Interim Results - Part 1

8th Aug 2006 07:02

Friends Provident PLC08 August 2006 Part 1 8 August 2006 Friends Provident plc Interim results for the half year ended 30 June 2006 Continued profitable growth Group highlights • Excellent Life & Pensions sales - Total Life & Pensions sales (PVNBP*) up 39% to £3,032 million (2005: £2,185m) - Total Life & Pensions sales (APE*) up 46% to £448 million (2005: £306m) • Strong performance in the UK - UK Life & Pensions new business profits up 51% to £53 million (2005: £35m) and margin improved to 2.6% (2005: 2.3%) • Continued growth in International - International Life & Pensions new business profits up 57% to £36 million (2005: £23m) and margin increased to 3.6% (2005: 3.4%) • Asset Management result maintained - Underlying profit before tax £51 million (2005: £52m) • Progress in Group EEV underlying profit result masked by mainly one-off items of £46 million in 2005 - Group EEV underlying profit before tax £247 million (2005: £272m), down 9% __________________________________________________________________________________________ EEV basis* IFRS basis* Half year ended Half year ended 30 June 30 June 2006 2005 Change 2006 2005 Change __________________________________________________________________________________________Group underlying profit before tax £247m £272m -9% £120m £125m -4% Group profit before tax# £60m £279m -78% £48m £206m -77%Life & Pensions PVNBP £3,032m £2,185m +39% - - -Contribution to profits from Life & Pensions new business £89m £58m +53% - - -Pro forma embedded value £3,451m £3,464m## - - - -Pro forma embedded value per share £1.63 £1.65## -1% - - -Underlying earnings per share 8.0p 8.5p -6% 3.8p 5.6p -32%Basic earnings/(loss) per share 3.8p 8.5p -55% (0.6)p 5.0p -112% Interim dividend per share 2.65p 2.60p +2% 2.65p 2.60p +2%__________________________________________________________________________________________ # The fall in Group profit before tax, under both reporting bases, was caused bya reversal in the investment return and economic basis items which aroseprincipally as a result of an increase in fixed interest yields, and a writedown in the carrying value of intangibles in F&C. Details are set out in theFinancial Review Section. ## as at 31 December 2005 * See notes to editors Keith Satchell, group chief executive, said: "The Group has excellent momentum underpinned by our leading scaleabletechnology platform and reputation for outstanding customer service. We hadrecord new business profits last year and this year has started even morestrongly as demonstrated by the excellent 53% increase in life and pensions newbusiness profits. "Friends Provident is now a major player in the UK market and well positionedfor continued strong organic growth with considerable opportunities available.Our recently announced plans to develop a wrap platform are just one example.Our international operations are developing rapidly in markets where we havebarely scratched the surface. Despite a tough start to the year F&C continues tomake good progress in implementing its programme of performance improvement andupgrading of resources. It also saw excellent growth of 158% in net UK retailfunds flows on the back of improved market sentiment and increased marketingactivity. "We remain confident that all three of our businesses will continue to deliverprofitable long-term growth." Philip Moore, group finance director, said: "Margins for our life and pensions operations increased, despite a shift in thebusiness mix towards lower margin products. This demonstrates the benefits ofour leading administration platform and continued tight control of expenses.Over the last five years we have doubled our UK new business volumes and keptoperating expenses broadly flat. Market share in our chosen segments isincreasing. Our share of the protection market grew to 7.1% on the back of oure-select proposition and we now command over 10% of the UK group pensions newbusiness market - business which sticks with us and is profitable. "Our growing portfolio of in-force business is cash generative. This hasprovided the bulk of funding to reinvest in writing profitable life and pensionsnew business in the UK, with the balance more than capable of being covered byreinsurance financing. Our fast-growing International business remains broadlyself-financing and F&C is cash generative. Taken together, we can support anattractive dividend. "EEV profits before tax were adversely affected by the falls in the value offixed interest investments and the adjustment to the carrying value of F&Cmanagement contracts. Nevertheless, F&C's underlying results remained steady.Taking into account adjustments for the one-off positive variances and changesin 2005, our underlying profits are on an encouraging trend. Our primary aimremains to add to the value of the business." - Ends - For further information, please contact:Nick Boakes Friends Provident plc 0845 641 7814 Di Skidmore Friends Provident plc 0845 641 7833 Simon Moyse Finsbury Limited 020 7251 3801 Ref: G119 Notes to editors: 1. An interview with Keith Satchell, group chief executive and PhilipMoore, group finance director, will be available to view in video, audio andtext formats at www.friendsprovident.com and www.cantos.com from 7.00am today. 2. An analyst presentation will take place at 9.30am today at JPMorganCazenove, 20 Moorgate, London EC2R 6DA. 3. The analyst presentation will be webcast live and can be viewed on theFriends Provident website: www.friendsprovident.com/results 4. The presentation slides will be available from 9.30am today onwww.friendsprovident.com/presentations 5. Friends Provident media image library is available atwww.friendsprovident.com/imagelibrary. A Newscast login is required. 6. Financial reporting dates Dividend dates: Shares go ex dividend 4 October 2006 Record date 6 October 2006 Dividend paid 24 November 2006 Financial Reporting Calendar: UK Life & Pensions presentation 31 October 2006 Friends Provident quarter 3 Life & Pensions new business 31 October 2006 F&C Asset Management plc quarter 3 funds under management 31 October 2006 Friends Provident full year Life & Pensions new business 31 January 2007 F&C Asset Management plc quarter 4 funds under management 31 January 2007 F&C Asset Management plc preliminary results 15 March 2007 Friends Provident plc preliminary results 20 March 2007 7. European Embedded Value (EEV) underlying profit is a measure of profitwhich excludes profit generated within policyholder funds that is not allocatedto shareholders. Management consider that underlying profit better reflects theongoing performance of the Group and focus on this measure of profit in itsinternal monitoring of the Group's EEV results. EEV underlying profit is basedon expected investment return and excludes: (i) amortisation and impairment ofAsset Management acquired intangible assets (ii) effect of economic assumptionchanges (iii) non-recurring items; and is stated after deducting interestpayable on Step-up Tier one Insurance Capital Securities (STICS). 