expenses were incurred group-wide, including a massive acceleration of plans to enable IT to adapt very fast to home-based working. Stripping out these COVID specifics, underlying operating profit rose by 7%. The outlook at an operational level for the second half of the year is resilient and robust.
Our ambition is for a similar performance in H2 compared to H1. LGRI suffered minimal impact from COVID and has a significant PRT pipeline of GBP 18 billion. GBP 675 million was completed in July, and a further GBP 2.7 billion is in exclusive negotiations. Volumes in LGRI are already coming back. Our ambition is for 2020 individual annuity volumes to be similar to last year's GBP 970 million. LGIM performed well and is expected to continue on that consistent path. LGI grew GWP during COVID and likewise is expected to continue growing. LGC sites are now all open and building again. Performance in H2 depends on a sustained recovery of the housing market. Looking forward, we see a total of over GBP 525 million of offsetting positive items from the disposal of mature savings and potential mortality releases. Turning now to dividend coverage.
Here you can see the sustained strength of dividend coverage under both IFRS and Solvency II. Over the past five years, including 2020 consensus, we have built GBP 3.6 billion of cumulative IFRS surplus above the dividend and GBP 2.5 billion of Solvency II surplus. Our aim over the longer term is to maintain our progressive dividend policy. This reflects the underlying strength and growth of our businesses, the clarity of our strategy and structure with its lack of trapped capital and cash, and of course, our rigorous focus on execution. Having kept the 2020 interim dividend flat to give ourselves flexibility against an uncertain economic backdrop, we'll update you through a Capital Markets Day in November when we should have greater clarity.
Having successfully come through H1 with profits resilient, the balance sheet robust, and our products more relevant than perhaps they've ever been, our outlook for the second half of the year is positive and realistic. I would now like to hand over to Jeff to take us through the numbers in more detail.
Thank you, Nigel. Let me add my own best wishes to you and your families at this time. In my presentation, I'm going to cover the financials for the first half of the year on both a group and divisional basis, the management of our traded credit and direct investment portfolio, and lastly, our capital position and surplus generation. The first half of the year has been challenging for global markets, and Legal & General was not immune to this. However, our focused, diversified, and resilient business model has seen limited real economic impact and has continued to deliver value to our shareholders. Operating profit from continuing divisions was GBP 1.1 billion, with growth in three of our five businesses. LGRI, LGRR, and LGIM delivered solid new business flows while also benefiting from continued profits from their respective portfolios.
In the first half of 2020, group investment spend was GBP 72 million. As previously indicated, we are continuing to make measured investments into our business in order to improve efficiency, drive growth, and meet evolving regulatory demands. Over the near term, this primarily relates to augmenting cybersecurity, upgrading the IT infrastructure, and preparation for IFRS 17. We expect this to reduce as these projects complete and move to BAU. Additionally, the group incurred approximately GBP 21 million of exceptional COVID-related costs, reflecting, for example, the deployment of hardware to facilitate remote working for our people and adapting our workplaces. Including these costs, group operating profit was down 6% to GBP 946 million.
The negative investment variance of GBP 661 million in the first half was largely due to the formulaic impact of discounting reserves at lower rates in LGI, as we have seen in previous periods, and unrealized market impacts within LGC's traded equity portfolio, where we are long-term investors and can absorb the volatility. Finally, the group Solvency II coverage ratio at the end of June was 173% and currently is broadly unchanged. I will cover our capital position in more detail later. Turning to our divisions, LGR delivered strong operating profit growth in the first half, up 10% to GBP 721 million. This performance was driven by the ongoing delivery of prudential margin releases from our growing backbook, new business surplus generated from a steady flow of UK PRT, the evident heavier mortality experience, and positive variance arising from routine updates to our modeling assumptions.
Our institutional business grew operating profit by 12% to GBP 585 million. In U.K. PRT, we maintained pricing discipline, achieving a Solvency II new business margin of 10.6%, reflecting longer duration transactions in the period compared to prior year and a capital strain of just 4%. Our retail business delivered operating profit of GBP 136 million, up 4%. Individual annuity and lifetime mortgage volumes were down year- on- year as they were temporarily impacted by the lockdown measures. To counter this, we accelerated technology innovation across our retail product offerings and have recently seen a recovery. Compared to May, annuity sales in June were up 27%, and lifetime mortgage applications more than doubled. We are considering very carefully the current and longer-term impacts of COVID-19, both direct and indirect, on the mortality of our annuitants.
Alongside this, we continue to analyze the impact of incorporating the next actuarial table, CMI 18, in our year-end reserving. In isolation, this would imply a release of around GBP 200 million. LGRI had a good first half, writing GBP 3.4 billion in global PRT across 29 transactions at attractive margins. The uptick in deal counts illustrates the continued demand for PRT, and smaller transactions allowed us to manage credit sourcing in volatile times. In the U.K., we wrote GBP 3.2 billion on a wide range of deals, including a ninth buy-in with ICI, another example of where we are able to leverage one of many long-standing client relationships. In the first half, 76% of U.K. PRT deals were with LGIM clients, demonstrating the resilience provided by our unique position in the market. We are continuing to make progress in the US PRT market, with premiums up 11% compared to the prior year.
During lockdown, we undertook the first international transaction, securing benefits for IHS Markit’s U.K. and U.S. pension plans at the same time. The PRT market remains very active. 2020 is anticipated to be the second largest on record, with GBP 20 billion-GBP 25 billion of U.K. PRT expected to transact. Our intention remains to write GBP 40 billion-GBP 50 billion of new U.K. PRT over the next five years. As always, we will be disciplined in our pricing and deployment of capital, weighing the interests of all our stakeholders when making new business decisions. Our LGR bond portfolio, which is a source of long-term captive AUM for LGIM, has now grown to GBP 76.4 billion. The portfolio is defensively positioned and has not been materially impacted by COVID.
