Earnings Call: H2 2010

Mar 29, 2011

Right. I think we have reached the appointed hour. Can I say good morning and welcome. It is a great pleasure to see you all, and thank you very much indeed for coming to hear the Phoenix 2010 results presentation. It is a particular pleasure to be introducing Clive Bannister to you today. Clive joined us, as I am sure you will recall, back in February as Group CEO. We are also joined on the podium there by Jonathan Yates, our CFO. Then we have Mike Merrick and Chris Samuel with us as well. Mike and Chris are the CEOs of Phoenix Life and Ignis respectively. We are going to be reporting today on strong progress on a number of fronts. We have come a long way in recent years. We are now well advanced in our journey to build an extraordinary business. It is a business that rests on a platform of financial stability, and it has a unique set of capabilities and infrastructure. The management of Phoenix, the Phoenix Way as we describe it, is all about bringing these to bear in the way we manage our assets and the way we manage risk in order to deliver value both to shareholders and to policyholders. The story of 2010, as you will hear in just a moment, is all about strong cash flow and growth in EV, and it is also about de-gearing. You will see that as we look forward to 2011 on this slide, that these remain our areas of focus as we look to the future. It is my pleasure to hand over to Clive and to Jonathan to take you through the detail of our 2010 results. After this, we look forward to answering any questions that you may have. Thank you very much. Ron, thank you and good morning. Good morning, everybody. It is a pleasure to be here to present the considerable progress that Phoenix has made in 2010 and to set out our financial objectives in 2011. Of course, it is a pleasure that my first presentation should be to our investors and the analysts who cover our story. 2010 was a year of strong financial delivery. We generated target-beating cash flows of GBP 734 million. Our IFRS profits remained strong at GBP 373 million, and we delivered significant MCEV growth to over GBP 2.1 billion. This is the first time as a group we have published an MCEV number in excess of GBP 2 billion. Ignis assets under management grew to GBP 67.5 billion. I am able to report that we made prepayments of over GBP 120 million against our bank debt, bringing down our gearing level to 52%. All of this has allowed us to recommend with confidence a final dividend of 21 pence per share, giving 42 pence for the full year. 2010 was also a year of significant corporate delivery. We simplified our capital structure, successfully achieved the premium listing in July, and gained our FTSE 250 Index inclusion in September. We also strengthened our corporate governance with a number of Senior Executive and non-executive appointments and enhanced our risk management framework. This has created a platform for future success. We have already been rewarded by increased liquidity in our shares, lower, broader analyst coverage, and a more diversified investor base. The Phoenix Group is more than a balance sheet. It is a business. For the first time, the CEOs of our core businesses, Mike Merrick and Chris Samuel, join us on the podium, and I welcome them. Alongside our high-profile corporate and financial attainments, we have delivered notable business successes. Mike and his colleagues in Wythall in Phoenix Life have undertaken a number of important tasks, which have resulted in improved customer service and a strengthened customer proposition. We improved our capital efficiency through the restructure of National Provident Life and the intragroup fund merger of Phoenix & London Assurance into the Phoenix Life Limited. These achievements improve customer outcomes and build value for our shareholders. We have also developed our outsourcer model. Our largest outsource partner, Diligenta, successfully introduced a new modern server-based administration platform to which we have already transferred over 4 million policyholders. Ignis, the group fund manager, strengthened its team with important new executive appointments. It also completed the integration of two legacy businesses. A signal of strength, we repatriated 5 billion of assets from third parties into the firm. Ignis is genuinely a business on the move. Our cash generation was strong. We delivered GBP 734 million, beating our target, which was set at a range between GBP 625 million and GBP 725 million. This is in addition to the GBP 700 million that we delivered in cash flow in 2009. As you well know, one of the strongest measures of a closed life fund is its long-term reliability and predictability of its cash flows. That is why we publish with confidence our cash flow targets. We strengthened cash flow in 2010 by managing the business better through improved asset and liability matching, the de-risking of certain investment portfolios, fund restructurings, and the successful resolution of some legacy tax issues. Cash is the most important measure for a closed life business, and this result, without doubt, proves and demonstrates our cash generative strengths. Management actions lie behind and accounted for the GBP 242 million of cash flow out of a total of the 734 I mentioned a minute ago. To provide some color and context to this slide has broken down management actions into three broad categories. Of the GBP 242 million of accelerated cash flow, the majority was developed and generated from improved risk management. GBP 88 million came from operational management initiatives and the balance from restructurings and fund mergers. I repeat, cash remains the most important financial measure for a closed life business. Our ability to accelerate GBP 242 million of cash flows in 2010 demonstrates our cash generative strength in terms of both quantum and resilience. Simultaneously, we improve the outcome for policyholders and add shareholder value. The MCEV has performed remarkably well, growing by GBP 277 million or 15% to over GBP 2.1 billion. This included GBP 296 million from management actions, of which GBP 157 million had been achieved at the time of our third quarter interim management statement in November. A further and powerful GBP 139 million comes from the restructuring of the corporate loan portfolio, which we announced last week. This translates into an MCEV per share of GBP 12.27, up 11% from the GBP 11.09 per share, which was where we were in 2009. The message is that despite the runoff in our book, we have been able to identify opportunities for operational synergy, integration, and more efficient use of capital that enhances our MCEV. As Jonathan will tell you in a few moments, we see opportunity for more of this in the future. MCEV management actions also increase the absolute quantum of embedded value within the group, creating tangible new shareholder value. The GBP 269 million increase in MCEV in this slide was generated by leveraging the benefits of funds restructuring and diversification, and GBP 34 million of operational improvements. This is a very clear manifestation of the ability of Phoenix Life and Mike and his colleagues to improve customer outcomes and drive shareholder value. In 2010, we were able to reduce our gearing with prepayments of GBP 122 million. As a result, the group gearing came