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Legal and General - what's going on?

Analysing companies' finances and value from their financial statements using ratios and formulae
TheMotorcycleBoy
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Legal and General - what's going on?

#321487

Postby TheMotorcycleBoy » June 25th, 2020, 5:59 pm

Hi folks,

Despite mainly investing in "growth" stocks, or rather stocks which are a mix of growth/modest income characteristics, I have one or two holdings in stocks which I think fit the "reach for yield" criteria. One of those is Legal and General (LGEN), which constitutes about 3.2% of our total market value. I notice that currently it's yield is rather tantalising. However, is it's dividend and SP safe? Being interested in analysing, well at least attempting to, the financial statements in company Annual Reports I decided to have a dig into LGEN's, and also to root around the internet looking for any gossip.

As some will suspect, the format of LGEN's statements and the nature of their business, makes the figures from this firm very difficult to represent in the "standard company analysis" spreadsheet which I usually like to use, for example their "revenue" figure is not the actual top line of their P&L and worse still, the figure to which they refer to as "Total revenue" becomes "Total income" in the period from 2014-2019. Furthermore LGEN's notion of Operating income seems to be a figure that comes before the total revenue/income. Subsequently I choose to fabricate my own version of their EBIT (operating income/profit to many) by adding back finance costs to PBT. (This may be entirely the wrong approach). Additionally, LGEN's CF statement, especially the "flows due to operations" section, seems to vary a lot from many other presentations: I notice that [1] some entries I usually associate with financing flows, and [2] an entry usually comprising a "from investing" flow also appears in Cash from Operations section.

So I decided to take a new blank sheet and just add any particular significant datas from the past six years worth of ARs, and see what conclusions jumped out at me.



So as we can see the (sort of) top line i.e. "Total Revenue" or what they now call "Total income" seems to be very erratic over the period, but for some reason their Net Earnings (PAT) figure seems to always gradually rise. This seems a little odd, but perhaps there is good reason. However what I find somewhat alarming is the negative position of their "Net cash from operations" figure for both 2018 and the recent 2019 ARs. The most recent seems to be pretty hefty - almost twice the magnitude of that year's earnings.

Whilst I appreciate that many here may hold LGEN in a high regard, I think it's reasonable to be wary of these figures and perhaps question why LGENs business can result in steadily increasing net earnings but these recent net CFO shortfalls. Any ideas anybody?

In addition to my concerns above regarding negative Net CFO for the two consecutive years, I'm curious as what exactly LGEN do and how that can create value. All I knew prior to reading AR2019 (which I've not read much of) about LGEN's business was that of Pensions, Insurance and Asset Management. After scanning the first few pages of this report, I came across these five summary business areas on page 16, which I decided to parse and contemplate for a while:

  1. Institutional retirement
  2. Individual retirement
    Both of the above categories clearly pertain to offer pension fund platforms, exchange pension pots for an annuity and provide pension (and mortgage) advice. Despite hearing that annuity rates are poor (so clearly ppl like LGEN win here) I'm surprised that anything in these areas is particularly lucrative for LGEN. We are now living in times where (apparently) pension fund fees are very low, and hence how much is really left for the providers?

    The big area where all the talk is re. Institutional retirement, it seems is something called "Pension Risk Transfer". Apparently this is just fancy jargon for A.N.Other company passing it's defined benefit pension scheme over to a firm like LGEN. I'm struggling to see why this is such a winner for LGEN...but I'm imagine the employee (whose pension is transferred) is the most likely loser, if there is one. I guess for the company, for a one-off known cost, they are rid of an obligation, and for the likes of LGEN - I'm not sure, do they still get any predictable cash flows due to remaining employees (who were on the transferred DB scheme) or must they be content with value of the pot they have just bought i.e. potential profits from any investments therein and residual monies where the holder/spouse die?
  3. Investment management
    From the AR there seems to be a lot of overlap here from investments required to back the DB, DC and PRT pension schemes mentioned above. There also some mention of provision of "regular" investment funds, presumably for retail customers.

