Final Results-Part 2

20th Mar 2007 07:03

Friends Provident PLC20 March 2007 PART 2 Contents EEV resultsSummary consolidated income statement on an EEV basisConsolidated statement of recognised income and expense on an EEV basisConsolidated movement in ordinary shareholders' equity on an EEV basisConsolidated balance sheet on an EEV basisNotes to the EEV results IFRS resultsConsolidated income statement on an IFRS basisConsolidated underlying profit on an IFRS basisConsolidated balance sheet on an IFRS basisConsolidated statement of recognised income and expense on an IFRS basisSummary consolidated cash flow statement on an IFRS basisNotes to the IFRS results Summary consolidated income statement on an EEV basisFor the year ended 31 December 2006 2006 2005 Notes £m £m------------------------------------------------------------------------Life & PensionsContribution from new business 2(b), 3(a) 204 144Profit from existing business:Expected return 207 196Experience variances 7 22Operating assumption changes (9) 16Development costs (26) (25)Expected return on shareholders' net assets within the Life & Pensions business 51 81------------------------------------------------------------------------Life & Pensions underlying profit 2(a) 434 434Asset Management underlying profit 89 108Expected return on net pension liability 9 (2)Expected return on corporate net assets (10) (7)Corporate costs (13) (12)Operating assumption changes forcorporate costs - 3------------------------------------------------------------------------Underlying profit before tax 509 524 Investment return variances (174) 550Effect of economic assumption changes 181 (238)Non-recurring items 4 (17) (59)Amortisation of Asset Management acquiredintangible assets (43) (56)Impairment of Asset Management acquiredintangible assets (58) (112)Variation in value of option onconvertible debt - (9)------------------------------------------------------------------------Profit before tax 398 600 Tax (101) (196)------------------------------------------------------------------------Profit after tax 297 404------------------------------------------------------------------------ Attributable to:Ordinary shareholders of the parent 308 441Minority interest (11) (37)------------------------------------------------------------------------Profit after tax 297 404------------------------------------------------------------------------ Earnings per share 2006 2005 pence pence------------------------------------------------------------------------Basic earnings per share 5 14.6 21.2Diluted basic earnings per share 5 14.2 21.0Underlying earnings per share 5 16.4 16.3------------------------------------------------------------------------ EEV underlying profit is a measure of profit which excludes profit generatedwithin policyholder funds that is not allocated to shareholders. Managementconsider that underlying profit better reflects the performance of the Group andfocus on this measure of profit in its internal monitoring of the Group's EEVresults. EEV underlying profit is based on expected investment return and excludes: (i)amortisation and impairment of Asset Management acquired intangible assets (ii)effect of economic assumption changes (iii) non-recurring items; and is statedafter deducting interest payable on STICS. Consolidated statement of recognised income and expense on an EEV basisFor the year ended 31 December 2006 2006 2005 £m £m------------------------------------------------------------------------Actuarial losses on defined benefit plansnet of tax (8) (28)Foreign exchange adjustments (2) (9)------------------------------------------------------------------------Net loss recognised directly in equity (10) (37)Profit after tax 297 404------------------------------------------------------------------------Total recognised income and expense forthe year 287 367------------------------------------------------------------------------Attributable to:Ordinary shareholders of the parent 300 417Minority interest (13) (50)------------------------------------------------------------------------Total recognised income and expense forthe year 287 367------------------------------------------------------------------------ Consolidated movement in ordinary shareholders' equity on an EEV basisFor the year ended 31 December 2006 2006 2005 £m £m------------------------------------------------------------------------Total recognised income and expense for the yearattributable to ordinary shareholders of the parent 300 417Dividends on equity shares (164) (157)Share based payments (impact on EEV reserves) 12 14Earn-out payments (87) -Conversion option on convertible bond - 51------------------------------------------------------------------------Increase in EEV reserves for the year 61 325Increase as a result of business combinations - 148Share based payments(impact on share capital and share premium) 13 5------------------------------------------------------------------------Net addition to ordinary shareholders' equity 74 478At 1 January 3,446 2,968------------------------------------------------------------------------At 31 December 3,520 3,446------------------------------------------------------------------------ Consolidated balance sheet on an EEV basisAt 31 December 2006 2006 2005 £m £m------------------------------------------------------------------------AssetsValue of in-force Life & Pensions business 2,031 2,019Intangible assets 676 807Property and equipment 80 73Investment properties 2,426 1,912Investment in associates and joint venture 15 14Financial assets 45,150 42,091Reinsurance assets 98 128Current tax assets 30 25Insurance and other receivables 647 640Cash and cash equivalents 3,581 2,614------------------------------------------------------------------------Total assets 54,734 50,323------------------------------------------------------------------------ LiabilitiesInsurance contracts 13,762 14,637Fund for future appropriations 439 420Financial liabilities - Investment contracts 32,451 27,539 - Interest bearing loans and borrowings 2,045 2,099Net asset value attributable to unit holders 941 751Provisions 187 265Deferred tax liabilities 166 125Current tax liabilities 116 177Insurance payables, other payables and deferred income 559 422------------------------------------------------------------------------Total liabilities 50,666 46,435------------------------------------------------------------------------ Equity attributable to:Ordinary shareholders of the parent 3,520 3,446Minority interest 548 442------------------------------------------------------------------------Total equity 4,068 3,888------------------------------------------------------------------------ ------------------------------------------------------------------------Total equity and liabilities 54,734 50,323------------------------------------------------------------------------ Notes to the EEV results 1. Methodology 1.1 Basis of preparation The EEV results presented in this document have been prepared in accordance withthe European Insurers' Chief Financial Officers Forum's EEV Principles issued inMay 2004 and the Additional Guidance issued in 2005. They provide supplementaryinformation for the year ended 31 December 2006. The EEV basis of reporting is designed to recognise profit as it is earned overthe term of the policy. The total profit recognised over the lifetime of thepolicy is the same as that recognised under the IFRS basis of reporting, but thetiming of recognition is different. The reported embedded value provides an estimate of the value of shareholders'interest in the covered business, excluding any value that may be generated fromfuture new business. This value comprises the sum of the shareholders' networth, the provision for future corporate costs and the value of existingbusiness. The shareholders' net worth is the net assets attributable toshareholders, and is represented by the sum of required capital and freesurplus. The value of existing business is the present value of the projectedstream of future distributable profits available to shareholders from theexisting business at the valuation date, on a best estimate basis allowing forrisk, adjusted for the cost of holding required capital. The supplementary information should be read in conjunction with the Group'sIFRS results. These contain information regarding the Group's financialstatements prepared in accordance with IFRS issued by the InternationalAccounting Standards Board and adopted for use in the EU. The results for covered business as reported under EEV principles are combinedwith the results for the remainder of the business reported in accordance withIFRS, except where EEV principles dictate otherwise. In particular the EEVprinciples have been applied to reflect Step-up Tier one Insurance CapitalSecurities (STICS) as debt rather than equity. In addition, a pro forma embedded value is reported showing ordinaryshareholders' funds on an EEV basis adjusted to include the F&C listedsubsidiary at market value. Shareholders' net assets on an EEV basis for the Group consist of the following: • Life & Pensions net assets;• the Group's share of its investment in the Asset Management business (including the net pension liability) on an IFRS basis;• corporate net assets;• the net pension liability of FPPS on an IAS 19 basis but, in 2005, including holdings in non-transferable securities issued by the Group (both net of deferred tax);• the provision for future corporate costs;• the present value of future profits attributable to shareholders from existing policies of the Life & Pensions business. It is currently expected that the final consideration in respect of the Lombardacquisition will be settled by way of shares and cash. Provision has been madein 2006 for the estimated cash element of the final earn-out payment. The shareholders' net worth includes the corporate debt of the Group. This debtis valued at market value, consistent with the EEV guidance. EEV and other balance sheet items denominated in foreign currencies have beentranslated to sterling using the appropriate closing exchange rate. The newbusiness contribution and other income statement items have been translatedusing an average exchange rate for the relevant period. 1.2 Covered business The covered business incorporates the Life & Pensions business defined aslong-term business by UK and overseas regulators. The asset management business is not included in the definition of coveredbusiness. 1.3 Allowance for risk The allowance for risk in the shareholder cash flows is a key feature of the EEVPrinciples. The EEV guidance sets out three main areas available to allow forrisk in an embedded value: • the risk discount rate;• the allowance for the cost of financial options and guarantees;• the cost of holding both prudential reserves and any additional required capital. The market-consistent approach has been used to allow for risk in all threeareas. 1.4 Deriving risk discount rates A market-consistent embedded value has been calculated for each product line byvaluing the cash flows in line with the prices of similar cash flows traded onthe open market. In principle, each cash flow is valued using the discount rate consistent withthat applied to such a cash flow in the capital markets. For example, an equitycash flow is valued using an equity risk discount rate, and a bond cash flow isvalued using a bond risk discount rate. If a higher return is assumed forequities, the equity cash flow is discounted at this higher rate. In practice, for liabilities where the payouts are either independent or movelinearly with market movements, a method known as the 'certainty equivalentapproach' has been applied whereby all assumed assets earn the risk-free rateand all cash flows are discounted using the risk-free rate. This gives the sameresult as applying the method in the previous paragraph. A market-consistent cost of financial options and guarantees and amarket-consistent cost of holding required capital have also been calculated.The cost of financial options and guarantees includes additional allowance fornon-market risk within the With Profits Fund. An additional provision has beenmade for operational risks. These are described in more detail below. For presentational purposes, a set of risk discount rates has been derived foreach product line, and for in-force and new business, by calculating the riskdiscount rate under a traditional embedded value approach that gives the samevalue as that from the market-consistent embedded value determined above. Thesederived risk discount rates are a function of the assumptions used (eg equityrisk premium, corporate bond spreads). However, as the market-consistentapproach is used, these assumptions do not impact the level of embedded value: ahigher equity risk premium results in an exactly compensating higher riskdiscount rate. 1.5 Financial options and guarantees The material financial options and guarantees are those in the Friends ProvidentLife and Pensions Limited (FPLP) With-Profits Fund, in the form of the benefitsguaranteed to policyholders and the guaranteed annuity rates associated withcertain policies. The risk to shareholders is that the assets of the With-Profits Fund areinsufficient to meet these guarantees. While shareholders are entitled to only asmall share of profits in the With-Profits Fund (via one ninth of the cost ofbonus), they can potentially be exposed to the full cost if fund assets areinsufficient to meet policyholder guarantees. The time value cost of thisasymmetry, known as the burnthrough cost, is modelled stochastically, as it willonly occur in some adverse scenarios. The burnthrough time value cost iscalculated as the difference between the average value of shareholder cash flowsunder a number of market-consistent scenarios, and the intrinsic shareholdervalue using risk-free assumptions included within the deterministic model. The burnthrough cost has been assessed using a stochastic model derived from thecurrent Realistic Balance Sheet (RBS) model. This model has been calibrated tomarket conditions at the valuation date. Allowance has been made under thedifferent scenarios for management actions, such as altered investment strategy,consistent with the RBS model. The burnthrough cost would be markedly higherwithout the hedging activities undertaken. The burnthrough cost at 31 December 2006 of £50m (2005: £75m), is split between£30m (2005: £40m) market risk and £20m (2005: £35m) non-market risk. Thenon-market risks include lapses, annuitant longevity, and operational riskwithin the With-Profits Fund. The allowance for non-market risks is made byconsideration of the impact of extreme scenarios from our economic capitalmodel. Significant amounts of new with-profits business are no longer written and theguarantee levels offered are lower, hence there is no material impact of theburn through cost in the contribution to profits of new business. 