down from 58% to 52%, and today we are setting a target to reduce that to below 50% in calendar 2011, entirely funded from organic cash flows. You will be very well aware that the group has complex banking relations. As a banker by background, I understand and appreciate where our bankers are coming from. There has been much speculation in the market about what happens next with our banking facilities. As this slide shows, no complete debt solution is being sought, nor is it necessary. The quantum of our debt is not the primary issue. All other things being equal, we would prefer to change some of the restrictive covenants, including those that set a cap on our dividend payment. We have been exploring carefully options with our lenders with a view to resetting some of those covenants. However, you will also know from previous disclosures that we enjoy favorable interest margins, and I want to make it clear that we will only enter into new arrangements with our bankers on the right terms at the right times and things which will be of benefit to our shareholders. We continue to talk to our banks and will advise the market if and when there is something to say. I want to take this opportunity to thank our banks for their support for us and our business. We are very pleased to recommend today a final dividend of 21p per share, taking the total dividend to 42p for the full year. This fulfills our 50/50 dividend policy, which we intend to maintain for 2011. Under the terms of our existing banking arrangements in calendar year 2012, the dividend cap will rise from 52 to 70, sorry, from 58 to GBP 72 million. This will enable us to sustain a dividend of 42 pence per share, giving the increased number of shares in issue following the interim scrip and placing. This increase will take place independent of any new arrangements that we might enter into with our lenders. The story, as Ron said, of 2010 describes a record of delivery by the group, both operationally and financially. We are confident that we have proved that we can be relied upon to deliver in the future. I am convinced that we have everything that we need to be very successful. We will continue upon the critical tasks of delivering improved cash flow, improving and strengthening our capital position, and continue de-gearing and building a stronger Ignis fund management business. I am looking forward with confidence to the remaining part of 2011. On that note, I would like to hand you over to Jonathan, who will present our financial highlights. Jonathan, the floor is yours. Well, thank you, Clive. Thank you, Clive, and good morning, everybody. I am delighted to be here to present what I hope you will agree is a very strong set of results for Phoenix Group. In particular, I would like to draw your attention to cash generation of GBP 734 million, which is well ahead of the target that we set for the year of GBP 625 million to GBP 725 million. Our solid IFRS operating profits. Our group MCEV grew up to GBP 2.1 billion, which is up over 15% from the end of 2009. IGD surplus remains strong at GBP 1 billion. We are introducing a new KPI in the form of IGD excess capital, and I will come on to talk about that later on. Despite the runoff nature of our business, assets under management grew to GBP 68 billion, and our financial indebtedness gearing fell by over 6% during the course of the year, from 58% down to 52%. Finally, as Clive just said, we are recommending that the dividend be maintained at GBP 0.42 a share. So I will go on now to talk through these highlights in more detail. The key feature of the Phoenix business model in financial terms is the emergence of cash from its operating subsidiaries, most notably Phoenix Life, but also, of course, Ignis. In 2009, we set a target for 2010 cash generation of GBP 625 million to GBP 725 million, but in practice, we were able to beat this and pass up GBP 734 million to our U.K. holding companies. This saw total cash in the U.K. holding companies increase from GBP 202 million at the start of the year, up to GBP 486 million by the end of 2010. This cash is now available to meet debt repayments and other group expenses, and also to pass up to Phoenix Group Holdings, our ultimate holding company, to enable it to make dividend payments to shareholders. Costs during the year increased, in part due to our now being a premium-listed company on the London Stock Exchange, which happened in the middle of last year. Debt interest and amortization included GBP 122 million of debt prepayment. As cash emerges strongly, we fully expect to make further debt repayments ahead of the mandatory amortization profile as we reduce our debt to below our target gearing level. I've put this slide up to try and explain a little more clearly, I hope, how cash actually comes out of our life companies and how it ends up in the holding company. But within our life companies, essentially what we hold is ICA, which as a Pillar 2 company represents the regulatory minimum capital that we're required to hold in order to meet liabilities to policyholders under stress conditions. In other words, it already includes a margin in excess of what we would expect to have to pay on a best estimate basis. On top of this, we also hold capital policies, which are the quantification of our risk appetite for not breaching ICA. In other words, they're the capital buffers. Everything in excess of this we consider to be free surplus, and in theory is available to be paid up to the U.K. holding company. In practice, there are timing delays due to the time taken to carry out the valuation, and in some instances, we may hold back a margin as we seek to harmonize approaches across the group. For example, in the calculation of capital policies. But as time goes by, the business runs off, and risks of future adverse outturn diminish, which leads to a reduction in ICA and the capital policies, and the release of this capital into free surplus. And to the extent that we're able, we use management actions to accelerate the release of this capital. For example, by de-risking or better identification and quantification of risks. Looking at this diagram, as you can see, at the end of 2009, the amount of capital within the life companies, in excess of ICA plus capital policies, was GBP 464 million. By the end of the year, this surplus had grown significantly up to GBP 750 million. But this was on top of the GBP 708 million that was passed up to the group during the year. In other words, free surplus in total increased by a little under a billion over the course of 2010. And I think that number bears contrasting with our market cap at the end of 2010, which stood at a little over a billion. Moving on to the emergence of free surplus. Let's look in particular about the components of that billion, what actually made it up. IFRS operating profits, tax, and economic variances together accounted for almost GBP 400 million. Movements in capital requirements and capital policies accounted for another GBP 400 million. As I described earlier, this reflects the runoff of the business together with the benefits of the management actions that we take to reduce risk. For example, through fund mergers or better risk diversification. Finally, the valuation differences that exist between IFRS and the regulatory valuation basis give rise to another GBP 