8. International Financial Reporting Standards (IFRS) underlying profitis a measure of profit which excludes profit generated within policyholder fundsthat is not allocated to shareholders. Management consider that underlyingprofit better reflects the ongoing performance of the Group and focus on thismeasure of profit in its internal monitoring of the Group's IFRS results. IFRSunderlying profit is based on longer-term investment return and excludes: (i)policyholder tax, (ii) returns attributable to minority interests inpolicyholder funds, (iii) non-recurring items, (iv) amortisation and impairmentof acquired intangible assets and present value of acquired in-force business;and is stated after deducting interest payable on STICS. 9. Pro forma embedded value is the shareholders' equity on an EEV basis,adjusted to bring the value of F&C to market value. 10. New business is reported on the Present Value of New Business Premiums(PVNBP) basis, which represents new single premiums plus the expected presentvalue of new business regular premiums. A table detailing sales on an AnnualisedPremium Equivalent (APE) basis (annualised new regular premiums plus 10% ofsingle premiums) is at the back of this announcement. 11. Underlying earnings per share is based on the EEV/IFRS underlying profitafter tax attributable to ordinary shareholders of the parent. 12. Interim dividend per share is based on the interim dividend of 2.65ppayable in November 2006 (2005: 2.60p paid in November 2005). 13. Certain statements contained in this announcement constitute'forward-looking statements'. Such forward-looking statements involve risks,uncertainties and other factors, which may cause the actual results, performanceor achievements, from time to time, of Friends Provident plc, its subsidiariesand subsidiary undertakings or industry results to be materially different fromany future results, performance or achievements expressed or implied by suchforward-looking statements. Such risks, uncertainties and other factors include,among others, adverse changes to laws or regulations; risks in respect oftaxation; unforeseen liabilities from product reviews; asset shortfalls againstproduct liabilities; changes in the general economic environment; levels andtrends in mortality, morbidity and persistency; restrictions on access toproduct distribution channels; increased competition; and the ability to attractand retain personnel. These forward-looking statements are made only as at thedate of this announcement and, save where required in order to comply with theListing Rules, there is no obligation on Friends Provident plc to update suchforward-looking statements. BUSINESS REVIEW GROUP PROGRESS AND OUTLOOK 2005 was a very successful year for the Group and the first half of 2006 hasdelivered robust growth in Life & Pensions new business profits against the sameperiod last year. The Group is managed as three core businesses: UK Life &Pensions; International Life & Pensions and Asset Management. We seeopportunities for further significant organic growth in each of these. Total Life & Pensions new business profit was up by 53% at £89 million (2005:£58m) while the total net margin improved to 2.9% (2005: 2.7%). This improvementwas partly due to a slight shift in the mix towards International business, butmainly due to the effect of increased volumes in the UK on a relatively flatoperating expense base. F&C's underlying profits have been sustained at aroundhalf of the full year 2005 level although this includes certain revenues thatwill not recur in the second half of the year. Group EEV underlying profits did not benefit from 2005's significant one-offitems. This year experience variances have been modestly negative at £8 millioncompared to positive £16 million in 2005. There have been no operatingassumption changes, whereas an update to realistic balance sheet assumptionsboosted the 2005 result by some £30 million. The cash position of the Group remains comfortable despite the demands ofincreased new business in the fast-growing life and pensions operations. Theresult for the first half does not reflect the offsetting cash flows fromreinsurance agreements expected to be received in the second half of the year. In July, the credit rating agency Moody's upgraded the financial strength ratingfor Friends Provident Life and Pensions Limited (FPLP) from A2 to A1 and made acorresponding change to Friends Provident plc's issuer rating for debt. TheGroup's main pension scheme remains in good health with a very modest deficit of2.6% of liabilities. Actions are being taken to further reduce the deficit andlimit the longer term risk in the scheme. Customer service is increasingly becoming a key differentiator. Being voted LifeInsurer of the Year at the recent British Insurance Awards acknowledges theconsiderable advances we are making. F&C was also the only fund manager to winthe Financial Advisor 5 star Service Award. Our current initiatives, '6 Star'for Friends Provident Life & Pensions and 'Performance First' in F&C, aim toensure continued leadership. We have identified attractive opportunities in both the UK and Internationalmarkets to accelerate profitable growth in Life & Pensions that will lead tofurther investment in development activities. We have announced initiatives inGermany, Singapore and Switzerland, and intend to outline our plans for the UKin the Autumn. F&C has made encouraging progress with its strategic focus onperformance and quality new hires. This will improve investment performancewhich is the prerequisite for long-term organic growth. We will pursue potential growth while reducing unit costs and continuing tomanage risk, cash and capital actively. The Group outlook remains one of strong organic growth. UK LIFE & PENSIONS Our view of the market Overall, market growth was 28% year-on-year in the first quarter, reflectingincreased consumer confidence and A-day related activity. Second quarter figuresare not yet available at an industry level, but we expect growth overall to havecontinued at a healthy level. A large proportion of the protection market is mortgage-related and dependent onhousing transactions. Housing market indicators have in general been marginallypositive. The protection market continues to be competitive. Returning consumer confidence in financial products boosted the investmentsmarket in the first part of the year, and has not been stalled by increasedvolatility in the second quarter. This market is increasingly focused on assetallocation and on platforms which offer financial planning and monitoring tools.We expect the wrap market to grow significantly over the next few yearsreinforced by feedback from IFAs that many will want to manage their business inthis way in the future. In the group pensions market, demand has been stimulated by the A-day changes inApril. These changes are expected to continue to impact demand for at least 18months, although not at the same level as the heightened demand in the secondquarter. The shift from defined benefit to defined contribution schemes hasaccelerated, and the trend away from trust-based towards contract-basedarrangements will continue. Strong market activity should be sustained over themedium term by a combination of these factors. In individual pensions, the single premium segment of the market continues tooffer more attractive returns than the highly competitive regular premiumsegment. Demand for consolidation of smaller pension pots into a single policywill remain healthy. DWP rebate business will fall away over the next five yearsas a result of legislative change. The