Good morning, ladies and gentlemen. Welcome to Storebrand's Capital Markets Day 2016. It's great to see so many of you here in the audience, and we would also like to welcome all of you who follow the webcast. On the screen behind me, you can see our speakers, and you can see the agenda for today. Odd Arild will start with an overview of strategy, how we think about capital contribution, distribution, and growth in the Front Book. After that, the Chief Commercial Officer, Staffan Hansén, and Chief Operating Officer, Heidi Skaaret, will present our ambitions to grow the Front Book while keeping costs flat.
After a quick coffee break, the Head of Capital Management, Trond Finn Eriksen, and Chief Investment Officer, Tørres Trovik , will give you two quick sessions on both how we think about economic capital management and how we think about our liability-driven investment strategy. Then Lars Løddesøl, the CFO, will share some insight into Storebrand's capital management framework and financial position before Odd Arild Grefstad, the CEO, will sum it up with some closing remarks. When we're done, there will be a lunch up in the fourth floor, and the staff from the hotel will guide the way for you. And I think then without any further ado, I will give the word to Storebrand CEO Odd Arild Grefstad, who will start the presentation for today.
Thank you, Kjetil, and thank you to all of you for joining us here today. I really look forward to this day, to this opportunity to both report on our progress on the capital side, but also how we will continue to grow our capital in a capital efficient way going forward. First of all, a very quick overview of Storebrand today. Storebrand is an integrated financial service group, and the only listed Nordic life insurance company. We are the largest actor in the Norwegian market for private sector occupational pension, with well over 30% market share. We also have a strong position in Sweden through SPP. Our internal and external assets are managed by our in-house asset manager, with NOK 567 billion in assets under management.
That makes us the largest Norwegian private asset manager. And all our assets under management are subject to clear sustainability criteria. To leverage both capital and customer synergies in an increasingly individualized market, we offer insurance, savings, and retail banking solutions, mainly for our employees in our occupational pension schemes, but also through cost-efficient external distribution. Now, this Capital Markets Day is really dedicated to all of you who view Storebrand as an investment. We have chosen to build the day and our presentation around what we view as the Storebrand investment case. And this page actually sums it all up. First, in 2012, we set a clear target to adapt to Solvency II without raising new equity capital. Since then, longevity reserves have been significantly strengthened, and of course, interest rates have dropped with more than two percentage points.
Still, we have managed to enter into Solvency II with a stronger and more resilient balance sheet. Today, we establish a new Solvency II target on 150%. We give guidance on normalized solvency generation of 5%-10% annually, and we are set to start paying a minimum of a half normal dividend from 2016. Second here, we continue the transition from capital intensive to capital light. Over half our assets under management are now without a guarantee. Today, we will give insight in the expected capital need and development going forward. We are now very close to the Back Book capital peak. The continuing transformation of the balance sheet and our capital generation makes me confident that we will be able to manage capital requirement going forward, in parallel with paying dividends. Third, the strong growth in our Front Book continues.
Our Front Book delivers high growth with a very high return on capital. There are strong customer synergies in our business to business to consumer strategy, and there are also strong capital synergies, which I will revert to later on. In addition to these three elements, there is, of course, a large upside in the investment case if inflation and interest rates picks up. Storebrand operates in a Nordic market with strong growth in non-guaranteed pensions, supported by attractive macro fundamentals.... The state finances are solid and unemployment rates are low. These factors give growth impulses to our core markets. The recent drop in oil prices and relatively lower investments in the oil industry have made some to question the strength of the Norwegian economy.
It is important to understand that oil investment still will be on a very high level the years to come, even if, even if they are somewhat reduced from the historical top in 2014. At the same time, the weakened Norwegian kroner and continued investment in domestic infrastructure keep the demand side of the economy still strong, and leave good prospects for growth also going forward. A couple of days ago, the Norwegian government presented its revised national budget for 2016. It was an expansionary national budget, and it is estimated that it will give an additional growth impulse of 1.1 percentage points to the inland GDP. Being a pension provider, we benefit from the strong economy for several, several reasons. First, the growth in the economy leads to growth in wages and pension premiums.
Second, it gives high participation in the workforce, and that leads to, of course, increased occupational pension premiums. And third, a strong economy leads to good asset returns and increasing reserves. This is a well-known picture. Interest rate levels are record low. The world's central banks are involved in currency wars with new means. We have demonstrated our ability to show balance sheet resilience, and we have developed our risk management tools. Therese, Torunn, and Lars will talk more about this after the break. As you are aware of, Storebrand's business model is undergoing a fundamental transformation. We report quarterly on three different segments. It's the segment of savings with our unit-linked operations, asset management, and retail banking, and it's insurance and guaranteed products. Savings and insurance is our Front Book, as guaranteed product segment represent our Back Book in run off.
Looking forward, there are some important factors that shape our financial landscape and development. Starting with the Front Book, we capture growth and increase our revenue in capital efficient savings and insurance products. We have realized an annual top line growth of 12% in savings and insurance since 2012. Second, in the Back Book, our traditional sources of revenue from guaranteed business are trailing off. This is a part of our strategy to reduce capital need and risk. When we add A and B here together, we still expect, in sum, a growing top line with a significant, of course, change in the business mix over the next years. So we continue our strategic response, continue our strategy, both then with managing the Back Book, ensure that we continue the transfer of the guaranteed reserve, and also guide on further cost reduction going forward.
All with more than 150% solvency ratio. And also continue the guidance on the growth of the Front Book, where we aim to grow with high rates, and it will be a capital light and very profitable growth, as we will revert to later on. This is an important picture. Let me give you some comments on the Back Book and our capital management strategy before I move into the Front Book. Managing the guaranteed Back Book and the solvency position in a period of declining interest rates and new requirements for longevity, have of course been challenging, and have required strong discipline and hard priorities from Storebrand. We have closed down our public sector pension in Norway, and we have sold our public sector portfolio in Sweden. We offer conversion of paid-up policies to paid-up policies with the investment choice.
We see altogether, we have moved close to NOK 40 billion out of our guaranteed back book over the recent years. We have also closed down our corporate banking loan book, and as you know, we fulfilled our cost program in 2014, reducing the cost with more than NOK 400 million. Heidi will revert to how we now are in a position and have made agreements that make us quite confident that we will really also realize the same amount of cost reduction for the years going forward. This, together with other, of course, elements that we do in the business, has led to quite a significant change in the capital position. We know that interest rates has been reduced with three percentage points over the last five years.
In that period, we have nearly doubled our tangible equity. That has been done in a situation where we also have strengthened our longevity reservations with more than NOK 10 billion. The leverage ratio and the net debt has been significantly decreased, and on top of that, the important customer buffer capital is significantly increased. As we will see later on, that is extremely important to ensure that we have the right amount of buffers to meet also our commitments going forward. Another important slide and let me give some comments on this slide today. The measures I've talked about have led us into a more comfortable solvency position under Solvency II. I want to use this opportunity to update on solvency target and share with you more broadly our thinking on capital management strategy for the group.
We aim to be, and expect to be, in the level of 150%-180% of solvency ratio. And this is also the range where we guide, where we guide on a normal dividend. And as you know, by the first quarter of 2016, we were at 175% solvency ratio. We have also set a trigger point here of 110% of our solvency ratio without transition rules for paying dividend in 2016. Trond Finn Eriksen will revert to that, but our calculation a couple of days ago showed a solvency ratio of 123% for this ratio without transition rules.
As the transition rules run off, the natural shift in the balance sheet and the underlying capital generation, mainly own fund or value in force generation, will keep Storebrand in the targeted range, while we also will be able to pay dividend. We estimate now that we are close to the hard peak capital requirements, and by that I mean the level of equity and sub-debt needed in the group. Furthermore, we expect to generate between five to 10 percentage points of capital each year, and this means that we will generate sufficient capital to first, stay in the targeted solvency range of 150%-180%, including trail off of the transition capital, and second, cover for normal dividend payments.
We also forecast that the run-off of the guaranteed liabilities over time will increase the level of capital generation to more than 10 percentage points each year. So let me conclude the run through of the back book and showing our revised financial targets. As I already touched upon, we have revised our solvency target and reiterated the link between solvency and dividend targets. We keep our rating target on an A level, but we have decided to remove the target from the overall financial targets. This is more of a technicality, as a targeted A rating, A level rating, is naturally derived from the other targets and therefore is redundant as explicit financial targets. Then let's move to the front book. The Front Book is well known, has well-known customer synergies. We work together with more than 40,000 corporates and around 2 million individuals.
The individualization of corporate pension strengthens our relationship with the individuals and represents an effective distribution of asset management solutions for pension and savings, and also insurance and retail banking. What is maybe less unknown is that there is great capital synergies in the group that benefits the growth of the Front Book. The unit-linked business growth is actually creating capital under Solvency II. Trond Finn Eriksen will revert to that. The asset management business adds, in itself, around two percentage points of cash earnings to the solvency ratio every year. Given the large portion of market risk in the solvency calculation, the marginal capital requirement for writing new insurance business is very low due to, of course, diversification effects. Also, this area builds cash earnings that improves solvency. Last but not least, we now grow retail lending on the life balance sheet.
