Earnings Call: H2 2015

Mar 23, 2016

Right. Good morning, ladies and gentlemen, and welcome to our 2015 results presentation. I am joined at the podium by faces familiar to most of you, Clive Bannister, our CEO, Jim McConville, our CFO, and Andy Moss, who is CEO of the Life company. By way of introduction, I took over from Howard Davies last September. One of the reasons I was interested in the role was that following Solvency II, I thought that some competitors would review their business models and consolidation opportunities could arise. I look forward to Phoenix taking advantage of that and growing this business further. Looking to the future, Phoenix is starting from a solid base and is well placed for that future. Our resilient long-term cash flows and robust Solvency II capital position are a testament to the group's business model. Thirdly, the achievement of an investment-grade rating in 2015 confirmed the rehabilitation of the group's balance sheet. The group continues to demonstrate its capabilities in managing closed funds efficiently and effectively for the benefit of customers and shareholders. As we announced today, the board is recommending a dividend of 26.7p, in line with the 2014 final dividend and consistent with our stable and sustainable dividend policy. I will now pass over to Clive and the team to take you through the results in more detail. Thank you, Henry, and good morning to everybody. 2015 was a year of major achievements for Phoenix. First, despite economic and regulatory uncertainties, we delivered both our cash generation and our MCEV management actions targets. Second, our Solvency II internal model was approved by the PRA last December, and we start the new Solvency II regime with a robust and resilient capital position. Finally, as Henry has already noted, we achieved an investment-grade credit rating from Fitch. This improves our access to capital markets and has facilitated a revised bank facility, lowering our cost of debt and positioning the group well for the future. In spite of the uncertainties that faced the group at the start of last year with regards to Solvency II, Phoenix delivered cash of GBP 225 million, and is well on track for the longer term 2014, 2019 cash target. In addition, Phoenix Life continues to execute value-added management actions. GBP 205 million of additional MCEV was created through management actions in 2015, and this has meant that the group has exceeded its GBP 400 million target one year ahead of schedule. The introduction of Solvency II was a major focus for the group in 2015. This culminated in the PRA approving the use of our full internal model in December, one of nine life companies. The opening surplus of GBP 1.3 billion is, as we guided last year, well in excess of the existing PLHL ICA surplus, and we report today a shareholder capital coverage ratio of 154%. More importantly, the surplus is resilient to market volatility. As of the 4th of March 2016, the surplus remains constant at GBP 1.3 billion. It should be stressed that the new Solvency II regime does not impact the underlying financial framework that underpins Phoenix's business model. Our stable and sustainable dividend policy is unchanged, and we will continue to seek to optimize the Solvency II position, our Solvency II position, through further management actions. As signaled this time last year, the 2015 cash generation was impacted by the transition to the new Solvency II regime, with the Phoenix Life companies retaining capital during the year to ensure a successful internal model application process. The capital position of the life companies is now clearer, and today we have announced a cash generation target of GBP 350 million to GBP 450 million for 2016. Put another way, normal service is now resumed. In addition, we have set a new five-year cash generation target of GBP 2 billion between 2016 and 2020, aligned with the maturity of our new bank facility. Cash generation remains the key focus for the group, and we will therefore continue to seek ways to maximize the cash generation from the group. The group's long-term cash profile not only supports our investment grade and our dividend policy, but provides the group with greater flexibility in growing the business through acquisitions. I will now pass you to Jim, who will take you through our financial results in greater detail. Jim. Thank you, Clive. Good morning, everyone. I will take you through each of the key metrics in more detail shortly, but let me set out the summary of the key results. Cash generation of GBP 225 million, in line with our stated target range for 2015. IFRS operating profit of GBP 324 million. MCEV of GBP 2.5 billion with a strong contribution from management actions. A robust group capital position with a Solvency II surplus of GBP 1.3 billion, and a shareholder capital coverage ratio of 154%. Our PLHL ICA surplus was GBP 0.6 billion, and our IGD surplus was GBP 1.5 billion, the last time we will report these two metrics. Finally, total 2015 dividends of 53.4 pence per share included a recommended final dividend in respect of 2015 of 26.7 pence per share. As we described last year, the 2015 cash generation was impacted by the transition to Solvency II, with the life companies retaining capital during the year rather than releasing it up to the holding companies. Of the GBP 225 million of cash generation during the year, management actions accounted for GBP 20 million. The operating expenses of the group have reduced through continued strong cost management. The payments to the group pension schemes have also reduced by GBP 33 million over the year, reflecting the contribution schedules agreed with the trustees. Non-recurring costs were lower this year due to the costs of the Ignis disposal and debt restructuring incurred in 2014. Debt interest payments increased during the period as a result of the Tier 1 bond exchange, which meant that paying both the Tier 1 coupon in January and the coupon on the new subordinated bonds in December. However, we have reduced debt during the year through a repayment of GBP 190 million, which will lower interest costs in the future. This demonstrates the group's confidence in its capital position and also helped facilitate the new revolving credit facility we announced today. The group's operating profit was GBP 324 million for the year, which includes GBP 58 million from management actions. The impact of management actions on IFRS profits can be lumpy and were lower than in the previous year. This has impacted the headline number, but it is still an excellent performance overall. 