Half Yearly Report

6 August 2014

Friends Life Group Limited

Results for the half year ended 30 June 2014

Strong cash performance

· Sustainable free surplus £163 million, up 15% (30 June 2013: £142 million); on track to deliver £39 million uplift in expected return

· Continued good performance in Corporate Benefits, net fund inflows of £0.4 billion

· Value of new business down 24% to £65 million as predicted trends continue, with full impact of the Budget(i) still to emerge

· IFRS based operating profit before tax of £159 million

· MCEV operating profit before tax of £193 million

Capital position robust, dividend secure

· Available shareholder assets £917 million

· IGCA(ii) surplus £2.2 billion, coverage ratio 235%

· Economic capital surplus(iii) £4.0 billion, coverage ratio 193%

· Interim dividend of 7.05 pence per share (30 June 2013: 7.05 pence per share) 

Business highlights and successful agreement of Lombard sale(iv)

· Disposal of Lombard announced and share buy-back increased to £317 million

· Peak of auto-enrolment activity in the first half of 2014 delivers 648 schemes with 108,000 net members added to defined contribution pension schemes during the first half of 2014

· Strong growth in Protection, APE is up 21%

· Agreement to reallocate circa £800 million of annuities from with-profits funds, subject to regulatory non-objection, resulting in a SFS benefit of circa £7 million p.a. from 2015

· £200 million syndicated loans mandate further underpins expected return in 2015

· Re-platforming in International division remains on track for new business in the third quarter of 2014 and for all in-force in 2015; interim dividend passed and full year dividend to Group under review

· Excellent progress made towards preparing the launch of new retirement propositions:

- Adding retail functionality to My Money Corporate Wrap platform

- New flexible propositions being developed to offer alternative solutions for customers

- Customer engagement model enhancements fully underway

Andy Briggs, Group Chief Executive said:

"It's clear that our industry has seen a large amount of change in the first six months of 2014. Our cash generation is strong while our dividend coverage is improving. The scale of our business with over 2 million pension customers representing one in seven DC savers, as well as our focus on customer needs, means we are well placed to win in the retirement and savings market. I remain confident that we can fully benefit from the opportunities presented to us and that we have the right people to deliver our plans to drive growth throughout the business."

(i) The Chancellor of the Exchequer's Budget announcement on 19 March 2014.

(ii) Representing estimated Insurance Groups Capital Adequacy ("IGCA") surplus as at 30 June 2014.

(iii) Estimated.

(iv) Lombard is treated as a discontinued operation within these half year results and is therefore excluded from the Group's key operating performance measures. It however, remains within the Group's capital measures.

Enquiries:

Forward-looking statements

This announcement may contain certain "forward-looking statements" with respect to certain of Friends Life's (and its subsidiaries) plans and current goals and expectations relating to future financial condition, performance, results, strategy and objectives. Statements containing the words "believes", "intends", "expects", "plans", "seeks", "aims", "may", "could", "outlook", "estimates" and "anticipates", and words of similar meanings, are forward-looking statements. By their nature, all forward-looking statements involve risk and uncertainty. Accordingly, Friends Life's (and its subsidiaries) actual future financial condition, performance or other indicated results may differ materially from those indicated in any forward-looking statement.

Any forward-looking statements contained in this announcement are made only as of the date hereof. Friends Life undertakes no obligation to update the forward-looking statements contained in this announcement or any other forward-looking statements it may make.

No statement contained in this announcement should be construed as a profit forecast.

Media

There will be a conference call today for wire services at 7.30 am (GMT) hosted by Andy Briggs, GCE. Dial in telephone number: +44(0)20 3427 1908, Participant code 8567399. 

Analysts/Investors

A half year results presentation will take place at 08:30am (GMT) at the London Stock Exchange, 10 Paternoster Square, London EC4M 7LS. Dial in telephone number: 020 3059 8125 (UK) + 44 20 3059 8125 (all other locations), Participant password: Friends Life.

A webcast of the presentation and the presentation slides will be available on Friends Life's website, http://www.friendslifegroup.com/

In accordance with the obligations for issuers of listed debt contained in the Disclosure and Transparency Rules, Friends Life Holdings plc will issue a separate half year results announcement later today.

Financial calendar

2014 Interim dividend

Website: http://www.friendslifegroup.com/

Group Chief Executive's review

Introduction

The first half of 2014 has witnessed some of the most far reaching changes to the UK life sector for more than a generation. The regulatory changes announced in March present challenges and opportunities for all market participants, especially in the UK retirement savings market. The industry has been presented with the opportunity to develop innovative solutions to serve the needs of its customers. Implementing reforms to deliver better solutions for customers will take time - and the final outcomes are not entirely clear at this stage. However, this provides an opportunity to learn from the experiences of similar reforms in other countries, adopting the best practices, understanding where improvements can be made but, importantly, retaining the best features and experience built by UK insurance companies over the years.

The change in the industry has coincided with the turning point in the history of our Company. Earlier this year, we announced the completion of our transformational restructuring and our new financial framework for the future. To recognise the integrated structure and governance of the business, we unified the Group's brand, renaming the parent company Friends Life Group Limited in May. Recently we announced the agreement to sell Lombard, and the intention to return cash to the shareholders by way of a share buy-back.

Despite all this change, the fundamentals of how we run our business have not changed. Our strategy has remained clear and consistent, to focus on managing legacy life and pension products, and capturing value in the retirement provision market, which is still projected to more than triple over the next decade. My executive team has been delivering this strategy with the rigorous financial discipline that underpins everything we do. Our focus has remained on cash generation, both in the short term and in the longer term as we transition into the new world of retirement. The overview of our business performance is considered in this context, given that this is how we run our business and make our strategic choices.

Cash today

Focus on generating cash today is of paramount importance to us, as our dividend commitment rests on our ability to achieve 1.3 times sustainable free surplus to dividend coverage, at which point the Board will consider moving to a progressive dividend.

Last month we announced the disposal of our Lombard business to the Blackstone Group subject to anti-trust and regulatory approvals. There were very limited strategic and operational synergies between it and the rest of the Group, therefore the disposal creates more value for the shareholders, and will benefit the Lombard business. I am also delighted to announce that regulatory approval has been granted to increase the scale of the share buy-back announced on 11 July 2014 from £261 million to £317 million, with this to be commenced once the sale has completed and proceeds received. The increase of £56 million is equivalent to the amount of the vendor loan note issued as part of the Lombard sale. This demonstrates the strength of our balance sheet and the confidence of the Board in the financial strength of the business. Following the disposal, and assuming an immediate share buy-back at a 10 day rolling average share price of 332.1 pence as at 4 August 2014, equating to approximately 95 million shares, full year 2013 pro forma sustainable free surplus cover of the Group's dividend would be improved to 1.17 times from 1.10 times.

I am also very pleased with the strong cash generation performance delivered in the first half of 2014. Sustainable free surplus has risen by 15%, to £163 million. The key drivers of this growth are the successful closure to new business in non-core international markets and the reallocation of £2 billion of annuities from with-profits funds, actions taken in 2013 that are now starting to deliver tangible benefits. The free surplus generated from the profitable new business in the UK division written in 2013, particularly in Corporate Benefits, is also successfully contributing to the offsetting of the expected run-off of the Heritage book. I am also pleased to note that we are on track to deliver low double digit percentage growth in sustainable free surplus in 2014.

Cash tomorrow

Beyond our objective to achieve 1.3 times sustainable free surplus coverage of dividend, we have a strong ambition to continue cash generation growth to support a progressive dividend. There are a number of opportunities that give me confidence in the longer term cash generation growth.

Revenue optimisation in Heritage

Heritage remains the cash generation engine of the Group. Last year, Heritage executed its first in-house with-profits annuity transfer deal that is generating an additional circa £10 million sustainable free surplus benefit per annum from 2014. Plans in Heritage to transfer a further circa £800 million of annuities from with-profits funds are expected to be effective and completed in the second half of the year. There remains a further £1.5 billion of annuities in the with-profits funds for potential future transfers, although because of the different profiles of each potential transaction, we would only consider proceeding with them if it is in the best interests of both our with-profits customers and our shareholders.

I'm pleased with the preparations for the transfers of the £14 billion of assets from F&C to Schroders and Friends Life Investments ("FLI"). Both are progressing well and I'm excited by the opportunities the new relationship with a partner of Schroders' standing will bring. The combined sustainable free surplus benefit of the proposed annuities transfer and the assets transfers is expected to generate circa £10 million of additional post tax cash benefit per annum from 2015 onwards. This is in addition to the £16 million per annum that previous initiatives have already been contributing from 2014.

Further revenue optimisation opportunities may present themselves as the £35 billion of discretionary assets currently managed by AXA come to the point, in late 2015, where we can seek to achieve the best possible outcome for our customers and shareholders.

Corporate Benefits and Heritage pension accumulation

It is also encouraging to see growing cash generation from the businesses that support customers during their accumulation stage. Last year our Corporate Benefits business turned cash positive on the underlying sustainable free surplus basis, as we maintained strict financial discipline of writing only profitable business and growing scale with no detriment to value. Compared to the first six months of 2013, the underlying sustainable free surplus generated by Corporate Benefits grew by £4 million to £14 million.

Combining Corporate Benefits and Heritage, our pensions accumulation businesses have over 2.3 million customers with over £48 billion of assets under administration. We believe this significant customer base is a considerable strategic asset as we move into the new world of retirement with over 80% of Corporate Benefits new business coming from our existing schemes. By continuing to provide excellent customer service, we believe that many of our customers will choose to de-cumulate on the same platform used for accumulation. Our scale position means we are well placed to support our customers over the long term.

Our Corporate Benefits business has delivered good performance in the first half of 2014 with positive net fund flows of £0.4 billion and regular premiums growing by 4% compared to the same period last year. The pace of auto-enrolment has peaked in the second quarter after a strong first quarter. 648 schemes auto-enrolled with Friends Life in the first six months of the year contributing to a 108,000 net increase in scheme members in this period. In addition, we have launched our new master trust proposition, and have developed a direct offer transfer proposition, to attract in new assets alongside our new scheme wins.

