Phoenix Group Holdings plc (PNXGF) CEO Andy Briggs on Q2 2022 Results – Earnings Call Transcript

Phoenix Group Holdings plc (OTCPK:PNXGF) Q2 2022 Earnings Conference Call August 15, 2022 4:30 PM ET

Company Participants

Andy Briggs – Chief Executive Officer

Rakesh Thakrar – Chief Financial Officer

Conference Call Participants

Andrew Sinclair – Bank of America

Andrew Crean – Autonomous

Larissa van Deventer – Barclays

Farooq Hanif – JP Morgan

Steven Haywood – HSBC

Ashik Musaddi – Morgan Stanley

Alan Devlin – Goldman Sachs

Dominic O’Mahony – BNP Paribas Exane

Nasib Ahmed – UBS

Mandeep Jagpal – RBC Capital Markets

Andrew Baker – Citigroup

Oliver Steel – Deutsche Bank

Andy Briggs

Well, good morning, everybody, and welcome to Phoenix Group’s 2022 Half Year Results Presentation. It’s great to be presenting here at our new London head office building for the first time. So thank you for coming. And welcome to those of you joining us on the live webcast.

Phoenix has had a fantastic first half, despite the tough economic backdrop. We have once again delivered a record set of results across our financial framework of cash, resilience, and growth. This is underpinned by the strong progress we’ve made across our wider strategic priorities, which ensure we are delivering for our customers, colleagues and investors, and on our core social purpose and wider role in society. We continue to grow organically, delivering strongly for customers with GBP1.8 billion of net inflows across our Open business and a very pleasing 42 new Workplace pension scheme wins, in just six months.

And I am delighted that we have announced our first ever cash funded acquisition of Sun Life of Canada UK and can demonstrate the value creation available from smaller cash funded M&A. This means, our dividend is now growing, both organically and inorganically. We have delivered, therefore, on all of the key objectives I’ve set for the business at the start of the year. And I’m proud of how well the team are delivering.

So, starting with the financials. Rakesh will cover this shortly in more detail, but in terms of the headlines. We’ve delivered GBP950 million of cash generation in the first six months and now on track to be at the top end of our target range for the year. Our balance sheet remains very strong and highly resilient, with our Solvency II surplus at GBP4.7 billion, while our shareholder capital coverage ratio of 186% is above our target range, providing the capacity for us to invest into growth such as the acquisition of Sun Life of Canada UK. Finally, we’ve reported GBP430 million of new business long-term cash generation. This is more than double the first half of last year on a like-for-like basis.

As you can see from this slide, we continue to make excellent progress across our five strategic priorities as we deliver on our purpose and strategy. The strength of this delivery is down to strong talent we have in our business. Engagement is high as we prioritize our culture and supports our colleagues through the cost of living crisis through a range of measures. This includes the payment of a one-off GBP1,000 net lump sum to all employees other than our top 100 leaders.

I’m not going to go through everything on the slide, but I did want to highlight a few key achievements. Optimizing our in-force business is the bedrock of Phoenix. I am, therefore, pleased that we’ve delivered a further GBP421 million of management actions in the period. While we remain a super resilient as always, with both our long-term cash and solvency surplus protected despite the volatile markets.

We’ve also continued to enhance our operating model with the standout success being the migration of all 400,000 Standard Life annuities to the TCS platform, which is our first major migration off the legacy Standard Life mainframe, a great outcome for customers and a key strategic milestone. And we’ve also delivered a further GBP15 million per annum of cost synergies from ReAssure, which means that we have now exceeded our revised synergy target with nearly GBP1.1 billion of synergies in just two years.

Our third strategic priority is to grow our business to support both new and existing customers. Here, we’ve continued to deliver organic growth in the first half, including another strong performance from BPA. But most pleasing for me, is the clear momentum we have in our capital-light, fee-based businesses with a GBP1.9 billion year-on-year increase in net fund flows.

Our fourth strategic priority is to innovate to provide our customers with better financial futures. On the slide, you can see just some of the initiatives we’ve delivered in the first half that go right to the heart of our purpose. We are here to help our customers on their journey to and through retirement, which is even more important, given the current economic backdrop. Finally, we’ve continued to invest in a sustainable future as we respond to both clear customer demand and demonstrate leadership as a purpose-led business. So, in summary, a great start to the year.

However, probably the biggest achievement in the first half has been the announcement of our first-ever cash funded acquisition, which I’m confident will allow us to demonstrate the significant value to shareholders available from smaller-sized cash funded M&A. We very much look forward to welcoming the Sun Life of Canada UK customers and colleagues to the Group. It will be a simplified integration as the vast majority of the business is already with TCS Diligenta, who are, of course, our strategic partner here.

As responsible stewards of shareholder capital, we remain disciplined in our transaction pricing, with the GBP248 million consideration, representing an attractive price to own funds of 83%, the lowest multiples for any deal we’ve ever done. We expect to generate GBP470 million of incremental long-term cash generation from this acquisition with around 30% of that to emerge in the first three years. And we are targeting a GBP125 million of net synergies. As a result of the value creation expected from this transaction, I am delighted that the Board has been able to propose a 2.5% inorganic dividend increase that, subject to completion, will be effective from the 2022 final dividend. This is proof of concept that smaller cash funded M&A can add significant shareholder value. And we expect further opportunities to emerge over time.

So what does our success in the first half mean for our dividend trajectory? As you can see, we have a consistent track record of dividend growth over the past 10 years, having delivered a compound annual growth rate of 4%, primarily driven by M&A. Last year, as we know — as you know, we delivered our first ever organic dividend increase from the growth of our Open business. This year, our interim dividend is, as ever, equal to last year’s final dividend, which is a 3% increase year-on-year, reflecting last year’s organic growth.

Looking forward to the second half, we have the opportunity to prove our unique business model by delivering both organic and inorganic dividend growth, with the 2.5% increase already announced for our recent acquisition and the potential for an organic dividend increase as well. Phoenix is, therefore, well positioned to deliver on our policy of paying a dividend that is sustainable and grows over time.

And with that, I will now hand over to Rakesh who will cover the financials in more detail. Rakesh?

Rakesh Thakrar

Thank you, Andy, and good morning, everybody. There are three key things I want you to take away from our financial results today. Firstly, we continue to deliver dependable cash generation, which underpins our reliable dividend. Secondly, we remain resilient as ever and are well hedged against the challenging economic backdrop. And thirdly, we are on track to deliver both organic growth and inorganic growth, which will support our dividend that is sustainable and grows over time.

So turning to the slides. As Andy said, Phoenix has delivered a strong financial performance in the first half of 2020. We delivered cash generation of GBP950 million in the period, maintained our strong solvency balance sheet and more than doubled our new business long-term cash generation to GBP430 million. Our leverage ratio has also reduced to 27% following a GBP450 million debt repayment in July.

Starting first with cash. Phoenix is unique in its ability to deliver dependable cash generation over the very long-term. This enables us to set very clear one year and three year targets and provide guidance for lifetime cash generation. I want to talk to you about each one of those in turn.

Starting with the one-year target. We have delivered GBP950 million of cash generation in the first half and now expect to deliver at the top end of our target range of GBP1.3 billion to GBP1.4 billion for the full year. We have also set a three-year cash generation target of GBP4 billion, which I will take you through over the next two slides.

We are often asked by investors who are not insurance specialists, how they can compare the performance of Phoenix against companies in the wider market. We primarily run our business to generate cash and this is easily comparable. Looking at the GBP4 billion of cash we expect to generate over the next three years and after deducting our operating costs and debt interest, we are left with around GBP2.9 billion of free cash flow. This translates into an impressive three-year average of free cash flow yield of 15%, nearly double the FTSE 100 average. This demonstrates just how cash generative our business is relative to companies in the wider market.

This slide sets out the expected sources and uses of cash generation over the next three years as at 31 December, 2021 and shows that we expect to generate GBP1.7 billion of surplus cash. We also have the capacity to raise up to a further GBP1 billion in debt while remaining within our leverage target ratio. This means we have a total of GBP2.7 billion available for growth. This provides us with the capacity to cash fund the Sun Life of Canada UK acquisition, invest our target allocation of around GBP300 million into BPA in 2022, and to continue investing into future growth opportunities over time.