This is helpful for three reasons: it is an attractive and capital effective asset class, well suited for the life book in itself, it gives fee income and reduced capital requirements in the bank, and of course, it gives us the opportunity to have favorable rates to our retail customers. The growth we have captured within unit links, asset management, insurance, and retail loans are well known. We report on this on a quarterly basis. As you can see from the slide behind me, we have succeeded both in gathering more pension assets and cross-sell to individuals. But this is yesterday. To stay competitive and to replace earnings from guaranteed business in the years to come, we also have to ensure strong Front Book growth going forward. One of the ways we seek to improve is by increasing customer satisfaction.
It is probably not a great surprise that satisfied customers recommend Storebrand to their friends and family, or that they buy more Storebrand products and leave us a higher share of their wallets. What is new is that we now have the ability to put together internal customer insight and match it with external big data management. This enables better decision making, better and more targeted advice to customers, which again leads to more sales and increased customer satisfaction. Staffan will take you through a couple of examples on how we innovate to make our customers more satisfied, more loyal, and more likely to buy even more. As you can see here, from the right-hand side, we have a great starting point.
With more than 10 years in a row with the market's highest customer satisfaction for occupational pension in Norway, and we also have a strong credibility from our leading sustainability position. So I will now leave the word to Staffan and Heidi, who will take us further into the development of the Front Book, and that includes how we will maintain our market leader role in occupational pension, how we will convert employees of corporate pension schemes to become loyal and profitable retail customers, and increase retail growth through strong product offering, innovation, and digitalization, while also keeping a strong cost control. So with that, Staffan, I leave the word to you.
Thank you, Odd Arild. My name is Staffan Hansén, and I'm the Chief Commercial Officer of our Swedish business activities, and in this section, I'm going to outline the group commercial strategy. So let me begin by going through the key takeaways. As Odd Arild pointed out, we are in the midst of a transition from managing capital-consuming guaranteed pensions to managing capital-light long-term savings. This transition creates a healthy rotation of the balance sheet to capital-light products from capital-consuming products. The main challenge is that savings rates in defined benefits used to be higher than savings rates in unit-linked. So even if it's a healthy rotation, it doesn't create net growth today. So where is the net growth coming from? Net growth is coming from a developed relationship with our retail clients are the employees of our corporate clients.
These retail, connections that we have developed generate net growth in banking, additional savings, and insurance. That's the main point and the business logic, built on the challenges and the possibilities we have. Let us start with looking at the dynamics of the Nordic pension markets. On the left-hand side, you have the premium growth in Norway and Sweden, premium growth in private competitive pensions. The growth is roughly 5%-6% per year. On the right-hand side, you can see the shift from defined benefit, guaranteed pensions, to unit-linked pensions. As you can see, the growth in unit-linked pensions is on aggregate double-digit over Norway and Sweden, and the growth in defined, benefits or guaranteed income is flattening out. In 2015, premium income from unit-linked surpassed premium income from guaranteed pensions.
This is the main challenge, once again, in figures, as was outlined as a key takeaway. If you look at the right-hand side of this page, you see the actual shift. You see the premium income. The premium income is flat from 2012- 2015. But below, behind the figures, you see the shift, the rotation of the balance sheet from capital-consuming defined benefit to capital-light Defined Contribution. And because this shift is flat in growth, you can see on the right-hand side how we create profits and profit development by engaging our corporate employees in becoming customers to us in retail, banking, in additional savings, and in insurance. And from 2012- 2015, you can see that the net growth in terms of profits is up 60%.
So this is the main challenge, and this is the response to the challenge, where we utilize our B to B to C, our employees of our corporates generate net profit growth... Next, let us look at our positions in the markets in Norway and Sweden. In Norway, when it comes to pensions, we are the undisputed market leader with a market share of 34%. In Sweden, we're a strong contender with an 11% market share. And what are then the drivers of the positive relationships with corporates? Well, it's a combination of customer excellence. We have a very good customer satisfaction in Norway, and we have the best customer service in Sweden for three years during the last five years.
It's our ability to transform pensions competence into simplicity, and it's our sustainability offering, where sustainability, in many cases, has become the dividing line between getting business or not. In Sweden, we can, for example, see that in asset management, some municipalities that buy mutual funds to manage their own pension, their own pension, funds, require fossil-free funds. That's something that is really required. They are not allowed to invest in mutual funds that are not fossil-free. So it's becoming really something that is necessary for the business. Next, let us look at the growth and projected growth in unit-linked reserves. You can see that over the next three years, we project a 15% growth. This growth is divided into market returns and to increased premium income.
The increased premium income is driven by a growing population, increased savings rates, increased salaries, new sales, and conversions from guaranteed pensions to unit-linked pensions. In Norway, it is also driven by a positive age distribution, which means that while unit-linked is a young product, more people are entering the scheme than exiting the scheme, building net growth. When it comes to our corporate offering, we see that there is an increasing demand for guaranteed products coming back in the wake of turbulent financial markets since the financial crisis. We have developed a new generation of capital guarantees over the last year, which have been launched in both Norway and Sweden. To sum up, these products, in Sweden, they are even more capital light than the unit-linked product.
I won't go into details about that, but you could revert to that afterwards if you want to discuss it. These guaranteed schemes, guaranteed products are complementing our offering in a very good way, and we see increased demands, demand, especially from Sweden, but also tentative, tentative signs in Norway. When it comes to our corporate relationship, insurance is a very, very important part of the corporate relationship. It's not only disability insurance, where we have 34% market share in Norway and 9% in Sweden. It's also complementary corporate insurance offerings of health and group life. In Norway, we have a 20% market share in the fast-growing health insurance market, and we have a 27% market share in group life.
So these are complementing the corporate offering, which means that we are a full provider of the schemes that corporates require, both in Norway and in Sweden. This was the corporate side of our group strategy, commercial strategy. Let us next move on to asset management, banking, and insurance. When it comes to asset management, we have undergone, or our asset management has undergone a turnover, a turnaround during the last years. As you can see, since 2010, revenues have increased by 34%, while costs have remained flat. On the profit side, you can see from 2012 that profits have grown by 127%, simultaneously increasing the profit margin on our assets under management from slightly below five basis points to exceeding eight basis points. So this has created a very, very profitable asset management.
It is also, it is also very positive that our asset management is not only managing assets on behalf of our pension schemes, so the asset management is not only a captive asset management. 24% of the assets come from external sources, external sources being institutional asset managers and retail clients that don't have a relationship with Storebrand or subsidiary SPP in Sweden. If you look at in terms of revenues, 36% of the revenues come from external sources, 24% of revenues come from unit-linked. So 60% of the revenues in asset management come from our growth lines of businesses. And this is a really, really diversified set of sources creating the asset management to a hub, gathering assets from diversified sources. Next, let's have a look at how we work with retail distribution.
Retail products, as mentioned, are insurance, individual insurance, it's additional savings, and it's retail bank. The distribution is both internal and external. Internal distribution is cost-efficient distribution through our call centers, through the web, and through mobile devices. When it comes to the very important external distribution, when it comes to insurance, we have a great cooperation with Norwegian academics, the Federation of Professionals, and its 110,000 members, where we're able to offer our individual insurance products to their members. When it comes to asset management, we offer our mutual funds through various platforms, fund platforms in Norway and Sweden, and our funds they are selling. When it comes to banking, we have a cooperation with Unio, which is a Norwegian federation of mainly public employees, a couple of 100,000, where we are able to offer our retail banking services to the members.
So this is the distribution of our retail strategy. So when it comes to our corporate employees, our ambition is to make our corporate employees also retail clients of Storebrand. Going back to 2012, 12% of our corporate employees had a retail engagement with Storebrand. That figure had grown to 17% last year, and our ambition is to get 25% of the corporate employees to become retail clients by 2018. And that is created through loyalty programs that we have developed together with our corporates. Corporate clients, I'm sorry. So finally, let's move on to to give a little bit of flavor of how we work to engage retail clients. As Odd Arild pointed out, innovation is at core for us in order to to develop the retail relationship.
On the banking side, we have digitized and automated the loan application processes, and this really, simplicity is at core when communicating, when engaging retail clients. So through streamlined processes, we can see that the conversion rate of customers or prospect customers starting the application has tripled from 11% to 25% in just one year. When it comes to signing, the digital signing by BankID has grown twofold, and the processing time has been cut by two-thirds. So this means that we have better processes that leads more prospective clients to actually become clients, and in this process, we create and develop happier customers. Next, let us look at two more examples of innovation. Through the advanced use of big data, we gather knowledge about our customers.
This knowledge is used to predict which products our customers are most likely to buy, and this is called, in technical terms, the next best activity. Using this, we can provide consistent and personalized advice across all our channels when we communicate with our retail clients. The result of this is that by giving advice, 15% of the clients that get, or the customers that get advice, actually executes that advice and converts it into some kind of transaction. Simultaneously, it creates happier customers. Advice creates satisfaction. Finally, pensions is a complicated theme, and we have built tools in order to for our customers to understand their pensions better.
If they understand how much they have saved by today, and if they understand how they can compare that with the desired level of income when they retire, they can, they can visualize how much they need to save in order to get that income they want in the future. So we are creating advice in terms of creating personalized insurance plans, where the customers can plan on how to retire with the desired level of income. So finally, let's wrap up. Our ambitions, commercial ambitions going forwards, is by 2018, we will obviously maintain the number one position that we have in unit linked, in occupational pensions in Norway. We want to build a number one position in unit linked occupational pensions private sector in Sweden.
