Friends Provident Interim Results - Part 1

11th Aug 2009 07:04



11 August 2009

Friends Provident Group plc  Interim management report and results for the half-year ended 30 June 2009 

A strong base for profitable growth

Trevor Matthews, chief executive officer, said:

"We are excited by the prospects for our business as the foundation for Resolution's consolidation and restructuring strategy for the open businesses in the Life and Asset Management sectors. Resolution is supportive of our current strategy and turnaround plan.

"Our achievements over the last 18 months in reshaping and refocusing our business have placed us well to participate in industry consolidation and leverage our efficient infrastructure.

"We sum up our existing organic growth strategy in just four words:

'Fix UK, Build International'. To this end, we have secured our targeted cost savings and have created an efficient platform capable of handling significant new business volumes making us an attractive distribution partner both in the UK and overseas.

"Trading conditions remain tough. In the UK, the economic slowdown has reduced new business from increments and new members on our existing group pensions schemes, while the protection market remains subdued compared to recent years. We are making headway in new schemes on nil or funded commission terms but there are significant timelags, exacerbated by the recession, from participating in tenders to winning the schemes and seeing new business volumes come through. As expected, these lower volumes have an exaggerated effect on new business metrics, but that will reverse when volumes recover. Our International businesses produced resilient results against a tough economic backdrop worldwide.

"The demerger of our stake in F&C represented a further significant achievement and bolsters our already strong capital position."

Financial Summary

	Half year ended
	30 June	30 June
	2009	2008
Cash
Life and pensions gross cash generated	£35m	£(19)m
Life and pensions net cash operating surplus	£23m	£10m
Shareholder cash outflow	£(7)m	£(121)m
Internal rate of return on new business (i)	10.7%	12.6%
Discounted cash payback on new business (i)	14 years	11 years
IFRS
IFRS underlying profit (i) before tax	£38m	£13m
IFRS loss before tax from continuing operations	£(102)m	£(221)m
Basic IFRS loss per share	(4.2)p	(2.6)p
IFRS net asset value per share excluding goodwill	75p	77p (iv)
EEV
Contribution from new business (i)	£30m	£67m
EEV underlying profit (i) before tax	£131m	£211m
Return on embedded value (i) (annualised)	5.9%	8.4%
Embedded value per share (ii)	124p	128p (iv)
Capital and dividend
IGD surplus capital resources(i)	£0.9bn(iii)	£0.85bn (iv)
Total shareholder return	(24)%	(34)%
Interim dividend per share	1.3p	1.3p

(i)	As defined within Appendix 4
(ii)	Embedded value is stated on a pro forma basis, including an uplift of
	the net asset value attributable to F&C to the market value
(iii)	As at 31 July 2009 (estimated)
(iv)	As at 31 December 2008

- Ends -

For further information please contact:

Journalists
Nick Boakes	Friends Provident Group plc	+44 (0) 845 641 7814
Peter Timberlake	Friends Provident Group plc	+44 (0) 845 641 7834
Vanessa Neill	Finsbury Limited	+44 (0) 20 7251 3801
Zoe Watt	Finsbury Limited	+44 (0) 20 7251 3801
Analysts
Richard Everett	Friends Provident Group plc	+44 (0) 845 268 4111
Chris Ford	Friends Provident Group plc	+44 (0) 845 641 7832

Ref: J077

Notes to Editors

1.	There will be a conference call on these results for investors and analysts 2.30pm
	BST hosted by Trevor Matthews, CEO and Evelyn Bourke, CFO. Dial in telephone  number +44 (0)20 3037 9157.
2.	A recording of this call will be available for 7 days by dialling
	+44 (0)20 8196 1998 (access code 3849752#)
3.	Presentation slides for this call will be available from 9.30am today on
	www.friendsprovident.com/presentations
4.	For more information on Friends Provident including photos, awards, fast facts,
	presentations, and media contacts please visit the media section at
	www.friendsprovident.com/media
5.	Financial reporting dates
	Financial Reporting Calendar:
	Friends Provident Group plc Interim Management Statement
	and Quarter 3 2009 New Business Announcement	27 October 2009
	Friends Provident Group plc Quarter 4 New Business	28 January 2010
	Friends Provident Group plc 2009 Preliminary Results	16 March 2010
	Friends Provident Group plc Interim Management Statement
	and Quarter 1 2010 New Business	28 April 2010
	Friends Provident Group plc 2010 Half-year Results
	and Quarter 2 2010 New Business	10 August 2010
	Friends Provident Group plc Interim Management Statement
	and Quarter 3 2010 New Business	28 October 2010
6.	Certain statements contained in this announcement constitute 'forward-looking
	statements'. Such forward-looking statements involve risks, uncertainties and
	other factors, which may cause the actual results, performance or achievements,
	from time to time, of Friends Provident Group plc, its subsidiaries and subsidiary
	undertakings or industry results to be materially different from any future
	results, performance or achievements expressed or implied by such forward-
	looking statements. Such risks, uncertainties and other factors include, among
	others, adverse changes to laws or regulations; risks in respect of taxation;
	unforeseen liabilities from product reviews; asset shortfalls against product
	liabilities; changes in the general economic environment; levels and trends in
	mortality, morbidity and persistency; restrictions on access to product
	distribution channels; increased competition; and the ability to attract and
	retain personnel. These forward-looking statements are made only as at the
	date of this announcement and, save where required in order to comply with the
	Listing Rules, there is no obligation on Friends Provident Group plc to update such
	forward-looking statements.

7.	We are holders of a large number of industry awards, showing continued
	recognition of the quality of our products and service:
	Service
	·;	SimplyBiz Awards 2009. Best Overall Service
	·;	FTAdviser.com - Online Service Awards 2008. Friends Provident received the 4 Star award for Life & Pensions Provider
	·;	Money Marketing Financial Services Awards 2008. Friends Provident came 3rd in the category of Company of the Year
	eBusiness
	·;	Investment Life & Pensions Moneyfacts 2008 Awards. Winner of Best Online Service
	·;	FTAdviser.com - Online Service Awards 2008. Friends Provident received the 5 Star award for Investment Providers and Packagers
	·;	Financial Technology Research Centre - e-Excellence Ratings 2009. Friends Provident received numerous Triple E ratings: Individual Pensions, Group SIPP, Life Protection, Critical Illness, Income Protection, Protection Menu, CIMP and Group Personal Pensions including Stakeholder for both new and existing business
	Pensions
	·;	Incisive Media - Gold Standard Awards 2008. Friends Provident won the Group Pensions category
	·;	European Pensions Awards 2009. Friends Provident was awarded Pension Provider of the Year
	·;	Professional Pensions UK Pensions Awards 2009. Friends Provident won DC Provider of the Year
	Protection
	·;	Online Finance Awards 2008. Friends Provident was awarded Best Online Protection Provider
	·;	Incisive Media Gold Standard Awards 2008. Winner of Protection category
	·;	Health Insurance Awards 2008. Friends Provident was named Best Individual Income Protection Provider
	Investments
	·;	Investment Life & Pensions Moneyfacts 2008 Awards. Friends Provident won award for Best Ethical Investment Provider

Overview

Trading conditions have been tough through the first half of 2009, with significant volatility in investment markets, especially in the first quarter. Against this backdrop, we have continued to implement the strategy set out at the start of 2008. Since a major element of the strategy is to focus on a narrower range of key products in the UK, we expected that our new business volumes would reduce and that this would impact on our profitability in the short term. The reported results do indeed bear this out. It remains our belief that in time we will be able to demonstrate the benefits of the strong progress we have made in reducing our cost base and building distribution relationships. We continue to build our International businesses, FPI and Lombard, to capitalise on opportunities as they arise. The ongoing cash generation of the business has improved and we are maintaining our current dividend policy. We have strengthened our management team through the arrival of Evelyn Bourke as chief financial officer, and also appointed key experienced personnel in human resources, risk and internal audit. Having now distributed our stake in F&C to our own shareholders, we have substantially reshaped the business to be well positioned to demonstrate the benefits of the turnaround and provide a strong base for the future.

Strategy implementation

We have now secured the delivery of the cost savings targeted for the end of 2009. The target was to reduce the operating cost base of the UK business and corporate functions by £40 million and development costs by £20 million, both in real terms, a total of over 20% of the 2007 cost base of the business. We have carried out a fundamental restructure of our UK operations over the last 18 months and we are now well positioned to compete strongly in the protection and group pensions markets. 

Demerger of F&C stake

On 3 July 2009, we demerged our 52% stake in F&C Asset Management plc by distributing the shares to our own shareholders. This was a further important milestone in the execution of the strategy set out at the start of 2008, allowing us to focus on our core operations.

Small shareholders who would have received 250 or fewer F&C shares were mainly paid in cash raised through a placement of their shares in the market. The demerger effectively returned 6.2 pence per Friends Provident share. We covered the costs of the transaction by selling residual shares in F&C.

Financial strength

Our estimated surplus on the IGD basis increased to £0.9 billion at 31 July (31 December 2008: £0.85bn) following the demerger of the Group's stake in F&C Asset Management plc and payment of the final 2008 dividend. The IGD surplus measure is conservative, excluding £0.4 billion of surplus assets held within long-term funds. 

Recommended offer from Resolution

Separately today we have announced that the Board of Friends Provident Group plc has recommended acceptance of an offer from Resolution Plc.

Resolution and Friends Provident believe that consolidation can be beneficial to the sector. The actions taken following the strategic review in January 2008 are transforming our business and as a consequence, Friends Provident brings to this deal: an attractive franchise; an experienced management team; efficient and scalable systems; a strong capital position; and a good fit with future possible acquisitions.

Outlook

The outlook for the remainder of 2009 remains challenging given the uncertain pace of recovery in the UK economy. In the UK we have now secured our targeted cost savings, extended our key distribution partnerships, and are well positioned to compete strongly in the protection and group pensions markets. FPI's sales will depend on the demand in the markets in which it operates, although it now has more balance between operations in different territories than ever before. We remain optimistic about the prospects for Lombard in the key fourth quarter as it has a very strong pipeline of potential new business.

Beyond this, there are significant opportunities to extend our distribution, as our operating platform is capable of handling higher volumes which would in turn improve reported profitability. In the UK we have reached agreement with Tesco Personal Finance to market our protection products and have further opportunities under discussion. Our ownership of Sesame will provide exposure to the UK's largest IFA network, together with options for responding to the FSA's Retail Distribution Review. FPI continues to provide exciting opportunities to extend our business to new markets. Lombard is uniquely placed and has considerable potential.

Financial performance

Cash

·;	Life and pensions gross operating cash (new business strain less in-force surplus) was £35 million up from £(19)m in first half 2008.
·;	New business strain reduced to £(134) million (2008: £(179)m) while in-force surplus increased to £169 million (2008: £160m).
·;	Shareholder cash and capital outflow reduced to £(7) million (2008: £(121)m) as we maintained our conservative reserving basis for credit default allowances in annuity liabilities, but there was no increase in credit spreads (2008: £(70)m).
·;	Internal rate of return on new business was 10.7% (2008: 12.6%) and cash payback increased to 14 years (2008: 11 years) primarily due to the impact of sharply reduced volumes.

