Legal & General completes first phase of US capital restructuring programme, increasing Group embedded value by Â£100m.
02 February 2011
US External Funding Replaced with Internal Reinsurance Arrangement
- Buyback at a discount of external debt of Triple-X funding vehicle, resulting in IFRS profit before tax of $72m (£46m)
- Replacement of Triple-X solution through internal reinsurance structure via UK life company gives a sustainable reduction in the Group’s external funding costs of $12m (£8m) per annum
Improvements to Group Capital Fungibility and Cashflow Sustainability
- Group IGD surplus increased by $129m (£82m)
- Transaction capital and related profits to be repatriated from the US in cash
Tim Breedon, Group Chief Executive, said:
“This announcement demonstrates our continued focus on improving return on capital from every business within the Group. Following the receipt of a $50m dividend from the US business in March 2010, we are pleased to announce the completion of the first phase of our US capital management programme.
“The execution of this transaction is beneficial to both our US and UK businesses. For the Group overall, IGD surplus is enhanced by $129m (£82m), embedded value is increased by $155m (£100m) and the US business’s annual external funding costs are reduced by an estimated $12m (£8m). The new internal reinsurance solution also demonstrates the potential for further capital and profit enhancing transactions from our US capital management programme.
“We remain committed to optimising the Group’s worldwide capital structure for the benefit of shareholders.”
Strategy and Background
Legal & General America (LGA) is a wholly owned subsidiary of Legal & General Group plc. It was established in 1981 upon the acquisition of Banner Life, and subsequently William Penn, and it operates in the USA under these brands. LGA focuses exclusively on writing mortality protection products in the term life and universal life markets. LGA competes in the protection market by focusing on being a low cost operator and delivering expert, medical-based underwriting on higher sum assured policies. LGA has in force sums assured in excess of $400bn with an average sum assured in excess of $500,000 and in force premiums of approximately $800m which has grown at 11% p.a. since 1999. In 2009, LGA delivered $135m of IFRS operating profit before tax – its 29th consecutive year of positive profits.
US Life insurance reserves represent portions of current and past premiums held as reserves to fund higher future claims as insured lives age. Because of US Triple-X regulatory requirements, LGA is required to hold reserves that are much greater than reasonably conservative future expected mortality should require. These reserves are often referred to as ‘excess’ or ‘redundant’ Triple-X reserves. Over the last 10 years Legal & General has executed a number of transactions to support around $3bn of Triple-X reserves. Each transaction relates to a specific tranche of LGA business with structures and costs varying according to capital market conditions and regulatory requirements at the time of execution.
Since 2009 our strategy has focussed on the twin aims of; improving cash flow from the US business to the UK parent and; improving return on capital through a capital management programme by reducing both the amount of capital tied up in the US and the associated funding costs.
In March 2010, the Group received a $50m (£33m) dividend from LGA which was reflected in the Group’s net cash generation of £526m for the nine months ending September 2010. This dividend from the US business is expected to be both sustainable and growing.
The transaction we are announcing today is the result of the first phase of our capital management programme.
In 2004, a block of LGA’s business was reinsured to a wholly owned captive insurer, First British American Reinsurance Company (FBARC). FBARC was funded by a $540m issue of Potomac Trust Capital Class A Money Market Securities (Potomac securities). These Potomac securities were actively traded in the US domestic Dutch Auction Market prior to the failure of that market in 2007, due to the financial crisis.
In 2009, Legal & General commenced a buyback of the Potomac securities. The initial open market transaction was announced on 17 November 2009 and further transactions were completed in 2010. $440m of debt has been repurchased at a total profit before tax (i.e. discount to par) of $72m. The repurchase has been financed via a temporary capital contribution to LGA from L&G Group which will be repaid in quarter 1 2011.
In December 2010, a reinsurance arrangement was established from LGA’s subsidiaries to Legal & General Assurance Society (LGAS) which replaced the original reinsurance of this block of business from LGA’s subsidiaries to FBARC. As security for the reinsurance in accordance with US regulations, LGAS posted assets of $565m from the Shareholders Retained Capital (SRC) of the long term fund to US trusts. LGAS is required to hold an additional £35m in respect of prudential reserves and solvency capital to back the new reinsurance liabilities.
The completion of the reinsurance arrangement enables LGA to collapse the Potomac Triple-X structure and redeem the remaining Potomac securities at par using the assets within the existing structure. Funds equal to the par value of the internally held Potomac securities, together with capital which had become trapped within the FBARC structure will then be released to LGA, and enable exceptional dividends /capital repatriation to Group1.
1 Dividends are subject to regulatory approval when year end accounts are drawn up
Legal & General has developed and successfully executed what we believe to be a repeatable, cost effective, solution for satisfying redundant Triple-X reserve requirements which leverages the financial synergies and risk diversification of both the US and UK businesses.
The solution generates several benefits to the US and UK subsidiaries:
- Increased capital efficiency and related returns;
- Future external Triple-X financing costs are saved;
- Increased IGD surplus and cash generation capacity from the US operations.
This particular transaction generated further exceptional benefits:
- Additional profit from repurchasing our Triple-X related debt at a discount;
- Release of capital trapped within FBARC as a result of the financial crisis and its impact in 2007 on the Dutch Auction Market.
The effect of the transaction on the Group’s EEV is approximately £100m, of which the key elements are:
|Repurchase of Potomac Securities at discount (net of transaction costs)||50|
|Present value of internalised financing costs||50|
|Reduced cost of capital from locked-in FBARC assets||20|
|Other impacts including cost of capital for reinsured risks||(20)|
The effect of this transaction is to increase Group IGD surplus by £82m. This increase can be broken down appr