When it comes to insurance, our ambition is to maintain long-term 10% top line growth, with 2016 being a slight, slight, on the side, because we are changing the distribution mix in 2016. But from 2017 onwards, 10% is the target, with a combined ratio around 90%-92%. In asset management, our ambition is to keep the number one position that we have towards institutional clients in Norway. To improve results by or revenues by NOK 160 million, and of these results, generate NOK 100 million additional profits by 2018. On the retail bank, our ambition is to double the loan book by 2018, with a return on equity exceeding 10%.
With these words, allow me to pass the word over to our Chief Operating Officer, Heidi Skaaret.
Thank you, Staffan, and good morning. The pace of change in financial services is higher than ever. I will address how we are transforming our operations to a digital business model based on customer centricity, innovation, and cost efficiency. As you probably know, the Nordics is an advanced and mature market for digital services. This graph shows the penetration of online banking and mobile internet, where Norway and Sweden are way ahead of continental Europe and the UK. Nordic customers prefer to engage with their banks and insurance companies digitally. Although retail banking is leading the way, things are evolving rapidly in the insurance and pension markets as well. Storebrand participated in the comprehensive benchmarking study with Bain & Company last year. Among leading global life and insurance companies, we were at the forefront in terms of digital maturity.
We are committed to keeping this position going forward. Staffan gave some examples of how we are achieving great results in this area. A digital business model is key to our strategy for three main reasons. It's at the heart of our growth strategy. Storebrand has a strong brand name, and we are the market leader in the occupational—or in the corporate sector. But we are a challenger in many areas of the retail market, with great opportunity for growth. Secondly, digitally engaged customers are more happy, they buy more products, and they stay with us longer, enabling us to unlock synergies in a broad product offering. Thirdly, digital transformation is an essential part of keeping a cost efficiency and profitability going forward. We are building a flexible infrastructure to service internal and external distribution channels.
Storebrand has strong digital competencies both in our business units and in IT, and I have shown that we are among the leaders in our industry. An important initiative to further enhance our digital transformation is the strategic partnership we entered into last year with Cognizant, a leading global IT and business outsourcing company. We sold a majority shareholding in our shared service center in Vilnius, Lithuania, and entered into a comprehensive master service agreement. As part of the deal, Cognizant took over 370 employees in Vilnius. Through the partnership with Cognizant, our goal is to deliver enhanced customer experiences through streamlining of processes, automation, and use of robotics. The partnership will reduce our cost base through further outsourcing and a global delivery model. And over time, we will move to more variable and business outcome-based cost model.
This is favorable, both from a business and solvency point of view. The partnership will also be an important accelerator for our innovation and digital transformation, improving our speed to market. We will tap into our partner's capabilities across the globe and across industries, and we have already established a joint innovation process. Lastly, we will move to more managed services for some of our key IT systems. In some areas, we will move into a business process as a service concept, with the possibility of sharing costs with other players in the market. We already have software as a service IT solutions for our asset management, retail banking, and P&C insurance business. But within the pension area, we have in-house IT solutions with no cost sharing possibilities today. These plans are now committed in the contract.
The value creation for us is outsourcing more from Norway and Sweden, using a global delivery model, and also the efficiency gain through automation and robotics. Today, we have more than 310 FTEs working for Storebrand in Lithuania, and over the next two years, we will outsource the workload of an additional 250. The cost level in a global delivery model is less than half of Norwegian labor cost. On top of this, we have a committed productivity gain of 40% through automation, streamlining, and use of robotics. As Odd Arild pointed out, Storebrand has been working hard to transform our business from a B2B guaranteed business to a B2B2C capital light business. We have...
At the same time, we have been investing in new technology and solutions, and growing our assets under management by 29%. On top of this, we have been able to reduce the underlying cost by 10%. We completed a successful cost reduction program in 2014, cutting costs by NOK 400 million. We increased our offshoring to Baltics, and last fall, we restructured our sales and marketing departments in Norway and Sweden, reducing it by 70 employees. We have completed other important cost initiatives, such as closing down the agent channel, converting to a new and cost-efficient banking IT platform, and converting to a new outsourced and more cost-efficient IT infrastructure platform. We are proud of what we have achieved, but we are planning for further cost reductions going forward.
Our cost base is predominantly linked to the number of FTEs and IT cost, and therefore, our cost initiatives are linked to outsourcing, automation, and digitalization. The partnership with Cognizant that I just mentioned is the key driver. Going forward toward 2018, we are planning for cost reductions of NOK 300 million-NOK 400 million. Allowing for inflation and wage increase, you should expect a lower but more flexible cost base with a higher degree of outsourced services. At the moment, we are in the middle of implementing a number of initiatives. The Vilnius Center was taken over by Cognizant on February 1st and is now running very well under their management. Now the transition of more services is ongoing. New innovative digital solutions are being developed as we speak.
We still have a lot of hard work ahead of us, but we have a strong and dedicated organization that will make this happen. I will leave you with the key takeaways that Staffan mentioned at the beginning of his talk. Storebrand is on a transition to being a capital light asset gatherer. Unitlinked is expected to grow by 15% annually over the next three years. Growth in savings and insurance will increase top line despite reduction in income from the Back Book, and our ambition is to keep the cost nominally flat. Thank you.
Yes. We will then open up for some Q&A. Do a quick round now, and then we will get some coffee. Let's start with Peter Eliot. Peter?
Thank you very much. I had one question for Heidi, first of all, on the digital side of things. I mean, obviously, everybody is trying to make inroads there. I mean, on the sales side, can you maybe comment on the relative advantage that you have, let's say, about new sales, and then perhaps on the cost side of things, you know, what... Thank you. And then on the cost side of things, you know, as everybody else aims to reduce their costs, you know, what is your view on the margin pressure that might result, so th-
... the fees that you can charge. And then perhaps quickly to, on Odd Arild, on the targets. Do you have a timeframe in mind for those targets? So for example, the 10% ROE, I'm just wondering when you expect to achieve that by. And I was wondering if you could maybe touch on the reasons for increasing 130% to 150%. What has sort of changed over the last couple of years there? Thank you.
Yes, I think to start on what is our competitive edge in terms of growing in the retail market, it's what Staffan mentioned, the large customer base of private customers that we have through our pension schemes. And we know that pensions are changing from being much more individualized. So to engage our customers in terms of understanding their pensions and actually taking an active ownership, we see the digital solutions succeeding well, very well in doing that. And through the Next Best Activity scheme that Staffan also mentioned, we are able to cross-sell at a much, much higher rate than we had previously. So I think the strength is in that large customer base and using smart digital solutions to actually cross-sell.
The second question was on margin pressure, if I understood it correct. We see that maybe you want to comment as well on that. But we see, of course, there is a pressure on margins, and we have built that into our plans, and therefore, also, cost efficiency in all parts of our operations is key to strong profitability going forward.
Yes, if I should comment on this, I would say, first of all, also with what is our competitive advantage in this distribution? I think you should bear in mind that Storebrand's position is a bit different from the other players. We compete against banks with our offering. And of course, we have already, for a long time ago, switched our distribution network towards net-based distribution and call center, and also channels built around this. So we don't have to do the switch from this large distribution network that banks are actually building down these days. We have that future set up on distribution already and can work with external distribution on top of that already future-ready distribution network.
Margin pressures, yes, it is, of course, margin pressure, but if you look at the corporate pension in Norway and in Sweden today, the rates are already on quite low levels. We don't expect those to be very much lower going forward. We have built a position now where we also utilize our growth in the retail market. Of course, the retail market differs a lot, but there is healthy margins when we are able to grow in the retail market. We also will show you later on in this presentation, when Lars revert to it, that we also have a benefit with capital, because we have a very strong diversification effect that make us possible to grow profitable our retail business in a very good way.
When it comes to financial targets, first, maybe, of course, we will dig into that, situations after the break and use a lot of time on both solvency and on the different targets as such. But you should bear in mind that we are now at 175% Solvency II. And what we see is that we will keep well above the 150% Solvency II going forward, and it will basically be a shift from transitional rules to Value in Force capital. So this does not mean that we will keep more tangible equity in the group going forward. So the shift from 130 to 150 does not imply that.
It's more like looking at where we really are and what we are able to do in the shift of the balance sheet from the capital generative products into the capitalized products. And then, we see that 150% is also a target that we believe, is very much in harmony with the A-level rating going forward. So that is why we set this target of 150%. When it comes to, return on equity, we are at the 7% return on equity today. Again, we will see later on in the presentation, there is a very strong return on equity on the Front Book, as of course, we have a Back Book that still are keeping a lot of the capital in the group with low return on equity today.
As this shift happens, we expect to be at 10% and above 10%. Lars will revert to the timing of it. It goes without saying that it will not be for 2016 to 2017, but going from that one, we hope and expect to be at the 10%, return on equity, and we will gradually build up to that level.
Okay, then it's Matti Ahokas. Please wait for the microphone.
Thank you. Matti Ahokas, Danske Bank. Two things that struck me in the presentation was the very strong growth ambitions you have both in the retail banking side and the insurance side, in a market where your competitors are seeing low single digit growth and citing quite tough competition, both in retail banking and non-life insurance. I would be very interested in hearing is how you can basically win so much market share and grow much faster than competition going forward?
