Last checked at 27 Apr 2015 09:51
ANNUAL FINANCIAL REPORT IN RESPECT OF THE FINANCIAL YEAR ENDED 31 DECEMBER 2014
The Company announced its preliminary results for the year ended 31 December 2014 on the 31 March 2015, which included audited Financial Statements and a review of the business that was fair, balanced and understandable. The Company today provides the following additional regulated information, included within its Financial Statements, in full unedited text as required to be made public under the disclosure and transparency rules. Where necessary reference is made to IFRS Financial Statements and the EEV Supplementary Information in the 2014 Annual Report & Accounts which have been posted on the Company's website www.chesnara.co.uk.
1. DIRECTORS' RESPONSIBILITIES STATEMENT IN RESPECT OF THE FINANCIAL STATEMENTS
The directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations.
Company law requires the directors to prepare financial statements for each financial year. Under that law the directors are required to prepare the group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and Article 4 of the IAS Regulation and have also chosen to prepare the parent company financial statements under IFRSs as adopted by the EU. Under company law the directors must not approve the accounts unless they are satisfied that they give a true and fair view of the state of affairs of the company and of the profit or loss of the company for that period. In preparing these financial statements, International Accounting Standard 1 requires that directors:
- properly select and apply accounting policies;
- present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;
- provide additional disclosures when compliance with the specific requirements in IFRSs are insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance; and
- make an assessment of the company's ability to continue as a going concern.
The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the company's transactions and disclose with reasonable accuracy at any time the financial position of the company and enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
The directors are responsible for the maintenance and integrity of the corporate and financial information included on the company's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
Responsibility statement
We confirm that to the best of our knowledge:
- the financial statements, prepared in accordance with International Financial Reporting Standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole;
- the strategic report includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face; and
- the annual report and financial statements, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the company's performance, business model and strategy.
Peter Mason John Deane
Chairman Chief Executive Officer
30 March 2015 30 March 2015
2. PRINICIPAL RISKS AND UNCERTAINTIES
Risks and uncertainties are assessed by reference to the extent to which they threaten, or potentially threaten, the ability of the Group to meet its core strategic objectives. These currently centre on the intention of the Group to maintain an attractive dividend policy.
The specific principal risks and uncertainties subsisting within the Group are determined by the fact that:
i) the Group's core operations centre on the run-off of closed life and pensions businesses in the UK;
ii) notwithstanding this, the Group has a material segment, which comprises an open life and pensions business operating in a foreign jurisdiction; and
iii) these businesses are subject to local regulation, which significantly influences the amount of capital which they are required to retain and which may otherwise constrain the conduct of business.
The following identifies the principal risks and uncertainties, together with a description of their actual or potential impact and of the way in which the Group seeks to control these risks. The table below is based on the Chesnara Group at 31 December 2014. The acquisition of the Waard Group, as discussed on page 24 of the 2014 Annual Report & Accounts will result in the following list of principal risks and uncertainties being reviewed.
Risk | Impact | Control |
Adverse mortality / morbidity / longevity experience | To the extent that actual mortality or morbidity rates vary from the assumptions underlying product pricing, so more or less profit will accrue to the Group. | - Effective underwriting techniques and reinsurance programmes. - Option on certain contracts to vary premium rates in the light of actual experience. - Partial risk diversification in that the Group has a portfolio of annuity contracts where the benefits cease on death. |
Adverse persistency experience | Persistency rates significantly lower than those assumed will lead to reduced Group profitability in the medium to long-term. | - Active investment management to ensure competitive policyholder investment funds. - Outsourcer service levels ensure strong customer service standards. - Customer retention processes. - Close monitoring of persistency levels across all groups of business |
Expense overruns and unsustainable unit cost growth | For the closed UK life and pensions businesses, the Group is exposed to the impact of fixed and semi-fixed expenses, in conjunction with a diminishing policy base, on profitability. For the Swedish open life and pensions business, the Group is exposed to the impact of expense levels varying adversely from those assumed in product pricing. | - For the UK businesses, the Group pursues a strategy of outsourcing functions with charging structures such that the policy administration cost is sensitive to book run off to the fullest extent possible. - The Swedish operations assume growth through new business such that the general unit cost trend is positive. - For both the UK and Swedish businesses, the Group maintains a strict regime of budgetary control. |
Significant and prolonged equity market falls | A significant part of the Group's income and, therefore, overall profitability derives from fees received in respect of the management of policyholder and investor funds. Fee levels are generally related to the value of funds under management and, as the managed investment funds overall comprise a significant equity content, the Group is particularly exposed to the impact of significant and prolonged equity market falls, which may lead to policyholders switching to lower-margin, fixed-interest funds. | - Individual fund mandates may give rise to a degree of diversification of risk and within those funds, hedging techniques are used where appropriate. - Investment management costs fall in line with market falls and hence cost savings partially hedge the impact on income. - There is a wide range of investment funds and managers so that there is no significant concentration of risk. |
Adverse Sterling: Swedish Krona exchange rate movements
| Exposure to adverse Sterling:Swedish Krona exchange rate movements arises from actual planned cash flows between the Swedish subsidiary and its UK parent company and from the impact on reported IFRS and EEV results which are expressed in Sterling. | - The Group monitors exchange rate movements and the cost of hedging the currency risk on cash flows when appropriate. |
Counterparty failure | The Group carries significant inherent risk of counterparty failure in respect of: - its fixed interest security portfolio; - cash deposits; and - amounts due from reinsurers.