    All 3 of the above would appear to be areas where LGEN is managing other people's money, so presumably any margin they make must be fee-based, which is increasingly competitive.
  4. Insurance
    I can understand why this business is potentially lucrative nowadays, since by using sophisticated probalistic algorithms LGEN can extract premiums whose total from the entirety of the people being insured, will significantly exceed liabilities. So whilst Black Swan type events (e.g. pandemics!) can potentially upset the rosiness of picture, I imagine that by and large, surplus monies and "float", must give LGEN ample funds to invest and magnify their profits.
  5. Capital investment
    As mentioned above it would appear that LGEN can easily move money around their business, and indeed the fee-based profits and surplus insurance premium can too provide the capital for investing in the markets or in various "projects" such as the urban regeneration, infrastructure, housing, and clean energy to which they refer in their AR.
With the above said it seems that LGEN's business if managed with an eye on costs, should be a profitable one, able to deliver good shareholder returns. However some concerns persist in my mind. Firstly given the apparent gravy train why the stonking cash from operations shortfalls over the past two consecutive years? Last year's loss looks particularly big....Also given that a part of their capital investment business looks really just like a lender, how will they make profit over this year and the next in this environment of almost zero or negative bank rates which are practically global now?

Furthermore making profitable investment (as we all know) is going to be much harder, and less predictable and require taking on more risk for the foreseeable. From a glance at the table in the post above we can see that in previous years a massive chunk of LGENs cash flows actually derive from dividends. How will this look in their next statement?

Possibly, just a rumour but it appears there is speculation that LGEN are currently sitting on some big losses on the bond markets. I don't how true this is, and whilst it's easy to find many references to this, presumably all the outlets are getting their feed from the same source.

Finally we see like others LGEN taking on more debt now. Is this to be ensure that they can cover the commitment to their promised dividend?

So whilst I am probably not for reducing my LGEN position right now, after taking another look at their business and reading around I don't plan on topping up despite their currently good yield. I may dig around some more, but I'm curious if anyone here either knows more about their business, for example why they account as they do or has more information on their recent ups and downs.

thanks Matt

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Re: Legal and General - what's going on?

#321497

Postby bluedonkey » June 25th, 2020, 6:14 pm

Just a general reply I'm afraid. Years ago when I did try to familiarise myself with insurance P&L's, the overall report usually boiled down to:
Profit = Underwriting Profit (actually usually loss) + Investment Profit.
Sorry not to be more help.

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Re: Legal and General - what's going on?

#321642

Postby xbigman » June 26th, 2020, 7:57 am

A big part of L&G's business is either annuities or running pension schemes. These provide a steady profit from year on year fees but the real payoff comes when those receiving the annuity/pension die. Then the assets backing the annuity/pension go straight to L&G's bottom line as profit. This makes it impossible for small investors to calculate what is going on because we never see the actuarial calculations at the heart of the business.

Given the number of pensioners that died this year I suspect we will see L&G report every part of the business that generates cash is trashed, but then they will reveal record profits.
I can provide zero evidence of this but it does seem to be the way it works.

I hold.


Darren

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Re: Legal and General - what's going on?

#321646

Postby TheMotorcycleBoy » June 26th, 2020, 8:17 am

bluedonkey wrote:Just a general reply I'm afraid. Years ago when I did try to familiarise myself with insurance P&L's, the overall report usually boiled down to:
Profit = Underwriting Profit (actually usually loss) + Investment Profit.
Sorry not to be more help.

Is Insurance underwriting usually a loss then?

That is

TOTAL_PREMIUMS_RECEIVED  - TOTAL_INSURANCE_CLAIMS = less than zero

?

I must say I'm surprised.

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Re: Legal and General - what's going on?

#321647

Postby Alaric » June 26th, 2020, 8:21 am

TheMotorcycleBoy wrote:Is Insurance underwriting usually a loss then?

That is

TOTAL_PREMIUMS_RECEIVED  - TOTAL_INSURANCE_CLAIMS = less than zero



That's general insurance, cars, household etc. If claims can take years to settle, invested funds and thus investment earnings can become substantial.

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Re: Legal and General - what's going on?