Finally, on cash, we have provided guidance for lifetime cash generation of GBP17 billion. After servicing and redeeming all outstanding debt and deducting committed integration costs, we expect GBP11.8 billion of long-term free cash available to shareholders. And this long-term free cash number is prudent because it is from our in-force business only, so does not include any new business or M&A, no management actions past 2024. This means we can cover our GBP500 million annual dividend cost over the very long-term. Protecting the resilience of this long term free cash is, therefore, key in ensuring the long-term sustainability of our dividend. We view the key market risk associated with equities, interest rates, and inflation as unrewarded risks and they could cause volatility to the value of this cash. Therefore, we hedge these risks to mitigate volatility and deliver dependable cash generation, which means there is no material impact on our long-term free cash from key market risks as you can see on the right-hand side of this slide. We are, therefore, well positioned to continue delivering for our shareholders in this challenging economic environment.

Our Solvency II capital position remains strong, with the resilient surplus of GBP4.7 billion, which, as ever, reflects the accrual of our interim dividend. Our strong position enabled us to repay the GBP450 million Tier 3 bond that matured in July, which was deducted from our June solvency position. Our economic variance is once again small at just GBP0.2 billion despite the market volatility. This reflects our approach of hedging the majority of our market risks, which is designed to stabilize our Solvency II surplus and our long-term free cash. This in turn underpins the resilience of our dividend over the long term. However, our approach does result in temporary own funds volatility. This is a trade-off we accept to deliver the sustainable and resilient dividend that Phoenix is known for and which our shareholders value. And looking to the full year, I currently expect our surplus to GBP4.7 billion to remain broadly stable.

Meanwhile, our shareholder capital coverage ratio has increased to 186% and the recently announced acquisition of Sun Life of Canada UK is expected to reduce this to 179% on a pro forma basis. With our Solvency shareholder ratio at the top end of our target range of 140% to 180%, we have the capacity to invest into future growth opportunities.

As I have explained, delivering resilience in our balance sheet is fundamental to Phoenix. We, therefore, have a low appetite for retaining equity, interest rate, inflation and currency risks, which we see as unrewarded and hedge. This translates into the low sensitivities presented here. We also manage our longevity risk through reinsurance, retaining around half the risk across our current in-force book and reinsuring most of the risk on new business. We continue to see credit risk as rewarded and actively manage our portfolios to ensure they remain high quality and diversified. The key sensitivity we focus on here is a full letter downgrade of 20% of our credit portfolio, which is currently GBP0.3 billion after expected management actions and small in the context of our GBP4.7 billion Solvency II surplus.

Given inflation is so topical at the moment, I thought it is worth reiterating that we have no material exposure to inflation. Inflation emerges in two principal areas within our business, both of which we have hedged. Firstly, we have the inflation-linked annuities, which are hedged within debt index-linked gilts. And secondly, we have the exposure on our policy administration and operating costs, which we also hedge. All of which means that the current inflationary environment will have no material financial impact on Phoenix.

As I have shown many times before, as a consequence of our comprehensive hedging approach, we continue to be far more resilient to the major market risks than our UK peers. This slow sensitivity is especially important during times of market volatility as we have at present. And therefore, it remains a key differentiator for us.

We manage around GBP270 billion of assets on behalf of our customers and shareholders. Our assets reduced in the period by around GBP38 billion due to the significant market movements experienced by all. However, these market movements have a limited impact on the fees we earn as we hedge annual management charges against movements in equities and interest rates.

We maintain a prudent diversified GBP34 billion shareholder credit portfolio comprising both liquid and illiquid credit, with a BBB exposure of 19% and our BBB minus exposure at just 3%. We also remain conservative in sector positioning of our credit portfolio. And have sought to limit our exposure to highly cyclical sectors by further rotating out of these during the first half. As a result, we have only GBP1.1 billion or 3% of our GBP34 billion credit portfolio exposed to cyclical sectors. However, these are with high-quality counterparties as evidenced by an average credit rating of A minus. And we continue to have a circa GBP1 billion credit default reserve. We, therefore, remain very comfortable with the quality of our credit portfolio.

Our ability to deliver value accretive management actions is a key differentiator for Phoenix and optimizing our in-force business is one of our five key strategic priorities. We continue to demonstrate our capability here with over GBP400 million of management actions delivered in the first six months of the year. These were primarily from recurring business as usual actions which are not reliant on integrations and will continue into the long-term. This included our ongoing illiquid asset origination where we delivered a 60 basis points illiquidity premium. We also invested over 50% of our illiquid assets, excluding ERM into sustainable assets during the period. And we have proactively deployed into US liquid credit to take advantage of the relative spread widening and delivered a host of other balance sheet optimization actions too.

Moving now to growth, and it is great to see that our investment here is paying off. I am delighted that we have more than doubled new business long-term cash generation to GBP430 million on a like-for-like basis. Retirement Solutions contributed GBP282 million in the first half, delivering more than triple the volume in the first half of 2021 from external transactions. Elsewhere, it was pleasing to see our fee-based businesses report a 17% year-on-year increase to GBP148 million, noting that the new business long-term cash generation here is seasonally more weighted to the first half. Last year we delivered organic growth that more than offset the Heritage run-off for the first time and given our performance in the first half of 2022, we are on track to achieve it again this year.

2021 was the year that Phoenix through our newly acquired Standard Life brand firmly established itself as a key player in the BPA market. We have built on this foundation with a strong start to 2022, having completed GBP1.6 billion of premiums across six external transactions. Our capital strain has also reduced again from 6.5% last year to 6.2% in the first half, which on a pre-capital management policy basis equates to 3.8%. And we have improved both the cash multiple and payback, leading to improved IRRs in the period.

Looking forward, we have a very strong pipeline for the second half. We have already completed two further transactions totaling GBP1.1 billion and our exclusive on another GBP500 million transaction expected to be complete in quarter three. We will also complete the buying of the remaining GBP600 million of the Pearl Pension Scheme liabilities in the second half two. As a result, we are confident of fully deploying our target level of capital into BPA this year of around GBP300 million, with the second half deal economics expected to be broadly similar to the first half.

I was particularly pleased to see the strong turnaround in net flows from our capital-light, fee-based business in the first half. We delivered a net inflow of GBP1.4 billion in the period, compared to a GBP0.5 billion outflow in the same period last year, an improvement of GBP1.9 billion. This was driven by a Workplace business where the investment we have made into our proposition and into our Standard Life brand is enabling us to both retain our existing schemes and win new schemes in the market. As you can see, the momentum in scheme wins continues to accelerate with 42 new scheme wins in the first half of 2022, which is more than the whole of 2021 already. The scheme wins this year do remain in the smaller scheme category, but we are now being invited to bid for the larger schemes and we are confident we will be successful here, too.

Turning to our IFRS results, we delivered operating profit of GBP507 million in the first half of 2022, marginally down on the prior year. This included increased BPA new business profits in our Open division, offset by a reduction in Heritage, primarily due to a lower expected return as the business runs off. We also experienced adverse investment variances under IFRS from rising yields due to our hedging approach or protecting the solvency balance sheet and our long-term free cash. Other non-operating items, includes a provision for future project costs in relation to the re-phasing of our Standard Life IT migration that we told you about at the full year. It also includes cost in relation to IFRS 17 and the planned investment into projects to support our open growth strategy.

So, to conclude, we delivered strong financial results in the first half of 2022 across our financial framework of cash, resilience, and growth and we are on track to deliver across all of our targets for 2022. This includes delivering at the top end of the 2022 cash generation target range of GBP1.3 billion to GBP1.4 billion and retaining our resilient balance sheet by operating within our target ratio ranges for solvency and leverage. In terms of growth, we are confident of delivering more than GBP800 million of long-term cash generation from new business this year. And we are aiming to complete the acquisition of Sun Life of Canada UK in quarter one 2023. This will support us in delivering on our dividend policy which is to pay a dividend that is sustainable and grows over time.

With that, I will now hand you back to Andy for the outlook.

