Final Results-Part 1

20th Mar 2007 07:03

Friends Provident PLC20 March 2007 PART 1 Friends Provident plc - Preliminary Announcement for the year ended 31 December 2006 Strong 2006 results - three core businesses well positioned and focused on future growth. Group highlights: •Strong growth in UK and International life and pensions - new business profits up 42% with margin improved •Strong international operations with continued growth potential •Accelerated growth plan to turn around asset management +--------------------------+-------------------------------+----------------------------+| | EEV basis* | IFRS basis* |+--------------------------+----------+-----------+--------+---------+--------+---------+| | 2006 | 2005| Change | 2006 | 2005 | Change |+--------------------------+----------+-----------+--------+---------+--------+---------+|Group underlying | | | | | | |+--------------------------+----------+-----------+--------+---------+--------+---------+|profit before tax | £509m| £524m| - 3%| £400m| £224m| +79%|+--------------------------+----------+-----------+--------+---------+--------+---------+|Group profit before tax | £398m| £600m| -34%| £491m| £367m| +34%|+--------------------------+----------+-----------+--------+---------+--------+---------+|Life & Pensions PVNBP | £7,074m| £5,397m| +31%| -| -| -|+--------------------------+----------+-----------+--------+---------+--------+---------+|Contribution to profits | | | | | | ||from Life | | | | | | |+--------------------------+----------+-----------+--------+---------+--------+---------+|& Pensions new business | £204m| £144m| +42%| -| -| -|+--------------------------+----------+----------++--------+---------+--------+---------+|Margin on Life & Pensions | | | | | | |+--------------------------+----------+----------+---------+---------+--------+---------+|new business | 2.9%| 2.7%| +7%| -| -| -|+--------------------------+----------+----------+---------+---------+--------+---------+|Pro forma embedded value | £3,660m| £3,464m| +6%| -| -| -|+--------------------------+----------+----------+---------+---------+--------+---------+|Pro forma embedded value | | | | | | |+--------------------------+----------+----------+---------+---------+--------+---------+|per share | £1.73| £1.65| +5%| -| -| -|+--------------------------+----------+----------++--------+---------+--------+---------+|Underlying earnings | | | | | | |+--------------------------+----------+-----------+--------+---------+--------+---------+|per share | 16.4p| 16.3p| +1%| 17.9p| 8.8p| +103%|+--------------------------+----------+-----------+--------+---------+--------+---------+|Basic earnings per share | 14.6p| 21.2p| -31%| 13.1p| 6.3p| +108%|+--------------------------+----------+-----------+--------+---------+--------+---------+|Dividend per share | 7.85p| 7.70p| +2%| 7.85p| 7.70p| +2%|+--------------------------+----------+----------++--------+---------+--------+---------++--------------------------+----------+----------++--------+---------+--------+---------+ *See notes to editors Philip Moore, group chief executive, said: "We are announcing a strong set of results built around solid operationalperformances in both UK and international life and pensions. We continue topursue our strategy of investing in markets where our competitive advantage ofproviding superior service, innovative products and managing distributionrelationships can really make a difference. "In the UK, we achieved excellent new business profit growth of nearly 70%. InOctober last year, we announced a demanding 2008 target of £180m-£200m for newbusiness profits. Although we remain committed to achieving this target, theproduct mix and, in particular, the level of protection sales, which has beensubdued in recent months, will be critical. It is early days, and we are makingprogress towards our goal, but the prospects for a more challenging protectionmarket, and the impact on our 2008 target, will not be fully understood untillater in 2007. "Both our international businesses have strong growth opportunities. Due to anumber of significant one-off events 2006 saw exceptional sales growth and,while we do not expect to see such strong growth, particularly in the first halfof 2007, we remain extremely confident for the future. "Over 2006 F&C has put the building blocks in place to turn the business around.We have seen a marked improvement in investment performance and have everyconfidence that these steps and the investment and new initiatives announced byF&C last week will put the business back onto a strong growth path in the mediumterm. "Overall, Friends Provident put in a very strong operational performance lastyear underpinned by our continued focus on expense and risk management. Ourapproach remains to invest for profitable growth whilst managing cash in the UK.We are confident that we have three businesses well positioned to deliverexcellent long-term future growth." - Ends - For further information, please contact: Nick Boakes Friends Provident plc +44 (0) 845 641 7814Di Skidmore Friends Provident plc +44 (0) 845 641 7833Vanessa Neill Finsbury Limited +44 (0) 20 7251 3801Alex Simmons Finsbury Limited +44 (0) 20 7251 3801 Ref: H071 Notes to editors: 1. An interview with Philip Moore, group chief executive and JimSmart, group finance director, will be available to view in video, audio andtext formats at www.friendsprovident.com and www.cantos.com from 7.00am today. 2. An analyst presentation will take place at 9.30am today at MerrillLynch Financial Centre, 2 King Edward Street, London EC1. 3. The analyst presentation will be webcast live and can be viewed onthe Friends Provident website: www.friendsprovident.com/results 4. The presentation slides will be available from 9.30am today onwww.friendsprovident.com/presentations 5. Friends Provident media image library is available atwww.friendsprovident.com/imagelibrary. A Newscast login is required. Financial reporting dates Dividend dates:Shares go ex dividend 11 April 2007Record date 13 April 2007Dividend paid 29 May 2007 Financial Reporting Calendar:Friends Provident quarter 1 Life & Pensions new business 27 April 2007F&C Asset Management plc quarter 1 funds under management 27 April 2007Friends Provident plc Annual General Meeting 24 May 2007F&C Asset Management plc interim results 6 August 2007Friends Provident plc interim results 8 August 2007F&C Asset Management plc quarter 3 funds under management 30 October 2007Friends Provident quarter 3 Life & Pensions new business 30 October 2007 7. European Embedded Value (EEV) underlying profit is a measure ofprofit which excludes profit generated within policyholder funds that is notallocated to shareholders. Management consider that underlying profit betterreflects the performance of the Group and focus on this measure of profit in itsinternal monitoring of the Group's EEV results. EEV underlying profit is basedon expected investment return and excludes: (i) amortisation and impairment ofAsset Management acquired intangible assets (ii) effect of economic assumptionchanges (iii) non-recurring items; and is stated after deducting interestpayable on Step-up Tier one Insurance Capital Securities (STICS). 8. International Financial Reporting Standards (IFRS) underlyingprofit is a measure of profit which excludes profit generated withinpolicyholder funds that is not allocated to shareholders. Management considerthat underlying profit better reflects the performance of the Group and focus onthis measure of profit in its internal monitoring of the Group's IFRS results.IFRS underlying profit is based on longer-term investment return and excludes:(i) policyholder tax (ii) returns attributable to minority interests inpolicyholder funds (iii) non-recurring items (iv) amortisation and impairment ofacquired intangible assets and present value of acquired in-force business; andis stated after deducting interest payable on STICS. 9. Pro forma embedded value is the shareholders' equity on an EEVbasis, adjusted to bring the value of F&C to market value. 10. New business sales are reported on the Present Value of New BusinessPremiums (PVNBP) basis, which represents new single premiums plus the expectedpresent value of new business regular premiums. 11. Underlying earnings per share is based on the EEV/IFRS underlyingprofit after tax attributable to ordinary shareholders of the parent company. 12. The Internal Rate of Return (IRR) is equivalent to the discount rateat which the present value of the after tax cash flows expected to be earnedover the lifetime of the business written is equal to the capital invested tosupport the writing of the business. All assumptions and expenses in thecalculation of IRR are consistent with those used for calculating thecontribution from new business. 13. The Payback Period is the time at which the value of the expectedcash flows, after tax, is sufficient to have recouped the capital invested tosupport the writing of the business. The cash flows are discounted at theappropriate risk-discount rate and calculated on the same assumptions andexpense basis as those used for the contribution from new business. 14. Margins are defined as the pre tax contribution from new businessgenerated by each product type, divided by the new business volume for thatproduct. Contribution is calculated using economic assumptions at the beginningof the period, and is quoted after the cost of required capital, share basedpayments and including an apportionment of fixed acquisition expenses acrossproducts. 15. Dividend per share includes the interim dividend of 2.65p paid inNovember 2006 and the proposed final dividend of 5.2p payable in May 2007, whichis subject to approval at the Annual General Meeting. 