200 million. Turning to the IFRS operating profits, we delivered solid operating profit for the year of GBP 373 million. As we've just seen, this included GBP 388 million from Phoenix Life, which was up 16% on 2009, excluding exceptional items. Ignis also produced a very satisfactory 35% increase in its operating profits to GBP 46 million. The bottom line after tax for the year was 76 after non-recurring items, which included, as I mentioned earlier, the cost of the premium listing and other regulatory restructuring change and transformation costs. This is a slide that we first used at the half year results last year, and we are using it to try and better explain just how the operating profits across the group actually emerge, how they are generated, the lines of business that actually contribute to them. There is a lot of detail on this slide. I appreciate that, and it is really one more to take away and for people to read. I do not propose to go through it in detail here, but we would certainly be delighted to answer questions on it later on. One of the pleasing things about it is the consistency that exists between 2010 and 2009 and 2010, with a few exceptions. In particular, the net margin on annuities fell, but that was mostly due to a one-off favorable change in longevity assumptions that was put through in 2009. The distressed with-profit funds, a relatively small driver of operating profit, those funds which require internal capital support. There was a small reduction there in the amount of profit, driven more by principally improved persistency, in other words, guarantees biting on policies within those funds. Moving on to Ignis, a similar sort of breakdown here. Again, something we presented at the half year results. What we have tried to do is break it down between the different lines of business that Ignis manages on behalf of its different clients. There are a few points I would like to draw out. Firstly, this slide helps to illustrate the disproportionate importance of our retail and institutional funds for revenue generation. Secondly, the margin earned on the management of the life funds increased quite significantly over the course of the year from 13 to 19 basis points. In the main, this was due to increased performance fees and helps to show that we are not managing a static book in run-off, but we are actually driving better returns, not just for shareholders, but also for policyholders. Most of this money is policyholder money. Of course, this comes at a cost, and Ignis has invested substantially in its own staff and has recruited where it did not have the talent necessary to sustain this outperformance going forward. Turning now to MCEV, as I mentioned earlier on, this grew by 15% over the period. Operating earnings generated GBP 247 million and management actions added a further GBP 296 million, which was comfortably ahead of our target for the year of GBP 145 million. Economic and non-operating variances was a small number, but it actually masked some very large movements in both directions. Most notable of these were the growth in MCEV due to the performance of the equity markets, which was a substantial gain, but that was offset almost entirely by the fact that short-term interest rates were incredibly low. Our operating earnings make an assumption about long-term interest rates in common with all companies reporting on an MCEV basis, which is obviously a much higher number. Finance costs reflect the interest that we paid on our debt, but it does not include the deferred 2009 Tier 1 coupon, which you may recall. That has been included in other, where there is an equal and opposite offsetting item relating to the proceeds of the share issue that took place last year, that we did to actually meet the terms of the repayment of that interest, under the alternative coupon satisfaction mechanism. Other than that, other comprises a number of items, most notably dividends to shareholders. Moving on to solvency, and in particular, I mentioned this measure of IGD excess capital. I thought it might be useful to try and just explain how we go from the capital that we have available in the group through to the reported IGD surplus and what happens along the way and what is actually a fairly convoluted and a highly complex calculation. Our IGD reported surplus at the end of December last year was GBP 1 billion. It actually represents only a small part of the solvency capital that we have available to act as a buffer against adverse scenarios and doesn't properly reflect our resilience as a business. We have tried to explain that a bit more clearly in this diagram. Total available capital is GBP 6.8 billion. Against this, we set our regulatory required capital of GBP 4 billion, and this leads to excess solvency capital for the group of GBP 2.8 billion, which was the number that I mentioned earlier. However, in order to get from this number to what we report as IGD surplus, we have got to first deduct the surplus that is sitting in the with-profit funds. The Phoenix Group doesn't count, due to these funds having been designated as closed to new business. When a fund is designated as closed to new business, effectively any surplus capital within that fund is then treated for IGD purposes as being already allocated for distribution to policyholders, with-profits policyholders, and so is excluded from the IGD calculation. Obviously, that makes a fairly material difference in that it reduces the apparent buffer within the group by 50%. As a with-profits company, of course, or a largely with-profits company, with-profits being one of our major lines of business, that is a very significant amount of capital that should be counted. Beyond that, we have another GBP 400 million of restrictions, and a lot of it relates to the relatively complex legacy nature and the structure of Phoenix Group and various pockets of capital that are sort of trapped around the group, which aren't recognized for various reasons, but which we are in the process of addressing through a range of different things, fund mergers and general discussions with the FSA about whether they should be treated as part of our capital. If you look at our excess capital of GBP 2.8 billion, it is getting up towards three times what we actually report as our IGD surplus. We think this gives a far more meaningful basis for comparison with our peers. Moving on to the assets under management. Despite the fact that we are a run-off life business with an asset management company, our group assets under management continued to grow over the course of 2010. Assets in the life company fell by GBP 5.4 billion as we pay out claims, but this was more than offset by investment performance, which again, largely related to Phoenix Life itself. It is very pleasing to see Ignis generate net third-party new business of GBP 1.3 billion, much of which related to its highly successful liquidity and property funds. Let us turn to the targets that we are going to set for 2011 and beyond. First of all, cash generation. We set ourselves a new target range for cash generation for 2011 of GBP 750 million to GBP 850 million. In other words, a fairly significant increase on the cash generation target that we set for 2010 of GBP 625 million to GBP 725 million. We have also raised the target for 2010 to 2014 by GBP 300 million to