We have kept lower-rated cyclical exposures to a minimum, including those directly impacted by COVID-19, for instance, airlines, hotels, and leisure, which together constitute less than 1% of our portfolio. We have been proactive in our risk management and continually review our triple B exposures, which remain well diversified. Over the last year, where appropriate, we've taken the opportunity to improve credit quality at attractive pricing levels and did so actively in H1. As a result, we have outperformed the downgrade experience of the market, with just 0.6% of our traded credit assets downgraded to sub-investment grade compared to around 1.5% for the total market. As further protection, we continue to hold a substantial credit default reserve of GBP 3.5 billion and experience no defaults across the portfolio in the first half.
We have maintained high credit quality, with two-thirds of our bond portfolio rated A or better and 18% in sovereign-like assets. Going forward, we recognize the economic impact of COVID-19 is still developing, and we will continue to monitor and safeguard our portfolio. LGR has a diversified and high-quality direct investment portfolio with stable income from high-quality counterparties, often additionally collateralized or secured, making it resilient to market stresses. The GBP 23.6 billion DI portfolio experienced no defaults in the first half, and 99% of scheduled cash flows were paid. Additionally, all assets are independently internally rated and, as with the traded credit portfolio, downgrades to sub-investment grade have been minimal. During H1, 1.4% of our U.K. DI downgraded to sub-investment grade. These downgrades relate to assets under construction, where we have experienced temporary delays. Upon completion, we expect these to be upgraded to investment grade.
As we show here in the chart on the left, the primary exposure in LGR's DI portfolio is counterparty risk to high-quality institutions such as HMRC. This constitutes 70% of the portfolio, as shown by the light gray circle. Our ability to self-manufacture attractive long-term assets to back annuities, such as build-to-rent or affordable housing or through lifetime mortgages, is a differentiating feature of LGR's business and remains a key competitive advantage. Moving on to LGIM, operating profit was up 2% year-on-year to GBP 196 million, reflecting increased revenues partly offset by continued investment in the business as part of LGIM's growth strategy. Higher revenues were driven primarily by LGIM's resilient AUM. As indicated at our full year results, GBP 29 million of annual LGIM-related project expenditure, previously reflected in group, has been allocated to the LGIM results from 2020.
This and LGIM's continued investment in data, analytics, and our investment platforms has led to a cost-income ratio of 58%. Total AUM reached GBP 1.2 trillion, with international assets accounting for 31% at GBP 385 billion. We remain a market leader in UKDC, where we now have 3.7 million workplace members and an AUM of GBP 97 billion. Despite significant market volatility, total retail AUM stands at GBP 39 billion, and we are top three in gross UK sales in H1. Our diversified asset base has been resilient during a period of significant market volatility, with AUM up 4% from the end of 2019. We maintain positive external net flows of GBP 6.2 billion, with good growth in UKDC driven by 41 new scheme wins in the half and ongoing demand from our UKDB clients for LDI solutions.
Following its strong performance in 2019, Asia continued to show good growth potential, with positive net flows of GBP 5.2 billion. However, this was offset by outflows in the U.S., where we saw some DB pension clients rebalance their portfolios away from fixed income towards other asset classes based on preset asset allocation thresholds. Despite this short-term volatility, we remain confident in our international growth strategy over the medium term. We continue to be a global leader on ESG, with more than GBP 170 billion in responsible investment strategies. In LGC, operating profit decreased 29% to GBP 123 million, primarily due to a pause in traditional house building activities during the U.K. lockdown. CALA Homes was the most operationally impacted of our build-to-sell businesses. Since June, we've seen an improvement in the housing market.
If conditions remain similar to today, we estimate a 30% reduction in sales across the year, with the majority of the impact already reflected in the first half result. Profit before tax was down due to the unrealized losses in the traded equity portfolio and some less significant valuation reductions, primarily our two DI retail assets that we've previously highlighted. Our diversified direct investment portfolio now stands at GBP 3 billion, up 15% on the prior year. In the first half, we continue to deploy cash to support the growth of our businesses, in particular making good progress in our affordable housing and later living activities. Over the next three to five years, we continue to expect to build our diversified direct investment AUM up to approximately GBP 5 billion, with a target blended portfolio return of 8%-10%. Now moving on to our protection division, LGI.
Operating profit was GBP 88 million due to higher COVID-related claims and provisions. The overall impact was partly insulated by the high proportion of reinsurance used in the U.K. retail protection. Profit before tax was down largely due to the formulaic impact on reserves of falling interest rates, as seen in previous periods. Despite market competition and the temporary disruption from COVID, total gross premiums were up 5%. The business continues to grow at good levels of profitability, with Solvency II new business value up 19% to GBP 138 million, driven by business mix and cost savings. We anticipate continued premium growth across our U.K. and U.S. businesses as technological innovation makes our products more accessible to customers and supports further product and pricing enhancements. Moving on to our capital position.
Despite recent market volatility, our balance sheet remains well capitalized, with the group Solvency II surplus of GBP 7.3 billion and a coverage ratio of 173% at the end of June. The quality of our capital remains strong. 74% of our own funds is Tier one, and we remain confident in the resilience and capacity of our balance sheet to withstand further shocks. We have bridged the Solvency II surplus to help explain the movement since the year-end. Operational surplus generation from the growing back book was GBP 0.8 billion. As in previous years, we paid by far the larger of the two dividend payments of the year in the first half, GBP 0.8 billion versus GBP 0.3 billion. The main impact on solvency surplus in the half relates to market movements of GBP 0.9 billion. There is a positive GBP 0.3 billion, mostly from inflation and FX-related movements.
These are offset by GBP 0.6 billion relating to interest rates, reflecting the non-economic impact of lower interest rates on the valuation of our balance sheet, GBP 0.2 billion relating to lower equity market returns, and GBP 0.4 billion reflecting the impact of spreads, with a positive impact of spread widening more than offset by the effect of dispersion. We use the term dispersion when spreads on lower-rated assets widen more than those with higher ratings. This increases our modeled cost of trading those assets after projecting downgrades in a range of scenarios. Under Solvency II, the main impact comes from sub-investment grade assets widening, and so our full disclosure includes a new sensitivity to help those of you that model our balance sheet. We wrote new business very efficiently, with total new business strain of just GBP 100 million.
