Earnings Call: H2 2012

Mar 22, 2013

Morning, ladies and gentlemen. Welcome to the Phoenix results presentation. This is the first time I have done an annual results presentation since I took over as chair on 1 October. Last year, though, of course, I think not many of you were here for our reterming presentation, which I also introduced. Let me just first briefly introduce our team. On the far end of the podium on your right, Chris Samuel from Ignis, Mike Merrick, who runs the life companies, Jim McConville, our finance director, and the one-armed man, Clive Bannister. I should point out that Clive did not break his arm in a fight with any of our bankers. He fell off his bicycle when he was speeding. His wife took the points, of course, but he got the broken arm. The key concern that our shareholders voiced when I joined the group last year was the need to reterm our bank debt. That was step one in any process which would deliver us a happier future, and we have achieved that. In doing so, I think we have delivered longer term stability for the group, which provides a platform for the next phase in our development. So I am delighted to be here today to announce a strong set of results for 2012 and to say that we look forward now with confidence to the group's future. We are going to take you through the presentation now, and then we are all at your disposal to answer any questions you may have at the end. So without further ado, I am going to hand you over to Clive Bannister. Clive? Howard, thank you. The truth about my arm is, of course, far more sinister. It is the attitude a new chairman takes to people who do not show enough enthusiasm in the budgeting process. So we will move rapidly on. I add my welcome to his, to hear about our 2012 results. As Howard has already highlighted, our most important achievement has been the debt reterming and equity raising, which we announced in January. To recap, we set out the key details here. The transaction comprised two equally important components. First, an equity raising of GBP 250 million at 500 pence per share. Second, GBP 450 million prepayment and a reterming of our Impala debt facility. At the EGM in February, 96% of our votes were cast in favor of the board's recommendation and 93% of our shareholders took up their entitlements. The key outcomes of this transaction from a shareholder perspective were as follows. First, the extension of our debt maturity from an average of 34 months to 78 months, ending in June 2019, and the elimination of a bullet payments which had previously posed a refinancing challenge. Second, a significant reduction in our mandatory amortization, which better aligns our debt repayments to our longer term cash flow profile, thereby improving our resilience during periods of stress. Finally, a 27% increase in the recommended 2012 final dividend to 26.7 pence per share and amended bank covenants, which allow for further dividend increases. As the chairman said, 2012 has been an important and successful year for the Phoenix Group, both from a financial and operational point of view. We have delivered cash generation at the top end of our target range. We've reduced our gearing and adopted a new methodology which is consistent with the approach used by the world's leading rating agencies. Our group solvency position has been strengthened through management actions, which increased the surplus and at the same time reduced our exposure to external market stresses. We've achieved strong IFRS operating profits and maintained the embedded value in the business despite the book's runoff. All of these achievements have culminated in a proposed final dividend of 26.7 pence per share. We set ourselves targets against three financial metrics. I am very pleased to report that we have met all of these targets in 2012. Our target range for cash generation for 2012 was GBP 600 million-GBP 700 million. It's good to report that we achieved cash generation of GBP 690 million. In total, over the course of the last two years, we have achieved GBP 1.5 billion of cash generation towards our six-year target of GBP 3.3 billion between 2011 and 2016. MCEV is the second key metric against which we measure our performance. By the end of 2012, we had delivered GBP 332 million of additional value towards our GBP 400 million cumulative target from 2011 to 2014. On our old gearing methodology, we achieved gearing of 42% at the end of 2012 against a target of 43% or below. Later on, I will describe the targets we are setting for ourselves in 2013 and beyond. Operationally, we have made significant progress across the entire group. Here we set out some of the key operational achievements in 2012. I am particularly pleased with the progress we have made in simplifying the group structure. Having gone from seven U.K. life companies at the premium listing in July 2010 to just three U.K. life companies by the end of 2012. In June, we announced the transfer of GBP 5 billion of annuity liabilities to Guardian Assurance, allowing the release of capital and the reduction by one-third of our sensitivity to longevity risk. During 2012, GBP 1.6 billion of our customers' pension policies vested. From this, we added GBP 1 billion of annuities to our annuities portfolio. Our ability to write annuities in this way increases our annuities book and provides the opportunity to consider further annuity transfer transactions in the future. We transferred 780,000 in-force policies onto our new administration platform. We now have over half of our six million policyholders on the pulse efficient system. Our policyholders remain a key focus of our business. Through distribution of the inherited estate, we have been able to continue to improve our customer proposition. Ignis continues to make good progress in building its third-party business, with GBP 1.6 billion of net third-party assets secured, excluding the annuity transfer transaction. Ignis' most important criteria, investment performance, continues to improve, with 79% of assets outperforming their relevant benchmark or peer group compared to 73% in the prior year. Ignis has also completed the outsourcing of certain of its back-office functions to HSBC and restructured its joint venture arrangements, allowing the company to focus more on its own clients. Now I'd like to hand you to Jim to take you through more of our maths. Jim. Thank you very much, Clive. Good morning, everyone. For the benefit of everyone, I have two hands. We set out here our key numbers. Where relevant, we have shown the pro forma position to reflect the impact of the debt reterming and equity raising, which we announced in January. I will take you through each of the key metrics in more detail