IFRS

·;	IFRS underlying profit before tax improved to £38 million (2008: £13m), with the new business strain and in-force surplus both reducing, while the charge in 2008 of £(70) million for increased credit spreads was not repeated.
·;	IFRS loss before tax from continuing operations was £(102) million (2008: £(221)m) and basic loss per share (4.2)p (2008: (2.6)p). The result in first half 2009 included investment return variances of £(44) million, amortisation of intangible assets of £(45) million and non-recurring costs of £(59) million, mainly related to implementing the cost savings programme.
·;	IFRS net asset value per share excluding goodwill was 75p (31 December 2008: 77p) representing the equity attributable to ordinary shareholders, less all goodwill.

EEV

·;	Our embedded value results are calculated on the market-consistent basis that we have used since 2005. This basis assumes that the illiquidity premium on corporate bonds is zero. There is considerable uncertainty around the eventual treatment of annuity business within the CFO Forum Market Consistent Embedded Value Principles. Using the approaches some of our peers have taken to corporate bond illiquidity premia would materially improve our reported results, so we have presented sensitivities, where appropriate, to assist investors.
·;	Contribution from new business was £30 million (2008: £67m) as UK business showed an anticipated fall in profitability due to volumes reducing by more than the reduction in acquisition expenses. Recalculating this result, allowing for an illiquidity premium of 100bps* over risk-free rates on assets backing annuity business, would increase the overall contribution from new business to £42 million.
·;	EEV underlying profit before tax of £131 million (2008: £211m) was lower due to the reduced contribution from new business shown above, together with a reduction of in-force profit to £83 million (2008: £108m) mainly due to adverse lapse and paid up experience variances. These adverse variances partly reflect an effect of our strategy, where we have withdrawn from the commission-paying group pensions market, and partly the impact of the recession.
·;	Return on Embedded Value on an underlying basis was 5.9% (2008: 8.4%) resulting from the same drivers as the reduction in underlying profit.
·;	Embedded value per share was 124p (31 December 2008: 128p), impacted by negative investment return variances. Embedded value per share would increase to 131p assuming a 100bps* illiquidity premium on annuity business.

* The sensitivities take into account potential illiquidity premia implied by appropriate bond indices and the derivative markets.

Debt, group structure and dividend

In May 2009 Friends Provident plc offered holders of its two long-term subordinated debt issues the opportunity to exchange their holdings for a new subordinated instrument maturing in 2021. Holders of £322 million of the debt outstanding before the exchange elected to receive £162 million of the new issue. This transaction allowed us to reduce the ultimate amount of debt outstanding, extend the call and maturity dates and modestly reduce annual interest costs, with no detriment to policyholder interests or IGD surplus.

In order to create sufficient distributable reserves to pay the final 2008 dividend and distribute the Group's stake in F&C, a new top holding company, Friends Provident Group plc, was put in place in June 2009. Subsequent capital reductions have created a significant amount of distributable reserves. Friends Provident Group plc declared and paid on 24 July 2009 a dividend of 2.6 pence per share representing the final dividend for 2008.

The Board has recommended a maintained 2009 Interim Dividend of 1.3 pence per share to be paid in October 2009. This is in line with the Group's policy, which is to maintain its dividend per share at the level determined by the Board to be supportable in due course by the operating cash flow of the business. 

Business Review

New business sales and profitability

Table 1: New business sales

	APE	APE		PVNBP	PVNBP
	First half	First half	APE	First half	First half	PVNBP
	2009	2008	Change	2009	2008	Change
	£m	£m	%	£m	£m	%
UK Corporate	144	246	(41)	666	1,179	(44)
UK Individual	47	74	(36)	373	602	(38)
UK Total	191	320	(40)	1,039	1,781	(42)
FPI	81	117	(31)	481	737	(35)
Lombard	47	70	(33)	466	702	(34)
Intl Total	128	187	(32)	947	1,439	(34)
Total	319	507	(37)	1,986	3,220	(38)

First half new business volumes reduced significantly year-on-year. The operating environment has remained tough throughout the first half of 2009 as a result of the worldwide economic slowdown. In addition, the strategy entered into at the start of 2008 means that prior year comparatives, particularly in the UK, include significant volumes of business from lines in which we are no longer active. New business volumes improved on a quarter-on-quarter basis in the second quarter, with total sales of £171 million APE compared to £148 million in the first quarter. Including results for the Malaysian joint venture AmLife, in which the Group holds a 30% interest, would increase the first half APE by an estimated £3 million. 

Table 2: Contribution from new business and PVNBP margin

	Contribution from new business				PVNBP margin
	First	First	First	First	First	First
	half	Half	half	half	half	half
	2009	2009*	2008	2008*	2009	2008
	£m	£m	£m	£m	%	%
UK Corporate	(1)	(1)	7	7	(0.1)	0.6
UK Individual	4	16	20	26	1.1	3.3
UK Total	3	15	27	33	0.3	1.5
FPI	18	18	22	22	3.7	3.0
Lombard	9	9	18	18	1.9	2.6
Intl Total	27	27	40	40	2.9	2.8
Total	30	42	67	73	1.5	2.1

 

* Contribution recalculated assuming 100 bps allowance for illiquidity on assets backing annuity business in the first half of 2009 (2008: 50bps).

Contribution from new business before tax has reduced to £30 million (2008: £67m). PVNBP margin (defined as contribution from new business as a percentage of PVNBP) is lower mainly due to the gearing effect on contribution of changes in new business volumes.

The UK contribution from new business has significantly reduced, with a consequent impact on PVNBP margin. Contribution is equal to the difference between margins on sales (the embedded value added by writing new policies allowing for directly incurred costs) and acquisition expenses. Volumes of new business in the UK are around 40% lower than in first half 2008, significantly reducing margin on sales to £60 million (2008: £93m). Margin on sales as a proportion of PVNBP in the UK increased to 5.7% (2008: 5.2%), as our strategy means we no longer compete aggressively in market segments where less attractive returns are available. Acquisition expenses have reduced as a result of our cost savings programme, but by less than the reduction in margin on sales, and this is the reason why contribution is modest both in absolute terms and expressed as a proportion of PVNBP.

Our platform for the UK and FPI businesses is able to handle higher volumes of new business than written in the first half, without corresponding increases in acquisition expenses. We would therefore expect both contribution from new business and PVNBP margin to improve as volumes grow. To illustrate the potential for future growth, a 25% improvement in UK volumes would be expected to improve UK contribution by £13 million if current expense levels are maintained.

International contribution was lower as a result of lower volumes in both FPI and Lombard. FPI margins have improved, mainly as a result of a change in business mix compared to first half 2008. Lombard's reduced contribution reflects lower volumes over its semi-fixed cost base and is expected to increase at the full year due to the weighting of business towards the second half of the year. Lombard's margin on sales was a higher proportion of PVNBP than in first half 2008, as a result of a smaller proportion of large cases and stable profitability on smaller cases. AmLife's contribution, based on our 30% share, is estimated to be £2 million.

Our market-consistent embedded value methodology does not fully value the anticipated returns on annuity business. This is because it makes no allowance for expected returns on assets backing policyholder liabilities above risk-free (gilt) rates until those returns are realised. We have seen significant volatility in the spreads implied by market prices of corporate bonds in the last 18 months. The sensitivity to an alternative approach, in line with peers, of allowing for 100 bps of the return on assets above risk free to be taken in to account within the calculation would increase the reported contribution from new business by £12 million for the half year. 

Table 3: Internal rate of return (IRR) and discounted cash payback of new business

	First half	First half	First half	First half
	2009	2008	2009	2008
	IRR	IRR	Discounted	Discounted
	%	%	payback	payback
UK Corporate	5.4	7.5	N/a	23yrs
UK Individual	16.3	20.2	15yrs	7yrs
UK Total	9.9	10.9	25yrs	16yrs
FPI	14.5	15.7	6yrs	7yrs
Lombard	10.0	17.4	13yrs	7yrs
International Total	12.3	16.4	9yrs	7yrs

IRR and discounted cash payback are measures of the expected returns on capital invested in new business. Each metric is strongly influenced by the initial cost incurred to acquire the business. As outlined above, volumes have reduced sharply year-on-year while acquisition expenses have not reduced by as much, consequently IRR and discounted payback are both behind the first half 2008 results. As with contribution from new business, we would expect volume growth and reduced expenses to improve these metrics. To illustrate this, a 25% increase in volume in the UK would improve UK IRR on new business to 12.2% and discounted payback to 16 years.

Management expenses

The management expenses of the life and pensions businesses, which exclude both commission payments and non-recurring costs, are set out in the table below. 

Table 4: Management expenses

	First half 2009				First half 2008
	UK	FPI	Lombard	Total	UK	FPI	Lombard	Total
	£m	£m	£m	£m	£m	£m	£m	£m
Acquisition	57	13	19	89	65	11	16	92
Maintenance	44	10	10	64	53	8	8	69
Development	1	2	1	4	-	7	1	8
Other	-	-	-	-	9	-	-	9
Total Life & Pensions	102	25	30	157	127	26	25	178
Corporate	6	-	-	6	8	-	-	8
Total	108	25	30	163	135	26	25	186

In January 2008 we set out our strategy, including the target to reduce the run-rate of UK and corporate operating costs by £40 million and development costs by £20 million in real terms by the end of 2009. This meant that the annual UK and corporate operating cost base following implementation of the cost savings programme would be £215 million, £60 million lower than the 2007 total of £275 million.

We have secured the identified cost savings with £40 million of operating cost run-rate savings and £20 million of development cost savings secured at 30 June (31 Dec 2008: £25 million operating cost and £15 million development cost savings). In order to achieve £60 million of real savings, we needed to secure some £80 million of nominal cost savings. The additional £20 million was required to allow for cost increases on the 2007 cost base (primarily salary inflation) and capability improvements not categorised as development spend. The total £80 million of savings secured comprises:

To achieve these savings, we have reduced headcount by 22% of full time equivalent roles from December 2007 to June 2009. 

The total cost of implementing these savings, plus a number of other strategic changes, is approximately £80 million. £32 million of this was incurred in 2008, with the remaining £48 million reported as a non-recurring item in first half 2009 IFRS and embedded value results.

Actual UK operating costs in the first half are £25 million below first half of 2008. International operating expenses continue to be tightly controlled, with FPI costs slightly down year-on-year and the reported increase in Lombard operating costs due primarily to exchange rate changes increasing the largely Euro-denominated costs when reported in Sterling.

The cost savings programme has reinforced the importance of cost control within the business. While the cost structure of the business is now appropriate for the anticipated future requirements of the business, we will continue to control our cost base carefully. We will continue to recognise development expenses only for significant extensions of our capabilities in to new products or territories.