2014 included a one-off benefit from the Ignis disposal, and in 2015 there was a further positive non-recurring item from the restructure of Opal Re, the group's captive Bermudan reinsurance company. This transaction involved recapturing the annuity liabilities and then agreeing a new reinsurance agreement with an external third party. Andy will go into further detail on this management action shortly. We incurred GBP 99 million of finance costs, which included a GBP 27 million impact from the accrual of the coupon of the new subordinated debt issued in January. The coupon on the previous Tier 1 bond was accounted for within equity, and therefore would not have been included in the analysis on this slide. Finally, after tax, we generated a profit of GBP 249 million. The tax credit in 2015 derives from the settlement of a number of historic tax issues. Now turning to look at MCEV. We set out here the material movements in MCEV over the year. For clarity, we have shown the value generated from management actions separately. So moving from left to right. We generated post-tax operating earnings of GBP 135 million, excluding management actions, which reflects expected returns on the life company embedded value at the long-term risk-free rate, plus assumptions of real-world returns. We delivered GBP 205 million of incremental value through a number of management actions, which Andy will discuss in a moment. Below the line economic variances, non-recurring and other items totaled a negative GBP 114 million, primarily reflecting the differences between the short and long-term rate assumptions and the negative market movements over the year. In particular, widening credit spreads had a significant impact on MCEV in 2015. We also had a negative impact to MCEV from certain actions we have taken to optimize the Solvency II balance sheet during 2015. These mainly resulted from the restructuring of various credit portfolios, which reduced the amount of liquidity premium within the MCEV. The increase in market value of the group's listed bonds during the year has reduced MCEV by GBP 26 million, and we incurred finance costs, including the Tier 1 coupon of GBP 91 million. Both the group's pension schemes are in surplus under IFRS, but these surpluses are not included within the group MCEV. Therefore, pension contributions are deducted from MCEV, and the post-tax contributions of GBP 44 million made during the year are shown here. Finally, we paid dividends of GBP 120 million during the year. At the end of December, the group MCEV was just over GBP 2.5 billion, representing MCEV per share of GBP 11.15. We will not report MCEV in future. We will continue to focus on meeting our cash generation targets and increasing future cash flows through management actions. We will be providing further details on Solvency II and future financial reporting at an analyst session in May. Fitch Ratings assigned investment-grade ratings to both our senior and subordinated debt in August last year. The investment-grade rating provides broader access to the capital markets in the future. With a wider potential investor universe, the group now has greater flexibility in future debt issuance, including the approved ability to issue regulatory compliant subordinated debt. We have also recently renegotiated our senior debt bank facility, putting in place a £650 million revolving credit facility at a reduced interest cost. This revised facility has no mandatory or target amortization payments and offers the group greater flexibility to make acquisitions. In terms of the future, we continue to examine options with regards to replacing our bank debt with a longer-term financing structure. Given the progress we have made over the past two years, we are well placed to access the markets at an appropriate time. Moving on to our regulatory capital position. This is the last time I will be reporting the group's IGD and PLHL ICA position. The only further point I will mention is that as part of our preparation for the introduction of Solvency II, we simplified the group structure, and this has had a positive impact on IGD over the course of the year. This slide sets out our Solvency II position at the end of 2015, representing the results of our full internal model calculated at PLHL level. We have eligible own funds of £5.8 billion, with 87% of group own funds being Tier 1 capital. The group SCR is £4.5 billion, giving a surplus of £1.3 billion. As we have done with IGD and PLHL ICA in the past, we will continue to focus on the overall surplus number and its resilience. As a closed fund business, we do not need to hold additional capital to fund new business growth. Phoenix has a number of strong with-profit funds with surplus estates, together with the group pension schemes that are in surplus. However, these surpluses are excluded from the group eligible own funds of £5.8 billion. There is an additional £0.4 billion of surplus in the strong with-profits funds and £0.1 billion in the group's pension schemes. Although these amounts are excluded from the group's eligible own funds, and hence the surplus of £1.3 billion, they are still available to absorb economic shocks. This means that the headline surplus is extremely resilient to economic stress. We have therefore split out the strong with-profits funds on the group pension schemes from the calculation. This is similar to the approach taken by some of our peers and provides a shareholder capital coverage ratio of 154%. Our unsupported with-profits funds are managed on an individual basis to ensure they maintain a surplus above their capital management policies, whilst aiming to accelerate the distribution of the estate to our policyholders over time. There remain a number of specific management actions we can take to improve our Solvency II position, including optimizing our matching adjustment portfolio and further hedging of market and longevity risk. As I mentioned, we will be providing a greater level of detail on Solvency II in May. The surplus and its resilience will remain the focus of our group capital reporting. As you can see, the surplus is highly insensitive to market movements, with the key sensitivity being to increase longevity. This insensitivity is partly due to the additional surpluses within the with-profits funds and the group pension schemes that I have just talked about. This is further reinforced by the risk management actions we take within each fund to allow for a smooth and stable run-off. This resilience is demonstrated by the surplus calculated as at