| - Operation of guidelines which limit the level of exposure to any one counterparty and which impose limits on exposure to credit ratings. - In respect of exposure to one major reinsurer, Guardian Assurance Limited ('Guardian'), the Group has a floating charge over the reinsurer's related investment assets, which ranks the Group equally with Guardian's policyholders. |
Adverse movements in yields on fixed interest securities | The Group maintains portfolios of fixed interest securities (i) in order to match its insurance contract liabilities, in terms of yield and cash flow characteristics, and (ii) as an integral part of the investment funds it manages on behalf of policyholders and investors. It is exposed to mismatch losses arising from a failure to match its insurance contract liabilities or from the fact that sharp and discrete fixed interest yield movements may not be associated fully and immediately with corresponding changes in actuarial valuation interest rates. | - The Group maintains rigorous matching programmes to ensure that exposure to mismatching is minimised. - Active investment management such that, where appropriate, asset mixes will be changed to mitigate the potential adverse impact on declines in bond yields. |
Failure of outsourced service providers to fulfil contractual obligations | The Group's UK life and pensions businesses are heavily dependent on outsourced service providers to fulfil a significant number of their core functions. In the event of failure by any of the service providers to fulfil their contractual obligations, in whole or in part, to the requisite standards specified in the contracts, the Group may suffer loss as its functions degrade. | - Rigorous service level measures and management information flows under its contractual arrangements. - Continuing and close oversight of the performance of all service providers. - The supplier relationship management approach is conducive to ensuring the outsource arrangements deliver to their obligations. - Under the terms of the contractual arrangements the Group may impose penalties and/or exercise step-in rights in the event of specified adverse circumstances. |
Key man dependency | The nature of the Group is such that it relies on a number of key individuals who have particular knowledge, experience and know how. The Group is, accordingly, exposed to the sudden loss of the services of these individuals. | - The Group promotes the sharing of know how and expertise to the fullest extent possible. - It periodically reviews and assesses staffing levels, and, where the circumstances of the Group justify and permit, will enhance resource to ensure that know how and expertise is more widely embedded. - The Group maintains succession plans and remuneration structures which comprise a retention element. - The Group complements its internal expertise with established relationships with external specialist partners. |
Adverse regulatory and legal changes | The Group operates in jurisdictions which are currently subject to significant change arising from regulatory and legal requirements. These may either be of a local nature, or of a wider nature, following from EU-based regulation and law. Significant issues which have arisen and where there is currently uncertainty as to their full impact on the Group include: i) the implementation of Solvency II requirements; ii) the FCA's review of legacy business; and iii) the changes in pensions legislation planned for April 2015. | The current opinion is that the implementation of Solvency II will strengthen the long-term risk management environment of Chesnara (as is its intention). The Solvency II programme is covered in more detail on the next page. The key risks are mitigated as follows: - Proposed appointment of an external specialist Quality Assurance partner; - Dedicated internal resource; and - Robust programme governance framework. - Management continually reviews the potential impact of any prospective regulatory changes. |
There were no significant changes in the nature and incidence of risks and uncertainties arising during the year ended 31 December 2014 when compared with the year ended 31 December 2013.
The sensitivity of the Group's IFRS and EEV results to a number of the principal risks and uncertainties highlighted in the above table can be found in Note 6 "Management of Financial Risk" to the 2014 IFRS Financial Statements and Note 7 "Sensitivities to alternative assumptions" to the 2014 European Embedded Value Basis Information in the 2014 Annual Report & Accounts.
3. CRITICAL ACCOUNTING JUDGEMENTS AND KEY COURCES OF ESTIMATION AND UNCERTAINTY
The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities and also makes critical accounting judgments in applying the Group's accounting policies. Such estimates and judgments are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable. The more critical areas, where accounting estimates and judgments are made, are set out below. Each item identifies the business segments, as described in Note 7 to the 2014 IFRS Financial Statements, to which it is relevant.