UK Corporate

Table 5: UK Corporate results

		Group	Group
		pensions	protection	Total
New business (APE)
	First half 2009	£140m	£4m	£144m
	First half 2008	£242m	£4m	£246m
New business (PVNBP)
	First half 2009	£652m	£14m	£666m
	First half 2008	£1,165m	£14m	£1,179m
Contribution
	First half 2009	£(1)m	-	£(1)m
	First half 2008	£7m	-	£7m
PVNBP margin
	First half 2009	(0.1)%	-	(0.1)%
	First half 2008	0.6%	-	0.6%
IRR
	First half 2009	5.8%	1.1%	5.4%
	First half 2008	7.9%	1.1%	7.5%
Discounted cash payback
	First half 2009	N/a	N/a	N/a
	First half 2008	23yrs	N/a	23yrs

Speculation on corporate ownership in early 2008 led, until Autumn 2008, to a number of employee benefit consultants and consulting actuaries ceasing to recommend Friends Provident to employers seeking to change their pension provider. Our UK Corporate business unit has made significant progress since then in re-establishing productive relationships with these key intermediaries. We have now achieved positions on pensions provider panels for almost all of our targeted distributors and are active in the market for new schemes. We intend to develop new additions to our product offering in order to support our activity in this market.

In particular, we are working with FNZ, one of the leading platform providers, to introduce a corporate platform in 2010, to maintain a leadership position in this market. This platform is planned to provide access to corporate ISAs and we are exploring how employers' ShareSave and Share Incentive Plan proceeds can be integrated. The development will also enable the delivery of an enhanced Group SIPP and a more sophisticated individual SIPP.

Group Pensions

Table 6: Group pensions new business APE

		First half	First half
		2009	2008
		£m	£m
Transfers in and lump sum contributions		13	31
Regular contributions
	- from increments to existing schemes	112	156
	- from new schemes with unfunded commission	-	40
	- from new schemes in target segment	15	15
Total		140	242

There are a number of drivers of reduced group pensions sales year-on-year. As part of our strategy change in early 2008, we revised terms so as not to take on new schemes on an unfunded initial commission basis. As a result we had no APE from new schemes on an unfunded commission basis compared to £40 million of APE in first half 2008.

Transfers in and lump sum contributions were lower due to a combination of reduced new scheme wins and the economic backdrop. The 2009 figure includes some £2 million of APE related to DWP rebates whereas all 2008 rebate premiums are reported within individual pensions.

As a result of the economic environment, increments to existing schemes, which form a major share of reported new business, have reduced significantly. Such increments arise from new employees joining employers for which we provide schemes, and increases in contributions, which typically are driven by annual salary increases. Both of these factors are affected by rising unemployment and wage constraints in the wider economy. We would expect increments to improve when economic conditions ease.

A total of 58 new mandates were won in the first half. New business is not recorded until funds are moved on to our systems, which is typically a number of months after the mandate is awarded. This pipeline of business from new mandates is now stronger than at the beginning of the year, although the time lag between winning mandates and funds coming on to the platform is greater than in previous years.

Table 7: Pension assets under management

	First half 2009
	£m
Start of period	7,281
Regular contributions	596
Transfers in and lump sum contributions	137
Transfers out and retirements	(316)
Net cash inflow	417
Investment return	(12)
End of period	7,686

Despite negative investment returns, and limited transfers in, we increased funds under management (including unit-linked individual and group pensions) to around £7.7 billion. Scheme members increased from 750,000 to 765,000 over the half year.

Reported profitability reflects the reduced volume in the first half. We do not believe that the reported IRR or payback for this period gives a guide to the ultimate returns from this business.

Group protection

Sales of group protection were steady year-on-year in a highly competitive market. We have enhanced our group income protection product to maintain its competitiveness and have further developments planned for the second half of the year. 

UK Individual

Table 8: UK Individual results

		Individual	Individual
		protection	pensions	Annuities	Investments	Total
New business (APE)
	First half 2009	£20m	£13m	£13m	£1m	£47m
	First half 2008	£24m	£30m	£14m	£6m	£74m
New business (PVNBP)
	First half 2009	£125m	£110m	£125m	£13m	£373m
	First half 2008	£155m	£250m	£139m	£58m	£602m
Contribution
	First half 2009	£1m	£5m	£(1)m	£(1)m	£4m
	First half 2008	£7m	£11m	£2m	£(1)m	£20m
PVNBP margin
	First half 2009	0.8%	4.5%	(0.8)%	(7.7)%	1.1%
	First half 2008	4.5%	4.4%	1.4%	(1.7)%	3.3%
IRR
	First half 2009	4.3%	24.3%	N/a	N/a	16.3%
	First half 2008	12.2%	N/a	30.9%	6.1%	20.2%
Discounted cash payback
	First half 2009	26yrs	6yrs	N/a	N/a	15yrs
	First half 2008	9yrs	N/a	8yr	N/a	7yrs

Individual protection

Activity in the protection market is closely related to the level of transactions in the housing market, because sales of protection products are often linked to mortgage sales. The low levels of housing market activity seen in second half 2008 have largely persisted in to first half 2009. As a result, first half sales remain relatively low, down 19% year-on-year. Second quarter sales were 15% higher than in the first quarter, reflecting some of the re-pricing activity undertaken during the half. Protection premiums in payment were £264 million, broadly in line with the year-end figure.

As with all UK product lines, declines in new business profitability are largely caused by the balance of volume against expenses in the first half and do not reflect the underlying returns available in this market.

During the first half we have undertaken considerable activity aimed at expanding our distribution to write more business on our platform. Currently we have some exposure to tied distribution, in particular through the Countrywide estate agency business, but limited bank distribution. In April we announced a distribution agreement with Tesco Personal Finance and have a number of similar initiatives under discussion. We will continue to seek out such opportunities.

Individual pensions

Individual pensions sales are lower year-on-year, primarily due to withdrawal of initial commission on this product during first half 2008. The comparative also includes £9m of DWP rebate business compared to £6 million in first half 2009 (with the remainder of the £8 million of DWP rebate premiums received now reported within group pensions after further analysis of the business giving rise to the premiums). We believe the majority of DWP rebate premiums for the year have now been received.

Annuities

Annuity sales reduced slightly year-on-year reflecting lower fund values for retiring pension policy holders. Over 9,000 annuities were written in the first half, representing more than 40% of vesting policyholders electing to take a Friends Provident annuity.

Investments

Investment sales are significantly lower as initial commissions are no longer paid.

Friends Provident International (FPI)

Table 9: FPI results

		First half	First half
		2009	2008
New business (APE):
	Asia	£38m	£62m
	UK	£2m	£8m
	Middle East	£21m	£21m
	Europe (excluding UK)	£14m	£18m
	Rest of the World	£6m	£8m
Total APE		£81m	£117m
New business (PVNPB)		£481m	£737m
Contribution from new business		£18m	£22m
PVNBP margin		3.7%	3.0%
IRR		14.5%	15.7%
Discounted cash payback		6 years	7 years
Assets under management		£4,516m	£4,526m*

 

* as at 31 December 2008

FPI operates a 'hub and spoke' model to enable cost-effective delivery of international products through distribution relationships in markets where more attractive returns are available to providers than in the UK. FPI first half sales were down 31% year-on-year, mainly driven by economic uncertainty constraining demand for investment products around the world. Second quarter sales were 20% above those in the first quarter. We have continued to tailor new products that position FPI to perform strongly in the medium term, as confidence returns in each of the markets where we operate.

The Hong Kong market comprises the majority of the Asia result. This is a territory where FPI has been established for over 20 years and has longstanding relationships with distributors. The first half comparative from 2008 is very strong as FPI wrote significant volumes of regular premium business on competitive terms in this market. This enabled FPI to capitalise on strong demand for savings products, before adjusting terms in mid-2008 as market demand reduced. Unit-linked regular premium Hong Kong market sales were down 64% year-on-year in the first quarter (source: Office of the Commissioner of Insurance), with FPI performing a little ahead of this. Singapore is our other main market within Asia, with a sales office established in 2007. Sales in this market were up 20% on first half 2008 to £5 million APE, reflecting a wider range of products offered over the last year.

Middle East sales have held up well, supported by growth in sales through Riyad Bank, and the branch in Dubai. We launched the Optus group savings product late in 2008. There has been strong interest and 15 employers have committed to place business with us. We expect funds to start to come on to the platform, and be reported as new business, over the second half of the year.

Sales from our German pensions distribution were in line with first half 2008 in Sterling terms at £8 million APE. Elsewhere in Europe, and in the UK, sales were lower due to reduced demand for investment products. 

Contribution from new business was down on reduced volumes. However, new business profitability has been improved, with a shift in the mix of business towards higher margin protection business. This allowed an improvement in PVNBP margin and payback while IRR was only slightly below 2008's result.

We have continued to develop this business to provide products leveraging our capabilities and UK expertise to address local market requirements. In July we launched group protection in the Middle East to enhance our Optus offering and we continue to add to the range of funds available on our platform. Also in July we announced a distribution partnership for insurance bond products in Singapore with ANZ bank. We will continue to seek to access new markets where we can do so cost effectively, for example, through extending our operations in the Middle East.

Lombard

Table 10: Lombard results

		First half	First half
		2009	2008
New business (APE):
	UK and Nordic	£11m	£20m
	Northern Europe	£14m	£23m
	Southern Europe	£21m	£23m
	Rest of the World	£1m	£4m
Total APE		£47m	£70m
Of which, large cases (greater than €10m)		£7m	£17m
Total APE excluding large cases		£40m	£53m
New business (PVNBP)		£466m	£702m
Contribution from new business		£9m	£18m
PVNBP margin		1.9%	2.6%
IRR		10.0%	17.4%
Discounted cash payback		13 years	7 years
Assets under management		£11,365m	£12,425m*

* as at 31 December 2008

 

Lombard specialises in estate planning solutions for wealthy clients throughout Europe and beyond. Sales are seasonal due to the concentration of European tax year-ends in December and the consequent peak of sales in the fourth quarter. New business volume in the first three quarters depend largely on timing of large cases. Second quarter results were stronger than the first quarter's, but first half 2009 results are significantly lower than first half 2008 reflecting the difficult economic climate, which has continued to affect client confidence. Large cases made up just 14% of first half 2009 results compared with 25% in first half 2008. We will be able to give some more guidance on the full year outturn with our third quarter trading results.

Sales by territory reflect the incidence of large cases, as well as specific drivers for each territory. Belgium, Italy, France and UK performed well. Spain and Germany were affected by previously reported legal and fiscal changes, where uncertainty remains on the implications of these changes. Clarification is anticipated in the autumn, and we are hopeful that new business will pick up in both these markets in the fourth quarter.

The new business contribution reflects the semi-fixed nature of Lombard's cost base and the relatively low first half volumes. Higher volumes in the second half will drive improvements in the full year financial metrics. Percentage margin on sales, before acquisition costs, was up on first half 2008, as a result of a reduction in the proportion of large cases and the maintenance of Lombard's margin on other business. In addition, Lombard continues to work to improve the cash characteristics of its products. This is progressing as planned.