Andy Briggs

Thank you, Rakesh. As I’ve said before, I passionately believe that the best businesses have a core social purpose which is why as is helping people secure a life of possibilities, helping a broad range of people in the UK to journey to and through retirement enjoy a better later life. As a purpose-led organization, we look to have the best people who are focused on our purpose to then deliver better outcomes for our customers and wider society and in turn, produce stronger returns for all of our investors.

Virtuous circle you see on this slide. And sustainability is embedded throughout this. From engaging customers with their financial futures, to being a model employer, to investing our GBP270 billion of assets to support net zero and leveling up. This purpose-led approach underpins everything we do at Phoenix and I am confident it will enable us to execute on the clear growth opportunities ahead of us.

Standing in the shoes of our customers, there are a number of sources of retirement income available to them and these underpin the four major trends in the UK long-term savings and retirement market, which offer us multiple growth opportunities. The first is the huge stock of legacy pensions and savings products where we can improve customer outcomes by moving them from outdated legacy systems to more modern platforms. There are GBP480 billion of Heritage assets, much of which we believe will come to market over time. The next key customer income source is from the GBP2 trillion of defined benefit liabilities in the UK. This underpins what is a thriving BPA market of around GBP40 billion per annum, where we are performing strongly. And finally, we have the capital-light, fee-based defined contribution pensions offered through the Workplace and direct to individuals.

In the Workplace market, which we believe will see around GBP40 billion of flows per annum, we’ve been building strong momentum, while in the individual pensions and savings market, which is another GBP40 billion of flows, we’ve been working on developing innovative retirement income solutions. The right hand side of this slide sets out the impact on these market growth trends of the current economic environment. We believe it accelerates both the M&A market due to cost inflation pressures of vendors and the BPA market where rising rates make BPA transactions more affordable for corporates. Clearly, many people are facing significant challenges from the cost of living crisis and this is impacting spending habits and bank deposits.

So far we’ve seen limited change in pension contributions and do not currently envisage a material impact on our fee-based businesses. But importantly, as we did in our response to COVID, we will continue to support our customers in every way we can. We have a clear and differentiated strategy which create shareholder value through leveraging all four of the major market trends I’ve just covered. It is simpler and more focused than our peers. Heritage is the bedrock of our business, which delivers high levels of predictable cash that covers our dividend into the very long-term and it also generates surplus cash that we can reinvest into both our Open business to support organic growth and into M&A to deliver inorganic growth, both of which can underpin future dividend increases.

But what really differentiates Phoenix is how the whole is greater than the sum of the parts, with our Heritage business creating clear competitive advantages in both Open and M&A. For our Open business, diversification with the large Heritage books means we will be more capital efficient than peers, particularly in retirement solutions, including BPAs, where we are already at a 3.8% capital strain on a more comparable pre-capital management policy basis while our strategic partnership with TCS provides us with a market-leading cost per policy administration platform that will give us a meaningful cost advantage for our fee-based businesses over time.

Now, to be clear, we are not fully leveraging these advantages for our Open business today. But if you think about the progress we are making and the structural competitive advantage we will have in time, I think this is really exciting. And exactly the same logic applies when we do M&A, which enables us to generate significant cost and capital synergies to underpin our ongoing track record of shareholder value creation in M&A as evidenced by the Sun Life of Canada UK transaction where our synergy target is 50% uplift on the price paid. So, a simple, clear strategy.

2021 was a pivotal year for Phoenix as we delivered organic growth from our Open business which more than offset the Heritage run off for the first time, which we accelerated through the acquisition of the Standard Life brand and the investment into our Standard Life business. We are now confident of delivering this on ongoing basis. And therefore, expect to continue growing our in-force cash generation over time.

I covered the full market trends earlier. Three of these are organic and we will leverage all three of these. We initially turned our focus on to BPA and have already become an established player in this market. We’re now turning our attention to the fee-based businesses with our momentum in Workplace building and a big opportunity in individual pensions and savings to go out. Over time, we expect to balance our growth between BPA and the capital-light, fee-based businesses. And we’ve scheduled a Capital Markets Day on the 6th of December where we plan to do a deep dive into our Open business.

M&A remains a core part of the ongoing growth strategy, both large and small, with the remaining GBP470 billion of UK Heritage assets potentially available over time. I continue to have cups of tea with my fellow insurance CEOs and the message from the majority of them remains very much one of when, not if. We stand ready to consider our next deal, enabled by our scalable platforms and our GBP1 billion of remaining firepower.

With Sun Life of Canada UK being our first ever cash funded acquisition, it was important that we clearly demonstrate the benefit for shareholders from smaller sized, cash funded M&A. And we did this by announcing our proposed inorganic dividend increase with the transaction announcement. However, going forward, given the Board’s confidence that we can now deliver both organic and inorganic growth on a long going basis, we intend to simplify our dividend communications. We will do this by announcing any potential annual dividend increase at our full-year results and which will combine both organic and inorganic growth.

In summary, Phoenix is unique in the insurance sector with the cash from our in-force business funding our attractive dividend over the very long-term. While our business is highly resilient adding to our strong capital position and our hedging which protects both the capital position and our long-term cash generation, particularly important in these uncertain times. And we are growing both organically and inorganically. This supports us in continuing to deliver cash, resilience, and growth. Phoenix is a growing business with a defensive balance sheet and offers a uniquely reliable dividend that is sustainable and grows over time. We believe this is hugely valuable and particularly so in an uncertain economic environment.

And with that, we’ll move to questions. So we are going to start with questions from the audience in the room. If you can raise your hand if you have a question. [indiscernible] and we will direct one of the microphones to you. If you can please start by introducing yourselves and the institution you represent. For one delved into the conference call please let the operator know you have a question. And for anyone watching on the webcast please use the Q&A facility and we will come to your questions after we’ve answered those in the room and on the call.

Question-and-Answer Session

Operator

Q – Andrew Sinclair

Thanks. Morning, everyone. Andy Sinclair from Bank of America. Three, please. Firstly was just on the Workplace pensions business on the 42 schemes you’ve won and frankly on the 41 you won last year. Just if you can give us an idea of how many those have of transitioned in H1 this year and just so we can get an idea of what that means for what’s going to be transitioning over the next kind of six, 12, 18 months?

Secondly, just on bolt-ons. Congrats on the first organically funded bolt-on, great to see, and the dividend increase. But at full year results obviously already looking for more full-year results, you said you saw a good chance of M&A deal this year. You’re clearly right. What is your outlook for the coming 12 months? Do you still feel similar levels of confidence?

And thirdly was just on the non-operating cash flows line, just fairly punchy cost again in H1 this year. Just if you can remind us what’s coming through that line and perhaps give some guidance on it? Thanks.

Andy Briggs

Okay. Thanks, Andy. So I will let Rakesh take the third of those. So in terms of the Workplace schemes, the schemes we’re winning at this stage are smaller screen. So don’t expect them to have a kind of transformational impact to the numbers overnight, but what’s pleasing is, we’re now getting invited to tender at the much larger schemes which clearly would have a more transformational impact. Typically, the lead time from winning a scheme, you tend to get the regular premiums come in within, say, six to nine months, but quite often you wait over a year to see the lump sum assets come across.

So just sort of summarizing our numbers in the first half, what we saw was that a big shift in the net fund flows from a small outflow to a GBP1.7 billion positive inflow from the Workplace pensions business. And that was basically a 28% increase in the gross inflows and that 28% increase in the gross inflows led to a 60% increase in the new business long-term cash generation from Workplace. So you can see the kind of benefits as you grow the kind of leverage effect on the business. But we also saw a 40% reduction in our outflows. So what was basically going on here is, we’ve invested heavily in the proposition. We’re now attractive in the market. So we’re stemming the outflows we had historically in terms of losing the existing schemes and we’re now starting to win the new schemes. So good positive momentum there. This is a flywheel business. So you work hard to get the flywheel going, it takes a while to get going. But when it does, it self-sustains and it’s obviously capital-light. And we are very determined and confident that we can balance the growth between the fee-based capital-light and the BPA going forward.