16. Certain statements contained in this announcement constitute'forward-looking statements'. Such forward-looking statements involve risks,uncertainties and other factors, which may cause the actual results, performanceor achievements, from time to time, of Friends Provident plc, its subsidiariesand subsidiary undertakings or industry results to be materially different fromany future results, performance or achievements expressed or implied by suchforward-looking statements. Such risks, uncertainties and other factors include,among others, adverse changes to laws or regulations; risks in respect oftaxation; unforeseen liabilities from product reviews; asset shortfalls againstproduct liabilities; changes in the general economic environment; levels andtrends in mortality, morbidity and persistency; restrictions on access toproduct distribution channels; increased competition; and the ability to attractand retain personnel. These forward-looking statements are made only as at thedate of this announcement and, save where required in order to comply with theListing Rules, there is no obligation on Friends Provident plc to update suchforward-looking statements. BUSINESS REVIEW Group progress and outlook The successful development of the Friends Provident Group has continuedthroughout 2006, driven both by sales growth and expense efficiencies. Ourgrowth is underpinned by a very strong capital base, and adequate cash flowshave been generated to sustain our dividend policy. We also continue to placehigh emphasis on effective risk management. The structure of the Group remains organised around its three core businesssegments of UK Life & Pensions, International Life & Pensions and AssetManagement. The Group strategy that has been in place since before our2001 stock exchange flotation continues to deliver value. In UK Life & Pensions, record levels of new business have been achieved. Saleswere up by 30% whilst acquisition costs increased by 5%. As a result, thecontribution to profits generated by new business increased by more thantwo-thirds. Our approach is to build on our already strong positions in thepensions and protection segments, and to renew our focus on investment businessthrough entry into the wrap market by the end of this year. In 2007, we expectthe overall life and pensions market to grow by 5-10%, our share of the marketto increase and overall product margins to continue to improve as a result ofoperational leverage. However, recent market turbulence, if prolonged, may havea dampening effect. We have continued to extend the diversity of our international businesses, whichprovide some 40% of our total sales and almost half of our total Life & Pensionsnew business profits, reflecting the generally more profitable nature ofinternational territories. Friends Provident International (FPI) achieved recordsales, up 16% on 2005, successfully entered the German personal pensions market,and received licence approval to operate in Singapore. These activities reflectFPI's approach, which is to look for growth opportunities in new markets. FPI'strading prospects remain very good. Lombard also achieved record sales growth, well above trend at 40%. Lombard'sprimary focus remains on further developing the already strong relationshipssecured with distributors. The new Swiss office supports this approach, as doesLombard's continued investment in quality people. Lombard is particularlyimpacted by tax regime changes, which can present positive opportunities as inItaly, or negative as in Mexico in late 2006. Whilst many of the situations thatcame together to drive the 2006 growth are unlikely to be repeated in 2007, weremain confident about the opportunities across the diverse and well-regulatedmarkets in which Lombard operates. Throughout 2006, our asset management company, F&C, has continued to put inplace the significant building blocks required to turn the business around. Themanagement framework has been comprehensively restructured and the investmentteams strengthened. Significant progress has been made to introduce a culturefocused on performance, and products have been developed for higher-marginbusiness, both of which are already having a positive impact. F&C has announcedan accelerated growth plan, which will encompass further new product anddistribution initiatives, and which we believe will generate higher margins andnew revenue streams well beyond 2007. This plan requires increased investment inthe business during 2007, to be financed through a rebasing of the F&C dividend.The approach is to have products appropriate for the changing marketplace, andto attract and retain quality people with the capability to drive up investmentperformance. In summary, we are announcing another year of strong results founded principallyon profitable growth in our life and pensions businesses, both in the UK andabroad. As to outlook, in UK life and pensions our goal for the next two years remainsto build our market share significantly and profitably, for which we areinvesting accordingly. Beyond that, we continue to expect the international lifeand pensions businesses to have greater potential for sustained growth at ahigher margin than the UK and believe that we have the right business model inplace to exploit that potential. In asset management, F&C has the potential togrow and generate substantial earnings for the Group, as its growth planprogresses. We therefore believe that Friends Provident has attractive growthcredentials. UK LIFE AND PENSIONS Our view of the Market A strong stock market performance and the continued movement from final salaryto defined contribution group pension schemes helped the UK life and pensionindustry to grow by 28% in 2006. The pensions market received a boost as theresult of the pension legislation changes that came into effect in April 2006. Despite the increased public awareness of pension issues following the releaseof the Turner Report, and the widely reported need for saving, we believe thatthe market will remain predominantly supply led for the foreseeable future. Onlymortgage protection and annuity sales are likely to be consumer led to any greatextent. Financial intermediaries remain key to the future growth of the market. Protection - The housing market defied many experts' predictions in 2006,setting records for both price increases and mortgage advances. The protectionmarket reflected this only to a limited extent with a 2% increase in sales. Themarket seems to have shrugged off recent interest rate rises. However, thereremains the possibility of further interest rate rises, and with the growingissue of first-time buyer affordability, a slowdown or even a significantdownturn cannot be discounted. We expect a more subdued market in 2007, eitherflat or slightly negative. Investments - A strong stock market performance in 2006 built on the recovery of2005. This drove a 27% increase in sales of investment bonds, which offerinvestors a simple, tax-efficient investment vehicle, as well as being a usefulInheritance Tax mitigation vehicle. The growth in the demand for accountaggregation and open architecture for funds has led to the development of wrap,a new form of investment trading platform. We believe that use of theseplatforms will grow steadily and support the growth of investment bond products.We expect market growth in 2007 to be in the range of 5-10%, although marketturbulence, as seen recently, may concern retail investors. Risks to this growthexpectation are therefore largely on the downside. Group pensions - The regulation changes in April had a significant impact in2006. Also, the financial risks and open ended obligations associated withdefined benefit arrangements have led many employers to move to definedcontribution plans either for all scheme members or just for new members. Thiscontinuing trend points to significant growth potential within new definedcontribution schemes over the coming years. The trend away from trust tocontract based arrangements is also continuing. We expect market growth in 2007to be in the range of 7-12%. Individual pensions - There is undoubtedly greater public awareness of the needfor adequate pension planning following the media coverage of Lord Turner'sreport on UK pensions, and a significant part of the 47% growth in theindividual market in 2006 was triggered by A-Day in April. Whilst we believethat a major change in government policy will be needed to encourage the UKpublic to take pension planning more seriously, we do expect the market forindividual pensions to grow steadily. We expect market growth in 2007 to be inthe range of 10-15%. Post-retirement - The post-retirement market is currently not a significant areaof focus for Friends Provident, although we continue to be mindful of potentialopportunities and risks within it. In general terms, the next 10 years will seethe post war baby-boom generation reaching retirement age, and this will lead togrowth in new and existing post-retirement products. We expect market growth in2007 to be in the range of 7-12%. Our trading performance and outlook UK total new business increased 30% to £4,162m and our share of this marketincreased from 5.2% to 5.5%. Our trading performance reflected in particular ourgrowing reputation in the pensions arena, and the trend towards this business,both group and individual, continued throughout the year. Protection - new business increased by 8% to £432m at a margin of 7.4%, up from5.4% in 2005. As anticipated, we slightly increased our share of this verycompetitive market, up from 7.6% to 7.8%, as the impact from some of the alreadysecured distribution agreements began to be felt. As well as exploring furtherdistribution opportunities, we intend to continue to grow our share in the groupprotection segment. We expect to grow our market share in the second half of theyear as the outlined initiatives begin to take effect. We will remain pricecompetitive, which may bring downward pressure on margin. Investments - new business increased by 2% to £687m at a margin of 1.5% slightlydown from 1.6% in 2005. Bearing in mind the 15% growth we achieved in 2005, welost some ground in 2006, which we hope to regain this year in this increasinglycompetitive market. In early 2007 we re-entered the guaranteed bond market,reflecting growing customer interest. Additionally, a number of productenhancements are planned for 2007, and we are on track to launch our wrapproposition by the end of the year, which is an important element of our futuregrowth prospects in this segment. The outlook for sales remains positive for theyear as a whole, particularly over the second half. Group pensions - new business increased by 46% to £2,298m at a margin of 1.6%,up from 1.1% in 2005, and accounted for well over