Funds under management are mostly euro-denominated. These increased from €13.0 billion at 31 December 2008 to €13.3 billion at 30 June 2009. In Sterling terms these have decreased due to strengthening of Sterling against the Euro. 

Lombard remains a business with considerable prospects and with a capable, motivated management team in place. Large case prospects are stronger than at the same stage last year.

AmLife

AmLife is the Malaysian insurance joint venture that Friends Provident entered into in December 2008 with AmBank Berhad, the major Malaysian banking group. This business has performed well over the first half while developing its range of unit-linked products. Friends Provident's 30% share equates to an estimated £5 million of EEV operating profit, including an estimated £2 million contribution from new business from £3 million of APE.

IFA businesses

Table 11: IFA business results

	First half	First half
	2009	2008
	£m	£m
Sesame underlying profit	(1)	2
Pantheon Financial underlying profit	1	2

Economic conditions in the UK have reduced revenues year-on-year for both Sesame and Pantheon. In each case, careful management of operating costs has offset the impact on underlying profit. However, we expect the full year underlying profit for Sesame to be below the £10 million reported in 2008, which benefited from a number of one-off items.

Sesame announced in June 2009 that it is in discussions with Skandia UK to acquire Bankhall and Premier Mortgage Services, two major UK distribution businesses. This combination would result in a 3,000-strong appointed representative network, a service business supporting over 1,500 firms, and a mortgage distributor that generated over £45 billion of applications in 2008. This transaction is not expected to require any additional funding from the Group to Sesame.

Asset Management

Table 12: Asset Management results

	First half	First half
	2009	2008
	£m	£m
Net revenue	105	118
Operating expenses	(86)	(89)
Other	(10)	(2)
Asset Management underlying profit before tax	9	27
Operating margin	18.1%	25.4%
Assets under management	£88bn	£99bn*

* as at 31 December 2008

Assets under management reduced in the first half due to £(4.3) billion of net fund flows combined with the influence of Sterling strengthening against the Euro. Net revenues were significantly affected by weakness in equity markets, which recovered in the second quarter but the average FTSE100 level for the first half was 30% below first half 2008. Operating expenses reduced as a result of F&C's own cost savings programme, although by less than the reduction in revenues. The operating margin was therefore lower than in first half 2008.

Other expenses are primarily financing costs on debt, net of income from shareholder-owned invested cash. The net difference increased year-on-year as the returns available on these investments have fallen and additional loan notes were issued related to the acquisition of F&C REIT.

Friends Provident Group plc distributed its shares in F&C Asset Management plc to shareholders on 3 July 2009.

  Financial Review

This review is structured in the following sections: Cash and capital generation, IFRS Profitability, Financial Strength, EEV Profitability, Embedded Value and Risk Management.

In the Financial Review published as part of the Interim management report and results for the half-year ended 30 June 2008, three businesses, F&C Asset Management plc (F&C), Lombard and Pantheon Financial (Pantheon), were identified as non-core and shown separately. Since that date it has been decided to retain and develop Lombard and Pantheon. Whilst the investment in F&C was de-merged on 3 July 2009, its results are included as continuing operations for the first half of 2009 as required by accounting standards. For the purposes of this report, all three businesses are included in the review of the Group's financial results. CASH AND CAPITAL GENERATION

Shareholder cash and capital generation is the cash and capital generated by the business during the year that is available to meet dividends and cover capital requirements. This is calculated on the regulatory basis and includes tax, realised and unrealised investment movements and one-offs.

Table 13: Summary of Shareholder cash and capital generation 

		Half year ended
		30 June	30 June
		2009	2008
		£m	£m
New business strain		(134)	(179)
In-force surplus		169	160
Life and pensions gross cash generation		35	(19)
Tax and other items		(12)	29
Life and Pensions net cash operating result		23	10
Investment return and other items		(9)	(26)
One-off items		(21)	(35)
Shareholder cash and capital generation before
	credit spread effects	(7)	(51)
Effect of credit spreads on assets and
	liabilities for annuities	-	(70)
Shareholder cash and capital outflow		(7)	(121)

Shareholder cash and capital outflow was £(7)m compared to £(121)m in 2008. This improvement arises from an increased Life and Pensions net cash operating result of £23m (2008: £10m) together with less adverse investment return and other items and lower one-off items. There was no repeat of the adverse £70m net impact of credit spreads on assets and liabilities for annuities seen in 2008. 

Table 14: Life and Pensions gross cash generation

	Half year ended			Half year ended
	30 June 2009			30 June 2008
	New			New
	business	In-force		business	In-force
	strain	surplus	Total	strain	surplus	Total
	£m	£m	£m	£m	£m	£m
Protection	(22)	22	-	(21)	28	7
Pensions	(44)	22	(22)	(58)	17	(41)
Annuities	5	1	6	(1)	1	-
Investments	(2)	6	4	(7)	1	(6)
With Profits Fund	-	31	31	-	34	34
UK Total	(63)	82	19	(87)	81	(6)
FPI	(46)	60	14	(69)	51	(18)
Lombard	(25)	27	2	(23)	28	5
Intl Total	(71)	87	16	(92)	79	(13)
Total	(134)	169	35	(179)	160	(19)

Cash new business strain mainly consists of acquisition expenses, commissions paid, and reserves established on a prudent basis in respect of the business written. The cash in-force surplus takes account of annual management charges received less maintenance expenses incurred together with other items. All figures are stated before tax and one-off items. Further detail is provided in Appendix 3.

Total cash new business strain is £(134)m compared to £(179)m last year. The UK strain has fallen by 28% as a result of the lower sales, commissions and acquisition expenses following implementation of the new strategy. International strain has fallen by 23% mainly as a result of lower sales from FPI. 

Total cash in-force surplus has increased from £160m to £169m driven by a rise in International in-force surplus of £8m as a result of annual management charges on higher funds under management in Sterling terms.

Table 15: Life and Pensions net cash operating result

	Half year ended			Half year ended
	30 June 2009			30 June 2008
	UK	Intl	Total	UK	Intl	Total
	£m	£m	£m	£m	£m	£m
New business strain	(63)	(71)	(134)	(87)	(92)	(179)
In-force surplus	82	87	169	81	79	160
Tax and other items	5	(17)	(12)	32	(3)	29
Total	24	(1)	23	26	(16)	10

The Life and Pensions net cash operating result was £13m higher than in 2008 at £23m. This increase was driven by £24m lower new business strain in the UK as a result of lower volumes, lower expenses and exiting high strain product lines, £21m lower International new business strain as a result of lower sales volume and £8m higher International in force surplus from the Premier business written in late 2007 and early 2008, offset by £41m lower tax and other items.

ProtectionUK Protection sales are 19% down measured on the APE basis. New business strain has not fallen, as reductions in commission and expenses have been offset by lower negative reserves also due to reduced new business volume. In-force surplus has fallen from £28m to £22m partly as a result of reduced persistency and partly as a one-off item within the 2008 result has not recurred.

PensionsPension sales have decreased by 43%, resulting in a £14m reduction in new business strain. Commission payments have fallen, with a 46% decrease from £27m to £15m, showing the effects of implementing our strategy and lower incremental business volumes. In force surplus rose by 29% as a result of a number of small items, despite broadly flat asset values. 

AnnuitiesAnnuity sales were comparable to 2008. Cash generation at point of sale was £5m, reversing a strain of £1m in 2008, as pricing margins improved relative to the reserving basis. In-force surplus was unchanged at £1m.

InvestmentsAdopting a more selective approach to writing new investment business has resulted in a fall in new business to £1m (2008: £6m) and consequently a substantially lower new business strain. In-force surplus has risen to £6m, as falls in investment markets impacted liabilities less adversely. 

With ProfitsThe reduction in the surplus generated by the With Profits Fund from £34m to £31m reflects a combination of the decline in the book and lower investment markets. Within this surplus the shareholders' one-ninth share of cost of bonus is £3m.

FPIFPI sales have reduced by 31% with the percentage fall in the new business strain being largely consistent with the fall in volume but slightly affected by lower single premium business. In-force surplus has increased from £51m to £60m, largely due to the increased volume of regular premiums from the Premier product, which was sold in large volumes in late 2007 and the first half of 2008, and exchange rate movements. LombardLombard sales fell by 33% but new business strain rose slightly as expenses were not reduced commensurately. The in-force surplus is largely unchanged.

Table 16: Tax and other items

	Half year ended			Half year ended
	30 June 2009			30 June 2008
	UK	Intl	Total	UK	Intl	Total
	£m	£m	£m	£m	£m	£m
Tax	9	-	9	35	4	39
Other items	(4)	(17)	(21)	(3)	(7)	(10)
Total	5	(17)	(12)	32	(3)	29

The tax credit of £9m (2008: £35m) is lower in 2009 as there were fewer investment gains in the unit-linked and with profit funds against which expenses can be relieved. International other items are mainly one-off of which the largest part relates to a reassessment of actuarial reserves.

Investment return and other items

Investment return and other items £(9)m (2008: £(26)m) comprises investment return on shareholder assets, net of interest charges on Group borrowings including STICS and lower tier 2 debt, of £(28)m (2008: £(32)m) and dividends received from F&C of £10m (2008: £10m) together with a number of smaller items.

One-off items

One-off items of £(21)m (2008: £(35)m) include the cost of the group reorganisation and demerger of our stake in F&C £(14)m and strategic review implementation costs of £(48)m in respect of the cost reduction programme, less release of the provision of £42m established for these at the end of 2008. In 2008 this item included £(15)m in respect of strategic review implementation costs and a one-off contribution to the Friends Provident Pension Scheme of £(20)m.

Credit default allowances in annuity liabilities

Within our portfolio, bond spreads above gilt yields as at the end of June 2009 were largely unchanged from end 2008 at approximately 450 basis points, the effect of spread narrowing within ratings bands having been offset by the effects of ratings migration. Our corporate bond portfolio remains highly rated with over 96% at investment grade.

Statutory reserving rules allow the recognition of an illiquidity premium in the discount rate used to value the annuity liabilities. As at the end of 2008, we included half of the spread above risk-free rates, up to a maximum of 250 basis points on a stock by stock basis, as an illiquidity premium, and this approach remains unchanged. This is a very prudent assumption, one of the most prudent assumptions in a range used by life assurers. 

As both spreads and the allowance for illiquidity are unchanged, a charge of £nil (2008: £70m) is recognised in the shareholder cash result.

At 30 June 2009 there is an allowance in liabilities for future credit defaults on corporate bonds of approximately £0.5bn on an investment portfolio of around £2.7bn, which includes £0.6bn of government backed securities. The shareholders' interest in this allowance is around 70%. As the bonds backing the annuities are generally expected to be held to maturity, the default allowance will be released as profit and shareholder cash flow over time, to the extent that defaults do not arise.

At a portfolio level, the statutory reserving basis is approximately equivalent to taking 30% of the spread above risk-free rates as an illiquidity premium. As a sensitivity, if we changed the recognised illiquidity premium to 70% of the spread above risk-free rates then the improvement in shareholder cash and capital and in IFRS profits would be £140m.