During the first half, debt markets for investment grade issuers were especially attractive, and we took the opportunity to successfully raise GBP 500 million of sub-debt and GBP 500 million of restricted tier one debt. This gives us additional buffers and optionality should there be further material market shocks. We will, of course, remain disciplined in the deployment of our surplus capital to ensure we meet or exceed our target returns and remain within our risk tolerances as market uncertainty continues. To conclude, it's been a challenging period for our customers, for our people, and for society at large. Where we have been able to, we have continued to execute our long-term strategy effectively, with three out of our five businesses delivering growth.
Our rigorous approach to risk management has ensured the balance sheet is strong, well capitalized, and continues to generate surplus, and our credit portfolio is positioned defensively. In the second half, we will remain extremely vigilant and will continue to monitor and manage the impact of COVID-19 across our businesses. We firmly believe that our synergistic business model is well placed to execute on opportunities in the second half, with all our businesses competitively positioned in growing and profitable markets. We intend to be a leader in the post-pandemic economic recovery, supporting our society, shareholders, and customers. As Nigel said, we are resilient, robust, and highly relevant, and our ambition is for a similar performance in H2. Thank you.
Thank you all for joining this Q&A session this morning. Sorry for the slight delay. We've had the highest number of attendees we've ever had, so we're expecting some tough questions.
I hope you've all had an opportunity to watch our virtual results presentation. If you haven't and would like to, you can find the link on the webcast. As I said in the presentation, I'm incredibly proud of the way Legal & General has risen to the operational market challenges presented by COVID. I'm actually excited and enthused about our prospects in H2 and beyond, leveling up, build back better, the planning changes, all played to Legal & General's narratives. People can see the importance of being an asset manager, but also increasingly an asset creator. As you've seen from the results, we've demonstrated that our balance sheet is robust, our operational earnings are resilient, and our strategy is highly relevant, probably more relevant than it's ever been. That's both to weather the storm of the health pandemic, but also to help build back better and investment-led growth.
I'm here joined at Coleman Street by my colleagues, and we're ready and looking forward to answering your questions. As normal, try and not ask more than three sub-questions within your questions, but we'll give you some grace time. Thank you. The first question is from Andy Sinclair.
Thanks, Nigel. You've got three questions, of course. First one, you've held the dividend flat today. I can understand the backdrop, but it is a divergence from your policy of interims being 30% of the prior year. Can you tell us a little bit more about the rationale for that decision, given it only saved about GBP 20 million? Secondly, within LGI, just wondered if you could give us a little bit more color about the experience fair and see how much was COVID-specific, how much attributable to each of the U.K. and the U.S.?
The third question being on the fixed income portfolio, you've got a little bit more double B today than previously, though still only about 2% of the portfolio and clearly hasn't had too much of an impact on solvency given the capital beat. You gave a bit of color in the presentation on some of this being assets under construction, but do you have a cap level in mind for which you'd like to keep sub-investment grades below, or does it just depend on the backdrop? That's the three questions.
Thank you, Andy. Those are more thought-provoking questions than we get from you usually, so I'll answer the first one. I'm going to ask Bernie to answer the second one if Jeff picks up the third one.
The dividend was a very good discussion with our board, and really there were two options, either 0% or 7%, and we came down on 0%. We thought that was the right thing to do for the right reasons at the right time. It was a very measured response. It also gives us flexibility over the rest of the year because although we've been robust and resilient, you can't tell what's really going to happen with COVID. The science is very imprecise. We're delighted with our results. The point you make is it's a relevant one. It was not much incremental cost from paying the extra amount of dividend of nearly GBP 20 million, as you said, and we could have easily afforded it. We thought we had to be relevant to the times, and I think that's what we've done with the dividend decision.
Recognize that lots of people are going through difficult times, and although we've done incredibly well, we think we're rewarding shareholders fairly by paying the same dividend as last year and being aware of the wider societal issues that are going on right now. Actually, it is the right thing to do. Bernie?
Yeah, sure. On the experience variances, yeah, we've given you the biggest one, obviously, which is claims. We're here to pay out when tragedy strikes, and that's exactly what we're here to do in a pandemic. We have seen a number of claims, particularly in the U.S., but also some small amounts in our group protection business. It's GBP 80 million overall from claims, which is the vast majority of the experience variances. It's about roughly a quarter in the UK, three quarters U.S. sort of would be where it is.
It is fair to say we have had about half of that already, and we have got another half as provisions, just slightly more than half as provisions. We are hopeful that we have already provided for claims coming through in the second half. Clearly, we do not know how things are going to pan out, so there is some uncertainty there, but we hope we have provided for enough there. Hopefully, that is the color you are looking for, Andy.
Yeah, sure. Just on the fixed income portfolio, as you say, Andy, we have had good experience to date. There are a small number of downgrades for sub-investment grade, and there are some very good reasons for some of those in the direct investment portfolio. As I said in the presentation, we do anticipate on completion that those would upgrade again.
We obviously would ultimately have a limit of concentration around this, but we look very much on a case-by-case basis. We will trade when we economically think it makes sense. We're never a forced seller. We also are looking in a more holistic sense of, you know, what do double Bs mean going forward? Is there a different dynamic around that? We will weigh that up against the economic or almost non-economic, if you like, impact that it has on the Solvency II ratio versus what is the best thing for us to be doing. We have trimmed slightly a couple of those that have downgraded. We thought that has made sense, and we'll continue to look at it, as I say, on a case-by-case basis.
I think those credit meetings have gone to weekly now from daily, so we constantly look at that and speak to the traders, speak to LGIM around what makes sense to look at those assets.