Retirement income

The retirement savings market is where we expect the most significant change, but this is also where we see significant opportunities for our business to add value to our customers. Customers are at the heart of our business and we have carried out extensive work to fully understand their specific needs. We will focus on our existing mass affluent customers, who do not have an active Independent Financial Adviser ("IFA") relationship and are unlikely to pay fees for IFA advice. Post Budget, these customers will have a much broader range of options and hence will have a greater need for guidance.

There is extensive customer research underway which will give us even greater insight into the needs of our core customer segments. Research we have undertaken, in conjunction with Ignition House Ltd, has so far revealed that about a quarter of retirees are struggling to understand the new freedoms they will soon enjoy and about two thirds are not aware of the potential tax implications of withdrawing cash as a lump sum at retirement. Research also shows that, the majority of mass affluent customers who do not have an advisor would not want to pay more than £500 for advice. Many of our customers remain uncertain about what products would suit them at retirement, for example three quarters of the surveyed retirees want the security of a fixed income and protection against inflation in retirement, but only a quarter intend to buy an annuity.

We have already made meaningful improvements in our customer engagement. Our customer relations teams make over 2,000 calls per month, covering over a half of the maturing pensions on our books. In the first half of this year we also contacted approximately 50,000 customers through direct mail, offering them support and guidance as they make their life defining choices in this period of uncertainty and change. By the end of the year we are also planning to contact a further 100,000 customers who are reaching a critical point in their retirement journey. We have also made some good progress in enhancing our online facility. New customer web pages were created to support customers post the Budget. Our new retirement planning "hub" went live in July on our customer website, providing a range of information to help customers at different stages of their retirement planning. Further, as part of our platform development, our extended customer interface will offer a single view of Friends Life holdings and tax guidance.

Most customers want simple, easily accessible products when they reach retirement. Features they would value most include a range of pre-selected funds, a facility to manage their income tax position, and a tool to assess current fund performance and impact of future fund performance on income. Alongside the proposed guidance regime, we will proactively engage with our customers to ensure they feel able to make an informed choice. By building on our already extensive knowledge of customer behaviour, we will deliver the right propositions to support our customers.

As far as these customer proposition choices are concerned, we believe that the biggest area of growth going forward will be in the 'flexible income' space. Those customers that decide not to buy an annuity will want much simpler propositions, so that they can take a regular income from their accumulated pension and other assets. In particular, they will want to do this in the most tax efficient way, and hence a proposition offering both a pensions based vehicle alongside an ISA, and ensuring tax efficient switching between the two, will be key.

We are well placed to do this, with a market leading corporate wrap platform and planned developments to add retail platform functionality. We will offer our customers a new range of retirement income products and services giving them greater flexibility in how they choose to generate an income in retirement. For example, we will be launching an easy to use, online tool to help customers manage a prudent level of spend from a tax and longevity perspective. The first phase of development will go live by the time the new rules come into force and will enable our customers to manage their financial affairs and purchase a range of flexible savings and income generating solutions, such as New ISA, pension with a tax free cash facility, General Investments account and cash savings account.

In the meantime, we have lowered the minimum fund size on our existing drawdown product to £30,000 (before tax free lump sum is taken) from £50,000 (after tax free lump sum is taken). To ensure our existing customers have options and choices we have designed and launched a guided consolidation offering to allow more customers to use Friends Life as their preferred provider. We are also building on our strategic partnership with Schroders to develop new fund propositions such as income generating funds for customers in all distribution channels.

Our customer feedback indicates an increasing number of customers are considering delaying their retirement decision, and we expect this to increase further. When our customers delay, it is likely to be within their existing pensions product, and we will continue to provide them with the high levels of customer service and support they have come to expect. During this period of deferment we will continue to build even deeper relationships with these customers, ahead of them making their retirement income decision.

Outlook

Despite the magnitude of change in the first half of the year, the UK businesses have delivered resilient performance. Although the auto-enrolment activity has peaked, the outlook for the Corporate Benefits business remains positive, as the Budget is likely to encourage additional pension savings in the future. Retirement Income is well placed to reposition itself in light of recent regulatory changes to support our mass affluent customers' retirement needs. Progress has been made to enhance customer engagement and our product suite. Protection continues to be ideally positioned to provide a profitable underpinning to our transition to retirement strategy.

Our International business is continuing to operate in a challenging market and regulatory environment. We are however taking proactive measures to re-platform the business which will strengthen its competitive positioning and longer term prospects.

There is much to do across the businesses, but our business is strongly positioned with over two million pension customers representing around one in seven defined contribution ("DC") savers and around £48 billion of pension assets in our UK and Heritage divisions. Friends Life is fully able to meet the challenges and opportunities it faces and we are excited about the future.

Key performance indicators

Set out below are the Group's key performance indicators. These have been restated where necessary to reflect the classification of Lombard as a discontinued operation.

Chief Financial Officer's review

Introduction

2014 marks the first year we report as Friends Life Group and the first year post the completion of the restructuring and transformation phase of the business. In March, I outlined the financial framework we would use to measure the progress of the business from 2014 onwards. Despite the magnitude of change we have seen in the industry in the first half of the year, I am pleased to announce a resilient set of financial results. In particular, sustainable free surplus, our primary measure of cash generation is up 15% to £163 million.

Of course, the retirement income market now looks very different to how it did six months ago. The Budget announcement has had limited impacts on our financial results to date but is expected to lead to lower levels of new business over time. However, our short term cash generation is secure so I reaffirm our previous guidance on the £39 million uplift in UK and Heritage expected free surplus returns for the full year, and I am also confident that we have the right skills to benefit from the exciting new opportunities in the retirement provision market place. We expect the Corporate Benefits business to be a beneficiary of the increased flexibility at retirement, which will encourage greater fund flows into pensions products. We also believe the new retirement income market place will play to our strengths, given our large existing customer base and strong focus on engagement with these customers.

We have also announced the expected disposal of Lombard for an initial consideration of £317 million. This disposal has sound strategic rationale: there were limited strategic or operational synergies with the rest of the Group and we believe the disposal realises more value for shareholders than continued ownership by the Group would create. I am also delighted to announce that regulatory approval has been granted to increase the scale of the share buy-back to £317 million from the £261 million announced on 11 July 2014, with this to be commenced once the sale has completed and proceeds received. The increase of £56 million is equivalent to the amount of the vendor loan note issued as part of the Lombard sale. This demonstrates the strength of the balance sheet and the confidence of the Board in the financial strength of the business. Once completed, the share buy-back will improve the coverage ratio of sustainable free surplus to dividend cost.

Financial performance

(i) With exception of the capital strength measures, the 2013 half year and full year results have been restated to exclude the results of Lombard, which has been classified as discontinued during the period.

(ii) Sustainable free surplus/Shareholders Net Worth ("SNW"), where SNW is free surplus and required capital (net of external debt), i.e. MCEV excluding VIF. The SNW is adjusted to exclude Lombard and to reflect the in-period impact of dividend payments and other capital movements.

Cash today

Our consistent strategy and focus on growing cash today is evident in the results above. Sustainable free surplus has risen by 15% to £163 million (30 June 2013: £142 million). There is much more work to do, but these results represent further tangible progress on the journey we are taking. Following the 7% growth in sustainable free surplus achieved in 2013, from £304 million to £325 million, I am very pleased to confirm that we expect to achieve further low double digit percentage growth in sustainable free surplus for the full year 2014.

The growth in sustainable free surplus has been a product of our strategic focus on improving the cash generation of the Group. The key contributions to the growth in the first half of 2014 are the benefits from actions taken in the second half of 2013, notably the closure to new business in non-core international markets and the reallocation of £2 billion of annuities from with-profits funds. The additional free surplus provided by the profitable new business written by UK divisions is also contributing successfully to the offsetting of the expected run-off of the Heritage book.

Looking forward, short term cash generation, after setting aside 150% of regulatory capital requirements, is not expected to be materially impacted by the Budget announcement, and actions continue across the Group to maintain the growth in sustainable free surplus. Good progress continues to be made on phase two of the with-profits annuity reallocation programme, and together with the agreement to transfer £14 billion of assets from F&C during 2014, these initiatives are expected to deliver circa £10 million per annum of additional sustainable free surplus from 2015 onwards.

It is also important to note that we have continued to deliver this increase in cash whilst increasing our investment in UK new business by £17 million, resulting from the improved competitiveness of the Retirement Income proposition.

In March I guided towards a circa £15 million increase in development costs for the full year 2014. Since then we have reduced our spend substantially and no longer expect anything like the previously guided increase. However, I am excluding here, and also from the full year 2014 sustainable free surplus guidance, the future costs associated with new retirement income product and platform development, which will be reported separately. Whilst it is difficult to predict the overall cost, we don't expect the expenditure to be more than £30 million in 2014.

Cash tomorrow

Value of new business in the first six months of the year has been impacted as expected by the increased competitiveness in the Retirement Income business and the continuing challenging markets for the International division. However, the Protection and Corporate Benefits businesses delivered resilient new business results in competitive markets.

The Protection business has performed well in the first half of the year, with value of new business of £31 million (30 June 2013: £32 million). Volumes have grown strongly, up by 21% from the first six months of 2013, enabling us to continue to deliver comparable value of new business despite the increasingly competitive market. As a result and as previously reported, we expect the full year 2014 value of new business to be lower than the £75 million achieved in 2013.

The performance of the Retirement Income business has been resilient with APE volumes of £30 million (30 June 2013: £32 million). The compression in Retirement Income margins is a continuation of that seen in the second half of 2013, as we moved to an increasingly competitive pricing position, resulting in value of new business of £28 million (30 June 2013: £44 million). Looking ahead, as expected, new annuity applications are now beginning to fall, albeit not yet to the level of long-term expectations. However, we expect applications in the second half of 2014 to fall further towards our long-term expectation of 20% lower than pre-Budget levels for Guaranteed Annuity Options ("GAO") business and 50% - 70% lower than pre-Budget levels for non-GAO business. GAO business currently comprises approximately half of new annuity applications in terms of premium, which will serve to partially insulate the Group against the larger expected market-wide falls in new annuity volumes. However, Retirement Income value of new business for 2014 will inevitably be materially lower than in 2013.