Movement in shareholder cash and capital resources

Shareholder cash and capital resources, and their movement, have been stated below excluding the mark to market of corporate debt. In disclosures as at 31 December 2007 and 31 December 2008 the mark to market had been included. The adjustment to exclude the mark to market of corporate debt from these opening balances amounted to £48m at 31 December 2007 and £254m at 31 December 2008.

Table 17: Movement in shareholder cash and capital resources

		Half year ended
		30 June	30 June
		2009	2008
		£m	£m
Shareholder cash and capital outflow		(7)	(121)
Dividends paid in the period		-	(123)
Cash and capital outflow after dividends		(7)	(244)
Capital items:
	Financial reinsurance	(3)	(2)
	Gain on exchange of STICS for Subordinated Debt	113	-
	Other finance items	1	3
Total movement		104	(243)

An interim dividend of 2.6 pence per Friends Provident Group plc share was paid on 24 July 2009 in lieu of the previously contemplated final 2008 dividend of 2.6 pence per Friends Provident plc share. A gain of £113m (net of expenses and tax) was realised on exchange of £322m of STICS for £162m of new subordinated debt.

Shareholder cash and capital resources rose by £104m from £897m to £1,001m,as set out below.

Table 18: Shareholder cash and capital resources 

		30 June	31 Dec
		2009	2008
		£m	£m
Shareholder invested net assets		1,159	1,181
Securitisation funding		71	71
Financial reinsurance funding		6	9
IFA subsidiaries - intangible assets		(46)	(48)
Mark to market of corporate debt (included in
	Shareholder invested net assets)	(169)	(254)
Regulatory reserves not included
	in Shareholder invested net assets	(20)	(62)
Shareholder cash and capital resources		1,001	897

The regulatory reserves of £(20)m (2008: £(62)m) include an allowance for future strategic review implementation costs of £nil (2008: £(42)m) together with a prudential margin of £(20)m (2008: £(20)m) in future unit cost assumptions.

IFRS PROFITABILITY

Our financial results are presented on two reporting bases: International Financial Reporting Standards (IFRS) as adopted by the EU and European Embedded Value (EEV). IFRS is the primary accounting basis. It includes the cash surplus earned during the period but differs from the EEV basis in that, with one exception, it does not recognise future cash flows in profit. The exception is that negative reserves on certain product lines are permitted.

Table 19: Summary of IFRS results

		Half year ended
		30 June	30 June
		2009	2008
		£m	£m
New business strain		(79)	(91)
In-force surplus		117	124
Investment return and other items		(6)	21
Asset Management		9	27
Corporate and other items		(3)	2
IFRS underlying profit before credit spread effects		38	83
Effect of credit spreads on assets
	and liabilities for annuities	-	(70)
IFRS underlying profit before tax		38	13
Non-underlying items		(140)	(234)
IFRS loss before tax from continuing operations		(102)	(221)
IFRS underlying profit per share		0.3p	1.2p
IFRS basic loss per share		(4.2)p	(2.6)p
Interim dividend per share		1.30p	1.30p
Dividend cover on an underlying basis		0.2 times	0.6 times
IFRS net assets excluding goodwill per share		75p	77p*

 

* 31 December 2008

IFRS underlying profit before tax has increased from £13m to £38m. Within this the net effect of new business strain and in-force surplus improved from £33m to £38m. Investment return and other items including interest charges on Group borrowings was £(6)m (2008: £21m) and the increase in allowances for credit spreads was £nil (2008: £(70)m).

The IFRS loss before tax from continuing operations fell from £(221)m to £(102)m. In addition to the underlying result, the main charges contributing to the loss are short term fluctuations in investment return £(44)m mainly arising on shareholder assets not backing policyholder liabilities, non-recurring items £(59)m, amortisation £(45)m together with the total of IFRS adjustments for STICS interest, policyholder tax and the loss attributable to minority interests in the F&C Commercial Property Trust of £8m.

IFRS underlying profit per share is 0.3p (2008: 1.2p) and IFRS basic loss per share is (4.2)p (2008: (2.6)p).

The interim dividend for 2009 is unchanged at 1.30p and is in line with our dividend policy. The dividend cover on an underlying basis is 0.2 times.  IFRS net assets excluding goodwill per share were 75p (31 December 2008: 77p). On a pro forma basis excluding F&C, IFRS net assets excluding goodwill per share were 77p.

Table 20: Underlying profit by segment 

		Half year ended			Half year ended
		30 June 2009			30 June 2008
		UK	Intl	Total	UK	Intl	Total
		£m	£m	£m	£m	£m	£m
New business strain		(49)	(30)	(79)	(63)	(28)	(91)
In-force surplus		73	44	117	82	42	124
Investment return and
	other income	12	(18)	(6)	25	(4)	21
Life and pensions
	underlying profit
	before credit
	spread effects	36	(4)	32	44	10	54
Effects of credit spreads on
	assets and liabilities
	for annuities	-	-	-	(70)	-	(70)
Life and pensions
	underlying profit/(loss)	36	(4)	32	(26)	10	(16)
Asset Management				9			27
Corporate and other items				(3)			2
IFRS underlying profit
	before tax			38			13

The UK underlying profit before credit spreads effects was £36m (2008: £44m). Within this, the net impact of new business strain and in-force surplus improved by £5m to £24m. Investment return fell to £12m reflecting lower expected returns on lower opening assets. There was no repeat of the net charge in respect of credit spreads seen in 2008.

The International underlying loss was £(4)m (2008: profit £10m). Recurring profit was unchanged at £14m, however this was offset by one-off items of £(18)m of which the largest item was a reassessment of actuarial reserves in respect of unit-linked policies.

Asset Management reflects lower F&C underlying profit in 2009, which is discussed in the Business Review section.

Table 21: Profitability by product

	Half year ended			Half year ended
	30 June 2009			30 June 2008
	New	In-	Profit/	New	In-	Profit/
	business	force	(loss)	business	force	(loss)
	£m	£m	£m	£m	£m	£m
Protection	(22)	22	-	(21)	28	7
Pensions	(30)	15	(15)	(35)	9	(26)
Annuities	5	1	6	(1)	1	-
Investments	(2)	4	2	(6)	10	4
With Profits Fund	-	31	31	-	34	34
UK Total	(49)	73	24	(63)	82	19
FPI	(11)	17	6	(11)	16	5
Lombard	(19)	27	8	(17)	26	9
International Total	(30)	44	14	(28)	42	14
Total	(79)	117	38	(91)	124	33

All figures are stated before tax and one-off items. More detailed analyses of new business strain and in-force surplus are provided below and in Appendix 3.

The IFRS new business strain is £(79)m compared to £(91)m last year. The UK IFRS strain has fallen by 22% as lower acquisition expenses and commissions were incurred on lower sales. International IFRS new business strain has increased by £2m despite much lower sales as expenses have increased.

The IFRS in-force surplus has reduced from £124m to £117m. UK IFRS in-force surplus has reduced by £9m mainly as a result of slower new business growth and lower asset values. International IFRS in-force surplus is £44m up 5% from £42m in 2008.

New business strain

New business strain consists of three elements: 

	the cash strain arising during the year;
	IFRS adjustments, reflecting the difference between regulatory and IFRS reserving bases; and
	an allowance for the deferral of acquisition costs (DAC), to the extent it is allowed by IFRS.

Table 22: New business strain

	Half year ended 30 June 2009				Half year ended 30 June 2008
		IFRS	DAC			IFRS	DAC
	Cash	adjust-	move-	IFRS	Cash	adjust-	move-	IFRS
	Strain	ments	ment	strain	strain	ments	ment	strain
	£m	£m	£m	£m	£m	£m	£m	£m
Protection	(22)	-	-	(22)	(21)	-	-	(21)
Pensions	(44)	2	12	(30)	(58)	(2)	25	(35)
Annuities	5	-	-	5	(1)	-	-	(1)
Investments	(2)	(1)	1	(2)	(7)	(4)	5	(6)
UK Total	(63)	1	13	(49)	(87)	(6)	30	(63)
FPI	(46)	(31)	66	(11)	(69)	(48)	106	(11)
Lombard	(25)	(2)	8	(19)	(23)	(3)	9	(17)
Intl Total	(71)	(33)	74	(30)	(92)	(51)	115	(28)
Total	(134)	(32)	87	(79)	(179)	(57)	145	(91)

The cash strain is discussed in the Cash and capital generation section above. 

The UK IFRS adjustments have changed from £(6)m to £1m because of the lower UK investments and commission-paying pensions sales. The UK DAC movement has decreased from £30m to £13m for the same reasons. We have maintained our policy of not taking credit for DAC on protection business, which errs on the conservative side.

The International IFRS adjustments £(33)m and DAC movement £74m have the effect of adjusting the cash strain so that the IFRS new business strain is broadly equal to acquisition expenses which increased over the period. The movement in these items since 2008 reflects changes in the volume and mix of sales. 

In-force surplus 

In-force surplus consists of three elements: 

	the cash surplus arising during the year;
	the amortisation of IFRS adjustments; and
	the amortisation of DAC.

Table 23: In-force surplus

	Half year ended 30 June 2009				Half year ended 30 June 2008
		IFRS	DAC			IFRS	DAC
	Cash	adjust-	move-	IFRS	Cash	adjust-	move-	IFRS
	Surplus	ments	ment	surplus	surplus	ments	ment	surplus
	£m	£m	£m	£m	£m	£m	£m	£m
Protection	22	-	-	22	28	-	-	28
Pensions	22	4	(11)	15	17	2	(10)	9
Annuities	1	-	-	1	1	-	-	1
Investments	6	9	(11)	4	1	20	(11)	10
With Profits Fund	31	-	-	31	34	-	-	34
UK Total	82	13	(22)	73	81	22	(21)	82
FPI	60	(12)	(31)	17	51	(25)	(10)	16
Lombard	27	8	(8)	27	28	5	(7)	26
Intl Total	87	(4)	(39)	44	79	(20)	(17)	42
Total	169	9	(61)	117	160	2	(38)	124

The cash surplus is discussed in the Cash and capital generation section above. 

The UK IFRS adjustments have decreased from £22m to £13m, with most of the decrease in respect of investment products. As explained above, falls in investment markets impacted liabilities less adversely than in 2008 for investment products and as these liabilities are reversed out in arriving at IFRS profits there is a corresponding item within the 2008 IFRS adjustments. The UK DAC movement is in line with 2008. 

The International IFRS adjustments and DAC movements reflect changes in the amount and composition of the business and of levels of funds under management. For FPI the dominant factor is the emergence as cash surplus of front-end fees on the large volumes of Premier products sold in late 2007 and early 2008 and its impact on IFRS adjustments and DAC amortisation. DAC amortisation has been further accelerated as a result of an increased propensity to make Premier plans paid up or to reduce premiums. 