1.6 Required capital and the cost of capital Required capital is set at the greater of regulatory capital and economiccapital. Regulatory minimum capital includes prudent reserves as well assolvency margin. Economic capital is determined from internal models, based onthe company's risk appetite. At a product level economic capital requirements are higher than regulatorycapital requirements for with-profits and annuity business, and lower thanregulatory capital requirements on unit-linked and protection business. Inaggregate, the economic capital requirements are higher than regulatoryrequirements by approximately £200m (2005: £100m). Capital requirements under EEV amounted to £652m (2005: £551m). For new business, regulatory capital requirements are higher than economiccapital requirements, given the high proportion of unit-linked and protectionnew business, and the contribution to profits from new business is thereforebased on regulatory capital requirements. The EEV includes a deduction for the cost of holding the required capital.Frictional costs, being the tangible costs of holding capital, have been allowedfor on a market-consistent basis. These consist of the total taxation andinvestment expenses incurred on locked-in shareholder capital and reflect thecost to an investor of holding an asset through investment in a life company,rather than investing in the asset directly. No adjustment has been made for any agency cost, this representing the potentialmarkdown to value that investors will apply because they do not have directcontrol over their capital. Any adjustment would be subjective and differentinvestors will have their own views of what adjustment, if any, should be made. 1.7 Non-market risk An investor can diversify away the uncertainty around the return on non-marketrisks, such as mortality and expenses. Hence in a shareholder valuation theallowance for non-market risk is made through the appropriate choice of bestestimate experience assumptions and the impact of non-market risks on the level,and hence the cost, of capital. In choosing best estimate assumptions the allowance for non-market risk has beenreviewed. However, best estimate assumptions may fail to represent the fullimpact on shareholder value where the impact of fluctuations in experience isasymmetric; that is where adverse experience has a higher impact on shareholdervalue than favourable experience. The areas identified as having suchasymmetries are the burnthrough cost and operational risk. The impact of variations in non-market risks have been taken into account in theburnthrough cost calculation. This allows for asymmetries arising from theprofit sharing mechanism. In addition, a provision of £85m (2005: £87m) has been set up for operationalrisks in the shareholders' funds. This provision has been calculated bycomparing the mean impact of variations in operational risk, as modelled in theeconomic capital calculations, with the existing allowance for operational riskin specific accounting provisions and embedded value projection assumptions. This provision of £85m is equivalent to a 0.4% (2005: 0.4%) increase in the riskdiscount rate for UK Life & Pensions business and 0.8% (2005: 0.8%) forInternational Life & Pensions business, recognising the higher operational risksin international business. This impacts both embedded value and the contributionfrom new business. 1.8 Expenses The EEV guidance requires companies to actively review expense assumptions, andinclude an allowance for holding company (corporate) costs and service companycosts. (a) Corporate costs Corporate costs relate to those costs incurred at the corporate level that arenot directly attributable to the Life & Pensions or the Asset Managementbusinesses. Under EEV methodology, corporate costs are classified as either ongoing costs ordevelopment and one-off costs. For 2006, £6m (2005: £6m) of corporate costs wereregular ongoing corporate costs and £7m (2005: £6m) were development or one-offcosts. The ongoing costs have been capitalised under EEV. The impact is aprovision of £47m (2005: £47m). (b) Service costs Service company costs are included in the EEV expense assumption calculations.Included within these are the fees charged by F&C for investment managementservices to the covered Life & Pensions business. F&C service fee profits in respect of covered Life & Pensions business are notcapitalised under the EEV methodology, as F&C is a separate business segmentwithin the Group and the arrangement between F&C and the Life & Pensionsbusiness is on an arm's length basis. Instead, these profits, approximately £11m(2005: £15m) are brought into the consolidated income statement on an IFRSbasis, and F&C is brought into the pro forma embedded value at market value. Productivity gains have been assumed within the EEV in respect of Internationalbusiness in anticipation of future business growth. The Lombard EEV has beenreduced by £13m (2005: £8m) for a projected expense overrun for the period 2007- 2012. 1.9 New business New business within the covered business includes: • premiums from the sale of new contracts;• payments on recurring single premium contracts, including Department for Work and Pensions rebate premiums, except existing stakeholder-style pensions business where, if a regular pattern in the receipt of premiums for individuals has been established, the regular payment is treated as a renewal of an existing contract and not new business;• non-contractual increments on existing policies; and• new entrants in the group pensions business. 2. Segmental analysis (a) Life & Pensions EEV Profit Year ended 31 December 2006 2006 2005 Notes UK Inter'l Total UK Inter'l Total £m £m £m £m £m £m------------------------------------------------------------------------------------------Contribution fromnew business 2(b),3(a) 108 96 204 64 80 144Profit from existingbusiness:expected return 173 34 207 170 26 196experience variances (i) 9 (2) 7 20 2 22operating assumptionchanges (ii) 1 (10) (9) 19 (3) 16Development costs (26) - (26) (25) - (25)Expected return onshareholders' net assetswithin the Life & Pensionsbusiness 50 1 51 80 1 81------------------------------------------------------------------------------------------Life & Pensions EEVunderlying profitbefore tax 315 119 434 328 106 434Non-recurring items 4 2 - 2 (10) (3) (13)Investment return variances 3(e) (179) (7) (186) 584 57 641Effect of economicassumption changes 187 (7) 180 (223) (13) (236)------------------------------------------------------------------------------------------Life & Pensions EEV profitbefore tax 325 105 430 679 147 826Attributed tax charge 3(f) (103) (18) (121) (204) (28) (232)------------------------------------------------------------------------------------------Life & Pensions EEV profitafter tax 222 87 309 475 119 594------------------------------------------------------------------------------------------ (i) UK experience variances include the positive variance arising from lowerburnthrough cost of £36m. Against this there have been adverse experiencevariances on persistency of £12m and other adverse variances amounting to a net£15m. This includes adverse variances on non recurring expenses and modelchanges, with positive variances arising from operational risk and taxation. (ii) The UK operating assumption change includes the adverse impact ofpersistency assumption changes of £41m offset by mortality and morbidityfavourable variances of £27m and £15m from other changes including PS06/14. (b) New business margin Year ended 31 December 2006 2006 2005 UK Inter'l Total UK Inter'l Total------------------------------------------------------------------------------------------Contribution from new business £108m £96m £204m £64m £80m £144m------------------------------------------------------------------------------------------Present Value of new BusinessPremiums (PVNBP) £4,162m £2,912m £7,074m £3,192m £2,205m £5,397mMargin - PVNBP 2.6% 3.3% 2.9% 2.0% 3.6% 2.7%------------------------------------------------------------------------------------------ PVNBP equals new single premiums plus the expected present value of new regularpremium business. (c) Pro forma embedded value At 31 December 2006 2006 2005 £m £m----------------------------------------------------------------------------Ordinary shareholders' equity on an EEV basis 3,520 3,446Adjustment to the value of the listed AssetManagement business to market value 140 18----------------------------------------------------------------------------Pro forma embedded value 3,660 3,464----------------------------------------------------------------------------Pro forma embedded value per share £1.73 £1.65---------------------------------------------------------------------------- (d) Summary consolidated balance sheet on an EEV basis 2006 2005 Intra Intra Segmental -Group Segmental -Group analysis debt(iii) Total analysis debt(iii) Total £m £m £m £m £m £m---------------------------------------------------------------------------------------------Life & Pensions - long-term funds 778 - 778 621 (180) 441Life & Pensions - shareholders'funds 419 795 1,214 429 770 1,199---------------------------------------------------------------------------------------------Life & Pensions net assets 1,197 795 1,992 1,050 590 1,640Corporate net assets (33) (795) (828) 14 (795) (781)---------------------------------------------------------------------------------------------Shareholders' investednet assets 1,164 - 1,164 1,064 (205) 859Attributable net asset value ofthe Asset Management businessnet of minority interest (i), (ii) 394 - 394 423 205 628Net pension liability ofFriends Provident Pension Scheme (22) (22) (13) - (13)---------------------------------------------------------------------------------------------Shareholders' net worth 1,536 - 1,536 1,474 - 1,474---------------------------------------------------------------------------------------------Provision for future corporatecosts (47) (47)Value of in-force Life &Pensions business 2,031 2,019---------------------------------------------------------------------------------------------Ordinary shareholders' netassets on an EEV basis 3,520 3,446---------------------------------------------------------------------------------------------Called-up share capital 214 214Share premium account 2,051 2,038EEV reserves 1,255 1,194---------------------------------------------------------------------------------------------Ordinary shareholders' equityon an EEV basis 3,520 3,446--------------------------------------------------------------------------------------------- At 31 December 2006 (i) The attributable net asset value of the Asset Management business includesgoodwill of £333m at 31 December 2006 (2005: £333m) and other intangible assets,net of related tax, of £105m (2005: £154m). Other intangible assets compriseinvestment management contracts £104m (2005: £153m) and software £1m (2005:£1m). (ii) The attributable net asset value of the Asset Management business includesthe value of the net pension liability of that business on an IAS 19 Employeebenefits basis, and is net of related tax. The net pension liability of FriendsProvident Pension Scheme (FPPS) is stated on an IAS 19 basis, but, in 2005,including holdings in non-transferable securities issued by the Group, and isnet of related deferred taxation. (iii) Intra-group long-term debt is analysed as follows: +-----------------------------------------+-------------------+------------------+| | Debt | Interest payable |+-----------------------------------------+-------+-----------+---------+--------+| | 2006 | 2005 | 2006 | 2005 |+-----------------------------------------+-------+-----------+---------+--------+| | £m | £m | £m | £m |+-----------------------------------------+-------+-----------+---------+--------+|Due from F&C to FPLP | - | 205 | 12 | 12 |+-----------------------------------------+-------+-----------+---------+--------+|Due from FPLP to Friends Provident Plc | 795 | 795 | 46 | 30 |+-----------------------------------------+-------+-----------+---------+--------+ (e) Life & Pensions net assets segmental information by business segment 2006 2005 UK Inter'l Total UK Inter'l Total £m £m £m £m £m £m-------------------------------------------------------------------------------Life & Pensions net assets 1,147 50 1,197 1,028 22 1,050Value of in-force Life &Pensions business 1,491 540 2,031 1,538 481 2,019------------------------------------------------------------------------------- 2,638 590 3,228 2,566 503 3,069------------------------------------------------------------------------------- 3. Life & Pensions EEV profit (a) Contribution from new business The contribution from new business is calculated using economic assumptions atthe beginning of the period. The contribution from new business usingend-of-period economic assumptions was £196m (2005: £143m). Derived riskdiscount rates for new business have been based on end-of-period economicassumptions. The contribution from new business is quoted after cost of required capital andshare incentives. The table below gives the contribution before cost of capitaland share based payments. 2006 2005 £m £m------------------------------------------------------------------------------Contribution from new business before cost of capitaland share based payments 212 152Cost of share based payments (2) (2)Cost of capital (6) (6)------------------------------------------------------------------------------Contribution from new business 204 144------------------------------------------------------------------------------ (b) Profit from existing business - Life & Pensions Profit from existing Life & Pensions business comprises the expected return onthe value of in-force business at the start of the period plus the impact of anychanges in the assumptions regarding future operating experience, changes in thereserving basis (other than economic assumption changes) and profits and lossescaused by differences between the actual experience for the period and theassumptions used to calculate the embedded value at the end of the period. The expected return on the value of in-force business is the difference betweenthe expected return on the assets backing the liabilities and the expectedchange in the market-consistent value of the liabilities. Effectively, thisapproach is similar to applying an unwind in the risk discount rate to the valueof the in-force business at the beginning of the year. However, the riskdiscount rate to be used is a rate appropriate over the period of return only,which is not necessarily equal to the overall in-force risk discount rateaveraged across all future durations above. (c) Development costs - Life & Pensions Development costs represent investments made to improve future EEV profits, forexample by reducing expenses or increasing future new business volumes. Inparticular, the Life & Pensions costs represent investment in developingadvanced electronic trading systems, e-commerce related activities, and newbusiness service automation and improvement. (d) Expected return on shareholders' net assets The expected return on shareholders' net assets held within the Life & Pensionsbusiness comprises the return on the shareholders' net assets held by the lifeassurance companies within that business, using the investment returnassumptions used to calculate the embedded value at the beginning of the period. The expected return on corporate net assets is the expected investment return onassets held by Friends Provident plc and its non-life subsidiaries. It excludesthe expected return on the net pension liability and the result of the F&Cbusiness, which are shown separately in the summary consolidated incomestatement. (e) Investment return variance The split of the investment return variance in the Life & Pensions EEV profit isshown in the table below: 2006 2005 £m £m---------------------------------------------------------------------------In respect of net assets at the start of year (16) 84In respect of covered business (122) 373---------------------------------------------------------------------------Investment return variances after tax (138) 457---------------------------------------------------------------------------Investment return variances before tax (186) 641--------------------------------------------------------------------------- The investment return variance of £(16)m after tax relates to shareholder netassets. The investment return variance in respect of covered business comprises£(110)m after tax, relating to assets backing actuarial liabilities, and £(12)mafter tax, relating to the value of the in-force business. Together thesevariances amount to £(138)m after tax and £(186)m before tax. (f) Attributed tax charge EEV profits are calculated net of tax and then grossed up at the effective rateof shareholder tax. Except for the expected return on shareholders' net assetsthe full standard rate of UK corporation tax has been used to gross up after taxprofits on UK business and appropriate tax rates have been used for theInternational business. 