Government is currently considering proposals for a National PensionsSavings Scheme (NPSS), starting in 2012, to help address the problem ofinadequate retirement savings. Individuals would be automatically enrolled intoeither the NPSS or alternative 'good' employer's pension schemes, with theoption to opt out. The government is currently examining two options for theNPSS: one which would involve a new system and administration infrastructure,perhaps with some outsourcing; and the other allowing individuals a choice ofbranded provider and building on existing private pensions infrastructure. The details of the NPSS are uncertain and so the threats and opportunities forcurrent pension providers are difficult to predict with certainty. However, webelieve that automatic enrolment into existing schemes will be generallybeneficial in increasing membership levels. There may also be an opportunity forexisting providers to be involved in the running of the NPSS, depending on theoperating model chosen and the level of charges allowed. Managers will berequired for the funds, a possible opportunity for F&C. There is a possibilitythat some employers might choose to 'level down' their existing pension schemesand adopt the NPSS instead. However, we believe that the impact of this on ourexisting portfolio of schemes will be limited. This is because most employerswho have installed pension schemes want their employees to value their benefitspackage and the NPSS is likely to be regarded as a poorer option than a goodquality private scheme. The government has stated that it is keen to ensureexisting good pension provision does not suffer. Trading performance and outlook • UK Life & Pensions new business profits were up by 51% to £53 million (2005: £35m) • UK Life & Pensions PVNBP was up by 34% to £2,020 million (2005: £1,510m) • Margin on UK Life & Pensions was 2.6% (2005: 2.3%) Our share of the UK life and pensions market for the first quarter of 2006 roseto 4.9% (2005: 4.3%). Continued strong growth in group pensions has underpinnedthis performance, with sophisticated systems and good scheme persistencyensuring profitability. The relatively flat cost base has meant that theincrease in new business profits has outstripped volume. A modest negative experience variance of £8 million primarily reflects lowerpersistency on a number of legacy bond products and more group pension schememembers taking advantage of flexibility in our products to reduce contributions.Scheme persistency, a major driver of group pensions profitability, remainsgood. The UK as a whole remains a market with stable margins, and good growthprospects for committed players. We see attractive opportunities in theinvestments market and have announced that we will develop a wrap propositionfor launch in 2007, with a consequent increase in development expenses expectedin the second half of this year. Accelerating new business growth will requireincreases in costs, but at a much slower rate than the growth of new businessvolumes. Therefore, we will continue to strive to reduce unit costs and as aresult margins across all our core product lines are expected to be broadlystable. We will be holding an analyst and investor workshop on 31 October to present amore detailed view on UK market developments and our position. Protection Protection PVNBP was down by 4% to £199 million (2005: £207m). Our market share grew in the first quarter, up to 7.1% from 6.6% in the fourthquarter of 2005 reflecting increased housing activity and the strength of oure-select proposition. In addition, the single-tie distribution agreements wehave entered into with intermediaries are starting to generate good levels ofbusiness. We have also signed two more agreements with building societies so farthis year. We repositioned pricing across a wide range of products in the first quarter ofthe year, supported by renegotiated reassurance arrangements which offset anypotential impact on margin. As a result, protection applications have improvedby around 50% between January and the later months of the first half, and inJune, were running 33% higher than June 2005. Despite the normal lag betweenapplications and policies coming onto the books, due to the nature ofmortgage-related protection sales, completed business picked up each monththrough the second quarter. New business volumes in June were up 17% on June2005. Prospects are encouraging and we are confident of an increase in newbusiness levels for the year as a whole. Investments Investments PVNBP was up by 21% to £364 million (2005: £301m). With the overall market stronger than last year, we have seen a steady level ofsales of investment products through the first two quarters, and anticipatesimilar levels of activity through the year. Our end-to-end online wrap platformwill launch in 2007 to provide attractive benefits for customers and IFAs. Itwill also allow increasing flexibility and improved speed to market for newinvestment products. Group pensions Group pensions PVNBP was up by 52% to £1,167 million (2005: £766m). Our performance in the second quarter was very strong. Although aided by someadditional business in the market around A-day, the underlying trend in growthin 2005 and the first quarter of 2006 is expected to be indicative of activityfor the full year. In July we passed the milestone of 500,000 scheme memberswith policies on our platform. There has been some movement in the mix towardslower and nil-commission business which is lower strain. Our pensions business is profitable due to our excellent scheme persistency,effective deployment of technology to control costs and pricing know-how. Ourleading customer service received further recognition in July 2006 when we wonthe Customer Care Award at the British Service Awards. Our success in attractingand retaining schemes means we are quickly building funds on the platform, with£4.2 billion at June 2006 compared with £3.7 billion at December 2005. Ouronline servicing technology also keeps costs low. Our sophisticated pricingmodel takes into account factors such as the scheme history and our detailedknowledge of the employer to ensure profitability. Individual pensions Individual pensions PVNBP was up by 80% to £171 million (2005: £95m). Our strategy continues to be to focus on single premium business and we continueto achieve good growth in this market with regular premium levels consistentwith last year. We foresee continued steady growth from this level as IFAsbecome more familiar with our products. DWP rebates included in the figure abovewere £34 million (2005: £7m). DWP rebate business during 2005 was lower than wewould usually expect due to problems with the installation of a new computersystem at the DWP. The 2006 volumes are higher as they include a catch up ofbusiness from last year. Post-retirement Post-retirement PVNBP was down by 16% to £119 million (2005: £141m). Our annuity business consists almost entirely of vesting pensions business andwe price to maintain an acceptable level of risk-adjusted profit. INTERNATIONAL LIFE & PENSIONS Our view of the market Friends Provident International (FPI) FPI targets the international mass affluent and high net worth individuals(HNWI) markets. These form an attractive niche which is able to support highermargins than the mature UK market. FPI