... Yes, I think you should bear in mind that we start from quite a low level. So we have small setups when it comes to banks and retail insurance, and we have great brand name that we can leverage on, especially on the insurance side. Then again, I also talked about how we now are able to use our life balance sheets effectively, cost effectively, and capital effectively, to create a very good offering on the retail banking side. And we have seen that the growth have picked up. It's 18% above the level it was in the first quarter of 2015. So we see that we are really growing the bank book from a level that is a low level, of course, and that helps for growth as well.
On the insurance side, we have constantly, since we started up again in 2006, had very strong growth rates, organically on, on insurance. It's been about 10%. We have been very clear that we are now shifting some of our distribution channels, shifting out some of our external distribution. That will impact the growth in 2016 and the starting of 2017. I mean, our long-term, ambition is to have about 10% growth in, insurance, where we today have a low market share to compare to what should be a natural market share for Storebrand going forward.
What does natural market share mean?
Oh, that's a good question, of course. But we are doing this, and I think we have a very strong brand name, and we have the opportunity, ability, and the distribution channels and the customers to grow this organically. We are not in the market to buy a lot of, of course, portfolios to do this growth. We will do it organically and gradually grow the market share. I will not set a market share target here today.
Odd Arild, just to build on that, our very constructive relationships with the external distribution channels, like your Akademikerne and Unio, is creating a very, very good soil for us to distribute both insurance and banking.
Okay, we will do one more quick question from Vegard from Pareto, and then we'll give you a little leg stretch.
Thank you. I'm just curious about the cross sales. And you have had the ambition for cross sales for several years and been quite successful, as you've shown yourself. How are you going to boost the cross sales so significantly from 17% and up to 25%?
Well, first of all, I think we have a good track record. We have now moved from 12%-17% in a few years, and that is based on a combined setup for distribution across all our products, both corporate and retail. We see that that helps really for the cross sales. We also have built very good solutions towards our corporate pension customers. 95% of our corporate customers have put up a loyalty program together with Storebrand that make us possible to both able give insight in the pension system in itself, but also make sure that it's possible to do additional savings, insurance, and banking solutions.
This combination with what we do in the setup with our corporates and the large opportunities within these 2 million employees in the corporates, and also what we do, as Heidi talked about when it comes to digital competence and using next best activities and so on, building our internal channels, make me confident that we are on the path where we will even get higher cross sales rate going forward and move towards this 25% level of our corporates that will also have Storebrand as a retail provider. Okay, everyone, then we will start again in 10 minutes. Please help yourself with some coffee, and management are available to talk also in the break.
... All right, ladies and gentlemen, please find your seats. We start in 30 seconds. All right, then we've been through the operational side and the Front Book part of the day. Now we'll move over to capital and financial position and the back book. First, Mr. Trond Finn Eriksen, which is head of economic capital at Storebrand, will run through how we think about solvency and economic capital modeling in Storebrand. So Trond, the stage is yours.
Thank you, Kjetil. I hope everyone enjoyed the break and are ready to begin to dig into the numbers. I use the next 15 minutes or so of this presentation to underline the following four statements. One, Storebrand has a solid Solvency II position, well above target of 150%, with reasonably low volatility in solvency ratios, including transitional measures. Two, although capital requirements will continue to grow, capital requirements attached to the back book is approaching peak. Three, Storebrand runs a profitable business measured in economic capital terms, and economic capital calculation build up on our Solvency II models shows a profitable, sound Front Book with strong value of new business. And finally, Storebrand has a long history of economic capital calculations, and our Solvency II models are robust. For the last two decades, Storebrand have calculated and reported embedded value.
Since 2007, using the market consistent approach, which is more or less the same approach that is used for Solvency II calculations. In 2012, Storebrand took an important decision to develop our own in-house Solvency II models. This was based on the need for, one, more granular models that allowed us to make more detailed calculations of the cash flows. And second, develop a system that allowed us to make fast, accurate, and automated calculations. Although working with economic capital models for a long time, the introduction of Solvency II made it necessary to improve modeling. Like many other insurance companies in Europe, we came from simplified models. When the models have become more sophisticated, assumptions can be set on a more granular level and hence be more accurate and precise.
Let me give you an example of a change in modeling that affected the Solvency II margins with approximately 1.5 percentage points in Q1. Storebrand has, for a number of years, invested in a small number of asset-backed securities, as they have an attractive risk-adjusted return. When stressing these assets on the Solvency II, we initially treat them too harsh, not taking account for the collateral. In addition, we spread risk with the duration of the loan agreement. A more detailed look at loan agreements show that they could be repriced within 12 months, and hence, the spread risk should be stressed on a 1-year horizon instead of the length of the loan. Taking this into account, we could reduce the stress from spread risk.
My point with this example is that the calculations are complex and that there are details that always can be worked with and improved. We will continue to work with model improvements going forward, but we believe that we have made the major bulk of the changes to the models at this time. Moving from history to present. Storebrand reported a solvency ratio of 175% as of Q1, excluding transitional measures of 117%. Including transitional measures, we have NOK 46.6 billion of own funds and a capital requirement or the SCR of NOK 26.7 billion. The SCR consists of NOK 7.5 billion from the guaranteed product. This is mainly the risk that profitable business will move...
Sorry, this is mainly the risk of not meeting the interest rate guarantee, i.e., financial market risk. In the appendix, you will find a more granular breakdown of the SCR. The SCR also contains NOK 6.7 billion of capital requirements from the non-guaranteed business. This is mainly the risk that profitable business will move away, lapse risk, or become unprofitable. This is, of course, a real business risk, but it's not a risk in the sense that it affects the group's capability to meet its obligations to the policyholders. Another way to view it is that if the contribution to own funds from the products of NOK 5.4 billion are removed from the available capital, the major bulk of the SCR from the non-guaranteed products of NOK 6.7 billion will disappear as well.
So, to the extent that I sometimes I'm met with the difference between hard capital and soft capital. If you remove the soft capital from the available capital, you should also remove the capital requirements attached to these products on the right-hand side of this picture. All economic capital calculations rest upon a number of assumptions. I attached some of the more important ones here. For the sake of time, I leave the slide for those of you that are interested to read at a later time. But we'll move on to have a look at the most relevant sensitivities. Moving to this slide, I also want to make you aware that these are updated solvency figures as of Tuesday this week.
So when we're looking at the sensitivities, we can, on an overall level, say that there are small sensitivities to Solvency II ratios, including transitional measures. However, changes to the interest rate levels, especially give sensitivity to Solvency position excluding the transitional. We can divide sensitivities into those caused by financial market movements, and those sensitivities caused by operations and regulatory changes. The first one, you are familiar with from our quarterly reporting. We have, however, for the first time, published a sensitivity to credit spread widening. As you can see, here, a 50 basis points credit spread widening will lead to a reduction in Solvency II ratios of 12 percentage points. Into this calculation, we have anticipated that a 50 basis points credit spread widening would lead to an adjustment in the Volatility Adjustment to increase with 15 basis points.
It's important, however, to note this, that Storebrand do not anticipate any changes in the volatility adjustment when calculating the SCR, as this is not allowed under the Standard Model. However, we do notice that some of our peers using internal model are doing so with strong positive impact on reported Solvency II ratios. Storebrand would also achieve a strong improvement in Solvency II ratios if we were to take account for shifting volatility adjustment in the credit stresses. As there is a process to change the ultimate forward rate within EU these days, we have also chosen to give the sensitivity to a UFR being 3.7%. The effect is five percentage points on the reported solvency figures and eight percentage points on the solvency levels, excluding transitional measures. It should be noted that the effect is sensitive to interest rate levels.
Trying to forecast the future solvency position, there is 3 key drivers. 1, the capital requirements on the products. 2, the development in the reserves on the same products. And 3, the development in capital requirements on the products and the measures we put in place to improve the solvency position. Starting with the first, it's important to forecast the future solvency position and the capital situation of the group, as this will ultimately influence on the dividend ratio, as Odd Arild has already elaborated on. On the graph here, the blue bars shows the own fund generation by the specific products. The gray bars shows the SCR for the same products. Some of the two bars will be the net capital requirement for the products. Not surprisingly, it's the high capital guarantees that requires most capital, with 12.6% of the reserves.
On the other hand, we have the capital efficient guarantees and the unit-linked business, which actually contributes with more capital than they consume, and hence contribute to the solvency position of the group. i.e., all new sales will give a solvency ratio higher than 100%. Now that we have determined the capital charge for the product, it can be interesting to look at the expected reserve development for the same products. In these projections, we have taken the Solvency II development of reserves and have added risk premiums to the expected investment returns, new premiums on existing contracts, and have assumed new sales to account for the lapse in the unit-linked business. This should give a realistic picture of the reserve development in the years to come. So what, what should you pull out of this? Well, first of all, all guaranteed products are in long-term run-off.
In fact, it's only the paid-up policies in Norway, which are growing for some more years. And that's due to the fact that the defined benefits book in Norway becomes paid- up over time. The paid up is in the gray area here. On the other hand, we have expected a strong growth in the unit-linked reserve, as Staffan has already used some time to elaborate on. So if we combine the two previous pictures, what does this tell us about solvency and position going forward? Well, financial market movements will impact the net capital requirements on a product level... But in the next few years, the transitional measures will reduce sensitivities to financial markets. Two, the reserve development should have a relatively small deviation from our projections, especially in the first years.