#321649

Postby TheMotorcycleBoy » June 26th, 2020, 8:30 am

Alaric wrote:
TheMotorcycleBoy wrote:Is Insurance underwriting usually a loss then?

That is

TOTAL_PREMIUMS_RECEIVED  - TOTAL_INSURANCE_CLAIMS = less than zero



That's general insurance, cars, household etc. If claims can take years to settle, invested funds and thus investment earnings can become substantial.

So is it your belief that Insurance underwriting usually generates a profit?

i.e.

TOTAL_PREMIUMS_RECEIVED  - TOTAL_INSURANCE_CLAIMS = a big positive number

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Re: Legal and General - what's going on?

#321651

Postby scrumpyjack » June 26th, 2020, 8:33 am

Premiums less claims would usually give a very large profit. You've forgotten about expenses and commissions

Premiums - commissions - overheads etc - claims = usually small loss or breakeven

But the investment earnings on the huge pile of cash from premiums is what makes it viable or even attractive. That's what Warren Buffett so likes about insurance, and why he bought lots of insurance companies - he could invest all the cash in other things

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Re: Legal and General - what's going on?

#321654

Postby TheMotorcycleBoy » June 26th, 2020, 8:40 am

xbigman wrote:A big part of L&G's business is either annuities or running pension schemes. These provide a steady profit from year on year fees but the real payoff comes when those receiving the annuity/pension die. Then the assets backing the annuity/pension go straight to L&G's bottom line as profit. This makes it impossible for small investors to calculate what is going on because we never see the actuarial calculations at the heart of the business.

Given the number of pensioners that died this year I suspect we will see L&G report every part of the business that generates cash is trashed, but then they will reveal record profits.

Whilst I am taking what you say in, my currently view is that the figure "Cash from Operations" is derived by starting off with a business's profit and then reconciling this against working capital changes and non-cash charges.

(I need to look more into their reconcilation process I guess)

So it still doesn't seem that healthy for this to be negative excepting the occasional year. (I noticed that the sum of "Cash from investing" and "Cash from financing" is also unsurprisingly negative).

The next thing for me to look at, I suppose, is further back in time to see if LGEN reporting -ve net CFOs is a frequent occurance.

scrumpyjack wrote:Premiums less claims would usually give a very large profit. You've forgotten about expenses and commissions

Premiums - commissions - overheads etc - claims = usually small loss or breakeven

I get it - makes sense.

But the investment earnings on the huge pile of cash from premiums is what makes it viable or even attractive. That's what Warren Buffett so likes about insurance, and why he bought lots of insurance companies - he could invest all the cash in other things

That's what I'd think. Which makes me curious about the differences across various periods.

Matt

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Re: Legal and General - what's going on?

#321655

Postby Alaric » June 26th, 2020, 8:43 am

TheMotorcycleBoy wrote:So is it your belief that Insurance underwriting usually generates a profit?


Don't include Legal & General, they don't write much general insurance.

Whether the likes of Direct Line, Admiral etc make an underwriting profit probably varies over time depending both on claim experience and how competitive they need to be to attract business.

Regarding L&G and its annuity business, a traditional approach to values and prices of annuities is this

Value of annuity = sum for each future period of the probability of making a payment multiplied by a discount factor based on investment returns.

Thus two sources of profit. Longevity, or rather the lack of it, that less payments are made than expected and better investment returns than anticipated. Those won't be equity returns rather it would be profits on bonds if defaults are avoided.

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Re: Legal and General - what's going on?

#321659

Postby ReallyVeryFoolish » June 26th, 2020, 8:50 am

Alaric wrote:
TheMotorcycleBoy wrote:So is it your belief that Insurance underwriting usually generates a profit?


Don't include Legal & General, they don't write much general insurance.

Whether the likes of Direct Line, Admiral etc make an underwriting profit probably varies over time depending both on claim experience and how competitive they need to be to attract business.

Regarding L&G and its annuity business, a traditional approach to values and prices of annuities is this

Value of annuity = sum for each future period of the probability of making a payment multiplied by a discount factor based on investment returns.