half of our total UK newbusiness. Our performance in 2006 reflected the quality and flexibility of ourproposition and lifted our market share to 12.8%, bolstered by the effect of thePensions 'A-Day' regulation changes in April. Underlying growth, both for ourbusiness and the group pensions market generally, looks set to continue over themedium term and we will continue to benefit from the transition in the marketaway from defined benefit schemes to defined contribution schemes. We will alsoincreasingly benefit from incremental business forming a greater proportion offuture new business volumes, thereby reducing volatility. Individual pensions - new business increased by 63% to £490m. Excludingcontracting-out rebate payments from the Department of Work & Pensions (DWP),new business increased 74% to £336m. This reflected the heightened publicinterest in pensions and primarily comprised the more profitable 'singlepremium' business, which we target. Margin was 1.3%, slightly down on the 1.4%achieved in 2005. We have achieved good growth since relaunching into thismarket in 2005, which we expect to continue into 2007. Beyond this, we expectfuture growth to be steady. DWP rebate payments will steadily decline through to2012. Annuities - new business increased by 5% to £255m at a strong margin of 5.3%, upfrom 2.8% in 2005. Our approach to this market segment remains cautious,primarily serving our existing customers only, although we continue to keep thebalance of risk and reward under active review. INTERNATIONAL LIFE AND PENSIONS Our view of the market Our international business is conducted across the globe, with specific emphasison four key regions: Asia, the Middle East, the UK and Continental Europe. The business mix includes regular premium savings and protection plans,alongside single premium savings, investment and estate-planning propositions.Customers are attracted by our innovative solutions, wide-ranging investmentopportunities, the portability of the products and the long-term confidence ofstrong currency investments. Friends Provident International (FPI) - FPI has followed a deliberate strategyof market diversification, ensuring that it does not limit itself to a singleregion or jurisdiction. From its bases in the Isle of Man and the UK, FPIoperates in all the four key regions, with a product mix that ranges fromregular savings and protection business to investment contracts, includinghighly personalised portfolio bonds. Distribution partners are primarily Independent Financial Advisers. FPI has alsoactively developed distribution relationships with a number of institutionalpartners. Asia remains FPI's largest generator of new business volumes, with thebulk of that business coming from regular premium savings. The overall Hong Kongmarket grew strongly over the first half of 2006 before slowing over the secondhalf. FPI continues to be confident in, and committed to, the region. TheContinental European strategy centres on the targeting of a small number ofspecifically selected territories, including the launch of a series of personalpension products in Germany, alongside a German distribution partner. Businessfrom the Middle East has benefited from the establishment of a local presence.The UK remains an exclusively single premium investment market with particularemphasis on tax and estate planning. 2006 saw no lessening of market activity and competitiveness, with a number ofcompanies expressing a renewed interest in the Asian region, but we maintain arobust position, based on strong relationships with distribution partners and ademonstrable commitment to the market. The successful development of a newbranch office in Singapore, and the continuing demand for high quality wealthmanagement solutions, adds to our confidence. Lombard - The provision of tailor-made financial and estate planning solutionsfor high net worth individuals (HNWIs) and ultra HNWIs in Europe and beyondremains the focus of the Lombard business. Lombard operates primarily acrosseight EU member states, while continuing to explore new opportunities in otherregions. Geographic diversification is supported by a uniquemulti-jurisdictional expertise. This expertise is critical in meeting theplanning needs of many clients and the business needs of international privatebanks, and has led to writing rapidly increasing volumes of new business. Lombard's approach is to partner with leading specialist advisers, which enablesthe combining of Lombard's financial expertise with the relationship and assetmanagement capability of the distribution partner. As the very large market forHNWI/ultra HNWI continues to grow, so does the requirement for effectiveprotection of private wealth. Lombard has been able to increase its penetrationof this market year-by-year and intends to deepen this penetration further asthe business develops. The HNWI sector in particular continues to attract the attentions of governmentsseeking to increase tax on private wealth. This intensifies the pressure ontraditional tax planning structures and offshore tax havens, and increases therelative attractions of life assurance being used as a tax shelter and estateplanning solution, such that experts increasingly recognise life assurance as animportant financial planning tool. Lombard competes through the provision of enhanced value-added services andadministration rather than on price. Competitors are mainly those that haveestablished subsidiaries in Luxembourg and Dublin, primarily to sell back totheir home country (although some are increasing their internationaldiversification), and generally offer a lower priced, less value-added service. Our trading performance and outlook International new business, achieved through Friends Provident Internationaland Lombard combined, increased by 32% to £2,912m, representing more than 40% ofthe Friends Provident Group's total life and pensions sales. Over the longer term, we continue to expect the pace of growth in ourInternational operations to exceed that of the UK Life & Pensions business withthe future trend growth rate for new business profit expected to be in doubledigits. Friends Provident International - New business increased by 16% to £823m at anunchanged margin of 3.1%, with sales higher in Asia, the Middle East, andContinental Europe. Sales are not generally seasonal and therefore the new business profile for 2006is not typical. The strong growth that characterised 2005 continued over thefirst half of 2006, with a marked slowdown over the second half of that year.Hong Kong is FPI's biggest contributor to new business and our performancemirrors the strong market growth seen in Hong Kong in the second quarter,followed by a market downturn in the second half. Other factors were the sale offewer large bonds in 2006, the weakening of the dollar (which had the effect oflowering average premiums for business sold in Asia and the Middle East), andthe impact of unexpected changes to UK trust and tax rules. The market remains avery competitive environment. Marketing focus throughout 2006 was primarily on the setting up of a new officein Singapore, successfully achieved, and delivering three new personal pensionplans into the German market. During 2007 we plan to review and enhance our corepropositions as well as introducing specifically designed products to theSingapore market. The new personal pensions for the German market wereintroduced in late 2006, with early indications of their success beingencouraging. We expect to build on this throughout 2007. For 2007, we do not expect sales in the first half to match the exceptionallystrong sales in the first half of 2006, although we do anticipate sales in thesecond half of 2007 to be higher than in the first half. Prospects for mediumterm growth are attractive. Lombard - New business increased by 40% to £2,089m with particularly strongperformances in the UK, Italy and Mexico. The geographic diversification of theLombard business is a major strength, with emphasis varying from year to year -often as a result of tax changes, as was the case in Italy in 2006. The UKmarket is the one most sensitive to prevailing investment markets, and salesmore than doubled over 2006 as investment sentiment continued to improve, and aspartnerships with those serving the HNWI-sector developed. Although the pattern of new business was, as always, skewed towards the fourthquarter, Lombard has achieved higher than usual growth throughout the year. Amajor factor in this was the increased proportion of large cases written in2006. Writing larger cases generates greater profits, although generally at alower margin, and the overall margin reduced to 3.4% from 3.9% in 2005 as aresult. In the latter part of 2006, a number of significant adverse tax changes wereannounced, particularly in Mexico where a legal change seriously reduced theattractiveness of foreign life policies and where the position remainsuncertain. Whilst Lombard's short term prospects are likely to be impacted, weexpect the growth trend in new business to continue, albeit that 2006 was abovethe trend and 2007 will be below it. This outlook recognises Lombard's abilityto deepen its penetration in European markets, with our new Swiss office furthersupporting the increasing number of our quality Swiss-based partners. ASSET MANAGEMENT Our view of the market In 2006 the asset management industry benefited from a year of positive returnsin the major assets classes. Despite a sharp correction in equities in May,markets staged a remarkably rapid recovery. The outlook for 2007 is one ofslowing economic growth and an easing of inflationary pressures. This benignbackdrop should be broadly supportive of equities, although we believe thatreturns are unlikely to be as high as those experienced in 2006. A key risk is amore pronounced deterioration in the US than expected. We also anticipate thatvolatility will rise from the low levels seen in 2006. Merger & acquisition activity was a significant feature of markets during 2006as companies have shifted their focus from balance sheet strengthening toaggressive growth. An injection of private equity cash has also helped fuel M&Aactivity, with deals increasingly taking place at the upper end of the marketcap