The Unit Linked, the reserves can, of course, differ from large movements in the equity market, but the direction, of course, is very clear. And three, finally, our own measures will impact the solvency ratio of the group. First and foremost, investment strategy that Tørres' soon will go more into, but also retained earnings, possible changes in the subdebt, reinsurance contracts, and further adoptions in modeling. So what I'm trying to say is that the graph shown on the right-hand side should give a relatively good picture of the expected solvency position of the group going forward. I started the presentation by telling about the journey from embedded value to Solvency II. Let me now end this presentation by bringing us back to embedded value type of thinking again by moving to economic capital.
Please note that these slides are on the reporting full year figures for 2015. Why are we focusing on economic capital calculations in Storebrand in addition to Solvency II? Well, first of all, because Solvency II does not reflect all the value embedded in the business. Well, we are using economic capital as a decision-making tool, and it's an important tool, both to see the value of the current business, but even more so to measure the value of new business. When we do Solvency II calculations, we are following the methodology given in the standard formula from EIOPA and the Norwegian regulator. However, when we want to see the value of our in-force book and the value of new business written, we do some modifications.
I will use some time on the modifications we do. First of all, in Solvency II, we have short contract boundaries. Since the major bulk of our business is occupational pension, and you have to remember that occupational pension is mandatory in Norway, we add on new premiums on existing contracts. When adding on new premiums, we, of course, also add on the costs associated with receiving these premiums and remaining the relationship with the clients. So that explains these two boxes. Then thirdly, we do a modification on how we calculate the risk margin associated with mass lapse. In Solvency II, we stressed that 40% of the individual clients and 70% of the corporate clients will move away in a single year.
We then set aside 6% of the change in own funds as a capital charge or a risk margin. We do not think that 40% and 17% reflects the true underlying business risk for mass lapse. We believe 20% is a better measure on that risk, and hence we are taking a 6% capital charge over the change in own funds from a 20% stress. Finally, we allow for the income in the asset management operation that originated from the life insurance business to be accounted for. That is roughly NOK 2.5 billion in net present value, as you can see up here.
Hence, we calculate a value of the in-force book of Storebrand Group to be NOK 37.1 billion, valuing other subsidiaries than the life operations at book value. A group embedded value of NOK 37.1 billion equals approximately 83.1 NOK a share. Adding on subordinated debt, we arrive at available financial resources of NOK 43.9 billion, which is NOK 1 billion less than available capital under Solvency II, including transitional measures. Finally, moving to the value of new business that was written in 2015. There are three key takeaways from this picture. First of all, Storebrand delivered very strong sales in 2015, among other winning contracts with large companies like Norwegian version of BBC, the NRK, and Statoil.
Secondly, we see that Storebrand is increasingly successful in selling additional savings products to individuals in connection to their occupational pension plans. The value of new business is hence almost double to NOK 130 million for private Unit-Linked contracts. And thirdly, and finally, we see that all Front Book sales are positive and give both positive economic capital contribution as well as a positive Solvency II contribution. So I leave the stage with the same four key takeaways that I started off with. Storebrand has a solid Solvency II position, well above the target of 150%, with reasonably low volatility in solvency ratios, including transitional measures. Two, although capital requirements will continue to grow, capital requirements attached to the Back Book is approaching peak.
Storebrand runs a profitable business measured in economic capital terms, and economic capital calculation, built up on our Solvency II models, shows a profitable sound Front Book with strong value on new business. We have a long history of doing these calculations, and our Solvency II models are robust. By this, I give the stage to Chief Investment Officer, Tørres Trovik . Thank you.
... Thank you very much, Tørres . Right. In this presentation, I will explain how we decide on the LDI in our liability-driven investment strategy in Storebrand. I will go into these four key takeaways in more detail. First, we have sufficient expected return to grow both buffers and solvency capital. Secondly, we have built a high level of buffers over the last few years, and I will show that 5.3% buffer level will provide low risk for shareholders and reduced net SCR. Third, we make efficient use of risk premiums by segmenting assets and liabilities, making sure that we take risk where it actually pays off. Fourth, we have a very strong double A-rated amortized cost portfolio, providing 65% of required return in the Norwegian guaranteed portfolio.
But let me start by giving an overview of the allocation in the guaranteed portfolios in Norway and Sweden. In this picture, we see that the main share of assets is allocated to fixed income securities. Note that the allocation to equities is quite low. The fixed income portfolios are quite different in Norway and Sweden because of differences in regulatory regime. So in Sweden, we manage duration mainly by swap exposure and take credit exposure in floaters. In Norway, we have a large amortized cost portfolio to manage the annual guarantee. It's worth noting that our exposure to the oil and gas sector is very limited, only 1% direct exposure for the total Norwegian portfolio. In general, we have, over the last few years, moved the portfolios towards asset classes with high expected return relative to capital charge and the Solvency II.
That means credit bonds rather than equities, and we are harvesting several forms of illiquidity premiums. We are continuing this process and increasing the allocation to loans, both commercial real estate loans and residential mortgages, as Odd Arild mentioned earlier. Moving on to the motivation for this allocation. Storebrand has done LDI, or liability-driven investments, under different regulatory regimes for a long time. LDI for Storebrand can be translated to risk management with a double purpose. We have to handle both the long-term perspective with risk management of own funds and the SCR, and we have to keep track of the shorter term IFRS perspective as well, with risk management of financial results and buffers. These two perspectives are quite different in Norway, because IFRS accounting use book value for assets and liabilities, and this guides the mechanics of buffer building.
These buffers play an important role in reducing net SCR under Solvency II. In Sweden, there is less difference between the IFRS and Solvency II perspectives. Here, own funds and buffer are more or less generated by the same procedure, because the IFRS accounting is based on market values of assets and liabilities as well. When moving on, I will spend my time on how we manage the two perspectives in the Norwegian Back Book. Priorities in this dual risk management are set by our financial targets, and we aim to contribute to increased solvency from the Back Book while keeping within the sustainable risk level. Now, this picture is important, so keep attention, please. It shows the different required returns in the solvency and the IFRS perspective. What matters in the solvency perspective is that assets must grow at least as fast as the value of liabilities.
So one target to beat is the internal rate of return for liabilities, and as long as the expected market return is higher than that, you see that 2.6, 50 basis points margin over the IRR of liabilities. As long as that is the case, own funds will grow over time in expectation. Now, moving on to the IFRS perspective, on the right-hand side of the graph, we also have to make sure that we manage buffers. That will reduce risk in the result and have an impact on the net SCR, and thus, the future solvency ratio as well. In Norway, as I've said, buffer dynamic depends on the difference between the book return and the annual guarantee.
So in the picture to the right, we see that expected book return, that is market return, plus the yield of the amortized cost portfolio, exceeds the annual IFRS requirement. And note also that in addition to that, we have 5.3% of buffers already to draw on if necessary. And that means we can smooth returns over time and that we have low IFRS risk in the Norwegian regime. Moreover, it means that buffers are expected to grow going forward. So summing up, we are confident that we can control short-term IFRS risk, we can increase buffers, and we can contribute to better solvency from the guaranteed business. So in this picture, we give an estimate of how expected book returns develop 10 years forward. We see the expected growth in buffers because expected return exceeds the guarantee.
If this scenario materializes, the increase in buffers will contribute to a reduced SCR for the guaranteed business. This expected book return estimate is based on a reinvestment yield assumption in the amortized cost portfolio. So we assume we reinvest today at the current market level for a single pay investment. And then moving forward, we expect the interest rate to move up slightly by 80 basis points over the next 10 years here. And this is in line with what was reflected in the forward curve at the time of analysis. The increase in buffers is produced by returns in excess of the annual guarantee, and in addition, the assets under management in the guaranteed portfolio is reducing as policies mature over time. And this as well, contribute to an increase in the level of buffers in percentage terms. But what if interest rates go even lower than today?
What happens to the yield contribution from the amortized cost portfolio in that case? So I'd like to show you this picture, which shows the sensitivity of the expected return prognosis as in the last picture, to a change in the interest rate assumption. So the base estimate of expected return, which is the green line in this picture, is the same as in the last picture. And we see that if the curve drops by 50 basis points, the difference is barely noticeable in the first few years, and then it gradually dips below the required return after in 2022 or so. And the reason for this is that the volume...
Oh, sorry, the reason for that we don't really see the difference in the first few years is that the reinvestment need in the whole maturity portfolio isn't that not that large in the first few years. But even as we go along, the effect is not dramatic. If this little dip was to happen, the deficit is to a large degree absorbed by buffers, and the effect on financial results is very limited. The previous picture showed an estimate from the IFRS perspective. In terms of solvency and our ability to grow own funds, what matters is the market return, where also the amortized cost portfolio is marked to market. This picture shows an estimate of that market return compared to the required internal rate of return for liabilities.
We see that we expect also to grow own funds with the current allocation. Together with reduced SCR from increased buffers, as I showed previously, this generates improved solvency going forward. The expected return that we see here of 2.6% can be broken down into a risk and illiquidity premium of 1.2%, and a risk-free swap rate of 1.4 at the time of this analysis. And this premium comes mainly from credit, from real estate, and from equities. Now, returning to our strategy for the paid-ups, I would like to share a few more insights. I'd like to continue by showing you this slide on how we segment our portfolio according to risk capacity. Segmentation is important because that makes us able to match characteristics of liabilities accurately with assets.