GBP 3 billion, and we have now rolled this target forward so that it is to cover the period from 2011 to 2016, and we have set a target for that period of GBP 3.2 billion. That is a six-year period, which might sound a bit strange. The reason for that is that the period from today through to the end of 2016 is the period over which our existing bank facilities actually pay down. We thought that that might be a useful period for you to have a cash generation target. Secondly, gearing. We set a new target for gearing to reduce this to below 50% during 2011, and we expect to do this through organic cash generation. In the longer term, we would look to have access to the debt capital markets, and clearly this will provide us with additional financial flexibility. Finally, MCEV. Whilst our cash management actions focus on accelerating the cash generation profile, our last financial target is to enhance MCEV through management actions of GBP 100 million per annum for every year between 2011 and 2014. Just to add a little more clarity to those cash targets, we have tried to set it out in a diagram. Our original target for 2010 to 2014 was GBP 2.7 billion. To this, we are adding GBP 300 million of new management actions in 2011 that will take that target up to GBP 3 billion. In 2010, we delivered GBP 0.7 billion of cash generation, which means our residual target for 2011 to 2014 becomes GBP 2.3 billion. To that GBP 2.3 billion, we are going to add GBP 900 million, GBP 0.9 billion, of recurring cash flows between 2015 to 2016, which gives us the target that I mentioned earlier for that period of GBP 3.2 billion. The one point that I should stress is that these cash generation targets do not capture any benefits from management actions beyond 2011. But as our 2010 results demonstrate very clearly, I hope, this is what the management of Phoenix Group is here to do. With that, I will hand back to Clive. Thank you. Thank you, Jonathan. Thank you very much. Let us look ahead to the journey in front. We have a simple and robust shareholder-driven business model. Phoenix Life is responsible for the operational, financial, and customer management of our life funds. It provides very specialist skills to deliver improved customer and policyholder outcomes. These, in turn, deliver significant value to our shareholders. Ignis, which in addition to managing the funds of the life companies, continues to successfully build a third-party franchise, which delivers significant profits to the group. Together, they make an enormously powerful profits engine. The reason why all of this works, and why we have such confidence in our future, is that we are not just the U.K.'s largest specialist closed life fund consolidator with real scale in both of our operating businesses, but that we have developed and are developing what we call the Phoenix Way. The Phoenix Way characterizes an approach and an infrastructure, which is unique in the industry for the integration and management of closed funds. That is our business. The bottom line is that Phoenix Way will help us deliver value. It ensures that our advantages are scalable and repeatable. By applying consistent best practice within the framework of the Phoenix Way, this reduces risk, complexity, and cost, whilst improving investment performance and improve customer service through effective working with our outsourcers. The inevitable outcome is enhanced MCEV and the release of capital to our shareholders. We are good at what we do, and the Phoenix Way will make us better. We are focused today on the business in hand, but I recognize that we have to touch on M&A. The key message, as we have shown throughout 2010, is that we drive improved shareholder value year on year without the need to do deals. Cash flow rewards our shareholders, which is not dependent upon transactions. Whilst there are clearly a number of opportunities in the market, any deal we do would have to be accretive to shareholder value. We are clear that any acquisition funding would have to take into consideration our current share price and leverage. We are very focused on continuing to develop our existing business. In due course, we believe that this will put us in a position to take advantage of potential opportunities to acquire and integrate businesses in the future. To help you measure our progress on the business in hand, and as Jonathan has already detailed, we have set ourselves four new, very clear, and challenging financial targets. A raised 2011 cash flow target range of between GBP 750 million and GBP 850 million, a six-year forecast for cash generation of GBP 3.2 billion in total, further de-gearing to take us from where we are today to below 50% in the year 2011, and GBP 100 million per annum contribution for MCEV every year until 2014. I believe that this positions the Phoenix Group very well for the future. I was honored to be given the opportunity to become the Group Chief Executive in February. Since I arrived, I have been impressed with the quality of the teams that we have in Phoenix Life, in Ignis, and in the group, and the quality of the operating platforms that we work through with our customers. There are clear opportunities to grow and develop the business we have in hand today. We have a clear strategy, and as a team, we are focused on delivering shareholder value. We are, of course, on a journey, and it is a successful journey of strengthening cash flows, improved MCEV, and progressive de-gearing. Thank you very much indeed for your attention. I am going to now hand over to Ron, who will chair our question and answer session. Ron? Thank you, Clive, and thank you all for your attention. We have some questions. We've got a microphone on its way. Good morning. Greg Patterson, KBW. Three questions. The first one is QIS 5. The U.K. did very badly relative to the peers, and there was a sort of raw number, and there was an adjusted number. Drilling down into the details, there was a big improvement in the U.K. result as a function of sorting out offshore internal reinsurance arrangements. You guys have a big offshore internal reinsurance arrangement. I was just wondering how this impacts you, what you're thinking in that regard is. The second thing is, you redirecting us towards looking at the inherited estate and adding the inherited estate to your capital measure. But if I'm not mistaken, the FSA has just come out with proposals that if you're a closed fund, you have to come up with a plan to distribute that inherited estate to policyholders. I was wondering, how fungible that exactly is? Maybe you can make some comments about that. The third point is more sort of a strategic question. If you've got such a high yield, and you've got such a pressing debt problem, why don't you just halve your dividend and really refocus your cash flow on getting the debt down more aggressively than we've seen at this point? Greg, thank you for all of that. I think we can spread those around the panel a bit here. If we start with Quiz Five, Mike, do you want to comment on that? Yes. Sorry, Ron. You are absolutely right, Greg. QIS 5 did identify for the industry and for us that certain internal arrangements that have been put in place that worked perfectly well under Solvency I caused some issues under Solvency II. That is something we will be taking into our restructuring