2006 2005 £m £m---------------------------------------------------------------------------Contribution from new business 51 35Profit from existing business 55 69Development costs (8) (8)Expected return on shareholders' net assets withinthe Life & Pensions business 16 24Non-recurring items 1 (3)Investment return variances (48) 184Effect of economic assumption changes 54 (69)---------------------------------------------------------------------------Attributed tax charge 121 232--------------------------------------------------------------------------- 4. Non-recurring items 2006 2005 £m £m---------------------------------------------------------------------------Life & Pensions integration costs - 6Closure of Appointed Representatives Sales Channel 2 -Provision for past sales (4) 7---------------------------------------------------------------------------Life & Pensions non-recurring items (2) 13---------------------------------------------------------------------------Asset Management integration costs 7 24Asset Management Reinvestment Plan cost 12 22---------------------------------------------------------------------------Asset Management non-recurring items 19 46---------------------------------------------------------------------------Total non-recurring items 17 59--------------------------------------------------------------------------- Explanations of the non-recurring items are set out in note 2 to the IFRSsection. 5. Earnings per share Basic and underlying earnings per share 2006 2005 Per Per Earnings share Earnings share £m pence £m pence----------------------------------------------------------------------------Profit after tax attributable toordinary shareholders of theparent 308 14.6 441 21.2Investment return variances 174 8.2 (550) (26.4)Variation in value of option onconvertible debt - - 9 0.4Effect of economic assumptionchanges (181) (8.5) 238 11.4Amortisation and impairment ofAsset Management acquiredintangible assets 101 4.7 168 8.1Non-recurring items 17 0.8 59 2.8Tax charge on items excluded fromunderlying profit (32) (1.5) 46 2.2Minority interest on itemsexcluded from underlying profit (40) (1.9) (72) (3.4)----------------------------------------------------------------------------Underlying profit after taxattributable to ordinaryshareholders of the parent 347 16.4 339 16.3---------------------------------------------------------------------------- 2006 2005 millions millions---------------------------------------------------------------------------Weighted average number of ordinary shares 2,111 2,082--------------------------------------------------------------------------- Diluted basic earnings per share 2006 2005 Weighted Weighted average average number of 2006 number of 2005 2006 ordinary Per 2005 ordinary Per earnings shares share earnings shares share £m millions pence £m millions pence--------------------------------------------------------------------------------------Profit after taxattributable toordinary shareholdersof the parent 308 2,111 14.6 441 2,082 21.2Dilution (i) 16 164 (0.4) - 15 (0.2)--------------------------------------------------------------------------------------Diluted profit aftertax attributable toordinary shareholdersof the parent 324 2,275 14.2 441 2,097 21.0-------------------------------------------------------------------------------------- (i) Details of dilution are set out in note 5 to the IFRS section. 6. Reconciliation of movement in pro forma embedded value Total UK Inter'l Life & Life & Life & Pensions Total Pensions Pensions EEV Other EEV £m £m £m £m £m--------------------------------------------------------------------------------------Pro forma embedded valueat 31 December 2005 2,566 503 3,069 395 3,464--------------------------------------------------------------------------------------Contribution from new business 108 96 204 - 204Profit from existing business - Expected return 173 34 207 - 207 - Experience variances 9 (2) 7 - 7 - Operating assumption changes 1 (10) (9) - (9) - Expected transfer to net assets - - - - -Development costs (26) - (26) - (26)Expected return on shareholders' net assets 50 1 51 - 51Other underlying items - - - 75 75--------------------------------------------------------------------------------------Underlying EEV profit before tax 315 119 434 75 509Non-recurring items 2 - 2 (19) (17)Investment return variances (179) (7) (186) 12 (174)Effect of economic assumption changes 187 (7) 180 1 181Other non-underlying items - - - (101) (101)--------------------------------------------------------------------------------------EEV profit before tax 325 105 430 (32) 398Tax (103) (18) (121) 20 (101)--------------------------------------------------------------------------------------EEV profit after tax 222 87 309 (12) 297Net movement recognised directly inthe statement of recognisedincome and expense - - - (10) (10)Minority interest - - - 13 13Dividends on ordinary shares (150) - (150) (14) (164)Share based payments - - - 25 25Earn-out payments - - - (87) (87)Adjustment to the value of thelisted Asset Management business tomarket value - - - 122 122--------------------------------------------------------------------------------------Total movement in EEV 72 87 159 37 196--------------------------------------------------------------------------------------Pro forma embedded valueat 31 December 2006 2,638 590 3,228 432 3,660-------------------------------------------------------------------------------------- Pro forma EEV comprises the EEV of the entire Group, incorporating the Group'sshare of F&C at market value of £531m (2005: £441m). "Other" consists predominantly of Asset Management business and corporate items. 7. Reconciliation of net worth and value of in force business for Life &Pensions Total Value of Life & Free Required Total net in force Pensions surplus capital worth business EEV £m £m £m £m £m------------------------------------------------------------------------------------Shareholders' capital andreserves At 1 January 2006 499 551 1,050 2,019 3,069------------------------------------------------------------------------------------Contribution from new business (299) 65 (234) 388 154Profit from existing business Expected return 37 (34) 3 145 148Experience variances, operating assumption changes and development costs 138 69 207 (223) (16) Expected profit - transfer to net worth 240 - 240 (240) -Expected return on shareholders' net assets 33 - 33 - 33------------------------------------------------------------------------------------Investment return variances and economic assumption changes 47 1 48 (58) (10)------------------------------------------------------------------------------------Life and Pensions EEV profitafter tax 196 101 297 12 309Dividend (150) - (150) - (150)------------------------------------------------------------------------------------Shareholders' capital andreserves At 31 December 2006 545 652 1,197 2,031 3,228------------------------------------------------------------------------------------ All items are shown net of tax. 8. Value of in-force Life & Pensions business on an EEV basisAt 31 December 2006 2006 2005 £m £m------------------------------------------------------------------------------------Value of in-force allowing for market risk (excludingtime value of options and guarantees) 2,215 2,215Time value cost of options and guarantees(including the impact of non-market risks) (50) (75)Cost of regulatory solvency capital, plus excess economiccapital requirements (49) (34)Provision for operational risks (85) (87)------------------------------------------------------------------------------------Value of in-force Life & Pensions business 2,031 2,019------------------------------------------------------------------------------------ 9. Equity attributable to equity holders of the parent Ordinary shareholders' equity on an EEV basis reconciles to equity attributableto equity holders of the parent on an IFRS basis as follows: 2006 2005 £m £m-----------------------------------------------------------------------Ordinary shareholders' equity on an EEV basis 3,520 3,446Less items only included on an EEV basis:Value of in-force Life & Pensions business (2,031) (2,019)Provision for future corporate costs 47 47Adjustment of long term debt to market value 105 134Add items only included on an IFRS basis:Goodwill (net of provision for future consideration) 283 198Other intangible assets 68 76Acquired PVIF 257 282STICS treated as equity 810 810Deferred acquisition costs 1,100 994Deferred front end fees (45) (85)IFRS reserving and other IFRS adjustments (497) (385)-----------------------------------------------------------------------Equity attributable to equity holders of theparent on an IFRS basis 3,617 3,498----------------------------------------------------------------------- 10. EEV assumptions 10.1 Principal economic assumptions - deterministic Economic assumptions are actively reviewed and are based on the market yields onrisk-free assets at the valuation date. 2006 2005UK and International (excluding Lombard): % %-----------------------------------------------------------------------Risk-free rate (i) 4.6 4.1Investment return before tax:Fixed interest 3.9-5.9 3.8-4.7Equities 7.6 7.1Properties 6.6 6.1Future expense inflation:UK business 4.3 3.9International business 4.3 3.15UK corporation tax rate 30 30Risk discount rate (average):In-force (UK business) 7.7 7.4In-force (International business) 6.8 6.3Risk discount rate:New business (UK business) 7.2 6.5New business (International business) 6.5 6.0----------------------------------------------------------------------- (i) For UK and FPI business the risk-free rate is set with reference to the giltyield curve at the valuation date. For annuity and with-profits business, aterm-dependent rate allowing for the shape of the yield curve is used as thiscan significantly impact value. For other business, a rate based on theannualised 15-year gilt yield is used. 2006 2005Lombard: % %-----------------------------------------------------------------------Risk-free rate 4.1 3.6 Investment returns before tax 5.5 4.9Future expense inflation 4.0 3.5Tax rate 25.2 25.8Risk discount rate (average) - in-force 7.0 6.3Risk discount rate (average) - new business 7.0 6.3----------------------------------------------------------------------- The key exchange rates used in respect of Lombard business were a closingexchange rate of 1 Euro = £0.674 (2005: 1 Euro = £0.687) and an average exchangerate over the year of 1 Euro = £0.678. Margins are added to the risk-free rates to obtain investment return assumptionsfor equity and property. For corporate fixed interest securities the investmentreturn assumptions are derived from an AA-bond yield spread, limited to theactual return on the underlying assets. As we have followed a market-consistentapproach, these investment return assumptions affect only the derived riskdiscount rates and not the embedded value result. Maintenance expenses for UK and International business (excluding Lombard) areassumed to increase in the future at a rate of 1% per annum in excess of theassumed long-term rate of retail price inflation. This is derived from thedifference between the risk-free rate of return and the average of the FTSEActuaries over five-year index-linked gilt yield at 5% and 0% inflation. For Lombard the risk-free rate is the average of the 10-15 year and the over 15year yields using the EuroMTS indices. The investment return assumption is theweighted average (based on an assumed asset mix) of returns on fixed interestsecurities, equities and cash. The Lombard investment return assumption is showngross of tax, but net of fund management charges. Average derived risk discount rates are shown below for the embedded value andthe contribution from new business. The average derived risk discount rate forin-force has increased over 2006 due mainly to a higher risk-free rate and ahigher risk margin on annuities. There is a reduction in the element of the riskdiscount rate relating to options on with-profits business which reflects thereduction in burnthrough cost. A more detailed split of the derived riskdiscount rates is given in the following table. Derived risk discount rates by product type31 December 2006 UK with- UK Other Average International profits annuity UK UK Sterling EuroEmbedded value % % % % % %-----------------------------------------------------------------------------------Risk-free rate 4.6 4.6 4.6 4.6 4.6 4.1Market risks 2.7 7.6 1.6 2.2 1.4 2.1(non-options)Options - market risks 2.6 - - 0.3 - -Options - non-market risks 1.8 - - 0.2 - -Other non-market risks 0.4 0.4 0.4 0.4 0.8 0.8-----------------------------------------------------------------------------------Risk discount rate 12.1 12.6 6.6 7.7 6.8 7.0----------------------------------------------------------------------------------- 31 December 2005 UK with- UK Other Average International profits annuity UK UK Sterling EuroEmbedded Value % % % % % %-----------------------------------------------------------------------------------Risk-free rate 4.1 4.1 4.1 4.1 4.1 3.6Market risks (non-options) 3.0 6.0 1.7 2.1 1.3 1.9Options - market risks 4.0 - - 0.3 - -Options - non-market risks 3.3 - - 0.2 - -Other non-market risks 0.4 0.4 0.4 0.4 0.8 0.8-----------------------------------------------------------------------------------Risk discount rate 14.8 10.5 6.2 7.1 6.2 6.3----------------------------------------------------------------------------------- 31 December 2006 International UK Sterling EuroContribution from new business % % %-------------------------------------------------------------------------------------Risk-free rate 4.6 4.6 4.1Market risks 2.2 1.1 2.1Non-market risks 0.4 0.8 0.8-------------------------------------------------------------------------------------Risk discount rate 7.2 6.5 7.0------------------------------------------------------------------------------------- 31 December 2005 International UK Sterling EuroContribution from new business % % %-------------------------------------------------------------------------------------Risk-free rate 4.1 4.1 3.6Market risks 2.0 1.1 1.9Non-market risks 0.4 0.8 0.8-------------------------------------------------------------------------------------Risk discount rate 6.5 6.0 6.3------------------------------------------------------------------------------------- With-profits and annuity business are subject to more investment risk than theremaining business, and so the appropriate risk discount rates are higher. 10.2 Principal economic assumptions - stochastic The cost of options and guarantees is determined using The Smith Plus Modeleconomic scenario generator. The model is calibrated to market conditions at thevaluation date and correlations between the asset classes are derived fromhistoric data, consistent with the model used for the Realistic Balance Sheet. Risk-free rates are calibrated to the Gilt yield curve. Equity volatility iscalibrated to replicate the implied volatility of FTSE 100 put options held bythe FPLP With-Profits Fund. Property holdings are modelled as a mix of equityand gilt assets, calibrated to derive a level of running yield and volatility asobserved in historical data. Sample implied volatilities by asset class31 December 2006 Term (years) 5 15 25 35--------------------------------------------------------------------------15-year risk-free zero coupon bonds 7.1% 4.7% 4.6% 5.1%15-year corporate bonds 9.4% 8.6% 8.3% 8.8%Equity 17.1% 18.2% 19.6% 20.8%Property 15.1% 16.4% 17.9% 19.0%-------------------------------------------------------------------------- 31 December 2005 Term (years) 5 15 25 35--------------------------------------------------------------------------15-year risk-free zero coupon bonds 8.7% 5.0% 4.4% 5.0%15-year corporate bonds 9.8% 7.9% 7.7% 7.6%Equity 17.7% 19.8% 21.6% 21.7%Property 14.9% 17.2% 19.2% 19.3%-------------------------------------------------------------------------- The volatility represents the variation of return around the average for theparticular asset class. Bonus rates are set at levels which fully utilise the assets supporting thein-force business over its lifetime and are consistent with the economicassumptions and the Group's bonus policy. 10.3 Other assumptions Other assumptions are regularly reviewed having regard to past, current andexpected future experience, and any other relevant data. These are set so as tobe best estimate assumptions. The assumed rates of mortality, morbidity, lapse, surrender, conversion topaid-up and early retirement, which are reviewed annually, have been derivedfrom analyses of the Group's recent operating experience and industry studies.In particular, improvements in annuitant mortality have been assumed to followthe medium cohort for males and 75% of this for females. Allowance for commission is based on the Group's recent experience. 