March 4, which remained at GBP 1.3 billion. Market movements have reduced the surplus by GBP 0.1 billion over the first part of this year, but this has been offset by management actions, including additional hedging of interest rate risk. We have today set a new annual target of between GBP 350 million and GBP 400 million for 2016, and a new longer-term cash generation target of GBP 2 billion between 2016 and 2020. We expect that around 25% of the GBP 2 billion target will come from management actions. In future, we will report the split of management actions between those that increase solvency to own funds and those that reduce capital requirements. Beyond 2020, we anticipate a further GBP 3.2 billion of cash generation, demonstrating that the long-term cash flow profile of the group remains a key strength. However, it is important to remember that the amount shown here after 2020 do not include any benefit from management actions. As Andy will demonstrate shortly, the key strength of the group is to continuously find ways to add value to shareholders and policyholders, and this will continue into the future. We have set out here an updated version of what is probably a fairly familiar slide, showing the illustrative sources and uses of cash over the period to the end of 2020 based on the new GBP 2 billion cash target. We begin with our cash at the holding companies of GBP 0.7 billion as at December 31, 2015. The green bar to the right of this of GBP 2 billion represents the cash generation expected to emerge over the period. Continuing to the right, we can show the various uses of that cash over the period to 2020. As can be seen, we have assumed that the new bank facility is fully repaid by 2020 through payments made during the period. There is GBP 0.6 billion to fund an illustrative stable level of dividends at the current cost of GBP 120 million per annum over the next five years. After these uses of cash, we are left with an illustrative GBP 0.8 billion of cash at the holding companies, and this demonstrates our confidence in a stable and sustainable dividend well into the future. Here we provide further information on cash generation expectations and the uses of that cash from 2021 onwards. We expect there to be around GBP 3.2 billion released as cash to the holding companies after 2020, as represented by the green bar. As I mentioned earlier, this does not assume any further management actions. Known uses of this cash include the remaining pension scheme contributions and outstanding debt, and this leaves an estimated GBP 3 billion of cash at the holding companies available to fund interest costs, expenses, and dividends. I will now pass you to Andy, who will talk you through recent developments at Phoenix Life. Thank you, Jim, and good morning, everyone. In 2015, there was an enormous amount of work carried out on the Solvency II transition. Despite this, we continued to enhance the Phoenix Way, our approach to delivering shareholder and policyholder value. We restructured Opal Re, the group's captive Bermudan reinsurance company, at the end of the year. This involved the recapture of GBP 1.4 billion of reinsured annuities from Opal Re and a new reinsurance agreement with an external reinsurer, which covers the bulk of the recaptured liabilities. This is more efficient from a Solvency II perspective. We also completed the fund merger of National Provident Life into Phoenix Life Assurance in the first half of this year, leaving only two remaining U.K. Life companies. A reduction from nine Life companies in 2009. Furthermore, we sold our small Irish subsidiary, SMI, which only had around 3,000 policyholders and therefore lacked the scale to operate efficiently. The key event on the customer side was the new pension freedoms, which I will cover shortly, and we've also continued to increase the distributable estate within our with profit funds to enhance future policyholder returns. We have now increased the distributable estate by GBP 817 million over the past three years. As Clive mentioned earlier, we set ourselves a target of achieving GBP 400 million of incremental MCEV over the three-year period from 2014 to 2016. I'm delighted that in 2015, we have achieved a total of GBP 205 million of incremental value, meeting the target a year early. Specific management action achieved include the acquisition of a portfolio of equity release mortgages and further benefits from the full implementation of the MG-ALFA system. In total, we'd have added GBP 1.4 billion of MCEV over the past seven years. As can be seen in the right-hand chart, we also have a long track record of accelerating cash flows on top of those that flow from the organic runoff of the group's life policies. Over the past seven years, Phoenix has generated a total of GBP 1.6 billion of cash from management actions. There are further management actions planned to optimize the group's Solvency II position, and therefore help to increase the cash flow over the coming years. As Jim mentioned, we expect around 25% of the new GBP 2 billion long-term target to be generated from management actions. One of the big challenges for closed book consolidators is to have an operating model that is scalable both upwards and downwards. This slide helps to demonstrate Phoenix track record in this regard. The table shows that we've continued to be successful in being able to run down our cost base in line with our policy runoff. This is underpinned by the variable cost nature of our outsourced relationships. The policy runoff can change from year to year, but you can see from the cumulative position that we have consistently managed costs down faster than policies have declined. All this demonstrates cost efficiency, and the development of our operating model means that it is also scalable upwards, allowing us to onboard further closed life funds in an efficient manner. As we have discussed in the past, there is a great deal of regulatory activity, and we have set out here just some of the key bodies involved in the U.K. life industry. This activity has been particularly marked from a conduct and customer perspective. As we have said many times before, having a strong customer proposition is vital to succeed in the closed life fund consolidation market. The FCA released its report on the treatment of legacy customers earlier this month. The report for consultation has set out a number of best practice ideas which we will be actively reviewing to see how we can further enhance our customers' experience and outcomes. With regards to the FCA consultation on capping exit charges, our experience is that these charges are not significantly influencing our customers' behavior. However, should a cap be introduced, we would not expect the impact to be material, given around 80% of our customers have no exit charge. Assuming the cap is set at, say, 5% for those over 55, the impact on cash flow would be in the order of GBP 6 million. 