spectrum. The asset management industry itself was not immune to this upsurge in corporateactivity, with a number of sizeable transactions during 2006 as well as anexpansion of the listed asset management sector. We envisage corporate activityremaining an industry trend, with drivers including the continued move towards'open architecture' by financial services institutions, notably banks, buildingsocieties and insurance companies. As these businesses re-focus on distribution,there is greater willingness to use multiple external asset managers in theirproduct ranges. In the UK, firms of Independent Financial Advisers are also scaling up to meetthe challenge of the new distribution landscape. This has led to increasingconsolidation in that sector as well as new entrants. The top tier of investmentadvisers are increasingly developing discretionary services while the broadadviser market is making more use of multi-manager products. Fund supermarketsare now widely used by IFAs and we anticipate that the use of wrap accounts willgather pace. Access to the retail market is therefore about positioning on theseplatforms and servicing distribution relationships in addition to theprerequisites of strong investment performance supported by a credible brand. The developments of the last few years in the institutional market continue togather pace. The UK has seen a shift over a number of years away from balancedmanagement towards the separation of 'alpha' and 'beta' and increasing use ofspecialist mandates, and this continues. A comparable trend towards specialistmandates is now emerging in The Netherlands, Europe's second largest pensionsmarket, with a number of schemes moving towards a fiduciary model where a thirdparty manager determines asset allocation, risk budgeting and underlying managerselection. This development poses a significant risk to balanced management inThe Netherlands. In addition, across a number of developed markets there is amuch greater focus on ensuring that pension scheme assets are sufficient tomatch their liabilities. This is driving interest in Liability Driven Investment(LDI) and Asset and Liability Management (ALM). Together, these market changes are leading to demand for multi-managementcapabilities, LDI products, active added value 'alpha' products and alternativeinvestments. Many of these trends require asset managers to deepen theirderivatives expertise. This demand for more specialist products is prompting asset managers to evolvetheir business models accordingly. 'House' processes and top down investmentleadership through a Chief Investment Officer are giving way to "multi-boutique"investment models where investment teams have much greater accountability forspecific products and processes, whilst leveraging off a common operationalinfrastructure. Likewise, remuneration is becoming more integrally linked to theperformance of specific teams and the products that they manage. Our trading performance and outlook Overall, funds under management as at 31 December 2006 were £104bn, comparedwith £131bn at the end of 2005. Across 2006 F&C experienced net outflows of £32bn of assets under management. Insurance - The remaining £21bn of Resolution Life assets were withdrawn duringthe second quarter of 2006 and F&C received £27m in compensation. F&C hasfocused its attention during 2006 on exploiting opportunities within theemerging sector of annuity consolidators. The development of a dedicatedInsurance and ALM capability has given F&C the ability to provide solutions tothe specific issues facing insurance businesses. Institutional - £8bn of institutional net outflows were broadly related to thefollowing factors: •An industry trend away from balanced to specialist mandates (including the migration of the £3.4bn Vervoer mandate in The Netherlands to a fiduciary model) •Loss of the £1bn Electricity Supply Pension Scheme property mandate •A shift towards passive management by some schemes •Disappointing legacy investment performance in sovereign fixed income At the end of 2006, F&C had been informed of further future outflows of some£5bn and further institutional outflows may result in 2007. The impact that theconsultant community has on our organic growth plans across Europe issignificant, particularly in the UK and Ireland. Sales activity has thereforefocused on extending investment consultant coverage. F&C has concentrated onpromoting composite UK bonds, high alpha UK equities, LDI and alternatives.Changes in regulation and a greater awareness of governance and social issueshave continued to create opportunities within Governance and SustainableInvestment across Europe. Good progress has been made with consultants in newer product areas such as LDIand UK High Alpha Equities. Investment Trusts - 2006 was a period of considerable corporate activity withinthe investment trust sector. A £694m net outflow of investment trust assetsrelated to three factors: •The loss of the F&C Emerging Markets Trust due to corporate activity •The loss of the F&C Latin American and ISIS Smaller Companies trusts following manager departures •Share buy backs, discount controls and restructurings Our investment trusts savings products continued to account for approximately athird of all inflows, with our Child Trust Fund exceeding our targeted businessvolumes. The F&C UK Select Trust adopted a unique strategy among UK equitytrusts ahead of its rollover. During the first half of 2007 we will look toexpand our range of investment trusts with the launch of a listed fund of hedgefunds vehicle. UK Retail - 2006 was a strong year with net retail sales up 98%. This was aheadof the industry increase of 87.5%. Flows were spread across a range of keyproducts including our ethical funds, UK equities, corporate bonds andmulti-manager. Relationships with key distribution partners have strengthenedand we have extended access to our products on a number of platforms. Our focusin 2007 will remain on multi-manager, UK equities, ethical investment andcorporate bonds. Additionally we are enhancing the marketing of our cash plusproduct and will cross-sell our Luxembourg registered global real estate fundinto the UK. Continental European Retail - We saw positive progress in The Netherlands and astrong first half in Portugal. Following the sharp decline in equities in May,fund flows reversed in Portugal as retail investors switched into cash. Thisresulted in a net outflow of £278m in our total sub-advisory business at yearend. Retail flows were positive in Germany, where we established awhite-labelled share class on our emerging debt fund for Commerzbank and reacheda five year performance record on our flagship F&C HVB Stiftungsfonds productwhich is co-branded with HypoVereinsbank. We have now created a Euro denominatedversion of the Stewardship International fund and will seek ways to enhance themarketing of our SICAV range. FINANCIAL REVIEW Our results are presented on two reporting bases: European Embedded Value (EEV)and International Financial Reporting Standards (IFRS). EEV BASIS EEV is the basis we find more useful because it provides a more representativereflection of the performance of the long-term business that fully recognisesthe shareholders' interest in the in-force portfolio on a risk adjusted basis. Group profitability on the EEV basis +----------------------------------------+---------+---------+---------+| | Change| 2006 | 2005 |+----------------------------------------+---------+---------+---------+| | %| £m | £m |+----------------------------------------+---------+---------+---------+|EEV underlying profit before tax: | | | |+----------------------------------------+---------+---------+---------+|- UK Life & Pensions | -4| 315 | 328 |+----------------------------------------+---------+---------+---------+|- International Life & Pensions | +12| 119 | 106 |+----------------------------------------+---------+---------+---------+|- Asset Management | -18| 89 | 108 |+----------------------------------------+---------+---------+---------+|- Corporate items | +22| (14)| (18)|+----------------------------------------+---------+---------+---------+|EEV underlying profit before tax | -3| 509 | 524 |+----------------------------------------+---------+---------+---------+|Other profit items | | (111)| 76 |+----------------------------------------+---------+---------+---------+|EEV profit before tax | -34| 398 | 600 |+----------------------------------------+---------+---------+---------+| | | | |+----------------------------------------+---------+---------+---------+|Contribution from Life & Pensions new | +42| 204 | 144 ||business | | | |+----------------------------------------+---------+---------+---------+|Life & Pensions new business margin | +7| 2.9%| 2.7%|+----------------------------------------+---------+---------+---------+|Life & Pensions return on embedded value| -12| 9.9%| 11.2%|+----------------------------------------+---------+---------+---------+| | | | |+----------------------------------------+---------+---------+---------+|Underlying EEV earnings per share | +1| 16.4p| 16.3p|+----------------------------------------+---------+---------+---------+|EEV basic earnings per share | -31| 14.6p| 21.2p|+----------------------------------------+---------+---------+---------+ EEV profit before tax Group EEV underlying profit before tax has reduced by 3% to £509m (2005: £524m).The small decrease arises principally from lower profits at our Asset Managementbusiness, where we have seen a net outflow of funds and resulting lowerrevenues. Overall underlying profits from our life and pensions businesses are unchangedat £434m. Within this result, strong growth in the contribution from newbusiness has been offset by lower in-force profits and a lower return onshareholders' net assets. The underlying profit before tax includes a charge forpersistency of £68m consisting of £21m in respect of the current pensionproducts, with the remainder primarily relating to legacy bond and with-profitsbusiness. This charge has been largely offset by a lower cost of burnthrough in2006 of £36m and favourable morbidity and mortality assumption changes of £27m. Group EEV profit before tax has reduced by 34% to £398m (2005: £600m). Thistakes into