Table 24: Investment return and other items

		Half year ended			Half year ended
		30 June 2009			30 June 2008
		UK	Intl	Total	UK	Intl	Total
		£m	£m	£m	£m	£m	£m
Longer-term return on life and
	pensions shareholder funds	13	(1)	12	22	-	22
One-off items		(1)	(17)	(18)	3	(4)	(1)
Total		12	(18)	(6)	25	(4)	21

UK longer-term investment return has reduced from £22m to £13m because of a 35% decrease in the weighted average value of UK life and pensions shareholder assets during the year from £975m for 2008 to £633m and because of generally lower expected rates of return. The longer-term rates of investment return are assumed to be: equities 6.7% p.a. (2008, 8.0% p.a.), gilts 3.7% p.a. (2008, 5.0% p.a.) and other fixed interest 6.7% p.a. (2008, 5.5% p.a.).

The major item within one-off items relates to a reassessment of actuarial reserves.

Table 25: Asset Management, corporate and other items

	Half year ended
	30 June	30 June
	2009	2008
	£m	£m
Asset Management underlying profit	9	27
Expected return on net pension asset	4	2
Expected return on corporate net assets	(1)	4
Corporate costs	(6)	(8)
IFA businesses /AmLife	-	4
Total	6	29

Asset Management underlying profit is discussed in the Business Review section. The increase in the expected return on the net pension asset reflects an increase in the opening surplus as reported under IAS19. The expected return on corporate net assets has decreased because of lower invested assets.

The trading results of our IFA businesses and of AmLife Berhad are discussed in the Business Review section.

Effect of credit spreads on assets and liabilities for annuities

There has been no repeat of the charge of £(70)m for credit spreads seen in 2008. This is discussed in the Cash Generation section.

Table 26: Non-underlying items

	Half year ended
	30 June	30 June
	2009	2008
	£m	£m
Short-term fluctuations in investment return	(44)	(68)
Non-recurring items	(59)	(17)
Amortisation of acquired present value of in-force business	(12)	(13)
Amortisation of Life & Pensions acquired intangible assets	(8)	(7)
Amortisation of Asset Management acquired intangible assets	(25)	(22)
Interest payable on STICS	24	26
Policyholder tax	14	(81)
Returns on Group-controlled funds attributable to third parties	(30)	(52)
Total	(140)	(234)

Non-underlying items reflect the differences between IFRS underlying profit and IFRS profit before tax from continuing operations.

Short-term investment fluctuations of £(44)m (2008: £(68)m) represent the differences between actual and expected longer-term investment returns. 

Non-recurring items include: strategic review implementation costs of £48m (2008, £15m) related to the cost reduction programme and costs of the group reorganisation and demerger of F&C of £14m.

Within the calculation of the underlying IFRS result, STICS are accounted for as debt to reflect the economic reality. However, IFRS rules require that STICS should be accounted for as equity in calculating IFRS profit before tax and consequently STICS interest is added back and treated as an appropriation of profit. The lower overall STICS interest results from the reduced principal outstanding following the debt restructuring. The lower tier 2 debt that in part replaced these securities is charged as a finance cost in underlying profit. The overall impact of the debt restructuring will be to modestly reduce the amount of annual interest payable.

Policyholder tax is excluded from the underlying result as it is not attributable to shareholders. The credit of £14m in 2009 is tax on policyholder income. In 2008 the charge of £81m is in respect of a reduction in deferred tax as a result of investment losses. 

Returns on Group controlled funds attributable to third parties mainly comprise the 49% minority interest in F&C Commercial Property Trust and reflect falls in underlying property values. The loss attributable to minority interests is excluded from the underlying result and is therefore added back to arrive at profit before tax.

FINANCIAL STRENGTH

Despite continued volatility in the investment markets during 2009, our business remains financially strong. We continue to meet all our capital requirements. These include the group-wide Insurance Groups Directive capital requirements, the realistic solvency requirement for our with profits business, the regulatory solvency basis for all life companies and our internal economic capital requirements. 

Table 27: Insurance Groups Directive (IGD) surplus resources

	30 June 2009	31 Dec 2008
	£bn	£bn
Total Group resources for IGD calculation	2.10	1.95
Group resource requirement	(1.35)	(1.10)
IGD surplus	0.75	0.85
Resource requirement coverage	1.6 times	1.7 times

Our capital position is strong with an estimated IGD surplus of £0.75bn (31 December 2008: £0.85bn), reflecting capital resources of £2.10bn less requirements of £1.35bn. The IGD surplus measure is conservative, excluding £0.4bn of surplus assets held within the long-term funds.

After allowing for the demerger of F&C and payment of the Friends Provident Group plc interim dividend (in lieu of the Friends Provident plc final 2008 dividend) the IGD surplus was estimated to be £0.9bn at 31 July 2009.

We have maintained an active hedging strategy throughout 2009 to mitigate the impact of equity markets and interest rate movements on the capital position of our with profits business.

Table 28: IGD surplus

The movement in IGD surplus to 31 July 2009 can be analysed as follows:

	£bn
Surplus 31 December 2008	0.85
Payment of dividends and STICS interest	(0.1)
Net transfers to long-term funds	-
F&C demerger	0.2
Other items	(0.05)
Estimated surplus 31 July 2009	0.9

Other items include the investment return on shareholder assets.

IGD surplus sensitivities

The IGD surplus has no material sensitivity to a 30% fall in equity markets from 31 July 2009 levels, and would not be reduced by more than £0.1bn if bond spreads were to widen by a further 100 basis points. 

Economic capital

We continue to use economic capital to inform business decisions. We have developed a sophisticated capital model, which has helped with setting our financial risk appetite and our continued drive for capital efficiency. The model forms the basis for discussions with the FSA to agree the individual capital requirements for each company based on an assessment of its own risk profile.

EEV required capital is set at the higher of regulatory capital and requirements arising from internal capital management policies, which include economic risk capital objectives. In aggregate, EEV required capital is higher than regulatory requirements by approximately £400m (31 December 2008: £400m).

Table 29: Life and pensions excess capital resources

	30 June	31 Dec
	2009	2008
	£bn	£bn
Total available capital resources	1.9	2.0
Regulatory capital requirement	(0.7)	(0.8)
Excess capital resources	1.2	1.2

Total available capital resources are calculated on a realistic basis for the FPLP With Profits Fund and on a regulatory basis for all other funds. The excess capital resources stand at £1.2bn, including the excess capital resources within the long-term funds. The bulk of the Group's capital is held outside the with profits funds and, consequently, can be deployed around the Group with a relatively high degree of flexibility.

FPLP With Profits Fund solvency

We manage the FPLP with profits business on a realistic balance sheet basis. For solvency monitoring, the assets and liabilities are calculated both on a realistic basis and on a regulatory basis. If the realistic balance sheet has a lower surplus than the regulatory balance sheet, an additional capital requirement, the WPICC, is applied to the regulatory balance sheet. As at 30 June 2009 and 31 December 2008 the more onerous requirement has been the realistic basis. 

For the realistic basis, policyholder liabilities (including options and guarantees) are valued using a market-consistent stochastic model. The realistic balance sheet is resilient in the event of falls or rises in investment markets, in large measure due to the actions taken to hedge the exposure to guarantees and options.

On the realistic basis at 30 June 2009 there were surplus assets of £225m available to cover the risk capital margin of £225m (31 December 2008: £291m available to cover the risk capital margin of £291m). Our objective is to manage the fund so that, over time, the risk capital margin remains covered from assets within the With Profits Fund. In accordance with the Principles and Practices of Financial Management, in the event that surplus assets exceed the risk capital margin, this excess is used to reduce the charge for guarantees. Conversely if the surplus assets are less than the risk capital margin, the charge is increased.

Free asset ratio

The free asset ratio is a common measure of financial strength. It is the ratio of assets less liabilities (including actuarial reserves but before the capital requirements), expressed as a percentage of actuarial reserves. The FPLP free asset ratio was 17.0% at 30 June 2009 (31 December 2008: 14.7%) and available assets to meet capital requirements were £2.4bn (31 December 2008: £2.2bn). 

FPLP financial strength ratings

Current ratings are:

	Standard & Poor's: A- (strong) with a stable outlook
	Fitch's rating: A (strong) with a negative outlook
	Moody's rating: A3 (strong) with a stable outlook

We target our financial strength ratings in the single A range and expect them to remain there for the foreseeable future.

The three rating agencies recognise the strength of our capital position as a positive rating factor. In recent years, capital strength, one of several factors considered by the agencies, has been one of the strongest components of our overall financial strength ratings.

Solvency II

Solvency II is still at an early stage of consultation in terms of the calibration detail. We participated in the last calibration exercise in 2008 (QIS 4)which provided a good indication of the solvency position for the FP Group. We are, however, conscious that the debate on calibration is still evolving. We are following closely the consultations by CEIOPS on the proposed implementation measures. We welcome the approach of a risk based capital regime but are concerned that recent consultations from CEIOPS appear to be excessively prudent in some areas, notably reserving for annuities and limits on forms of capital. However, discussions are at an early stage on these issues and we are supportive of the work of the ABI in these debates. 

Liquidity

Our liquidity remains strong. We also have an undrawn £300m funding facility with a consortium of banks. This facility runs until April 2011 and provides the group with considerable flexibility. 

Financial risk reduction

We actively manage financial risk and have taken a number of initiatives to reduce our exposures.

FPLP With Profits Fund

The overall aim remains to balance risk to shareholders with maximising returns to policyholders whilst ensuring guarantees are met as they fall due. We have continued to manage the proportion of equities and property backing asset shares actively. At 30 June 2009 the effective proportion of equities and property in the fund was 20% (31 December 2008: 16%).

Other life and pensions funds

Other risk mitigation activities include cashflow matching and other inflation and interest rate hedging.

Pension schemes

 

Before the IFRIC 14 ('The limit on a defined benefit asset, minimum funding requirements, and their interaction') restriction on the carrying value of the IAS 19 surplus, the after tax surplus of the Friends Provident Pension Scheme (FPPS) was £2m (31 December 2008: surplus of £82m). The change in surplus mainly arose from changes in corporate bond spreads, as the liabilities are discounted based on AA rated corporate bond yields, as required by the accounting standard.

After the application of IFRIC 14, the carrying value of the pension scheme asset has been restricted to £nil (31 December 2008: £nil).

Following the triennial valuation of the FPPS in September 2008, the Scheme Trustees and Company have reached agreement in principle on an increase in funding of which an element is contingent on future investment returns.

Table 30: Financial assets

The Group's financial assets, excluding cash and property, are summarised as follows as at 30 June 2009:

		With			30 June	31 Dec
	Unit	Profit	Non-	Share-	2009	2008
	linked	Funds*	profit	holder	Total	Total
	£bn	£bn	£bn	£bn	£bn	£bn
Shares, unit trusts & OEICs	23.1	2.5	0.1	-	25.7	26.2
Gilts	1.9	3.4	0.7	0.1	6.1	6.7
Corporate bonds & ABS	2.8	4.2	2.6	0.4	10.0	10.3
Derivatives	-	0.3	-	-	0.3	0.6
Deposits	0.4	-	-	-	0.4	0.5
Total	28.2	10.4	3.4	0.5	42.5	44.3

*With Profit Funds includes the non-profit assets within the FPLP With Profits Fund of £2.2bn including £0.2bn gilts and £1.9bn corporate bonds and ABS.