shortly. In summary, cash generation was at the top end of our target range. IFRS operating profits were up 6% from last year. MCEV remained resilient and maintained at £2.1 billion, despite the natural runoff of the book. Our IGD and PLHL ICA positions have been strengthened, gearing has reduced, and assets under management were down slightly at GBP 70.2 billion after taking account of the remaining annuity transfer assets still to be received. As Clive mentioned, we have announced a 27% increase in our final dividend. Free surplus represents the excess capital over and above the strong capital policies in the life companies, which is available for distribution to the holding companies. I am very pleased to report free surplus generation during 2012 of £1.1 billion. By comparison, the 2011 position was adversely impacted by the effect of challenging market conditions. Contributing to the free surplus generation was strong operating profits. The annuity transaction, which generated £252 million of free surplus, and our London Life and Phoenix Life Assurance Funds merger, which completed in Q3 and generated £192 million of free surplus. Capital requirement runoff of approximately £200 million also contributed to the overall movement. Of the £1.1 billion of free surplus generated in 2012, we distributed £661 million or 62% to the holding companies in the form of cash to meet holding company outflows, including shareholder dividends. This left a closing free surplus in the life companies of £514 million, in addition to the £1.1 billion of cash in the holding companies. We generated £690 million of cash in 2012. Excluding management actions, the operating subsidiaries distributed £481 million of cash to the holding companies. Distributions from the operating companies are typically around £400 million per annum, but favorable market conditions, particularly narrowing credit spreads and rising equities, resulted in the 2012 distributions being higher. Operating expenses fell by 29% during 2012, reflecting the impact of cost management. The increase in pension costs is due to all contributions now being paid by the holding companies. Outflows in respect of debt interest, debt repayments, and shareholder dividends in 2012 relate to the previous bank facility agreements. We finished 2012 with over £1 billion of cash at the holding companies, and £239 million of this was used in February towards the £450 million debt repayment. We generated IFRS operating profits of £410 million in 2012, a 6% increase on 2011, driven by our focus on management actions such as modeling improvements and policy harmonizations, which enhanced the Phoenix Life operating profit by £117 million. Group costs, which reduced by £22 million compared to 2011. We continue to amortize the acquired-in force intangible, which was recognized at the time of the Liberty transaction in 2009, in line with the runoff of the book. Following the transfer of £5 billion of annuities to Guardian, recurring operating profits generated by Phoenix Life are expected to be in the region of £250 million per annum. Of course, this will trend down over time but does not include any benefits which may arise from our ongoing program of management actions. The annuity transaction resulted in a £177 million one-off gain under IFRS. The deal was priced on best estimate liabilities, whereas IFRS liabilities were valued on a more prudent basis, so we recognized a gain under IFRS. This was offset by other regulatory change and systems transformation costs totaling £28 million and restructuring costs of £913 million. After finance costs and tax, we generated a profit of £409 million. Ignis generated profits of £43 million in 2012, a slight dip versus 2011 and 2010, reflecting the restructuring of joint ventures and the impact of outsourcing administrative services to HSBC, offset by growth in the third-party franchise. In addition, Ignis has invested in its fund management capability as it continues to grow its third-party business. Overall expenses remain flat despite this investment. Since the end of 2009 and taking into account the remaining £1.6 billion of assets relating to the annuity transaction, third-party assets as a proportion of total group assets under management has almost doubled to 19%. Having outsourced its back-office functions to HSBC and restructured Ignis's joint venture arrangements so it can focus on its proprietary investment capabilities and own clients, Ignis is well-placed to continue to grow its third-party franchise. After taking into account the remaining £1.6 billion of assets relating to the annuity transaction, group assets under management fell slightly by £1.9 billion or 2.8% during 2012 to £70.2 billion. £4.7 billion of natural life company asset run-off was offset to a large extent by net third-party inflows of £1.6 billion, excluding the annuity transaction, and £2.7 billion of positive market movements. But the impact of joint venture restructuring and a net £0.4 billion reduction from the annuity transaction also contributed to this overall decrease. Now turning to look at MCEV. We set out here the material movements in MCEV over the year. We have stripped out the value generated from management actions from operating earnings and economic and non-operating variances to provide a more meaningful analysis. We closed 2012 with MCEV at £2.1 billion. The MCEV has remained stable at this level for the last three years, demonstrating a real strength in delivering incremental value through management actions, which we have used to offset the natural run-off of the closed book. So moving from left to right. We generated post-tax operating earnings of £203 million, which reflects expected returns on the £3.8 billion of life company value at the long-term risk-free rate of 2.58%. In 2012, we delivered management actions of £167 million through modeling and policy harmonizations within Phoenix Life and the annuity transaction. Below the line, economic variances and non-recurring items totaled negative £45 million in 2012 and included the impact of the increase in market value of the tier one bonds during the year and various project-related costs. We incurred finance costs of £123 million and dividends of £73 million. The final impact we show here primarily relates to the change in the IFRS position of the Pearl pension scheme. During 2012, the Pearl pension scheme moved into an IAS 19 deficit, and this was included in the closing MCEV, reducing it by 0.1 of a billion GBP. At the end of 2012, the MCEV of £2.1 billion represented MCEV per share of £12.15p. It is important to remember that the MCEV includes Ignis and the service companies at their net asset value of 0.2 of a billion