31 MARCH 2015ALEXANDER FORBES GROUP HOLDINGS LIMITEDINTEGRATED ANNUAL REPORT
Group Chief Financial Officer's report
Financial highlights and challenges
The financial year ended 31 March 2015 has been a year in transition; our listing on the JSE on 24 July 2014 marked the end of seven years of private equity control and the beginning of a new era as a publicly listed entity with a strong cornerstone investor. Despite this considerable corporate activity, the group grew in all its operating segments and continued to invest in people and processes. Today, Alexander Forbes provides a solid platform to respond to the changing needs of our clients, thereby ensuring our own growth and sustainability ambitions which we are confident of achieving.
In 2014/15, the group generated net operating income (NOI) of R4.9 billion and profit from continuing operations (PCO) of R1.1 billion, compared with R4.3 billion and R1.0 billion respectively in 2013/14. This shows healthy growth of 12% in NOI and 10% in PCO. In 2014/15, 63% of the group's NOI and 76% of PCO (excluding property lease) were derived from the South African operations, 6% of NOI and 5% of PCO from the sub-Saharan African (excluding South Africa) operations, and 31% of NOI and 19% of PCO from the non-African (primarily UK) business.
A review of the group's portfolio of businesses in support of its strategic focus has resulted in various corporate actions over the past number of years. The final material disposal of the Guardrisk business was concluded on 3 March 2014 and the board approved management's recommendation to dispose of the Alexander Forbes Compensation Technology business in March 2015. This business has therefore been recorded as discontinued in the current year's results. The businesses that were treated as discontinued operations at the end of the previous financial year were materially disposed of during the year under review, with the exception of LCP Belgium, which is expected to be disposed of in the first quarter of the new financial year.
Five-year trend analysis of net operating income and operating profit from continuing operations
Net operating income from continuing operations (Rm)
Net revenue growth
Profit from continuing operations (Rm)
Operating profit growth
Operating margin (on net operating income)
Performance of continuing operations
The group's results from continuing operations for the financial year ended 31 March 2015 continued to show solid growth.
Gross revenue from operations is a good measure of the size of the group's operations. The group's gross revenue from continuing operations, including insurance premium earned, increased from R6.6 billion in 2013/14 to R7.2 billion in the current year (9%).
net operating income
Net operating income (NOI) consists of income earned net of direct expenses such as underlying asset manager fees paid by Investment Solutions and reinsurance premiums paid by the short-term and long-term insurers in the group. The group generates NOI primarily from two sources: commissions and fees for services rendered; and net underwriting profit from the risk-taking activities of the insurance operations.
We use NOI as the more appropriate measure of the income for financial analysis.
The group continued to show good growth in NOI across its continuing operations in 2014/15. Net operating income increased by R513 million, or 12%, from R4.3 billion in 2013/14 to R4.9 billion in 2014/15, primarily due to strong new business flows in the South African and AfriNet Financial Services businesses and Investment Solutions benefiting from good new business flows and strong equity market performance. The weakening rand exchange rate had a positive effect (2.4%) on revenue contribution from the international operations for the year.
The strategy to grow the group's retail operations continued to show good progress, with combined net operating income from retail clients increasing by 12%.
Operating expenses (excluding non-trading and capital items) of continuing operations increased by R406 million, or 12%, from R3.3 billion in 2013/14 to R3.7 billion in 2014/15, which includes the impact of the weaker rand when converting the expenses incurred in pound sterling to the reporting currency.
The group continues to balance disciplined cost management in the established business areas with investment and capacity building in the strategic growth areas. Apart from the impact on expenses resulting from the weaker exchange rate, the increase in operating expenses in 2014/15 was primarily due to further investment in the strategic growth areas of the group, including the appointment of further new business consultants in AFI and financial planners and advisers supporting the retail strategy.
In addition, the group has experienced a significant increase in regulatory compliance and related costs in preparation for, among others, the introduction of the Solvency Assessment and Management (SAM) regulatory regime, the Protection of Personal Information Act (POPI), Treating Customers Fairly (TCF), and various new developments in regulation and legislation. The recent disposals of businesses resulted in some shared services costs, previously absorbed by those businesses, having to be absorbed by the remaining continuing operations of the group.