Thank you, Andy. Just in terms of quantification from Bernie's answer, we've provided about GBP 44 million for H2 in LGI, and we hope that's a good number. Clearly, given that we've already provided that, that will influence the level of profits. Therefore, what Bernie was telling you is he's going to do much better in H2 than he's done in H1. On the rating, obviously, we have a lot of assets under construction, and they're naturally upgraded when the construction's finished, and some of those are achieving practical completion in the next few weeks. Thank you. The next question, gosh, Andrew Crean. We're sticking with the ears to start with.
Andrew.
Morning, all. Yeah, three questions. Firstly, Elgin. At the full year, you dodged the question about whether you were sticking with the 8%-10% growth rate. I just wonder whether that is your commitment and when that starts, because obviously, it's a little bit behind this year. Secondly, on LGR, GBP 81 billion portfolio, trying to grow the book by GBP 8 billion-GBP 10 billion a year in terms of not grow the book, but growing your business. What kind of growth in cash profit does that allow you to achieve while maintaining a decent solvency position? Finally, you've talked about a GBP 3.5 billion credit provision under IFRS. How does that provision play into Solvency II? If you do get defaults in Solvency II, is there a provision sitting there which can be deployed, or will it hit the capital generation?
Okay, thanks, Andrew.
I do not think we dodged questions, Andrew. I think that is a bit harsh to say we dodged questions.
I think Michelle had a broken leg, did she not? Which was fair talk.
She is just about recovered from her broken leg, and she will be joining us on the call. I will pass that to you in a second. I think what we said was that we would update you on a lot of strategic issues at the November Capital Markets Day, and that really has not changed. Clearly, in the first half of the year, we saw good revenue growth from LGIM and assets went up as well, but costs went up by a higher percentage. The rate of growth of profits is a lowish number, but it is unusual at the moment to get growth in profits in the fund management industry.
Again, the robustness and resilience of the business has shone through. Michelle, would you like to add to that?
It's a great question, Andrew. As I said, as Nigel just said, we'll definitely come back to this at the capital markets day. I did not deliberately make that promising. I would just echo what Nigel has said for it is a tough environment for asset managers. I mean, we talk about looking to deliver positive net flows and the percentage of opening AUM. That's something I think that we will continue to talk about. Clearly, there's a market return that goes with that. I would love to come back to this at the capital markets day.
Thank you. Okay, thanks. Jeff, can you answer questions two and three? Y
Yeah, sure.
I mean, to some extent, the second question would also be a core element of our Capital Markets Day because clearly, the growth we achieve on LGR will be a big driver of what's possible. We've talked before about the sustainable portfolio, and at that level of GBP 8 billion-GBP 10 billion per annum, the capital base deals with that, and the business becomes self-financing. You still get significant growth, as you say, in cash earnings that come from that. There's a lot of surplus thrown off the backbook, prudence, whether that be on an IFRS basis or Solvency II. We'd be confident of continuing to deliver growth of the sort of scale that we've seen to date. We will be more specific around that.
Does it alter by plus or minus a few percent as we move to a more steady state on LGR, which will then depend on what other businesses are doing and how much growth we get in the U.S.? The GBP 3.5 billion on the credit default reserve, yes, that's the IFRS basis. Interestingly, there's almost as much embedded in the best estimate in Solvency II because the fundamental spread is a deduction over 50 basis points, and that's slightly less, in fact, than we get or we hold for IFRS to get to the GBP 3.5 billion. Even in your base balance sheet, you have prudence of GBP 3.5 billion or so in a similar way in Solvency II, and then you hold capital on top of that. There isn't the same loss absorbency because they're not seen as margins.
Of course, unless you get a jump to default from a higher-rated asset, then this would tend to be an asset that is on its way down, probably being downgraded. We'll do something about trading it. At the point it would default, we'd naturally be replacing that or probably already have replaced in the portfolio with a higher-rated asset. The marginal impact on the Solvency II balance sheet would therefore be reduced. That's Nigel.
Okay, thanks, Jeff. I mean, we're obviously incredibly pleased with the performance of the people within both LGR divisions. Under these really short times, they produced fantastic sales numbers. Just looking at H2 again, why are we positive about H2? LGR has already completed nearly GBP 700 million of PRT deals and has GBP 2.7 billion in exclusive and a pipeline of GBP 18 billion just in the U.K. alone.
People have really risen to the challenges across all of the divisions of L&G and delivered a great outcome for H1, and we are very positive about H2. The next question, it is another A. It is Andrew Baker, and look forward to a B or a C coming up in the future.
Hi, Nigel. Thank you, guys, for taking my questions. Three again, keeping with the theme. The first, I guess, just a quick one, just returning to the dividend. Appreciate that it is flat year- on- year and the answer that you gave there. Can I assume there is no change to your underlying progressive dividend policy? Second, on the COVID-19 impact. Specifically, as I look at LGRI, had a positive GBP 32 million impact. LGRI, the negative GBP 80 that you have talked about, GBP 44 million of which was from future claims.
Should we expect greater positive variance from LGR in H2? I guess what I'm getting at is your overweight longevity, but it seems like so far, at least, mortality has had a larger impact on your results. The third one is on the bulk annuity pipeline. You disclosed in June GBP 25 billion. There is GBP 18 billion today, but I think that is U.K. only. What is your overall bulk annuity pipeline? Is it materially different to that GBP 25 billion that was announced previously? Thank you.
Thank you. I mean, on the dividend, the message we are trying to give is we thought we were being appropriate in these times with the 0%. If you had listened to the brilliant virtual presentation that Jeff and I have given, we have said and reiterated that there is no change to our progressive dividend policy.
On the LGR questions, I'm going to pass you over to Laura Mason, who can talk about the pipeline and the COVID impacts and maybe the longer-term impacts on mortality that we're seeing.