11. Life & Pensions EEV sensitivity analysis The table below shows the sensitivity of the embedded value and the contributionfrom new business to changes in assumptions for 2006. For each sensitivity otherfuture experience assumptions remain unchanged, except where changes in economicconditions directly affect them. The assumptions underlying the statutory reserving calculations remain unchangedin all sensitivities. Change in Change in new embedded business value contribution Notes £m £m--------------------------------------------------------------------------1% increase in risk discount rates (i) (168) (37)1% increase in equity and propertyexpected returns (ii) - -1% reduction in risk-free rates,with corresponding change infixed-interest asset values 112 710% reduction in market values ofequity and property assets(for embedded value) (iii) (138) -£100m reduction in capitalrequirements (for embedded value) (iv) (8) -50% increase in capital requirements(for new business contribution) - (3)10% reduction in expenses 48 910% reduction in lapses 59 185% reduction in annuitant mortality (47) (2)5% reduction in mortality and morbidity(excluding annuities) 27 5-------------------------------------------------------------------------- (i) Although not directly relevant under a market-consistent valuation where therisk discount rate is a derived disclosure only, this shows the impact of a change in the average derived risk discount rate, to enableadjustments to be made to reflect differing views of risk. (ii) As a market-consistent approach is used, equity and property expectedreturns only affect the derived risk discount rates and not the embedded valueor contribution to profits from new business. (iii) The movement in embedded value comprises a £45m decrease in shareholders'invested net assets and a £93m reduction in the value of in- force Life &Pensions business. (iv) Required capital is set at the greater of regulatory capital and economiccapital. In aggregate the economic capital requirements are higher than theregulatory requirement by approximately £200m. Consolidated income statement on an IFRS basisFor the year ended 31 December 2006 2006 2005 Notes £m £m-------------------------------------------------------------------------RevenueGross earned premiums 2 980 977Premiums ceded to reinsurers 2 (84) (56)-------------------------------------------------------------------------Net earned premiums 2 896 921 Fee and commission income and income fromservice activities 565 483Investment income 3,697 6,287-------------------------------------------------------------------------Total revenue 5,158 7,691------------------------------------------------------------------------- Claims, benefits and expensesGross claims and benefits paid 1,587 1,569Amounts receivable from reinsurers (43) (37)-------------------------------------------------------------------------Net claims and benefits paid 1,544 1,532------------------------------------------------------------------------- Insurance contracts liabilities (764) 514Investment contracts liabilities 2,620 3,822Transfer to fund for future appropriations 19 187Movement in net assets attributableto unit holders 131 136-------------------------------------------------------------------------Movement in policyholder liabilities 2,006 4,659-------------------------------------------------------------------------Acquisition expenses 412 285Administrative and other expenses 618 759Finance costs 88 89-------------------------------------------------------------------------Total claims, benefits and expenses 4,668 7,324-------------------------------------------------------------------------Share of profit of associates and joint venture 1 --------------------------------------------------------------------------Profit before tax from continuingoperations 491 367Policyholder tax (124) (218)-------------------------------------------------------------------------Profit before shareholder tax fromcontinuing operations 367 149-------------------------------------------------------------------------Total tax expense (70) (178)Policyholder tax 124 218-------------------------------------------------------------------------Shareholder tax 54 40-------------------------------------------------------------------------Profit after tax from continuingoperations 421 189Profit after tax from discontinued - 8operations-------------------------------------------------------------------------Profit for the year 421 197-------------------------------------------------------------------------Attributable to:Equity holders of the parent: (i)Ordinary shareholders 276 132Other equity holders 52 37------------------------------------------------------------------------- 328 169Minority interest 93 28-------------------------------------------------------------------------Profit for the year 421 197-------------------------------------------------------------------------Earnings per share 5Basic earnings per share from continuingoperations (pence) 13.1 6.3Diluted basic earnings per share fromcontinuing operations (pence) 12.8 6.3------------------------------------------------------------------------- (i) All profit attributable to equity holders of the parent is from continuingoperations Consolidated underlying profit on an IFRS basisFor the year ended 31 December 2006 2006 2005 Notes £m £m -------------------------------------------------------------------------Profit before tax from continuing operations* 491 367Policyholder tax (124) (218)Returns on Group-controlled fundsattributable to third parties (104) (57)-------------------------------------------------------------------------Profit before tax excluding profit generated within policyholder funds 263 92Non-recurring items 2 17 59Amortisation of Asset Managementacquired intangible assets 6 43 56Amortisation of acquired present valueof in-force business 6 25 28Amortisation of Life & Pensions acquiredintangible assets 7 7Impairment of Asset Management acquired intangible assets 6 58 112Interest payable on Step-up Tier oneInsurance Capital Securities (STICS) 4 (52) (37)Short-term fluctuations in investment return 39 (102)Variation in value of option on convertible debt - 9-------------------------------------------------------------------------Underlying profit before tax* 400 224Tax on underlying profit 6 (5)Minority interest in underlying profit (29) (36)-------------------------------------------------------------------------Underlying profit after tax attributable to ordinary shareholders of the parent 377 183-------------------------------------------------------------------------Earnings per shareUnderlying earnings per share (pence) 5 17.9 8.8------------------------------------------------------------------------- IFRS underlying profit is a measure of profit which excludes profit generatedwithin policyholder funds that is not allocated to shareholders. Managementconsider that underlying profit better reflects the performance of the Group andfocus on this measure of profit in its internal monitoring of the Group's IFRSresults. 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 impairmentof acquired intangible assets and present value of acquired in-force business;and is stated after deducting interest payable on STICS. * Included in profit before tax from continuing operations, and underlyingprofit before tax, are one-off items relating to basis changes and the partialadoption of FSA Policy Statement PS06/14 Prudential Changes for Insurers whichhave increased profit by £156m in 2006. Consolidated balance sheet on an IFRS basisAt 31 December 2006 2006 2005 Notes £m £m-------------------------------------------------------------------------AssetsIntangible assets 6 1,405 1,590Property and equipment 80 73Investment properties 2,426 1,912Investments in associates and joint venture 15 14Financial assets 45,150 42,091Deferred acquisition costs 1,111 994Reinsurance assets 85 183Current tax assets 30 25Insurance and other receivables 606 590Cash and cash equivalents 3,581 2,614-------------------------------------------------------------------------Total assets 54,489 50,086-------------------------------------------------------------------------LiabilitiesInsurance contracts 13,762 14,637Fund for future appropriations 439 420Financial liabilities- Investment contracts 32,821 27,857- Interest bearing loans and borrowings 1,130 1,155Net asset value attributable to unit holders 941 751Provisions 215 364Deferred tax liabilities 318 288Current tax liabilities 116 177Insurance payables, other payables anddeferred income 582 497-------------------------------------------------------------------------Total liabilities 50,324 46,146-------------------------------------------------------------------------Equity attributable to equity holdersof the parentAttributable to ordinary shareholders:Share capital 9 214 214Share premium 9 2,051 2,038Other reserves 9 542 436------------------------------------------------------------------------- 2,807 2,688Attributable to other equity holders 9 810 810------------------------------------------------------------------------- 3,617 3,498Minority interest 9 548 442-------------------------------------------------------------------------Total equity 9 4,165 3,940-------------------------------------------------------------------------Total equity and liabilities 54,489 50,086------------------------------------------------------------------------- Consolidated statement of recognised income and expense on an IFRS basisFor the year ended 31 December 2006 Equity holders of Equity Total the parent holders of equity (ordinary the parent holders of Minority shares) (STICS) the parent interest Total £m £m £m £m £m-------------------------------------------------------------------------Actuarial losseson defined benefitschemes net oftax (8) - (8) 1 (7)Foreign exchangeadjustments (10) - (10) (2) (12)Revaluation ofowner occupiedproperties 6 - 6 - 6Shadow accounting (6) - (6) - (6)-------------------------------------------------------------------------Net income recogniseddirectly in equity (18) - (18) (1) (19)Profit for the year 276 52 328 93 421-------------------------------------------------------------------------Total recognisedincome and expense for the year 258 52 310 92 402------------------------------------------------------------------------- For the year ended 31 December 2005 Equity holders of Equity Total the parent holders of equity (ordinary the parent holders of Minority shares) (STICS) the parent interest Total £m £m £m £m £m-------------------------------------------------------------------------Actuarial losseson defined benefitschemes net oftax (18) - (18) (10) (28)Foreign exchangeadjustments (7) - (7) (1) (8)-------------------------------------------------------------------------Net expense recogniseddirectly in equity (25) - (25) (11) (36)Profit for the year 132 37 169 28 197-------------------------------------------------------------------------Total recognisedincome andexpense forthe year 107 37 144 17 161------------------------------------------------------------------------- Summary consolidated cash flow statement on an IFRS basisFor the year ended 31 December 2006 +------------------------------------------------------+---------+---------+| | 2006 | 2005 |+------------------------------------------------------+---------+---------+| | £m | £m |+------------------------------------------------------+---------+---------+|Operating activities | | |+------------------------------------------------------+---------+---------+|Profit for the period | 421 | 197 |+------------------------------------------------------+---------+---------+|Net increase/(decrease) in operational assets and | 905 | (896)||liabilities | | |+------------------------------------------------------+---------+---------+|Net cash inflow/(outflow) from operating activities | 1,326 | (699)|+------------------------------------------------------+---------+---------+|Investing activities | | |+------------------------------------------------------+---------+---------+|Acquisition of subsidiaries, net of cash acquired | (21)| 603 |+------------------------------------------------------+---------+---------+|Reduction in participation of subsidiaries, net of | 49 | 44 ||cash disposed | | |+------------------------------------------------------+---------+---------+|Compensation from investment mandate loss | 27 | - |+------------------------------------------------------+---------+---------+|Additions to internally generated intangible assets | (18)| (13)|+------------------------------------------------------+---------+---------+|Purchase of property and equipment (net) | (11)| (10)|+------------------------------------------------------+---------+---------+|Net cash inflow from investing activities | 26 | 624 |+------------------------------------------------------+---------+---------+|Financing activities | | |+------------------------------------------------------+---------+---------+|Finance costs | (81)| (82)|+------------------------------------------------------+---------+---------+|STICS interest | (52)| (21)|+------------------------------------------------------+---------+---------+|Proceeds from issue of long term debt, net of expenses| 258 | 229 |+------------------------------------------------------+---------+---------+|Repayment of long term debt | (312)| - |+------------------------------------------------------+---------+---------+|Issue of STICS, net of expenses | - | 495 |+------------------------------------------------------+---------+---------+|Net movement in other borrowings, net of expenses | 12 | 5 |+------------------------------------------------------+---------+---------+|Dividends paid to equity holders of the parent | (164)| (157)|+------------------------------------------------------+---------+---------+|Dividends paid to minority interest | (46)| (29)|+------------------------------------------------------+---------+---------+|Net cash (outflow)/inflow from financing activities | (385)| 440 |+------------------------------------------------------+---------+---------+|Increase in cash and cash equivalents | 967 | 365 |+------------------------------------------------------+---------+---------+|Balance at beginning of year | 2,614 | 2,249 |+------------------------------------------------------+---------+---------+|Balance at end of year | 3,581 | 2,614 |+------------------------------------------------------+---------+---------+ Notes to the IFRS results 1. Basis of preparation The financial information included in this announcement has been extracted fromthe Group's financial statements prepared in accordance with InternationalFinancial Reporting Standards as adopted by the European Union (EU). The preliminary announcement for the year ended 31 December 2006 does notconstitute statutory accounts within the meaning of section 240 of the CompaniesAct 1985. The Group's financial statements for the year ended 31 December 2006have been audited by KPMG Audit Plc and include its unqualified audit reportwhich does not contain a statement under sections 237(2) or 237(3) of theCompanies Act 1985. The Group's 2006 Report & Accounts will be available from 13April 2007. The Group's 2005 Report & Accounts has been filed with the Registrarof Companies. 