150 JUST GROUP PLC Annual Report and Accounts 2020
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued
35 CAPITAL continued At 31 December 2020, Just passed the PRA EVT with a buffer (0.63%) (unaudited) (2019: 0.67%) over the current minimum deferment rate of zero (allowing for a volatility of 13%, in line with the requirement for the EVT). From 31 December 2021, when SS3/17 is fully phased-in, firms will be expected to meet the EVT with a deferment rate above 0%, as specified by the PRA and reviewed twice a year. The minimum deferment rate (to apply from 31 December 2021) was 0.5% at 31 December 2020 (as published by the PRA on 30 September 2020). As at the end of February, we estimate that Just passed the PRA EVT with a buffer of more than 1% (unaudited) over a deferment rate of zero. The increase in buffer from year end is driven by the increase in long-term rates since 31 December 2020. We note that the increase in real rates could lead the PRA to increase the minimum deferment rate when it is reviewed. JRL received PRA approval for an updated MA application in December 2020. The updated approval captures changes since our original application in 2015 and provides greater flexibility to invest a wider range of asset classes going forward. The Group is exploring ways to reduce its exposure to UK residential property risk, with hedging transactions and a sale of a portfolio of LTMs completed during 2020 and further action anticipated in the future. There are remaining areas of uncertainty that could impact the capital position of the Firm: • The PRA has published PS 14/20 and SS 1/20 which confirms their expectations of firms’ compliance to the Prudent Person Principle with regard to managing investment risk. The proposals took effect on 27 May 2020. The Group has reviewed and is further enhancing its investment strategy, including taking steps to reduce exposure to property risk through LTMs. • The minimum deferment rate within the EVT, published by the PRA, could increase from 0.5%. The PRA reviews the minimum deferment rate every six months and publishes the result of the review in March and September. Increasing JRL’s deferment rate by 0.5%would lead to a c.6 percentage point (unaudited) reduction in the solvency coverage ratio. • JRL is preparing a major model change application for updates to its internal model. We plan to submit this to the PRA for approval in 2021. The purpose of model change is to ensure that the capital requirement produced from the model remains appropriate for the risk profile of the business and is in line with latest regulatory expectations and emerging best practice. At this stage, we do not expect that the internal model change will have a significant impact on the capital requirement. However, we note there is uncertainty on the final outcome. In particular, the approach to assessing the EVT in stress, as required from 31 December 2021, and agreeing appropriate treatment of NNEG risk transfer transactions remain uncertain. • The PRA issued CP 1/21 – Solvency II: Deep, liquid and transparent assessments, and GBP transition to SONIA, on 7 January 2021. This proposes that the change in the reference rate used for valuing liabilities, from LIBOR to SONIA, is implemented on 31 July 2021. Any difference between the risk-free curves on this date will have an impact on Excess Own Funds. • The PRA published a Dear Chief Actuary letter in February 2021 setting out the application of the EVT, in particular setting expectations of current balance sheet values of property and allowance for other risks. The recommendations should be incorporated by 31 December 2021. Given that the Group continues to experience a high level of regulatory activity and intense regulatory supervision, there is also the risk of PRA intervention, not limited to the matters described in the paragraphs above, which could negatively impact on the Group’s capital position. The Group has completed a number of actions in relation to capital during the year: • Continued reduction in new business strain through a planned reduction in new business volumes, re-pricing and cost reductions. • Launch of DB partner business which is much less capital intensive. • Completion of additional reinsurance of existing GIfL business to release risk margin and SCR in respect of that business, and to increase resilience to future variations in longevity experience. • Completion of the second and third NNEG hedges in March and December 2020 and a sale of £540m of LTMs to increase the firm’s resilience to adverse property market events. • Increased interest rate hedging early in 2020, helping to protect the Group from the adverse impact of falling interest rates, particularly the impact on the value of MA derived from LTMs given the EVT’s sensitivity to nominal interest rates. • In October 2020, the Group raised £175m of net new capital, through the issue of £250m 7% Tier 2 loan notes (before issue costs) and tender for £75m of its existing £230m 3.5% Tier 3 loan notes. The Group has planned actions to improve the resilience of the balance sheet. These include: • On-going cost savings with a target to eliminate expense overruns by the end of 2021. • Further NNEG hedging transactions and continuing review of opportunities to dispose of blocks of LTMs, aligned to the strategy to increase the resilience of the Solvency II balance sheet to property risk. • Additional reinsurance or longevity swaps on the Group’s existing book of GIfL business. • New business strain could be further reduced by limiting the volume of new business written or by changing the mix of new business. • The Board continues to review the optimal capital mix, subject to market liquidity and availability. The Board recognises that the successful implementation of some of these potential or planned actions are not wholly within the control of the Group. In June 2020, the Government announced that it would review certain features of Solvency II. The reviewwill ensure that Solvency II properly reflects the specific features of the UK insurance sector. The call for evidence to support the review, issued by HM Treasury in October 2020, states that “The Government intends to work with the PRA to reform the risk margin. Reform could reduce the volatility and pro-cyclicality of insurance firms’ balance sheets”. The PRA has indicated that the risk margin is too sensitive to interest rates and higher than needed in the current interest rate environment (letter from SamWoods to the Chair of the Treasury Committee, June 2018, reiterated in Anna Sweeney’s speech given at the Westminster Business Forum, February 2021). Any reduction in magnitude or volatility in the risk margin would be expected to support the Group’s capital position. The Group’s risk margin was £846m (unaudited) at 31 December 2020, of which £762m (unaudited) is backed by TMTP. Further information on the matters considered by the Directors at 31 December 2020 in relation to capital and going concern is included in note 1.1, Basis of preparation. The Group’s objectives when managing capital for all subsidiaries are: • to comply with the insurance capital requirements required by the regulators of the insurance markets where the Group operates. The Group’s policy is to manage its capital in line with its risk appetite and in accordance with regulatory requirements; • to safeguard the Group’s ability to continue as a going concern; • to ensure that in all reasonable foreseeable circumstances, the Group is able to fulfil its commitment over the short term and long term to pay policyholders’ benefits; • to continue to provide returns for shareholders and benefits for other stakeholders; and • to provide an adequate return to shareholders by pricing insurance and investment contracts commensurately with the level of risk.
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