In terms of the M&A question, as I say, think about the market as GBP470 billion of assets. Just under half of that is a small number of larger deals and it’s hard to know the when or if, but if ever anything in that space was available, we’d obviously be very enthusiastic. But then you have over half the market is a much larger number of smaller deals. And basically what the CEOs say to me when I talk to them is that they like the cash flow coming off that closed book business, but then they recognize that — typically a Heritage book runs off at about 6% a year. So every year, they have to cut their cost by 6% in order to stand still. And if they don’t cut the cost by 6%, effectively there is an increased expense reserve and they don’t get the cash flow out. And that’s why people say, it’s the question of when not if, because they are struggling with legacy platforms fixed cost of regulatory change. So it’s hard for us to predict the exact timing of when deals will come about, but we are confident there will be deals going forward for those very market dynamics I’ve just set out. And say, the Sun Life of Canada UK is a fairly straightforward integration for us. We remain keen and enthusiastic to do and ready to do the next deal as soon as anything is available in the markets. We have GBP1 billion of remaining cash firepower.

Rakesh, do you want to pick up on the non-operating items?

Rakesh Thakrar

Yeah. So I think the question was in relation to cash uses within non-operating. So these really are in two areas. I probably want like you to think about it. One is, just generally the fact that we hedge a lot of the currency risk at the Group level in relations to the debt and that will have collateral movements and close out of position. So that will be one aspect of it. And the second aspect which I already touched on, but probably more in the context of the IFRS results is the fact that we have integration still and going through this Standard Life IT migration, the ReAssure integration, that will have cash associated with it and that will come through that line as well.

Andrew Crean

Good morning. It’s Andrew Crean with Autonomous. Again, three questions again. On Europe, you failed to sell the package of European businesses last year. Would you consider — I just assume that the Irish business will be a lot easier to sell than your German. Would you consider — is that’s something which is on the table? Secondly, you’re still due running platforms, the ALPHA platform and the TCS platform. Would you consider shutting one of them and what would be the cost benefits of doing that? I’m assuming the ALPHA platform. And then thirdly, Andy, you talk about how many cups — well, you talk about your cups of tea, outside of the large deals which I think we know, how many cups of tea are you — are actually there? I mean, how many companies are actually likely to consider, because there is a bottom end to this way where it’s just not worth to bother you actually going out and doing something?

Andy Briggs

Okay. So let me take each of those in term. We did a strategic review of Europe last year, having had a number of unsolicited expressions of interest. What we basically concluded was the highest value way forward on Europe was to sell the Ark Life business, which we did for 91% of own funds. But then there was real value to be had by both putting in place a partial internal model to Standard Life International, which we got approval for much quicker than actually others have done from the CBI in Ireland, but then also as part of the Standard Life transition to migrate to much more modern technology. So that’s what we’re focused on in Europe. That will then — that’s the right thing to do to optimize the value of the European business, which is performing strongly and is making a good contribution in terms of flows going forward. But it also would create the right base for us to consider inorganic expansion into Europe in due course.

In terms of the dual — ALPHA, two platforms, and so on, so you’re absolutely right, when we did the ReAssure acquisition, we’ve now exceeded our revised target of synergies were up at nearly GBP1.1 billion, but there is nothing in there for Phase III integration. That’s just the head office phase 1 integration and phase 2 for finance and actuarial. But the reason we haven’t looked at is that our priority has been migrating off the old Standard Life mainframe across to TCS BaNCS platform and delighted in the first half that we moved our first 400,000 customers across in terms of all the Standard Life annuity customers went across really smoothly without any hitches. The team did a fantastic job of that.

So that is our priority there, but in time, we could well consider whether there is a more efficient way of looking at the operations in terms of ALPHA and the ReAssure side and I would say that historically when we’ve done phase three integrations, there has been material benefits attaching to those. So not going to give any specific numbers, but they have historically been material benefits attaching to those.

Finally, in terms of the cups of tea, I mean, I think the — one of the things I was quite keen to demonstrate with the Sun Life of Canada UK acquisition, it’s only GBP10 billion of that GBP480 billion, so it’s what, 2% of it. Yeah. And that led to a 2.5% inorganic dividend increase and really trying to demonstrate that actually doing smaller deals can be really quite accretive and valuable from a shareholder perspective. So the way to kind of think about this is, as we had on the slide, there is GBP245 billion of assets in these smaller deals that we could kind of cash fund, so they would be up to GBP1 billion of purchase price.

So there is — I’m not going to put specific numbers around it, but there are a significant number. If you think that the GBP10 billion in Sun Life of Canada acquisition, there is books from that size up to so 30 or 40 odd billion that we’re fitting to that GBP1 billion purchase price. And if there is GBP255 billion of assets there, you can kind of get a sense of working through the number of numbers. Different organizations are different places on their journeys, but there is significant number of potential opportunities out there.

Unidentified Participant

Hi, good morning. [Ming Zhu] (ph) from Credit Suisse. My first question is on your BPA. You’ve mentioned — you’ve reiterated your GBP300 million capital commitment. Is there scope for this to go up and when would you reach the self-sustainability level? And my second question is on the Group cost base. Would you be able to disclose on a clean set what’s the steady state on the cost base going forward if we exclude those one-off projects and assuming Andy’s cup of tea are not material? And my third question is actually on M&A. What sort of M&A and pricing landscape are you seeing, because the deal you’ve just done, the Sun Life one, it says 17% discount while your shares were trading slightly a bit more discount than the deal. So why didn’t you just do the share buyback?

Andy Briggs

Okay, So if I take the first and third of those. So it is our intention to spend GBP300 million of capital on BPA. We think that’s a sensible allocation. Think about BPA as an attractive profitable market, but I sort of tend to think about Phoenix as a three-legged stool. We’ve got Heritage, Open, the Standard Life Open business and M&A and within that kind of open leg, we want to be balanced between BPA and the fee-based capital-light business. Now that’s not to rule out that we might not spend a bit more. And what happened last year in practice is, we secured two large cases, two cases over GBP1.5 billion in December. And ultimately you’re bidding for these cases. We were seem — did a fantastic job, So we won both of them. And it meant we spent a bit more capital, but all other things being equal, we’d expect to spend around that GBP300 million level and that kind of keeps things balanced.

In terms of the M&A pricing landscape, so — and I maybe get Rakesh to add a comment to this in a moment. But I mean the 83% of our own funds is the lowest price of any of the deals we’ve ever done. I think own funds is a reasonable metric to look at closed book businesses. I think it’s a pretty poor metric to look at our open businesses. There’s a lot of conservatism built into risk margins and fundamental spread and so on and so forth. So the way we go about valuing deals that we do is, we actually look at the cash flows and then we look at the synergies we can generate. In the case of Sun Life of Canada that the synergy — net synergy number we’re targeting is 50% the price paid. So we can basically run — our cost and capital efficiency, our structural competitive advantage means we can run at 50% more efficiently than the previous owners. And that then delivers an attractive return on capital on those cash flows. So we’re not valuing it by looking at our own funds. We don’t think it’s a particularly good measure. We’re focused on predictable cash over time. And that’s how we think about the value created.

Rakesh, you want to add anything to that and then talk about the cost base?

Rakesh Thakrar

Yeah. Thanks, Andy. So I think in this Capital Markets Day probably two years ago we talked about how we looked at acquisitions. And as Andy pointed out, we actually look at those cash flows and then effectively determine an IRR and then consider that in the context of other opportunities. And certainly for these transactions that’s in my view the right way to look at it, because — and that would include if there was a buyback opportunity you look at it in that context. But in terms of buyback anyway, we have a capital framework that’s out there and we operate within that framework. And then currently, we’re at the top end in terms of our shareholder coverage ratio, but we know post the acquisition of Sun Life of Canada UK we will be just on the cusp or the border. But when looking at those cash flows, it was — certainly in our view, its value — it is better to do this transaction than consider any alternatives such as share buyback. But we’d also consider how quickly the cash comes back and the potential for reinvestment of that cash for other growth opportunities. So we think there is a some sort of compounding effect happening there, especially if we also over-deliver on synergies as well.

