principles and practices of financial management. - Legal & General

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PRINCIPLES AND PRACTICES OF FINANCIAL MANAGEMENT – REPORT ON COMPLIANCE FOR 20092INTRODUCTIONThe Board of Legal & General Assurance Society (the Society Board) published its Principles andPractices of Financial Management (PPFM) for its with profits business on 30 April 2004. RevisedPPFMs were published on 29 June 2005, 29 June 2007 and 31 December 2007.Each year, the Society Board must report to with profits policyholders on compliance with itsobligations relating to the PPFM. This report covers governance arrangements; exercise of discretion;compliance with the PPFM; competing or conflicting rights, interests and expectations; and includesstatements from the independent assessor and the With Profits Actuary.The report covers the period from 1 January 2009 to 31 December 2009 inclusive, plus the bonusdeclaration for the year ending 31 December 2009, which was announced on 18 February 2010.Defined terms in this report have the meaning set out in the PPFM published on 31 December 2007.GOVERNANCE ARRANGEMENTSThe following statements relate to the governance arrangements and systems and controls in placeover the period 1 January 2009 to 31 December 2009 and at the time of the 18 February 2010 bonusdeclaration.The Legal & General Group Board has overall responsibility for the Group’s internal control systemsand for monitoring their effectiveness. Implementation and maintenance of the internal controlsystems are the responsibility of the executive directors and senior management. The performanceof internal control systems was reviewed regularly by the Audit Committee, the Group Risk andCompliance Committee (GRCC) and the boards and risk committees of subsidiary companies,including the Society Board. The Group’s control policies and procedures were set out in an operatingmanual, which was regularly updated and distributed throughout the Group. Executive directors wererequired to confirm compliance with these policies.The GRCC met in February, June, September and December 2009 and was chaired by the Group ChiefExecutive. All executive directors of the Group were members. In addition, senior managers drawnfrom across the Group were regular attendees. Its primary role was to ensure there were appropriateprocesses in place across the Group to identify, assess, monitor and control critical risks facing theGroup, including regulatory risks.In order to provide more detailed management of risks, the following sub-committees of the GRCCwere in place:Group Capital Committee – to assess the capital requirements (including the risk-based capitalrequirements) of the Group; to monitor the sources of capital available to meet these requirementsand oversee the allocation of capital to firms.Group Counterparty Credit Committee – to set limits for the Group’s exposure to any singlecounterparty failure and to manage exposures within these established limits.Group Investment and Market Risk Committee – to ensure that investments supporting the UKinsurance business were appropriately managed.Group Insurance Risk Committee – to ensure that products for the UK businesses were appropriatelydesigned and priced, that product legal risks were assessed and that appropriate processes were in placeto identify, assess, monitor and, where deemed appropriate, reinsure risk.Group Operational Risk Assessment Committee – to ensure consistency in approaches to operationalrisk management across the Group.Bonus declaration decisions were made by the Society Board. These decisions were subject toratification by the Legal & General Group Board.
PRINCIPLES AND PRACTICES OF FINANCIAL MANAGEMENT – REPORT ON COMPLIANCE FOR 20093EXERCISE OF DISCRETIONThe main areas in which discretion is exercised in the operation of with profits business areinvestment policy; setting of bonus rates; proportion of distributed surplus allocated to shareholders;setting of surrender values; new business terms and volumes; apportionment of expenses;investment management arrangements; changes to reviewable terms under policies; changesto the PPFM; policyholder communications on relevant issues.Investment policyInvestment policy was subject to review by the Group Investment and Market Risk Committee.Following the turbulence seen in investment markets worldwide during 2008, markets continued tofall in the early months of 2009 leading to further reductions in the value of the With Profits Fund’sequity, property and corporate bond holdings.In order to limit the impact of further equity market falls on the With Profits Fund’s capital position,the higher level of equity hedging maintained in the Inherited Estate established during 2008continued during the early part of 2009. Later in the year as equity markets rose the level of equityhedging was reduced accordingly but a short position in corporate bonds was established in theInherited Estate in order to reduce the impact of widening credit spreads on the With Profits Fund’scapital position. In addition, in the latter part of the year certain derivative contracts were enteredinto in order to reduce exposure to property market movements within asset shares and in orderto establish a partial hedge against the impact of these movements on the Inherited Estate.Significant holdings of equities and property were maintained within policyholder asset shares overthis period, albeit at reduced levels following market falls seen in 2008, consistent with the objectiveof maintaining a balance between risk and reward for groups of policies and the With Profits Fundas a whole. The value of the equity holdings rose materially over the latter part of the year as equitymarkets recovered worldwide.There were no other significant changes to investment strategy for the With Profits Fund overthis period.Setting of bonus ratesDue to the recovery in equity and credit markets seen during 2009 and the resulting reduction inpayout ratios the Society Board decided that it was not necessary to implement an interim bonusdeclaration during the year.When setting bonus rates at the 19 February 2009 bonus declaration, the Society Board took intoaccount the falls seen in most major investment markets during 2008 and the further reductions seenearly in 2009. The bonus declaration as at 18 February 2010 allowed for the impact of investmentreturns to 31 December 2009. The approach to smoothing used at this declaration allowed for thefact that the impact of market falls early in 2009 had already been taken account of at the earlierdeclaration. Decisions on annual and final bonus rates were again guided by the smoothingformulae used in recent declarations.All bonus decisions were made by the Society Board after receiving advice from the With ProfitsActuary. These decisions were then subject to ratification by the Legal & General Group Board.Shareholder transfer proportionThe Society Board decided to maintain a shareholder transfer proportion of 10% of distributedsurplus from the With Profits Fund and to charge additional tax due in respect of the shareholdertransfer to the Inherited Estate of the With Profits Fund.Setting of surrender valuesThe appropriateness of surrender values was regularly monitored over the period, in line withthe approach agreed at the Group Insurance Risk Committee. Surrender values and Market ValueReduction Factors were changed during the year, having regard principally to movements in thevalue of the underlying investments.
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