Further, 2014/15 also reflects the impact resulting from the prescribed method used to account for operating leases. In terms of IFRS the annual contractual rent escalations, despite being market-related, are required to be accounted for on a straight-line basis over the term of the lease. This increases the lease cost in the first half of the 12-year rental period and reduces the lease cost in the latter half of the rental period.
The impact on the current year amounted to R40 million (2014: R47 million) and is isolated in the segmental results from operations.
Segmental analysis of operating profit from continuing operations before non-trading items
2014 – 2015
Alexander Forbes Financial Services SA
Alexander Forbes Insurance
Total continuing operations (Rm) excluding property lease
The above results also include the impact of accounting for the new share-based long-term management incentive and remaining amortisation of deferred compensation of transaction incentives totalling R32 million (3% negative growth impact). In the prior year, these incentives were largely ownership-based.
profit from continuing operations
Profit from continuing operations increased by R107 million, or 10%, from R1 030 million in 2013/14 to R1 137 million in 2014/15.
Investment income includes income of R103 million (2014: R162 million) related to individual policyholder funds in Investment Solutions that are liable for fund-level taxes and for which an equal tax liability is raised. This income should theoretically be excluded when assessing the group's own investment income, which largely relates to return on assets backing regulatory capital adequacy requirements. Excluding the policyholder income, the group's investment income amounts to R123 million for the year.
The significant changes to the group's capital structure which became effective on 31 March 2014, the last day of the previous financial year, are reflected in the income statement below the profit from operations. When comparing to the prior year, it should therefore be borne in mind that the comparative period includes interest paid on the previously highly leveraged capital structure. Finance costs for the period amount to R119 million compared to the R843 million of the previous year.
Accounting for Alexander Forbes shares held in policyholder investment portfolios
In terms of IFRS as presently constituted, any Alexander Forbes shares acquired by underlying asset managers and held by the group's multi-manager investment subsidiary for policyholders (the shares) are required to be accounted for in Alexander Forbes' consolidated financial statements as treasury shares and the elimination of any fair value gains or losses made on the shares.
This accounting treatment results in fair value movements in respect of linked investment policy assets and liabilities that would normally be offset (and which, economically, should be offset) no longer being matched in the income statement. The resultant mismatch between the asset and liability movement does not reflect the economic substance of the transactions. The result of this mismatch is that an accounting expense or gain will be reported in Alexander Forbes' consolidated income statement, whereas no actual economic loss or gain will ever be realised by the group. The reported loss of R26 million arising from the accounting for policyholder investments as treasury shares for the reporting period since listing is separately disclosed on the face of the income statement.
Profit before taxation from continuing operations
After non-trading items, finance charges and the effect of the policyholder investments explained above, the group's profit before taxation from continuing operations of R866 million shows a significant increase from the R317 million of the previous financial year.
The effective tax rate compared to profits before tax appears high as a result of taxation payable on behalf of policyholders being included in this amount (refer to the investment income discussion), resulting in an after-tax profit of R505 million compared to a loss of R167 million in the previous year.
Normalised profit from continuing operations
The profit after tax from continuing operations should be viewed in the context of:
non-trading costs related to the transition from the private equity shareholding structure and listing of the group;
the change in capital structure of the group on 31 March 2014 which impacts on the comparison to prior year; and
the requirements for accounting under IFRS for certain transactions which do not necessarily reflect the underlying economic substance of the transactions.
In order to facilitate proper comparison of results, we highlight various items to consider when analysing our results for the year. These normalisation items should be considered individually and collectively depending on the purpose of normalisation.