(a) Classification of long-term contracts (CA, S&P, PL and Movestic)
The Group has exercised judgment in its classification of long-term business between insurance and investment contracts, which fall to be accounted for differently in accordance with the policies set out in Note 2 "Significant Accounting Policies" to the 2014 IFRS Financial Statements. Insurance contracts are those where significant risk is transferred to the Group under the contract and judgment is applied in assessing whether the risk so transferred is significant, especially with regard to pensions contracts, which are predominantly, but not exclusively, created for investment purposes.
(b) Acquired value of in-force business (CA, S&P, PL and Movestic)
The Group applies accounting estimates and judgments in determining the fair value, amortisation and recoverability of acquired in-force business relating to insurance and investment contracts. In the initial determination of the acquired value of in-force business, the Group uses actuarial models to determine the expected net cash flows (on a discounted basis) of the policies acquired. The key assumptions applied in the models are driven by the expected behaviour of policyholders on termination rates, expenses of management and age of individual contract holders as well as global estimates of investment growth, based on recent experience at the date of acquisition. The assumptions applied within the models are considered against historical experience of each of the relevant factors.
The acquired value of in-force business has been amortised on a basis that reflects the expected profit stream arising from the business acquired at the date of acquisition. Acquired value of in-force business is tested for recoverability by reference to expected future income and expense levels. Such impairment testing requires a degree of estimation and judgment. In particular the value is sensitive to the rate at which future cashflows are discounted and to the rates of return on invested assets. Analysis shows that, based on applying a range of discount rates, which have been determined with reference to our review of the current market assessment of the true value of money and the risks specific to the asset for which the cash flows have not been adjusted. The rates used for the purpose of the impairment testing were 6%, 8%, 10% and 12%.
As at 31 December 2014, the carrying value of acquired in-force business, net of amortisation, was £9.8m in respect of CA (as at 31 December 2013: £12.0m), £5.8m in respect of S&P (as at 31 December 2013: £6.5m), £17.6m in respect of PL (as at 31 December 2013: £20.0m) and £40.2m in respect of Movestic (as at 31 December 2013: £49.9m).
(c) Deferred acquisition costs and deferred income - investment contracts (CA and Movestic)
The Group applies judgment in deciding the amount of direct costs that are incurred in acquiring the rights to provide investment management services in connection with the issue of investment contracts. Judgment is also applied in establishing the amortisation of the assets representing these contractual rights and the recognition of initial fees received in respect of these contracts. The assets are amortised over the expected lifetime of the investment management service contracts and deferred income, where applicable, is amortised over the expected period over which it is earned. Estimates are applied in determining the lifetime of the investment management service contracts and in determining the recoverability of the contractual rights assets by reference to expected future income and expense levels. This test for recoverability is performed using best estimates of future cash flows, using a market consistent estimate of future investment returns.
As at 31 December 2014, the carrying values of deferred acquisition costs, net of amortisation, and of deferred income, in respect of CA, were £3.9m and £7.0m respectively (as at 31 December 2013: £4.4m and £7.9m respectively). The impact on the above numbers of a one year movement in the estimated lifetime of the management services contract or amortisation period is not material.
As at 31 December 2014, the carrying values of deferred acquisition costs, net of amortisation, in respect of Movestic, was £27.4m (as at 31 December 2013: £23.8m). An increase in the length of the amortisation period by one year would have increased profit before tax for the year ended 31 December 2014 by £1.0m and shareholders' equity as at 31 December 2014 by £0.8m.
(d) Fair value of financial assets and unit-linked investments (CA, S&P, and Movestic)
Fair value measurement has been adopted to reduce volatility in reported earnings in the Consolidated Statement of Comprehensive Income as the liabilities so determined are measured in a way which is consistent with the fair value of the underlying invested financial assets.
Fair value is the amount for which an asset could be exchanged, or a liability settled, between willing, knowledgeable parties in an arm's length transaction. Fair values are determined by reference to observable market prices where available and reliable.
(e) Estimates of future benefits payments arising from long-term insurance contracts (CA, S&P and PL)
The Group makes estimates of the expected number of deaths for each of the years that it is exposed to risk. These estimates are based on either standard mortality tables or reinsurers' rate tables as appropriate, adjusted to reflect the Group's own experience. For contracts without fixed terms the Group has assumed that it will be able to increase charges to policyholders in future years, in line with emerging mortality experience.
The Group has offered guaranteed annuity options within certain contracts. Estimates have been made of the number of contract holders who will exercise these options, in order to measure their value. Changes in investment conditions could result in significantly more contract holders exercising their options than the Group has assumed in determining the liabilities arising from these contracts.
The Group makes estimates of future deaths, voluntary contract terminations, investment returns and administration expenses at the inception of long-term insurance contracts with fixed and guaranteed terms. These estimates, which are reconsidered annually, form the assumptions used to calculate the liabilities arising from these contracts.
