FINANCIAL STATEMENTS
STRATEGIC REPORT
GOVERNANCE
The Business Review presents the results of the Group for the year ended 31 December 2021, including IFRS and Solvency II information. The business continues to benefit from the strong positive progress in previous years, in particular a transformed, lower capital intensity new business model, combined with a strengthened and increasingly resilient capital base. Our new business franchise delivered 25% growth in Retirement Income sales during 2021, with strong momentum continuing into the first half of 2022. We continue to maintain discipline in pricing and risk selection as we build on our strong foundations and the Group moves forwards in the next phase of its development to deliver sustainable long-term growth. We have a track record of delivering results that exceed our commitments. After achieving the capital self-sufficiency milestone more than a year earlier than originally planned, we have subsequently almost trebled the underlying organic capital generation, also a year ahead of target. This strong performance was driven by our disciplined approach to acquiring business through our highly successful new business franchise, which delivers low levels of capital strain. We have eliminated the cost overrun as planned. We have also successfully reduced our property sensitivity, and in September, took advantage of favourable credit market conditions to lower future debt interest costs. The strong sales growth in 2021 helped achieve a 13% increase in new business profit, to £225m, with sales of £2,674m up 25% and a new business margin of 8.4% (2020: 9.3%). 2021 margins reflected adjustments made to the asset mix backing the new business, tighter credit spreads, in particular on lifetime mortgages, and a significant increase in the proportion of DB deferred business within the sales mix (2021: 38% of DB sales, 2020, 2% of DB sales). DB deferred sales are more capital efficient, but are longer duration with a lower upfront margin than pensioner in payment DB and retail business. 2021 IFRS adjusted operating profit was broadly unchanged at £238m (2020: £239m) as the increased new business profit was offset by lower assumption changes and reduced in-force profit (with 2020 boosted by increased credit spreads). Rising interest rates led to IFRS losses from hedges we use to protect the Solvency II balance sheet. Sales of LTM portfolios to reduce the sensitivity of our Solvency II balance sheet to UK house prices resulted in a loss of £161m. These two elements offset the operating profit above, resulting in an IFRS post tax loss of £16m. Underlying organic capital generation increased by £33m in 2021 to £51m (2020: £18m), even after writing significantly higher new business volumes during the year. Our target was to double the 2020 result by 2022, but we have strongly exceeded that objective one year early. The capital strain fromwriting new business reduced to 1.5% (2020: 2.2%) reflecting continued pricing discipline and risk selection, together with the increased proportion of low capital strain DB deferred business in 2021. Over the past 3 years we have implemented management actions to reduce the recurring core management expense cost base by 18%. In 2021, we achieved our target to successfully eliminate the new business expense overrun in line with target. The £51m of underlying organic capital generation contributed towards a further strengthening of the Group’s Solvency II capital position. During the year, the Solvency II capital coverage ratio increased to 164% 2 (2020: 156% 2 ), a level we continue to be comfortable to operate at. Recognising the strengthened financial position of the Group, the Board has decided to re-introduce a dividend for the Group’s shareholders. Over the past two years, we have demonstrated our ability to deliver significant growth in new business, at low strain, our capital generation is now sufficient to fund our on-going growth ambitions and pay a distribution to shareholders, while continuing to maintain a comfortable capital position. We now expect growth in new business and in-force profits to deliver on average 15% growth per annum in our IFRS underlying operating profit over the medium term.
In the second half of 2021, we completed an internal model update, incorporating the new regulatory treatment of LTMs, which was approved by the Prudential Regulation Authority in December 2021. The overall impact of the newmodel was a £33m decrease in the capital surplus. This was more than offset by management actions of £16m and other operating items including positive mortality experience, which contributed £26m towards the capital surplus. Over the past three years, we have successfully taken action to reduce the Group’s exposure and sensitivity of the Solvency II balance sheet to UK house prices. This has been achieved through a combination of NNEG hedging, LTM portfolio sales and reducing the LTM backing for new business. We have completed three NNEG risk transfer hedges totalling £1.4bn and with the third LTM portfolio sale announced in February 2022, we have also completed our planned programme of portfolio sales (totalling £1.6bn of LTMs). The LTM backing ratio for new business in 2021 at 18% was below our 20% target. Taken together, our various property de-risking actions have almost halved the Solvency II UK house price sensitivity to close to 10% (for a 10% house price fall) a level at which we are comfortable. In 2022, we expect further clarification from HM Treasury following its review of Solvency II and its consultation on the Future Regulatory Framework (“FRF”) Review for financial services following the UK’s exit from Europe. We anticipate progress in helping the insurance industry to better support the government’s twin-pronged agenda of infrastructure development and decarbonising the economy through an increased pool of matching adjustment eligible assets, which we can invest in to back our customer promises. Financial markets have had limited impact on the Group’s capital position over the past two years, which demonstrates the resilience of our balance sheet. Interest rates rose during 2021, the impact of which was hedged in relation to our Solvency II position but resulted in a loss for our IFRS balance sheet of £226m for the year. We continue to monitor the effect of the interest rate hedging programme on the IFRS result, with rates being volatile on geopolitical and other macro-economic concerns such as inflation. The key sensitivities of the Group’s capital and financial position to future economic and demographic factors are set out below and in notes 17 and 23 of these financial statements. Credit downgrades affecting 9% of the Group’s corporate bond portfolio were offset by credit upgrades on 8% of the portfolio as the economy continues to recover. This led to a negligible £13m reduction in the Solvency II surplus, which was more than offset by £49m of positive capital impacts from portfolio management. We are committed to further growing and diversifying the non-LTM illiquid portfolio, in particular through continued investment in infrastructure projects, commercial real estate, ground rents, social housing and local authority loans. Our manager of managers investment model for non-LTM illiquid assets has 13 active originators, which provides a healthy pipeline of investment opportunities, both domestic and international. Typically, going forward, we expect non-LTM illiquids to back up to 30% of new business, with LTMs backing up to 20% and liquid bonds/cash backing the remainder. At this time, the outlook for the economy continues to evolve, as the world learns to live with COVID-19 and with heightened geopolitical tensions associated with the conflict in Ukraine. Inflation is likely to continue to be the dominant economic theme in 2022, as central banks commence tightening of monetary policy to combat rising prices. We expect these macro forces to have a negligible effect on the Group’s business model, with active hedging to protect the Solvency II capital position and limited impact from higher interest rates/inflation on demand for our products. With a strong, stable and more resilient capital base and a low strain business model that is now generating substantial on-going excess capital on an underlying basis. The foundations are firmly in place to take advantage of the multiple growth opportunities available in our attractive markets.
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