2016 will see changes to complaint reporting for the industry, which we welcome in terms of transparency for customers. We believe we are well-positioned to not only deliver the new reporting, but to drive improvement in this key area. This regulatory focus will certainly continue in the future, and therefore it is essential to have in place an operational model that can demonstrably add value to customers. As I mentioned earlier, the introduction of the new pension freedoms have been the main customer event of the year. There was a significant initial surge in customer calls in April, and we have seen, along with our peers, an increase in full encashment for smaller pension pots. During 2015, we have seen 43,000 customers requesting full encashment at an average pot size of GBP 13,000. Although we have seen limited interest from our customers in alternative drawdown products. We have taken steps to offer a full range of products to our customer base to meet either investment needs or long-term income needs. This includes an extended partnership with Just Retirement that allows customers to access options such as simplified financial advice, drawdown products, and enhanced annuities. In 2015, we wrote GBP 485 million of annuities compared to GBP 545 million in 2014. 71% of these annuities had guaranteed rates. These policies provide attractive rates for customers, and we continue to believe that our assumptions with regard to take-up rates remain appropriate. Non-guaranteed annuity values written were down slightly by 8% compared to 2014. We still see annuities being an attractive option for many, and we aim to provide competitive rates to our customers, benchmarking against the top five open market providers. We continue to ensure delivery of the promises made to customers in their products and to provide high levels of security and service. We also look for possible ways to engage with customers and help them understand their policy benefits. During 2015, we instigated new or amended mail-ins to around one million customers with the aim of improving engagement with their products. We have also continued our actions to prevent pensions fraud and have prevented a further GBP 10 million of potentially fraudulent transfers in 2015. The right-hand side of the slide sets out some of the key customer metrics and indicators that we track against. I am glad to say that we have met or exceeded all of the stated targets. These take into account benchmarks that we see externally, and we will continue to seek ways to improve and ensure that these levels are maintained. I will now pass you back to Clive to wrap up. Thank you, Andy. Today, we have set a new target of between 350 million GBP and 450 million GBP for 2016, and a new longer-term cash generation target of 2 billion GBP between 2016 and 2020. Beyond 2020, we anticipate a further 3.2 billion GBP of cash generation, as Jim indicated, demonstrating that the long-term cash flow profile of the group remains a key strength. The 3.2 billion GBP shown here after 2020 does not include any benefit from future management actions. The strength of the group is its ability to continue to find ways to add value to shareholders and policyholders alike, and this we will continue to do well into the future. The regulatory landscape is evolving, and we believe it is therefore essential to have an operational model that is specifically designed for the management of closed life funds. Phoenix is well positioned to benefit from the capital changes that are taking place in the open business models and that are impacting the industry across the U.K. The actions we have taken from a financial and operational standpoint put Phoenix in a strong position to play a leading role in future consolidation, and I am certain, more certain than ever, that there is a significant opportunity for Phoenix to generate further value for mergers and acquisitions. To end, 2015 was a busy year for the group, and our achievements have positioned us well for future growth. We will continue to focus on delivering value to customers and shareholders alike. There remain a long list of management actions to deliver, including optimizing the Solvency II balance sheet and further simplification of the group structure. Phoenix is active in industry discussions with regards to the future of our entire industry, and we expect that in the coming years there will be a number of opportunities for the group to acquire and manage additional closed life portfolios. We look forward to the future with confidence. That, ladies and gentlemen, brings to the end the formal part of our session. Thank you very much for your engagement. Let's move on to questions and answers. Can I ask you to wait for the microphone to be brought to you? I can see Ben's already there. Could you give us your name, tell us which institution you work for, and go via the chairman, and we'll address the questions. Thank you very much. Ben. Right. Thank you very much, Clive. It's Ben Cohen at Canaccord. I had two questions on the outlook post-Solvency II. The first was if you could give any more details about, in the Solvency II world, the different type of approach you might have to take with regard to management actions. Also that question with regards to your view of M&A. Now that you've worked through Solvency II, has your view as to the attractiveness of different types of books that might be out there, how has that changed in a post-Solvency II environment? Thank you. Jim. Thanks, Ben. Jim, fire ahead. Yeah. I'd like to deal certainly with the first question, Ben. I think in the immediate future, we will continue to work on optimizing our Solvency II position. During 2015, we did quite a significant amount of work. First of all, as we mentioned, the recapture of the internal reinsurance agreement with our Bermudan reinsurer and replacing that with an external reinsurance deal. We also did quite a lot of work in terms of optimizing the credit position within the with-profits funds and moving from gilts to swaps and so on. That was a lot done in 2015. What you will see going forward into this year is further work to optimize our matching adjustment portfolio. We basically took, hopefully, a