And then your question on the growth — the cost base within the Group. Certainly, if I put those into two categories. One is just the normal operating expenses that we would expect and that would be somewhere around GBP75 million, GBP80 million a year on an ongoing basis. And then you’d have the, what we call, the one-off costs. And as I mentioned earlier in my response, effectively made up of two areas. One is movements in our hedging, that will come through. And now it’s difficult to predict what that will be, depends how — on the currency movements how that will change. In terms of projects, probably fair to say we are probably — we are seeing higher level of these projects, because of the integration that we’re doing. We’ve got the Standard Life, we’ve got the ReAssure, we’ve got the IT migration that we spoke about. We’ve also got some payments we are making in relation to IFRS 17. So these are one-off multi-year programs that just meaning that at the moment, they are quite high. But all other things being equal, you would expect this to normalize.

Andy Briggs

Sorry, Ming, I didn’t answer about the competitive landscape. So up until a couple of years ago, obviously there were two players that were kind of bidding for these types of businesses. Phoenix and ReAssure, we’re now together as one. And so we are undoubtedly seen as a very credible counterparty by anyone looking to sell a business. We know that will be the best home for their customers and for their people, that we’ve got a strong track record of successfully executing on these deals through regulatory approvals and so on and so forth. And so we’re never complacent. There’s a lot of private equity money looking to get into this space, but I’d say generally that private equity money is more focused on Continental Europe and the US than it is on the UK, because it is a challenging regulatory environment for private equity to come into the life insurance space. And you’ve only got to look at what happened with the LV deal with Bain to see some of the potential challenges within that. So we think we are well placed in a competitive landscape and I think because of the scale of our Heritage business, we will generate higher levels of cost and capital synergies.

Unidentified Participant

Thank you. So, sorry, I think there is one question missed. It was on the BPA. What sort of level of AUM or which year you think you will achieve the self-sustainability? Thank you.

Andy Briggs

I mean, I think I’m going to say we don’t — we are — BPA is actually quite — we got GBP38 billion of annuities and BPA would be less than GBP10 billion of that. So we are — because we are far more diversified than others across our fee-based, capital-light businesses, annuities and then the Heritage business, we tend to look at the financials of the business in the round. We’re generating lots of excess cash from Heritage and it’s attractive to redeploy that at attractive returns on both M&A and on BPA.

Larissa van Deventer

Larissa van Deventer from Barclays.

Andy Briggs

Hi, Larissa.

Larissa van Deventer

Good morning. Congratulations on very strong cash generation and I have three questions on that, if you don’t mind. The first one, it was a major beat relative to expectation consensus and ours. Can you help us understand a little bit better about the moving parts and why you’re so confident that the levels are sustainable? Second, in light of the strong generation in the first half, is the second half target too modest? And third, you mentioned the contribution from illiquids and that it added to the cash generation. Can you help us understand what’s changed in the illiquids and how we should think about that going forward, please.

Andy Briggs

That’s three for you.

Rakesh Thakrar

Thank you.

Andy Briggs

I can sit back and have a cup of tea now.

Rakesh Thakrar

So let us start with the first one. So this was done on the GBP950 million cash generation in the first half. I mean, what you see there, we delivered our normal organic surplus which is about GBP0.4 billion. We also had a strong, if you recall, management actions during 2021. And again, this — we had GBP1.5 billion last year and we had over GBP400 million in the first half of this year. That together with the fact that — I was also cognizant of the fact that we had the Tier 3 repayment GBP450 million due in July, which is why that’s been slightly probably higher than you were probably expecting. But it is taking all of those items in the round and coming to that.

So the second point, is the cash generation in the second half too modest. I mean, clearly, I did reiterate, albeit it is not a change in the target that we will be at the top end of the target range. And then we do think that it’s fairly pretty good for the full year. Do we think that will — that is sustainable? I mean, you’ve seen from what we’ve done previously, and I’ll leave it at that.

And then finally, on the illiquids, right, so illiquid, this is — we were currently at 32% in terms of our illiquid allocation. Our aim is to get to about 40% across annuities in the medium term and then we’ll consider further thereafter. But what we get from illiquids, we will still focus on value over volume and — but we haven’t gone probably as much as people would have thought this year in illiquids because we’ve seen opportunities in liquid credit. So we diverted a lot of funds to US because we saw the relative spread widening and we took that opportunity, which I think is absolutely the right thing to do. And — but despite that, in the illiquid space, we still got 60 basis points premium on that. And as you know, the illiquid assets are really good match for our BPA annuity liabilities and therefore we were in a good space in that regard.

Andy Briggs

And I’ll just quickly add Larissa. One of the thing — many things impress me at Phoenix, one of the things that impresses me most is this core capability in the organization to optimize the in-force business. So the fact that we had GBP421 million of management actions in the first half just from BAUs. So that’s now integration-related, that’s just BAU, really does demonstrate the ability of creating value from our in-force business over the long term. And that’s one of the key drivers behind cash generation is the ability to drive those management actions is impressive stuff.

Farooq Hanif

Hi, thanks very much. It’s Farooq Hanif from JPMorgan. Just on the Workplace expansions, I mean, that was really impressive growth and the new business contribution from that is not completely comparable on a full year basis, but it’s getting chunky. Can you talk about the outlook here? You talked about larger schemes. What have you done that’s different and do you think you can maintain that level of new business profit generation?

Secondly, can we go back to the whole question of air traffic control of deals. So obviously the Sun Life of Canada is on Diligenta already, but if it wasn’t, what will be the constraint in sort of number of deals you can do and therefore, how many [indiscernible] sort of forego, because there is no point?

And then last question is on the commercial real estate portfolio. Can you remind us about your exposure there. There has been — obviously been heightened concerns about refinancing risk and how do you feel about the safety of that portfolio? Is it a big deal for you? Thank you.

Andy Briggs

Okay. So I’ll take the first two and ask Rakesh to cover the third. So we are pleased with the progress in Workplace and [indiscernible] sitting in the front okay for saying this, but we haven’t scratched the surface of what we can do in this market yet. So — and there is three reasons why there is a lot more to come here. The first is, as we migrate this across onto the BaNCS platform, we’ve negotiated by far a market-leading cost rate there. In the past, we got a fantastic right from the Heritage business. But because it’s declining each year, cost per policy, TCS kind of thinking, okay, I’ve got to manage that reduction every year, we said they are more — this is growing, so we need a much, much lower rate if we’re going to give this to you which they’ve agreed to. So we got — that margin benefit is still to come through is the first.

The second is, the new schemes we’ve been winning, have all been smaller schemes. Advisors are going to try you out with their smaller clients before they get you going on the bigger clients. We’ve got a couple of inquiries on the go at the moment, for example, where we’re well advanced with inquiries. We haven’t won them yet, but we are well advanced and progressing well over GBP1 billion of assets. So we’re starting to play in that space, which will accelerate as well.

And then the third is, I sort of think about the three main drivers of the Open business going back to the market trends: BPA, Workplace and then the individual pensions and savings. So we started out on BPA in 2018. We’re now established. We are number two in market share last year. Workplace we’ve got real momentum going. The third area we are starting to turn our attention to is the individual pensions and savings market where basically customers need to consolidate their different pension pots together and plan a journey through into retirement income. And yet only 10% of the UK population get advice on that journey to and through retirement. 90% currently flounder around kind of largely in the dark.

So we are building our capability within the advisor market as well. We’re building capability to play in the 10%, the customers that advice. But the 90%, we’ve got more of those customers than anyone else, 13 million customers and a lot of them in the Workplace. So the ability to talk to Workplace members, get them to consolidate other pots and stay with us to journey into retirement income will be another driver. So in time — and this will take time, but in time, we want the fee-based, capital-light businesses to give us a similar kind of value creation each year as we get from BPA.

Air traffic control of deals, I think the key point I’d make here is that we can buy businesses and run them separately on the side for a period of time. So it’s unlikely that there’ll be a constraint for us around doing the deals. What will be a constraint — just as — to Andrew’s question on ReAssure, we are full at the moment in terms of migrating to BaNCS. So we’ve not planned that part of the ratio business at this stage. It hasn’t stopped us doing GBP1.1 billion in synergies from ReAssure in two years. So we can still do the deals. I think the — even kind of constraints around the finance and actuarial side, the phase 2, we need to be mindful of those, but to-date, we’ve never — not back an M&A opportunity for bandwidth within the business. We gear up and create the bandwidth and would look to take advantage of the opportunities as they present themselves. On real estate.