Difficult trading conditions in the International division have led to a disappointing new business performance in the first half of the year. Value of new business has fallen to £5 million (30 June 2013: £9 million). Challenging market conditions for regular premium insurance business throughout the regions have impacted new business performance in the first half of 2014. As announced in March, we are investing in a new International IT platform, which will support future growth and product development. The project is progressing well and we expect to re-platform new business by the end of the third quarter of the year, with in-force business expected to be re-platformed during 2015. This is an important development for the FPI business, one which creates a foundation for growth in future new business.

Our asset-based business, Corporate Benefits, has performed well in the first six months of the year, with a net fund inflow of £0.4 billion (30 June 2013: £0.0 billion). 648 new schemes have auto-enrolled in the first half of the year, leading to a net increase in members of 108,000 to over 1.25 million. Regular premiums received have also increased by 4% from 12 months ago due to the large numbers of new members. This significant increase in new members and in-force regular premiums provides a strong platform for further growth in assets under administration. This growth in the business has contributed to an increase in underlying free surplus generation from £11 million in the full year 2013 to £14 million in the first half of 2014, demonstrating the improved operational leverage in the business. Value of new business in the first six months of the year at £12 million (30 June 2013: £13 million), is slightly lower than the same period in 2013 due to the higher proportion of lower margin auto-enrolment business. Overall, however, the momentum in the Corporate Benefits business is very pleasing and with a strong proposition and growing assets under management, we are excellently placed for the expected future growth in this market, now more attractive than ever to savers post the Budget announcement.

Returns

IFRS based operating profit has fallen by 7% to £159 million (30 June 2013: £171 million), largely reflecting adverse one-off items in the period and lower in-force surplus. This has been partially offset by higher returns on shareholder assets as long-term expected rates of return improve. The result also reflects the increased new business strain within the UK Retirement Income business, arising from the increased competitiveness of the proposition as seen in the latter half of 2013, and marginally lower sales volumes. This is partially offset by a reduction in new business strain on non-core Overseas Life Assurance Business ("OLAB") business, following the closure to new business in the second half of 2013.

MCEV operating profit has also been affected by the increased competitiveness in Retirement Income, with a fall of 5%, to £193 million (30 June 2013: £203 million). This is a resilient result, and illustrates the benefit on the MCEV basis of management actions undertaken to increase future cash generation. A reduction in expected future investment management costs has contributed £25 million to MCEV operating profit, of which the strategic investment partnership with Schroders announced in March 2014 played a principal part.

The cash return ratio has increased in the first half of 2014 to 21.1% (30 June 2013: 19.5%). This largely reflects the increase in sustainable free surplus on a stable shareholder net worth position.

Capital strength

Our continued financial discipline across all areas of the business has maintained the strong balance sheet and robust capital position of the Group. Our coverage ratios on both an IGCA and economic capital basis remain stable at 235% and 193% respectively.

Group available shareholder assets are unchanged at £917 million. This includes the new syndicated loans mandate worth £200 million announced in May. This mandate offers the Group the potential for higher returns on shareholder funds, alongside the increased diversification from investing in a new asset class. £139 million has already been invested, with the remainder expected to be invested in the third quarter of 2014.

Free surplus emergence

In March, we announced an expectation of a £39 million increase in the full year 2014 free surplus expected return in the UK and Heritage divisions compared to the prior year equivalent. Today we report half year results that are in line with this guidance and that we are currently on track for the full year expectation.

There is no material change to the profile of expected free surplus emergence as a result of the regulatory announcements in the first half of the year. In the shorter term, we expect the run-off of the Heritage book to be more than offset by the additional contributions from UK new business and the continuation of Heritage initiatives. With the development of broadened retirement income propositions in the medium term, combined with contributions from the other new business propositions, we are confident in offsetting the longer term run-off.

Following the transfer of the OLAB business from the International division into Heritage, the estimated expected returns for the UK and Heritage businesses in 2014 have been revised as follows:

Dividends

The interim dividend per share is confirmed as 7.05 pence, in line with 2013.

In light of recent trading performance, adverse foreign exchange movements and a potential change in the biting capital constraint, the International division will not pay an interim dividend to Group in 2014, and the full year dividend to Group remains under review. This does not impact the Group's full year ordinary dividend expectations.

Outlook

The continued growth in sustainable free surplus highlights our consistent focus on the generation of cash for shareholders and our progression towards meeting our criteria for triggering a review of the move to a progressive dividend. However notwithstanding this progress, there remain uncertainties as to when this will be achieved, with the impact of the share buy-back and expected return growth dependent on the average price of shares acquired and cancelled in the share buy-back programme, and economic factors respectively, neither of which can be predicted.

Given the impact on new annuity volumes created by the Budget announcement, and as communicated in May, the ambition to grow the Group value of new business by 10% per annum will not be achievable in 2014. Our short term cash generation is secure, even after the Budget announcement, with a steady run-off from the Heritage book expected to be more than offset by disciplined growth in profitable new business and cash optimisation initiatives undertaken within the Heritage division. The disposal of Lombard, alongside the strategic rationale for the transaction, is an example of our rigorous financial discipline and focus on cash generation.

Business review

Group operating results

Shown below are the Group operating IFRS, free surplus and MCEV results. Further detail on business unit performance can be found in the sections that follow.

£m

Group operating free surplus generation

Group MCEV operating results

(i) 2013 half year and full year results have been restated to exclude the operating results of Lombard, which has been classified as discontinued during the period.

(ii) 2014 IFRS based operating profit excludes investment variances on unit-linked sterling reserves and the assets backing these reserves. The change has not had a material impact on the results of the Group.

Non-operating results

£m

Group free surplus generation

Group MCEV profit after tax

(i) 2013 half year and full year results have been restated to exclude the results of Lombard, which has been classified as discontinued during the period.

(ii) 2014 short-term fluctuations in investment return include investment variances on unit-linked sterling reserves and the assets backing these reserves. The change has not had a material impact on the results of the Group.

Group IFRS: non-operating results

Short-term fluctuations in investment returns amounted to a favourable £25 million. This principally reflects the release of credit default reserves and annuity portfolio mismatch variances, where the liabilities are matched on a realistic basis as opposed to the reported regulatory basis.

Other non-recurring items of £(55) million include:

· outsourcing implementation costs, net of provisions, of £(26) million;

· finance transformation costs, net of provisions, of £(20) million, largely in relation to Solvency II;

· separation and integration programme costs of £(5) million; and

· other non-recurring costs of £(4) million.

A shareholder tax credit of £15 million is recognised for the period and includes a £31 million tax credit in relation to the amortisation and impairment of AVIF and other intangibles.

Group free surplus generation: non-operating results

Economic variances combine the impact of changes to economic assumptions with the investment return variances over the period. Total economic variances in the first half of 2014 had a £56 million positive impact on free surplus. The largest component of this is due to gains on equities and bonds over the period, which have allowed historic taxable losses to be valued. In addition, a positive impact arose on annuity business, primarily as a result of the unwind of credit default allowances, in addition to an assumption change to reduce future credit default allowances due to the narrowing of corporate bond spreads in the first half of 2014.

Other non-operating items of £(38) million include £(55) million of non-recurring items, consistent with those reported within the IFRS result. In addition, there is a net impact of £17 million from items specific to free surplus, including £9 million in respect of capital releases due to the de-authorisation of Friends Life Company ("FLC") and Friends Life Winterthur Life ("FLWL") following the completion of the 2013 phase of the capital optimisation programme.

FLGL other income and charges of £(9) million relate to investor related corporate costs incurred within the Friends Life Group holding company, and are in line with those reported in the first half of 2013.

Group MCEV: non-operating results

Economic variances combine the impact of changes to economic assumptions with the investment return variances over the period. Total economic variances in the first half of 2014 had a £134 million positive impact on MCEV profit before tax. This was due to the narrowing of corporate bond spreads on assets backing annuity business and increases in the value of fixed interest assets in unit-linked business partially offset by a negative economic variance from an increase in the market value of the Group's external debt.

Non-recurring costs, other non-recurring items and non-operating variances total £108 million and include costs of £55 million, consistent with those reported within the IFRS result, in addition to net costs of £53 million specific to MCEV. The £53 million specific to MCEV includes a £50 million provision (split £15 million in Heritage and £35 million in UK division) established to cover the anticipated impact of the imposition of a charge cap of 0.75% p.a. on default funds for qualifying auto-enrolment schemes and a £10 million provision established to cover the anticipated impact on future profits from the removal of Active Member Discounts ("AMD") on existing schemes. Furthermore, we have today also set out our approach to paying initial commission, with commission on new entrants replaced with a 2% level rate from 1 September 2014. The Group believes that alongside our commitment to paying other commission types until April 2016, provided the scheme's default fund charge is already within the cap, that this is a sustainable solution that smoothes the transition for advisers and employers to fee-based remuneration.

Group net assets and shares in issue

(i) Adjusted to exclude 3,972,022 FLGL shares held by the Employee Benefit Trust ("EBT") at 30 June 2014 (31 December 2013: 600,877). The increase reflects additional purchases made by the EBT to deliver shares to employees under various Share Based Payment schemes of the Group.

At 30 June 2014, IFRS total equity was £5,260 million (31 December 2013: £5,549 million), with equity attributable to equity holders of the parent of £4,949 million (31 December 2013: £5,229 million). IFRS net assets per share attributable to shareholders were £3.50 (31 December 2013: £3.69) based on shares in issue (excluding shares held in the EBT) at the balance sheet date.

Net Group MCEV was £5,724 million (31 December 2013: £6,065 million) giving MCEV per share of £4.05 (31 December 2013: £4.28). The decrease in net Group MCEV reflects the remeasurement of Lombard at the lower of its carrying amount and fair value less costs to sell. Lombard MCEV of £578 million has been adjusted down by £268 million to the £310 million held for sale carrying value.

Heritage division

Half year 2014 highlights

· Sustainable free surplus generation up to £233 million (30 June 2013: £181 million) reflecting reduced levels of free surplus invested in new business from the non-core OLAB business and £16 million higher expected return from in-force business.