activity that we look to complete in 2011. Fund merger activity and the like will bear in mind and reflect changes that will optimize the Solvency II balance sheet, as well as the Solvency I position. But we think we can do that at the same time as we are simplifying our business. Because some of these intergroup reinsurance arrangements, whilst effective under Solvency I, did add complexity to our business. It is a good simplification opportunity as well. Is there a cost to that sometimes in capital requirement? There- A reduced capital requirement. There will obviously be a reduced capital requirement under Solvency II, but the cost will be manageable because we will be able to implement it alongside restructuring we were planning to do anyway. Jonathan, do you want to comment on the inherited estate or the Yes the IGD measure, the excess capital? Yeah. You are absolutely right. Closed funds have to put in place a plan to distribute the estate to policyholders, and that is exactly what we are doing. But it is not really about whether that money is allocated to policyholders or not. It is whether it is available to cope with stresses that hit the business. The IGD surplus is very much a solvency measure. If you are going to cover solvency, then you should include the excess which exists within those funds. At the moment, it is surplus to the actual sort of guarantees to the policies and is available to meet those stresses going forward. I am not going to say over the next two years or something like that. I know that you must have had some discussions. I am just trying to get a feel. Is it distributed over the period, or do they want an accelerated plan or what? Like we said, distribute over the life of the policies, but that is common with all companies. Mike, do you want to add something? It is smooth because it is closed funds they are concerned about, and you guys are the big example. It is closed funds. What we do is that we take all of the free capital which is inside the with-profit funds, and we add that to the asset share calculations that we do for our policies, which effectively increases the payouts to this year's maturities, but also future years' maturities. Whilst a small amount of the capital that we are adding is actually paid out to policyholders in any given year, the bulk of it, as Jonathan Yates says, sits within the fund and is there and is available to deal with future risks that emerge within that fund and future risks for the business. Greg Patterson, your final question was about de-gearing. You used the words debt problem. We do not think we have a debt problem. We see ourselves very much on a path to de-gearing this business, as is set out in our financial targets. We are very concerned to ensure that shareholder value is maintained and enhanced in this business, and our policies towards such things as dividends will reflect that. Did you actually say you have a flat dividend per share for 2 years? Is that what the guidance was? You made some statement about the 42p would remain. Was it 2011 and 2012, or was it just in 2011 you were giving guidance? Well, clearly ultimately, what the dividends will be will be what the dividends will be. The cash flows that we have will allow a maintenance of the dividend of 42 pence per share through 2011. There is a question over here. Thanks. It is Kevin Ryan, Investec. If I could ask a bit of Greg's question another way. You seem very confident in your increased cash flows. One thing that puzzles me is it seems to me that given that confidence and given that confidence going forward, you could pay down a lot more of your debt and rid yourself of these restrictive covenants, which would give you as a management team a lot more flexibility. My question is, what is stopping you? I think as was said by both colleagues, I will allow each to comment, we are in constant dialogue with our lending banks. This is a subject between us, and has been such for some considerable time. We enjoy what we regard as a favorable set of interest rate arrangements in our existing debt. Any moves to restructure that debt have to take into account a range of considerations. If and when we feel that there is an arrangement to be struck with our banks, which is attractive to our shareholders, we will do so. There is no pressing requirement to do that, and certainly not on a basis which we do not regard as favorable to our shareholders. Clive, do you want to? Ron, I think you've said it all. It's not the quantum of the debt that causes any concern. There are restrictive covenants, all things being equal, related to the dividend cap. We are in constant discussions with banks who have been extremely supportive. As Ron has pointed out, we enjoy very favorable interest rates and interest margins, which are to the benefit of our shareholders. We have shown from the power of our cash flows that we can organically de-gear from 58% to 52%. We made a comment, well, not a comment, a target to be below 50% by the end of 2011, and this is part of a continuum. We will, as Ron absolutely accurately says, on the right terms, at the right time for our shareholders, make amendments or make changes in our banking arrangements with our bankers' full support. James. Morning. James Pearce from UBS. Couple of things. First of all, your IGD surplus fell a bit during the year. Could you give us some of the reasons for that? Within that, could you say how much of the GBP 4 billion capital requirement relates with profit so we can compare that to the with profit capital? Second, could you explain what the GBP 1.2 billion loan portfolio restructuring actually was? You promised you were going to last week. I haven't seen it in the statement so far. Why was it included in 2010? Finally, the GBP 100 million of management actions that you highlight for the next few years, will that include the eventual merger of Resolution and Pearl funds, or is that the existing restructurings that you have in hand? A good set of questions. Thank you, James. Jonathan, do you want to start on the IGD? Yeah and the with profit requirement? Yeah. The IGD number fell over the course of the year from 1.2 down to one. The IGD goes down for all manner of reasons. I mean, the most obvious one in our case being the repayments of debt. As we mentioned, we actually did prepay GBP 122 million worth of debt in excess of what was scheduled to be paid, which was part of it. There are quite a number of things in there that were driving that. The point I would make, though, is that whilst it was GBP 1 billion at the end of last year, within a day or two, it actually went up to GBP 1.1 billion when we merged the Pearl business into Phoenix Life. I think that's right, isn't it, Ron? Yeah. The With profits component within the GBP 4 billion. Yes, sorry. Yeah, the with-profits component. I am afraid I do not know the answer to that. We will have to come back and give you a response on that one. Obviously, there is the 1.4, which is part of it, and whether it is anything more than that, I do not know. I do not think so, but let us see. The alpha What do you call it? The alpha Yeah, the alpha restructure. Alpha restructure. As you point out, we did a restructuring of a structured asset that existed on our balance sheet a couple of weeks ago. That involved effectively taking a leveraged portfolio