Rakesh Thakrar

Yeah, on the commercial real estate, probably just worth putting into context for us, we have total of just over GBP11 billion of illiquid assets and commercial real estate is probably just over GBP1 billion to GBP1.5 billion in half in that region. So it’s not material in our overall context. Clearly with our asset management team, they are in a regular interaction with the people on the commercial real estate investments. Clearly, a lot of these have relatively lower loan to values, at about 60%, 65% and they are also secured on the underlying property. So certainly what we see is that we are absolutely happy with the credit portfolio and our exposure to commercial real estate. And then we keep close eye on all our investments, not just commercial real estate.

Steven Haywood

Good morning. Steven Haywood from HSBC. Three questions, please. In one of your slides, I can’t remember which one, sorry, apologies, inflation going high has no impact on your long-term free cash flow. Can you explain the dynamics on this, please? Secondly, in your sensitivities, the credit downgrade sensitivity, it now includes management actions, whereas previously excluded management actions. I mean, the difference between the two sensitivities is very low, but if you can explain why the change, that’d be great. And finally, on the BPA and the Workplace, what rate of IRRs are you achieving here and what capital strain margin can you come down to on the BPA? Thank you very much.

Andy Briggs

Okay. So I’ll take the third of those and ask Rakesh take the first two. Good to see — I will do the third one first and you think about the first two. So good luck on that. So we don’t disclose specific IRRs, but that’s exactly how we think about it. We think about all the excess capital we have. We are very determined stewards of that capital to allocate against the highest value opportunities. And so the IRRs are comfortably double digits on what we do, but we don’t disclose them explicitly.

In terms of capital strain, we did think it would be helpful because we think about capital strain with the capital management policy because we like every other insurer have our capital management policy and that’s the capital you deploy and that’s the kind of clean way to think about what you are actually tying up in terms of capital. But most of our peers quote a pre-capital management policy number. So our 6.2% in the first half would be 3.8% on a pre-capital management policy basis which is more comparable with others and in a similar ballpark to others.

Now, what we said is, our ambition is to get the strain, including capital management policy down to 5% so that will be more like 3% on a pre-capital management policy basis on a kind of like-for-like with others. And the reason why that is lower than many others achieve is basically the points I made about the diversification with Heritage. So others don’t have a big Heritage business of different risks and therefore we will be more capital efficient, because we get the opportunity to diversify against that. The levers to get there are basically a broader range of reinsurance partners. Our Solvency II internal model is not fully optimized for yet in the way some of our peers are and also broadening the breadth of illiquid assets that we can invest into. So all of those are actually a well-trodden path. We know what we need to do. We’ve got plans in place to do it. We’ll do it and we’ll get the strain lower still and will then be a structural competitive advantage over others.

Rakesh Thakrar

Thanks, Andy. Let me start with the second question which was around the credit downgrade and the management action. So, I mean, certainly, from our perspective, it was important that we showed a realistic position of what would actually happen in practice if that stress actually merged and also for — to allow you to actually compare against our peers in this regard. So what we’ve done for that particular sensitivities assume that we would take what we call reasonable management actions to adjust for now. The impact of it with those management actions is a strain to surplus of GBP0.3 billion. Without any management actions the strain will only be GBP0.5 billion. So it’s not talking big numbers here. So, even without the strain, we are only at GBP0.5 billion, with the stress it’s that GBP0.3 billion.

And the kind of actions we would do is what — certainly I consider is reasonable. So we wouldn’t do anything on — clearly on the illiquid space, because that will be what it will be and there is not much we can do there. But on the liquid we just aim to get back to the overall portfolio average and there’ll be a cost of change in doing that. And that’s what’s reflected. And then there is the reasons why.

On first — on inflation, so what we do see? Inflation, as I mentioned in my presentation, come from two areas. One is from annuities where effectively you get — there is annuities going up with inflation. So we use index and gilts to match them. So we are actually really well matched on that basis. So then the other area comes through a policy administration and through our costs. So what we do is, effectively we look to hedge long term inflation by stressing our capital balance sheet and looking how that would move with inflation and then putting a hedge in place that effectively cover this across all our products, et cetera and our MSA charges against those costs. And that’s why the inflation sensitivity is virtually nil, because we do that on a regular dynamic basis.

Ashik Musaddi

Hi, thank you. This is Ashik Musaddi from Morgan Stanley. Good morning. Just a couple of questions I have is, first of all, if I look at — I mean, the thing about integration keeps on coming especially on Standard Life. I mean, if I remember correctly, this deal was done about five, six years back. So when do we think that Standard Life and ReAssure deal will be completely integrated and there will not be any extra cost or would you say that because your incurring at the moment is in line with when you announced the deal? So that would be the first question.

The second one would be about management actions. I mean, it was a phenomenal first half, GBP421 million of management action, which is kind of equal to the organic capital generation of GBP400 million. If I remember correctly, historically, your guidance has been that whatever capital you generate, I mean, one-third would be roughly management action. So is there any upgrade on that or would you say that longer-term it’d still be one-third, it’s just that first half was strong.

And thirdly, just on management action again. I mean, there is a big item called balance sheet efficiencies, removing inefficiencies and it’s a big one, GBP280 million or something. Any color on that would be would be good. Thank you.

Andy Briggs

Okay. I’m happy to take the first of those and Rakesh you take the second. So the way we think about the integrations is we set clear targets. So if you take Standard Life, we set a target originally of GBP0.7 billion. We then upped that to GBP1.2 billion. At the full year, we delivered GBP1.6 billion. So, we spent GBP2.9 billion to buy the business, we did GBP1.6 billion of synergies. So what we basically said is, look, you’re right, it’s a few years down the track. We’re going to stop reporting Standard Life synergies because we have already busted the target by some margin.

The other point I would add is that what we’re doing is kind of more than the base migration. So what Andy and the team are doing, yes, they are migrating all 4 million Standard Life customers across on to BaNCS, but they are doing it in a way that we then have this really attractive advantaged platform for the Open business growth going forward. And so — but, yeah — and that’s basically kind of reflected through the numbers. If I take ReAssure, the original target was GBP0.8 billion. We upped that to GBP1.05 billion and we’re now just under GBP1.1 billion after two years. But we’ll keep reporting on the ReAssure side as well going forward.

Rakesh Thakrar

Yeah. So on management actions, clearly very pleased with delivering GBP421 million of management actions in the first half. When I look ahead to the second half, it’s not going to be as high as that and that’s why when I said in my presentation that I broadly expect the solvency surplus to be flat during the year with inorganic surplus plus management actions offsetting our financing costs and offsetting the investment into BPA, that’s why I think it will be broadly flat. Now, over the longer term, I still think that about a third is about right going forward. But clearly as you get closer, you have a better idea on what exactly those items will be. But over time, if you look at our track record, I think third continues to be and many of you know as well, continues to be a good proxy here.

In terms of the other areas, and what’s been pleasing is, as Andy said before, lot of these actions are being — are recurring actions that we know will be there each year. So, for example, on the other line, including items like ERM securitizations. For example, we go and get ERM to back our business, but we can then do further actions to make sure they are more efficient within the structures to generate the additional benefits on that. There is the fact that we’ve got this new internal model that we’re making tweaks to that as the business grows in terms of the way we model certain businesses, the capital associated with that. And there is continuous harmonization to the fact we’re doing a lot of this integration and doing this phase 2 for Standard Life we just finished and do the same on ReAssure. That gives a number of opportunities. So it’s again that — those are the kind of items in that other line.

Alan Devlin

Alan Devlin from Goldman Sachs here. Couple of questions from me. First of all, just a couple of follow-ups on the Workplace pension opportunity. What makes you confident that you got the competitive advantage now in that market through your investments? Where do you think that competitive advantage is? Is it on the cost side, on the new platform or on the capability side? And you said you are only kind of scratching the surface of the opportunity, given there is only three big players in that market, do you think you’ll get your fair share of the GBP40 billion of flows at some point in the future when you’re fully competitive? And the second question on the liquid opportunity. Is that temporary given the market dislocations in H1 or do you think there is a more of an opportunity on the liquid credit side over and above the illiquids given — I think your portfolio is still heavily UK focused, so there’s more you can do to diversify that? Thanks.