· Regulatory change: Significant levels of regulatory change have been announced during the first half of 2014. The Heritage division is in a strong position to respond positively to these changes, many of which focus on the fair treatment of customers which is central to the Heritage strategy.

· Reallocation of with-profits annuities (phase 2): Agreement has been reached, subject to regulatory non-objection, to reallocate circa £800 million of annuities from a with-profits fund into a shareholder owned non-profit fund, with this expected to be effective and completed in the second half of the year. This transaction is currently expected to require a 2014 free surplus investment of around £(15) million and result in a sustainable free surplus benefit of circa £7 million per annum from 2015.

· Strategic investment partnership with Schroders: Preparations for the asset transfers to Schroders continue to progress well with £12 billion of equity and multi-asset funds to be transferred from F&C in the fourth quarter of 2014. As part of this transaction a further £2 billion of fixed interest assets will be transferred to Friends Life Investments ("FLI").

· IFRS based operating profit increased to £131 million (30 June 2013: £116 million) with benefits from reduced new business strain and improved long-term investment return.

· MCEV operating profit is in line with prior year at £140 million (30 June 2013: £141 million).

Heritage division's 2013 full year and half year results have been restated to reflect the transfer of OLAB from the International division.

Strategy

The Heritage division has £69 billion of assets under administration and serves circa 4 million customers across a range of products. These products are no longer actively marketed and are largely administered on legacy systems.

A dedicated management team is in place with a focus on looking after customers' needs and enabling the Heritage division to become the UK's leading legacy business manager.

The value drivers for the Heritage division, in the context of the overall Group's strategy are:

· Operational excellence: dedicated customer service within an efficient cost base in line with business scale;

· Capital efficiency: optimisation of capital required for the business;

· Cash generation: safe generation with focused opportunities for enhancing future cash generation;

· Strong risk focus: robust financial risk and balance sheet volatility management; and

· Focus on investments: utilising the Group's internal asset management capability to maximise returns and lower costs.

The Heritage division is making good progress towards achieving its strategic outcomes.

The division continues to provide good customer service supported by its outsourced suppliers. Following the first major migration from two legacy administration systems onto the Diligenta BaNCS IT platform at the end of 2013, initial issues have been successfully resolved and learning points have been factored into plans for future migrations.

A multi-year programme to implement a uniform capital management framework for the six with-profits funds continues. As part of that initiative and the ongoing objective to ensure that with-profits funds remain appropriately invested for customers and shareholders, the with-profits annuity reallocation programme continues. Phase 2 of this has seen an agreement being reached, subject to regulatory non-objection, to reallocate circa £800 million of annuities from a with-profits fund into a shareholder owned non-profit fund, with this expected to be effective and completed in the second half of the year. This transaction is currently expected to require a 2014 free surplus investment of around £(15) million and result in a benefit of circa £7 million per annum from 2015.

FLI now manages £17.4 billion of fixed interest assets. A further £2 billion of assets will be re-captured from the transfer of fixed interest assets currently managed by F&C later in 2014, alongside the move of circa £12 billion of assets from F&C to Schroders. A benefit to MCEV across the UK and Heritage divisions has been recognised in respect of the anticipated investment expense savings.

Investments have also been made in a number of different asset classes to drive increased yield within the annuity portfolio and shareholder funds across the Group. These include a £500 million commercial real estate mandate awarded to Pramerica (£60 million invested), a £500 million infrastructure loan mandate awarded to MetLife Investment Management (£60 million invested), and a £200 million syndicated loans mandate awarded to Ares Management (£139 million invested, full capital deployment anticipated by end of the third quarter of 2014).

Regulatory changes

During the first half of 2013, the FCA announced plans to incorporate a legacy product review within its 2014 Business Plan, which has added a level of uncertainty to the industry as a whole. The Group is confident that the Heritage division is in a strong position to respond to the FCA.

The FCA's 2014 outlook identified a number of potential emerging risks relating to the fair treatment of long-standing customers by life insurers. The Thematic Review now underway on this topic will assess a number of areas connected to the operation of legacy business, including back book strategy and governance, how products have performed and the quality of customer communications.

The Group is part of a highly regulated industry which has undergone a series of independent reviews to ensure transparency and fair treatment of customers over a number of years. Friends Life's customers are at the heart of the business and it is firmly believed that by doing right by the customers this will in turn create a strong and successful business that will support the Group's future success. The Heritage division is specifically focused on meeting the ongoing needs of Friends Life's legacy customers to ensure fair customer outcomes. As part of this there is significant ongoing investment across a number of change programmes (such as the Service Improvement Programme in partnership with Diligenta) that will deliver improved customer service and provide customers with a more consistent and reliable customer experience.

The business is working with the FCA, responding to their requests and is looking forward with confidence to the next steps of the review.

Financial performance

IFRS based operating profit

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

The 2014 half year Heritage IFRS based operating profit of £131 million is £15 million higher than the prior period. This improvement has been driven by higher in-force surplus, improved long-term investment return and lower new business strain. In-force surplus is favourable compared to the first half of 2013 with the run-off of the closed book of business being more than offset by a £5 million benefit from the first phase of the with-profits annuity reallocation programme and higher management charges, due to improved economic conditions. Improved long-term investment return is primarily due to improved long-term interest rates whilst lower new business strain reflects the cessation of new business sales within the transferred OLAB business.

Development spend of £(10) million is higher than 2013 reflecting the interim cost of completing the transfer of equity and multi-asset funds to Schroders and FLI, the reallocation of with-profits annuities, the ongoing cost of implementing regulatory change together with improvements to existing products and systems to support the in-force business.

Operating expenses

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

Half year 2014 acquisition costs are lower than 2013, mainly driven by the cessation of new business sales within the transferred OLAB business.

Maintenance costs of £104 million are lower than the first half of 2013 due to contractual savings in customer service and IT achieved through the Diligenta partnership and a reduction in costs following the successful completion of the AHM programme to move all IT infrastructure and business applications hosted by AXA to Friends Life in 2013.

Sustainable free surplus generation

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

The 2014 half year sustainable free surplus generation of £233 million is £52 million higher than the first half of 2013, with lower investment in new business and higher expected return from in-force business.

Expected return from in-force business at £252 million is £16 million higher than 2013 with the run-off of in-force business being more than offset by the ongoing benefits from the first phase of the with-profits annuity reallocation programme, FLI asset recaptures, the benefit of 2013 being the last year of repayment of a previous loan with FLAS with-profits fund, improved economic conditions and tax benefits.

The reduction in investment in new business reflects the cessation of new business sales within the transferred OLAB business.

MCEV operating profit

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

The Heritage MCEV operating profit of £140 million is in line with the equivalent period in 2013.

Expected existing business contribution is in line with the first half of 2013 with the ongoing benefit from the first phase of the with-profits annuity reallocation programme and improved economic conditions offsetting the general run off of in-force business.

The £29 million operating assumption changes includes an £11 million benefit reflecting revised assumptions in respect of lower future investment expenses after the transfer of assets to Schroders and FLI from F&C, and an increased recognition of deferred tax assets of £18 million.

Value of in-force business

The Heritage business represents a significant proportion of the Group's in-force value and regulatory capital. The breakdown by product is shown below.

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

Total Heritage value of in-force business remains unchanged from 2013. This reflects the positive economic conditions in 2014 which have offset the run-off of the in-force book.

Heritage assets under administration

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

The increase in assets under administration reflects favourable investment returns over 2013 offsetting the run-off of the business.

New business

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

The Heritage division specifically focuses on those products no longer actively marketed. Despite not actively seeking new business, the Heritage book delivers ongoing incremental business written across all product types. This incremental new business is largely accepted as part of the contracts on existing business.

The reduction in investment in new business reflects the lower sales volumes following the cessation of new business sales within the transferred OLAB business.

Outlook

During the second half of 2014, further progress is expected to be made on the multi-year programmes to migrate customers to new platforms, involving the Group's two largest outsource partners (Capita and Diligenta), with migrations targeted during 2015. These migrations continue to support the drive for operational efficiency and simplification to improve customer service.

The transfer of assets from F&C to Schroders and FLI is expected to complete in the fourth quarter of 2014, these transfers support the drive for generating good returns for policyholders and shareholders, and cost efficiency.

Phase two of the reallocation of with-profits annuities is also expected to complete in the second half of the year; delivering significant de-risking of future returns for policyholders and generating circa £7 million SFS per annum for the shareholder, with an upfront investment of circa £(15) million. In addition, further reallocations are being considered.

Throughout the remainder of 2014 and beyond, Heritage will focus on responding to the regulatory changes within the industry and ensuring the division works together with the UK division to provide solutions for Friends Life's customers in an ever changing regulatory environment.

UK division 

Half year 2014 highlights

· UK free surplus expected return up £7 million to £56 million, driven by profitable new business written in 2013. The division is on target to deliver the expected increase in the full year.

· New business APE up 25% from strong sales in Corporate Benefits and Protection with Retirement Income volumes down less than 10% despite the Budget announcement in March. However, VNB and investment in new business ("INB") were impacted by margin changes in Retirement Income following improvements to the competitiveness of annuity pricing, which has also exerted pressure on IRRs.

· Net fund flows in Corporate Benefits of £0.4 billion, from a neutral position in the same period last year, taking assets under administration to £20.8 billion.

· Sustainable free surplus down to £(30) million from £(4) million in the first six months of 2013 driven primarily by the improvements to the competitiveness of annuity pricing and some adverse experience variances. IFRS based operating profit and MCEV operating profit of £10 million and £88 million, respectively, are lower than in the first half of 2013.

· The Embassy transition programme to move clients' assets onto the division's strategic platform has successfully delivered six tranches of assets with the remaining four planned to complete this year.

Strategy

The UK division continues to focus on helping customers enjoy a financially secure and prosperous retirement, protect their loved ones should they fall ill or die and make their money work hard for them. The UK division's two insurance businesses, Protection and Retirement Income, remain focused on leveraging successful management of risk to provide valuable products to customers at suitable returns for shareholders. Despite the Budget, the Group still expects three fold growth in the funds available at retirement over the next decade. The asset-based business, Corporate Benefits, focuses on cash delivery driven by growth in assets under administration and as the number two player in the market by assets managed is expected to leverage opportunities from the fast growing retirement savings market, which will triple in size over the next decade.