In the Swedish portfolio, this is taken to the extreme, where we decide on a separate allocation for each individual contract. So we have about 1 million segments in Sweden. In that way, we can provide a competitive allocation to those contracts with low guarantees and high risk capacity. And such capital-light guaranteed products are part of our Front Book. Segmentation in the paid-up portfolios are very important to control risk. And in the paid-ups, we have identified four different segments with internal similarities across contracts. So within these four segments, contracts are pretty similar. And the segments are categorized along two dimensions. We have high or low, required return and high or low buffers.
The corresponding differences in matching allocation are shown in the pie charts covering the segments, and we see that we have high allocation to amortized cost bonds for segment one, which has high required return and low risk capacity. In segment four, which have relatively higher risk capacity, we set an allocation with a higher expected return from mark-to-market assets.... So here we have lower allocation to amortized cost and a larger allocation to equities. Now, as we have seen, the amortized cost portfolio is an important tool for risk management. We have had a conscious strategy over many years to build as much amortized cost bonds as possible within the liquidity requirements or constraints of the portfolio. So this slide gives some more details of the amortized cost. In the upper left part, we see how the book value matures over time.
The average maturity of the portfolio is about 8 years, its duration is 6.5 years. This shows that the development of the book value with no reinvestment, but obviously we are investing continually, and last year, we invested around NOK 15 billion. So far this year, we have accumulated around NOK 3 billion. Average yield in those purchases this year has been 3.2%. The average rating has been around single A, and the average maturity has been around 14 years. Now, in the lower left pane, we see the development in yield, assuming no reinvestment, and the development in the average rating as well. And we see the current yield today of the portfolio is 4.5%, and then it lowers as portfolio matures. Reinvestment at lower yields will bring the average yield further down, depending on how much we buy.
We have a target of keeping around NOK 100 billion in the amortized costs portfolio. On the right, we see the ratings composition and the sector composition of the bonds in the amortized cost portfolio. Now, in the next slide, we give more insight into the combined portfolio of mark-to-market fixed income in Norway and Sweden. Within our exposure to mark-to-market bonds, we have a 64% exposure to double A or better rated credit. In terms of sectors, we have a 32% exposure to sovereigns, and in total, 60% allocation to credit, and that includes 25% to covered bonds. The current allocation to loans is 9%, and this is loans sourced from both our own bank and from external sources.
Residential mortgages are sourced from our own bank at this time, and this segment is expected to increase going forward because of its very nice properties and the solvency, too. So finishing off, I have shown you some background and arguments for the following key takeaways. We have sufficient expected return to strengthen own funds. Buffer capital reduces risk and plays an important part in reducing net SCR. I have shown that buffers are expected to increase as well. We do efficient risk management by segmentation, and we have a high-quality amortized costs portfolio. So with that, thank you for your attention, and I pass the word to Group CFO, Lars Løddesøl.
Thank you, Toris. Let me finalize today's presentations with a look at the capital management framework and the financial position of Storebrand. After my presentation, I want you to remember these four things. Storebrand is on a transition towards a capital-light asset gatherer. Growth and profitability from savings and insurance replace run-off business, both in terms of revenue, of profits, and balance sheet. The Back Book run-off and the Front Book solvency generation will enable future capital release, and we introduce a new capital management policy with solvency target above 150% to ensure a clear dividend policy. Let's start with premium income in our main business areas, pension savings in Norway and Sweden. The transition from guaranteed premiums to non-guaranteed premiums has accelerated over the last few years, as shown in the pictures on the left-hand side.
At the same time, pension payouts have grown rapidly in the guaranteed book, while still being marginal in the non-guaranteed book, something which can be explained by the age distribution shown on the right-hand side. The picture shows the age distribution of the individual policyholders in Norway and Sweden in guaranteed and non-guaranteed pension plans. Last year, the payouts in Norway equaled new premiums, while there were NOK 6 billion in payouts from guaranteed in Sweden, as opposed to NOK 2 billion in new premiums. The average age of guaranteed policyholders in Norway is 60 years old, and in Sweden, 64 years old. Holders of unit link contracts, on the other hand, are on average 46 years and 54 years, respectively. Looking at the balance sheet transition, Storebrand is moving from guaranteed business to a capital-light asset gatherer.
This chart is similar to the ones we have shown on the last Capital Markets Days and illustrates a long-term forecast of the group's total assets under management. 53% of assets are already non-guaranteed, and the trend continues. In 2020, the non-guaranteed part of total assets is expected to be two-thirds of the total. The Norwegian paid-ups and the Swedish pension products with the highest guarantees, here called high capital consumptive guaranteed products, will continue to grow in size for about 4-5 years, but will tie up relatively less capital as the duration declines and the average guarantees falls. Peak capital consumption for these products is but a few years away. External assets in this picture are institutional and retail money run by Storebrand Asset Management, typically in mutual funds or as discretionary mandates without guarantees.
In 10 years' time, the group business will be clearly dominated by non-guaranteed assets run as a margin business. The graph on the left-hand side on this picture shows the estimated capital tied up in the guaranteed book in the group and how it will be reduced in the coming years. We expect the capital consumption from the guaranteed business to reach its peak in 1 or 2 years from now, and then gradually decline. The reduced capital consumption is explained by the factors I've already mentioned: age, lower guarantees, and shorter duration. The new business replacing the run-off business is capital light and will be practically self-funded, as explained earlier today. What hinders all of this capital to be available for dividends is a reduction of the 16-year transitional rules, the bulk of which will disappear over the next 8-10 years.
I would also like to emphasize that the actual capital requirements will be sensitive to interest rates and may be both significantly higher and significantly lower than I've shown in this, graph. Profits unwind the risk margin, real world returns, and gradually reduce capital consumption from the guaranteed back book translate into an expected annual solvency capital generation of five to 10 percentage points of the SCR per year over the next five years. Thereafter, the capital release from the guaranteed book will increase the capital generation to more than 10 percentage points of the SCR. Additional management actions have the potential to further improve solvency. With this, Storebrand will generate sufficient capital to resume and grow dividends and to stay safely above the target solvency level of 150%.
We expect the run-off of the transitional rules to be largely offset by increased value of in-force of the non-guaranteed business. The need to build more tangible IFRS equity will, as we've, as we've seen, be limited and can be done through retained earnings after dividends. Trond Finn has already shown you this picture but let me repeat a couple of points. The development of the solvency ratio is sensitive to a number of variables. First of all, it is sensitive to financial markets, as shown in our sensitivities presented quarterly and a moment ago. Furthermore, we have assumed a best estimate for reserve development, which can vary with assumptions and customer behavior. Lastly, it will depend on risk management, model improvements, earnings, reinsurance, subordinated loans, and other measures implemented by management.
We have shown a good ability to make such improvements historically, and we will continue to explore opportunities to improve risk management and solvency ratios. As the graph indicates, this should allow for rising dividends over and above the 35% in the dividend policy in a few years down the road. Here we show the group profitability over the last six years. If we focus on core earnings, which is labeled results before profit sharing and loan losses, and shown here in red, we see a steady and relatively predictable growth. Despite having run off the corporate bank and the municipality pension business and receiving much lower returns on the company portfolios, we have managed to replace the earnings from discontinued operations with growth in core business.
We expect margin pressure and strong competition to persist, but we aim to continue the trend, the trend growth in underlying profitability in the years ahead. As a consequence of the transition from higher margin defined benefit business to lower margin defined contribution business, combined with the implementation cost in the startup of the Cognizant partnership, we will see profitability under pressure this year and next. Thereafter, we should be back on a path of more steady and predictable growth. Storebrand targets a 10% return on equity adjusted for amortization. While the new business, savings, and insurance generate a high ROE, the combination of heavy capital requirements and the reduced income from guaranteed pensions has put pressure on the group ROE. We maintain the target of 10% ROE, while we have to emphasize that the...
We are likely to achieve a below target return this year and next. As most of you are familiar with, we break the group profit generation into three segments. Savings, which consists of the non-guaranteed occupational defined contribution business, the unit link business, the asset management business, and the retail bank. Insurance, which captures the short-term underwriting results, including P&C, disability, health, and group life, and guaranteed, which represent the run-off guaranteed business. If we break the results of the last few years into these segments, we clearly see the transition in the result generation. While guaranteed generated 53% of the profits in 2012, it only provided 19% of the profits in 2015.
Adjusting for the extraordinary good results in 2013 and 2014, partly as a consequence of the closing of the group-owned defined benefit pension scheme, we have managed to replace the guaranteed revenues with revenues from savings. The growing revenues and profits coming from non-guaranteed occupational pension plans, but also from increased sales of retail products, asset management, and more, as Stefan has previously covered. This picture illustrate return on IFRS equity split into the different profit segments. It is based on last year's actual results. The equity in the group sits within different legal units. The estimated allocation is based on the capital consumption and the Solvency II and CRD IV. The allocation of equity we show here is done on a pro forma basis to reflect an approximation to the IFRS equity consumed in the different reporting segments.
The savings and insurance areas have been allocated 150% capital based on the SCR of the different products. Then we have deducted the value of in-force to come to a hard capital requirement. For the guaranteed segment, we have allocated the remaining capital, including the transitional capital. There are significant differences in returns in the different areas. Savings generated a profit of NOK 1.02 billion in 2015, before tax, and consumed only NOK 4.3 billion in hard capital, about half of which comes from the bank. As the unit-linked business generates about as much capital as it consumes, the return on hard equity is high. Similarly, the insurance business requires very little net capital in a group like ours, as diversification benefits all but nets out the additional capital requirements.