2. Segmental information (a) Summary Segment information is presented in respect of the Group's business andgeographical segments. The primary reporting format, based on the Group'smanagement and internal reporting structure, is business segments. Inter-segment pricing is determined on an arm's length basis. Segment results,assets, and liabilities, include items directly attributable to a segment, aswell as those that can be allocated on a reasonable basis. Segment capitalexpenditure includes purchases of property and equipment, investment propertiesand intangible assets. Business segments (primary segment) The Group comprises the following main business segments: • UK Life & Pensions (including corporate items)• International Life & Pensions• Asset Management (including F&C's Managed Pension Fund business) Geographical segments (secondary segment) In presenting information on the basis of geographic segments, segment revenueis based on the geographical location of customers. Segment assets are based onthe geographical location of the assets. The Group has defined two geographicalareas: • UK• Rest of the world (b) Business segment information (primary segment information) (i) Revenue and expenses Year ended 31 December 2006 Elimination UK Life Inter'l of inter- & Life & Asset segment Pensions Pensions Management amounts Total £m £m £m £m £m------------------------------------------------------------------------------------------Gross earned premiums on insurance and investment contracts 3,709 2,769 199 - 6,677Less investment contracts premiums (i) (2,741) (2,757) (199) - (5,697)------------------------------------------------------------------------------------------Gross earned premiums 968 12 - - 980Less premiums ceded to reinsurers (82) (2) - - (84)------------------------------------------------------------------------------------------Net earned premiums 886 10 - - 896Fee and commission income and income from service activities 148 198 258 (39) 565Investment income 2,934 640 123 - 3,697------------------------------------------------------------------------------------------Total revenue 3,968 848 381 (39) 5,158------------------------------------------------------------------------------------------Net claims and benefits paid 1,542 2 - - 1,544Movement in insurance and investment contracts liabilities 1,176 579 101 - 1,856Transfer to fund for future appropriations 19 - - - 19Movement in net assets attributable to unit holders 131 - - - 131Acquisition expenses 329 72 11 - 412Administrative and other expenses 240 130 287 (39) 618Finance costs 72 15 1 - 88------------------------------------------------------------------------------------------Total claims, benefits and expenses 3,509 798 400 (39) 4,668------------------------------------------------------------------------------------------Share of profits of associatesand joint venture 1 - - - 1------------------------------------------------------------------------------------------Profit before tax from continuing operations 460 50 (19) - 491------------------------------------------------------------------------------------------Policyholder tax (124) - - - (124)Shareholder tax 45 1 8 - 54------------------------------------------------------------------------------------------Segmental results after tax 381 51 (11) - 421------------------------------------------------------------------------------------------Inter segment revenue/(expense) (39) - 39 - ------------------------------------------------------------------------------------------- (i) Accounted for as deposits under IFRS Year ended 31 December 2005 Elimination UK Life Inter'l of inter- & Life & Asset segment Pensions Pensions Management amounts Total £m £m £m £m £m------------------------------------------------------------------------------------------Gross earned premiums oninsurance and investment contracts 3,122 2,011 170 - 5,303Less investment contracts premiums (2,153) (2,003) (170) - (4,326)------------------------------------------------------------------------------------------Gross earned premiums 969 8 - - 977Less premiums ceded to reinsurers (56) - - - (56)Net earned premiums 913 8 - - 921Fee and commission income and income from service 116 124 276 (33) 483activitiesInvestment income 5,180 932 175 - 6,287------------------------------------------------------------------------------------------Total revenue 6,209 1,064 451 (33) 7,691------------------------------------------------------------------------------------------Net claims and benefits paid 1,528 4 - - 1,532Movement in insurance and investment contracts liabilities 3,291 888 157 - 4,336Transfer to fund for future appropriations 187 - - - 187Movement in net assetsattributable to unit holders 136 - - - 136Acquisition expenses 207 67 11 - 285Administrative and other expenses 295 121 376 (33) 759Finance costs 77 11 1 - 89------------------------------------------------------------------------------------------Total claims, benefits and expenses 5,721 1,091 545 (33) 7,324------------------------------------------------------------------------------------------Profit before tax from continuing operations 488 (27) (94) - 367------------------------------------------------------------------------------------------Policyholder tax (218) - - - (218)Shareholder tax 67 2 (29) - 40------------------------------------------------------------------------------------------Segmental results after tax 337 (25) (123) - 189------------------------------------------------------------------------------------------Inter segment revenue/(expense) (33) - 33 - ------------------------------------------------------------------------------------------- (ii) Underlying profit Year ended 31 December 2006 UK Life Inter'l & Life & Asset Pensions Pensions Management Total £m £m £m £m--------------------------------------------------------------------------------Profit before tax from continuing operations 460 50 (19) 491Intersegment loan interest 12 - (12) -Policyholder tax (124) - - (124)Returns on Group-controlled funds attributable to third parties (104) - - (104)--------------------------------------------------------------------------------Profit before tax excluding profit generated within policyholder funds 244 50 (31) 263Non-recurring items (i) (2) - 19 17Amortisation of Asset Management acquired intangible assets - - 43 43Amortisation of acquired present value of in-force business 9 16 - 25Amortisation of Life & Pensions acquired intangible assets - 7 - 7Impairment of Asset Management acquired intangible assets - - 58 58Interest payable on STICS (52) - - (52)Short-term fluctuations in investment return 41 (2) - 39--------------------------------------------------------------------------------Underlying profit before tax 240 71 89 400Tax on underlying profit 6Minority interest in underlying profit (29)--------------------------------------------------------------------------------Underlying profit after tax attributable to ordinary shareholders of the parent 377--------------------------------------------------------------------------------Earnings per shareUnderlying earnings per share (pence) 17.9-------------------------------------------------------------------------------- (i) Non-recurring items Life & Pensions items include costs of £nil (2005: £6m) relating to integrationactivity following the acquisition of Friends Provident International Limited inAugust 2002, a credit of £3m (2005: charge of £14m) in respect of the cost toshareholders of mortgage endowment complaints and historic business reviews, acredit of £1m (2005: £7m) in respect of the review conducted into pensiontransfers and opt-outs and a charge of £2m (2005: £nil) arising from the closureof the Appointed Representative sales channel. Asset Management items include costs of £10m (2005: £22m) incurred integrating,rationalising and reorganising the Asset Management business following theacquisition of F&C Group (Holdings) Limited, £nil (2005: £2m) of otherreorganisation costs, £12m (2005: £22m) in respect of issuing shares toemployees under the 2004 Reinvestment Plan and £3m (2005: £nil) compensationreceived on loss of an investment management contract. The profit after tax from discontinued operations amounted to £nil (2005: £8m). Year ended 31 December 2005 UK Life Inter'l & Life & Asset Pensions Pensions Management Total £m £m £m £m--------------------------------------------------------------------------------Profit before tax from continuing operations 488 (27) (94) 367Intersegment loan interest 12 - (12) -Policyholder tax (218) - - (218)Returns on Group-controlled funds attributable to third parties (57) - - (57)--------------------------------------------------------------------------------Profit before tax excluding profit generated within policyholder funds 225 (27) (106) 92Non-recurring items 10 3 46 59Amortisation of Asset Management acquired intangible assets - - 56 56Amortisation of acquired present value of in-force business 10 18 - 28Amortisation of Life & Pensions acquired intangible assets - 7 - 7Impairment of Asset Management acquired intangible assets - - 112 112Interest payable on STICS (37) - - (37)Short-term fluctuations in investment return (101) (1) - (102)Variation in value of option on convertible debt 9 - - 9--------------------------------------------------------------------------------Underlying profit before tax 116 - 108 224Tax on underlying profit (5)Minority interest in underlying profit (36)--------------------------------------------------------------------------------Underlying profit after tax attributable to ordinary shareholders of the parent 183--------------------------------------------------------------------------------Earnings per shareUnderlying earnings per share (pence) 8.8-------------------------------------------------------------------------------- (iii) Assets and liabilities Year ended 31 December 2006 Elimination UK Life Inter'l of inter- & Life & Asset segment Pensions Pensions Management amounts Total £m £m £m £m £m--------------------------------------------------------------------------------------Segment assets 40,182 12,243 2,126 (77) 54,474Investment in associates and joint venture 15 - - - 15--------------------------------------------------------------------------------------Total assets 40,197 12,243 2,126 (77) 54,489--------------------------------------------------------------------------------------Total liabilities 36,991 11,730 1,680 (77) 50,324--------------------------------------------------------------------------------------Other segmentinformation:Capital expenditure 313 4 5 - 322Depreciation 7 - 3 - 10Amortisation 24 24 44 - 92Impairment losses (i) - - 58 - 58-------------------------------------------------------------------------------------- Year ended 31 December 2005 Elimination UK Life Inter'l of inter- & Life & Asset segment Pensions Pensions Management amounts Total £m £m £m £m £m---------------------------------------------------------------------------------------Segment assets 38,586 9,766 1,936 (216) 50,072Investment in associates and joint venture 14 - - - 14---------------------------------------------------------------------------------------Total assets 38,600 9,766 1,936 (216) 50,086---------------------------------------------------------------------------------------Total liabilities 35,665 9,262 1,435 (216) 46,146---------------------------------------------------------------------------------------Other segmentinformation:Capital expenditure 226 3 6 - 235Depreciation 8 - 3 - 11Amortisation 45 8 56 - 109Impairment losses (i) - - 116 - 116--------------------------------------------------------------------------------------- (i) Comprises impairment losses on acquired intangible assets £58m (2005: £112m)and impairment losses on associates £nil (2005: £4m). The presentation of intercompany liabilities has been amended in 2006 resultingin the reclassification of certain segment liabilities reported in 2005. (c) Geographical segmental information (secondary segment information) Year ended 31 December 2006 Rest of the UK world Total £m £m £m-------------------------------------------------------------------------Gross earned premiums 968 12 980Fee and commission income and income from service activities 274 291 565-------------------------------------------------------------------------Revenue from external customers 1,242 303 1,545-------------------------------------------------------------------------Investment income 3,697Less premiums ceded to reinsurers (84)-------------------------------------------------------------------------Total revenue 5,158-------------------------------------------------------------------------Total assets 43,238 11,251 54,489-------------------------------------------------------------------------Capital expenditure 316 6 322------------------------------------------------------------------------- Year ended 31 December 2005 Rest of the UK world Total £m £m £m-------------------------------------------------------------------------Gross earned premiums 969 8 977Fee and commission income and income from service activities 243 240 483-------------------------------------------------------------------------Revenue from external customers 1,212 248 1,460-------------------------------------------------------------------------Investment income 6,287Less premiums ceded to reinsurers (56)-------------------------------------------------------------------------Total revenue 7,691-------------------------------------------------------------------------Total assets 40,852 9,234 50,086-------------------------------------------------------------------------Capital expenditure 232 3 235------------------------------------------------------------------------- 3. Staff pension schemes (a) Introduction The Group operates several defined benefit schemes: the Friends ProvidentPension Scheme (FPPS), to which the majority of the Group's UK Life & Pensionsemployees belong, and various schemes operated by F&C. In addition, the Groupoperates two defined contribution schemes, the scheme operated by F&C and thescheme operated by FPI. Lombard does not operate a pension scheme. (b) Total provisions for pensions liabilities Under IAS 19 Employee Benefits, the pension liability is recognised on thebalance sheet, gross of deferred tax. A reconciliation of the Group pensionliability included in the consolidated balance sheet and the net pensionliability as determined by actuarial valuations is set out below. 2006 2005 £m £m-----------------------------------------------------------------------Deficit in FPPS (31) (59)Deficit in the F&C schemes (46) (48)-----------------------------------------------------------------------Group pension liability included in provisions (77) (107)Non-transferable assets - 40Deferred tax 23 20-----------------------------------------------------------------------Net pension liability (54) (47)-----------------------------------------------------------------------Analysis of net pension liabilityFPPS (22) (13)F&C schemes (32) (34)----------------------------------------------------------------------- (54) (47)-----------------------------------------------------------------------Amounts recognised in the income statementFPPS (14) (17)F&C schemes (4) (4)----------------------------------------------------------------------- (18) (21)-----------------------------------------------------------------------Amounts recognised in the statement of recognised income and expenseFPPS (12) (9)F&C schemes 2 (31)Deferred tax 3 12----------------------------------------------------------------------- (7) (28)----------------------------------------------------------------------- The cumulative amount of actuarial gains and losses recognised in the statementof recognised income and expense since adoption of IFRS is a loss of £59m (2005:loss of £49m). (c) Friends Provident Pension Scheme The FPPS is a UK defined benefit scheme to which the majority of the Group's UKLife & Pensions employees belong. The scheme's assets are administered by F&C. (i) Major assumptions used by the Scheme Actuary +-------------------------------------------------+--------+--------+| | 2006 | 2005 |+-------------------------------------------------+--------+--------+| | % | % |+-------------------------------------------------+--------+--------+|Inflation assumption | 3.02 | 2.85 |+-------------------------------------------------+--------+--------+|Rate of increase in salaries* | 3.50 | 3.50 |+-------------------------------------------------+--------+--------+|Rate of increase in pensions in payment | 3.02 | 2.70 |+-------------------------------------------------+--------+--------+|Discount rate | 5.02 | 4.75 |+-------------------------------------------------+--------+--------+ * Plus allowance for salary scale increases (ii) Mortality assumptions Mortality assumptions are based on the medium cohort basis, projected forward,to take account of future improvements in mortality, according to eachindividual's year of birth. The mortality assumptions provide the following life expectancies of membersretiring at the age of 60: 2006 2005---------------------------------------------------------------------------Basis - future pensioners PM/FA92BMC* PM/FA92BMC*Basis - current pensioners PM/FA92BMC* PM/FA92BMC*Expected age at death of future male pensioner 88 88Expected age at death of future female pensioner 90 90Expected age at death of current male pensioner 87 87Expected age at death of current female pensioner 90 90--------------------------------------------------------------------------- *Projected according to individual's year of birth The present value of providing an annuity from the age of 60, based on the abovelife expectancies, for every one pound of pension accumulated, is as follows: Cost of annuities 2006 2005 £ £-------------------------------------------------------------------------Male annuity 24.68 22.72Female annuity 23.81 22.29------------------------------------------------------------------------- These rates assume a monthly payments model with a discount rate of 5.02% (2005:4.75%). The rates also assume two thirds of the members benefit will be paid tothe spouse, a 5-year guarantee is provided and pensions in excess of theGuaranteed Minimum Pension will increase by 3.02% (2005: 2.70%) per annum. 