The Protection business delivers profitable growth driven by the provision of highly regarded products. The business participates at the premium end of the market offering high quality, innovative products centred on providing value to customers in their time of need.

With an estimated one in nine of all UK retiring DC pension customers, Friends Life is well placed to capitalise on the opportunities afforded by the recent Budget announcement and is developing new simple, flexible propositions and enhanced customer engagement to offer solutions for those customers seeking an alternative to the traditional annuity. However, the Retirement Income business strongly believes that annuities will continue to play a vital role for those customers who value a guaranteed income in retirement and utilises its longevity and fixed interest asset management expertise to offer products that deliver a stable income.

The Corporate Benefits business continues to pursue an asset gathering strategy of growing assets under administration and improving net fund flows, by writing profitable new business and focusing on customer retention. It continues to invest in its core propositions and migration of the book to more cost efficient platforms is progressing in line with expectations.

The business is pleased to announce the appointment of Andy Curran as the new interim UK CEO, subject to regulatory approval. Andy brings with him extensive experience of the UK insurance industry and his experience will be invaluable as the division works to deliver the major programmes and drive forward the business' growth aspirations.

Financial performance

UK division

The UK division delivered strong growth in volumes in the first half of 2014 with APE up 25% to £405 million. Growth has been delivered by the Corporate Benefits and Protection business units which are up 30% and 21% respectively. Retirement Income volumes are only slightly down on the first half of 2013 demonstrating the excellent engagement the business has had with its customers, especially as the impact from the Budget announcement begins to emerge.

VNB is down 20% on the same period of 2013 mainly as a result of improvements in the competitiveness of annuity pricing which has impacted margins, whereas Protection VNB is marginally lower than the same period in 2013 driven by a higher proportion of lower margin group life schemes and reduced margins in individual protection.

Corporate Benefits has delivered positive net fund flows of £0.4 billion with assets under administration increasing to £20.8 billion. A higher proportion of auto-enrolment business resulted in VNB falling £1 million compared to the first half of 2013.

Protection

Protection sales volumes have increased by 21% compared to the first half of 2013, driven by growth in the individual protection proposition. Although volumes in the first quarter of 2013 were depressed due to gender neutral pricing rule changes, there has been continued strong volume growth in this business. In the second quarter of 2014, individual protection sales were up 31% on the second quarter of 2013.

Much of this volume increase has been through individual critical illness. In May, Friends Life strengthened its highly regarded Critical Illness Protect+ products. These enhancements focus on the core illnesses which generate most claims and hence matter the most to the business' customers. These changes ensure the Protect+ range continues to deliver high-quality protection products to customers, and were very well received in the market. Further enhancements are planned across the Protection range in the second half of 2014 to ensure that these products continue to support customers in their time of need.

Overall, Protection VNB is marginally behind the first half of 2013 due to changes in new business mix and margin pressures offsetting the growth in volumes. In addition, an increase in long -term interest rates meaning future emerging profits are worth less in today's terms has also reduced VNB when compared to the first six months of 2013. At a proposition level the contribution from group protection has reduced, reflecting a shift in mix towards lower margin group life business. This reduction is only partially offset by the individual protection proposition where higher volumes, albeit at lower margin as a result of increased competitive market pressure, have resulted in an increased contribution.

Through disciplined use of a modest amount of financial reinsurance and a focus on the cost of writing new business the Group has been able to limit the increase in INB to 5% whilst increasing volumes by 21%.

Retirement Income

The Retirement Income business has delivered strong volumes of new business in the first half of the year, with total volumes less than 10% down on the same period in 2013 despite the changes announced in the Budget. Indeed volumes written in the second quarter, post Budget, are in-line with those written in the first quarter of this year. The business believes that some new business was delayed from the first quarter into the second quarter as customers considered but then re-affirmed their annuity purchase. The business is writing steady volumes of annuities originating from policies with GAOs, which continue to represent strong value for money for customers. Though applications on non-GAO annuities have fallen since the budget, APE has held up as those customers wishing to defer retirement are typically those with a smaller pot, wishing to take advantage of increased commutation limits. While the Retirement Income business is observing an increasing number of customers choosing to defer retirement decisions, the business's improved ability to support its customers in their decision making has helped to address the uncertainties created by the recent Budget and as a consequence resulted in only a moderate fall in new business levels.

The year-on-year reduction in VNB was expected and reflects the improvements made to the competitiveness of the business' annuity proposition through the latter part of 2013.

The business continues to consider entry into the bulk annuity and longevity swap markets; leveraging the Group's expertise in longevity modelling and fixed interest asset management. Any business written will be subject to the strict financial discipline that is applied to the rest of the Group.

Retirement Income remains focused on the mass affluent customer base existing in Heritage and Corporate Benefits. In the lead up to April 2015 when the new rules announced in the Budget come into force, the business' customer service staff will continue to support customers by explaining the effect of the rule changes and customers' range of options. In parallel, the business is developing a new range of services and propositions to ensure customers can enjoy a fully flexible approach to retirement in the post Budget landscape.

Corporate Benefits

Assets under administration

Corporate Benefits has returned to positive net fund flows of £0.4 billion continuing the trend seen in the first quarter of 2014 compared with a flat performance in the first half of 2013. This has contributed to assets under administration increasing to £20.8 billion including market growth of £0.3 billion. Notwithstanding this very pleasing performance, Corporate Benefits has been notified of the potential loss of a large scheme (circa £0.35 billion) which is expected to disinvest in the second half of 2014 to pursue an unbundled proposition.

Regular premiums on existing schemes have shown strong growth principally driven by auto-enrolment with strong new business volumes written in the second half of 2013 and the first half of 2014. In the first half of 2014, 542 employers have auto- enrolled 648 schemes, leading to a net increase in new members of 108,000 to over 1.25 million. This rate of auto-enrolment trajectory is expected to slow materially in the second half of the year as the majority of the business' target customer schemes have now completed their transition.

Income from annual management charges is higher than the first half of 2013 owing to market growth seen in 2013. Expenses have been held at a broadly constant level with only variable expenses, such as investment fees, showing a small increase with volume growth. The growth in income on a largely fixed expense base has led to an increase in underlying free surplus generation from £11 million in the full year 2013 to £14 million in the first half of 2014. This has also resulted in improved positive operational leverage from 9 bps in the first half of 2013 to 13 bps in the first half of 2014.

Corporate Benefits continues to focus on providing value to the customer and has previously communicated that it will be offering all 169 of its schemes with AMDs the chance to move to a single annual management charge ("AMC") in the foreseeable future. This AMC is likely to be the current active member rate, subject to a minimum. So far new terms have been offered to schemes representing around 70% of the total assets under administration of schemes with AMDs.

The Corporate Benefits business has shown strong growth in APE in the first half of 2014, up 30% on the first six months of 2013 with strong growth in sales of new schemes and the client management team renewing their focus on growing the back book through increasing contributions from existing schemes.

The Embassy transition programme which is moving client's assets from the Embassy platform to NGP is showing good progress and is on track to complete in 2014, releasing the cost burden of running a legacy platform. Corporate Benefits has now successfully moved six out of the planned 10 tranches. The remaining four tranches are planned at monthly intervals with the final one expected to transition before the end of 2014.

Since the launch of the Master Trust solution in early 2014, there has been increased interest from key sales partners. In addition, there are growing levels of enquiries to utilise the Master Trust as an alternative buyout vehicle to traditional transfer policies, offering the potential to increase fund flows and assets under administration.

IFRS based operating profit

IFRS based operating profit of £10 million is down by £16 million compared with the first half of 2013. New business strain has increased by £10 million relative to the first half of 2013 principally driven by adverse impacts in the Retirement Income business. This business still generates a positive new business strain, however due to the more competitive positioning of the Retirement Income proposition and lower volumes, the positive new business strain created by the business is below the 2013 level.

In-force surplus has reduced by £9 million, principally driven by a £4 million adverse claims experience in Protection and a £4 million one-off positive adjustment for investment expenses in 2013 that has not been repeated in 2014.

Operating expenses

With the growth in APE of 25%, strong cost control has been exercised and as a result acquisition costs have only increased by £1 million on the same period in 2013. Maintenance expenses are in line with the prior year.

Development costs have reduced as the business has neared the end of a large number of significant investments including auto-enrolment, the launch of Open Market Annuities and Protection proposition enhancements. The business continues to exercise financial discipline in selecting development projects to ensure that value for money is maintained.

Sustainable free surplus generation

SFS is £26 million lower than the first half of 2013 as a result of a higher investment in new business due to the improvements to the competitiveness of annuity pricing and some adverse operating experience variances. Expected returns have increased by £7 million from the first half of 2013 as a result of the profitable new business written in 2013.

The Protection business has delivered a £(7) million underlying free surplus loss, in line with the first six months of 2013, with expected returns up £1 million driven by profitable new business written in 2013. This is offset by higher costs of writing new business as a result of increased volumes and sales mix, despite a £5 million benefit from financial reinsurance.

In Retirement Income underlying free surplus has fallen to £(6) million from a profit in the first half of 2013. Whilst expected return is up by £1 million, this is more than offset by the reduction in new business margins leading to a higher investment in new business, with this primarily driven by the more competitive pricing.

Corporate Benefits, the Group's asset based business, has shown strong cash generation growth with underlying free surplus increasing to £14 million. The table below shows how underlying free surplus is analysed between income and outgoings with the growth in income driven by increasing assets under administration. Income levels are now at 60bps and show growing operating leverage against a stable cost base (outgoings 47bps).

MCEV operating profit

MCEV operating profit before tax is down £7 million compared with the first half of 2013, mainly due to the fall in VNB, partially offset by a £8 million increase in the expected existing business contribution arising from the growth in the business and favourable economics.

Operating experience variances are adverse compared to the first half of 2013 by £14 million. The principal experience items are £4 million as a result of an increase in protection claims and £4 million adverse persistency experience primarily as a result of the impact of scheme re-writes in the Corporate Benefits business.

Operating assumption changes of £14 million reflect a reduction in expected future investment management expenses after the transfer of assets to Schroders and FLI from F&C.