low-risk approach to the matching adjustment application in 2015, and there is further work we can do to maximize the matching adjustment position this year. We will continue on the journey of improving strategic asset allocation to access some higher yielding funds. Of course, hedging continues to be managed on a dynamic basis. Just to recap, Solvency II is the prime driver of cash flows. That is why MCEV is a much less useful indicator. As Jim has indicated, we took actions during the year which were positive for Solvency II and actually therefore some of them turned out to be negative for MCEV, so that is why we are dropping MCEV and focusing on Solvency II. In terms of M&A, do you want to comment on the particular products and how they are impacting? Certainly. So two parts of M&A. There is a sort of big structural environmental consequence of Solvency II, Ben, and then I think your question is more focused on does it change our appetite or push us in one direction or another? Let me deal with the micro, and we may get back to the macro question later on today. At one end of the spectrum, you have annuities and the cost of longevity and credit. At the other end, unit-linked pension somewhere in the middle. We are agnostic. We have a great predisposition and ability to deal with with profits, and as you know, we were involved in a transaction last year, which was substantially in the annuities environment. Andy said that we are proud of the GBP 485 million worth of annuities that we wrote. It is the only part of our new business. It is only new business we do. It is vesting. So we think that annuities have a role to play going forward. They have to be properly priced. That has to be done in the context of a capital charge from Solvency II on longevity, and then also what we can get on the other side of the balance sheet in terms of a sensible asset strategy. As you know, the shareholder funds in our group are very cautiously invested, 77% plus are in single A or above. On the other side, we look for acquisitions that principally give us a scope. The maximum scope to demonstrate our ability to do more management actions, either the enhancement of old MCEV, as the Chairman has correctly said, and also the acceleration and release of cash. So I end where I began, which is we are agnostic to the underlying business. We are capable and competent and happy to take on any. But obviously, pricing has to reflect the new regulatory environment and the capital charges therein. And of course, it will be partly driven by what competitors decide to do. And of course, it could be that they are more interested in asset management and therefore less interested in particular products. It could be close with profits policies or whatever. So it will be not only what we want to do, but what others decide to, what fits in with their strategy. Sir. Yeah. Hi, good morning. Ashik Musaddi from JP Morgan. Just a couple of questions. One, can you give us some sense about your appetite for M&A in terms of what sort of size should we expect, or what sort of size are you comfortable with? And secondly, you mentioned that you are not particularly drawn to one sort of business, be it annuities, unit linked, or with profit, but is there any preference that you have? Clearly, you are open to more or less everything because your management actions has been pretty strong. But is there any preference? Thank you. Well, obviously, before I hand over to Clive, I would say we looked at Guardian, which was a GBP 1.5 billion or so acquisition. So we would clearly not be frightened by something of that sphere. But I think if it was below GBP 100 million or so, these deals are complicated, so why would we necessarily get involved in something that small? So there is a range, and below a certain amount, it just would not be worth the hassle. In terms of products, I think you have partly covered already, but- Ashik, I am very happy to comment. We want to do deals that have three characteristics. The first is they have to be accretive to our shareholders. That is why we get out of bed. We are stewards of other people's capital. The second is we are determined to defend the investment grade and position ourselves, because that is a very important benchmark, which was achieved by Jim and his colleagues. So we are going to protect that. And then finally, the dividend is an important signal. That is what we believe is at the heart of our business model, the ability to deliver cash, benefit our policy holders, and take care of shareholders. So deals that fall within those three criteria, accretive, dividend protecting, and ensuring that our investment grade rating is protected. Those are the key drivers. I go back, I am agnostic on the business type. It is the type of opportunity we are seeking is one where we can demonstrate to the maximum our scope. On average, we have delivered GBP 1.2 billion in the last four years of additional cash flow delivery. I think you heard from Andy, we set ourselves a target to deliver GBP 400 million of MCEV over four years. We actually delivered GBP 466 million of incremental MCEV, and we did it in three years. If we get hold of the right asset, what we have been doing to ourselves in the bringing together of five life companies in the last seven years, what we have been doing to ourselves, we will do to a target if we are given the opportunity. Oliver. Oliver Steel at Deutsche Bank. Three questions. The first is, you used to give us the sort of headroom over your targets for solvency. Do you have a headroom figure for Solvency II? Secondly, obviously what happened in 2015 is that you were forced to hold cash back in the life companies. Yet you only give us sort of sensitivity at the totality level. Can you give us some sort of idea as to sort of how close you are to the minimum you need to hold down in the life companies out of that solvency ratio? Because actually out of the surplus, less than half of it is actually in the life companies. Any guidance you can give on that would be useful. Third question is on the GBP 650 million revolving credit line. You say on acquisitions, and you say this gives you flexibility for acquisitions, but equally, you say on acquisitions that you do not want to increase the debt to a level where you might see a rating deterioration. How long would you expect your debt to increase by if you were to use that GBP 650 million? Do you want to start, Jim, with Solvency II headroom? Yes. Previously under the Solvency I regime, Oliver, we did disclose the headroom as they were imposed on us by the