Yep. Thank you. Thank you, Andrew. I mean, on the mortality, we're continuing to monitor this on a regular weekly basis in terms of the impact on COVID, as we do with many other impacts on mortality. As you may be aware, recently, actually, the impacts of mortality have been less than usual over the last, taking the average over the last five years and comparing to mortality in the U.K. We're just continuing to monitor. In terms of your question on the pipeline, yes, you're quite right. The GBP 25 billion is referring to the U.K.
I think that was Hymans Robertson's estimates, and that's something that we can consider about right, given what we can see in both the wider market pipeline and our LGIM pipeline. The U.S market is picking up. It's been a good market over the first half of the year. Q4 is always a busy time in the US, and there are certainly some larger deals coming through, larger than we'd expected, actually, in the U.S., which isn't included in the GBP 25 billion. Thank you.
Back to you, Nigel.
Yeah, in big picture terms, last year was a record year, and this year will be probably the second best year ever. We expect to get our normal market share in the UK and gradually keep edging up in a very measured way in the United States.
We're now moving away, excitedness, moving away from the ears, and John Hocking's next up to ask a question.
Thanks, Nigel. Morning, everyone. I've got three questions, please. Firstly, on the mortality within LGR, Jeff, on the presentation mentioned the GBP 200 million guidance for the CMI 18. Is it reasonable to assume that, given there's been an acceleration in the first half, that the net number's likely to be lower than that? It's the first question. Second question on new business strain. It was very low in the first half. Should we assume that normalizes somewhat in the second half? And then the final question, on LGC, below the line, in the release, I think it mentions that the majority of the below-the-line write-down is on the equity portfolio and not on the two retail assets. Could you give some idea of the split there, please? Thank you.
Yeah.
I'm going to ask Jeff first, and then maybe Laura to back up the answers to the first two questions, and I'll pass the third one on to Kerrigan, who can talk not just about, who can talk in general about the investment markets in the U.K. for the assets in his portfolio.
Yeah, John, on the LGR mortality, certainly the GBP 200 million I gave, that was simply for moving to CMI 18 for year-end reserving. That's irrespective of COVID impacts, etc., within the year. That would be more in the base table. That's where we're looking today. We are, at the same time, looking at the medium to long-term impacts of COVID and whether there will be a change of funding, whether there'll be changes in what flu does because people wash their hands and are more conscious, etc. There are numerous other effects.
Who knows where unemployment might go, delays in treatment around cancer. We will also feed that into our view, but those are independent of first-half experience. You saw the GBP 32 million come through in LGR. That was the experience to date around COVID that has already been allowed for. There is no offset between the two. Now, new business strain was around 4%. We continue to be very efficient. It was a slightly longer-duration business, the third business. We work harder to keep the strain down on that. We would be reasonably positive for the second half around new business strain. No reason to think it would be fundamentally different as ever. It will depend. If there is one or two lumpy schemes with slightly different features, that can change. It is broadly in line with where we expect it to be ongoing.
I think what Jeff said is 4% for the H2 as well. Thank you, John, for your question. We'll now move on to
Kerrigan.
Oh, sorry, Kerrigan. Gosh.
Thanks, John. The below-the-line LGC comments, I mean, as you quite rightly pointed out, the majority of the impact is public market equities. We mentioned a couple of our retail assets, and there is some noise there. Probably I'll describe that as noise in terms of some other assets there. Those are the main two themes. To be helpful, just trying to do the figures in my head, I think it's roughly 55%-60% of that would be the public market equities. In terms of the two retail assets, we talk about Bracknell, Lexicon, and the Springs at Leeds Thorpe Park really as the ones that have the independent valuations came in lower for those.
I mean, again, as we'd expect, and obviously in context, we have a just over GBP 3 billion direct investment portfolio. Less than 10% of that is in these two retail assets. Yes, they are more experienced and destination-focused modern retail, but they've had, as we all know, a very short, sharp impact that's exacerbated the ongoing trend in retail that we're seeing. We have taken a sensible valuation on those, we think.
Thank you, Ke rrigan.
Thank you.
We will now move on to Oliver.
Good morning. I knew having a name at the end of the alphabet never helped. Three questions. First of all, the capital requirements pushed up by GBP 1.2 billion in the first half. I mean, okay, obvious reasons behind that. I am just sort of wondering, what can you envisage from a market perspective or indeed any other perspective that brings that capital requirement down anytime soon?
I guess I'm looking for a sort of breakdown of how much of that was caused by rating downgrades and so on. Second question is, the flows within LGIM appeared to drop away quite sharply in June from GBP 11.2 billion at the end of May to GBP 6.2 billion. Is that the U.S. business that you're talking about? If so, what's the outlook for that particular segment? The third question is a bit of a simple question, but Nigel, you talked about a similar second half performance in terms of operating profit. Are you talking here the underlying GBP 107.5 million in the second half as being the aim?
Okay. Jeff takes the first question. I'll take the second one and the third.
Sure. I mean, there's two different things I think there.
You're talking that, obviously, the STR increased and what does that do on coverage ratio? We're very happy with the 173. There's different things we can do to improve coverage ratio versus STR falling. Clearly, a big impact in that STR growth is the fall in interest rates. Everyone will have their view on where the yield curve is going. We won't be relying on it increasing anytime soon. We'll be well set up, by the way. Those of you that have got to our sensitivities will see that we're now slightly less sensitive to rates, which is helpful. Obviously, the recovery in equity markets and the other LGC investments that Kerrigan talked about would increase down funds, increase the ratio, and in particular, spreads as well move in.
Some of that impact will also have been the dispersion that I talked about in my presentation, where if we see those double B assets in particular coming back in over time, that again flows through. There has not really been a material impact from any credit downgrade, migration, etc. That has not been an impact. It is really those movements, as I talked about. We continue to have management actions available. We see the longevity releases would increase our solvency position. Very comfortable where we are and ongoing being able to use capital to write new business versus managing the overall position.
Okay. Thanks, Jeff. On LGIM's assets, we had one very large outflow from one specific client of about GBP 6 billion. They are very large clients of ours, and they simply took some of the assets in-house.