GBP. It does not include anything in respect of the value of future profits from these operating companies, which represents a significant source of additional value in the group. The debt reterming and equity raising increases the 31st December position to £2.3 billion on a pro forma basis, representing MCEV per share of £10.39p, after taking into account the new shares issued during the equity raising. Moving on to group capital. As a reminder, we look at our group solvency position on top 2 bases. The PLHL ICA, which is an assessment on a pillar two basis of the capital resources and requirements arising from the obligations and risks which exist outside the life companies. The IGD, which is a pillar one assessment of the group's capital resources and requirements, and further details of the group's capital management framework are set out in the appendix. Since 30th June 2012, we have significantly strengthened the PLHL ICA position, increasing the surplus from 0.4 of a billion GBP to £1 billion at the year-end. This was largely a result of the agreement with the Pearl pension scheme trustees, which improved the surplus by 0.3 of a billion GBP and reduced the sensitivity of the calculation to external market stresses. Capital generation of 0.4 of a billion GBP, including the transfer of the business from London Life to Pearl and positive market movements. The £450 million debt repayment made in February was partly funded by internal cash resources, and therefore, the surplus is 0.2 of a billion GBP lower at £0.8 billion on a pro forma basis. Our IGD position remains robust and continues to be relatively insensitive to market movements. The IGD surplus increased by 0.1 of a billion to £1.4 billion at the year-end. The impact of entering into the reinsurance arrangement for the annuity transaction was relatively limited from an IGD perspective during 2012. However, when the Part VII transfer takes place later this year, we would expect a significant benefit on an IGD basis of at least 0.2 of a billion GBP. As with the PLHL ICAs, the surplus would be 0.2 of a billion lower after the debt repayment made in February, bringing the surplus to £1.2 billion on a pro forma basis. Finally, turning to dividends. We have increased our final 2012 dividend by 27% compared to the 2011 final dividend, to 26.7p per share. This represents a total cost of the 2012 final dividend of £60 million. The previous dividend restrictions have now been removed, and we now have dividend capacity for 2013 of £125 million. This capacity will increase by £10 million per annum. Future dividends are met by strong and predictable cash generation from the operating companies. You will hear from Clive that we have increased our cash generation target from 2011 to 2016 to GBP 3.5 billion. After the GBP 1.5 billion we have already delivered, we have GBP 2 billion to deliver over the next four years, giving average annual cash generation of GBP 500 million. For reference, we have set out the sensitivity of the GBP 3.5 billion target to external market stresses in the appendix. On this slide, we show the various uses of that cash at the holding companies. Moving from left to right. Annual operating expenses in the holding companies are around GBP 40 million. Then there is GBP 80 million of illustrative average annual pension contributions, reflecting GBP 25 million of contributions into the PGL scheme, which was what we paid in 2012 under the existing funding plan. On the Pearl side, GBP 70 million per annum in 2013 and '14, and GBP 40 million per annum in '15 and '16 under the new funding plan. An average of GBP 55 million per annum. We have average debt interest costs of around GBP 100 million on the revised facilities, including the tier one coupon. Then the target debt repayments of GBP 145 million, being GBP 120 million per annum on Impala and GBP 25 million on Pearl. Giving illustrative net cash available for additional debt repayments, dividends, and reinvestment of GBP 135 million. This is, of course, in addition to the GBP 0.8 billion of cash at the holding companies, post the Power debt prepayment. As we said, this time last year, including 2011 and 2012, GBP 9 billion of cash is expected to emerge from the existing business, inherent future profits, and capital releases. We remain confident in the business's strong and predictable cash generation and in our ability to deliver value to shareholders. I would now like to hand you over to Mike Merrick. Thanks, Jim. Good morning, everyone. I am very pleased to have the opportunity today to talk to you about the Phoenix Life operating model. We call this the Phoenix Way. The Phoenix Way is our solution to the challenge of increasing value and generating cash flow for shareholders and for policyholders. Our operating environment is a complex one. We have a myriad of reporting bases and methodologies that Jim has just taken you through, and a book of business with various systems. Alongside that, we have an ever-changing regulatory landscape, and throughout, we need to maintain a flexible cost base. The Phoenix Way is our methodology to delivering value within this operating environment. The four boxes represent the categories in which we place all of our activity. Restructuring represents activities such as funds mergers. Operational management seeks to address legacy issues and to standardize how we do things, such as dealing with and providing for outstanding claims. Outsourcing is all about simplifying our arrangements and helping to ensure our cost base reduces as the policies run off. Risk management focuses on taking risk in the right places and ensuring we have standardized controls to reduce operational risk. We operate an efficient outsourced model and have converted almost two-thirds of our Phoenix Life cost base from fixed to variable costs through our outsource arrangements. The cost paid to outsourcers for core administrative services has reduced by approximately 9% per annum over the last three years, while our policies run off at around 8% per annum. The simple, scalable operating model which we've put in place helps to ensure costs run off in line with our policies and can be applied to other closed funds in the future. Our policyholders are central to everything that we do, and we are very focused on improving our customer proposition. We wrote GBP 1 billion of new annuities from existing policyholders in 2012. Typically, 99% of policyholders with guaranteed annuity rates choose to take those rates up. In 2012, we also retained almost 75% of those policies that don't have these guarantees. The remaining 25% took their open market option. We will continue to write annuity business where it makes sense for