account the impacts of investment return variances, economicassumption changes, non-recurring items and other costs totalling £111m negative(2005: £76m positive). The investment return variances and economic assumptionchanges in 2006 largely offset each other whereas in 2005 they were positive by£312m. The most significant part of the other profit items is the amortisationand impairment of Asset Management intangible assets. These items are discussedbelow. The contribution from total Life & Pensions new business, which is included inunderlying profits, has increased by 42% to £204m (2005: £144m). The newbusiness margin as a percentage of PVNBP has increased from 2.7% to 2.9%,largely driven by 30% sales growth in the UK where operational leverageincreased the margin from 2.0% to 2.6%. The Life & Pensions return on embedded value has decreased from 11.2% to 9.9%reflecting unchanged underlying profits and higher opening net assets on an EEVbasis. The UK return is 7.9% (2005: 9.4%) and the International return is 19.8%(2005: 21.5%), which reflects the much higher proportion of new business profitto embedded value compared with the UK business. Underlying EEV earnings per share have increased from 16.3p to 16.4p as a resultof a slightly lower tax charge. The basic earnings per share have fallen from21.2p to 14.6p as a result of the impact of negative other profit items. UK Life & Pensions +----------------------------------------+---------+---------+---------+| | Change | 2006 | 2005 |+----------------------------------------+---------+---------+---------+| | % | £m | £m |+----------------------------------------+---------+---------+---------+|Contribution from new business | +69| 108 | 64 |+----------------------------------------+---------+---------+---------+|Profit from existing business: | | | |+----------------------------------------+---------+---------+---------+|- Expected return | +2| 173 | 170 |+----------------------------------------+---------+---------+---------+|- Experience variances | -55| 9 | 20 |+----------------------------------------+---------+---------+---------+|- Operating assumption changes | -95| 1 | 19 |+----------------------------------------+---------+---------+---------+|Development costs | +4| (26)| (25)|+----------------------------------------+---------+---------+---------+|Expected return on shareholders' net | -37| 50 | 80 ||assets | | | |+----------------------------------------+---------+---------+---------+|EEV underlying profit before tax | -4| 315 | 328 |+----------------------------------------+---------+---------+---------+| | | | |+----------------------------------------+---------+---------+---------+|New business margin | +30| 2.6%| 2.0%|+----------------------------------------+---------+---------+---------+|Return on embedded value | -16| 7.9%| 9.4%|+----------------------------------------+---------+---------+---------+ The contribution from new business has increased by 69% to £108m (2005: £64m)with group pensions amounting to 35% and protection 30% of the total. Thecontribution is stated net of the cost of solvency capital of £6m (2005: £5m)and share based payments of £2m (2005: £2m). New business margins are asfollows: +-----------------------------------------+-----------------+---------+| | 2006 | 2005 |+-----------------------------------------+-----------------+---------+| | % | % |+-----------------------------------------+-----------------+---------+|New business margin: | | |+-----------------------------------------+-----------------+---------+|- Protection | 7.4 | 5.4 |+-----------------------------------------+-----------------+---------+|- Investments | 1.5 | 1.6 |+-----------------------------------------+-----------------+---------+|- Group pensions | 1.6 | 1.1 |+-----------------------------------------+-----------------+---------+|- Individual pensions | 1.3 | 1.4 |+-----------------------------------------+-----------------+---------+|- DWP rebates | 6.7 | 5.4 |+-----------------------------------------+-----------------+---------+|- Annuities | 5.3 | 2.8 |+-----------------------------------------+-----------------+---------+|UK new business margin | 2.6 | 2.0 |+-----------------------------------------+-----------------+---------+| | | |+-----------------------------------------+-----------------+---------+|Internal rate of return (IRR) per annum | 10.3 | 8.6 |+-----------------------------------------+-----------------+---------+|Payback period (discounted) | 12 years |17 years |+-----------------------------------------+-----------------+---------+ The overall margin has increased from 2.0% to 2.6% as a result of the gearingeffect of higher volume and relatively flat expenses. The IRR has increased to10.3% during 2006, again primarily as a result of operational gearing. Theoverall payback period has reduced accordingly. The expected return on the value of the in-force book increased by 2% to £173m(2005: £170m), reflecting the increase in the value of the in-force businessoffset by lower discount rates. Within operating assumption changes andexperience variances, the total UK in-force charge for persistency is £53m, andthis has been offset by profits from a change in morbidity and mortalityassumptions of £27m and a reduction in the cost of burnthrough of £36m. The morbidity assumption change arises from lower claims experience following areview of our claims management process. The lower burnthrough charge is as aresult of the improved financial position of the With-Profits fund and bettermodelling of the dynamic sold futures strategy (a risk management hedge in thefund). Development costs have increased to £26m (2005: £25m), reflecting continuedinvestment in our market leading protection and group pensions e-commercepropositions, infrastructure to support our strategic distribution relationshipsand the development of a wrap platform. Development costs in 2007 - 2008 areexpected to be higher than in 2006 (in the range of £30m - £40m per annum) insupport of our growth strategy. The expected return on shareholders' net assets decreased by 37% to £50m (2005:£80m), partly due to a reduction in the expected rates of return on equities andfixed interest securities and changes in the mix of assets. Part of thisdecrease also results from a change in the tax gross-up basis. Operating expenses have increased by 4% to £253m (2005: £243m). Since 2003,operating expenses have increased by only 2% against an increase in PVNBP of 64%over the same period. This demonstrates the efficiency of our processes andpower of our technology to deliver substantial new business growth whilstmaintaining excellent levels of service, with only a small increase in cost. Webelieve there are further opportunities to leverage future efficiencies due tothe scalability of our solutions and the continued development of ourself-service offering. International Life & Pensions +--------------------------------------+------------+--------+---------+| | Change| 2006 | 2005 |+--------------------------------------+------------+--------+---------+| | %| £m | £m |+--------------------------------------+------------+--------+---------+|Contribution from new business | +20| 96 | 80 |+--------------------------------------+------------+--------+---------+|Profit from existing business: | | | |+--------------------------------------+------------+--------+---------+|- Expected return | +31| 34 | 26 |+--------------------------------------+------------+--------+---------+|- Experience variances | | (2)| 2 |+--------------------------------------+------------+--------+---------+|- Operating assumption changes | +233| (10)| (3)|+--------------------------------------+------------+--------+---------+|Expected return on shareholders' net | -| 1 | 1 ||assets | | | |+--------------------------------------+------------+--------+---------+|EEV underlying profit before tax | +12| 119 | 106 |+--------------------------------------+------------+--------+---------+| | | | |+--------------------------------------+------------+--------+---------+|New business margin | -8| 3.3%| 3.6%|+--------------------------------------+------------+--------+---------+|Return on embedded value | -8| 19.8%| 21.5%|+--------------------------------------+------------+--------+---------+ The contribution from new business has increased by 20% to £96m (2005: £80m).The contribution is stated net of the cost of solvency capital of £1m (2005:£1m). The Lombard contribution is £70m (2005: £58m) and the FPI contribution is£26m (2005: £22m). New business margins are as follows: +-----------------------------------------+------------------+---------+| | 2006 | 2005 |+-----------------------------------------+------------------+---------+| | % | % |+-----------------------------------------+------------------+---------+|New business margin: | | |+-----------------------------------------+------------------+---------+|- FPI | 3.1 | 3.1 |+-----------------------------------------+------------------+---------+|- Lombard | 3.4 | 3.9 |+-----------------------------------------+------------------+---------+|International new business margin | 3.3 | 3.6 |+-----------------------------------------+------------------+---------+| | | |+-----------------------------------------+------------------+---------+|Internal rate of return (IRR) per annum | 25.7 | 28.3 |+-----------------------------------------+------------------+---------+|Payback period (discounted) | 4 years | 4 years |+-----------------------------------------+------------------+---------+ The overall margin has reduced from 3.6% to 3.3% with Lombard achieving 3.4%(2005: 3.9%) and FPI 3.1% (2005: 3.1%). The Lombard margin has, as anticipated,fallen slightly as a result of higher case sizes written which have lowermargins. Low new business strain results in a high IRR and a relatively shortpayback period of 4 years (2005: 4 years). The expected return on the value of the in-force book increased by 31% to £34m(2005: £26m), reflecting the increase in the value of the in-force business,offset by lower discount rates. The in-force profit includes a charge foroperating assumption changes of £10m (2005: £3m charge). The main item in 2006was a change in persistency assumptions on