operates exclusively throughintermediaries - typically through specialist IFAs in Asia, UK and ContinentalEurope, but increasingly with partner banks in the Middle East. By contrast,some competitors have direct sales operations in overseas territories, whilstothers sell only to the home market via offshore subsidiaries. Our approachleverages our expertise in managing distribution relationships withintermediaries. The strategy of a single operating hub maximises efficiency, asscale is more readily achievable on a single platform. The markets where FPI operates are fast growing, well regulated and include bothexpatriates and local customers. Key products are regular premium savings inAsia, the Middle East and Europe, and single-premium investment bonds in Asiaand the UK. In general the key differentiators from local providers are fund andcurrency choice, rather than tax advantages. Lombard Lombard's key market is delivering financial and estate planning solutions forEuropean High Net Worth Individuals (HNWIs), although distribution is extendingto new territories in Latin America and Asia. Distribution is through partners,typically private banks, high-end IFAs and advisers to HNWIs. Expansion to newterritories is being led by the strong relationships with partners. The HNWI andultra-HNWI markets grew by over 8.5% in 2005 according to an industry report,The Merrill Lynch/Capgemini World Wealth Report 2006, published in June 2006 andare expected to continue to grow. The potential addressable pool of wealth heldby private banks is vast and growing as awareness and acceptance of lifeassurance solutions spread. We have only scratched the surface. Lombard has no close peers, although a number of competitors provide lowerpriced and lower value-added service, and do not target the ultra-HNWI market asLombard does. Its strength is in building relationships with private banks andother partners, which will typically retain control of the assets placed insidethe life assurance solution. The key barriers to entry are the in-depth marketknowledge, required technical skills and the time to build up true partnershiprelationships with distributors. The market for Lombard's solutions is lesssusceptible to an investment market downturn than conventional insurance marketsand the limiting factor on growth is the availability of the highly skilledindividuals needed to devise and promote effective solutions in the localmarkets. Trading performance and outlook • International Life & Pensions new business profits up by 57% to £36 million (2005: £23m) • International Life & Pensions PVNBP up by 50% to £1,012 million (2005: £675m) • Margin on International Life & Pensions increased to 3.6% (2005: 3.4%) Our International Life & Pensions businesses have both recorded impressiveincreases in new business volumes and contribution to profits. These are marketswith typically higher margins, with Lombard's business slightly higher marginthan FPI. Friends Provident International (FPI) FPI PVNBP was up by 43% to £466 million (2005: £325m). FPI has delivered strong growth compared to 2005. Business levels in the secondquarter were close to the levels seen in the record first quarter of the year,with the regular premium Premier savings product continuing to perform well inAsia and the Middle East. The UK market has seen some lag in demand for singlepremium products as a result of the Finance Act changes to trust taxation. Weexpect demand for these products to revive in the third quarter. Looking ahead, an innovative personal pension product will be launched in thegrowing German pensions market later in the summer. This will be a niche productoffering greater flexibility than mass-market products, and will be developedand distributed in conjunction with a German partner. A licence has been grantedfor a local branch in Singapore, a respected and well-regulated centre forprivate banking and wealth management in South Asia. We expect a meaningfulcontribution to our results from 2007. After the exceptional start to the yearwe expect good growth in Hong Kong supported by our strong regular premiumproposition. Buoyant economic conditions in the United Arab Emirates areexpected to be a strong contributor to fast growth from our Dubai branch. Outlook for the remainder of the year is good. The overall margin was stable inthe first half and any change will be dependent on geographical mix. Lombard Lombard PVNBP was up by 56% to £546 million (2005: £350m). Sales were well diversified across Europe, with the UK and Southern Europebenefiting from large cases. In Italy growing awareness of Lombard's solutionsand a change of Government have led to high premium growth in a market that hasbeen relatively small for Lombard in recent years. Margins are largely in linewith 2005, with more business in higher margin territories offsetting most ofthe margin reduction from a higher proportion of very large cases. Outlook is good for the remainder of the year. Strong results to date in the UKand Southern Europe, especially Italy, together with the potential from possibleGerman inheritance tax changes and continued opportunities in the newerdevelopment markets, provide a solid base for good final results. The seasonalnature of Lombard's sales makes the full year result very dependent on salesperformance in the fourth quarter. Margins continue to be dependent on case sizeand territorial mix. Lombard is also in the process of opening a branch office in Switzerland, toenhance its relationships with distribution partners in the key European privatebanking market. This provides a significant opportunity for growth in the mediumto long term. ASSET MANAGEMENT Our view of the market In terms of investment markets, the strong performance of equity markets in 2005continued through the first quarter of 2006. This proved particularly beneficialfor UK retail fund flows which experienced sharp year on year increases acrossthe industry. Then we saw sharp falls in global equity markets and increases infixed interest yields in May and June. However, we expect equities to continueto offer relative value for the long-term investor. The industry-wide shift from balanced to specialist mandates, a factor ininstitutional outflows, appears to be largely played out in the UK, but the riseof fiduciary management in The Netherlands remains a risk factor. Service is a growing key differentiator in asset management. F&C launched itsPerformance First initiative at the beginning of the year to drive top quartileperformance throughout every part of the business through clear objectives andlines of responsibility. Trading performance and outlook Funds under management as at 30 June 2006 were £107 billion (31 December 2005:£131bn). The main movement in insurance funds was the outflow of virtually all of theremaining funds, some £20.1 billion, that were managed for Resolution Life andinternalised following its own merger with Britannic as well as certain otherlosses. Despite this withdrawal, F&C generated investment management fees of£131 million, level with the same period in 2005. These management fees do,however, include some revenues which will not recur in future periods. As highlighted in F&C's December 2005 trading statement, the pattern ofsignificant institutional outflows continued into the first quarter of 2006. Inaddition