PRA, and therefore we were obliged to disclose that. The boards of the life company and at group level have internal capital management policies agreed, but we haven't chosen to disclose these as I think it's not normal practice that these are disclosed. But they are prudent capital management policies designed to obviously protect the position in times of stress. In terms of your question on the new debt arrangements, let me deal with that first, and you discuss the further flexibility. What the new arrangement does, first of all, it's a revolving credit facility for the full GBP 650 million, and it has no mandatory or target payments associated with it. What it does have is lighter restrictions in relation to the approvals we would need from the banks to engage in acquisitions. So there's more freedom to do acquisitions without the need for bank consent. Plus, there is also a facility attached to the deal, which is, if you like the phrase, it's a super-sized facility to increase the amount of debt to support an acquisition up to a certain amount. So that gives us much greater flexibility in terms of thinking of our funding requirements associated with an acquisition. But if you stand back and look at how we would approach an acquisition, one of the criteria we have always said is that on an acquisition, we would expect leverage to fall, and therefore, the mix of equity, debt, and cash resources, and the debt structure of the acquired company would have to be taken into account to make sure we come up with a cocktail of financing that delivers that lower leverage. I've completely forgotten your second question. I apologize. Life company with solvency and life company versus the 650. Yeah. Andy has said we've covered that. It's dealt with by the capital management policy within the life company. Is there anything you'd add on the debt, Clive? Fine. All I was going to say is Jim has been naturally modest. It's been an extraordinary journey. About five years ago, when we had the two in parlor, the two silos, it was a cat's cradle of covenants. I thank the key stakeholders, our banks, who've shown us enormous support on that journey. In 2011, we paid GBP 122 million of interest cost. Last year, if you take out the Tier 1 cost, it was GBP 71 million. It's that sort of delta, and this new facility at 175 basis points versus two years ago at 475 basis points shows the journey that the company has taken, and Jim has already referred to how it will help us when we do M&A. I just would add that Fitch are clearly aware of our plans because they're out in the open to actually make acquisitions. So, in terms of their credit ratings, Jim has mentioned, it wouldn't just be all for debt if we did a deal of GBP 1.5 billion, et cetera. But they're aware of our plans, so it's built into their credit rating. Can I quickly just come back to you on the debt? You say you want the debt leverage ratio to come down. Are you prepared to give yourself some time to do that? If, for instance, you are expecting management actions to deliver value within, say, 12 months, are you happy for the debt leverage to go up for 12 months in the knowledge that it will come down thereafter? No, I don't think we expect to see leverage increasing. We are going to avoid any downgrades because we think an investment grade gives so much stability and additional resilience to this organization. Yep. Andy Sinclair from BofA Merrill Lynch. Just three questions, please. Firstly, equity release mortgages. You mentioned that you bought a portfolio. Apologies if I missed the number, but could you just let us know what size was that portfolio, and did you get matching adjustment for that portfolio? Secondly, you mentioned the impact of a 5% cap on exit penalties. Just wanted to give us an idea of what a lower cap would be and actually how much income you get in total from exit penalties at the moment. Thirdly, on M&A, another question with M&A. It seems that most of the things that have been stopping M&A are now out the way, be that the back book review, Solvency II, investment grades rating. What is stopping us now? Is it just a competitive environment? Could you comment on that? Thanks. Excellent. Perhaps if Jim could talk about matching adjustment and Andy could talk about the 5% cap. Okay. On the equity release mortgages, Andy, we acquired a portfolio of GBP 300 million last year, and at the tail end of last year, we also entered into an arrangement which increases our portfolio by GBP 15 million-GBP 20 million per month. That was not included, neither of these were included in our original matching adjustment application and will be part of our next application as we refine our Solvency II position. Yeah. On the exit penalties, just to give you an idea of the range then, if that exit penalty was actually set at zero, we anticipate the cost for the over 55 population would be about GBP 22 million. Obviously, exit penalties only arise for those that exit. I think in terms of exit charges, I think I will refer to the fact that only about 80% of them have no exit charges. Of the remaining 20%, the average exit charge that we see is about 1%. What is stopping Clive is, of course, as Chairman, I think that is interesting. Thank you very much. This is where I get the opportunity to wave my hands around. Andy, it is a very good question. So I am going to step back a bit and then dive into detail. If I step back, let us look at the broader industry. There are three great big trends which are going to drive our industry forward. One of which is increased consumer flexibility. So A-Day was an immensely big change for our industry, giving people the freedom appropriately, entirely appropriately. So there is a consumer dynamic here. The second is the regulatory change over the capital in our industry. We noted in January that our friends at the Pru said that they thought that longevity risk was more expensive after Solvency II, and that drives a cost of capital which is critical against various risk types. Then finally, we have the background of continued long-term interest rate declines. So those are the three major systemic drivers which are going to force, we believe, and we wrote a thought piece with Cass Business School called "The Meaning of Life," where we said the old vertical stack of an old insurance company was going to be severely challenged. So the old model, which combined savings with some form of protections with investment, we think is going to be challenged, and the industry is driving itself into two directions. There is one direction, which is