Outlook

The significant changes to the UK retirement savings market resulting from the Budget announcement are far reaching and the UK division is excited by the new opportunities to add value for customers. The division's focus will be on increasing the already strong engagement with its large existing customer base, most of whom do not have an active IFA relationship, and so will be in greater need of support and guidance in order to make an informed choice from the broader range of options now available to them. Utilising the Group's extensive knowledge of customer behaviour, the division has plans to add simple and flexible product propositions to satisfy the increased demand from customers for innovative solutions aligned to their needs.

The Retirement Income business will also continue to meet the needs of customers who value a guaranteed income in retirement. Given the upcoming legislative change there is naturally uncertainty as to the size of the individual annuity market going forward, albeit as a large proportion of the Group's annuity new business arises from policies with GAOs, our volumes are expected to fall comparatively less than the rest of the market. The business is also continuing to look at widening its reach by entering the bulk annuity and longevity swap markets; leveraging the Group's expertise in longevity modelling and fixed interest asset management.

The Corporate Benefits business will continue to drive growth in assets under administration through the right level of attention from relationship managers and appropriate focus on those clients transitioning from the Embassy platform, to ensure high levels of retention. Additional growth opportunities are expected from the development of the Master Trust proposition, recently launched on NGP, and the development of a proposition suitable for small to medium sized employers, which will be particularly important as the business expands distribution into the corporate IFA sector. The business is well placed to benefit from the expected economic recovery. Higher employment levels and salary inflation will drive increased contributions from workplace schemes and growth in financial markets will also drive higher revenue flows and increased operational leverage.

The Protection proposition suite remains highly regarded and the Group is well placed to benefit from strong relationships from the division's partnerships with estate agencies and intermediaries operating through panels. The Protection business continues to develop new channels through existing partners. In addition, greater focus is being placed on strengthening and expanding relationships with key partners, customers and extending distribution reach through employee benefit consultants.

International division 

Half year 2014 highlights

· The first half of 2014 has been a difficult trading period for the International business, FPI, with challenging market conditions and significant regulatory changes. VNB has fallen by 44% from the first half of 2013 and trading is expected to remain challenging in 2014.

· The results of the International division in the first half of 2014 are mixed, with assets under administration in line with 2013. IFRS based operating profit is below the first half of 2013 but in line with the full year 2013 result. MCEV operating profit is adverse to half year 2013, driven by a combination of lower new business volumes and adverse experience variances. Sustainable free surplus generation has been adversely impacted from lower expected return as a result of falling volumes in the past two years.

· The focus of the FPI business continues to be on investing in a new International IT platform and product development to support future growth. The project to build the new business platform is on track for the third quarter of 2014 with the in-force book expected to be on the new platform in 2015.

· Solvency remains above the monitoring levels of 380% coverage. However, in light of recent trading performance, adverse foreign exchange movements and a potential change in the biting capital constraint, the International division will not pay an interim dividend in 2014, and the full year dividend remains under review.

International division's 2013 full year and half year results have been restated to reflect the transfer of OLAB to the Heritage division.

Strategy

FPI continues to focus on building a sustainable business from its portfolio of international licenses in Singapore, Hong Kong, UAE and Isle of Man, focusing on profitable growth and cash generation.

The priorities of the division are to:

· selectively grow the business and generate sales of profitable products;

· improve the efficiency of the back-office and deploy more resources to Asia; and

· target growth in assets under administration to support future cash generation.

Financial performance

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

Due to difficult market conditions for regular premium unit-linked insurance business throughout the regions, as well as competitive and regulatory pressures, APE in the first half of the year has fallen by 33% to £47 million. As a result of the lower volumes combined with relatively fixed acquisition costs, VNB decreased by 44% to £5 million compared to the first half of 2013.

In North Asia, volumes in the first half of the year have principally been impacted by the regulatory changes applied during 2013, resulting in the whole unit-linked insurance market falling by approximately a half in the first quarter of 2014 compared to the first quarter of 2013. In addition, volumes in South Asia dropped by 36% and Middle East fell by 20% compared to the first half in 2013 due to aggressive competitor activity.

In the first half of 2014, FPI launched a new Flexible Future Benefit Trust in the UK offshore region and a Decreasing Term Assurance product in the Middle East region. Both of these new products are expected to improve future trading.

IFRS based operating result

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

IFRS based operating result decreased to £32 million from £41 million in the same period of 2013. This reflects an adverse movement in both economic and experience variances within in-force surplus, due to positive variances in the first half of 2013, not repeated in 2014.

New business strain has decreased since 2013 principally due to lower sales of protection business.

Operating expenses

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

(ii) Development costs are shown gross of the 2013 platform provision release and agree to IFRS based operating profit only

Operating expenses, which exclude commission payments and non-recurring costs, increased marginally to £26 million from £25 million in the first half of 2013. An increase in acquisition costs was offset by a reduction in maintenance costs. Development expenditure amounting to £4 million principally reflects the cost of building the new IT platform. All planned future expenditure on the new International IT platform was provided for in 2013 under MCEV and SFS.

Sustainable free surplus generation

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

Sustainable free surplus decreased by £5 million to £9 million, mainly due to lower expected return as a result of falling volumes in the past two years.

Expected return from in-force business has decreased by £16 million due to lower in-force surplus emerging from the FPI back-book as a result of 2013 sales volumes being lower than 2012. Given the levels of APE in 2014 it is expected that the returns will drop further in 2015. This is partially offset by investment in new business being £10 million lower than the first half of 2013 also principally due to lower sales volumes.

MCEV operating result

(i) 2013 results have been restated to reflect the transfer of OLAB from the International to Heritage division

MCEV operating profit of £12 million has decreased by £3 million and principally reflects a £4 million fall in VNB as a result of difficult market conditions for regular premium unit-linked insurance business throughout the regions.

The expected existing business contribution has increased from £8 million to £11 million, reflecting a larger book of business combined with higher expected rates of return.

The operating experience variances of £(2) million is driven by a small increase in provisions.

Outlook

Despite disappointing first half results in 2014, the Group continues to focus on turning around the FPI business and remains confident that the International division will make an increasing contribution towards generating shareholder cash and value for the future.

FPI has completed the process of reviewing its markets and de-risking its business. The business is focused on delivering profitable growth within its core markets and building on its licences and strong relationships in the Middle East and Asia. The Group believes that recent regulatory changes in the Middle East will strengthen FPI's competitive position in that region.

The new International platform is being implemented and is expected to be ready to accept new business by the end of the third quarter of 2014 with the in-force business phase following in 2015. This will support future growth and product development and improve the division's competitive position. The changes to the product range are underway with the launch of two new products on the existing platform.

Discontinued operations - Lombard

On 11 July 2014 the Group announced the sale of its Luxembourg based business, Lombard. The deal, which is subject to regulatory approval, is expected to complete in the second half of 2014. For more details on this transaction, see note 2d.

The financial impact of the proposed sale, including the operating and non-operating results for the period, are included below:

Financial performance

(i) Free surplus is presented net of tax.

Within the MCEV result and consistent with CFO forum principles, a capital adjustment totalling £(268) million has been made for the remeasurement of the carrying value amount of Lombard. This is excluded from the above table.

IFRS based operating result

Lombard generated an IFRS based operating profit before tax of £12 million in the first half of 2014, £8 million below the first half of 2013. The decrease principally reflects one-off costs incurred as a result of the expected sale of the business and lower AMCs resulting from adverse persistency experience since 2013.

Assets under administration

Assets under administration increased by €0.2 billion since the beginning of the year, however fell by £0.6 billion mainly due to exchange losses. Adverse currency fluctuations, together with negative fund flows are only partly offset by a positive net investment return.

Sustainable free surplus generation

Sustainable free surplus of £1 million is down £4 million on 2013. The result is driven by one-off expenses incurred due to the sale of the business.

MCEV operating result

As a result of the difficult trading environment in Lombard's core markets, due largely to the regulatory and legal framework changes and uncertainty around the sale of the business, the MCEV operating result for 2014 is materially down on 2013, resulting in a loss of £(2) million. The result reflects a lower contribution from new business and materially adverse persistency experience particularly in Belgium as a result of tax and legal changes.

Expected existing business contribution has remained stable at £18 million because the impact of higher economic assumptions is offset by the lower opening value of the in-force book following the 2013 year end long term assumption changes.

Corporate review

The Corporate segment includes the corporate holding and service companies, as well as the net debt liabilities of the Group.

IFRS based operating result

The Corporate IFRS based operating result is principally driven by external finance costs and corporate costs, offset by interest on internal debt.

The other corporate net costs of £(15) million principally relate to overhead costs associated with management of the Friends Life holding companies principally in respect of investor related activities.

Sustainable free surplus generation

The sustainable free surplus contribution from Corporate principally reflects the debt costs (net of tax) incurred by the Group. Increases in external debt costs in the first half of 2014 reflect the reduction in the rate of corporation tax. Sustainable free surplus excludes corporate costs in respect of investor related activities.

MCEV operating results

The Corporate segment consists of both non-covered and covered business. The non-covered element relates to the net assets of the corporate holding and service companies whilst the covered element principally represents the net debt liabilities held at the Group level.

The expected existing business contribution on debt has reduced following a decrease in the expected rate of return applied to external debt.

Financing and interest costs

The Group has a number of debt instruments and the operating costs of financing these for the period ended 30 June 2014 are presented below.

(i) Market value is based on listed ask price, at 30 June 2014, excluding accrued interest.

(ii) The UT2 reset perpetual subordinated debt is a $575 million US Dollar denominated instrument. The principal and clean market values represent sterling equivalent values as at 30 June 2014. The finance cost of £14 million is based on the sterling equivalent principal on the day of issue of £356 million.

(iii) Finance costs within sustainable free surplus amount to £(47) million, being the IFRS amount of £(60) million net of tax.

Gearing and liquidity

(i) Loans and borrowings as reported on the IFRS balance sheet where debt is measured at amortised cost. See note 10. IFRS debt gearing excludes the 2003 and 2005 STICS, as these securities are classified as equity in IFRS.

(i) Debt being the clean market value of the debt as at 30 June 2014 and the currency swap associated with the UT2 reset perpetual subordinated debt.