to this, in the second quarter a longstanding Dutch pension fundclient, Vervoer, conducted a review of its structure and appointed a fiduciarymanager with responsibility for asset allocation, risk budgeting and underlyingmanager selection. As a result, and despite out-performance both at the overallmanager level and in most of the sub-portfolios, F&C has been notified that allequity portfolios are to be withdrawn amounting to £1.5 billion of assets. Inaddition, a £1 billion contract for the Electricity Supply Pension Scheme isalso being terminated. Both are expected to be withdrawn in the third quarter of2006. Excluding insurance flows, the total net outflow for the first half amounted to£3.9 billion of which £3.5 billion occurred during the first quarter. Grossinflows were £3.4 billion. A key driver for inflows was the UK retail market where improved marketsentiment and momentum from building the sales, marketing and brand buildingactivities generated £165 million net inflows during the half year, a 158% yearon year increase. A particular success has been the new F&C Opportunities Fundthat has received encouraging support from multi-managers and discretionaryintermediaries. Both investment performance and new business flows were stronger in the firstquarter than in the second when sharp falls in global equity markets andincreased market volatility affected results. Despite this, F&C's UK retail fundsales in particular continued to be resilient through May and June,demonstrating momentum in this part of the business. F&C's European wholesale business also enjoyed a strong first quarter butredemptions were high in the second quarter, particularly in Portugal whereinvestors tend to be more risk averse. Whilst there was a small net outflow of£24 million in the sub-advisory business during the half year, the underlyingstrength of the business was masked by a £182 million outflow in the firstquarter as a result of the closure of the Friends Provident GPI SICAV range -there was no loss of assets to the Group. In the investment trust area F&C recorded a £495 million net outflow,principally as a result of the merger of the F&C Emerging Markets InvestmentTrust with a competitor and the loss of the F&C Latin American Investment Trustfollowing the departure of the lead manager. The latter loss was particularlydisappointing given the strong long-term out performance of the Trust. F&Cremains committed to rebuilding its emerging equities franchise and hassubsequently strengthened this area through focused recruitment. As F&C outlined in its 2005 Annual Report, it views asset management to be aservice industry and therefore its philosophy is to seek to exceed clients'expectations through the Performance First initiative. Investment performance is pivotal to success and F&C has continued to implementchanges, where necessary, to improve it. Merger synergies have allowed it tofinance the upgrading of resources whilst reducing overall costs. During thefirst half F&C hired 12 senior investment professionals as well as significantlyupgrading marketing teams in both the UK and The Netherlands. Specific action was taken to address two areas of performance weakness; emergingequities and Euro Government bonds. In particular, a new Head of EmergingEquities was appointed and F&C has undertaken focused recruitment in this areain order to rebuild its long-term track record. F&C has a major presence in fixed income with a strong record in credit, highyield and emerging debt but Euro Government bond performance in London haslagged the benchmark. To address this F&C has consolidated the Euro Governmentbond investment proposition in Amsterdam where the team servicing the Dutchinsurance clients has a stronger performance record. An additional benefit ofthis move is that it will enhance F&C's ability to deliver a Euro government/corporate aggregate product as the Euro/global credit team is already based inAmsterdam. However, looking forward, investment performance alone is no guarantee of clientretention. The move from balanced to specialist mandates is a risk factor asdemonstrated by the recent decision by Vervoer. To address these industry developments F&C has further developed the'multi-boutique' investment framework and is focusing on higher marginspecialist areas for net new business, such as private equity funds, high alphaequities, emerging debt and high yield bonds. F&C has also been strengtheningand developing key overlays for institutional clients in areas such as GlobalTactical Asset Allocation and Liability Driven Investment (LDI). Building on theexperience of its Dutch LDI pooled funds, F&C is developing similar productswith a view to launching into the UK and Irish market places in the second halfof the year. Despite turbulent markets, good progress has been made in both UK retail andEuropean wholesale businesses which are in growth mode. However, institutionaland investment trust net outflows will put pressure on short-term revenueswhilst F&C seeks to develop new product initiatives in these areas. Stronginvestment performance is without doubt essential in order to grow organically.Whilst the necessary building blocks for improving performance are now largelyin place, F&C will continue to invest where necessary to ensure it is wellpositioned to benefit from the considerable growth opportunities in the Europeanasset management industry. FINANCIAL REVIEW Our financial results are presented on two reporting bases: EEV and IFRS. IFRSresults are presented following the EEV results. The key differences betweenthese accounting bases are in respect of the timing of profit recognition: • IFRS profits tend to be lower than EEV profits when new business volume is growing because EEV recognises future cash flows in profit, while IFRS does not. • In addition, IFRS does not allow full deferral of acquisition expenses which is particularly onerous for investment products, such as Group Pensions, which accounted for 58% of our UK Life & Pensions new business. IFRS profit is not a good proxy for cash, since some acquisition costs can bedeferred to offset new business strain. Also, for FPI contracts withfront-loaded charging structures, IFRS requires the removal of the impact ofthese charges from the reserve calculation, meaning that IFRS profit emergencelags cash generation. Therefore, we have disclosed shareholder cash generationas an additional table in these results. EEV BASIS EEV is the basis we find most useful because it provides a more representativereflection of the performance of the long-term business that fully recognisesthe shareholders' interest in the in-force portfolio on a risk adjusted basis.For this reason we manage the business to maximise value on an EEV basis. Group profitability on the EEV basis__________________________________________________________________________________ Half year ended 30 June Change 2006 2005 £m £m __________________________________________________________________________________EEV underlying profit before tax: - UK Life & Pensions -21% 154 196 - International Life & Pensions +45% 48 33 - Asset Management -2% 51 52 - Corporate items +33% (6) (9)__________________________________________________________________________________EEV underlying profit before tax -9% 247 272 Other profit items (187) 7 __________________________________________________________________________________EEV profit before tax -78% 60 279 __________________________________________________________________________________ Contribution from Life & Pensions new business +53% 89 58 Life & Pensions new business margin 2.9% 2.7%Life & Pensions return on embedded value 9.6% 11.8% Underlying EEV earnings per share -6% 8.0p 8.5pEEV earnings per share -55% 3.8p 8.5p__________________________________________________________________________________ EEV profit before tax EEV underlying profit before tax is down 9% to £247 million (2005: £272m). Thisresult masks robust growth in profits from new Life & Pensions business. The2005 results included a number of mainly one-off positive variances, which havenot been repeated. These were in respect of UK Life & Pensions operatingassumption changes and experience variances. Underlying profit fromInternational Life & Pensions has continued to grow strongly. Asset Managementunderlying results have remained steady despite the previously reportedwithdrawal of Resolution Life funds and operating margins have held up well. The contribution from Life & Pensions new business has increased by 53% to £89million (2005: £58m) driven by strong volume growth and increasing efficiency.The increase in new business margin as a percentage of PVNBP from 2.7% to 2.9%is mainly as a result of straight through processing systems enabling us toprocess the additional volumes at relatively little additional cost, supportedby an increased proportion of International business. Group EEV profit before tax has reduced by 78% to £60 million (2005: £279m). Inaddition to the above factors impacting underlying profit, this has also beenaffected by the performance of investment markets during the first half of 2006,the impacts of economic assumption changes, and non-recurring and other items: __________________________________________________________________________________ Half year ended 30 June 2006 2005 £m £m __________________________________________________________________________________Investment return variances (327) 207 Effect of economic assumption changes 219 (134)Non-recurring items (12) (29)Amortisation of Asset Management acquired intangible assets (22) (28)Impairment of Asset Management acquired intangible assets (45) - Variation in value of option on convertible debt - (9)__________________________________________________________________________________Other profit items (187) 7 __________________________________________________________________________________ The negative investment return variance of £327 million (2005: positive £207m)arose as a result of an increase in fixed interest yields, a change in the shapeof the yield curve and an increase in market volatility. This caused: • A decline in the market value of fixed interest investments. • An associated impact on our ability to offset new business strain losses against investment returns for tax purposes. • An increase in the cost of options and guarantees. This was partially offset by a reduction in the mark-to-market value ofcorporate debt of £55 million. Positive economic assumption changes of £219 million (2005: negative £134m)reflect the increase in the future investment return offset by the increase inthe discount rate applied to future cash flows. These changes flow directly fromthe increase in the risk-free rate since 31 December 2005 from 4.1% to 4.7% forSterling and from 3.6% to 4.4% for the Euro. Non-recurring items comprise mainly F&C integration costs and F&C ReinvestmentPlan costs relating to the share schemes put in place at the time of the mergerto lock in and incentivise senior staff. The F&C integration is nearingcompletion, and overall non-recurring items fell from £29 million to £12million. The amortisation of acquired intangible assets of £22 million (2005: £28m)reflects normal amortisation of Asset Management investment managementcontracts. An impairment review was undertaken at 30 June 2006 of the AssetManagement investment management contracts, resulting in a write down of £45million (2005: £nil). These items are discussed further in the Asset Managementsection below. Following an amendment to its terms, there is no longer a requirement to reflectthe change in the value of the option on the convertible debt. Commentary on the EEV underlying profit before tax arising from each of thethree business segments is given in the following sections. UK Life & Pensions__________________________________________________________________________________ Half year ended 30 June 2006 2005 Change £m £m __________________________________________________________________________________Contribution from new business +51% 53 35 Profit from existing business: - Expected return 94 79 - Experience variances (8) 19 - Operating assumption changes - 30 Development costs (12) (10)Expected return on shareholders' net assets 27 43 __________________________________________________________________________________EEV underlying profit before tax -21% 154 196 New business margin 2.6% 2.3% Return on embedded value 8.4% 11.5% __________________________________________________________________________________ UK Life & Pensions EEV underlying profit decreased by 21% to £154 million (2005:£196m), as a result of non-recurrence of the 2005 positive, mainly one-off,items in operating assumption changes and experience variances, modest negativeexperience variances and a lower expected return on shareholders' net assets.Offsetting these items were the strong growth in new business contribution andthe growth in expected return on in-force business. The return on embedded value, based on underlying profit after tax, hasconsequently reduced from 11.5% to 8.4% for the same reasons. The contribution from UK new business has increased by 51% to £53 million (2005:£35m) driven by strong new business growth and improved expense efficiency. Thecontribution is stated net of the cost of solvency capital of £2 million (2005:£2m) and share based payments of £1 million (2005: £1m). The contribution from the in-force business decreased to £86 million (2005:£128m). It comprises expected return on in-force business of £94 million (2005:£79m), experience variances of £(8) million (2005: £19m) and operatingassumption changes of £nil (2005: £30m). The 19% uplift in expected return on in-force business was driven by theincrease in size of the portfolio. The main component of the adverse experience variance arises from lowerpersistency on legacy bond products, mainly investment bonds and With Profitsbonds where market value reduction factors on surrender no longer apply, and, toa lesser extent, more group pension scheme members taking advantage offlexibility in our products to reduce contributions. The contribution from newbusiness reflects the impact of this emerging experience which is expected toresult in a modest adverse operating assumption change in the full year results.There were a number of other variances, including a negative tax variancereflecting lower than expected utilisation of tax losses arising on new businessstrain and a positive variance reflecting reduced shareholder exposure to thecost of options and guarantees arising from an increase in working capital inthe With Profits fund. The positive 2005 operating