Legal & General Group PLC's Core Subsidiaries 'AA-' Ratings Affirmed After Insurance Criteria Change; Outlook Stable

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1 Research Update: Legal & General Group PLC's Core Subsidiaries 'AA-' Ratings Affirmed After Insurance Criteria Change; Outlook Stable Primary Credit Analyst: Simon Ashworth, London (44) ; Secondary Contact: Mark Button, London (44) ; Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria And Research Ratings List MAY 30,

2 Research Update: Legal & General Group PLC's Core Subsidiaries 'AA-' Ratings Affirmed After Insurance Criteria Overview Following a review of U.K.-based Legal & General Group (L&G) under our revised insurance criteria, we are affirming our 'AA-' ratings on the group's core subsidiaries. The ratings predominantly reflect our view of the group's very strong business risk profile, based on its very strong competitive position largely through its U.K. operations, and its very strong financial risk profile. The stable outlook mainly takes into account our view that the group will continue to maintain its diverse competitive position in the U.K. market and that its profitability is above average compared with levels in the U.K. life market. Rating Action On May 30, 2013, Standard & Poor's Ratings Services affirmed its 'AA-' long-term insurer financial strength and counterparty credit ratings on U.K.-based Legal & General Group's (L&G) core subsidiaries. At the same time, we affirmed our 'A/A-1' long- and short-term counterparty credit ratings on holding company Legal & General Group PLC. The outlooks are stable. Rationale The ratings reflect our view of the group's very strong business risk profile and very strong financial risk profile, built on a very strong competitive position and very strong capital and earnings. We combine these factors to determine an anchor of 'aa-' for L&G. The anchor and the long-term ratings are at the same level because we view management and governance and enterprise risk management (ERM) as neutral rating factors and liquidity as exceptional. L&G faces low industry and country risk based on our assessment of the U.K. life insurance market as low risk. We also factor in our positive opinion of the institutional framework and the market's strong track record of minimizing asset-liability mismatches. We consider the market to be highly competitive, but nevertheless believe that profitability will generally remain moderate. The current wave of regulatory change in the U.K. market, including the Retail Distribution Review and auto-enrolment, and to a lesser extent Solvency II, MAY 30,

3 may influence L&G's business risk profile over the next two years. However, as a multi-distributor with a broad product range, the group is less vulnerable to changes in regulation and consumer buying preferences than many peers. We assess L&G's competitive position as very strong. In our opinion, L&G retains one of the most favorable business risk profiles in the U.K. life sector through its expertise across products--including its market-leading risk and asset management operations. It also has a multichannel distribution model, a respected brand, and a reputation for good-value products. L&G has strong product and distribution diversity in the U.K. New business sales are increasingly well balanced across product and benefit types, in particular given the synergies between the different business units. This diversity has enabled L&G to manage its business mix and earnings profile, while enhancing returns in a tough market. We believe the strength of L&G's earnings illustrates its competitive advantages, particularly within the U.K. life insurance market. L&G's overseas operations, especially in the U.S., which we assess as core to the L&G group, provide some geographic diversity. The group's strategic focus in the U.S. is on high-end-term assurance through brokers. This narrow focus allows L&G to concentrate on developing an efficient, well-underwritten, and competitive product. Although the U.S operations are increasing in scale and importance to the group, the relative concentration to a single market, namely the U.K., is likely to restrict an upward revision in our assessment of its competitive position. Despite the difficult operating environment, we expect further sales and market share growth in 2013 in the U.K. L&G aims to exploit its current competitive advantages to bolster its market position through a period of regulatory change, which should contribute to this growth. The group focuses on sustainable organic growth and selected bolt-on acquisitions, which we think will leverage and enhance existing competitive advantages, especially across asset management and risk product offerings. L&G's capital and earnings are very strong, in our opinion. We expect retained earnings to be sufficient to fund the group's growth strategy, current capital management, and dividend plans. However, the quality of the group's capital weighs on our assessment of capital and earnings, given that available capital includes sizable proportions of value in force and hybrid instruments. In our base-case scenario, we assume that L&G will continue delivering above-average operating performance compared with the U.K. life market. Our ratings factor in assumptions of an annual return on equity (under International Financial Reporting Standards (IFRS)) of no lower than 13% in 2013 and 2014 and new business margins at about 4%. In our view, L&G's risk position displays intermediate risks, owing to its somewhat low-risk balance sheet. The credit quality of the bond portfolio remained stable in 2012 and the portfolio remains well diversified by geography and sector. Exposure to speculative-grade bonds remains very modest, and shareholder capital remains invested largely in bonds and cash. L&G's MAY 30,