At 30 June 2014, the ratio of debt to IFRS equity attributable to equity holders of the parent, gross of debt, was 17.2% (31 December 2013: 16.7%), with the change in equity principally reflecting the payment of dividends in the period.

The MCEV gearing of 22.7% (31 December 2013: 21.1%) is up in the period principally reflecting the decrease in gross Group MCEV.

The liquidity of the Group remains strong and is complemented with an undrawn £250 million funding facility with a consortium of banks.

Cash and capital

Introduction

The Group remains committed to the optimisation of capital within the business. The Group has established cash and capital frameworks which are used to evaluate and monitor excess cash and capital, driven by strong governance and subject to regulatory approval. The cash and capital position of the Group including Lombard at 30 June 2014 remains strong with ASA of £917 million and an estimated IGCA surplus of £2.2 billion resulting in a coverage ratio, excluding WPICC, of 235%. At 30 June 2014 the estimated economic capital surplus at Group level was £4.0 billion corresponding to a coverage ratio of 193%.

Cash and capital definitions

(i) WPICC represents the difference between the surplus capital calculated on a regulatory basis and that on a realistic basis, in accordance with regulations, and is excluded from both IGCA capital resources and capital resources requirements under the CMP.

(ii) Economic capital represents management's internal risk-based estimate of the amount of capital needed to be held to mitigate the risk of insolvency to a minimum of a 99.5% confidence level over a one year period. The coverage ratio represents the proportion of capital resources to capital resource requirements.

(iii) The IGCA and economic capital position at 30 June 2014 of the Group and its subsidiaries are estimated.

Capital management policies and monitoring buffers

The Group's capital management policies ("CMPs") that apply at a life company level and at the Group level were set out in the 2013 full year results. These policies remain unchanged and are summarised below.

Life companies CMP

The CMP of FLL, the principal UK life company, is to meet the higher of:

· 150% of Pillar 1 requirements, excluding WPICC, FPIL and Lombard; and

· 125% of Pillar 2 requirements, including any ICG and specifically excluding FPIL and Lombard.

In addition to the above, capital within FLL is held to cover at least one year of the FLL debt servicing costs (currently £115 million per annum) and any debt repayment requirements in the following year.

Group CMP

The CMP at Group level is to meet 150% of IGCA requirements, excluding WPICC. In order to protect the CMP in the highly remote event that payment of debt costs would lead to a breach of the policy, the Group has an additional requirement in respect of debt servicing costs. This requirement is to hold excess capital, over 150%, in the form of cash or cash equivalents at holding company level sufficient to pay at least the next year's gross annual interest cost (currently £120 million per annum) and any mandatory repayments of principal that fall due on debt in the next year.

Capital monitoring buffers

The Group has a robust monitoring system and in addition to the amounts held to meet its CMPs, it holds a prudence buffer together with a monitoring buffer held within working capital.

The prudence buffer is designed to cover an additional year of the Company's current dividend and the holding companies' corporate costs and is currently £325 million, reflecting the current level of dividends and corporate costs.

The monitoring buffers for the Group and life companies are reviewed regularly alongside the Group and life company solvency risk appetites. At 30 June 2014 the biting constraint is the Group IGCA position, and a monitoring buffer of 10% of the IGCA requirements, excluding WPICC, is held within the working capital.

Cash and capital management framework

The Group's cash and capital management framework is based on MCEV as this comprises the discounted value of expected future cash flows on a market consistent basis. The chart below shows how the core components of MCEV reconcile to ASA as at 30 June 2014.

The total MCEV is split between the net worth, or shareholder resources, and the VIF. Shareholder resources comprise the free surplus, required capital and inadmissible assets of the business. Required capital is based on the most onerous CMP for the Group, currently the IGCA. For the holding companies and other non-regulated businesses, free surplus is defined as IFRS net assets less required capital and inadmissible assets on an IGCA basis (for MCEV, where these assets relate to non-covered business, they are all included within free surplus). VIF comprises the value of the future cash flows arising from the policies currently in-force.

External debt issued by FLH is offset against required capital in the life businesses as this debt has been guaranteed by life operating companies and has been used to support their activities.

Working capital represents assets set aside to cover known future requirements and amounts necessary to maintain sufficient flexibility to facilitate compliance with the Group CMP and additional regulatory requirements. In addition, any assets subject to restriction in their availability to shareholders will be designated as working capital and this includes any free surplus held in the life companies in excess of the life companies CMP.

ASA consists of cash and other liquid assets held by the Friends Life holding companies, together with any dividends declared and approved by the operating companies that are yet to be remitted. As such, ASA is stated after the deduction of working capital from free surplus. ASA represents cash available to cover Friends Life's corporate costs, to service debt issued by holding companies and, subject to shareholder approval, to pay dividends or returns to shareholders. The generation of ASA therefore represents a key performance metric of the Group.

The following table outlines the key movements in each of the components of total MCEV during the period:

(i) Required capital is calculated based on the requirements under the Group CMP, and includes required capital of £202 million (2013: £224 million) in respect of non-covered business and £22 million (2013: £21 million) in respect of covered business.

The free surplus generated in the period of £172 million principally reflects the £163 million sustainable free surplus result with the benefit of positive economic variances partially offset by non-recurring items. 

Other reserve movements include the impact of foreign exchange movements and actuarial losses on the Group's defined benefit pension scheme.

Working capital and other assets and liabilities

The working capital at 30 June 2014 of £483 million has reduced from the £534 million held at 31 December 2013 and is held in both the life companies and the holding companies.

The working capital comprises:

· amounts required to meet current estimates of future non-recurring costs and discretionary working capital allowances offset by related benefits that are expected in the short term;

· an appropriate monitoring buffer to facilitate ongoing compliance with the Group's CMPs;

· amounts to cover the necessary funding to protect against any temporary shortfall in delivery of cash generation relative to Group targets; and

· restricted assets included within free surplus e.g. illiquid or intangible assets and any assets in excess of the CMP held within the life companies. This includes a contribution to the 2014 final dividend in the first half of the year which will only be released to ASA once the year end actuarial valuations have been completed.

The largest components of working capital are the monitoring buffer (£163 million), the amounts set aside to meet non-recurring costs (£106 million), and amounts retained within the life companies in excess of the CMP (£89 million).

Available shareholder assets

The ASA of £917 million comprises £778 million of shareholder cash at Friends Life holding company level (including the £120 million interim dividend proposed by FLL) and £139 million of investments in syndicated loans.

The following table outlines the key components of ASA by reference to the expected utilisation of the cash balances:

The ASA balance as at 30 June 2014 is held to cover the costs of the proposed interim dividend and to maintain a prudence buffer of £325 million which is designed to cover an additional year of the Company's current dividend cost, and the holding companies corporate costs. The Group CMP requirement to hold cash at FLH sufficient to meet one year of FLH's debt servicing costs is expected to be met from capital retained in the life companies. This is not considered to be a restriction on the availability of FLH cash, however is covered by the additional ASA holdings at Group level.

The proposed share buy-back of £317 million following completion of the sale of Lombard will be funded by £261 million of expected cash proceeds from the sale with the balance of £56 million being funded from ASA.

Economic capital position

The UK life operations perform a risk-based assessment of economic capital, incorporating management's estimate of the capital required to mitigate the risk of insolvency to a minimum of a 99.5% confidence level over a one year period ("the ICA"). At an individual life company level this is referred to as the Pillar 2 basis of capital management.

The Group's CMP is to maintain capital resources at the life company level to cover 125% of the capital requirements on an economic capital basis.

The Group also monitors a pro forma economic capital position at a Group level, which comprises:

· the surplus of FLL, excluding FPIL and Lombard, on an economic capital basis;

· the surpluses of the International life companies on an economic capital basis; and

· the fungible net assets of the other operating and holding companies.

The estimated Group economic capital surplus above capital requirements as at 30 June 2014 is strong at £4.0 billion (a coverage ratio of 193%). The change since 31 December 2013 (surplus of £3.9 billion) primarily reflects the generation of operating profit, offset by external dividend payments.

The sensitivities to market shocks show that economic capital surplus at a Group level would change by:

· an estimated £(0.7) billion in the event of a combined 40% fall in equity markets and a 30% fall in property markets;

· an estimated £0.2 billion in the event of a 200bps rise in interest rates; and

· an estimated £(0.5) billion in the event of a widening of corporate bond spreads of 200bps (of which one-third is assumed to relate to defaults).

The impact of the sale of Lombard and proposed share buy-back of £317 million on the Group's estimated economic capital surplus is expected to be a reduction of £(0.3) billion, which if the sale and share buy-back had occurred at 30 June 2014 would have reduced the Group's estimated economic capital surplus from £4.0 billion to £3.7 billion with the coverage ratio marginally reducing to 192%. The estimated sensitivities of the economic capital surplus to interest rates and corporate bond spreads remain unchanged, but the sensitivity to a 40% fall in equities and 30% fall in property values would change from £(0.7) billion to £(0.6) billion.

Insurance Groups Capital Adequacy

In addition to individual company requirements, the Group is required to meet the IGCA requirements of the Insurance Groups Directive. The Group's capital policy is to maintain sufficient Group capital resources to cover 150% of Group CRR (excluding WPICC).

The balance sheet remains strong with an estimated IGCA surplus of £2.2 billion at 30 June 2014, with Group capital resources being 235% of Group CRR (excluding WPICC of £4.3 billion).

The movement in IGCA surplus over the period largely reflects the generation of surplus offset by external dividend paid.

At 30 June 2014 the capital held to meet CMPs was £816 million (1 January 2014: £812 million) and the excess over the CMPs was £1,384 million (1 January 2014: £1,424 million).

The sensitivities to market shocks show that IGCA surplus would change by:

· an estimated £(0.2) billion in the event of a combined 40% fall in equity markets and a 30% fall in property markets;

· an estimated £0.2 billion in the event of a 200bps rise in interest rates; and

· an estimated £(0.6) billion in the event of a widening of corporate bond spreads of 200bps (of which one-third is assumed to relate to defaults).