assumption change was the shareholder impact ofupdating the With Profits Fund realistic non-economic assumptions (such as theproportion of cash taken by deferred annuitants with guaranteed annuity optionsat the time of vesting). UK operating expenses (ie acquisition, maintenance and development costs butexcluding commission and investment fees) have reduced by 2% to £119 million(2005: £122m), but are expected to increase in the second half of the year as aresult of investment in the growth of our business. Our technology provides theability to process higher volumes of new business with little additional cost.We expect to drive growth in new business volume at a considerably faster ratethan expenses. Therefore we expect acquisition costs to increase modestly andmaintenance costs to be broadly flat. Development costs have increased from £10million to £12 million, in line with the indication given at our 2005preliminary results. This reflects additional investment in our e-commercepropositions and infrastructure to support our new distribution relationships.In accordance with our planned development of a wrap platform for implementationin 2007, development expenses will increase in the second half of the year. The expected return on Life & Pensions shareholders' net assets has fallen by37% to £27 million (2005: £43m). This is due to a number of different factorsincluding a reduction in the assumed rate of return to 4.1% (2005: 4.6%), areduction in shareholders' investments in equities, and the net impact ofincreased STICS interest payments after the 2005 issue. The expected tax rateapplied has increased due to there being lower tax losses brought forward. International Life & Pensions__________________________________________________________________________________ Half year ended 30 June 2006 2005 Change £m £m __________________________________________________________________________________Contribution from new business +57% 36 23 Profit from existing business: - Expected return 12 12 - Experience variances - (3)- Operating assumption changes - - Expected return on shareholders' net assets - 1 __________________________________________________________________________________EEV underlying profit before tax +45% 48 33 New business margin 3.6% 3.4% Return on embedded value 15.9% 13.3% __________________________________________________________________________________ International Life & Pensions EEV underlying profit has increased by 45% to £48million (2005: £33m), mainly as a result of strong new business profits. The return on embedded value based on underlying profit after tax has increasedfrom 13.3% to 15.9%, also driven by new business profits. The contribution from International new business has increased by 57% to £36million (2005: £23m), driven primarily by 50% volume growth. The marginincreased from 3.4% to 3.6%. The Lombard contribution is £20 million (2005:£12m) with the increase due to 56% higher new business volumes. The growth ofthe FPI contribution to £16 million (2005: £11m) was driven by 43% growth in newbusiness. The profit from existing business is £12 million (2005: £9m). This comprises theexpected return on the value of the in-force business, which is unchanged at £12million and experience variances of £nil million (2005: £(3)m). Asset Management__________________________________________________________________________________ Half year ended 30 June 2006 2005 Change £m £m __________________________________________________________________________________Net revenues -1% 126 127 Underlying operating expenses # -4% (75) (72)Other expenses # - (3)__________________________________________________________________________________Underlying profit before tax -2% 51 52 Operating margin 41% 43% F&C underlying earnings per share 7.4p 7.9p __________________________________________________________________________________ # Underlying operating expenses exclude the Re-Investment Plan costs,amortisation and impairment of intangible assets, restructuring costs and netoperating costs on investment and insurance contracts. Other expenses includecosts of servicing loans and pension scheme costs. F&C Asset Management plc is our 52% owned Asset Management business. Underlyingprofit is £51 million (2005: £52m), although as described below the second halfresult is not expected to mirror the first half. Funds under management have reduced from £131 billion at 31 December 2005 to£107 billion at 30 June 2006, mainly impacted by the previously reportedwithdrawal of £20 billion Resolution Life plc funds late in quarter 1. F&Creceived a termination payment of £27 million in respect of the withdrawals,which does not impact underlying profit, as it reduces the carrying value of therelated intangible asset. F&C has been notified of the loss of a long-standing Dutch pension client,Vervoer and also the property portfolio mandate of the Electricity SupplyPension Scheme (ESPS). Despite the loss of the Resolution funds, investment feeswere £131 million, on a par with those earned in the first half of 2005.However, revenues benefited from some £7 million of fees in respect ofResolution, Vervoer and ESPS. These revenues will not recur in the second halfof 2006. The average fee rate for funds managed has risen from 21 basis points for thefull year 2005 to 22 basis points for the first half of 2006. F&C's expenses are categorised below: __________________________________________________________________________________ Half year Half year Half year 30 June 31 Dec 30 June 2006 2005 2005 £m £m £m __________________________________________________________________________________ Underlying operating expenses 75 78 72 Amortisation of acquired intangible assets 22 28 28 __________________________________________________________________________________ Recurring expenditure 97 106 100 __________________________________________________________________________________ Integration costs 7 11 14 Re-Investment Plan 6 9 13 Impairment of acquired intangible assets 45 112 - __________________________________________________________________________________ Non-recurring expenditure 58 132 27 __________________________________________________________________________________ The underlying operating expenses of F&C for the six months to 30 June 2006amount to £75 million. These are £3 million less than the comparable costs forsecond half of 2005 and demonstrate the achievement of F&C's anticipated costssynergy benefits arising from the merger, despite further investment duringfirst half of 2006 to support a number of new revenue enhancing initiatives. The restructuring costs incurred during the first half of 2006 include the finaltranche of staff related expenditure associated with the merger, the costs offurther integration of its information technology (IT) infrastructure and thecost of providing for onerous lease obligations in respect of vacant premises.While further IT restructuring costs will be incurred in the second half of 2006the cumulative restructuring expenditure associated with the merger will notexceed the previously stated target of £50 million. The Group's balance sheet incorporates the net book value attributed by F&C tomanagement contracts acquired as a result of the merger of F&C and ISIS. Theloss of the investment trust and institutional