customers and continues to be profitable. Moving on to the inherited estate. Some of our healthy with-profit funds have more assets than they need to cover their liabilities to policyholders. We call this the estate. During 2012, we distributed GBP 109 million of the estate, of which GBP 10 million was distributed to the shareholder fund. At the end of the year, the estates in our with-profit funds were worth GBP 2.3 billion. So there remains a significant opportunity to increase policy payouts in future, benefiting both policyholders and shareholders. We have real strength and expertise in managing closed life funds. As Jim has already mentioned, we have generated GBP 332 million of incremental value over the last two years. Over the last three years, we've also accelerated GBP 0.8 billion of cash to the holding companies, which would have emerged from the business over a much longer period. During 2012, improved actuarial modeling as a result of our actuarial systems transformation program released GBP 60 million of capital, and we were also able to release GBP 22 million of capital held against operational risk. The management of our equity exposure and reduction of other market risks released GBP 43 million of capital, and GBP 29 million of capital release was accelerated through the harmonization of accounting policies across the book. Since we now have three U.K. life companies, there is less intercompany restructuring to do. But the aim remains to simplify the structure further to leave just one U.K. life company. Within these three life companies, there still remain many funds, and opportunities exist to undertake restructuring between those funds, which will add value and accelerate cash. Other areas of management action focus include further annuity transfers, further data cleansing, which will accelerate capital release, and further risk management as we rationalize and harmonize asset liability management practices across the group. We remain convinced that there is still a significant opportunity to generate value and accelerate cash from this business for the benefit of both policyholders and shareholders. With that, I'd like to hand you back to Clive. Mike, thank you very much. This slide, which sets out how we see the Phoenix Group. This time last year, I stood here and talked about how reterming all our bank debt was our number one priority. This has now been achieved, and through the new terms, we have been able to align our debt repayments more closely to our longer term cash flows. We have now put in place a capital structure for the long term that removes uncertainty and allows us to focus on the next stage of a journey as the U.K.'s leading and largest consolidator of closed life funds. In addition to the very many organic opportunities that Mike has just described, key to the next phase of the group's journey are external opportunities for growth. We estimate that there are over GBP 200 billion of assets sitting in closed or quasi-closed life funds in the U.K. These assets are owned by banks, other U.K. life companies, and other foreign-owned life companies based in the U.K., which are either formally closed to new business or write so little new business in actuality that they are effectively closed. As the regulatory environment evolves, these assets will become increasingly costly to administer for their current owners, are inherently capital intensive, and are likely to come under increasing regulatory scrutiny to ensure that policyholders are treated fairly. Having delivered long-term capital stability through the debt reterming and equity raising, we now have a capital position and an operating platform, which is scalable. We are well positioned to take advantage of the opportunities for consolidation in this industry. It goes without saying that we would only do deals if they are good for all of our stakeholders and deliver reduced gearing to maintain the group's financial stability and its target of 40% gearing by 2016. We have a strong and predictable business, which provides the confidence to set long-term targets for cash generation in addition to our shorter annual cash generation target. We have achieved or exceeded our annual cash generation target for the last three years, and our ability to undertake management actions, as Mike has shown, to accelerate cash and increase value, has allowed us to increase this long-term cash generation twice in the last 12 months. This time last year, we had a long-term cash generation target of GBP 3.2 billion. At the time of our interim results, we increased it by GBP 100 million, and I am delighted to announce a further increase of GBP 200 million to GBP 3.5 billion, demonstrating this business's real strength in cash generation. I'm very pleased that we achieved all of our financial targets in 2012, and today we set new targets for 2013 and beyond. In addition to the long-term cash generation target I have just mentioned, we set an annual cash generation target for 2013 of between GBP 650 and GBP 750 million of cash flow. Having already delivered GBP 332 million of incremental embedded value in 2011 and 2012, we reiterate our MCEV management actions target of delivering GBP 400 million of incremental embedded value by 2014. Finally, we have adopted a revised and more industry-consistent gearing methodology. At the end of 2012, and after taking account of the debt repayment made in February, our gearing was 48%. We set a new target to reduce our gearing to 40% or below by the end of 2016. To conclude, we have delivered a strong set of results of which we are proud, which demonstrate the resilience of the Phoenix Group. In 2012, we generated GBP 1.1 billion of free surplus and a further GBP 690 million of cash. We delivered GBP 410 million of IFRS operating profits, and in the last two years, we have generated GBP 332 million of incremental MCEV value through management actions. We remain convinced of the inherent value of this business and have a clear strategy to deliver that value to all of our shareholders. Our focus in 2013 and beyond is first, to ensure we achieve the financial targets we have set ourselves in respect of cash generation, incremental MCEV, and reduced gearing. Second, to continue to build both on our operational achievements in Phoenix Life and in Ignis. Finally, to pursue opportunities for growth through the consolidation of closed life funds in the U.K. This brings me to the end of the formal presentation, and I will hand you over to our Chairman. Thanks very much. Hi, Jim, Mike. We're now happy to take your questions. We'll take them in the hall first and maybe have some that appear over the airwaves. But if you could wait for a microphone and then