Shares, unit trusts and OEICs comprise: unit trusts and OEICs £13.7bn, listed equity £10.7bn and unlisted equity £1.3bn. 

The equity exposure to the FPLP With Profits Fund is largely hedged with sold futures. The net exposure of the FPLP With Profits Fund to equity at 30 June 2009 was £0.9bn. The net exposure of the Fund to property was a further £0.6bn. 

Corporate bonds and ABS comprise: listed corporate bonds, £8.2bn, unlisted corporate bonds £0.4bn and Asset Backed Securities (ABS) £1.4bn. 

Table 31: Corporate bonds

Listed corporate bonds of £8.2bn are analysed by fund and credit rating as follows:

			With			30 June	31 Dec
		Unit	Profit	Non-	Share-	2009	2008
		linked	Funds	profit	holder	Total	Total
		£m	£m	£m	£m	£m	£m
AAA		131	1,005	193	50	1,379	1,319
AA		136	440	1,740	48	2,364	2,667
A		346	1,377	358	141	2,222	2,190
BBB		153	461	74	31	719	605
Sub-BBB or rating not
	available	*1,316	165	19	8	1,508	1,780
Total		2,082	3,448	2,384	278	8,192	8,561

* £1.0bn out of the £1.3bn corporate bonds in the unit linked 'Sub-BBB or rating not available' category represent Lombard investments where the ratings information is not retained. These are all unit-linked assets with no shareholder exposure.

Our corporate debt portfolio remains highly rated, with over 96% of £6.1 billion of corporate bonds (excluding unit-linked funds) at investment grade. 

The value of debt holdings in UK banks and building societies, including foreign-owned subsidiaries, was as follows:

	30 June	31 Dec
	2009	2008
	£m	£m
Senior and government backed	338	93
Lower tier 2	276	241
Tier 1 and Upper tier 2	288	429
	902	763

Over the period an additional £200m nominal value of UK Government guaranteed bank debt was purchased and some lower ranked debt has been tendered for more senior rated tranches.

Holdings within unit-linked funds are excluded from the above analysis because there is no direct shareholder exposure to asset price falls. More than 80% of the total debt holdings shown above are held within the with profit funds to back asset shares or non-profit liabilities. 

Asset Backed Securities (ABS)

Of the £1,382m total ABS, £1,245m is managed by F&C on behalf of the Group. The balance is represented by investments in ABS held by externally managed funds in which the shareholder has no exposure. The F&C managed ABS is analysed as follows:

Table 32: Type of ABS

		£m by ratings
Type of ABS		AAA	AA	A	BBB	BB	Sub B	Unrated	Total
Collateralised Debt
	Obligations (CDO)	-	-	10	-	-	-	7	17
Collateralised Loan
	Obligations (CLO)	2	-	-	-	-	-	-	2
Commercial Mortgage
	Backed Securities
	(CMBS)	185	71	44	36	-	-	-	336
Residential Mortgage
	Backed Securities
	(RMBS)	111	8	-	-	-	2	-	121
Monoline Wrapped		-	207	62	160	-	-	6	435
Other ABS		123	65	124	10	5	7	-	334
30 June 2009 Total		421	351	240	206	5	9	13	1,245
		34%	28%	19%	17%	0%	1%	1%	100%
31 December 2008 Total		524	323	386	62	4	7	14	1,320
		40%	24%	29%	5%	0%	1%	1%	100%

'Other ABS' in the tables above cover a variety of securities including credit card receivables, Structured Investment Vehicles, whole business securitisations, housing association and other asset backed securities.

Of the above ABS, the shareholder exposure amounts to £661m, including £361m of assets backing annuity liabilities. 

Analysis of exposure is as follows:

Table 33: ABS exposure

		£m by ratings
Exposure		AAA	AA	A	BBB	BB	Sub B	Unrated	Total
Shareholder exposure
	- 30 June 2009	231	189	121	105	-	5	10	661
	31 December 2008	269	162	171	20	-	2	11	635
With Profit Funds
	Exposure
	- 30 June 2009	171	143	90	76	5	2	1	488
	- 31 December 2008	227	136	171	31	4	4	1	574
Unit linked exposure
	- 30 June 2009	19	19	29	25	-	2	2	96
	- 31 December 2008	28	25	44	11	-	1	2	111
30 June 2009 Total		421	351	240	206	5	9	13	1,245
31 December 2008 Total		524	323	386	62	4	7	14	1,320

The above exposure analysis takes account of the profit sharing proportions of the funds. 

The movement of ABS in the period is analysed in the following table:

	£m
Value at 1 January 2009	1,320
Maturities and disposals	(47)
Impact of mark to market	(28)
Defaults	-
Value at 30 June 2009	1,245

ABS are valued using external pricing services. Almost all of the ABS portfolio is valued using active prices, generally from multiple pricing sources.

In addition to the Group's ABS exposure, the Friends Provident Pension Scheme has direct exposure to ABS of £60m and a further £87m via its investment in F&C Liability Driven Investment Pools. The ABS represent 23% of the investment pools and these are all AAA rated.

Defaults

Total corporate bond and ABS defaults during the period were £1m representing a default rate of less than 0.1% of the portfolio. The shareholder exposure was £0.1m.

EEV PROFITABILITY

European Embedded Value (EEV) is an alternative accounting basis to IFRS for life assurance companies. EEV profit reflects the future cashflows that are expected to arise from sales in the year and the effect of updating previous assumptions with actual experience.

In June 2008 the CFO Forum published its Market Consistent Embedded Value (MCEV) Principles that it is intended will replace the current EEV Principles. Following continued debate over the Principles, in particular the appropriate risk-free rate to apply to certain classes of business, the CFO Forum announced in April 2009 it was to delay the implementation of the MCEV Principles until 2011. In line with our 2008 reporting we have not adopted the revised Principles for these results. Once the CFO Forum has confirmed the Principles, we will re-assess whether to adopt them and when.

We continue to use a market-consistent approach and in particular use gilt returns to represent risk-free returns. 

There is much debate at present around the most appropriate discount rate to use to discount cashflows on business such as annuities. In current market conditions, with very wide spreads on corporate bonds, it is likely that some of this spread represents illiquidity risk rather than credit risk and therefore some companies have sought to modify the risk-free rate for their spread business in their EEV. For annuity business the impacts of using a risk-free rate above gilts have been provided for the values of new and in-force business.

Table 34: Summary of EEV results

	Half year ended
	30 June	30 June
	2009	2008
	£m	£m
Contribution from new business	30	67
In-force profit	83	108
Other life and pensions items	8	7
Asset Management	9	27
Corporate and other items	1	2
EEV underlying profit before tax	131	211
Non-underlying items	(222)	(216)
EEV loss before tax	(91)	(5)
Return on embedded value	5.9%	8.4%
EEV underlying earnings per share	3.7p	6.5p
EEV basic loss per share	(2.9)p	(1.0)p
Pro forma embedded value per share	124p	128p*

* 31 December 2008

EEV underlying profit has reduced from £211m to £131m. The main drivers for the reduced underlying profit are the reduced contribution from new business, reduced Asset Management profits, and reduced persistency on UK business. 

The EEV loss before tax is £91m (2008: £5m). This takes into account the impacts of investment return variances and economic assumption changes. These items totalled to a £222m charge in 2009 compared to a charge of £216m in 2008.

The return on embedded value, which is calculated on the underlying basis after tax, has reduced from 8.4% to 5.9%. The UK return reduced from 7.1% to 5.0% and the International return reduced from 14.4% to 8.5%.

The EEV underlying earnings per share reduced from 6.5p to 3.7p and the EEV basic loss per share was 2.9p (2008: 1.0p)

Table 35: Underlying profit by segment

		Half year ended
		30 June
		2009			2008
		UK	Intl	Total	UK	Intl	Total
		£m	£m	£m	£m	£m	£m
Contribution from new business		3	27	30	27	40	67
In-force profit		62	21	83	80	28	108
Other life and pensions items		12	(4)	8	14	(7)	7
Life and pensions underlying profit		77	44	121	121	61	182
Asset Management, corporate
	and other items			10			29
EEV underlying profit before tax				131			211

The UK underlying profit has reduced from £121m to £77m, because of the lower contribution from new business and worsening persistency on group pensions, single premium bonds and protection business. In addition the expected return on shareholder net assets has fallen due to lower invested assets in 2009 compared with 2008.

The International underlying profit has reduced from £61m to £44m mainly due to a reduced contribution from new business, partially offset by lower development expenses.

Contribution from new business

The UK contribution from new business decreased from £27m to £3m, and the International contribution has decreased from £40m to £27m. This is discussed in the Business Review section.

The pro forma impact of using risk-free rates of 100 basis points above gilts for annuity business is shown in the table below. 

Table 36: Contribution from new business 

		Half year
		ended
		30 June
		2009
		100 bps
		£m
UK Contribution from new business as reported		3
Impact of additional spread above gilts		12
UK Contribution from new business with additional
	spreads above gilts	15
International contribution from new business		27
Contribution from new business with additional
	spread above gilts	42

Table 37: In-force profit

	Half year ended
	30 June 2009			30 June 2008
	UK	Intl	Total	UK	Intl	Total
	£m	£m	£m	£m	£m	£m
Expected return on in-force	87	27	114	73	26	99
Experience variances	(25)	(6)	(31)	7	2	9
Total	62	21	83	80	28	108

The expected return on the UK in-force book has increased from £73m to £87m reflecting the wider credit spreads on corporate bonds backing annuity business. The expected return on the International in-force book has slightly increased to £27m with the growth in the in-force business in 2008 offset by adverse investment and exchange rate movements.

Within the UK experience variance the main item is a charge of £19m for reduced persistency over the first half of 2009 in respect of reduced contributions received on individual and group pensions and increased lapses on protection and investment business. Some of the losses on the group pensions book are due to the withdrawal from the unfunded commission part of the group pensions market. This has led to some of the business being rebroked to companies who still pay initial commission. There is also a recessionary impact as premiums reduce or cease on group pensions plans and customers cancel policies due to affordability concerns. Both these impacts are expected to be short-term. The balance of £6m includes a number of items, largely one-off in nature, including some repricing activity on schemes following corporate restructuring.

International experience variances include small adverse persistency experience within both Lombard and FPI. 

Operating assumption changes

We have not sought to anticipate in these results the potential effect of a continued recession on future profits from the in-force business. To give an indication of the sensitivity, the value of in-force business would reduce by approximately £80m (equivalent to approximately £110m pre-tax EEV profit) if the persistency and morbidity experience were to deteriorate by approximately 25% over the average assumption for the next two years as a result of the economic downturn for life protection, income protection, unit-linked bonds, pensions (group and legacy) and International business.