A normalised income statement for the group
Operating income net of direct expenses
Profit from operations before non-trading and capital items
Non-trading and capital items
Loss from policyholder investments as treasury shares
Share of net loss of associates (net of income tax)
Profit before taxation
Income tax expense
Profit/(loss) from continuing operations
The adjustments are summarised as follows: Non-trading items include the following:
Transaction costs incurred during the current financial year amounting to R50 million. These costs were detailed in the pre-listing statement. Included in the prior year are transaction costs amounting to R60 million which relate to the capital restructure.
Culmination of historical incentive costs in the current year amounting to R99 million. These costs were also detailed in the pre-listing statement and include the exit transaction incentive and 2011 executive long-term incentive plan.
Management Share Trust payment agreement amounting to R58 million which resulted from the capital restructure in the previous year and the leveraged Management Trust shareholding. Details of the structure and payments are included in notes to the annual financial statements.
Normalisation adjustment for the results of the professional indemnity cell recorded in the prior year and in the current year. This result will typically be highly variable from year to year as it reflects the result of developments and assessment of a number of claim years with open claims. However, expectation is that this result should trend to zero if measured over the medium to long term.
Accounting adjustments include the following:
An adjustment for the IFRS accounting treatment for operating property leases. This adjustment is explained in the discussion of operating expenses above and amounts to R40 million in the current year (2014: R47 million).
An adjustment of the accounting for individual policyholder funds in Investment Solutions that are liable for fund-level taxes and for which an equal tax liability is raised.
The accounting for Alexander Forbes shares acquired by underlying asset managers and held by the group's multi-manager investment subsidiary for policyholders (the shares) as explained here.
The amortisation of intangible assets amounting to R131 million for the year is a result of the capitalisation of intangible assets and related amortisation required at the time of the private equity acquisition of the group in 2007. The holding company that was established at the time remains in existence (and is now the listed entity); the amortisation will continue as long as it is required to amortise the remaining asset balance to zero. The useful lives of the various assets determined at the time of the exercise varied from eight to 20 years. The amortisation is a non-cash accounting item.
Change in capital structure adjustment includes the following:
A pro forma adjustment to the comparative number for the historical interest expense which was incurred under the private equity structure. The adjustment to prior year interest cost amounts to R700 million. The interest adjustment is calculated based on a term loan balance that would have been held during the year, resulting in the actual closing term loan balance given the cash generated during the year.
Quality and sustainability of revenues and profits
The following charts demonstrate the stable nature of the group's net operating income based on the year ended 31 March 2015.
Net operating income by type
Approximately 77% of Alexander Forbes' revenue base is recurring or predictable in nature, with approximately 8% representing net underwriting profits in FY2015. The recurring fee income comprises asset-based income (approximately 34%), fee income from services rendered to clients, monthly administration (either on a fee per member or a percentage of salary contribution basis), consulting fees and commission income.
Other than the indirect exposure to equity markets, there is limited volatility in the group's revenues due to the relatively low proportion of one-off consulting fees, ad hoc retirement fund administration services and underwriting income.
As a material proportion of the group's income is linked to pension contributions, we benefit from the macro-economic drivers affecting employment and wage inflation which have been low but positive in recent years.
Net operating income by business unit (%)
Alexander Forbes has limited working capital requirements with high cash flow generation and limited credit risk exposure in the business as a significant proportion of our income is collected from the retirement funds and investments it administers. Our exposure to debtors remains limited as investments into retirement funds and investment products are made only once funds are received from clients and payments to clients are made only once funds are received from redeemed investments.
Alexander Forbes' capital expenditure requirements, relating mainly to IT investments, are relatively stable and predictable, and have historically been in line with depreciation. The strategic investment in the retail market has increased the demand for greater technology solutions during the current year, an increase in capital expenditure that is likely to continue in the near future.
The group completed the sale of Guardrisk in March 2014 for R1.6 billion. In addition to the discontinuance of LCP Belgium reported in the previous year which is still in process, the board has approved a strategic decision to dispose of the Alexander Forbes Compensation Technologies business. The process of this disposal of the business is underway. As a result of this decision, the operating results of the division have been reclassified to discontinued operations and the carrying value of goodwill allocated to this cost- generating unit has been impaired.