2006 2005 % of total % of total membership membership--------------------------------------------------------------------------Active members 24 23Deferred members 56 57Pensioners 20 20-------------------------------------------------------------------------- 100 100-------------------------------------------------------------------------- The sensitivities regarding the principal assumptions used to measure the schemeliabilities are set out below: Assumption Change in assumption Impact on scheme liabilities------------------------------------------------------------------------Inflation Increase/decrease by 0.5% Decrease/increase by 2.3%Salaries Increase/decrease by 0.5% Decrease/increase by 1.7%Pensions Increase/decrease by 0.5% Decrease/increase by 5.6%Discount rate Increase/decrease by 0.5% Decrease/increase by 10.2%Rate of Increase/decrease by 1 Increase/decrease by 2.5%mortality year------------------------------------------------------------------------ (d) F&C Asset Management plc pension schemes The assumptions used for the F&C Pension schemes are broadly consistent withthose used for FPPS. The total deficit on these schemes was £46m (2005: £48m). 4. Appropriations of profit (a) Dividends paid and proposed on ordinary shares Dividends paid during the year and recognised in reserves 2006 2005 £m £m--------------------------------------------------------------------------------Final dividend in respect of 2005 and paid in May 2006 of 5.1p per share (in respect of 2004 and paid in May 2005 of 5.0p per share) 108 103Interim dividend in respect of 2006 and paid inNovember 2006 of 2.65p per share (in respect of 2005 and paid in November 2005 of 2.6p per share) 56 54--------------------------------------------------------------------------------Total dividends paid 164 157-------------------------------------------------------------------------------- After the balance sheet date the dividends set out below were proposed by thedirectors. In accordance with IAS 10 these have not been provided as a liabilityat the balance sheet date. 2006 2005 £m £m-------------------------------------------------------------------------------- Final dividend in respect of 2006 payable in May 2007of 5.2p per share (in respect of 2005 and paid in May2006 of 5.1p per share) 111 108-------------------------------------------------------------------------------- The 2006 final dividend is based on 2,136m shares estimated to be in issue atthe dividend payment date (excluding treasury shares). The 2005 final dividendwas based on 2,114m shares (excluding treasury shares). (b) STICS interest STICS interest paid during the year and recognised in reserves 2006 2005 £m £m-------------------------------------------------------------------------------- Interest on 2003 STICS at 6.875% Paid in May 2006 (May 2005) 10 10 Paid in November 2006 (November 2005) 11 11-------------------------------------------------------------------------------- Total 2003 STICS interest paid 21 21Interest on 2005 STICS at 6.292% paid in June 2006 31 --------------------------------------------------------------------------------- Total 2005 STICS interest paid 31 --------------------------------------------------------------------------------- Total STICS interest paid 52 21-------------------------------------------------------------------------------- 5. Earnings per share (a) Basic and underlying earnings per share from continuing operations Earnings per share have been calculated based on the profit after tax and on theunderlying profit after tax, attributable to ordinary shareholders of theparent. The directors consider that the underlying earnings per share figuregives a better indication of operating performance. 2006 2005 2006 Per 2005 Per Earnings share Earnings share £m pence £m pence----------------------------------------------------------------------------------- Profit after tax attributable to ordinary shareholders of the parent 276 13.1 132 6.3Short-term fluctuations in investment return 39 1.8 (102) (4.9)Variation in value of option on convertible debt - - 9 0.4Non-recurring items 17 0.8 59 2.8Amortisation and impairment of acquired intangible assets 133 6.3 203 9.8Minority interest on items excluded from underlying profit (40) (1.9) (72) (3.4)Tax credit on items excluded from underlying profit (48) (2.2) (46) (2.2)-----------------------------------------------------------------------------------Underlying profit after tax attributable to ordinary shareholders of the parent 377 17.9 183 8.8----------------------------------------------------------------------------------- (b) Diluted basic earnings per share from continuing operations 2006 2005 Weighted Weighted average average number number of 2006 of 2005 2006 ordinary Per 2005 ordinary Per Earnings shares share Earnings shares share £m millions pence £m millions pence-------------------------------------------------------------------------------------Profit after taxattributableto ordinary shareholdersof the parent 276 2,111 13.1 132 2,082 6.3Dilution (c) 16 164 (0.3) - 15 --------------------------------------------------------------------------------------Diluted profit after tax attributable to ordinaryshareholders of the parent 292 2,275 12.8 132 2,097 6.3------------------------------------------------------------------------------------- (c) Dilution Options over 32,816,922 (2005: 47,707,385) shares are outstanding under theCompany's option schemes as at 31 December 2006. Of these, 24,239,504 (2005:32,319,827) options were not dilutive for the period shown because the marketprice of the Company's shares was below the option price or the performancecriteria were not met. There were £283m (2005: £276m) bonds in issue, convertible to ordinary shares atany time on or after 27 December 2005. If all these bonds were converted at 31December 2006, 133,640,553 new shares would be issued. This has a dilutiveimpact on earnings per share in 2006 (2005: no dilutive impact). The calculation of diluted earnings per share also includes an allocation ofshares in respect of the final earn-out payment for the Lombard acquisition. (d) Earnings per share from discontinued operations Discontinued operations have no impact on profit after tax attributable toequity holders of the parent. Earnings per share from discontinued operationswas £nil in both years. 6. Intangible assets Investment Acquired management Goodwill PVIF contracts Other Total £m £m £m £m £m-------------------------------------------------------------------------------------CostAt 1 January 2005 586 264 626 82 1,558Acquisitions throughbusiness combinations 151 230 - 109 490Other additions 6 - 1 14 21Disposals (68) - - (7) (75)Foreign exchange adjustments 2 (10) (7) (3) (18)-------------------------------------------------------------------------------------At 31 December 2005 677 484 620 195 1,976Other additions 4 - - 18 22Disposals (4) - (43) - (47)Adjustment to consideration (12) - - - (12)Foreign exchange adjustments (3) (4) (4) (3) (14)-------------------------------------------------------------------------------------At 31 December 2006 662 480 573 210 1,925-------------------------------------------------------------------------------------Amortisation and impairmentAt 1 January 2005 - 87 36 47 170Amortisation charge for year - 28 56 25 109Impairment charge - - 112 - 112Disposals - - - (5) (5)-------------------------------------------------------------------------------------At 31 December 2005 - 115 204 67 386Amortisation charge for year - 25 43 24 92Impairment charge - - 58 - 58Disposals - - (16) - (16)-------------------------------------------------------------------------------------At 31 December 2006 - 140 289 91 520-------------------------------------------------------------------------------------Carrying amountsAt 31 December 2005 677 369 416 128 1,590At 31 December 2006 662 340 284 119 1,405------------------------------------------------------------------------------------- (a) Goodwill Goodwill is the only intangible asset which has an indefinite useful life. Thegoodwill has been allocated to the following cash-generating units: 2006 2005 £m £m--------------------------------------------------------------------------------UK Life & Pensions 191 193Lombard 138 151Friends Provident International Limited - -Asset Management 333 333--------------------------------------------------------------------------------Total goodwill 662 677-------------------------------------------------------------------------------- In accordance with IAS 36 Impairment of Assets, goodwill is assessed forpossible impairment each year. This assessment takes place in December of eachyear and compares the carrying value of goodwill for each segment with itsrecoverable amount. The recoverable amount has been taken to be the segment'scalculated value in use. There has been no goodwill impairment charge in 2006 (2005: £nil). The value in use for UK Life & Pensions and Lombard has been taken from theirbusiness plans. These projections reflect the long-term nature of the businessand forecast the cash flows over the anticipated terms of the policies. Theplans include forecast sales of new business for three years and otherassumptions that take into account both past experience and market conditions.The key assumptions to which the calculated values in use are most sensitive areset out below: • Investment market conditions: the plans assume modest investment growth. • Policy lapses: the plans assume no change from recent experience. • Sales and margins: the plans assume a modest reduction in margins but an increasing level of sales. • Expenses: the plans assume that expenses will broadly increase in line with inflation. • Discount rate: the discount rate applied to UK Life & Pensions is 8.0% and to Lombard is 7.2%. The outcome of the impairment assessment has been that it is considered unlikelythat goodwill in respect of UK Life & Pensions would be impaired given that thevalue in use is significantly higher than the carrying value of goodwill. The UKLife & Pensions segment is operated as a single group and so a single value inuse has been prepared. For Lombard, acquired in January 2005, the levels of newbusiness have indicated that there is no requirement for any impairment ofgoodwill. No goodwill has been allocated to FPI. For the Asset Management segment, the value in use is calculated using a cashflow projection based on the latest annual financial budget approved by theBoard of F&C Asset Management plc. The Asset Management segment is operated as asingle group and so a single value in use has been prepared. The key assumptionsto which the calculated values in use are most sensitive are set out below: • Investment market conditions: the plans assume modest investment growth. • Sales and margins: the plans assume modest sales and margin growth although operating margins have been capped as a measure of prudence. • Expenses: the plans assume cost growth in excess of inflation recognising the impact of staff costs. • Discount rate: the discount rate applied to the cash flow projections is 8.9% based on F&C's weighted average cost of capital. The outcome of the impairment review is that there is no requirement for anyimpairment of goodwill in the Asset Management segment. In addition, the fair value of the Group's holding in F&C, at 31 December 2006,based on the quoted bid price of F&C's listed ordinary shares was £531m. Thiswas in excess of the carrying value of the Group's holding in the AssetManagement business at this date. (b) Acquired PVIF Acquired PVIF is amortised over the lifetime of the in-force policies and isanalysed as follows: 2006 2005 Cumulative Cumulative Cost amortisation Net Cost amortisation Net £m £m £m £m £m £m--------------------------------------------------------------------------------UK Life & Pensions 184 100 84 187 91 96International Life & Pensions 296 40 256 297 24 273--------------------------------------------------------------------------------Total acquired PVIF 480 140 340 484 115 369-------------------------------------------------------------------------------- Acquired PVIF has been assessed for possible impairment and there is noindication that it has been impaired. (c) Investment management contracts Investment management contracts relate to the Asset Management segment and areamortised over their expected useful economic lives of between 10 and 20 yearsuntil 30 June 2006, and between 6 and 20 years from 1 July 2006 until 31December 2006. As indicated in 2005, Resolution plc withdrew the majority of its assets in thefirst quarter 2006. The agreed compensation of £27m received from Resolutionduring the period has been recognised as proceeds in respect of the deemeddisposal of intangible assets. The cost, with respect to the original valuation,of the assets disposed of was £43m and the related cumulative amortisationamounted to £16m. Therefore the carrying value of the disposed asset equalledthe proceeds received giving rise to neither a gain or a loss. During 2006 the business continued to experience a level of fund outflows whichwas higher than anticipated. This level of lost business will have notableimpact on revenues and was significant enough to be considered an indicator ofpotential impairment of certain intangible assets, namely the related investmentmanagement contracts. In accordance with IAS 36, a full impairment review of these assets wasundertaken. The review resulted in an impairment being recognised (includedwithin Administrative and other expenses in the income statement) in respect ofmanagement contracts as follows: 2006 2005 £m £m--------------------------------------------------------------------------------F&C Investment Trust contracts 22 56F&C Institutional contracts 36 56--------------------------------------------------------------------------------Total impairment recognised in the income statement 58 112-------------------------------------------------------------------------------- The above contracts relate to the investment trust management contracts andinstitutional fund management contracts acquired as a result of the creation ofF&C Asset Management plc following the business combination of ISIS AssetManagement plc and F&C Group (Holdings) Limited on 11 October 2004. The recoverable amounts of the assets have been determined based on value in usecalculations using cash flow projections based on the latest annual financialbudget approved by the F&C board. The discount rate applied to the cash flow projections is 9.4% (2005: 9.4%) forinvestment trust contracts, 9.4% (2005: 9.4%) for institutional contracts withno fixed term and 8.4% (2005: 8.4%) for fixed term institutional contracts.These rates reflect the varying risks and uncertainties inherent in the revenuesfrom the underlying assets, using F&C's weighted average cost of capital of8.9%, calculated as at 31 December 2006 (31 December 2005: 8.9%), as abenchmark. Revenues in the projections have been grown at 5.75% (2005: 6%) per annum inline with the Group's long-term view of market growth, which is consistent withthat experienced over the last 16 years across the markets in which the managedassets are invested. The revenue projections are derived using the estimateduseful lives of the underlying contracts and assume a constant loss of revenuesover the projection periods. Costs for the first year of the projections are driven by the budgeted F&Coperating margin for 2007. Thereafter costs are driven by F&C's projectedoperating profit margins, as determined for the purposes of the goodwillimpairment review. Impairment has been determined by comparing the results of the value in usecalculations in respect of the remaining contracts at the year end to thecarrying value (cost less aggregate amortisation and prior impairment) of theassets at 31 December 2006, with any deficits arising constituting impairment tobe recognised for the year. The Group continues to monitor the level of investment contracts undermanagement and to assess any impact on the expected lives of the related assets.Following further business outflows in the second half of the year, the Boardrevisited the useful life estimates of the affected assets at the year-end andas a result, with effect from 1 January 2007, the remaining life of non-fixedterm institutional contracts is now assessed as being 4 years. The revised useful lives represent a change in the accounting estimate and willaccelerate the amortisation of the remaining value of the assets. The effect ofthese changes increased the amortisation charge in the second half of 2006 by£1.7m and the charge in future years will be increased by £2.6m per annumcompared to continuing to amortise over the lives assigned from 1 July 2006,until such time as the assets become fully amortised. (d) Other intangible assets Other intangible assets mainly consist of distribution channel relationships andsoftware development which are amortised over their anticipated useful lives ofbetween 3 and 15 years. The analysis for each segment is as follows: 2006 2005 Cumulative Cumulative Cost amortisation Net Cost amortisation Net £m £m £m £m £m £m-------------------------------------------------------------------------------------UK Life & Pensions 90 69 21 77 54 23International Life & Pensions 116 19 97 114 11 103Asset Management 4 3 1 4 2 2-------------------------------------------------------------------------------------Total other intangible assets 210 91 119 195 67 128------------------------------------------------------------------------------------- Included in amortisation is £7m (2005: £7m) in respect of Life & Pensionsacquired intangible assets. Management have assessed other intangible assets for possible impairment andthere is no indication that they have been impaired. 