give your name. Whoa, gosh. Second row here. I think you just about got it. Thanks. Press star one to ask a question. Kevin Ryan from Investec. Just a couple questions, please. Could you give us a feel for the timing of getting three life companies into one? Also, what sort of benefits we might expect to emerge from that? Second, how hot to trot are you in terms of looking for non-organic growth? What sort of size of fund are you looking at? Or does that depend on the cash that might be extractable from it? Thanks. Mike, do you want to do the first one and then Clive the second? Yeah. Getting the three life companies into one, I think that is a cross silo fund merger, and therefore needs there to be effectively one within one banking silo. So it will follow any change to the silo arrangements. I think we've said that it'll generate capital synergies in the mid tens of millions. I think in terms of timing, if you thought of the repayment of the parental debt in 2016, that would be a time when we could contemplate putting the two main companies together. Fine. Kevin, thank you for your question. Hot to trot. There's an interesting way of describing it. This group's success for its shareholders is not predicated on doing any deals. The success of this organization for its shareholders is doing more and better with what we have got. We deliberately asked Mike to go through in great detail the management actions that have been achieved to date and the more management actions that stand in front of us. And in that respect, shareholder value by announcing GBP 650 million to GBP 750 million cash flow, increasing our 2016 target to GBP 3.5 billion, is to allay anybody's concerns that we have to do deals to make this business economically successful for our shareholders. I would say that we do think that there are opportunities. I went through the size of the market of GBP 200 billion. We think there is going to be a change. Things in the life business, as we know, evolve slowly. So the tectonic plates are moving in the sense that there are businesses that are either closed or closing. They live in homes, let's say a foreign insurer, a bank in the U.K., where it becomes more costly to administer. There's a capital cost attached, and there will be ever-increasing scrutiny on how policyholders are treated. So we think that with the way the market's moved, that there is the opportunity for deals to emerge. I don't think it's like a set of red London buses, and there are going to be a whole slew of them. As you know, there was only one deal done, Cinven, and there's been a period of quiet. And I think a lot of that was associated with Solvency II. Vendors did not know what they were selling, and acquirers did not know what they were really going to buy. But with the evolving ICAS+ regime, I think it makes it easier for both sides. I would hasten to add that we are very clear that we would only do a transaction which was enhancing to our shareholder, delivering value to them. And we are categorically committed to de-gearing this business. And we've given the target to be 40% or better by 2016. So any deal that we would contemplate would have to be done fulfilling those two criteria. And that is very important for all of our shareholders. So I end with where I began. We do not need to be dependent upon doing deals to deliver to shareholders value, and we are enormously committed to doing more and better with what we've got. Warren. Yeah, Ben. Thanks. No worries. Thank you. Ben Cohen at Canaccord. I had two questions, please. Firstly, on Ignis, I was just wondering if you could say something as to how you see the operating performance going forward. I don't know whether you saw the 2012 result as maybe a little bit disappointing, but maybe you could just say more in terms of how you're going to take that business going forward. And the second thing I wanted to ask was on slide 25, you had a discussion of the inherited estate distribution. Could you just remind us in terms of the levers that you have there to increase the payouts to policyholders and then to shareholders? Thank you. Thanks. Chris, do you want to do the first one? Yeah, Ben. Thank you. I suppose two things. First of all, we certainly don't see Ignis's results as disappointing. Just to give you the overview, we reported 46 last year. There are some quite big changes to the business model. We've ceased to provide administration services to the life company on the back of the outsourcing and also restructured the JVs, which means that we're forgoing a revenue share now in return for a capital gain we hope in the future. So that's quite a significant restructuring of the business. Against that, of course, you've got the life company assets running off. We feel that we've done well to win third-party business that has brought us, if you like, from that adjusted number back up to 43. I think it's worth saying what we've said in the past as well, which is that we have a significant element of performance fees in here, which are a tad down from last year, but there will always be that variability. In terms of going forward, it's business as usual for us. I think we've set out our stall very clearly, that what we want to do is to have a broad business, and to develop each of those. I think we've said publicly, certainly I've said publicly, that we're extremely pleased with how our fixed income business, our multi-manager business, our real estate businesses are going. We feel we've got a bit more work to do on the equity side. So we will be focusing on pushing that forward. Jim. Thank you. The heritage estate, Mike. Yeah. In terms of the inherited estate, if I can refer you back to slide 25. We have the picture there on the right-hand side of the broad balance sheet of a with-profit fund. The totality is the assets, and the assets back either liabilities, the ICA or the estate. The more we can convert, the bigger we can get that excess estate figure, then we can therefore release that extra capital confidently to policyholders. So, it is either by directly increasing the estate through the similar kinds of management actions that we talk about in the shareholder world. We are doing the same kinds of things for policyholders, but also risk reduction. If we can actually reduce risk for policyholders through better asset liability management or risk transfer, then the ICA will come down, and if the ICA comes down, the excess assets goes up, and you can distribute more to policyholders. So it is a very similar picture to the shift, what we go through in terms of releasing capital for shareholders. Thanks. Yeah. Then immediately behind, and then you, and then Nick. John Hocking for Morgan Stanley. I have