A new note from analysts Berenberg says that next year’s adoption of IFRS 17 has led to Legal & General announcing a 20-25% reduction in its operating profit.
The firm said that the incoming standard had led to a ‘dominance of annuities’ in Legal & General’s business model, becoming a key factor in the operating profit reduction.
“However,” it wrote, “management was at pains to highlight that this is purely a timing issue regarding the recognition of earnings from insurance products, not a fundamental change in the quantum of earnings generated from insurance products.”
It added: “Additionally, management also reiterated its commitment to deliver on the cumulative capital generation target of £8.0bn- 9.0bn between 2020 and 2024, which it is well on track to achieve, with £4.1bn generated up to H1 2022. Furthermore, the group has clarified that the board is committed to growing the dividend at 5% pa to 2024; however, this is broadly in line with current consensus expectations. We note that solvency remains very strong at 220-225%.”
Berenberg also wrote that it was expected that the transition to IFRS 17 would reduce shareholder equity to around £5.5bn due to the requirement to set up a contractual service margin (CSM). According to the IFRS website, IFRS 17 replaces IFRS 4 and sets out principles for the recognition, measurement, presentation, and disclosure of insurance contracts within the scope of IFRS 17. It is effective for annual reporting periods beginning on or after 1 January 2023 with earlier application permitted as long as IFRS 9 is also applied.
It wrote: “The CSM is essentially a store of future profits held on the balance sheet to be released over time. The leverage of the group will, however, likely reduce if management decides (as other insurers have) to include the CSM in the denominator. While the calculation approach for leverage is yet to be defined, it is worth noting that Fitch has stated that it expects to add CSM, net of tax, to shareholders’ equity.”
Looking forwards, Berenberg predicted that the market would focus on the dividend and capital generation of the group in 2023.
It added: “However, Legal & General shares are likely to continue to lag Aviva’s given the latter’s stronger capital return potential.”