7. Realistic balance sheet The main UK with-profits fund is in FPLP and the capital position of this fundhas been determined in accordance with the RBS regulations prescribed by theFSA. There is also a small UK with-profits fund in FPLA. The capital position ofthis fund has been calculated on a regulatory basis as this fund is closed tonew business, and is significantly below the £500m level that the FSA hasdetermined should be applied for calculating liabilities under the realisticmethodology. The RBS for FPLP's with-profits business can be summarised as follows: 2006 2005 £m £m--------------------------------------------------------------------------------Total net assets 16,087 17,366Less non-profit liabilities including share ofresilience capital reserves and required minimum margin (2,670) (2,774)--------------------------------------------------------------------------------Total regulatory assets 13,417 14,592Additional assets arising on realistic basis 265 253--------------------------------------------------------------------------------Total assets 13,682 14,845--------------------------------------------------------------------------------Policyholder liabilities: asset shares 11,365 12,342 financial guarantees (net of charges) 101 149 options (guaranteed annuities) 747 796Other liabilities 1,249 1,322--------------------------------------------------------------------------------Total liabilities 13,462 14,609--------------------------------------------------------------------------------Excess of assets over liabilities 220 236-------------------------------------------------------------------------------- At 31 December 2006, the surplus of realistic assets over realistic liabilitiesinitially amounted to £254m (2005: £236m) with a Risk Capital Margin (RCM) of£220m (2005: £276m), the surplus assets have subsequently been reduced by £34mvia a reduction in future guarantee charges leaving the working capital at £220mfully covering the RCM. This results in an excess of realistic assets overrealistic liabilities of £220m (2005: £236m). Adding back the shareholders'share of future bonuses totalling £95m (2005: £85m) and deducting adjustments toeliminate double counting of acquired PVIF of £19m (2005: £20m), the excess inaccordance with FRS 27 amounted to £296m (2005: £301m). The main element of the realistic liabilities is the asset shares ofwith-profits business. This represents the premiums received to date togetherwith the investment return earned less expenses and charges. This is mainlycalculated on an individual policy basis using historic information and in linewith the company's PPFM. Assets and realistic liabilities are closely matchedsince they move with the value of the underlying assets. Policyholder liabilities (including options and guarantees) are then valuedusing a market consistent stochastic model. Included in other liabilities areprovisions for specific items such as mortgage endowment reviews and otherliabilities of the fund. Realistic valuations also allow for future profits ofnon-profit business written in the With-Profits Fund to be included. Inaccordance with FRS 27, the value of future profits of non-profit business hasbeen deducted from policyholder liabilities in the balance sheet. Options and guarantees are features of life assurance and pensions contractsthat confer potentially valuable benefits to policyholders. They are not uniqueto with-profits funds and can arise in non-participating funds. They can exposean insurance company to two types of risk: insurance (such as mortality/morbidity) and financial (such as market prices/interest rates). The value of anoption or guarantee comprises two elements: the intrinsic value and the timevalue. The intrinsic value is the amount that would be payable if the option orguarantee was exercised immediately. The time value is the additional value thatreflects the possibility of the intrinsic value increasing in future, before theexpiry of the option or guarantee. Under FSA rules all options and guaranteesmust be valued and included in policyholder liabilities. For funds within theFSA's realistic capital methodology, options and guarantees are valued on amarket-consistent stochastic basis that takes into account both the time valueand the intrinsic value of the options and guarantees. The majority of the Group's life and pensions options and guarantees are withinFPLP's With-Profits Fund. These are valued stochastically and included in therealistic liabilities. There are two main types of guarantees and options in theFPLP With-Profits Fund: maturity guarantees and guaranteed annuity options.Maturity guarantees are in respect of conventional with-profits business andunitised with-profits business and represent the sum assured and reversionarybonuses declared to date. The cost of these guarantees, net of charges, has beencalculated at £101m (2005: £149m). For certain with-profits pension policiesissued, there are options guaranteeing the rates at which annuities can bepurchased. The cost of these guarantees has been calculated at £747m (2005:£796m). The cost of the with-profits guarantees is assessed using a market-consistentstochastic model (using The Smith Plus Model as the scenario generator) and iscalculated using 5,000 simulations. The model has been calibrated using the giltrisk-free curve assuming interest rates of between 3.9% and 5.3% pa (2005:between 4.0% and 4.2% pa) and implied volatilities in the market. The capitalreturn has been calibrated and compared to the actual asset portfolio. Forequities, the capital return volatility varies by year with 20% pa (2005: 21%pa) assumed in year 7, increasing to 23% pa (2005: 24% pa) by year 14 and 25% pa(2005: 26% pa) by year 21. Volatility for property returns has been assumed at15% pa throughout (2005: 15% pa). The cost of guarantees also depends on management actions that would be takenunder various scenarios. For example, the future level of the equity-backingratio (the ratio of funds held in equities and property to total investments)varies in each scenario depending on the ratio of the guarantee cost to theasset share. Similarly, the reversionary bonus rate is set each year such that,by maturity, guaranteed benefits are targeted as a prescribed fraction of thetotal asset share, leaving the remaining portion of the asset share to be paidas terminal bonus. The management actions are in line with the company's PPFMand are programmed into the model. The guarantee cost in respect of guaranteed annuity options is assessed using amarket-consistent stochastic model and values both the current level of theguaranteed annuity rate benefit (allowing for future improvements in annuitantmortality) and the time value due to uncertainty in future interest rates. Theguarantee cost in each scenario is the value of the excess annuity benefitprovided by the options, relative to an annuity purchased in the open market. Inestimating the future open market annuity rate, the model allows for stochasticvariation in interest rates and for future mortality improvements. Thestochastic interest rate assumption reflects that implied by current marketinterest rate derivative prices. Future annuitant mortality has been derivedfrom the premium basis at which annuities can be purchased from FriendsProvident Pensions Limited, which allows for future mortality improvements.Future improvements are difficult to assess as there is no industry consensus. The guaranteed annuity options cost also depends upon other factors such aspolicy discontinuance and tax-free cash take-up. The factors are based on recentexperience adjusted to reflect industry benchmarks and to anticipate trends inpolicyholder behaviour. A summary of the key assumptions is as follows: Policy discontinuances: lapse, early retirement and paid-up rates vary by policytype and period and have been based on recent experience. Policy lapses forpensions are generally in the range of 1% to 3% pa (2005: 0.5% to 2% pa) withpolicy lapses for life business in the range of 3% to 9% pa (13% pa for mortgageendowment and with-profit bond policies) (2005: 3% to 9% pa (13% pa for mortgageendowment policies)). Paid-up rates for pensions are generally in the range of7% to 11% pa (2005: 7.5% to 10% pa) with life policies generally in the regionof 0.5% to 2% pa (2005: 1% pa). Early retirement rates vary by age band andpolicy type and have been reviewed and amended in 2006 based on recentexperience. Tax-free cash option: where a guaranteed annuity option is more valuable thanthe cash equivalent it is assumed that 18% to 27% of the benefit is taken astax-free, depending on type of business (2005: 18% to 25%). This is based onrecent experience. There are also guarantees and options in respect of some of the other lifeassurance business within the Group, but these are not considered to be materialto the Group's future cash flows. In addition, they have largely been matchedwith suitable assets and there is no material exposure to market or interestrate changes. Provisions have been established using deterministic scenariosbased on prudent assumptions. 8. Capital statement The capital statement in respect of the Group's Life & Pensions business is setout below. This statement shows an analysis of the available capital resourcescalculated on a realistic basis for the FPLP With-Profits Fund and on aregulatory basis for all other funds. It also shows the regulatory capitalrequirements and, in total, the overall surplus capital over regulatoryrequirements. In addition the statement provides an analysis of policyholders'liabilities. At 31 December 2006 UK UK Overseas Life & Total with- with- UK non- Life & Pensions Life & profits profits participating Pensions shareholders' Pensions (FPLP) (FPLA) funds funds funds business £m £m £m £m £m £m----------------------------------------------------------------------------------------------Shareholders' fundsOutside fund - - - - 1,045 1,045Inside fund - - 1,211 30 - 1,241---------------------------------------------------------------------------------------------- - - 1,211 30 1,045 2,286Other qualifying capitalSubordinated debt - - - 10 300 310Preference shares - - - - - -FFA 296 143 - - - 439---------------------------------------------------------------------------------------------- 296 143 1,211 40 1,345 3,035Regulatory adjustmentsAssets 19 - (725) (323) - (1,029)Liabilities - (1) 237 327 - 563Shareholders' share of future bonuses (95) - - - - (95)----------------------------------------------------------------------------------------------Available capital resources 220 142 723 44 1,345 2,474----------------------------------------------------------------------------------------------Capital requirementUK realistic basis 220 - - - - 220Other regulatory bases - 21 368 33 - 422---------------------------------------------------------------------------------------------- 220 21 368 33 - 642----------------------------------------------------------------------------------------------Overall surplus capitalover regulatory requirements 1,832----------------------------------------------------------------------------------------------Analysis of policyholders' liabilitiesWith-profits 12,505 217 - - - 12,722Unit-linked - - 16,954 11,323 - 28,277Non-participating 2,595 38 2,896 55 - 5,584----------------------------------------------------------------------------------------------Total 15,100 255 19,850 11,378 - 46,583---------------------------------------------------------------------------------------------- At 31 December 2005 UK UK Overseas Life & Total with- with- UK non- Life & Pensions Life & profits profits participating Pensions shareholders' Pensions (FPLP) (FPLA) funds funds funds business £m £m £m £m £m £m--------------------------------------------------------------------------------------------Shareholders' fundsOutside fund - - - - 951 951Inside fund - - 1,149 13 - 1,162-------------------------------------------------------------------------------------------- - - 1,149 13 951 2,113Other qualifying capitalSubordinated debt - - - 10 - 10Preference shares - - - - 300 300FFA 301 119 - - - 420-------------------------------------------------------------------------------------------- 301 119 1,149 23 1,251 2,843Regulatory adjustmentsAssets 20 (1) (610) (228) (8) (827)Liabilities - - 275 261 - 536Shareholders' share of future bonuses (85) - - - - (85)--------------------------------------------------------------------------------------------Available capital resources 236 118 814 56 1,243 2,467--------------------------------------------------------------------------------------------Capital requirementUK realistic basis 276 - - - - 276Other regulatory bases - 17 332 29 - 378-------------------------------------------------------------------------------------------- 276 17 332 29 - 654--------------------------------------------------------------------------------------------Overall surplus capitalover regulatory requirements 1,813--------------------------------------------------------------------------------------------Analysis of policyholders'liabilitiesWith-profits 13,519 243 - - - 13,762Unit-linked - - 13,853 8,871 - 22,724Non-participating 2,783 39 3,128 58 - 6,008--------------------------------------------------------------------------------------------Total 16,302 282 16,981 8,929 - 42,494-------------------------------------------------------------------------------------------- (a) Summary As can be seen from the above table, the total available capital resources ofthe Group's Life & Pensions business amounts to £2,474m (2005: £2,467m), itsregulatory capital requirements amount to £642m (2005: £654m) resulting in asurplus of available capital resources over regulatory capital of £1,832m (2005:£1,813m). Set out below are details of how the available capital resources have beencalculated, the restrictions that are in existence over the available capitalresources, the basis of calculating the