two questions, please. Slide 45, where you give the maturity profile of cash flows. You can see the impact of management actions in terms of accelerating those cash flows. How do you think of the dividend policy in the light of that chart? Because you are growing the dividends, obviously, the cash flows in the medium term are that much lower than would have been had you not put through the management actions. That is the first question. The second question, on the annuity transfers. Given that you are looking at external opportunities, what is the judgment call between actually retaining those annuities, and using that as part of the sort of growth strategies at work, rather than actually looking at inorganic opportunities? Thank you. Thanks. Jim, on the first, perhaps, and then Claire. Yes. Thank you. As you quite rightly observed, John, clearly, cash profile of the business and MCEV generation has been enhanced by management actions. You see the maturity profile of the business from the MCEV of going out in outer years. Now that analysis will not have within it the management actions that could be delivered in the outer years, because by definition, we haven't got to that point where we identify them. We have a continual program for looking at management actions. It's regularly refreshed and monitored on a very regular basis, and typically looks forward 2 or 3 years. As we keep going, we see further opportunities arise that will hopefully benefit the future cash flows and capital releases. On the annuity point, Clive. John, thank you for your question, and it was shown on slide 25. Last year, the annuities out of GBP 1.6 billion being written, invested and retained for us was GBP 1 billion. We're proud of that number. It makes us a top 5 player, and this is profitable business for our shareholders. Mike also alluded to the fact that in the range of management actions we can consider, we clearly have future opportunities as we did the transfer last year in June, so those type of transactions can be conceived. We will do that in terms of in thinking through the priorities to release cash, accelerate cash. That is one of our options. You then link that, John, to a question about which is preferential, to retain it for the reasons that make sense, or to accelerate further releases as to be able to better finance or pursue non-organic growth, i.e., transactions. That's a sort of counterfactual. It's a what if. I think, with any transaction you would ask or the board would ask itself four questions. What is the size of the transaction? What is the quantity of percentages that could be generated? What is the timeframe over it to be completed, one next Wednesday or in four years' time? Because of our balance sheet position, where we would be. Then also in any financing, what financing structure would be dependent on the quantity of equity or quantity of debt, which would depend in part of the nature of the balance sheet of that which we might acquire. I can't answer your second question other than say that you've got multiple variables, which would have to be considered at the time of the transaction. But I go back to saying that our primary role is to do more and better with what we've got. This company's success is not deal dependent, and any deal has to be add value to shareholders, and at the same time de-gear this business. Why we are monomaniac on getting to 40% or better is because we are determined to get to an investment grade so that we have access to the subordinate debt market. That's in all of our stakeholders' interest, and to be able to refinance in an appropriate way our senior debt. Good. Next question. Press star 1 to ask a question. Morning. James Pearce from UBS. I imagine you've got a pretty good line into what the PRA and the FSA are thinking. What do they think about you doing M&A? I can see why it's good for getting your gearing down, but for the target company's policyholders, they'd be exposed to a very geared capital structure. What implications does that have for the funding? So you're saying for the target, a GAR? For the acquired company's policyholder base, it exposes them to a much more geared owner, presumably. What are they thinking about the funding that you would now need to put in place? Is it purely equity, or could you fund it in other ways? Secondly, something strange seems to have happened to your MCEV basis costs in the second half of the year, which I reckon were positive. Can you just elaborate on what happened there? I think you did 29 of costs in the first half of head office operating costs, and it was 25 in the full year. So what was behind that? Jim, do you want to deal with that second point? I'll deal with that second point in a second, once I get to my notes. The answer is, what we have for MCEV costs in 2012 was 25 million, and in 2011, 54 million. So you see the following cost for two main reasons. First was a following group cost of GBP 10 million, which related to really cost management activity. We continually seek to drive down costs, and that is a pressure that we will be under forever. I'm very keen that we continue on that journey. And secondly, in 2011, there was a net interest charge included within that figure because the Pearl pension scheme was in deficit, and that amounted to GBP 14 million, but that was not repeated in 2012. I think part of the reason, James, you are looking at the half-year results and going forward, you will also note in the detailed commentary in the accounts that we have restated 23 million of costs from the previous year from operating earnings to OCI. Again, these are related to pension schemes, and we have adopted a treatment which is consistent with others in showing those costs within the OCI element of the statement, but it is only a line switch, and there is no impact on the total MCEV. I think that is maybe why you are looking at the numbers quite oddly. James, it is not my job to speak for the FSA, but let us take the observations you have made. A priority you have said, is it a good idea to take policyholders out of a less leveraged business and put them, is it in their interest to put them in a more leveraged business? I do not think that stacks up. In any Part VII, the FSA would be party to any transaction because of the change in control requirement. As you know, in Part VIIs, you have to have expert advice ensuring that policyholders are not diminished, and that is on both sides of the fence. We are completely committed to doing the deleveraging. If we look at the maths, if you go back to 2009 on the new gearing methodology, we had met a leverage level of 63%. At the closing of last year, having done the refinancing, it had gone down to 48%. That