4 robust underlying earnings generation and derisking have improved capital adequacy. L&G's risk profile has evolved over recent years as the group has managed down equity risk and replaced it with risks associated with its growing annuity business. L&G's risk profile is concentrated on risks relating to its annuity business (credit and longevity risks), but we view the group's management of these risks as strong. L&G has strong financial flexibility, in our view, primarily due to proven access to capital markets and the strong ability to service interest charges. The financial leverage ratio was approximately 23% as of year-end We forecast reductions of about 1% per year in the financial leverage ratio over the next two years. L&G's hybrid-equity ratio is lower than 25%, which means the group has room to improve capital adequacy through new issues. Given the group's current capital strength and cash generation, however, we see limited need for additional capital. We forecast the fixed-charge coverage ratio will stay resilient at more than 8x. We view the quality of the group's ERM as adequate with strong risk controls. This is based on our opinion that risk culture and strategic risk management are consistent with a neutral assessment, reflecting the group's focus on IFRS and regulatory solvency metrics rather than on economic considerations in managing the business. In addition, the group is embedding its risk appetite statement and limit framework, its internal model, and risk-based pricing. The group has strong controls for the majority of its risks, including market risk and insurance risk--the most critical for the group. Consequently, we consider it unlikely that the group will experience losses that are outside its risk tolerances. We view the importance of ERM to the rating as high. We assess management and governance as satisfactory. L&G has followed a consistent strategy over many years, although more recently it has focused increasingly on execution and shareholder value. L&G has successfully implemented its strategy through a difficult period for U.K. life insurers, demonstrating the robustness of its strategy and strength versus peers and highlighting robust operational delivery. Overall, we assess risk tolerances as conservative. In our opinion, L&G has exceptional liquidity. It has no debt maturities or call dates on hybrids until June 2015, other than a modest amount of outstanding commercial paper ( 333 million at year-end 2012). We view liquidity risk as low given the liability profile and the focus on products with no surrender risk, such as annuities, and the high proportion of liquid assets. The group continues to maintain sufficient liquid assets and stand-by facilities to ensure it can meet its cash requirements over a two-year period. L&G has the flexibility to draw on a $2 billion commercial paper program and a 2 billion medium-term note program. L&G's liquidity is also supported by a five-year 1 billion revolving credit facility with 21 banks. MAY 30,

5 Outlook The stable outlook takes into account our view that the group will continue to maintain its diverse competitive position in the U.K. market and that its profitability is above average compared with levels in the U.K. life market. In addition, we assume that short-term pressures from regulatory changes in the U.K. life insurance market will affect L&G less than other U.K. peers given the group's diversity. We may lower the ratings if: The group's growth strategy or changes in its capital management plans weakened our view of capital and earnings to strong from very strong; or Operating performance, particularly as reflected by earnings and new business profitability, deteriorated below our current expectations; or The group's competitive position was unexpectedly negatively affected by regulatory changes in the U.K. life insurance market. We view a positive rating action as remote over the next months, but one could arise if: We revised up our assessment of the business risk profile, particularly as the result of unexpected significant and profitable diversification outside of the U.K.; or The group's operating performance sustainably and significantly exceeded the expectations and contribution we factor into the ratings. Ratings Score Snapshot Financial Strength Rating Anchor Business Risk Profile IICRA* Competitive Position Financial Risk Profile Capital and Earnings Risk Position Financial Flexibility AA-/Stable aa- Very Strong Low Risk Very Strong Very Strong Very Strong Intermediate Risk Strong Modifiers 0 ERM and Management 0 Enterprise Risk Management Adequate with strong risk controls Management and Governance Satisfactory Holistic Analysis 0 Liquidity Exceptional Support 0 MAY 30,

6 Group Support 0 Government Support 0 *Insurance Industry And Country Risk Assessment. Related Criteria And Research Related criteria Insurers: Rating Methodology, May 7, 2013 Group Rating Methodology, May 7, 2013 Enterprise Risk Management, May 7, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 Principles Of Credit Ratings, Feb. 16, 2011 Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model, June 7, 2010 Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008 Related research List Of Issuers With Ratings Under Criteria Observation Due To S&P's New Insurers Rating Methodology, May 7, 2013 Standard & Poor's Assigns Insurance Industry And Country Risk Assessments, May 7, 2013 Ratings List Ratings Affirmed Legal & General Group PLC Counterparty Credit Rating Junior Subordinated Banner Life Insurance Co. William Penn Life Insurance Co. of NY Legal & General Assurance Society Ltd. Counterparty Credit Rating Financial Strength Rating A/Stable/A-1 BBB+ AA-/Stable/-- AA-/Stable Legal & General Finance PLC Senior Unsecured* A Commercial Paper* A-1 *Guaranteed by Legal & General Group PLC. Additional Contact: Insurance Ratings Europe; [email protected] MAY 30,

7 Complete ratings information is available to subscribers of RatingsDirect at and at spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at Use the Ratings search box located in the left column. Alternatively, call one of the following Standard & Poor's numbers: Client Support Europe (44) ; London Press Office (44) ; Paris (33) ; Frankfurt (49) ; Stockholm (46) ; or Moscow 7 (495) MAY 30,

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