of corporate loans and eliminating the leverage, which was very much a de-risking action on our part. It was a highly volatile portfolio of assets, very highly performing, but actually didn't sit well in capital terms because the risk capital we had to put up against it, but also because we weren't able to take credit for the, effectively, the liquidity premium or the illiquidity premium within the margin on the corporate loans. So having restructured it, we were able to take credit for that, and that's why it gave rise to a significant benefit, both in capital terms and also in embedded value terms. Can I just comment on the fact that it was taken in 2010, the EV- Yes. Sorry- Go ahead Ron, very good point. It was actually something we have been working on since last year, and therefore, because it was actually in train, we were able to anticipate it in our MCEV results. But because it had not actually happened by the end of last year, we were not able to take it into our IFRS results, or indeed our solvency results at the end of last year. I think the final point was on About management actions, the GBP 100 million of MCEV for the next four years, and will it be related to the fund mergers or ultimate fund merger? Well, across the two silos, I think was the question. The fund mergers will be a contributory part of that, but Not across the two silos. That's not necessary to deliver the 100 million, but if that opportunity arose, then it potentially would. Clearly take it. Do not. The message is that we have put that target out there without consideration of having to merge across the two silos. I think the important thing to bear in mind is where we've been able to generate management actions in the past, which is very much a focus on the capital that sits within our business today against the risk that we have and the way in which we can better allocate that capital, either through de-risking or through just putting businesses together and getting better diversification of risk. To that extent, we're always looking to see what gains we can make. The 100 million that we've set ourselves as a target for those four years, we think is very much achievable based on the sorts of returns that we've achieved over the last few years, in particular, obviously, last year. Other questions. There is one in the front. Good morning. It is Andrew Crean at Autonomous. Could you give us a sense of the additional debt cost if you were to renegotiate your debt? Essentially what you are saying is you are bound by restrictive covenants, which you would like to be released from, but there is a cost of doing that in terms of the debt interest. Can you give us some monetary estimate of what the differences would be? No, I do not think we can. I think that if we decided or were able to conclude an arrangement with the banks, we would only do so, as I said earlier, on favorable terms, and that requires a quite complicated calculus of all of the possible benefits against the incremental costs of the lending banks may seek to obtain through that process. I do not think it is worth speculating on what the outcome of such a process might be, or indeed, whether such a process ever might take place. I just want to make sure that it is understood that we are very cognizant of our responsibilities to shareholders, and we will not enter into any new arrangement unless we deem that to be on favorable terms. How would your shareholders be able to judge whether it was worthwhile doing? Some of these questions are suggesting that a different course might be possible and favorable. Well, I think our shareholders continue to have to judge across a whole measure of dimensions, how well the company is performing and whether the decisions that the management and the board is taking are sound and effective decisions. That is reflected ultimately in the movement of the share price. If we were to do a transaction of any sort with or a restructuring of the debt with the banks, we would obviously expose to our shareholders any revised terms, and our shareholders would form a judgment on the basis of that as to whether or not they thought it was a good or a not good deal. There is a question over there. Yeah. Marcus Barnard from Oriel Securities. Can you just explain your cash generation target in a bit more detail? Because I just need a bit more clarity here. If you are going to generate GBP 750 million to GBP 850 million in 2011, then GBP 3.2 billion cumulative from 2011 to 2016, it looks like GBP 2.4 billion in the last five years, 2012 to 2016. Am I reading that right? Are there any one-offs in 2011 that are boosting that number? Because if I take the last five years, it looks about GBP 500 million a year, which implies quite a steep runoff profile. Am I reading that wrongly? This is repeating old numbers, if you like. What we have always said is that our regular sort of normal cash flow generation off the book, other things sort of being equal, is in the range GBP 400 million to GBP 500 million per annum. Clearly, over time, that starts to go down. Starts higher, starts to go down over time. What we said was we are looking to deliver cash flow management actions in the order of about GBP 300 million for 2011, which are included within the target of GBP 750 million to GBP 850 million that we set. The GBP 2.4 billion that you mentioned over the remaining five years is very much within that sort of GBP 400 million to GBP 500 million range on average for that remaining period. Right. The GBP 300 million is a one-off, effectively. Yes, it is. Yeah. To be clear, going forward, we expect to, as I say, the management of Phoenix Group is here to deliver management actions at the end of the day, not sort of stand idly by whilst the cash emerges. So we will be looking to come up with new management action targets going forward. It's just that we haven't actually put any out there at this stage. Oliver. Thank you. Oliver Steel at Deutsche Bank. Three questions. The first is just to sort of help us a bit more on the debt front. There's a step-up in the interest rate that on quite a lot of the bank debt that comes through, I can't quite remember, in 2013, 2014 or something like that. Can you just sort of remind us as to what the step-up is, what you're paying at the moment, what you'll be paying after that? I'm assuming from what you say that actually there's really no point renegotiating the debt in its entirety in the first couple of years while you're paying very low rates of interest. It's only after that that it perhaps becomes more interesting. Anyway, whatever comments you've got on that would be interesting. Secondly, in the light of your comments about the IGD, what is the solvency effect of paying down the bank debt over the next few years? Are you actually generating enough cash to keep the solvency where it is? Then finally, I know that the warrant exercise prices are sort of changed by the dividend payment, so perhaps do you have an updated set of warrant exercise prices? Jonathan, can I throw those in your direction? Thank you, Ron. I think you make a really good point on the debt. The debt is very cheap. There is absolutely no question that the rates that we're paying on the debt at the moment, Ron's absolutely right to say we can't speculate on what refinancing the debt might actually cost. But the debt