is a 15% decline in our gearing in three years. Therefore, we have the ambition of going down from 48% to 40%, and we have four years to do that. So one of the asks for our investors is for them to rely on us to achieve that. We do not need to do deals. We are going to do more and better with what we have got. That is how I would answer your question. Yeah. Here. Row 3, and then Press star one. Hello. Hi, it's Andy Hughes from Exane BNP Paribas. I've got three questions, if I could. The first one is about the plus bit. Obviously, you mentioned the regime. The first bit is about the plus bit. So the first bit you mentioned was you're on ICAS+ basis. All the disclosure we've got here is on the ICA. Particularly, I'm thinking about the group pension scheme because I can see quite a big ICA surplus at the holding company on an ICA basis, but I'm a bit worried that on an IGD basis, it would look very different because you'd include the funding deficit in the pension scheme, which is about GBP 500 million. The second thing is on, I guess, come back on James' question about the new regulator, but my concern is somewhat different. Over the past, the group have quite successfully took management actions and merged pillar one and pillar two firms together to release capital from these businesses, yet the agreed basis of capitalization is unchanged. Presumably, they are still holding 125% of your ICA, and yet the new regulator is probably going to step up and relook at the capital management plans for what is a business which has substantially lower ICA, but presumably a large degree of the same risks. Is there a danger they're going to come back and say, "Well, you need to hold much higher capital because the business has changed substantially over the last five years"? And the final bit was on Mike's presentation on the annuities. I think you said that 99% of the GARs, are the guaranteed annuity rate policies are staying internally. Presumably, that's net of the 75%, 25% tax-free cash. And has that changed at all, given interest rates are very low? And what's the sensitivity to that? Thank you. Mike, could you deal with the last one? And then Jim, I think the other two. Yeah. It is. The 99% is after 25%, more or less, has gone out in cash. That we do in the kind of stress scenarios we look at. We assume that that 25% actually declines as the interest rates fall. But actually, policy holder behavior doesn't actually change very much. People do tend to take the cash. Jim, the points about ICAS+. Yeah. ICAS+ regime obviously is due. We've obviously just introduced the ICA last year, so the discussions we've had with the FSA on how the PLHL ICA works are fairly recent. We're not anticipating, in the ICAS+ regime, changes in terms of the mechanics of that calculation. On your second question, clearly, we are very aware of the pillar one and pillar two requirements, and we monitor both on a very careful basis. Again, Mike Merrick may want to comment further, but in thinking of our management actions, we do consider both bases, and we don't see any worsening of opportunity there as we go forward. I think you also asked about the capital policy and whether that might change. I think you put us having 125% of ICA capital policy, isn't it? It's actually nearer 140%. I think that puts us towards the upper end of the range of capital policy. So I think we're at lesser risk of that. Yes. Third row here. Sorry, I thought you Oliver. Oliver Steel at Deutsche Bank. Couple of questions. The first is about the GBP 3.5 billion target. If I take the midpoint of your target for 2013, you have a bit over GBP 430 million of gross cash flow built into your target per annum for 2014, 2015, and 2016. You made GBP 481 million clean in 2012. Is that GBP 433 million your estimate of what the average underlying cash flow should be of the business? Because that sounds quite low for those three years. Or are you being conservative? The second question I have is, you have tended to beat your underlying cash flow projections by a good GBP 200 million, even GBP 300 million a year per annum over the last four years or three years. I have forgotten by which. You seem to be targeting the same sort of beat in 2013. Hypothetically, if you like, how does the chairman view the choices between paying down debt faster and increasing the dividend capacity versus organically funded acquisitions? I am sorry, I have got one more question, which is you said that the benefit from the equity raise was GBP 211 million net. That sounds quite a low figure compared to the GBP 250 million. I am just wondering what went into that calculation. Well, let me with my question first. I think that the board has debated this at some length, and our view is very clear that the targets and priorities that have been set out today are the ones we support. We believe that we have to get the gearing down, as we explained in the reterming and in this presentation, in fact, the language is the same. That is the number one priority for the group at this point. Once you get to that point, you begin to have some more flexibility. At that point, we can look at it again in the light of opportunities that are available to us. But I would not want to prejudge how we would go beyond that point. Mike. Now I deal with the first question, and I'm going to turn to that slide there, which comes from Mike Merrick. Cash generation, how do we do the maths and are we erring on the side of caution? Well, you'll see on the top left-hand side, 3 years ago, it was GBP 734 million, then it was GBP 810. Last year, GBP 690, and we're forecasting for this year a number between GBP 650 million and GBP 750 million. On the left-hand side, you'll see the organic cash flows. That would be the winding down and the runoff, the natural runoff. Above that in the blue, you see the management actions. This is a business where the horizon over which we choose to forecast and the quantities we forecast for management actions has to be thought about very carefully. We want the market to be very clear about what we genuinely believe we even see and can do in the immediate 365 days. Then we have given a longer term target to give people confidence about what is possible co-terminus with our debt repayments, substantial debt repayments of over reterming of our debt in 2016. As Jim McConville said when he was speaking, we expect cash in total of circa GBP 9 billion to emerge over time, and that's a longer time period to the maturity of our policies. To date, we've taken GBP 1.5 billion out of that GBP 9 billion. So what's going to happen this year? The maths that you did, Oliver Steel, was and here I would go back to 21. That GBP 500 million was, of course, the