The impact of the sale of Lombard and proposed share buy-back of £317 million on the Group's Pillar 1 capital is expected to be a reduction in the IGCA surplus of £0.1 billion, which if the sale and share buy-back had occurred on 30 June 2014 would have reduced the Group's estimated IGCA surplus to £2.1 billion and with coverage marginally reducing to 233%. The estimated sensitivities of the IGCA surplus to market shocks would be unchanged.

Asset quality and exposure

The Group's financial assets as at 30 June 2014, excluding cash, are summarised as follows:

Shareholder exposure to corporate bonds and asset-backed securities is analysed by fund and credit rating as follows:

97.3% of the corporate bonds and asset-backed securities to which the shareholder funds are exposed are investment grade. The Group controls its exposures to corporate issuers by rating, type of instrument and type of issuer. The sub-investment grade bonds held in investment portfolios are monitored closely in order to maximise exit values. Where asset-backed securities and other complex securities are held, the Group monitors closely its exposures to ensure that the relevant structure, liquidity and tail credit risks are well understood and controlled.

No defaults have been experienced in the period to 30 June 2014. The Group holds default reserves to cover the risk of defaults and credit rating downgrades on corporate bonds that back all annuity business within Friends Life group. The reserves reflect assumed defaults over the outstanding terms to maturity of the bonds. The shareholder share of default reserves at 30 June 2014 was £0.44 billion (31 December 2013: £0.45 billion). This represents a haircut of 50% of the overall corporate bond spreads over gilts of equivalent term (31 December 2013: 48%).

Financial strength ratings

The Group targets financial strength ratings in the single A range for its principal life business and expects them to remain there for the foreseeable future. Current financial strength ratings are set out below.

Principal risks and uncertainties

The Group actively manages its risk profile and the Group's risk appetite framework drives the identification and mitigation of strategic, group, financial and operational risks to support the achievement of its objectives. The Group included details of the principal risks and uncertainties related to its business on pages 67 to 69 of its 2013 Annual Report and Accounts.. The principal risks and uncertainties to which the Group has been exposed during the first six months of 2014 are unchanged from those described in the 2013 Annual Report and Accounts. These are:

· Regulatory change, including taxation and Solvency II

· Economic conditions

· Credit

· Principal valuation assumptions

· Outsourcing

All of these are expected to remain relevant and applicable for the remainder of 2014.

The well publicised proposals in the Chancellor's 2014 Budget for increased choice within the pensions and retirement market pose a challenge to the current structure of the annuity market. The implications of the change will be borne out over time, with the new flexibility available to retirees expected to result in a sustained reduction in annuity new business volumes across the industry.

The Group considers itself well placed to deal with the changes to the annuity market, as currently known. The fundamentals for growth in the retirement provision market and the strength of the business' competitive position within this market are both unchanged. As part of the Group's annual strategic review, the Group will consider the customer engagement profile and are developing broader retirement income propositions to provide more flexibility and choice through the retirement process. The proposals will not affect the Group's short term ability to generate cash but will impact on the delivery of the value of new business target.

Linked to the annuity developments, the Chancellor has committed that all vesting customers will have access to free, impartial guidance. The Group will continue to monitor emerging requirements and consider how best to ensure compliance while maintaining the best interests of existing and potential customers.

In March, the Financial Conduct Authority ('FCA') announced that they would undertake an industry wide review into the fair treatment of long standing customers in life insurance. A review is underway into the way in which the FCA's proposed review was announced given that the announcement had a significant detrimental effect on the share price of leading life assurers with closed funds, including Friends Life. Given the significant book of legacy business within the Heritage division, the Group will proactively engage with the FCA review and closely monitor implications for the industry arising from the review outcomes.

Solvency II, which starts on 1 January 2016, will have implications for the whole industry as to the way in which companies calculate capital. There remains further work to transition the Group across to a Solvency II basis and the Group's internal programme to achieve this is fully mobilised. Through the transition, there will be an impact in terms of the way in which the Group needs to hold capital and this will be adjusted accordingly and in a manner that best serves Friends Life's customers and shareholders.

There is a risk that politically motivated changes will impact on the insurance market in the run up to the next UK General Election which will be called on or before 7 May 2015. Further, the economic implications of Scottish independence, whether it is attained or not, along with rising anti-EU sentiment across the UK and Europe present uncertainty for UK businesses.

More broadly, the Eurozone's economic recovery suffered a setback in the first quarter after slower-than-expected growth. The economy grew just 0.2% in the first three months of 2014; GDP in the second quarter has been forecasted to increase by 0.4% on the first quarter. Global economic activity has broadly strengthened, whilst remaining fragile and is expected to improve through 2014, with much of the impetus coming from developed economies

The reliance of the Group on outsource service providers is unchanged. Processes for managing all outsourcing contracts are actively monitored and managed, in particular in relation to service improvement plans.

As stated in note 1 to the condensed consolidated financial statements, the directors are satisfied that the Group has sufficient resources to continue in operation for the foreseeable future, a period of not less than 12 months from the date of this report. Accordingly, they continue to adopt the going concern basis in preparing the condensed consolidated financial statements.

Going concern and Directors' responsibility statement

Going concern

The directors have undertaken a going concern assessment in accordance with "Going Concern and Liquidity Risk: Guidance for UK directors of UK Companies 2009", published by the Financial Reporting Council in October 2009. As a result of this assessment, the directors are satisfied that the Group and the Company have adequate resources to continue to operate as a going concern for the foreseeable future and have prepared the financial statements on that basis. In assessing whether the going concern basis is appropriate, the directors have considered the information contained in the financial statements, the latest business plan profit forecasts, the latest working capital forecasts and estimated forecast solvency of the regulated subsidiaries of the Group. These forecasts have been subject to sensitivity tests and the directors are satisfied that the Group and Company have adequate resources to continue in operational existence for the foreseeable future. Key information in respect of the Group's business activities, financial performance (including cash generation and financial strength) and risks is set out in the Business Review section of this document.

Directors' responsibilities

Each of the directors of the Company confirms that to the best of their knowledge:

· the condensed consolidated financial statements have been prepared in accordance with IAS 34: Interim financial reporting as adopted by the European Union;

· the interim results statement includes a fair review of the information required by Disclosure and Transparency Rule 4.2.7, namely important events that have occurred during the period and their impact on the condensed consolidated financial statements, as well as a description of the principal risks and uncertainties faced by the Company and the undertakings included in the condensed consolidated financial statements taken as a whole for the remaining six months of the financial year; and

· the interim results statement includes a fair review of material related party transactions and any material changes in the related party transactions described in the last annual report as required by Disclosure and Transparency Rule 4.2.8.

On behalf of the Board

Tim Tookey

Chief Financial Officer

5 August 2014

Independent review report to Friends Life Group Limited

Introduction

We have been engaged by the Company to review the condensed set of financial statements in the interim results statement for the six months ended 30 June 2014 which comprises the condensed consolidated income statement, the condensed consolidated statement of comprehensive income, the condensed consolidated statement of IFRS based operating profit, the condensed consolidated statement of financial position, the condensed consolidated statement of changes in equity, the condensed consolidated statement of cash flows and the related notes 1 to 14. We have read the other information contained in the interim results statement and considered whether it contains any apparent misstatements or material inconsistencies with the information in the condensed set of financial statements.

This report is made solely to the Company in accordance with guidance contained in International Standard on Review Engagements 2410 (UK and Ireland) "Review of Interim Financial Information Performed by the Independent Auditor of the Entity" issued by the Auditing Practices Board. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company, for our work, for this report, or for the conclusions we have formed.

Directors' responsibilities

The interim results statement is the responsibility of, and has been approved by, the directors. The directors are responsible for preparing the interim results statement in accordance with the Disclosure and Transparency Rules of the United Kingdom's Financial Conduct Authority.

As disclosed in note 1, the annual financial statements of the Group are prepared in accordance with IFRSs as adopted by the European Union. The condensed set of financial statements included in this interim results statement has been prepared in accordance with International Accounting Standard 34: Interim financial reporting, as adopted by the European Union.

Our responsibility

Our responsibility is to express to the Company a conclusion on the condensed set of financial statements in the interim results statement based on our review.

Scope of review

We conducted our review 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 United Kingdom. A review of interim financial 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 interim results statement for the six months ended 30 June 2014 is not prepared, in all material respects, in accordance with International Accounting Standard 34 as adopted by the European Union and the Disclosure and Transparency Rules of the United Kingdom's Financial Conduct Authority.

Ernst & Young LLP

London

5 August 2014

IFRS FINANCIAL INFORMATION

Condensed consolidated income statement

The notes 1 to 14 form an integral part of these financial statements.

The condensed consolidated income statement includes the results of Lombard as a discontinued operation. A single amount is shown on the face of the income statement comprising the segment's post-tax result, the post-tax loss recognised on the remeasurement of its net assets to fair value less cost to sell and associated corporate non-recurring costs of disposal. 2013 results have been restated to reflect Lombard as a discontinued operation.

Condensed consolidated statement of comprehensive income

(i) Foreign exchange adjustments relate to the translation of overseas subsidiaries.

(ii) Shadow accounting that may be reclassified subsequently to profit and loss is as a result of a loss of £(2) million (30 June 2013: gain of £8 million, 31 December 2013: loss of £(4) million) included within foreign exchange adjustments on translation of overseas subsidiaries held by a with-profits fund of Friends Life Limited ("FLL").

Condensed consolidated statement of IFRS based operating profit

(i) IFRS based operating profit excludes:

(a) profit or loss from discontinued operations;

(b) investment variances on unit-linked sterling reserves and the assets backing these reserves, which in previous periods were included within operating profit. This is a change in approach for 2014 but does not materially impact the 2013 comparative results and these have not been restated for this change;

(c) investment variances from expected investment return for non-linked business which is calculated using a longer term rate of return;

(d) returns attributable to non-controlling interests in policyholder funds;

(e) significant non-recurring items;

(f) amortisation and impairment of present value of acquired in-force business and other intangible assets; and is stated after policyholder tax and the deduction of interest payable on STICS. Given the long-term nature of the Group's operations, IFRS based operating profit is considered to be a better measure of the performance of the Group and this measure of profit is used internally to monitor the Group's IFRS results.

Condensed consolidated statement of financial position