legacy with-profits bond businessresulting in a charge of £13m. Development costs within our International businesses during 2005 and 2006 werenot significant. Development expenditure is expected to be in the order of £10mper annum in 2007 and 2008 as we seek to exploit opportunities for furthergrowth and to deliver our award winning e-commerce solutions to the widerinternational market. Operating expenses have increased by 17% to £63m (2005: £54m) against anincrease in PVNBP of 32%. The growth in expenses reflects the less mature natureof our International business, which is still building critical mass to supportthe growing portfolio of products, markets and customers. There is a firm focuson cost efficiency, with a number of initiatives underway which will contributein 2007 and beyond. These include greater use of technology to improve serviceand reduce costs across the international markets in which we operate. Asset Management +---------------------------------+---------------+---------+--------+| | Change| 2006 | 2005 |+---------------------------------+---------------+---------+--------+| | %| £m | £m |+---------------------------------+---------------+---------+--------+|Net revenues | -7| 248 | 267 |+---------------------------------+---------------+---------+--------+|Operating expenses | +5| (159)| (151)|+---------------------------------+---------------+---------+--------+|Other expenses (net) | | - | (8)|+---------------------------------+---------------+---------+--------+|Underlying profit before tax | -18| 89 | 108 |+---------------------------------+---------------+---------+--------+| | | | |+---------------------------------+---------------+---------+--------+|Operating margin | -17| 36.5%| 44.1%|+---------------------------------+---------------+---------+--------+|F&C underlying earnings per share| -19| 12.8p| 15.9p|+---------------------------------+---------------+---------+--------+ Net revenues amounted to £248m (2005: £267m). Revenues were impacted by net fundoutflows of £32bn (2005: £6bn) including £21bn in respect of Resolution Lifefollowing their merger with Britannic. Net revenues include performance-relatedmanagement fees of £10m (2005: £13m). Operating expenses represent the ongoing costs of running the business and thesehave increased by 5% to £159m (2005: £151m). Expenses have increased due toinflationary pressure and increasing competition for management talent. Staffrelated costs amount to approximately 60% of total costs and the management ofheadcount is critical to effective cost control. Other expenses included in underlying profits, but excluded from operatingcosts, mainly consist of net finance costs. Operating margin represents the ratio of operating profit to net revenues anddecreased from 44.1% to 36.5%. The decline in operating margin is mainly due tothe lower revenue resulting from the loss of mandates. We anticipate that themargin will fall to around 30% in 2007 as although new products will have ahigher margin, our accelerated investment plan will mean investing in additionalproducts, distribution personnel and infrastructure. Funds under management reduced from £131bn to £104bn. Whilst new business of£6bn was won during the year, the loss of the Resolution Life contract throughcorporate activity was a major factor impacting our net outflows of £32bn.Resolution outflows in 2005 were approximately £5bn and a further £21bn waswithdrawn in the first quarter 2006. We agreed a termination payment withResolution in respect of this business of £27m. Net fund flows are a keyperformance measure for us and indicative of the growth of our business. Corporate items +----------------------------------------------------+----------+----------+| | 2006 | 2005 |+----------------------------------------------------+----------+----------+| | £m | £m |+----------------------------------------------------+----------+----------+|Expected return on net pension liability | 9 | (2)|+----------------------------------------------------+----------+----------+|Expected return on corporate net assets | (10)| (7)|+----------------------------------------------------+----------+----------+|Corporate costs | (13)| (12)|+----------------------------------------------------+----------+----------+|Operating assumption changes for corporate costs | - | 3 |+----------------------------------------------------+----------+----------+|Corporate items | (14)| (18)|+----------------------------------------------------+----------+----------+ The expected return on the net pension liability has increased in 2006 mainlybecause the calculation includes the expected return on derivative assets forthe first time. Expected return on corporate net assets includes the STICS interest payable. Thenegative return mainly arises because the coupon payable exceeds the interestreceivable on the parent's investment in preference shares of FPLP. Other profit items 2006 2005 £m £m--------------------------------------------------------------------------Investment return variances (174) 550Effect of economic assumption changes 181 (238)Non-recurring items (17) (59)Amortisation of Asset Management acquired intangible assets (43) (56)Impairment of Asset Management acquired intangible assets (58) (112)Variation in value of option on convertible debt - (9)--------------------------------------------------------------------------Other profit items (111) 76-------------------------------------------------------------------------- The combined impact of investment return variances and economic assumptionchanges is £7m positive (2005: £312m positive). The main factors impacting 2006were good equity returns which generated a positive impact, but these wereoffset by an increase in fixed interest yields which resulted in a negativeimpact. In addition, investment return variances were negatively impacted by anincrease in the market value of our £290m convertible bond (reflecting theincrease in Friends Provident's share price over the year) and by an increase inthe investment related costs of options and guarantees. The positive variancewas significantly higher in 2005 as equity returns were higher and fixedinterest yields fell - both of which generated significant positive impacts. Therisk free rates used for Sterling were 4.6% (2005: 4.1%) and 4.1% for the Euro(2005: 3.6%). Non-recurring items comprise: F&C integration costs of £7m (2005: £24m), F&CReinvestment Plan costs of £12m (2005: £22m) relating to the share schemes putin place at the time of the merger to retain and incentivise senior staff, FPIintegration costs of £nil (2005: £6m), a release of mis-selling provisions of£4m (2005: charge of £7m) and costs associated with the closure of the AppointedRepresentative sales channel of £2m (2005: £nil). The reduced amortisation of Asset Management intangible assets of £43m (2005:£56m) reflects a lower book value of these assets as a result of impairmentspartially offset by a higher amortisation rate implemented during 2006. Theimpairment charge of £58m (2005: £112m) arises from reviewing the fair value ofthe intangible assets associated with F&C investment management contractsfollowing the loss of mandates. IFRS BASIS We present IFRS results in accordance with the EU regulations requiring allEuropean listed groups to prepare IFRS accounts. Group profitability on the IFRS basis +----------------------------------+-----------+-----------+----------+| | Change| 2006 | 2005 |+----------------------------------+-----------+-----------+----------+| | %| £m | £m |+----------------------------------+-----------+-----------+----------+|IFRS underlying profit before tax:| | | |+----------------------------------+-----------+-----------+----------+|- UK Life & Pensions | +84| 254 | 138 |+----------------------------------+-----------+-----------+----------+|- International Life & Pensions | | 71 | - |+----------------------------------+-----------+-----------+----------+|- Asset Management | -18| 89 | 108 |+----------------------------------+-----------+-----------+----------+|- Corporate items | +36| (14)| (22)|+----------------------------------+-----------+-----------+----------+|IFRS underlying profit before tax | +79| 400 | 224 |+----------------------------------+-----------+-----------+----------+|Other profit items | -36| 91 | 143 |+----------------------------------+-----------+-----------+----------+|IFRS profit before tax | | | |+----------------------------------+-----------+-----------+----------+|from continuing operations | +34| 491 | 367 |+----------------------------------+-----------+-----------+----------+|IFRS underlying earnings per share| +103| 17.9p| 8.8p|+----------------------------------+-----------+-----------+----------+|IFRS basic earnings per share | +108| 13.1p| 6.3p|+----------------------------------+-----------+-----------+----------+|Dividend per share | +2| 7.85p| 7.7p|+----------------------------------+-----------+-----------+----------+|Dividend cover on underlying basis| | 2.3 times| 1.1 times|+----------------------------------+-----------+-----------+----------+ Group IFRS underlying profit before tax has increased by 79% to £400m (2005:£224m). The total Life & Pensions underlying profit was 136% up in 2006 to £325m(2005: £138m) with increased volumes of new business generating higher newbusiness strain being offset by higher profits from in-force business andpositive basis and regulatory changes. These include a benefit from thereserving changes for non participating business arising from implementation ofPS06/14 Prudential Changes for Insurers which removed the requirement to setaside very prudent reserves for certain classes of business. This contributed£33m of profit to the underlying result. The result in 2006 also benefits fromthe release of morbidity reserves for income protection business amounting tosome £123m following changes to our claims management processes and theresulting improvement in claims experience. The underlying profit from AssetManagement fell by 18%, mainly arising from the withdrawal of funds as a resultof corporate activity. Group IFRS profit before tax from continuing operations has increased by 34% to£491m (2005: £367m). This profit measure takes into account the