Higher rates give Legal & General £8bn cash boost

Much of the reporting prior to these results focused on the retirement of Legal & General’s (LGEN) much respected chief executive, Nigel Wilson, who steps down this year after a decade in the job. The news in January obscured Legal & General’s resilience in a high inflation, higher interest rate economic environment. Resilience was clear to see in these results as the company reported a 12 per cent leap in operating profits to £2.52bn, driven by interest rate gains generated by the assets on its balance sheet. With a widening gap between capital generation and the level of its dividend payout, the company now has options for what to do with its surplus, in a way that underlines its importance as one of the FTSE 100’s key income shares.

To illustrate this point, the net surplus over the dividend was £700mn and Legal & General reckons that even with zero growth it will generate £8bn-£9bn of cash and capital through to 2024 – such is the power of rising interest rates. The market environment meant that rates added £9.9bn to Solvency II regulatory capital during the year, giving management confidence that the insurer can ride out any market downturn.

The other impact of rising interest rates is that defined-benefit (DB) schemes are now running surpluses again, and this has shortened the timeline for schemes to organise the transfer of liabilities to the life insurance industry. There was also renewed retail investor interest in the guaranteed income offered by annuities. Against this backdrop, the LGRI segment, which handles prudential transfers, delivered operating profits that were 9 per cent higher at £1.25bn. Writing new business can be capital-intensive for Legal & General, but the average new business strain in these results was below 4 per cent. The company reckons it can continue writing up to £9bn of prudential business each year.

Analysts at RBC Capital Markets said in a note: “bulk annuities are core to L&G’s growth, and it benefits from being able to achieve a higher margin than peers due to the synergies of its in-house capabilities for illiquid asset origination.” The broker noted that the shares currently trade at a 12-month forward yield of 7.8 per cent, a material discount to its 5-year average of 6.7 per cent. Legal & General is valued at a five-year average price/earnings ratio of just 8, slightly behind its global peers. Despite the prospect of new management, maintaining our advice is not a difficult decision. Buy.

Last IC view: Buy, 270p, 9 Aug 2022