On 31 March 2014, the group completed a comprehensive capital restructure. The rationale for this restructuring was to:
optimise and simplify our capital structure;
ensure compliance with upcoming regulatory changes, most notably the proposed introduction of consolidated supervision;
align the company's shareholder interests in the group capital structure; and
facilitate the realisation of their investment by the company's shareholders in due course.
The restructure was aimed at redeeming substantially all remaining debt instruments and preference share instruments in the funding structure of the group and replacing such outstanding amounts with ordinary equity. The unsecured single layer of term debt which was introduced at the time of the restructure was negotiated in the current year to include a revolving credit facility component. This facility is renewable annually for a 12-month period.
The capital restructure at the end of the previous year achieved exactly what was planned and positions the group well for compliance with regulatory capital requirements.
Under the current FSB rules, a minimum level of solvency is required to be held within each insurance subsidiary to meet the regulatory capital adequacy requirements (CAR). For the long-term insurance subsidiaries, the CAR is calculated to determine whether the excess of assets over liabilities is sufficient to provide for the possibility of actual future experience departing from the assumptions made in calculating the policyholder liabilities and against fluctuations in the value of assets.
The new SAM regime, which will be implemented on 1 January 2016, will impose more stringent regulatory requirements on both long-term and short-term insurers, requiring them to maintain adequate solvency capital based on risks faced on a day-to-day basis. This is likely to have a positive impact on Investment Solutions given that it assumes no insurance underwriting – provided that the business will be allowed by the regulator to use internal models for capital determination. Any such approval is only expected to become effective some time after the introduction of SAM.
The following CAR and cover ratios are maintained by our insurance entities:
Under the broader SAM framework, the group will also be subject to regulation by the FSB at the ultimate holding company level. The group deliberately positioned itself through the capital restructure to target regulatory compliant solvency at 31 March 2015. Despite regulatory changes through the year which increased the requirements, the current group surplus is estimated at approximately R100 million under the SAM standard formula basis.
The FSB has the right, after consultation with the insurer, to impose a capital add-on where the risks, including those posed by the non-regulated entities, are not adequately taken into account in the group capital adequacy or deduct the value of holdings in non-regulated entities from the capital resources of the insurance legal entities in the group. Consolidated supervision is likely to become effective in January 2016.
Shareholder performance measures
Being a newly listed public group, management is keenly aware of shareholder performance measurements. The historical capital structure was not conducive to the standard measures, and as a result no historical trend is provided. However, trends all have a beginning and, as such, the following performance measures are calculated:
Mar 2015 Actual
Earnings per share (cents)
Headline earnings per share (cents)
Return on equity* (%)
Total shareholders' returns (%)
Return on capital employed (%)
This measure is distorted by the 2007 capitalisation of goodwill and intangible assets brought to account upon the acquisition of the group by Private Equity shareholders.
A dividend has been declared taking onto account the group's current and projected regulatory capital position. The group's strategy to build a significant retail business will demand additional capital investment; however, this is expected to be provided through ongoing earnings and cash generation of the group. A dividend of 12 cents per share is payable to shareholders recorded on 3 July, with the payment being made on 6 July 2015.
This dividend must be viewed in the context of the group's transition to the anticipated new regulatory capital requirements under SAM. The long-term dividend guidance provided at the time of listing of 2 to 1.5 times dividend cover remains in place.
The strategic repositioning and refocusing of the group is substantially complete. The group is now exceptionally well-positioned to continue to strengthen its core businesses and related market positions even further and to drive its growth strategies with clear focus.
The group capital structure positions the group well to operate under a fast changing and more demanding regulatory environment and provides a simplified and more flexible financial position. The group will continue to manage the balance between allocating resources and capacity for long-term growth versus maintenance of short-term objectives.
We continue to make progress in achieving our short-term goals. The results, both financial and non-financial, confirm that our strategic choices are valid and, with greater focus and execution, will deliver shareholder value. Although we acknowledge the challenges that lie ahead, our bias for top-line growth, while optimising operational efficiencies and sustainable organisational integrity, remains unchanged.