When assessing assumptions relating to future investment returns the Group makes estimates of the impact of defaults on the related financial assets. The estimates are reassessed annually. The assumptions used to establish insurance contract liabilities and appropriate sensitivities relating to variations in critical assumptions are disclosed in Note 31 "Insurance contract provisions" to the 2014 IFRS Financial Statements.
(f) Estimates of future maintenance expenses (CA)
Future expense levels are a key variable that influence the value of insurance contract provisions. Under normal circumstances the nature of the cost base underpinning our UK regulated entities means that future expenses are relatively predictable and hence assumptions made for actuarial reserving purposes are not subject to material levels of judgment. This is because asset management and policy administration in the UK are outsourced and hence the future costs are defined in contractual arrangements. In addition, governance overheads are by their nature relatively stable and predictable. During 2014 the outsource contract for the CA book was extended with our outsource provider (HCL) for a further 10 year period. The financial terms are in line with revised expense assumptions recognised in 2013. We have also transferred the actuarial services that HCL used to provide to Towers Watson.
(g) Contracts which contain discretionary participation features (S&P)
All S&P with-profits contracts contain a discretionary participation feature ('DPF') which entitles the holder to receive, as a supplement to guaranteed benefits, additional benefits or bonuses:
- that may be a significant portion of the total contractual benefits;
- whose amount or timing is contractually at the discretion of the Group; and
- that are contractually based on realised and/or unrealised investment returns on a specified pool of assets held by the Group.
The terms and conditions of these contracts, together with UK regulations, set out the bases for the determination of the amounts on which the additional discretionary benefits are based and within which the Group may exercise its discretion as to the quantum and timing of their payment to contract holders.
As at 31 December 2014, the carrying value of insurance contract liabilities which contain S&P discretionary participation features was £310.4m (31 December 2013: £310.5m).
As stated in Note 31 "Insurance contract provisions" to the 2014 IFRS Financial Statements, the cost to shareholders of guarantees in respect of S&P contracts with discretionary participation features is estimated, using a stochastic model, which runs simulated economic scenarios to estimate the cost of the product guarantees to the shareholder. During the year a new calculation model was implemented that enhances the accuracy of the estimated policyholder guarantee costs by removing certain data groupings. Historically, for IFRS reporting purposes the cost of with-profits guarantees has been set at 110% of the equivalent cost for EEV reporting. This was largely because, for IFRS reporting purposes, it was felt necessary to add in a margin of prudence as a result of the use of the way input data was grouped in the old model. The new model utilises more granular data inputs, which has lead to a greater degree of confidence in the model. It has also increased the calculated cost by a small amount. As a result the IFRS reserves are now set at 100% of the equivalent EEV cost. Were a 10% margin to still remain this would decrease the net assets at 31 December 2014 by £3.5m.
(h) Insurance claim reserves (Movestic)
Provisions are determined by Management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the timing, incidence and amount of claims. In order to calculate the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable parameters, the value of outstanding claims.
For more recent underwriting years the provisions will make more use of techniques that incorporate expected loss ratios. As underwriting years mature, the reserves are increasingly driven by methods based on actual claims experience. The data used for statistical modelling is internally generated. Actual claims experience may differ from the historical pattern on which the estimate is based and the cost of individual claims may exceed that assumed.
Liabilities carried in respect of waiver of premium and income protection policies are sensitive to the Group's assessment of the length of period in which benefits will be paid to policyholders (which can be significant). Estimates are made based on the sex, age and occupation of the claimant as well as the length of time the claimant has been claiming on the policy.
As at 31 December 2014, the carrying value of the insurance claim reserves, gross of reinsurance, was £65.2m (as at 31 December 2013: £66.1m). The key sensitivities in respect of insurance claim reserves are considered in Note 31 "Insurance contract provisions" to the 2014 IFRS Financial Statements.
(i) Insurance claim reserves - reinsurance recoverable (Movestic)
A significant proportion of the insurance claims arising within Movestic are ceded to reinsurers. In preparing the financial statements the Directors have made an assessment as to whether claims ceded to reinsurers are recoverable. As at 31 December 2014, such claims ceded to reinsurers and reflected on the balance sheet were £43.2m (31 December 2013: £44.4m). The application of a 10 per cent bad debt provision on the reinsurance balance would reduce 2014 profit before tax by £4.3m and shareholders' equity by £3.2m.
(j) Accounting for pension plans (Movestic)
The Group participates in a defined benefit pension scheme on behalf of its Swedish employees. The scheme is a multi-employer plan to which a number of third party employers also contribute. The underlying assets and liabilities of the scheme are pooled and are not allocated between the contributing employers. As a result, information is not available to account for the scheme as a defined benefit scheme and the Group has accounted for the scheme as a defined contribution scheme.