capital-light and a savings model, which has tax advantages, and the other, which is a more protection heavy, capital heavy business, and these are priced differently by the market. I am looking at our investors here. They are managed differently by companies, and they are certainly looked at differently by consumers who now have increasing choice. Therefore, we believe fundamentally that this industry is going to evolve, there will be further consolidation, and that there is a completely different business model for those of us who run a closed life business. Different types of actuaries. We do not worry about products. We do not write the new business. We do not have a capital strain. We look after policy holder outcomes in a different way, such as the accelerated estate distribution. This is a different model from our colleagues who very actively pursue an open model. Therefore, against that backdrop, your question is well posed. We think future consolidation is inevitable, and your question is, well, what is holding it back? So I am going to draw your attention to that slide, which is page 33. We think there is a big market out there. It is a big swimming pool. You can choose a number between GBP 250 billion and GBP 300 billion. Those businesses are owned by three types of owners. Closed life businesses, 17% in the hand of banks, 35% in U.K. life companies, and then foreign insurance companies. In the middle category, we describe the vendor motivation. That slide has not changed in two years. When I first put it up, I said the big hiatus, and there would be a period of hiatus, was awaiting the outcome of Solvency II, so that vendors were more certain about what they had for sale, and acquirers would understand the capital implications for in-boarding, and in our case, harmonizing on Solvency II. I think that, Andy, you are right to say that the game is changing. Those tectonic plates are moving, and we wish to be actively involved in future discussions. What are the breaks? Those are the accelerants for why change should take place, is that for the owners of these companies, it's quite an interesting trade-off between the dependency upon the stable cash flows from an old business versus building a new capital-light business, which is more dependent upon, shall we say, asset management fees. You need a very big business in the new world compared to the business you were running in the old world. That transition, for many firms, will take several years, and it requires a series of actions which are not, as you can imagine, non-trivial when a firm shifts from being a capital heavy protection model to something that is different. But I think the change is underway. Sir. Hello, hello. Oh. Sorry. Dave, sorry. This is Fu Liang from Morgan Stanley. I have two questions, please. First of all, you provided the sensitivity results for the shareholder part of the surplus. Just wondering, do you have similar sensitivity results for the group pension schemes? That's the first one. Second question is, I noticed that actually you reported a negative IFRS operating profit for your unit linked business without significant drop in the assets. Just wondering what is causing that. Thank you. The pension scheme, Jim, and perhaps Andy can pick up the update bit. Yeah. Okay. The sensitivities that we have shown are based on the overall position taking into account the pension scheme surplus and the with-profits funds. But if you go back to the slide that I showed where the surpluses within those funds are sufficient to be able to absorb the shocks in those funds themselves. So without taking into account the overall position, they do have the effect of dampening down that shock because they are in a strong surplus position. So Andy, did you want to talk about the unit link? Yeah. So on the unit link business, what we did during the year, we harmonized our expense mechanism charging on the unit linked business. So we moved it all to a per policy fee away from some of the business which was charged on assets under management fee. That meant in terms of IFRS reserving, that we had to increase the reserves in the short term. When we look at it over the lifetimes of the policies, the actual value increases slightly because overall the charges were reduced. So it's a one-off reduction in the operating profit this year, which will come back over time. Just whilst that slide is up, Andy, do you just want to touch on anything on slide 39 that is just worthwhile just in case any other questions arise around the IFRS business? Yeah, no, I think overall the profit is reasonably stable when you look at the margins which are being generated. Our profits are reasonably predictable on the with-profit side. The internally supported funds, again, we are seeing similar sort of margins coming through. Obviously what we do see in the operating profit line is any assumption changes coming through or any one-offs. As Jim referred to earlier, sometimes they can be a little bit lumpy. On the annuity side, we were slightly lower this year because there was a squeeze in terms of pricing and to maintain our competitive position. To ensure we are providing good value to customers, then pricing was squeezed slightly. But other than that, it is a reasonably stable position. Thank you. I see one over there. Clive, can you take that off the screen there? Thank you. Just the one at the front to the left there. Sorry, miss. Eamonn Flanagan at Shore Capital. Clive, can I bring you back to your three criteria for M&A? Yeah. You talk about accretive for investors. By what measure should we look in terms of your focus in terms of accretion? Is it net asset value accretion, earnings accretion? If you are dropping MCEV, is it IFRS, NAV, et cetera? Then the second point about the dividend, forgive my ignorance here, have you changed the focus slightly from enhancing the dividend to protecting the dividend? Eamonn, thank you. Good questions. Accretion in the old days used to be easy to show because you would pay something for MCEV, and there would be either a positive or negative delta against where you were actually trading. We think MCEV is in the rearview mirror for the reasons that Jim has described. So we are not thinking about accretions in terms of MCEV, nor would we be doing it against anything published in the NAV space, which is not a relevant criteria. So it goes to the heart of what we are focusing on, what we have always focused on, is cash flows and the abilities that any acquisition will do to enhance. Enhancing in 2 ways. There is a volume and an extension. So