We'd been discussing with them for a very long period of time to make sure the transition worked well. It was a pretty low-fee mandate. I think the second part of your question, I think, is a fair one that in the U.S., we had net outflows, which we've had an amazing track record for a number of years. That was just really because of various trigger points in certain mandates where they were switching their assets out of our business and into others because of the trigger points in the mandates. It wasn't part of natural and long-term outflows. We're very pleased at a macro level that we had GBP 6 billion of inflows in the first half of the year. In terms of similar, in the first half, I would say we had a similar level of profit to last year's first half.
We were down 2%. I think that's fairly similar. In the second half of the year, I think we've guided to the fact that we expect LGI to do better. I think Kerrigan's just articulated why LGC should do a little bit better. We expect the other three divisions to continue on the course that they've been on in the first half of the year. Therefore, that's how we think of similar in that context. Thank you. We're now going to move back on to the ears. Having briefly disappeared from the ears, Ashek, can you come forward next with your question or questions?
Yeah. Thank you, Nigel, and good morning, everyone. Just a couple of questions. First of all, can we get some clarity on your debt leverage capacity? You have raised about GBP 1 billion of debt this year.
How much more debt you can issue, be it to capture the growth or be it to absorb macro shock? That would be the first one. The second one is just going back to Oliver's question about the operating profit. I mean, clearly, you reported only 2% drop, but then there was a big about GBP 200 million-GBP 230 million of positive one-off in operating profit from assumption changes and some non-cash items. How should we think about that number? I mean, how much of that number should be recurring in future? How much that should not be? Because there is a material difference. I mean, GBP 585 is a—sorry, GBP 720 is a reported operating profit in annuities, but then GBP 200-GBP 220 could be, say, one-off non-cash items or model changes.
Just trying to get a bit of sense of how much we should start taking in on an ongoing basis. Third would be, again, going back on dividend. I'm sure you had this earlier as well. How should we think about the full-year dividend? It could be a decision that I'm pretty sure you'll make at the end of the year. Any thoughts on full-year dividends at the moment? Thank you.
First two questions, and I'll take the third question.
Yeah. Oh, excuse me. Sorry. Yeah. On debt leverage, certainly one of the positives, if you like, have come out of the market volatility is a lot greater interaction with rating agencies. We've been talking to them a lot to help them understand our balance sheet and the movements. Clearly, we're talking around the leverage ratios.
Generally, the RC1 was positive for Moody's and Fitch and others. It was a good conversation with S&P. We've looked at those. We continue to deliver and grow our balance sheet, which gives us the headroom. We potentially have expensive debt next year that we will consider and whether that would be kept on the balance sheet. At that point, we would certainly have more headroom. Within RC1, on a pure metrics basis, there is plenty of headroom. We are very conscious of the rating agency metric. Some have improved. Some were getting closer to sort of the AA limit. We constantly improve that metric as the balance sheet grows and all parties are comfortable on that. We are happy we have enough headroom to manage that on an ongoing basis. On the second one, I do not quite recognize the number you talk about.
Clearly, there was a release in LGR. Generally, this is sort of ongoing management of the bases. As Tim Stedman said, we have lots of simplifications in our model in that over time they become more material. They always set up, we hope, on a prudent basis given their simplifications. We get to these on a list, and we slowly update them. Luckily, they are ongoing basis. They are positive because that is the way they are set up. There is an underlying level of maintenance of your methodology and assumptions that leads to these on an ongoing basis, I would say, as you have seen in our results over many years. It is not that they are suddenly a different way from them.
Thank you. The Tim that he was referring to is Tim Stedman. Please call him up with any really, really difficult questions afterwards.
On the dividend, we think zero is just the right signal at this time. It's an appropriate signal, not an inappropriate signal for us to make. It's a very measured one. It gives us flexibility around it. It's meant to demonstrate our long-term commitment to a progressive dividend policy, which we're not changing away from. We thought zero was the best way of signaling that given all of the circumstances that exist right now. Okay. Thank you. We're going to move on to another A. Abid, please.
Hi, morning. Thanks for taking my questions. I've also got three questions. The first one is coming back, actually, just following on from a previous question on mortality. I'm not quite clear on the mortality release, the size of the release on the annuity business of LGR versus the negative on LGI.
The quantum seems odd given that the annuity book is much larger. The question really is, I mean, is it just the case that you're being really conservative on the annuity book? I'm just sort of thinking about stats from the ONS. They're suggesting that deaths so far this year in the U.K. are about 50% above the past five-year average. Just any additional color on that would be helpful. The second question is on lower interest rates. Could you just share your thoughts on if we do start to see the interest rates lower from here? I mean, I know there's not much room to go to zero, but potentially go lower or even negative from here. How does that impact the affordability and demand for PRT business? The final question is on superfunds.
I think you've said in the past that superfunds are complementary to you. Indeed, I think the legislation that's come out requires them to offload the business to insurers before they can extract any earnings, any profits. From that sense, it clearly is complementary. I also recall that there were plans that you may be setting up under a similar structure, a similar structure under the pensions regulation to benefit from the lower capital position there. I'm just wondering if you can update us on your thoughts there, please.
Okay. If Jeff just goes through the structure of the releases for LGR and LGI. I'm going to ask Laura to comment on the PRT affordability and other questions. I'm also going to ask Chris to comment on that for his business as well for the individual annuities, lifetime mortgages.
Indeed, if you want to make some passing comments on your digital care business, that would be great to hear.
Yeah. We can offline get people through the dynamics of what leads to this for the deaths that you see. At a very basic level, of course, do not forget you might be paying out GBP 500,000 or GBP 1 million for a death claim, whereas on an annuity, the reserve that you would be holding would be maybe a multiple of 12-14 times the actual annuity per annum. You would not necessarily get to the same sort of quantum, even if it was the same lives, if you like. Clearly, we did see a lot more older deaths in the population. That is very much what is reflected there.