Thus two sources of profit. Longevity, or rather the lack of it, that less payments are made than expected and better investment returns than anticipated. Those won't be equity returns rather it would be profits on bonds if defaults are avoided.

I rather imagine that when L&G take on massive future commitments like the old ICI pension fund, they are tough negotiators. They will load the dice in their own favour as much as possible whilst still attracting the long term multi-billion £ mandate(s). It could be that all parties actually benefit, unusual, but it could be the case. Happy to hold LGEN myself.

RVF

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Re: Legal and General - what's going on?

#321661

Postby scrumpyjack » June 26th, 2020, 8:52 am

There is a lot of scope, particularly in long tail insurance, for management 'judgement' on what reserves are required for future claims.

The Lloyd's Insurance market was brought to the point of collapse because it transpired that they were woefully under reserved in respect of many decades old liabilities re asbestosis.

The other side of that coin is that frequently you will see releases of reserves substantially bolstering current year profits of an insurance company.

There can be a lot of scope for current year profits to be 'set' at the level management want.

You really want to have confidence in the integrity and conservatism of the management of any insurance company you invest in.

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Re: Legal and General - what's going on?

#321663

Postby Alaric » June 26th, 2020, 9:01 am

ReallyVeryFoolish wrote:I rather imagine that when L&G take on massive future commitments like the old ICI pension fund, they are tough negotiators. They will load the dice in their own favour as much as possible whilst still attracting the long term multi-billion £ mandate(s). It could be that all parties actually benefit, unusual, but it could be the case.


The sting in the tail for Companies that ran defined benefit schemes was that they became the underwriter of last resort of the benefits in the scheme. A disaster might never happen, but perhaps better to pay the likes of L&G to take the risk away.

For L&G a useful feature about investing funds raised by selling annuities, as distinct from offering a Bond fund is that they can invest without liquidity concerns that the investors will demand their money back.

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Re: Legal and General - what's going on?

#321675

Postby Dod101 » June 26th, 2020, 9:31 am

The first thing I would say is do not confuse life insurance/fund management with general insurance such as scrumpyjack refers to. L & G sold its general insurance business last year. The point of their buying old books of defined benefit schemes (mostly closed) and annuity books is much the same as with the zombie life companies like Phoenix and Chesnara. They are obliged to hold very large surplus reserves against these liabilities and then as the members inevitably die, the reserves attaching to the liabilities can be released and fall in to the lap of L & G as profit. This point has already been alluded to higher up the thread.

No doubt they will have losses on some of their bonds and they were challenged on this last month by UKSA (they ignored the question at the time and went on to pay their final dividend) More recently (mid June) they issued an RNS in which they said

'' Legal & General’s balance sheet is strong and the solvency ratio is robust. We expect our shareholder solvency ratio at half year to be in a range of 162% to 167% and a surplus over the Solvency Capital Requirement (SCR) of circa £6 billion. These estimates do not include the proposed RT1 debt issuance, and assume unchanged market conditions to the end of June.

Our £76.9 billion annuity portfolio1 continues to outperform markets on downgrades and defaults due to thoughtful asset allocation and active asset management. For example, we have limited exposure to airlines, hotel, leisure and traditional retail which together represent less than 2% of our portfolio2.

Downgrades within investment grade have minimal impact on our solvency ratio. Our defensive positioning has meant that we have outperformed the downgrade experience of the market, with just 0.65% of our traded credit portfolio (excluding gilts) downgraded to sub-investment grade.3 While we have had no defaults year to date, our balance sheet remains underpinned by a credit default reserve of £3.2 billion2. The annuity portfolio’s direct investments continue to perform strongly, with 99% of scheduled cash-flows paid year to date, reflecting the high quality of our counterparty exposure.''

You either believe that or not but I chose to believe them, based on their past record

Undoubtedly life insurance companies' accounts are obscure and that is why I do not try very hard to understand them. I prefer to accept their past record, having held them for 25 years. I first bought them in August 1995 and have held them continuously since.

Dod

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Re: Legal and General - what's going on?