cost that we have at the moment is very cheap, and that certainly does mean that it lifts the pressure, if you like, in terms of having to do something. But of course, the other side to that is if we are able to negotiate something which is overall attractive, maybe an increase in the cost of that debt and maybe significantly less onerous covenants surrounding the debt going forward, then obviously we would look to do that. But as both Clive and Ron said, we're not looking to. We don't feel under any great pressure to go out there and do a deal at any cost. Absolutely not. I don't have to hand the step-up of the interest cost, but we have made that clear in the past. We can dig those numbers out. Again, I just don't have them at my fingertips. Yeah. So, we can provide all that detail, and we have been providing previous presentations, and nothing has changed there. The step-up in the interest rate is something that we factored into all our modeling going forward in terms of how we look at the business. The step-up does not take it from a level at which it's incredibly cheap to incredibly expensive. Far from it. In terms of the second item was the, if we start paying down debt, what would be the impact on our solvency? I mean, the key solvency measure is there is obviously IGD. As we do start to pay down the debt, the IGD surplus is affected, not exactly GBP pound for GBP pound, because our group structure is anything but that simple, but clearly, it starts to go down, and that's one of the factors that we're very conscious of, and it's an area that we need to work with the FSA to make sure that we maintain a sensible buffer in excess of the required minimum. I mean, as you can see in the figures that we presented in the slides, we've got GBP 1 billion of excess IGD surplus, even on the basis of the FSA's current measure. So a reasonably solid amount there. But we are very mindful of making sure that we don't trip over thresholds as we start to pay down debt. Your final question was about the warrant exercise prices. We went through a process last year of removing as much of the contingent capital within the group as we were able to do, as we felt sensible at that time. Therefore, the amount of warrants outstanding and convertible shares has come down quite significantly. I can't give you the exact numbers, I'm afraid, off the top of my head, but all that information is available and will be made available. Ashik Jinsi, JP Morgan. Just two questions. One is on your IFRS operating profit drivers. It looks like you have changed the basis of the average net assets. Earlier you used from FSA returns, and now it's IFRS net assets. There's a huge difference between, especially for the annuities assets, which used to be GBP 10 billion and now it's GBP 5.5 billion. Can you please comment on that? Secondly, on the Ignis AUM, which it looks like fell in the second half. Can you comment on that as well? Thanks. Sorry, so what's the last question? Sorry, about how AUM- On Ignis asset management. The AUM fell in the second half of 2010. I remember it was GBP 62 billion for life funds, and now it is GBP 60. Thanks. Well. Yep. Sorry. Jonathan, do you want to start? Maybe we can bring Chris Samuel in on the AUM. Yeah. Okay. In terms of the profit drivers, to be honest, I will have to come back to you on that. I cannot really give you an answer. In terms of the assets, then clearly, you have a choice. You can either use the IFRS assets, or you can use the FSA return assets. I am not quite sure what the difference is. Again, I will have to come back to you on that one, I am afraid, as well. Finally, the life fund, I think the way in which the assets fell is probably in line with the movements in the assets under management due to market movements, combined with the fact that the business is, of course, running off over that period. I do not know if Chris Samuel has got anything to add perhaps to that. No. Greg, further question? Yes. I won't say I did problem because it's not easy. I remember there used to be a restriction that the FSA put that you've got to have a IGD surplus, including the WPICC, in excess of 125%. That's when you were under review, and they dropped those conditions. I was wondering if there's any issue, the fact that now it's breached that rule and you've actually dropped your rule there. Second one, just in terms of these debt covenants, could you just confirm that some of the covenants prevent you from purchasing any closed books, or are they just related to the level of dividends you can pay? Mike, do you want to start on the 125% of the IGD? Yeah. Sorry. Could I just clarify what the question was again? Well, I mean, when I saw that you changed your internal target from 125 down to 105 on the IGD, the first thought that went through my mind was, "Wait a second, didn't the FSA insist on the 125?" Then I remember that you were under review because of what had gone on before, and they dropped it. So I was wondering, are they happy with 105 now? They absolutely are. I mean, the issue was that the previous target just didn't behave in a rational way. There are some idiosyncrasies in the overall IGD calculation itself, but the target itself was not operating in the way that FSA expected it to or that we expected it to. So it was definitely a dialogue with the FSA, where we agreed that the formula we've moved to would be a more sensible and more appropriate hedging target to go through. So yeah, absolutely. Fully engaged with the FSA on that. Clive, do you want to comment on the debt covenants? Well, Greg, thank you for the question. The covenants, as you can imagine, with a large complex facility in two silos, are numerous and linked. You could put them into three buckets. One bucket is to do with the dividend cap. One is to do with internal restructurings. The third, which you alluded to, is the ability to do acquisitions and use cash flow for purposes outside the firm. There are others, and I think it goes and plays exactly to what Jonathan said about not feeling impelled and having no need, and therefore doing something which is in the round of benefit to shareholders. There are many moving pieces. There's not just one covenant. There are restrictions that in all things being equal, we'd like to operate the business in a more flexible way, and that does also include the legal structure. Would you add to that, Jonathan? No. I think that expresses it perfectly. There's a few. I believe there's a few, and you alluded to it early on, closed funds up for auction or up for sale currently. I was wondering if you raised equity to buy them, whether the covenants would prevent you from doing it? Or was it only if you make use of whatever the 700 that you release. I'm just trying to understand. If your hands are tied completely or if some very lucrative deal came along and you could motivate it to shareholders, you could do it by raising equity. As I said, we have these buckets, dividend cap, internal restructurings, the way we use cash flow for acquisitions, and our legal structuring. So they're all linked. We are in constant and productive dialogue with our banks, and under circumstances which were favorable to shareholders, we would have a discussion with them. There is a congruence between our desire to run the business in a manner which progressively de-gears, as