We've tried to reflect the COVID deaths in the period in what we've done for the annuity release. As I say, we could explain the dynamics from that and what that leads to. This 32 is very clearly the answer. LGR, we don't believe we've been prudent, conservative either way on that. We believe that's what our data is telling us for the COVID deaths in the period. We have paid out and put IBNR away for the group life business, in particular in the U.K., and the U.S. mortality business, as Bernie talked about. We do believe we've been prudent in setting aside GBP 44 million for the second half on the mortality claims, in particular focus at what the uncertainty in the U.S. may lead to.
Yes. Thank you.
On the impact of lower rates, I mean, most of the clients in our pipeline have been preparing for buyout or buy-in for a long period of time. They will have relatively sophisticated LGI programs in place, which means they've been relatively immune as the rates move in terms of their new risky journey. I think just sort of noting that a lot of our pipeline this year has been for buyouts, which tend to be longer duration. We've seen no real change to that pipeline, even due to the recent move. I'll just quickly comment on superfunds before handing over to Chris on the rates question for his business. You're quite right to point out that the guidance has been helpful to us. We'll wait to see how it is only guidance at the moment.
We continue to work through a number of different solutions within L&G that sort of will be directly competing with those superfunds, our ISS and ACP products, which will be sort of directly competing and have the added benefit of being insurance contracts too. As you say, it is definitely complementary in terms of what the guidance has come out with. We will be continuing to work under the insurance regulations in the short to medium term, that's for sure. Thanks, Chris.
Thanks, Laura. Yes, we saw quite a brief drop in annuity sales, individual annuity sales earlier this year, but it came back quite quickly. I think on the one hand, people were having mixed thoughts about whether this is a good time or a bad time to retire. In fact, we've seen volumes come back quite strongly.
In a way, this has kind of proved our case if you're comparing an annuity with a drawdown product for most normal people, they've now had a lesson in what happens when you're invested in the equity market and your pension funds drop. I think in the long run, that will be really supportive for the product. Remember, there's a sort of secular increase at the moment in numbers of people reaching age 65 each year, which is going to go up from about 700,000 this year to about 900,000 by the end of the decade. That's sort of a good long-term growth driver for us. Lifetime mortgages was very slow in Q2 in terms of applications, and that would have been throughout across the market. Probably we'll see that coming through in completions in Q3.
In fact, we've also seen a big bounce back there with the reopening of the housing market, and applications in July were back where they were in February, which is a positive sign for us going forward. As you mentioned, care. Obviously, care is a huge issue for lots of people and our customers. We're doing more work digitally on a website and other channels to help people understand, find, and fund the care that they need for themselves and their loved ones. We've made some good investments in recent years in companies like CareSourcer and Current Health, who are really coming into their own now in this sort of crisis and helping both individuals and society help fix the care conundrum, so to speak.
Thanks, guys. On individual annuity sales, I think that's another one that we can put in the bucket, similar and resilient.
We would expect sales this year to be similar to last year, given the current trend that Chris and Emma and the team are seeing. We'd now like to hand over to Don to ask his question.
Hello. Can you hear me?
Yes, we can hear you.
Great.
Very well.
Thank you so much. Oh, right. I'll whisper. Thank you for taking my questions. A lot of them have been answered already, but I still have three, if that's all right. Laura, you spoke a bit about the impact of rates or the lack of impact of rates on demand from your customers. At the same time, lower rates make it more capital-intensive to write bulk annuities. Is that impacting the way that you're thinking about pricing and capacity?
I suppose notwithstanding that, I noticed that your Solvency II margins have improved really strongly, from 7.8 to 10.6, clearly getting a lot more bang for your buck for your capital deployment this period. I assume that's to do with the fact that these are buyouts and so longer duration. Is that right? Should we expect that to sort of normalize? Just one more question on bulks. Nigel, as you indicated, the GBP 675 million done in July plus the GBP 2.7 billion in exclusive, I mean, that suggests actually GBP 3.4 billion already sort of good line of sight. Is this going to be a normal year then for bulks? Would it be reasonable to expect sort of GBP 8 billion-10 billion for the year? Final question. You've got an awful lot of cash. You raised GBP 1 billion of, I mean, cash, not capital.
You raised $1 billion of cash through debt. I noticed you've got, I think, about GBP 1.8 billion more cash on the shareholder account than you did at the end of the year. I mean, if you put that to work in LGC and into direct investments, that would clearly be very accretive. I recognize you can't deploy that all in one go, but does this give you the firepower to accelerate your allocations to direct investments and to grow LGC? Thank you.
Thank you for those questions. You sound like me at the management meetings. Why are we not going to do it? Why are we not going to do that? I am going to be very interested in my colleague's answers here. Kerrigan can answer the question as to why he's been lazy in deploying the capital and earning better returns for shareholders.
Laura can tell us why we're going to get a similar performance year- over- year in the PRT business.
Okay. Thanks, Dom. I thought you would pick up on the increase in Solvency II new business value. I mean, I think the first two bits of your question are quite linked in terms of the rates and the 10%. I mean, as well as what Jeff talked about and you alluded to, yes, we have been seeing longer duration buyouts in the market, which again sort of plays well to the or is evidence really that these schemes are very well hedged and are able to execute in these types of market environments.
As well as things like long duration, we have been able to work with the market and invest in assets, particularly in March and April, at very good values in the credit markets, which helped both pricing from customer's perspective and our metrics. I think it is those two combinations that really give you the sort of answer of both your grain and your value. Just picking up again on the 8 billion-10 billion, yes, we do. We think the pipeline, we have talked a little bit about the pipeline already. We think the U.K. will be about GBP 25 billion. The U.S. is some really large deals coming through in the U.S. As you know, Dom, we will not be necessarily playing on those large deals for those large deals, but we will hopefully give us some room for the slightly smaller deals.
We were fifth in terms of total sales in the US in Q1 and expect to be fairly similar in half one. Definitely the 8 billion-10 billion guidance certainly still stands. Over to you, Kerrigan.
