Legal & General : Analyst Q&A transcript –

Legal & General Half Year Results, 9th August 2022, Q&A
Sir Nigel Wilson, Group CEO, Legal & General
Thank you. And we’re now very happy to take questions. Before each question, can people state their name and the organisation they’re representing? And why don’t we start with Andy?
Andy Sinclair, Bank of America
Thanks. It’s Andy Sinclair from Bank of America. Three for me, please. Firstly, on LGC, just wondering if you could give us an idea of the actual cash generated within LGC and if possible, just to give an idea of that by mature businesses, disposal proceeds and margins and third-party capital. That’s question one.
Second was just on the bond portfolio.
I think for the first time, correct me if I’m wrong, under 50% of the portfolio is now in the UK with over 50% international. Just wondering, are you looking to further internationalise that portfolio and does the average credit rating differ by geography? And thirdly, on LGIM, with a slightly lower AUM base, just if you could give us an update on outlook for costs and cost income ratio for the rest of the year and beyond.
Sir Nigel Wilson, Group CEO, Legal & General
Thanks. Okay. Jeff, do you want to take the first one? I’ll do the second one. And Michelle, if you’re happy with the third one?
Jeff Davies, Group CFO, Legal & General
The cash around LGC for the first half was round about op profit. I think you’d said before, sometimes it’ll be less than our profits, sometimes it will be more, sometimes it’ll be significantly more, as it was last year with the sale of Media City, for example. So, there were no large transactions as such in the first half.
So it was good steady cash emergence, round about just higher than our profit number.
Sir Nigel Wilson, Group CEO, Legal & General
It was very observant of you on the bond portfolio because that was in the appendix in one of these slides, so well done Andy! It is indeed the case that we’ve invested more of the assets in outside the UK than in the UK; 51:49. And that’s one of the arguments we’ve been having with both the government and the regulator, because clearly ideally we’d like to invest more of those in the UK.
So, giving us a mandate where we have more opportunities and more asset classes in the UK would undoubtedly result in a better outcome for the UK. Unfortunately, America is very open for business as my colleagues will tell you and therefore we are getting some pull from America and in one sense the attractiveness of America is going up a bit and the UK is going down a bit.
And under the current politically regulatory environment over here, we’d like to reverse that and we’re hoping one of the things that the new Prime Minister does is indeed reverse that, to give us more opportunities to invest here in the UK. Plus, ironically, they’ve got a bit ahead of us in things like retrofitting – retrofitting of housing and offices already produces a matching adjustment asset class.
But you know, we’d like the UK to at least keep up with the US and indeed Europe.
Michelle Scrimgeour, CEO, Legal & General Investment Management
On costs, just to say… clearly, it’s a challenging time and I’m not going to lie about that. But in terms of what we said at the Capital Markets Day in November 2020 was that we would expect to see the cost income ratio go up towards the mid-to-high fifties, given that we’re going to invest in the business.
That hasn’t changed. What’s happened, and as Jeff has also indicated, is that we would expect that to probably drift up a little bit actually in the next year or so. But that’s not going to be the norm. It’ll normalise once markets settle. And we’d expect that to come down again over time.
Ashik Musaddi, Morgan Stanley
All right thank you, Ashik Musaddi from Morgan Stanley. First of all, great set of results and pretty clean this time. So really appreciate that. Not many one offs. So that’s the good news. Just three questions. One, I saw somewhere in the table at the end of the presentation, the credit default reserve was 3.4 billion last year. It’s 2.7 billion this year.
I think it has to do with the level of assets, but would be good to get a bit of mechanics as to how you decide on this number. Thank you.
The second one is around solvency ratio. 212% is a number which looks pretty good. I guess you would agree that there is a lot of buffer to absorb shocks here, but how are you viewing this?
I mean, would you like to capitalise on this through some extra capital return or some accelerated growth? Are you looking to do that or you’re just waiting for markets to settle and then take a call at that point?
And the third one is, one of the sensitivities that you have around interest rates and a bit of benefit that has gone through in solvency ratio rates.
Is there any way you can hedge that out at a reasonable cost so that the solvency ratio doesn’t go down even if interest rate drops again? Thank you.
Sir Nigel Wilson, Group CEO, Legal & General
Jeff, do you want to take the first and the third question? I’ll do the second one.
Jeff Davies, Group CFO, Legal & General
The first one is reasonably straightforward. It is just the discount rate. The methodology is still the same. It’s the 43 basis points applied to the same assets as it was before basically. But I think our discount rates had gone up by something like 170 basis points, so it’s literally just discounting at a higher rate for the same cash flows gives you a much smaller number. If we put it back to the old [discount rate], it would be virtually the same. So there’s no big change there.
On the third one. Rates hedging. We constantly look at this, it is a big question, we have our smartest people on it all the time to think, we try to balance solvency versus IFRS and of course with the change coming in IFRS we’re looking at what’s possible there. You shouldn’t confuse solvency ratio movements with whether we’re matched or not.