Andy Briggs

Okay. So on the — I will let Rakesh take the second in a moment. On the first, in terms of Workplace, I’d draw out four key advantages. The first is the Standard Life brand. It’s one of the strongest, highest awareness, most trusted brands and obviously we bought that last year. The second is, our proposition where we’re building a very strong proposition. I mean, you wouldn’t be invited to tender and winning all these schemes if that wasn’t the case. The third, and probably most important is actually the people. So we’ve built a fantastic team of people here from across the market from different places.

I think people love the fact we’re a purpose-led organization with sustainability at the core. We’re able to attract fantastic talent in the Group and so maybe that’s the most compelling competitive advantage over the longer term. People want to join us and to work here. But then the cost advantage is very material. So the right talent we’ve got with TCS Diligenta here is — I mean, I’ve run the Workplace pensions businesses at Prudential, Scottish Widows, Friends Life, Aviva, I know this market well over decades and we will have a material cost advantage in a relatively thin margin business. That’s a huge structural advantage.

So, the other point I’d make here is, we’re not fully leveraging these things yet. I mean, Standard Life as a core business has got some real strength, but it was under invested in for a number of years and we’re making good investment now. We’re making great progress. We’re pleased with progress, but we’re not — what’s often done and what might be feasible.

Rakesh Thakrar

Alan, just to then add on that second question, I mean, clearly, what’s important to us is that we have the right assets backing our annuities. But overall asset portfolio has got the right diversification across currency and also against geographies as well. So we want to have a high-quality credit portfolio. Now, clearly our sterling exposure is highly weighted. And so there is a natural tenancy that we want to go more and diversify that portfolio into the US and therefore it’s the right action to take and getting that relative spread widening is a fantastic effort from the guys to actually achieve that with the same credit quality. So that gives us a clear management action going forward, but what it also does is, then also allows us to buy — effectively allow us to move to illiquid credit at the right time. As I said earlier, over time, we want to get to 40%. We’re currently at 32%. And this allows us to get there as well. So there is further upside to this as well. So I think the guys are doing a fantastic job.

Dominic O’Mahony

Thanks. Dom O’Mahony, BNP Paribas Exane. Three questions, as well. Firstly on management actions, GBP0.5 billion of own funds creation, Is this already in the cash guidance as you said AT full year or is there a risk to the upside on the cash guidance, specifically from the management actions point? The second — on the fee-based business, LTCG very strong. So, those were incremental LTCG, very strong. Could you remind us, is there a seasonality H1, H2? And if there is, how pronounced is that seasonality and just thinking about expectations for the full year? And then a third, I guess, broader point, how has the change in inflation and rates impacted your counterparts both on the BPA side and on the sort of the back book transactions? Has it changed the conversations? Has it made it, in your view, more likely that people will bring deals to the table or indeed less likely? Thank you.

Andy Briggs

Okay. So I’ll take two and three and ask Rakesh to cover one. And I’m going to pick up pace a bit, we’re due to finish at 11 in theory. So on the fee-based side, yeah, there is some seasonality. Basically in Workplace you tend to get more salary increases in January and April than you do in the second half of the year. But if you look at previous year, you’ll get a sense of the typical split between the two halves. So that’s as good a guide as any there.

In terms of the change in inflation and rates, so to say, there are two big impacts. One is, if you’re running a close book portfolio and you don’t hedge it out inflation, then you’re going to struggle to get the cash flow out, because you are going have to increase expense reserves. And that we think could well lead to more CEOs saying, right, I’ve enjoyed the cash flow a bit, but maybe now is the time to offload this. So we think it will be positive in terms of the deals there. I know the team are doing a fantastic job. Doing a deal within four months of joining, not bad effort for Anna who’s joined us in March there.

And then on the interest rate side, basically it makes BPAs cheaper, because we are pricing relative to the return we get on fixed income and cash flow matching. And so for those schemes that are fully cash flow matched already, typically their assets are going down less than the amount which the price of the BPA is going down. So BPAs have become more affordable. So more of the market and hence, all players calling the market is going to be pretty buoyant this year.

Rakesh Thakrar

On management actions, there is — again just to reiterate, really pleased what we delivered and GBP0.5 billion of it was own funds. Some of that would have already been in our numbers and I’ll probably look at the full year. See, how we’ve done. Whether there is any impact on that in terms of our overall performance of the year. But certainly some of that’s already been reflected on what we’ve done.

Nasib Ahmed

Thanks. Nasib Ahmed from UBS. So first question coming back to sort of the M&A landscape and GBP470 billion that you’ve got just focusing on the larger deals. If I look at the two biggest UK with profit funds, they’ve got about GBP300 billion. I appreciate some of them would be open to new business. The first question is, would you have cups of tea with those guys as well? And within the GBP2 billion to GBP5 billion of large deals, is there like a really big one that’s GBP150 billion and lots of small ones that make up the rest? And on M&A again, would you consider given your focus on fee-based businesses and advisor and/or a platform business to acquire as well? Again, would you have cups of tea with them? And then finally on Sun Life, is that going to be funded through the LifeCo surplus or holdco? Thanks.

Andy Briggs

Okay. So I love tea. So I mean — and I’m interacting with the CEOs of all these businesses. I mean, I kind of play — we’re a leader in sustainability. So I’m going out talking to people about sustainability and how the insurance sector — we reckon the insurance sector could contribute about a third of what the UK needs to spend, invest to get to a net zero, for example. We’re doing a lot on Solvency II and again I take kind of leading role around that. So I’m meeting people all the time anyway and I would look at all of those. We’d be relaxed if a profit fund was open or closed, that would be fine for us either way. And I think in terms of the bigger deals and I’m not going to comment on specifics, but I would say the questions there are more strategic. Generally, in the insurance sector, people are moving to focus on core businesses and generally people are moving to more focused strategies. Lots and lots of examples of that, but you would know better than I.

And so organizations that still have capital-heavy life businesses with capital-light asset management, for example. Most others are moving away from that and so it will be a strategic call in terms of those. In terms of advisor and platform businesses, so I wouldn’t rule out doing potentially smaller acquisitions of capability build for the Open business. Equally, if you look at the valuations of platform businesses, I think that’s unlikely. I think the valuations there are particularly choppy and we’ve already got strong capability through our Standard Life platforms in that space at the moment.

Rakesh Thakrar

Should I take that final one?

Andy Briggs

Yeah.

Rakesh Thakrar

So this is whether — this will be funded by holdco cash, because as you know, well, the way our operating model works, cash comes from the underlying businesses, but it will be funded from the holdco cash.

Mandeep Jagpal

Good morning. Mandeep Jagpal, RBC Capital Markets. Thank you for the presentation and taking my questions. Two from me, please. And the first is on H2 BPA. In the presentation I think you mentioned that the economics for BPA will be similar in H2 to H1. Could you help us understand the specific economics you are referring to here? For example, as we head into H2, are market conditions now more positive than they were in H1 for margins or are you referring to the profile of the deals you’re expecting to do? So deferred pension splits and therefore the strain? And then second question on the longevity. Rakesh mentioned that half of the in-force longevity is reinsured. So it’s one of the few areas where you appear to be keen to take some balance sheet risk. How would you consider your approach to retaining longevity risk on the in-force or new business if the risk margin comes down under any Solvency II reforms?

Andy Briggs

You want to do both of those?

Rakesh Thakrar

Yeah. So first on the deal economics, I think generally what I was saying, at the high level that we expect the cash multiple, the payback and the strain to be broadly similar to the first half generally. Across clearly each BPA will have its different characteristics in terms of the underlying, but overall in terms of deal economics I would be expecting the same for the full year.