actualinvestment returns achieved during the year, offset by the impacts ofnon-recurring and other items. It is also shown gross of policyholder tax andminority interests. In net terms these were £91m positive in 2006 and £143mpositive in 2005, as discussed below. Underlying IFRS earnings per share have increased from 8.8p to 17.9p as a resultof the increase in IFRS profits. The basic earnings per share have increased bya similar percentage from 6.3p to 13.1p. The total dividend for 2006 of 7.85 pence per share (including the proposedfinal dividend of 5.2 pence per share) represents an increase over 2005 of 2%.This is covered 2.3 times (2005: 1.1 times) by IFRS underlying profit after taxand minority interests. After deducting the basis and regulatory changesdiscussed above, the dividend cover is approximately 1.5 times. The 2006dividend is covered more than 5 times by available distributable reserves in thecompany and FPLP. The increase in dividend is in line with our policy ofproviding dividend growth up to the rate of inflation. UK Life & Pensions UK Life & Pensions underlying profit has increased by 84% to £254m (2005:£138m). New business strain in UK Life & Pensions has increased to £96m (2005:£82m) due to increased new business volumes, offset by higher deferredacquisition costs. In 2006, £216m (2005: £190m) of acquisition expenses weredeferred. The in-force profit has increased to £298m (2005: £157m) primarily due to thebasis and reserving changes described above. The PS06/14 rules are being phasedin by the Group over 2 years and we anticipate a similar impact on IFRS profitsin 2007. The other underlying profit component is the expected return on shareholders'net assets. The expected return in 2006 was £52m (2005: £63m). The longer-terminvestment return rates assumed were: equities 7.25% (2005: 7.5%), property6.25% (2005: 7.5%), gilts 4.25% (2005: 5.0%) and other fixed interest 4.75%(2005: 5.75%). For 2007, these rates of return will all be increased by 0.75% toreflect increases in interest rates. International Life & Pensions International Life & Pensions underlying profit amounts to £71m (2005: £nil)made up of FPI of £57m (2005: £11m loss), Lombard £13m (2005: £9m) and other £1m(2005: £2m). New business strain in International Life & Pensions has fallen to £28m (2005:£33m) as a result of a change in business mix enabling more acquisition costs tobe deferred. In 2006 £116m (2005: £82m) of acquisition costs were deferred. The in-force profit has increased to £98m (2005: £31m) due to growth in the sizeof the in-force book and to changes in actuarial funding which contributed £26mfor FPI (2005: negative valuation adjustments of £21m). Asset Management Asset Management underlying profit has reduced by 18% to £89m (2005: £108m). Forthe Asset Management business, underlying profits under IFRS are the same asunder EEV and are discussed in the EEV section above. Corporate items Corporate items included in underlying profits total £14m negative (2005: £22mnegative). These items comprise the expected return on the net pension liabilityof £9m positive (2005: £2m negative), expected return on corporate net assets of£10m negative (2005: £6m negative), less corporate costs of £13m (2005: £14m). Other profit items 2006 2005 £m £m-----------------------------------------------------------------------Policyholder tax 124 218Returns on Group controlled funds attributable to third parties 104 57Short-term fluctuations in investment return (39) 102Interest payable on STICS 52 37Non-recurring items (17) (59)Amortisation of Asset Management acquired intangible assets (43) (56)Amortisation of acquired present value of in-force business (25) (28)Amortisation of Life & Pensions acquired intangible assets (7) (7)Impairment of Asset Management acquired intangible assets (58) (112)Variation in value of option on convertible debt - (9)-----------------------------------------------------------------------Other profit items 91 143----------------------------------------------------------------------- The other profit items excluded from underlying profit but included in profitbefore tax are shown above. The non-recurring items, amortisation and impairmentof intangible assets are the same as under EEV and discussed in the EEV section.The other main items are set out below: •Policyholder tax and returns on Group controlled funds attributable to third parties (the latter mainly representing the minority interest held in F&C Commercial Property Trust, which is 53% owned by the Group's long term funds) are excluded from underlying profit as neither is attributable to shareholders. •The short-term fluctuations in investment return of £39m negative (2005: £102m positive) reflect differences between the actual and expected investment market returns. •Within the calculation of underlying IFRS profit (as in EEV) we account for the STICS as debt to reflect the economic reality. However IFRS rules require that STICS is accounted for as equity in calculating IFRS profit before tax. STICS interest that was deducted in arriving at underlying profit is added back and treated as an appropriation of profit. SHAREHOLDERS' NET ASSETS The shareholders' net assets, including the asset management business at marketcapitalisation, have increased by 6% to £3,660m (2005: £3,464m) as set outbelow: 2006 2005 £m £m-----------------------------------------------------------------------Shareholders' invested net assets 1,164 1,064Value of in-force Life and Pensions business 2,031 2,019Market value of Asset Management business 534 441Other (mainly provision for future corporate costs) (69) (60)-----------------------------------------------------------------------Pro forma net assets on the EEV basis 3,660 3,464----------------------------------------------------------------------- As at 31 December 2006, the Shareholders' net assets were invested broadly in amix of 44% equities and 56% fixed interest securities and cash. CASH GENERATION Shareholder cash generation and financing is set out below: 2006 2005 £m £m-----------------------------------------------------------------------UK Life & Pensions: - New business strain (295) (261) - In-force surplus 233 253 - Taxation 35 102International Life & Pensions: - New business strain (65) (63) - In-force surplus 99 71 - Taxation (1) (2)-----------------------------------------------------------------------Life & Pensions net cash operating surplus 6 100Reserving changes 274 -Other operating surplus/(deficit) 1 (8)Investment return 31 87F&C dividend received 28 27-----------------------------------------------------------------------Cash generated by the businesses 340 206Dividends paid (164) (157)Securitisation (86) (49)Financial reinsurance (net) (69) 23Other finance items (76) (36)-----------------------------------------------------------------------Total movement (55) (13)----------------------------------------------------------------------- The decrease in cash resources of £55m reconciles as follows: 2006 2005 Movement £m £m £m-----------------------------------------------------------------------Shareholders' invested net assets 1,164 1,064 100Securitisation 93 179 (86)Financial reinsurance - 69 (69)-----------------------------------------------------------------------Shareholder net cash resources 1,257 1,312 (55)----------------------------------------------------------------------- Total cash generated before application to financing items increased to £340m upfrom £206m in 2005. Significant contributions to this increase are: £151m fromthe impact of implementing the reserving rule changes in PS06/14 for someproducts; and £123m from the release of excess prudence in morbidity reserves onincome protection business. When we complete the implementation of the changes in PS06/14 for the remainderof the affected products, we expect there to be a similar in-force item in 2007. The new business strain has increased to £295m (2005: £261m) due to increasedlevels of new business, offset by lower new business strain due to the reservingbasis changes. The ongoing in-force surplus has decreased to £233m (2005:£253m). Of this decrease £23m is as a result of the one off acceleration ofsurplus caused by reserving changes. The underlying trend is for the ongoingin-force surplus to increase at a rate consistent with the growth in ourbusiness. Investment return has decreased to £31m (2005: £87m) reflecting lower returns onboth equity and fixed interest securities. The total tax credit of £34m (2005: £100m) arises from the offset of taxableprofits against increased expenses following losses on the fixed interestinvestment portfolio. The 2005 figure benefited from relief for brought forwardtax losses. We expect tax credits to arise in future periods, albeit at a lowerlevel than in 2006. After application of this surplus to repaying financial engineering, capitalpayments including the Lombard earn-out and payment of the 2006 dividend, therewas a modest cash outflow of £55m (2005: £13m outflow). GROUP BORROWINGS +-------------------------------------------------+----------------+--------+----------+|Long-term borrowings | Coupon| 2006 | 2005 |+-------------------------------------------------+----------------+--------+----------+| | %| £m | £m |+-------------------------------------------------+----------------+--------+----------+|Subordinated liabilities: | | | |+-------------------------------------------------+----------------+--------+----------+|£215m FP Finance Plc undated subordinated | | | |+-------------------------------------------------+----------------+--------+----------+|guaranteed bond (repaid 2006) | 9.125| - | 215 |+-------------------------------------------------+----------------+--------+----------+|£260m F&C subordinated debt | Various| 258 | - |+-------------------------------------------------+----------------+--------+----------+|£10m Lombard undated subordinated loans | Various| 10 | 10 |+-------------------------------------------------+----------------+--------+----------+|£10m F&C subordinated loan | 6m LIBOR + 1.05| - | 10 |+-------------------------------------------------+----------------+--------+----------+|Debenture loans: | | | |+-------------------------------------------------+----------------+--------+----------+|£280m