Just on the point about cash, I mean, just in terms of balance, of course, we remain enthused by our strategy. I'll just talk about that in a few minutes. Of course, we're thoughtful in the current environment. Just in terms of the strategy, housing, future cities, SME investing, we think those are all the right areas. On housing, it's everything, as you recall, but everything by tenure, houses to sell, houses to rent, everything by affordability and also by life stage. We think strategically that's a long-term positive. Of course, we'll be investing more there, but thoughtful as we go through the second half of the year.
Similarly, future cities, all those themes remain of science and technology focus, real estate, things like data centers, and that much-needed urban generation. Of course, we have continued to invest partly in that, as Nigel's mentioned on the video in Sheffield over the lockdown period. We remain enthused by that strategy. Of course, thoughtful again. Yet again, SME investing, we know there will be a huge need for equity and debt in portfolios of SMEs. Again, we think we are on the right strategy there, but again, thoughtful. That is probably the color that I want to give you.
Thank you.
Thanks. It was good of you to highlight the improvement in margin in LGR. To give Bernie some credit, which we infrequently do on these calls, we saw new business value for his business go up by 19% year- over- year in the first half.
The margin got from 7.6% to 9.4%, which is really as a result of all the digital initiatives that Bernie and the team have executed actually brilliantly well in both the U.K. and the U.S. We'll now pass on to Steven.
Oh, hi. Thank you for taking the question. I only had one question, actually. It was on your credit migration sensitivity. Now, that's nearly doubled year to date from GBP 800 million to GBP 1.5 billion impact. Your credit portfolio hasn't really doubled in size in the first half of this year. Can you tell me exactly what's going on and why your credit migration sensitivity has increased so massively despite still only applying a 20% downgrade to your portfolio? Your ratings don't seem to have moved that much over the six months either. Thanks.
Reasonably simple one.
It's simply that the spreads are wider on the double B assets in particular. The biggest impact of that is that we assume this is not what we actually do all the time, but what we assume in the model is that as a triple B is downgraded to double B, that we sell it and rebalance. We do that across the whole portfolio, but that is where you get the most material impact. Because the starting point of the double B spreads is so much wider than it was at year-end, when you simply do the math and say, "Okay, the same amount of downgraded, you're selling them at a bigger loss," that flows through in the sensitivity. It is just the math that flows through on that because of your starting point of spreads.
On a personal level, I've never agreed with this methodology, as you can imagine.
But my actuarial colleagues tell me I'm wrong. And it's extraordinarily prudent given our 20-year track record of what has happened under Simon's leadership, Kerrigan's leadership, and Laura's leadership of the business. We've had nothing like this. This is the real outcome. Can we now pass on to Trevor, please? We've got time for two more questions, actually. So Trevor, can you be one of those last two?
Yeah, I can try. I can try, Nigel, if you like. Actually, they were quite straightforward, really. You are trying, really. Yeah. It's good to see your banter and enthusiasm has not waned in this period, Nigel. Right. First question. You referenced in your descriptions earlier on the cross-border—well, I call it cross-border—the U.S./U.K. PRT deal with market.
I wondered if you might want to talk a little bit more about the potential that that may have to do these kind of deals when you're the only player in town, really, as far as I can see for a U.S./U.K. deal. The second thing really was just relating to LGC. Given the economy, we'll need more investment capital than ever before, I suspect, in the next year or two. I wonder whether there won't actually be more opportunity for you to direct money towards direct investments within LGC than you've already targeted because it does seem to me there's going to be lots of demand for your capital and probably some reasonable returns on offer.
Trevor, I absolutely agree with your second question, but I'm going to get Kerrigan to answer it in more detail. If Laura, could you pick the first one?
Thanks for noticing that one. Something that we're really quite excited about, as you say, Trevor, we're the only direct PRT writer at the moment that operate both in the U.K. and U.S. There are a number of global multinationals who are clients of both LGIM and LGIMA. We are working on a pipeline at the moment where we'll be hoping to execute more of these types of transactions simultaneously in the U.K. and U.S. Yeah, something that's pretty exciting for us.
A few years ago we ended up winning the U.K. leg and not the U.S. leg, in part because of brand recognition in the United States. Our brand recognition now is way, way higher today in America thanks to all the good work of our various U.S. teams. Kerrigan?
Great, Trevor.
I couldn't agree with you more in terms of the opportunities, the themes of build back better, a green economy with our clean energy assets. Of course, things like affordable housing or rental more broadly. These are all areas that will need new investments. They talk about shovel-ready projects across the country. Nigel's phrase was from a decade ago. These are all things that are reality now. We're absolutely excited by the opportunities there.
Thank you.
Do you think that might imply, Kerrigan, that your—I don't know. Sorry, Nigel. Carry on.
No, go on, Trevor.
No, I was just thinking whether it implies that your targeted level might be a little bit low. Or maybe that's something you're going to address in your CMD in November.
Yeah, I agree. Nigel's agreeing with you, Trevor.
I mean, those are the statements we gave with the GBP 5 billion, up to GBP 5 billion, 8%-10%. Of course, we continue to think about that.
Yeah. Okay.
Thank you, Trevor, for your continued enthusiasm and energy towards the sector. Thank you to everyone for dialing in for this call and your questions. It was good to see the variety sometimes. The first time, we did not get three questions off everyone. I think there were a couple of twos and one one. We really value and appreciate your continued interest and support in Legal & General. I mean, what we have tried to demonstrate, and I think what we have demonstrated, is that Legal & General is robust and resilient, and its strategy and business model are the most relevant that it has ever been. We are optimistic, ambitious, and realistic about the future.
We look forward to meeting with many of our investors who are on this call in the next few weeks and to updating you all at our capital markets event on the 12th of November. Be safe, be healthy, both yourself and your families. We look forward to seeing some of you physically in person as you come to the City of London. Take care. Bye.