A bit like inflation we’re matched, cash-flow matched, we’re rates matched on the annuity portfolio. It is the fact that you’ve got an SCR which has got a big stress which brings in more duration to that. So, we constantly look at it, we balance using derivatives to do that, spend some money or use the liquidity in a stress up by putting more derivatives on.
But we’re pretty happy. We wouldn’t want it to get higher, we try and balance that, too. But we will be making changes as we go into IFRS 17 and we’ll try and optimise between the different metrics.
Sir Nigel Wilson, Group CEO, Legal & General
We want an investment-led recovery here in the UK. In fact, everywhere, we fundamentally believe that’s the right thing to do. We would like to be given a bigger mandate to allow to invest. And so the fact that the Solvency II ratio is well over 200 is very comforting. And it does bring into the question of buybacks, so we’ve made a comment on that in the RNS. A preference if we can still deliver a 20 odd percent return on equity is to continue investing in our very attractive high growth businesses and just relentlessly pursue that. We’ve hired some great new people into our
organisation who are globally dispersed looking at investment opportunities everywhere. We’ve got a great track record in pretty much all of the businesses right now.
And with 500 start-ups, our activity in new and attractive sectors like renewables give us lots and lots of opportunities to invest and to grow the business and in fact, accelerate the growth of the business. And one of the things we’re looking forward to is explaining why we’re accelerating growth in 2023 and 2024 and beyond.
And we’re not going to go along the 0% line that I had in in my slide.
Nasib Ahmed, UBS
Nasib Ahmed from UBS. Thanks for taking my question. So first one on your Capital Generation Target for 2022 of 1.8 billion, if I double the half one number, I get to 1.9. And you’ve got management actions coming in the second half presumably. So are there any offsets that bring you down to 1.8? And then on the 25 billion of pipeline, what percentage are you exclusive on?
I didn’t see that in the release. Apologies if I missed that. And then on the credit migration sensitivity, it was a little bit higher. What’s driving that and what’s the difference between the -19 on the slide and the -14 in the press release?
Sir Nigel Wilson, Group CEO, Legal & General
Thanks. Jeff, do you want to take the first and third question? Andrew, do you want to take the pipeline and the opportunities and why you’re so confident that we’re going to outperform?
Jeff Davies, Group CFO, Legal & General
The capital generation, to be honest there’s not a lot going in there. It’s pretty much the same. It just doubles up, there’s a bit of rounding, in 0.9s and 1.8s, but there isn’t much there. We expect double digit growth in the OSG. It’s obviously dependent what was in the previous period when you’re only looking at a half year, what’s in the full year. But we expect that 1.8 round about double digit growth in OSG. So there’s nothing major going on within that.
I’ll do the last one, if you like. Again, a lot of it is maths, the credit migration one is very simply, and we saw this in the pandemic in our numbers, because the sub-investment grade spreads have widened.
So, when we formulaically model our stress, we say, BBB’s downgrade, and then we sell them and we go back. So, we make a bigger loss at the p oint we sell them in our model because the spreads are wider that they’re migrating to. So, we saw exactly that in the pandemic. It’s just the maths of having wider spreads as a starting point.
So, there’s nothing, we haven’t strengthened [the sensitivity]or anything, it’s just the market conditions, the way it flows through. And on the 19 to 14%, yes, we showed 19% was the net impact of 20% downgrade. We showed 14% in our sensitivities. As I said, we’ve taken a slightly more prudent view. So, we’ve only rebalanced sub-investment grade and not quite all of it.
Partially, let’s call it 75% or so of the sub-investment grade. If we rebalanced all the sub-investment grade, that would give you another couple of percent. And if we rebalanced the investment grade, which we also haven’t done in the slide that would give you another 3%, which closes the gap on the
5. So, we’ve just taken a more prudent view on what we would rebalance to show in the sensitivity on the slide.
Andrew Kail, CEO, LGRI
Morning, everybody. So, on the 25 billion, we haven’t disclosed the number, we’re exclusive and that’s a relatively small number at this stage. The 25 billion would cover the transactions that we’re in active conversations through to pricing across the UK, US and Canadian markets. So as Nigel said
and Jeff said, very buoyant markets both in the UK and the US and as with other commentators, we’d expect 2022 to be a high level of transacted volumes than we saw in the previous year.
And we are in the final stages of some very significant pricing conversations, but we’re not exclusive at that stage.
Sir Nigel Wilson, Group CEO, Legal & General
It’s fair to say we’ve got more active conversations than we’ve ever had in the history 35 years that we’ve been doing this business. So, the sales teams are very busy at the moment, pricing up various things and people are pulling forward deals that they might have been thinking about doing three, four or even five years’ time because rates have moved up, deficits have gone.
Chairman of trustees are pretty anxious now that they’ve got a window of opportunity to do things, and so they’re kind of getting on with it. I think the other thing, Jeff, about our portfolio, we don’t have very much BBB minus in our portfolio as well, which I think is a good thing. And Chris Knight is sitting at the back there and he’s always commenting on the fact that we’ve got so little cyclical, BBB minus as well.
And so, the clever team who construct the portfolio, [they] spend a lot of time figuring out what’s the right portfolio for us to have as a business.