Box Hill Life Finance plc securitisation | | | |+-------------------------------------------------+----------------+--------+----------+|notes - class A-1 due 2016 | 3m LIBOR + 0.20| 198 | 280 |+-------------------------------------------------+----------------+--------+----------+|£100m Box Hill Life Finance plc securitisation | | | |+-------------------------------------------------+----------------+--------+----------+|notes - class A-2 due 2019 | 3m LIBOR + 0.23| 100 | 100 |+-------------------------------------------------+----------------+--------+----------+|£6m Friends Provident Investment Holdings plc | | | ||loan | | | |+-------------------------------------------------+----------------+--------+----------+|notes due 2006 | LIBOR - 0.5| - | 6 |+-------------------------------------------------+----------------+--------+----------+|£230m F&C Commercial Property Trust (a | | | ||policyholder | | | |+-------------------------------------------------+----------------+--------+----------+|investment) secured bonds due 2017 | 5.23| 229 | 229 |+-------------------------------------------------+----------------+--------+----------+|€35m Lombard financial reinsurance treaty | LIBOR + 2.0| 24 | 22 |+-------------------------------------------------+----------------+--------+----------+|£18m Friends Provident plc loan notes due 2011 | LIBOR - 0.75| 18 | - |+-------------------------------------------------+----------------+--------+----------+|Convertible bonds: | | | |+-------------------------------------------------+----------------+--------+----------+|£290m Friends Provident plc convertible bonds due| 5.25| 283 | 276 ||2007 | | | |+-------------------------------------------------+----------------+--------+----------+|Total long-term borrowings | | 1,120 | 1,148 |+-------------------------------------------------+----------------+--------+----------+|Subordinated borrowings | | | |+-------------------------------------------------+----------------+--------+----------+|(designated as equity under IFRS): | | | |+-------------------------------------------------+----------------+--------+----------+|£300m Friends Provident plc STICS callable 2019 | 6.875| 297 | 297 |+-------------------------------------------------+----------------+--------+----------+|£500m Friends Provident plc STICS callable 2015 | 6.292| 495 | 495 |+-------------------------------------------------+----------------+--------+----------+| | | | |+-------------------------------------------------+----------------+--------+----------+|Total long-term borrowings including STICS | | 1,912 | 1,940 |+-------------------------------------------------+----------------+--------+----------+ Borrowings are net of capitalised issue costs. F&C raised £260m fixed/floating rate subordinated notes in December 2006 usingthe proceeds of the issue to repay an existing £180m loan from FPLP and othersmaller loan facilities with the balance retained for general corporatepurposes. In addition some £82m of the Box Hill Life Finance plc A-1securitisation notes were repaid as a result of surplus emerging. Of theremaining £198m of class A-1 notes outstanding, £144m is expected to be repaidin April 2007. In 2007, the £290m convertible bonds are expected to be convertedinto ordinary shares. FINANCIAL STRENGTH The Group remains financially strong and our financial standing has been furtherimproved during 2006. We continue to manage our business financially on thebasis of our economic capital. We have developed a sophisticated economiccapital model, which has helped with setting our financial risk appetite and ourcontinued drive for capital efficiency. In arriving at the EEV result, the allowance for required capital is set at thehigher of regulatory and economic capital. In aggregate, the economic capitalrequirements are higher than regulatory requirements by approximately £200m(2005: £100m). In addition to maintaining our economic capital, we also ensure that we complycomfortably with all other regulatory capital requirements. These include therealistic solvency requirement for our FPLP with-profits business, ourregulatory solvency in accordance with FSA regulations for the remainder of ourUK Life & Pensions business and Asset Management business, local regulatoryrequirements for overseas businesses and our Group solvency requirements. We have continued to make good progress in reducing financial risk in thebusiness and these actions are reaping tangible benefits, for example with ourmanagement of the FPLP With-Profits Fund and the staff pension scheme asdiscussed below. Life & Pensions capital position The total available capital resources, calculated in accordance with FRS 27 on arealistic basis for the FPLP With-Profits Fund and on a regulatory basis for allother funds, amounts to £2.5bn (2005: £2.5bn). The regulatory capitalrequirement is £0.7bn (2005: £0.7bn). Therefore the excess capital resourcesover the capital requirement amounts to £1.8bn (2005: £1.8bn). The bulk of theGroup's capital is held outside the with-profits funds and, consequently, can bedeployed around the Group with a relatively high degree of flexibility. Group solvency The Group is required to comply with the Insurance Groups Directive, whichrequires a very prudent measure of excess capital resources as it excludes anysurplus capital within the long-term fund. On this measure the provisional GroupCapital resources exceeded Group Capital requirements by approximately £1bn(2005: £0.8bn). Credit ratings External agencies such as Standard & Poor's, Fitch and Moody's regularly performindependent assessments of the financial strength of life companies and publishtheir ratings. In July 2006, Moody's upgraded FPLP's rating from A2 to A1(strong) with a stable outlook. Standard & Poor's credit rating for FP plcremained at A- stable. FPLP realistic solvency The assets and liabilities of the FPLP With-Profits Fund are calculated on arealistic basis. Policyholder liabilities (including options and guarantees) arevalued using a market consistent stochastic model. At 31 December 2006, surplus assets amounted to £254m and the Risk CapitalMargin (RCM) was £220m. Our objective is to manage the Fund so that, over time,the RCM should be covered from assets within the Fund. Accordingly the excessassets have been reserved for policyholders via a reduction in future guaranteecharges leaving residual surplus assets of £220m. At 31 December 2005, surplusassets amounted to £236m and the RCM amounted to £276m leaving £40m to be met bysurplus assets outside the Fund. The FPLP With-Profits Fund Realistic Balance Sheet is resilient in the event offalls or rises in investment markets. This is due in large measure to theactions we have taken to hedge the provisions made to cover the cost ofguarantees and options. FPLP regulatory solvency In addition to a realistic basis, the solvency for FPLP's With-Profits Fund isassessed on a regulatory basis. The two calculations are then compared and themore onerous requirement is applied. For 2006 and 2005 the more onerousrequirement for FPLP has been the realistic basis. The Free Asset Ratio (FAR) is a common measure of financial strength. It is theratio of assets less liabilities (including actuarial reserves but before thecapital requirements) expressed as a percentage of actuarial reserves. For FPLPit has increased to an estimated 22.2% at the end of 2006 (2005: 18.3%) andavailable assets to meet capital requirements have increased from £3.5bn to£3.9bn. The main reasons for the increase are the investment return achievedduring the year and changes to the regulatory requirements. The quality of our regulatory capital is very high and does not include anyimplicit items. Financial risk reduction We actively manage financial risk and have taken a number of initiatives toreduce our exposures. FPLP's With-Profits Fund: Our overall aim remains to balance risk to shareholders with maximising returnsto policyholders whilst ensuring guarantees are met as they fall due. Particularactivities include: •Managing the proportion of equities and property backing the asset shares. At 2006 year-end this proportion was 54% (2005: 52%) •Active management of bonuses and any market value reduction factors •Hedging strategies to mitigate market and interest rate risks The gross investment return achieved by the FPLP With-Profits Fund in 2006 was8.1% (2005: 16.5%). Other Life & Pensions Funds: We carry out other risk mitigation activities outside the FPLP With-ProfitsFund, including cash flow matching and other inflation and interest ratehedging. Pension schemes: The principal defined benefit scheme, Friends Provident Pension Scheme, is in ahealthy position. At 2006 year-end there was a small deficit of £31m, equivalentto 3.4% of assets (2005: deficit £59m). The near fully funded position is partly due to the success of ongoing riskmanagement activities including: •The individual derivative hedges against the risk of inflation have been exchanged for positions in ten liability driven investment pools which better match the liabilities of the scheme •Employer and employee contributions were increased in 2006 •From July 2007, the scheme will be closed to new entrants with a defined contribution plan for new employees to be introduced •Employees will choose in 2007 whether they wish to increase their contributions and maintain a retirement age of 60, or maintain their contributions and increase their retirement age to 65 Future consideration for Lombard The acquisition of Lombard in January 2005 allowed for future consideration(earn out) based on Lombard achieving certain performance thresholds for bothnew business profits and underlying embedded value. The total earn out has beenestimated at €551m with €440m having been settled by 31 December 2006. Theestimated final amount of €111m (£75m) has been provided for at 31 December 2006and will be settled in April 2007. The provision established at 31 December 2005for future earn out amounted to €213m (£146m) and included an estimated finalamount of €128m (£87m). This information is provided by RNS The company news service from the London Stock Exchange

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