As I said in relation to longevity, so you are absolutely right we reinsure across — we take the whole of longevity risk. One of the slides you called out, you can see our exposure to longevity with — is about circa 20% of our SCR. We do hedge 50% across all of it. All the new schemes are, pretty much all of it is hedged out under the current regime. Now if the risk margin falls and clearly the market or — it’s expecting in terms of the public comment is about 70%. I don’t think it would change anything. We will still continue to reinsure all of that longevity risk, because it’s not — in our view, it’s not quite big enough to make that difference. But we are working with both the PRA and treasury to make sure we get the right outcome for us. It’s really — it’s not a capital release. We’re not — what’s more important is to have the ability to invest into the different illiquid assets whilst protecting policyholders, but also then ensuring that we can get to net zero. We need to find that balance and it’s not about capital. It’s making sure policyholders are protected and we have the opportunity to do our bit and then we can do a big bit in this to help the — building — return back better and getting to net zero.

Andrew Baker

Hi, Andrew Baker, Citi. Thank you for taking my questions. Three from me, actually. So the first one is on the dividend. And so Slide 7 shows an organic dividend increase at least, as I eyeball it about 2.5% for this year. What would have to happen for that not to I guess get implemented? And then secondly, on your debt capacity, so the GBP1 billion, presumably that’s on a Fitch basis. If you were to move up I guess utilizing that, your Solvency II leverage would be high relative to peers. So is Solvency II leverage something that you think could be a constraint at some point going forward? And then thirdly just on the Sun Life integration of GBP125 million. You mentioned the simplified integration because it’s already on the Diligenta platform. So where are those sort of cost and capital synergies coming from? Thank you.

Andy Briggs

Okay. So I’ll take the first and third of those. So on Slide 7, it’s not to scale, yeah. It says not to scale, but good try. But I mean the organic dividend increase is a judgments the Board makes. You can do the sums yourselves. If we — we’ve already written GBP1.1 billion so far in the second half with GBP1.1 billion we are exclusive on. We are confident deploying the GBP300 million of capital. You do the sums. We’re clearly very confident that we’re — let’s say the GBP800 million we will be growing organically once again this year. The Board will form a judgment on a range of factors at year-end around what level of organic dividend increase might be appropriate based on the performance of the business.

The one sort of watch out, I would say, is last year we invested GBP360 million into BPA. The plan this year is to invest GBP300 million. And obviously that will have an impact on the level of new business long-term cash generation. But suffice it to say, we are confident we’ll grow organically and then the Board will form a judgment from there.

On the Sun Life of Canada deal, basically the synergies are roughly half and half between capital and cost synergies. And the cost synergies would be phase 1 and 2. So combing kind of the head office side if you like and combining the finance and actuarial side would be the drivers of those. Not a concern in terms of job losses. Phoenix Group employees 8,000 people, just natural turnover each year with several hundred people, they have 70 people in Sun Life of Canada and one of the attractions of the deal is 70 very good people that we will add to the strength we’ve got in the business.

Rakesh Thakrar

Yeah. So on the debt capacity, I think it’s one of the slides that we showed that we have a GBP1 billion of debt capacity and those numbers are as at 31 December, 2021. And then clearly from our perspective is looking at that Fitch leverage ratio to say, can we be within that 25% to 30% range, because that’s our target ratio. But we also are aware of the other ratios as well. So — and as you can see in our presentation in the appendix, you’ll have the IFRS ratio as well as the Solvency II leverage ratio as well. So we will look at that. But what I will say is that if you look at our business, it’s cash generative and we then apply our resilience around it. We hedge it. We know the cash is predictable and long term. So we’re happy to operate in that range and that’s why 25% to 30% from a Fitch basis is appropriate for us because of the long-term cash generation of our business.

Andy Briggs

Oliver, the last word of the questions in the room.

Oliver Steel

Oliver Steel, Deutsche Bank. So the first back to Andy Sinclair’s question about the GBP165 million of non-operating cash. You said part of that was FX hedging. Why is the FX hedging in the holding company rather than the life company? And then secondly, on the basis that you have actually put dollar assets into US liquids, does that number grow or does it, at least — should we at least assume a maintenance of that sort of number going forward? And then secondly, you’ve stopped giving us the proxy to shareholder value. No surprise there given your own funds have come down. But the — you’ve moved from a discount to that figure to a premium I suspect if you were to give the figure. And look, I’m sort of teasing you slightly, because you always used to push this number and they are not pushing it anymore. But I’m just sort of wondering here, you don’t hedge or rather you hedge out the upside from rising rates, but equally the NPV of your future cash flows has come down because of rising rates. I’m just wondering how you feel about that or we should feel about it.

Andy Briggs

Okay. So just taking take the second one, I think our own funds and the shareholder value is not an unreasonable way to look at closed book Heritage business. I think it’s a really poor way to look at our growing open businesses, because you have a big risk margin, you have a fundamental spread and various other kind of conservatism and it’s not giving a realistic view. So what we are all about, which in fact we have been consistently all about is cash generation. And we are looking to protect both the solvency surplus, which is what drives cash generation and the dividend now and we’re projecting the GBP11.8 billion — we’re protecting the GBP11.8 billion of cash over the lifetime of the business. So the shareholders can be really confident that they are going to get the dividend from a short-term and decades ahead into the long-term. So — and that’s always been our focus, that remains our focus in terms of that cash generation. Do you want to pick up on the operating cash.

Rakesh Thakrar

Yeah. So it’s probably straightforward answer to that, Oliver. So the debt sits outside of the life companies and that’s why it’s done at the Group level rather than at the lifeco levels. The debt is outside of the life companies. There is no debt that sits in the life companies itself. And then second on the asset side, so clearly the assets sit in the life companies. So all the hedging for that will be done in the life companies to ensure they match. So where we went and got US dollar credit to invest and put in our matching adjustment fund, that fund will ensure that it has the right hedging in place to make sure we’re cash flow matched on that basis. That happens in the life companies. The debt that sits outside the Group debt, that is done at the group level.

Oliver Steel

This exceptional FX hedging cost in the holdco, is that going to continue.

Rakesh Thakrar

So that will — because we still have — that will move as currency movements happen, because we have a number of US dollar and euro denominated debt, which we are hedging.

Andy Briggs

Okay. Operator, do we have any calls or any questions from the conference call?

Operator

We have not questions on the line. [Operator Instructions]

Andy Briggs

Okay. While anyone on the conference call is pressing star one, do we — have we had any questions come through on the webcast?

Rakesh Thakrar

The only question outstanding that hasn’t been covered yet is just on Solvency II reform. And could you give your thoughts on the package of measures and when do you think it’s going to deliver the aims the government set and what impact would it have on Phoenix?

Andy Briggs

Yeah. So our focus on Solvency II reform is on broadening the matching adjustment eligibility. So as I said before, the UK needs to invest about GBP2.7 trillion over the next 15 years in order to get to net zero and we believe the insurance sector to do about a third of that, about GBP0.9 trillion. You can only do that with regulatory reform because currently the matching adjustment eligibility is really tightly defined and it doesn’t mean to anything like that type defined. Inevitably, when you’re quoting regulations to suit 28 member states, which is what the EU does, you’re not going to be ideal for any individual country and we think there is the opportunity to change that.

Quite a lot of the debate has been around capital release. From a Phoenix perspective, we’ve not been lobbying for capital release. We think it’s important that the regime protects policyholders. So our focus is on matching adjustment eligibility. I mean, for me, to be honest, the acid test here is trying to move away from hard and fast rules and have more ongoing judgmental approach to this, because at some point someone will crack a model for hydrogen power for example in terms of the journey to net zero, but it hasn’t been cracked yet and instead it has. We don’t know exactly what it’s going to look like.

So trying to codify rules today in detail isn’t going to work. It needs a more judgmental approach where we can work with regulators when there are scale, sustainable investment opportunities and look to frame those in the appropriate way, recognizing that from our perspective we want predictable cash flows in our annuity portfolio matching adjustment portfolio because we want to be confident that we’re going to have the money to pay our pensioners overtime.

Anything else from the conference call. Okay. Well, look, we are slightly over 5 past 11. But after a long results season, not everybody — some of them holiday tonight. And I am sure that if you — but thank you very much indeed for coming along. Well, we’ll be hanging around for a few minutes afterwards if anybody wants to catch up. And then I think my journalist call starts at 11:15. But thanks so much for coming along. We’ll catch up soon. Thank you.