division. We've put out a target of GBP 3.5 billion. We've paid down GBP 1.5 billion. You've got GBP 2 billion left in 4 years, and you divide it by 4 and you get the GBP 500 million. If we do, your maths suggests circa GBP 700 million in cash flow. That would mean in the remaining 3 years, GBP 433. I can't fault your maths, but I'm going to go back to orthodoxy, and I'll sound like a broken record, that we err on the side of caution because we would far prefer to underpromise and overdeliver, and that is what we have achieved to date. But there are many variables. To give you a reminder of last year, we achieved no cash flow virtually in the first half of the year, and it all happened in the second half. So we have to give you counsel both about quantity and also timing. There's a lumpiness to our business, depending on Part VIIs and things beyond our control, judicial processes. But what we want to communicate is the sustainability of the cash flow in 1 year until 2016, and in the context of our overall book. There is one more here. Yeah. Sorry, there was a. Sorry. The final question that you asked Oliver, which was on the fees related to the equity transaction, which created the GBP 250 million equity raising and the net 211. I think the thing to remember, it was both an equity raising and a debt reterming. That difference does include the bank consent fees, which were approximately GBP 21 million. Then there was a spread of GBP 18 million related to both the professional fees and underwriting fees for both the equity transaction and the bank reterming. So you have to look at it in the context of a GBP 2 billion bank reterming and a GBP 250 million capital raise. Yeah. Hi, it is Colin Simpson from Goldman Sachs. Could you give us a sense of the quantum of capital that might be sitting with profits funds backing non-profit business that could be released if you were to move that non-profit business out of the with profit funds? The second question is maybe somewhat theoretical, but I noticed that your MCEV growth metric has the same value as cash flow in management remuneration. One of the easiest ways to improve MCEV might be through annuity transfers. But the market is almost telling you that the MCEV of an annuity book is not its true market value because the market is willing to pay more than that. I just wonder, maybe a bit of color just on why MCEV is so important to the group. The first one, do you want to deal with that, Mike? Then Clive on the second one. The question was, is there capital tied up in the with profit fund that could be released by transferring non-profit business out of the with profit fund? There is. I cannot tell you the quantum, but in any event, it would fall to policyholders and not to shareholders. It is mainly, going back to the point earlier, it would enable estate distribution to happen. There is shareholder capital backing some of the with profit funds. That is something that we seek to try and reduce and is part of the management actions that we look at. But that would not necessarily be directly affected by transferring non-profit business out. If I may, I will give the untechnical answer, and I am going to look for Jim McConville to give us the technical answer. Positioning the firm 3 years ago, there was a challenge as to whether a run-off fund just inexorably runs off, and the DCF models that many analysts use needed to see if that rate was accelerating or could be arrested. It was very important for us to put clear metrics in the public domain that people could track and then believe in, and as we reliably delivered. They were cash flow, MCEV enhancement, and de-gearing. The MCEV enhancement, if we were to do nothing, there would be a capital unwind of circa 5%-8% per annum. It was important to show that we could do not just capital acceleration, cash flow acceleration, but we could add real value through restructurings, as have been mentioned today, tax enhancement, et cetera. Therefore, we gave ourselves the target of GBP 400 million incremental MCEV between 2011 and 2014. We are proud that we are more than two-thirds, 75% ahead of that. That gives us confidence that we can add value by actively managing the assets that we have. So that is my non-technical answer. I am sure there is a better technical answer, which is going to come from Jim McConville. Yeah, well, I think the important thing to remember is we have got a range of different measures. MCEV is a value measure, and in relation to the annuity transactions that you alluded to, if you think what happened in 2012, the annuity transaction resulted in a small incremental benefit to MCEV, so it was value enhancing, but it delivered a very significant increase in the ICA surplus, which will turn itself into cash. So there was a disconnect between the size of the cash benefit versus the size of the value generation on an MCEV basis. So different activities do have different impacts across the different measures. And I think what we are trying to get is that basket of measures within the remuneration structure. Thank you. I think that's Oh, no, it's another one. Yeah. Thanks. Pink shirt, blue tie. Hi. Alan Devlin from Barclays. Just a question on page 37 on your sensitivity to the cash flows. First of all, you say a movement of 75 basis points increase in interest rates has basically no impact on the GBP 3.5 billion of cash. I was just wondering why is that the case, and what actually does that GBP 3.5 billion assume? Does that assume interest rates stay at this level for the next four or five years? Secondly, on the impact of the 20% fall in the equity markets. Is the reverse true? If markets increase by 20%, does that add GBP 100 million to your cash flow targets? Jim. Okay. Thank you for that one, Alan. I do love you. What these cash sensitivities show is the base case is obviously the cash generation over the period 2011 to 2016. Clearly, we're part of the way through that period, so the sensitivity movement is applied from 31st December 2012 through to 2016. That's how you get a relatively small impact in terms of the measures. In terms of, I think the second part of your question was, would a 20% increase in equity markets improve the position by roughly an equivalent amount? The life companies are broadly hedged in terms of equities, so there would be a small uptick in terms of a 20% increase, but it wouldn't be a huge number. Okay. Do we have any questions that have appeared from anywhere else? No, we don't. So, speak now or forever. Well, until the half year, hold your peace. Okay. Thank you very much, the team. Thank you for some interesting questions, and particularly thanks for coming. Thank you very much. Thank you, Jim McConville.