there are 2 ways that were we doing an acquisition, we would like to be able to advertise that we have better coverage because of enhanced cash flows and that they are attenuated. They go out further years. That is why it was important for us to take that last 5-year target and extend it out beyond 2019 to 2020. So that is on how we are thinking about accretion. Then on the other 2 criteria, we want to protect our investment grade rating, and we want to make sure that the dividend. Then it goes into your second question about dividend. We have always said that we want to have a stable and sustainable dividend. That is the phrase used by the board for the last 3 years. We changed the dividend in 2013 when we raised it by 20%-plus to its current level. We have always thought it would be curious to do anything to our dividend other than in a situation when there has been a transactional material change in the business, which would allow us to move from stable and sustainable. I am saying that we are stable and sustainable. You use the word, are we protecting the dividend? No. I am saying that in an M&A situation, it might allow us to move from being stable and sustainable where we are today, because we have a greater confidence about future cash flows, which would give the board the flexibility to look at our dividend policy then. On the back of a not unreasonable current yield. Yep. Sir, over there. Ashok Gupta, private investor. A couple of questions, probably more for Jim. The first is on the pension scheme. You seem to be paying an awful lot of money into a pension scheme with a surplus. Is it possible to give some flavor as to your plans for managing this? For example, buying it out or whatever, if that is the intention. Secondly, when you do your May MCEV presentation final piece, it would be very helpful to see some sort of reconciliation between own funds and MCEV. Reconciliation, sorry, help me. Between own funds, Solvency II own funds and MCEV, just to sort of understand how the switchover compares. Okay. I think they're for me, Ash. Yeah. I always love your questions. Thank you very much. The contribution schedules that you see going through the accounts are based on agreements that we've reached with the trustees on the 2 schemes some time ago. These are contribution schedules which allow for payments over the next few years and do reduce over time. We're obviously just in the process of completing the next triennial valuation. We do not anticipate any major change really to those contributions as a result of that valuation. We do, however, work with the trustees of the pension schemes to work with them in terms of the way they look at their risk profile and so on, and in how we can improve the efficiency of the scheme and the surplus position. We take action with other pension exchanges and so on as appropriate. We do from time to time look at whether a wider action such as buying out part of the pension scheme may be the right thing to do. That is not something that is currently planned, but certainly is something that we would look at from time to time. In terms of the investor day, we will be providing a lot more information about the Solvency II position on funds, and going back to Eamonn's point, what replaces MCEV accretion. I am sure we will be talking about MCEV and the transition into Solvency II in more detail. May I add, Jim? I know that we inherited pension funds which needed strengthening. Both funds are now in terms of IFRS in surplus. The reduction in payment, we paid GBP 88 million last year. It is GBP 55 million, so 2014, and it is a GBP 55 million contribution. In the slide Jim showed going forward, the monies post 2020, there is no further contribution to those pension funds. That is something that we had to worry about and we do not worry about anymore. You do not want any detailed questions on IAS 19. No. We would be shoved in that direction terribly quickly. Any other questions? Sir. Hi. Just one remaining. It is Kailash from HSBC. In the report, you mentioned one of your priorities in 2016 is to, I think it says something like broaden your funding sources further. Yeah. Could you just elaborate on what that means? Is it getting rid of the bank facility and issuing? Did you say getting rid of the banks? You know where you are sitting right now. So I am being naff for what you said. Kailash, thank you. Yeah. I think it is consistent with what we have said last year, Kailash, that at the moment, clearly a substantial proportion of our funding is in the form of bank debt, although that is reducing. We have made very good progress in terms of restructuring that bank debt and lowering the interest cost of that bank debt, as we have described a number of times over the past few years. However, we have an ambition to reduce the proportion of bank debt further, and that would involve probably the issue of capital qualifying Tier 2 debt into the future. The important point is we have no immediate financing, refinancing requirement. Our arrangements go out to 2020, so there is no pressure for us to do anything on that front in the immediate term. Clearly, the debt markets are not in great shape at the present time, and the cost of that debt would be quite high, but it is something we monitor on a regular basis. As and when we saw a sensible opportunity, we may well take advantage of that. Just to the front. Oliver Steel, Deutsche Bank. Sorry, just one more question. On the back of that pension scheme question. You said that you were stripping them out of your solvency calculation. But if you are still contributing to them, that just seems a little odd that you can strip them out of your solvency while still contributing, because clearly by implication, you have an economic deficit in those. Well, what we're not recognizing in the GBP 1.3 billion surplus is the surplus in the pension schemes. Because that gets taken back down to zero is the way it works. Your 154%, are you stripping out both pension schemes from that? Yes. What's the SCR for the two pension schemes so that we can adjust back if we want to? The adjustment is, the surplus was 0.1 of a billion. I think one of the slides shows the adjustments that we've stripped out. Yep. What about the SCR? I will get you that question. I do not have it to hand. Any other questions from the floor? If not, are there any other questions online? No. Have I missed anybody? I think that is it. Thank you very much for coming, and we look forward to seeing you in May. Thank you. Thank you very much indeed. Thank you. This presentation has now ended.