Marginal ROE in these segments is even higher. This is indeed one of our competitive advantages. We can write new savings and insurance business with very limited marginal capital. On the other hand, the guaranteed business consumes a lot of capital and generates reduced profits in the rundown phase. Hence, the relatively weak overall ROE of 7% is a result of a strong and growing Front Book and a capital-intensive legacy business. As this business gradually, the guaranteed business gradually reaches maturity, combined with the growth in the Front Book, the ROE is set to improve in the years ahead. From 2011 up until the end of last year, we have increased tangible equity by 72%, while the intangible equity, which consists mostly of the SPP goodwill, has been amortized according to plan.
In the same period, the leverage ratio has been reduced from 29%-22%. The buildup of hard capital has been necessary in preparation for Solvency II, and has ensured Storebrand's solid solvency position under the new regulatory regime. As we have shown, the required need for additional hard capital for the Back Book is limited, and we will reach its peak in a couple of years, after which additional capital generation will substitute transitional capital and gradually be available for increasing dividends. And that leads me back to the picture shown by Odd Arild, earlier today. Our updated group capital management policy links our dividend policy to a solid solvency position. We established a clear link between the two through a management heat map, indicating where dividends will increase and when they will be reduced.
Our objective is to have a solvency position above 150%. A solvency position below 100%, 130% will lead to cancellation of dividends. No dividends can be expected to be paid if the underlying solvency position without transitional rules fall below 110%. A solvency position above 180% will lead to increased dividends, share buybacks, or both. By presenting our business plans, our sensitivities to external factors, and how the solvency position impacts dividends, we hope that we have reached our objectives of increased transparency and better predictability around Storebrand business development and future dividends. These are our previous financial targets, and in light of the aforementioned points, we present updated financial targets as follows.
We maintain the return on equity target above 10% to be achieved in a few years' time. Dividends shall be at 35% or more of IFRS earnings before amortization and after tax, and a minimum of half that for 2016.
... The solvency margin shall be above 150%. With delivery on these targets, we also expect to return to the desired A rating in due course. With that, I finish my part of the presentation and give the word back to Odd Arild for concluding remarks.
Thank you, Lars. I'll be quick to open up for questions. My final remarks goes first on the Front Book, where we have realized 12% Front Book growth historically, and we are well positioned to grow our top line, even with significant earnings going forward, as the guaranteed book will also disappear. So in combination, we will have a top line growth going forward, and you have also just seen that our top line growth will be done on a very capital effective way. We have also realized quite significant cost reduction over time, and today, we have shown you that we also set clear targets for reduction in cost up to 2018, and that we also have the measures in place with agreements and outsourcing agreements that will make sure that we will reach these targets.
Lars and Trond Finn have shown us how we expect our solvency position to continue going forward and be in the range of 150%-180% in the years to come. Our CEO has also shown how we will build both buffers in the IFRS context, but also have a mark-to-market return that will build solvency capital going forward. As transitional capital is trailing off, it will be replaced with value-enhancing capital, ensuring that targets to be above 150%. We are, as we have said, close to the peak capital in our back book. Then it all brings me back to this slide where I started the presentation today.
I must say, I'm quite confident that we are now back on a normalized situation, where we have clear triggers and also clear communication around dividend payments. We have today closely linked our dividend to our solvency ratios, and as you see, we expect to start dividends from this year off. We have also shown how the development of the solvency position will be when we, in a few years' time, will reach the peak capital in combination with the Front Book that hardly needs capital for the growth. Of course, that will be a situation where dividend policy needs to be looked into once again, and we expect higher dividend payouts than the 35% we communicate here when we reached that time, when we reach that point. I think with that, I open up the floor for questions on all of these elements.
Three questions, if I may, and you... I could direct them to the three speakers, so we could choose to answer them. Trond, you mentioned, and it was mentioned again by Lars, the possibilities for further model improvements. Could you tell us if you have included anyone in the path going forward? If not, where can you find potential model improvements or other management measures? Lars, I noticed, and maybe I'm stuck a little on the details there, but you said that the 10% ROE target will not be reachable this year nor the next. Will that open up for 10% in 2018? Then there is for...
Since we have such a stable capitalization that's been shown here today, is there potential for increasing IFRS earnings by taking more risk on the company portfolios or in the products such as paid-up policies? Thank you.
Then, I should maybe start. There are no model improvements in the projections. I also said that the major bulk of model improvements are behind us. We are continuously working on model improvements, as I said, but, but, it's not like I can stand here today and promise very many more basis points, but we work very hard to realize them.
But I think it's also so that you don't find these things before you find it.
We have found a lot of it in the future, and of course, we are working hard every day to also improve our allocations and our models.
With respect to the ROE target, it is at 10%, as you say. We say that with the what happens in the transition from the Back Book to the Front Book, and the fact that especially within unit-linked and defined contribution, you have a fee which is based on the assets under management. So even if you have strong premium growth, that doesn't become assets under management overnight, it has the growth in reserves is, as Staffan said, 15% per annum. It has been 25% per annum, so but you get some of the revenue comes later, then you lose it from the guaranteed book.
So in that shift, combined with the fact that we will have somewhat double cost in the transition to the Cognizant relationship, we said that we are likely to achieve a below target ROE for 2016 and 2017. So yes, I hope we can achieve in 2018 or 2019, but it's not too far away. Okay. Your question was whether we could take more risk in the company portfolios. I think what I've tried to say is that we set our risk targets based on the financial targets. So what we aim to achieve over the next five, six, seven, eight years is to bridge the situation with transitional rules to a situation without. And what I've shown is that we are confident that we can grow that with the current risk level.
When we are sort of evaluating this, we try to minimize risk, given that we actually reach our financial targets. The company portfolio is part of that equation, but just taking risk there is has a lot of different, well, arguments to it.
All right.
It's not a lot.
The next was, Matti Ahokas.
Obviously, one of the key value drivers, the value creation drivers, is the capital reduction in the guaranteed portfolio. And in the excellent slide on page 79, where you show that you also have own measures, you say here, actually, own other measures, reinsurance and sub-debt. Sub-debt is quite self-explanatory, but could you describe a bit on the reinsurance side and any other potential own measures that you could actually reduce the capital requirement in the guaranteed book, and how big, potentially, these measures could be?
Yeah, on reinsurance, especially the lapse risk, as Trond mentioned and described in the economic capital valuation. Under Solvency II, you have to stress retail clients to move 40% of the portfolio and corporate clients 70% of the portfolio. In a market like the Norwegian market, with only two operators in the large corporate market, moving 70% of those customers from one to the other is, first of all, impossible. And then if DNB Life has to hedge the same or have to have capital for the same thing to happen, it just doesn't make sense. So there are ways of reassuring lapse risk, and that is one area where we see potential to reduce the capital requirements.
How big potentially could that be?
We are exploring that as of right now.
What we think is that that would be a more cost-efficient way of bringing Solvency capital than compared to taking additional subordinated debt.
What about in general, if I may, as a follow-up, kind of other hedging procedures on the guaranteed book, are they simply too costly at these levels? Or kind of other financial engineering methods that you could reduce the capital requirement on the guaranteed book?
I can mention longevity risk, which we've received a lot of questions on and where you see transactions in the market. We have not seen that that is an effective way to manage the capital requirements of Storebrand. So that's an area that could be or that has been explored, but doesn't seem to make sense as of now.
Thanks.
All right. Bengt Sifjin first.
Yeah, just to follow up on, to Lars on, with your, commenting on, on earnings for the next few years. I understand very well that you, you won't reach the 10% ROE, but you're also, commenting or stating that earnings will be under pressure. What are you comparing with here? Is... What's your basis? Are we down from last year, or if you can, elaborate a little bit on that. Also on costs, you are talking about double costs, related to the outsourcing. At the same time, we, or you should see, cost reductions of NOK 300 million-NOK 400 million in the next few years. When will we see those, cost reductions? Will the bulk of it come in 2018 or, or when?
To start with the first question, to be under pressure means that it's below potential, and it's below the potential and below the trend line that you can see from the picture I showed, due to the double cost and the shift in the balance sheet. So that does not mean that it's lower, but it's below what it, we would like to see it being, because we have these elements of temporary nature that is hurting earnings in the short term. When it comes to double cost, we have, as Heidi explained, a number of people that are being transferred, or FTEs that are being transferred to Cognizant.
We have to have those FTEs to teach Cognizant how to do it, while at the same time, hiring people from Cognizant to actually do it before they know the different tasks sufficiently well so that we can lay off the people and save the cost in Norway. That will have an impact on the cost level this year and to some extent next year, and we will get the full effect of the cost.
... measures that we do in 2018, as explained during the first quarter, where we said that the 2018 cost will be lower than the 2015 cost on a nominal level.
All right. Then it's Peter Eliot.
Kepler.
Thanks a lot. Probably sounds very bullish, but in the past, you've seemed open to, you know, potentially looking at M&A again, once your sort of capital position is restored. I noticed that on the chart of the solvency bands, you know, above 180%, that didn't feature as one of the potential uses of capital. So I was just wondering if you could update us on your thoughts on whether, you know, in the future, you do see opportunities still to expand. And then I had one detailed question for Tor. I may be being very... I'm sure I am being very stupid, or I missed the explanation.
But on slide 67, where you show the sensitivity to the interest rate reduction of 50 basis points, and you drop below the guarantee. I wasn't quite clear why you then rise above it again immediately afterwards. Could-- Sorry if I missed that in the explanation.
