Overview of results
Worldwide new life and pensions business grew by 20% on an APE basis to £661m (H1 06: £553m). UK life and pensions volumes increased by 21% year on year, with strong growth in pensions, investment bonds and individual annuities. Total worldwide sales, including retail investments, were £830m APE. This compares with £896m APE in the first half of 2006, which included unusually high volumes of institutional and wholesale transfer business. Legal & General Investment Management (LGIM) attracted a record £16.2bn of new money in the first six months of the year and now has over £250bn of funds under management.
On an EEV basis, the Group’s operating profit before taxation increased by 5% to £589m (H1 06: £560m). Worldwide contribution from new life and pensions business reduced to £178m (H1 06: £192m), primarily reflecting the change in mix of new business written in the period. Life and pensions experience variances and operating assumption changes were a positive £58m (H1 06: £43m). This resulted primarily from the move in July to charging fees for investment management services provided to Legal & General Assurance Society Limited (Society) by LGIM on a higher market referenced basis, rather than the cost recovery basis used historically.
On an IFRS basis, the Group’s operating profit increased by 2% to £342m (H1 06: £334m). UK life and pensions operating profit grew by 16% to £249m (H1 06: £215m) and there were increased contributions from our overseas life and pensions business and LGIM. However, these were partly offset by an operating loss of £38m in our general insurance business (H1 06: £2m profit), reflecting weather-related losses in January and June. The final impact of the severe flooding from 20 July 2007 has not yet been quantified. However, early indications suggest that it could give rise to claims of the order of £30m net of reinsurance in the second half of 2007.
Capital return, dividend policy and ongoing investor communication
In November 2006, Legal & General committed both to conducting an annual assessment of the capital we hold and to communicating our findings at each set of Interim results. We indicated that where capital was identified as clearly in excess of the requirements of the business, this would be returned to shareholders.
Following this year’s detailed assessment of our capital position, we have been able to confirm that the Group currently holds £1bn of capital in excess of requirements. This assessment has taken into account the long term growth potential of the business, our capital requirements and our strategic aim of maintaining a AA financial strength rating, even following a moderate shock event.
Based on this year’s findings, the Board has approved a £1bn capital return programme, in the form of an on-market share buyback which will begin shortly. We will buy shares using a volume-led approach, based on typical buyback percentages of the average daily volume of Legal & General shares currently traded. Whilst we are committed to executing as quickly as possible, there is the potential that this process will last beyond July 2008.
Maintaining our AA financial strength rating continues to be a key constraint on the capital we hold. Legal & General does not expect the announcement of the capital return programme to have any impact on the current ratings or ratings outlook of the Group from the rating agencies, Standard & Poor’s and Moody’s.
We took a number of actions to ensure that sufficient liquid assets and distributable reserves were available in Legal & General Group Plc (Group Plc) at 30 June 2007 to support a return of capital to shareholders. During the first half of 2007, Society repaid internal subordinated debt of £602m and paid an interim dividend of £400m, both to Group Plc. We sold approximately £180m of equities held by shareholders’ funds as part of this process.
The Board considered its dividend policy alongside its assessment of capital. It took into account the Group’s future capital requirements, projections of future profits and dividends from subsidiaries, current investment market conditions and the aim of maintaining a progressive dividend policy. It concluded that it was appropriate to increase the 2007 Interim dividend by 7.5% to 1.87p per share.
In addition to conducting annual assessments of capital held, Legal & General will update its balanced scorecard of capital measures every six months, to assist investors in tracking movements in our capital base against key target ranges. The 2007 Interim results update can be found in the ‘Capital and financing’ section.
Update on capital review
Also in November 2006, Legal & General set out the timetable for a detailed review of its capital structure. The structure we have had in place has supported our strong, profitable growth for more than a decade. However, management indicated the need to review our structure in light of regulatory and fiscal developments over recent years. Our aims are to enhance the efficiency and flexibility of capital we hold, to improve the clarity of capital structure, and to support the continuing profitable growth of our business. We have detailed our progress during the first half of 2007 below:
1. Legal & General Pensions Limited
In December 2006, we ceded the non-linked non profit pensions and annuity business of Society to a new, wholly owned reinsurance company, Legal & General Pensions Limited (LGPL). This was an important first step in the broader restructuring of our balance sheet. However, as we anticipated, it gave rise to a capital inefficiency of £0.5bn on a regulatory basis due to the requirement to hold solvency capital in both entities. We disclosed this at the 2006 Preliminary results and indicated that we would work to remove the inefficiency.
The FSA introduced a framework for a new regulatory insurance entity – an Insurance Special Purpose Vehicle (ISPV) – in December 2006. It remains our preference to convert LGPL into an ISPV. This would provide greater structural flexibility and, we believe, would have the effect of largely reversing the capital inefficiency created by establishing LGPL. We have lodged an application with the FSA and, together with the ABI, are seeking further clarity on the basis of taxation of this new type of vehicle. We remain keen to effect the conversion to an ISPV in the second half of 2007.
2. Capital structure of Society
Legal & General continues to review the long term structure of Society, including the Shareholder Retained Capital and the Sub-fund. We have appointed an independent expert to ensure that, in any future restructuring, all policyholders are treated fairly.
3. Internal investment management contracts
LGIM has historically charged investment management services to Society on a cost recovery basis. From 1 July 2007, the service will be provided at higher market referenced fees. We believe this aligns our practice with peers, recognises the value of services provided by LGIM and better reflects the generation of profits in the value chain. Investment management services provided to LGPL have been charged at market referenced fees since its inception.
4. Innovative tier I issue
In May 2007, Legal & General issued £600m of Innovative tier I debt. The proceeds were used in part to repay short term senior debt and the balance will be used to finance the acquisition of Nationwide Life and Nationwide Unit Trust Managers. This issue increased our Group regulatory capital surplus. It also counts as equity in the capital models of the rating agencies, Standard & Poor’s (100%) and Moody’s (75%), further supporting our AA+/Aa1 financial strength ratings.
Distribution and product developments
As previously disclosed, we secured new distribution partnerships with Nationwide Building Society and Intelligent Finance in the first half of this year. We now expect our relationship with Nationwide to go live in early 2008, slightly later than the timing originally announced, following the completion of the planned merger of Nationwide Building Society with Portman Building Society later this year.
We continue to develop new products and improve existing ones. We were pleased with the launch of our ‘Open Architecture’ Group SIPP product to the corporate pensions market and we have delivered enhancements to our Group Income Protection, Critical Illness Cover and high net worth protection products, among many others, in the first half of the year. We expect to launch an International bond product from our new Dublin subsidiary in the second half of 2007. The bond is aimed at the high net worth segment, will give Legal & General access to the £7bn International bond market in the UK and will further enhance our suite of ‘Open Architecture’ products.