regulatory capital requirements and anexplanation for the increase in the available capital. Apart from capital employed in the Life & Pensions business amounting to £2,286m(2005: £2,113m), the Group's other main activity is that of Asset Managementoperated by the F&C Group in which Friends Provident owned 52% at 31 December2006. The total capital in the Asset Management business amounts to £683m (2005:£745m). The capital employed in these two activities reconciles to the Grouptotal equity attributable to ordinary shareholders of £2,807m (2005: £2,688m) byway of central corporate activities and consolidation adjustments (mainlygoodwill), amounting to £(162)m (2005: £(170)m). (b) Basis of calculating available capital resources in Life & Pensions business The available capital of the two UK with-profits funds has been determined inaccordance with FSA regulations and includes the FFA. The FFA represents theestimated surplus in the funds that has not been allocated and is available tomeet regulatory and other solvency requirements of the funds. Adjustments havebeen made to restate all assets and liabilities onto a regulatory basis. The majority of the Group's life and pensions options and guarantees are withinFPLP's With-Profits Fund and details are set out in note 7. These are valued ona market consistent stochastic basis. Options and guarantees outside FPLP'sWith-Profits Fund are not considered to be material to the Group's future cashflows. In addition they have largely been matched with suitable assets and thereis no material risk to market or interest rate changes. Provisions have beenestablished using deterministic scenarios based on prudent assumptions. The With-Profits Fund in FPLP has available capital of £220m (2005: £236m) andhas been calculated in accordance with the FSA's realistic capital regulations.In accordance with accounting rules, the realistic liabilities only representamounts relating to policyholders and do not include the shareholders' share offuture bonuses. However, the shareholders' share is treated as a deduction fromcapital that is available to meet regulatory requirements and shown as aseparate adjustment in the capital statement. The available capital in the closed with-profits fund in FPLA amounts to £142m(2005: £118m). This has been calculated in accordance with the FSA's regulatorycapital requirements. The available capital in the Group's UK non-participating businesses has beendetermined in accordance with FSA regulations and amounts to £723m (2005:£814m). Adjustments have been made to restate all assets and liabilities on to aregulatory basis. The regulatory adjustment to assets mainly consists ofeliminating deferred acquisition costs. The regulatory adjustment to liabilitiesmainly represents the additional regulatory capital arising as a result of thesecuritisation of a defined book of pre-demutualisation business in December2004 and deferred tax. The available capital in the Group's overseas businesses written by FPI andLombard has been determined in accordance with local requirements and amounts to£44m (2005: £56m). FPI is based in the Isle of Man and Lombard is based inLuxembourg. The analysis of available capital is £19m FPI and £25m Lombard(2005: £31m FPI and £25m Lombard). Adjustments have been made to restate allassets and liabilities onto local regulatory bases. The shareholders' funds held outside the Life & Pensions funds are shownseparately in the capital statement. It is the Group's policy to ensure thateach subsidiary is adequately capitalised to support its life businesses and toexceed regulatory capital requirements. The amount of shareholders' fundsavailable capital resources is £1,345m (2005: £1,243m). (c) Restrictions on available capital resources in Life & Pensions business The available capital is subject to certain restrictions as to its availabilityto meet capital requirements elsewhere in the Group. In particular, no transfersfrom long-term funds can take place without an up to date actuarial valuation.The main restrictions on capital are set out below. UK With-Profits Fund in FPLP: the available surplus held in the FPLPWith-Profits Fund can only be applied to meet the requirements of the funditself or be distributed to policyholders and shareholders. Shareholders areentitled to an amount not exceeding one-ninth of the amount distributed topolicyholders in the form of bonuses on conventional policies. Non-profitbusiness written in the FPLP With-Profits Fund has been securitised andsurpluses are initially used to repay £380m of floating rate loan notes issuedby the Group and any subsequent surplus may be distributed 40% to FPLP'sWith-Profits Fund and 60% to shareholders. Arising from this arrangement, theFPLP Non-Profit fund has loaned £90m (2005: £173m) to FPLP's With-Profits Fund.The FPLP Non-Profit fund has also provided a contingent loan of £50m (with afacility for a further £50m) to the FPLP With Profits Fund which is repayableout of future surpluses in the With-Profits Fund, subject to certainrestrictions. UK With-Profits Fund in FPLA: the available surplus held in the closedWith-Profits Fund of FPLA can only be distributed to policyholders. UK non-participating funds: for non-participating business, the majority ofsurplus can be distributed to shareholders subject to meeting the requirementsof the business. Overseas life funds: the available surpluses in FPI and Lombard can bedistributed to shareholders subject to meeting the requirements of thebusinesses. Shareholders' funds: the capital is generally available to meet requirementsanywhere in the Group. It remains the intention of management to ensure thatthere is adequate capital to exceed the regulatory requirements of the Group'slife and pensions businesses, to meet any net new business strain and to supportthe Group's overall credit ratings. FPLP has guaranteed the £300m STICS issuedin 2003 and the £500m STICS issued in 2005 by the parent company. (d) Basis of calculating capital requirements for Life & Pensions business Each Life and Pensions company has to hold sufficient capital to meet itsregulatory capital requirements. For the FPLP With-Profits Fund, the capital requirement is the risk capitalmargin (RCM) which amounts to £220m (2005: £276m). This is calculated on setcriteria of adverse scenarios laid down by the FSA (the market risk scenariostested are what would happen if property prices fall by 12.5%, equity pricesfall by 20%, corporate bonds spreads increase by 5.23%, fixed interest yieldsrise 0.81% and persistency increases by 32.5%). The RCM is based on the assetmix at the year-end and takes into account hedging strategies and the actionsmanagement would take in the event of particular adverse market conditions. Under the realistic capital methodology, the capital requirement is the higherof the 'twin peaks' test of the realistic peak and the regulatory peak. In FPLPWith-Profits Fund, the realistic peak applied in both 2006 and 2005. This hasresulted in a With-Profits Insurance Capital Component (WPICC) of £866m (2005:£639m) required to bring the regulatory peak of £1,475m (2005: £599m) in linewith the realistic peak of £nil (2005: £(40)m). Regulatory reserving rulechanges arising from the adoption of PS 06/14 allow the value of futuretransfers to be deducted from the WPICC for 2006; this has resulted in a surplusin the FPLP With-Profits Fund, on a regulatory basis, of £609m. Realistic Regulatory 2006 2005 2006 2005 £m £m £m £m--------------------------------------------------------------------------------Available capital 220 236 Surplus 1,933 1,498Risk capital margin (220) (276) Long term Insurance - - Capital requirements (458) (549) - - Resilience capital - (350)--------------------------------------------------------------------------------Realistic peak - (40) Regulatory peak 1,475 599-------------------------------------------------------------------------------- With Profits Insurance Capital Component (866) (639)-------------------------------------------------------------------------------- - (40) 609 (40)-------------------------------------------------------------------------------- The capital cover to meet the regulatory solvency requirement of FPLP'sWith-Profits Fund is provided from FPLP's Non-Profit Fund and shareholders'fund, to the extent not met from the With-Profits Fund itself. For the FPLA closed With Profits Fund, the capital requirement has beencalculated on a regulatory basis in accordance with FSA regulations at £21m(2005: £17m). For UK non-participating funds, the relevant capital requirement is the minimumsolvency margin determined in accordance with FSA regulations. This, in total,amounts to £368m (2005: £332m). For overseas business, local regulatory capital requirements are determined andthese amount to £33m (2005: £29m). This is analysed £9m (2005: £8m) for FPI and£24m (2005: £21m) for Lombard. (e) Movement in available capital At 31 December 2006 total available capital resources had increased by £7m to£2,474m, as shown below. UK UK Overseas Life & Total with- with- UK non- Life & Pensions Life & profits profits participating Pensions shareholders' Pensions (FPLP) (FPLA) funds funds funds business £m £m £m £m £m £m------------------------------------------------------------------------------------------At 1 January 2006 236 118 814 56 1,243 2,467New business strain - - (297) (35) - (332)Surplus in year* (4) 25 155 49 73 298Assumption changes - - - - - -PS 06/14 - - 123 - - 123Morbidity basis - - 123 - - 123Other (12) (1) 6 (1) - (8)Transfers - - (200) (25) 225 -Dividend and STICS interest - - - - (197) (197)------------------------------------------------------------------------------------------At 31 December 2006 220 142 724 44 1,344 2,474------------------------------------------------------------------------------------------* All tax items are included within Surplus in year. 9. Movement in capital and reserves Equity attributable to equity holders of the parent Share Share Other Minority capital premium reserves STICS Total interest Total £m £m £m £m £m £m £m---------------------------------------------------------------------------------------------At 1 January 2006 214 2,038 436 810 3,498 442 3,940Total recognised incomeand expense for the year - - 258 52 310 92 402---------------------------------------------------------------------------------------------Dividends on equity shares - - (164) - (164) (46) (210)Interest paid on STICS - - - (52) (52) - (52)---------------------------------------------------------------------------------------------Appropriations of profit - - (164) (52) (216) (46) (262)Share based payments - 13 12 - 25 7 32Change in participation in subsidiary - - - - - 53 53---------------------------------------------------------------------------------------------At 31 December 2006 214 2,051 542 810 3,617 548 4,165--------------------------------------------------------------------------------------------- Equity attributable to equity holders of the parent Share Share Other Minority capital premium reserves STICS Total interest Total £m £m £m £m £m £m £m---------------------------------------------------------------------------------------------At 1 January 2005 199 1,799 421 299 2,718 80 2,798Total recognised incomeand expense for the year - - 107 37 144 17 161---------------------------------------------------------------------------------------------Dividends on equity shares - - (157) - (157) (29) (186)Interest paid on STICS - - - (21) (21) - (21)---------------------------------------------------------------------------------------------Appropriations of profit - - (157) (21) (178) (29) (207)Issue of STICS - - - 495 495 - 495Share based payments - 5 14 - 19 12 31Disposal of subsidiary - - - - - 54 54Change in participation in subsidiary - - - - - 42 42Allotment on acquisition of Lombard 15 234 - - 249 - 249Conversion option - - 51 - 51 - 51Property transfer into trust - - - - - 266 266---------------------------------------------------------------------------------------------At 31 December 2005 214 2,038 436 810 3,498 442 3,940--------------------------------------------------------------------------------------------- 10. Contingent liabilities and commitments (a) Past sales The Group has made provision for the estimated cost of settling complaints inrespect of past sales. Although the provisions are regularly reviewed, the finaloutcome could be different from the provisions established as these costs cannotbe calculated with certainty and are influenced by external factors beyond thecontrol of management. Such uncertainties include future regulatory actions,media attention and investment performance. The majority of the uncertaintyrelates to endowment mortgages although a number of other products are beingreviewed as an ongoing process. It is expected that the majority of endowmentcases requiring compensation will be settled in the next two years. (b) VAT on investment trust management fees In a current European Court case, a UK investment trust is seeking to establishthat management services to UK investment trusts should be a VAT exempt supply,rather than a taxable supply in accordance with current UK VAT law. If this casewere successful, a number of group companies, in common with other relevant fundmanagers in the UK, would face claims from those investment trusts to which theyhave supplied services for repayment of the VAT they have charged to them. TheAssociation of Investment Companies (AIC), a party to the above litigation, hasindicated that it believes claims dating back as far as 1990 may be lodged withfund managers by investment trusts. Companies in the F&C group can submitrepayment claims to HM Revenue & Customs, but only dating back as far as 2001,being the maximum time period permitted. F&C has begun to receive protectiveclaims from a number of its investment trust clients and has lodged protectiveclaims with HM Revenue & Customs. The Advocate General issued an opinion on thecase, on 1 March 2007, which is in favour of Investment Trusts. However, untilthe decision of the European Court of Justice and the subsequent UK VAT tribunaldecision are known, the directors of F&C are not able to judge the likelihoodthat the investment trusts and the AIC will be successful, nor are they able toquantify the claims that may be received or the extent to which such claimscould be mitigated and therefore, are not able to quantify the potentialliability. (c) F&C acquisition In December 2000, when Eureko BV acquired F&C Group (Holdings) Limited,approximately 73% of the issued ordinary shares of F&C Group Management Limited,a subsidiary company, were held in the form of two bearer share warrants whichcould not be located prior to the completion of the sale. Eureko BV wasindemnified by F&C Group (Holdings) Limited against any losses suffered as aresult of the loss of the old share warrants or the issue of replacement sharewarrants. Since a bearer share warrant issued by a company entitles the bearerto the shares specified in the share warrant, there is a risk that the thirdparty holding the old share warrants may claim that it is entitled to thespecified shares in F&C Group Management Limited. If a third party weresuccessful in establishing a claim in relation to the old share warrants, F&CGroup (Holdings) Limited could be liable to indemnify F&C Group ManagementLimited under the original indemnity arrangements, which could have a materialadverse effect on F&C's business, results of operations and/or financialcondition. Although there is a possibility that a third party may seek to establish that itis entitled to the shares specified in the old share warrants, the directors ofF&C have been informed that Eureko BV has been advised that the prospect of athird party succeeding in such a claim is remote. Under the terms of the 2004merger between ISIS and F&C, Eureko Holdings has given a specific indemnity(guaranteed by Eureko BV) to F&C in respect of losses arising in relation to thelost share warrants to bearer in F&C Group Management Limited (including inrespect of the indemnity granted by F&C Group (Holdings) Limited to F&C GroupManagement Limited), which is capped at approximately £432m. This information is provided by RNS The company news service from the London Stock Exchange

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