Larissa Van Deventer, Barclays
Larissa Van Deventer from Barclays. Congratulations on a good set of results. Two questions, please. The first one on LGC. How should we think about growth and the sustainability of growth to the end of your five year plan? Specifically, which areas do you expect most aggressive growth? And what is most at risk? And then with respect to bulk annuities, you mentioned the active discussions on margin. What are those margins most sensitive to and what would be the biggest risk be to the margin compressing? Thank you.
Sir Nigel Wilson, Group CEO, Legal & General
Laura Mason unfortunately is not here. We don’t have all of the executive team here today, so I’ll have a go on LGC and if Jeff takes the second question that’d be great. I think we’re very fortunate now, we’ve created lots of optionality for ourselves across the whole of the LGC business and we really started that in 2013, 2014, and lots of those businesses which were tiny in those days have, really become quite substantial businesses already and are in structurally growing markets.
So, the £600-700 million target which I know from some of your papers, you think is very conservative, I may well agree with that myself and in fact, I certainly agree with it myself, but that’s kind of the targets we’ve set at the moment. I think if you talk to the management team and Gareth Mee is here, who’s the LGC CFO… if you catch Gareth afterwards, he can go through some of the more detail about it and why we’re very excited about the American opportunity, which has really opened up for us and the renewables opportunity.
And again [on renewables], Simon Gadd’s here sitting at the front and he can go through some more of the detail around what are the opportunities. We’ve done, sort of tactical equity and a small amount of debt investment so far, but the universe of opportunities is very wide, which just goes back to this point about Solvency II. There’s a lot of that we have to do outside the Solvency II buckets at the moment. We’d like to push a lot more of that into Solvency II and get rid of the fixed cash flows and come round to highly predictable cash flows. And hopefully our regulator and the treasury can see eye to eye on that, that just makes a huge amount of sense for here in the UK and indeed elsewhere.
Jeff Davies, Group CFO, Legal & General
The PRT margins, [in the first half] are pretty consistent with the first half last year. You know, we
absolutely will only deploy capital if we believe the margin is there. The big thing that drives that for us I talked about it, is obviously the asset manufacture that gives us a big competitive advantage.
Spreads widen and also make it easier to achieve those margins with traded credit, which gives us a bit more optionality in the investment. And… we are able to get very good reinsurance terms. We then make a decision about how much capital, how much to reinsure, pending Solvency II discussions and everything else, our capital headroom, how much do we want to maintain?
But we have a model that works extremely well to deliver that margin, with a really good team that can deliver the hedging required on day one. And source the assets… And we’re very careful to make sure we’ve got a sight on those assets. What are the spreads? What are we going to achieve? And that’s the main thing, drives the margin in conjunction with the reinsurance.
Alan Devlin, Goldman Sachs
Alan Devlin, Goldman Sachs. Two questions. F?irst of all, on capital, how are you thinking about capital given your strong solvency re-issue and the comments with the jaws of Capital Generation, increasing above the dividend? I think in your press release, you included for the first time that you wouldn’t sit on excess capital if it was in the best interest of returning to shareholders.
But then obviously given the very strong bulk annuity volumes and your comments that things you’re expecting to see in three or four years coming through potentially earlier, you would use that excess capital to take advantage of that market if you could. And then secondly, I read a question, just given the big move in interest rates and credit spreads, you’ve seen both in the US and UK and you’ve talked about it in the investment portfolio, does that change your kind of view on what part of the bulk annuity market that’s incrementally more attractive to you to invest capital for … as obviously both markets have got more attractive but in relative terms has there been any change?
Sir Nigel Wilson, Group CEO, Legal & General
Thanks. Andrew, do you want to take the second one? And Jeff, do you want to take the first question?
Jeff Davies, Group CFO, Legal & General
We did include some [wording] as we had lots of questions over the last few months. Well, ratios are higher. What does that mean? As you know, we don’t set a range of solvency ratio because we like to look at economically what’s really going on within that. So, you hit on the right point.
It’s the jaws… what is real economic capital projection and generation that we are producing and as those open that’s real generation. So, if rates go back down and we’ve created that capital and we’ve either put it to work or we’re sitting on, that’s when we have a discussion, not just because rates move around, that gives us great optionality, as Nigel said at the start to invest.
And it’s not just capital for PRT. That’s pretty efficient, but it’s also capital… whether it’s LGC, LGIM, to grow those businesses create assets for the third parties, create assets for other parts of the business. You don’t need too much capital for retail. It’s a very efficient business. So, we balance the two all the time. But it’s that real economic capital growth that is important for us.
Andrew Kail, CEO, LGRI
And then just on the UK / US markets, obviously we have a very different market profile in the US to the UK. We’re typically competing on $500 million and below schemes and plan termination and we do see a difference in margin in the UK and US. So, I won’t repeat Jeff’s comments, but we’re very disciplined around how we deploy capital and making sure we achieve the right margins, recognising our US business is in scale up and just like I said on the UK, the US business volumes and the market opportunities there are significant.
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