#321734

Postby 77ss » June 26th, 2020, 11:08 am

[quote="TheMotorcycleBoy"].....However what I find somewhat alarming is the negative position of their "Net cash from operations" figure for both 2018 and the recent 2019 ARs. The most recent seems to be pretty hefty - almost twice the magnitude of that year's earnings.

..../quote]

I suspect that you may be are overanalysing - or underanalysing!

The "Net cash from operations" figure is bound to vary wildly from year to year, being the total of some very large sums (both +ve and -ve). For detail, check out:

https://www.investegate.co.uk/legal---3 ... 00089181E/

Rightly or wrongly, this is not something that concerns me.

I have held LGEN since 2008 - others here will have had it for a lot longer. It suffered badly in the financial crash, but made an impressively speedy recovery. Unlike many other companies.

The current 8% yield is tempting/dangerous - you pay your money.....

FWIW, I have increased my holding by 40% this month. We shall see.

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Re: Legal and General - what's going on?

#321752

Postby Dod101 » June 26th, 2020, 11:42 am

77ss wrote:I have held LGEN since 2008 - others here will have had it for a lot longer. It suffered badly in the financial crash, but made an impressively speedy recovery. Unlike many other companies.


I do not think it suffered badly in the financial crash of 2008/9 which is why it 'recovered' so quickly. It cut its dividend but that I think had more to do with appearances than anything else.

Dod

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Re: Legal and General - what's going on?

#321759

Postby flyer61 » June 26th, 2020, 11:54 am

Lots of good points coming out about LGEN but I cannot help but think there is a clear big picture here.

The Government swatted the banks at the beginning of this crisis and has attempted the same with the insurers. LGEN paid their dividend even though the likes of AVIVA who tell us they are in a very strong position did not. The 8% dividend yield is telling you expect the Government or it's tentacles to be along to help itself in one form or another. You will have to wait for that threat to recede before there is any meaningful price appreciation.

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Re: Legal and General - what's going on?

#321765

Postby scrumpyjack » June 26th, 2020, 12:06 pm

Whenever the markets fall sharply, insurers fall far more sharply and go to very high historic dividend yields. I recall buying LGEN at 27p back in the 2008 panic.

As the panic subsides and markets come round to the view that it is not the end of the world, they bounce back very sharply.

Of course one of these bear markets might eventually turn out to be the end of the world (financially)

One could say banks are much the same, except they they don't bounce back but stay at the new lower level :D

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Re: Legal and General - what's going on?

#321872

Postby TheMotorcycleBoy » June 26th, 2020, 4:28 pm

77ss wrote:I suspect that you may be are overanalysing - or underanalysing!

Definitely underanalysing! I wish I had the time to investigate all our investments. But like many I take most at their word. However I've did briefly follow that link you referred i.e.



Clearly the reason their Net CFO is a large negative, is because their Gross CFO is even more so, and the cash they made from interest and dividend could not swallow this.

I *believe* that their gross cash is in the red because they spent a large amount on investments in the financial and property markets in the Year of 2019 (NB. not in 2020, the Covid year). I've emphasised what I think were the monies they spent[1] in red in the table above. Clearly these spends (on assets which *could* be worth less now) exceeded by a significant margin the stuff [2] on the liability side. Sorry I've got had quite the time to fully figure all this out - and I'm certainly not a time-rich expert - so probably won't! In fact I want to look at another firm over the weekend so won't spend much more time on this one for now, I don't think.

Matt

[1] But I'm no expert so don't take my word for any of this.
[2] Ok, techical term here, but I'm still getting to grips with comparing LGEN cash flows to more regular (e.g. engineering) firms.
Last edited by TheMotorcycleBoy on June 26th, 2020, 4:41 pm, edited 4 times in total.

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Re: Legal and General - what's going on?

#321877

Postby TheMotorcycleBoy » June 26th, 2020, 4:36 pm

"Finally" I went back a few more years, to discover that LGEN's Net CFO is usually positive.


Matt

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Re: Legal and General - what's going on?

#321972

Postby flyer61 » June 27th, 2020, 9:40 am

Matt, you are probably on to it. Potentially investing in areas which they do not have any particular expertise where the assets and returns going forward are probably 'murky' at best.


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