Jonathan said, towards an ability to fund in the capital markets, and also the bank's desire to see us as very successful. But we would not look, as I said, to doing anything that was dilutive or non-accretive to our shareholders for any form of transactions. Just a simple yes or no. If a deal came along Sorry could you raise equity? Our structure is such that we have a holding company that sits at the top, then we have two effectively silos underneath, which hold the life companies and which relate to where the debt is raised. Our holding company could raise equity capital and could go and make an acquisition. However, there is no suggestion that we're even remotely thinking of doing that. At the current share price, we don't think that would necessarily be in our shareholders' best interest. We could use some of the cash within the silos that exist to go off and make acquisitions, but that would require bank consent at any material level. I think that we were quite explicit on that point about acquisition funding in the presentation. I urge you to go back to some of the words that we used because they were quite carefully chosen. We have a question at the back there. Hi. Thank you very much. Andy Hughes, Exane BNP Paribas. Just quick questions about the GBP 100 million that you are talking about in terms of EV benefit. I think Jonathan mentioned it might be largely capital related. I was just struggling how you could get such a large EV benefit from changing capital, given the runoff of the business and the difference between the discount rate and the earned rate. It seems to suggest you are going to release an awful lot of capital to generate GBP 100 million per annum of EV benefit. Are these things other things such as reviewing the outsourcing arrangements or are they largely capital related? Thank you. It is a combination of all this. If you release capital, the point there is you have actually released it a hell of a lot sooner, therefore, you do not suffer the discount on it. But as you say, you would need to release a lot of capital to get that sort of measure of benefit. There are other means of enhancing EV as well, such as getting a better yield at a less risky basis on assets. So there are a range of options that we can look at. Merging funds, those sorts of issues or opportunities. Thank you. Are there any further questions? Are there questions from the web or Apparently not, I am being advised. Okay. Any question over the phones? No. Okay. There is a question from the front row, however. Great. I serve a role here amongst the community. One was this GBP 1.2 billion loan portfolio. When you remove the gearing structure over it, you effectively reduce the risk, reduce the return. Hence, which would imply if you're using like a CFO Forum of MCEV basis, that would reduce the liquidity premium. That's a point. Maybe you want to discuss why it went the other way. Second of all is, under market consistent principles, one pound of assets is one pound of assets whether you put it in cash or property or whatever. I was just trying to figure out what sort of logic you apply to produce your liquidity premium, because they're sort of in breach of the general certainty equivalent principle. Are you using the explicit CFO Forum methodology, which is that 40% plus the triple A minus 40 bps, or are you using a more discretionary basis? You understand there's some oddity in the direction and there's some oddity in the behavior. I think it's a fairly simple answer, which is that we just weren't taking any credit for that liquidity premium before, and we are now afterwards. In other words, we weren't taking any benefit from holding these assets at all. Is the formula that you were suggesting there to be practically that explicit? Yeah. No, entirely in line with our disclosed basis. Yeah, but is it that explicit, the CFO Forum's latest thinking? Because I know people have moved to that. Yep. All right, cool. We have another question. Andy Hughes. Just a quick question on the loans portfolio, the unleveraged loans portfolio you just described for us. Do they have market value? How do you put them on the balance sheet? Are they fair value or are they at face value? How does the- Are you talking about the debt on our balance sheet? Just the Alpha loans. Yeah. Are they at fair value or are they accounted for at face value? How do you- Oh, they are marked to market. Right. Is there market value for these? How do you assess? Well, yeah. We are able to work out if they have a yield, and we are able to work out a value based on the rating. Right. How does that compare roughly to the face value of the loans? Is it a lot higher given interest rate movements since then? Or is it- I am not sure of the answer to that, to be honest. I do not know. Do you know where they are standing relative to par? No. Okay. Right. Thank you. I think they are probably slightly above par actually, but I would need to check up on that. Are there any final questions? Apparently, we do not have anything from the web or the phones. I am just checking again at the back. We have one. On that last question, can I just say, actually, they are standing at a discount to par. Because of the way in which they are They are fairly illiquid assets. So obviously they are standing at a reasonable discount. Sorry, I should have given you that answer straight off. Can we route the call through, please? Yes. We have our first question today from the line of Marcus Rivaldi from Morgan Stanley. Please go ahead, Marcus. Your line is now open. Thank you. Good morning. I was wondering if you could just explain, provide some more color around, please, one of the risk factors that you flag up in the reporting this morning around distributions from the companies, around Solvency II risk, around that, please. Mike, can I look to you or Jonathan on Solvency II? Well, there's still a considerable amount of uncertainty around where Solvency II will end. We've done our QIS 5 results. We're not disclosing the detail of those, but very broadly, the picture is not dissimilar to the picture that we see under our Pillar 2 results. There's still a way to go, though. It still remains a risk. Has there been any discussion that perhaps, your current legal structure, which has the Impala Holdings and then the bank debt sitting above that, would get wrapped into the current IGD scope of Solvency? I think our expectation is that the scope of IGD will remain the same. The IGD will be struck at the PLHL level rather than the PGH level. That therefore, those structures will remain in place as they are today. Though we'll continually keep our eye on the emerging regulations. Okay, thank you. I think that's a fairly key point to make. We have no expectation that IGD will be struck anywhere other than at the level at which it's currently struck in terms of the U.K. holding companies. It won't be struck at the level of PGH, which includes the debt. That's a discussion that we have had with the regulators. Thanks very much. If there are no further questions, and I don't believe there are any, I think all that remains for me to do is to say thank you very much indeed for your time and your attention. Thank you, colleagues, for your contribution this morning. We look forward to taking any further questions that you may have offline. Thank you very much.