No, you want me to take?
The reason why that is not in sort of a smooth graph is that the reinvestment need of the portfolio is a little bit different. It's not smooth. So in some years, we have a larger reinvestment need. And then as the time passes, the forward expectation of the interest rate curve brings it up again.
Mm-hmm.
M&A. I will say, first of all, we are in a very comfortable situation, where actually we are in markets where our Front Book grows a lot. And we have positions in this market with a strong brand name. That means that we do not need to do M&A activities to have a strong growth in our Front Book going forward. We, of course, follow what happens in the Nordic market when it comes to M&A, and if there is great opportunities, we will look into that. But that is not our core, when we build our project, prospects going forward and look into building our business, that is based on our ability and opportunity to really grow our Front Book based on the positions we have.
I also want to be really clear about that we now have been in a position where we needed to build capital, but that we, as management, really like to be right capitalized and will bring capital back to the shareholders when we reach this peak capital, and also when we reach the situation where, in combination with the peak capital, have a very capital-light Front Book that grows.
Okay, then it's Blair Stewart, Bank of America Merrill.
Thanks for the introduction, Kjetil. It saves me the job. I've got a couple of questions. Is it possible to walk through the five to 10 points capital generation? I think we can all at least guess what your earnings might be, but then you've got the other moving parts of how much value of new business gets credited into capital, what the transitional run-off is annually, and the movement in the guaranteed book. And would I be right in suggesting that the 5-10 might be a challenge during the period where the guaranteed book is still increasing? And that's going to be the case for the next couple of years. Secondly, on the guaranteed book and the peak of the capital requirements, clearly very important aspect.
Have you been surprised at how that book has evolved over the last couple of years? And is there potential for you to be surprised in the future as to how resilient the size of that book is? And finally, you showed helpfully the capital intensity of the guaranteed book. I think it was 12.6%, if I'm not wrong. Where does the new guaranteed business that's created sit in that scale? Because you showed 12.6% as the worst case, but there's also lower requirements than that. So where should we think about the new guaranteed business that's created in terms of capital intensity? Thank you.
Should I go off with at least the first question, Blair? When it comes to capital generation, I think there are four key elements to that. Number 1 is, of course, results generated in the group outside what's already in the Solvency II models. And I think it's fair to say that that should be roughly 5 percentage points.
It is basically asset management and insurance.
Yeah, and,
The banking.
The bank, yeah.
Yeah.
The second element is the unwind or the risk margin in the models. That should be two to three percentage points as well. The third element, being what Torjus alluded to, actually creating more investment return than the average or the internal rate of the liabilities. That should create another two to three percentage points. As you rightfully pointed to, the growth in the paid-up policies will consume some of this capital generation. Let's say 2-3 percentage points, and that really gives us the range between five to 10 percentage points that are shown on the graphs here... on the balance sheet of the-
Sorry, what were the transitional rules?
Yeah, the transitional rules is kept out of that picture, because that will slide down over the years. So the capital or the solvency capital generation that was shown on the picture was on the solvency position without the transitional. So hence, also the picture showing then actually a somewhat dip in the solvency position, including transitional in the first years before picking up again.
On peak capital and balance sheet development surprises, it's relatively predictable to see what happens with the customer portfolio these days. We can see the development in very significant fall in premiums on the guaranteed book. We know the payouts when people will reach retirement. Most of the companies have already closed their defined benefit schemes, and we have we know the pipeline of customers looking at doing a final close on the defined benefit books. So we feel that in terms of the balance sheet, we have a fairly good predictability on the balance sheet. In terms of peak capital, that will be dependent on the interest rate level, which we unfortunately cannot control.
But, apart from that, that should also be manageable to the extent that we, or you can model what you believe about interest rates in, in that. And the last-
The last question was regarding the different capital requirements on guaranteed products. The paid-up policies currently has the capital requirements as of Q1 of roughly 15%. All new premiums coming in or that are sold are, of course, in capital efficient products. So what we said was that all new guarantees that are sold, mainly in Sweden today, actually generate as much capital as they consume. Then we are still receiving some premiums on the defined benefit book in Norway. And the defined benefit book has capital requirements over roughly five percentage points today. So I say that all new sales generates more capital than it consumes.
The premiums that we are still receiving on the defined benefit consumes roughly 5 percentage points.
And then the new paydowns don't consume as capital as old paydowns?
No, they don't. They consume less, but it depends somewhat on the duration or the age of the policyholder, the buffer capital, et cetera.
But of course, when you see that the peak of the, the paid-up policy portfolio is maybe four or five years from now, but we have also guided that the peak of the capital is just one to two years from now. That indicates the quality of the new paid-up policies to be quite, much better compared to the, the average of the, paid-up policy book today.
It's also one other element to that, and that is, of course, that, if or when investment returns materialize, as Terje showed in his presentation, you will build more buffer capital, and buffer capital will, all other equal, reduce the capital requirements on the products.
Yes.
Just wanted to clarify one point that, Trond, you mentioned that when you show the Solvency II projection, there is an initial decline. That's really driven by the unwind of the transitional rules. So if you show this without transitional rules, there wouldn't be this initial decline, right?
Yeah, that's correct. That will be a steady, a steady decline.
Yeah.
But of course, from a somewhat lower level.
Yeah.
Good. Then, oh, there's one more question there.
Yes, question on the potential subordinated debt. I understand you are not planning to do issue any sub debt any time soon, but could you tell what the capacity of how much you theoretically could raise to improve the solvency?
If you take theory from the Solvency II framework, we have a very significant ability. It can be 50% of the total capital, so we're talking tens of billions of NOK subordinated debt. But if you look at that, look at it from a rating perspective, interest rate coverage perspective, it's much lower. You should expect the real potential to be a couple of billion NOK in that area. But as I said, from a regulatory point of view, it's by NOK 20 billion or something, but in reality, we're talking a few billion NOK.
Thanks. I've got two more. Trond, do you have any ambition or expectation of moving to your own model rather than a standard formula under Solvency II? If so, what would you expect the impact to be?
Mm-hmm.
That's one impossible question to answer, I guess. And, Lars, can you get to a 10% ROE without managing the E?
... When it comes to move to an internal model, I think we are satisfied of being on the Standard Model. I think it's fair to say that we are developing the solvency, the two models, to be a continuous, better decision-making framework. So being much more integrated in the investment decisions that Torjus and his team make. I think that will give us experience and necessarily documentation to be able to move for an internal model in due course. But we don't have a set target for more than due course yet.
Is that, is that just because you would fail the use test?
Among others at this time, yes.
Okay, thanks.
In terms of ROE, if you look at capital, capital is approaching peak, and then the hard capital requirement will go down. The income is going through a trough now due to the shift in the balance sheet and the higher cost in the implementation of Cognizant, as I mentioned. So if you have a trough in the earnings and a peak in the capital, then you have two curves that meet each other in the different direction in one or two years from now. That should enable us to reach the ROE of 10%, and that means that it's a combination of both the R and of the E, obviously.
How do you manage the E?
Hmm?
How do you manage the E?
Well, by paying out dividends, for example.
Through dividends.
Okay, very good. Thought of that.
Quick question. Can you tell us what the future profits component of the available funds is? My question also relates to the fact that if I look at correctly, last year in the MCEV, it sounded like on a risk neutral, your future profits are close to zero. I was trying to sense if you can tell us what the future profits is in the own funds.
How should I go about that? On this slide, I showed NOK 5.4 billion in contribution. That consists of a larger number from defined contribution and a negative number from defined benefit products, especially the paid-up policies. The profits generated in the solvency or in the projections, I don't have them readily available to give a very detailed answer on that now. I don't-- I'm not sure if I really understand the question.
Is the future profit within your NOK 46 billion of available capital?
Yeah.
Is that NOK 5 billion?
Yeah, on that slide, yes. It's more in the defined-
Yeah
contribution products, but then it's dragged down by higher liabilities in
Guaranteed
in guaranteed products.
My question then is: how can you have a LAC DT of NOK 4 billion when your future profit on an MCEV work are only, you know, NOK 5 billion? Because, you know, in theory, the rules are that you should be capped to your maximum DTL in the own funds. So I assume you will have NOK 2 billion of, you know, DTL in the own funds. How can you have NOK 4 billion LAC DT, when in theory there should be a, you know, a NOK 2 billion cap?
That's the questions you are asking about now is really how a deferred tax liability or the risk mitigating effect on the tax on the SCR. And that's a long discussion, but first of all, there are no such gap as you allude to. Second of all, is that when you're doing this test, if you have enough future profits to cover up for the change in the SCR, then you actually add on new business elements. Because what is already in the balance sheet is already taken accounted for in the opening balance sheet of the Solvency II framework.
So, what you're actually then doing is to see, okay, what cash flows are within your Solvency II models, and then you remove yourself somewhat from the Solvency II models and say, "Okay, in the real world, as a business plan, what other competence will you have?" And then you start to add on the future premiums on existing contracts. You start to add on risk premiums on your investments, and you start to add on new sales, and of course, the cost associated with all this. And then you are really seeing if you can recover the loss that you are getting in the SCR.
And also asset management, and bank-
Yeah
which is outside the present value calculation and in terms of it. I'm ready. All right. I think we are, we are then on time to say thank you to all of you for listening to us today. There will now be hotel staff who will show you the way to a light lunch up in the fourth floor. So we look forward to talk to you more up there. Thank you.