Table 38: Other life and pensions items

		Half year ended
		30 June 2009			30 June 2008
		UK	Intl	Total	UK	Intl	Total
		£m	£m	£m	£m	£m	£m
Expected return on shareholder
	net assets	13	(1)	12	21	-	21
Development costs		(1)	(3)	(4)	-	(7)	(7)
Other income		-	-	-	(7)	-	(7)
Total		12	(4)	8	14	(7)	7

The UK expected return fell from £21m to £13m because of a decrease in the weighted average value of UK life and pensions shareholder assets during the year from £975m for 2008 to £633m. 

As indicated in 2008, development costs now only include costs relating to developing wholly new products or entering wholly new markets.

Other income in 2008 included a charge of £(5)m relating to the Wrap project.

Table 39: Asset Management, corporate and other items 

	Half year ended
	30 June	30 June
	2009	2008
	£m	£m
Asset Management underlying profit	9	27
Expected return on net pension asset	4	2
Expected return on corporate net assets	(1)	4
Corporate costs	(6)	(8)
Other income	4	4
Total	10	29

Asset Management underlying profit is discussed in the Business Review section. The increase in the expected return on the net pension asset reflects an increase in the opening surplus as reported under IAS19. The expected return on corporate net assets has decreased because of lower invested assets.

Other income includes AmLife £5m (2008: £nil), Sesame £(1)m (2008: £2m) and Pantheon £1m (2008: £2m) which are discussed in the Business Review section. 

Table 40: Non-underlying items

	Half year ended
	30 June	30 June
	2009	2008
	£m	£m
Investment return variances	(102)	(289)
Effect of economic assumption changes	(34)	115
Non-recurring items	(59)	(17)
Amortisation of Asset Management acquired intangibles	(25)	(22)
Amortisation of Sesame / Pantheon acquired intangibles	(2)	(3)
Total	(222)	(216)

Investment return variances of £(102)m include the investment variances on life and pensions assets of £(139)m. The life and pensions investment variances comprise £(90)m of UK variances and £(49)m of International variances, and derive from equity market movements, interest rate changes, credit spreads and exchange rate movements.

The effect of economic assumption changes of £(34)m comprises £(27)m UK changes, and £(7)m of International changes.

Non-recurring items include: strategic review implementation costs of £48m (2008, £15m) related to the cost reduction programme and costs of the group reorganisation and demerger of F&C of £14m.

EMBEDDED VALUE

The embedded value has reduced by 2.4% from £2,965m to £2,894m. It comprises:

Table 41: Total embedded value 

	30 June	31 Dec
	2009	2008
	£m	£m
Shareholders’ invested net assets	1,159	1,181
Value of in-force life and pensions business	1,652	1,731
Market value of the listed asset management business	180	150
Provision for future corporate costs	(97)	(97)
Net pension scheme asset	-	-
Total embedded value	2,894	2,965

The pro forma embedded value per share is 124p (31 December 2008: 128p).

Table 42: Shareholders' invested net assets

Shareholders' invested net assets have decreased by £22m over the year and comprise:

	30 June	31 Dec
	2009	2008
	£m	£m
Life and pensions shareholder funds	96	113
Life and pensions long-term funds	478	496
Total life and pensions net assets	574	609
Corporate net assets	585	572
Shareholders’ invested net assets	1,159	1,181

Life and pensions shareholder funds have decreased reflecting unrealised investment losses. Life and pensions long-term funds have decreased reflecting the negative life surplus in the period.

Corporate net assets have increased mainly because of the £13m impact of marking to market the STICS, partly offset by unrealised investment losses.

Value of in-force life and pensions business 

The reduction in the period is mainly due to investment market movements.

The impact of using risk-free rates of 100 basis points above gilts would be to increase the value of in-force annuity business by £159m. 

Table 43: Market value of the listed Asset Management business 

	30 June	31 Dec
	2009	2008
Share price of F&C	70p	58p
Number of shares held	259m	259m
Percentage of shares held	52.3%	52.5%
Market value of holding in F&C	£180m	£150m

Provision for future corporate costs

Regular on-going corporate costs of £12m p.a. (31 December 2008: £12m p.a.) are capitalised and deducted from the embedded value.

Net pension asset

As explained in the Financial Strength section, the surplus in the Friends Provident Pension Scheme has again been restricted to £nil value at 30 June 2009. 

EEV tax assets and taxation of foreign profits

The Finance Act 2009 was enacted on 21 July 2009 and this changed the UK taxation basis of foreign profits remitted to the UK. As a consequence of this change we would consider releasing the provision in the EEV in respect of tax on the International Business profits at the end of 2009. This, however, is subject to potential changes emerging from the Controlled Foreign Companies Consultation by HM Treasury. In addition, we will review the value of tax assets in the EEV at year end, in light of market conditions and expected future levels of life business investment income in the UK. The outcome of that review is uncertain and, therefore, there is a possibility of a reduction in the current EEV deferred tax values at the end of 2009. Consequently, we have not reflected any adjustments to the current value of tax assets in the first half of 2009.

RISK MANAGEMENT

The reporting requirements for listed companies require us to comment on the risks and uncertainties that could affect results in the second half of 2009. The Board believes that the principal risks and uncertainties facing the Group are those that were explained in the Annual Report & Accounts for 2008 (pages 30-31) and is satisfied that there are appropriate arrangements in place to manage and mitigate them. The following are the key risks during the second half of 2009.

Consolidation activity in the insurance sector

We see advantages in consolidation within the UK life industry that allows life companies to achieve the scale necessary for margins to rise and payback periods to fall to levels that provide greater returns for shareholders. Consolidation could also enhance returns to shareholders through operational and financial efficiencies and improved cash flows. The Board has an effective strategy in place for responding to potential consolidation activity. 

Implementation of the revised strategy

Implementation of the revised strategy announced in January 2008 has entailed making changes to the organisation's structure and business processes as well as to some of the products offered to the market. These changes are now largely complete. The second half of 2009 will see the more recent changes becoming bedded in, with new operational processes in place, in particular in the relationship with our recently demerged fund manager, F&C Asset Management plc.

Changes or volatility in UK and global economic factors

The economic outlook remains challenging, despite some early signs of a possible improvement, particularly in relation to credit default risk and spreads and to the UK housing market. There remains a risk that a prolonged downturn will reduce the Group's income. Although we cannot control the external environment, the Board monitors the situation closely and will continue to adapt the Group's approach to the market as required.

Statement of directors' responsibilities

The directors confirm that the condensed consolidated IFRS interim financial information has been prepared in accordance with IAS 34, Interim financial reporting, as adopted by the European Union and that the interim management report includes a fair review of the information required by 4.2.7 and 4.2.8 of the Disclosure and Transparency Rules, namely:

	an indication of important events that have occurred during the first six months and their impact on the condensed set of financial statements, and a description of the principal risks and uncertainties for the remaining six months of the financial year; and
	related party transactions that have taken place in the first six months of the current financial year and that have materially affected the financial position or performance of the entity during that period; and any changes in related party transactions described in the last annual report that could do so.

By order of the Board

Trevor Matthews	Evelyn Bourke
Chief Executive Officer	Chief Financial Officer

10 August 2009

Independent review report by KPMG Audit Plc to Friends Provident Group plc

Introduction

We have been engaged by the Company to review the condensed set of financial statements in the half-yearly financial report for the six months ended 30 June 2009 which comprises the Condensed consolidated income statement on an IFRS basis, the Condensed consolidated statement of comprehensive income on an IFRS basis, the Condensed consolidated statement of financial position on an IFRS basis, the Condensed consolidated statement of change in equity on an IFRS basis, Condensed consolidated cash flow statement on an IFRS basis and the related explanatory notes (including the Condensed consolidated underlying profit on an IFRS basis) and to review the European Embedded Value Basis Supplementary Information for the six months ended 30 June 2009 which comprises the Summary consolidated income statement on an EEV basis, the Consolidated statement of comprehensive income on an EEV basis, the Consolidated statement of changes in ordinary shareholders' equity on an EEV basis, the Consolidated statement of financial position on an EEV basis and notes thereto (the Supplementary Information).

We have read the other information contained in the half-yearly financial report and considered whether it contains any apparent misstatements or material inconsistencies with the information in the condensed set of financial statements or the Supplementary Information.

This report is made solely to the Company in accordance with the terms of our engagement to assist the Company in meeting the requirements of the Disclosure and Transparency Rules (the DTR) of the UK's Financial Services Authority (the UK FSA) and also to provide a review conclusion to the Company on the Supplementary Information. Our review of the condensed set of financial statements has been undertaken so that we might state to the Company those matters we are required to state to it in this report and for no other purpose. Our review of the Supplementary Information has been undertaken so that we might state to the Company those matters we have been engaged to state in this report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company for our review work, for this report, or for the conclusions we have reached.

Directors' responsibilities

The half-yearly financial report is the responsibility of, and has been approved by, the directors. The directors are responsible for preparing the half-yearly financial report in accordance with the DTR of the UK FSA. The directors have accepted responsibility for preparing the Supplementary Information contained in the half-yearly financial report in accordance with the European Embedded Value Principles issued in May 2004 by the European CFO Forum and supplemented by the Additional Guidance on European Embedded Value Disclosures issued in October 2005 (together the 'EEV Principles') and for determining the methodology and assumptions used in the application of those principles.

As disclosed in note 1, the annual financial statements of the Group are prepared in accordance with IFRSs as adopted by the EU. The condensed set of financial statements included in this half-yearly financial report has been prepared in accordance with IAS 34 Interim financial reporting as adopted by the EU. The Supplementary Information has been prepared in accordance with the EEV Principles, using the methodology and assumptions set out in notes 1 and 13 to the Supplementary Information. The Supplementary Information should be read in conjunction with the Group's condensed financial statements.

Our responsibility

Our responsibility is to express to the Company a conclusion on the condensed set of financial statements and the Supplementary Information in the half-yearly financial report based on our review.

Scope of review

We conducted our reviews in accordance with International Standard on Review Engagements (UK and Ireland) 2410 Review of Interim Financial Information Performed by the Independent Auditor of the Entity issued by the Auditing Practices Board for use in the UK. A review of interim financial information and Supplementary Information consists of making enquiries, primarily of persons responsible for financial and accounting matters, and applying analytical and other review procedures. A review is substantially less in scope than an audit conducted in accordance with International Standards on Auditing (UK and Ireland) and consequently does not enable us to obtain assurance that we would become aware of all significant matters that might be identified in an audit. Accordingly, we do not express an audit opinion.

Conclusion

Based on our review, nothing has come to our attention that causes us to believe that the condensed set of financial statements in the half yearly financial report for the six months ended 30 June 2009 is not prepared, in all material respects, in accordance with IAS 34 as adopted by the EU and the DTR of the UK FSA.

Based on our review, nothing has come to our attention that causes us to believe that the Supplementary Information for the six months ended 30 June 2009 is not prepared, in all material respects, in accordance with the EEV Principles, using the methodology and assumptions set out in notes 1 and 13 to the Supplementary Information.

Ian A Dewar

For and on behalf of KPMG Audit Plc

Chartered Accountants

8 Salisbury Square

London

EC4Y 8BB

10 August 2009

  

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