mandates referred to abovenecessitated a further impairment review being performed by F&C. This resultedin an additional impairment charge of £45 million. The methodology employedcompared the discounted profit attributed to these assets with their carryingvalue. The amount of impairment charge recognised was determined by two factors:firstly, the anticipated remaining lives of these contracts has been shortenedto 6 years and 10 years for institutional and investment trust contractsrespectively; and secondly, the use of an increased risk discount rate as aresult of a small increase in the cost of capital for F&C. Further details aregiven in the notes to the financial statements. Since 31 December 2005, F&C's pension deficit has reduced from £48 million to£35 million. This has largely been driven by the increase in corporate bondyields since the year-end. F&C's underlying earnings per share for the six months to 30 June amount to 7.4pence compared to 15.9 pence for the full year to 2005 and 7.9 pence for thefirst half of 2005. F&C continues to display a strong underlying operating margin in comparison toits peers, achieving 41% for six months to 30 June 2006. The margin has fallenfrom 44% for 2005, although this is primarily a result of the loss of revenuefrom Resolution Life. IFRS BASIS The June 2005 IFRS results have been restated to reflect the reclassification ofSTICS from debt to equity, as set out in the 2005 year-end accounts. This hasincreased profit by £10 million for the half year ended 30 June 2005 as STICSinterest is now treated as an appropriation of profit (as required by IFRS)rather than an expense. Underlying profit is not impacted by the restatement. Group profitability on the IFRS basis__________________________________________________________________________________ Half year ended 30 June Restated 2006 2005 Change £m £m __________________________________________________________________________________ IFRS underlying profit before tax: - UK Life & Pensions 55 78 - International Life & Pensions 20 2 - Asset Management 51 52 - Corporate items (6) (7)__________________________________________________________________________________ IFRS underlying profit before tax -4% 120 125 Other profit items (72) 81 __________________________________________________________________________________ IFRS profit before tax from continuing operations -77% 48 206 __________________________________________________________________________________ IFRS underlying earnings per share 3.8p 5.6pIFRS basic (loss)/earnings per share (0.6)p 5.0pDividend per share 2.65p 2.60pDividend cover on underlying basis 1.0 times 1.4 times__________________________________________________________________________________ IFRS underlying profit before tax is £120 million, a decrease of 4% comparedwith £125 million in the first half of 2005. UK Life & Pensions underlying profit has reduced by 29% to £55 million (2005:£78m). The reduction in underlying profit is a result of increased strain fromnew business. We manage our businesses for shareholder value and although newbusiness strain can be monetised, this is not reflected in the IFRS result. Inthe first half, volumes of group pensions sales rose significantly. Althougheconomically profitable, the new business strain causes an initial loss in IFRSterms, to some extent offset by a shift within new group pensions businesstowards lower and nil-commission business which generates less strain as aproportion of volumes of business written. Lower expected investment returnsalso influenced the result. These were due to a combination of factors includinga reduction in assumed rate of return on fixed interest investments to 4.25%(2005: 5.0%), reduced shareholder equity holdings and the net impact of theSTICS interest charge. The UK Life & Pensions underlying profit comprises: • With Profits Fund with-profits business of £3 million (2005: £2m) • With Profits Fund other business £39 million (2005: £39m) • Other life and pensions business £(12) million (2005: £2m), which includes strain on new business • Longer-term investment return £25 million (2005: £35m) International Life & Pensions underlying profit has increased to £20 million(2005: £2m). In force surplus has fully covered the increase in new businessstrain. The majority of the increase in profit arises from a larger back bookand as a result of the reduced impact of front-end charging adjustments. Asset Management underlying profit has reduced by 2% to £51 million (2005:£52m). The underlying profits for Asset Management are the same under IFRS asdiscussed in the EEV profits section above. Corporate items comprise the expected return on the net pension liability £3million (2005: £1m), expected return on corporate net assets £(3) million (2005:£(2)m), less corporate costs of £6 million (2005: £6m). IFRS profit before tax from continuing operations has decreased by 77% to £48million (2005: £206m). This takes into account the difference between theassumed longer-term rate of return and actual investment returns, which was £(60) million (2005: £44m). In 2006 these mainly reflect the decline in fixedinterest values. The other items excluded from underlying profit but included inprofit before tax from continuing operations are shown in the following table: __________________________________________________________________________________ Half year ended 30 June 2006 2005 £m £m __________________________________________________________________________________ Policyholder tax 5 97 Returns on Group controlled funds attributable to third parties 52 14 Non-recurring items (12) (29)Amortisation of Asset Management acquired intangible assets (22) (28)Amortisation of acquired present value of in-force business (12) (14)Amortisation of Life & Pensions acquired intangible assets (4) (4)Impairment of Asset Management acquired intangible assets (45) - Interest payable on STICS 26 10 Short-term fluctuations in investment return (60) 44 Variation in value of option on convertible debt - (9)__________________________________________________________________________________ Other profit items (72) 81 __________________________________________________________________________________ The non-recurring items and amortisation and impairment of Asset Managementacquired intangible assets are all discussed in the EEV profits section above.The other main items are: • Policyholder tax and Returns on Group controlled funds attributable to third parties (the latter mainly representing the minority interest held in F&C Commercial Property Trust, which is 53% owned by the Group's long term funds) are excluded from underlying profit as neither is attributable to shareholders. Policyholder tax was significantly lower than 2005 due to reduced asset values. • Life & Pensions acquired intangible assets mainly relate to Lombard and FPI client lists. • Within the calculation of underlying IFRS profit (as in EEV) we account for the STICS as debt to reflect the economic reality. However we are required under the IFRS rules to account for STICS as equity in calculating IFRS profit before tax. We therefore add back the STICS interest that was deducted in calculating underlying profit. The result for 2006 includes interest on the 2005 issue. DIVIDEND The interim dividend declared for 2006 is 2.65 pence per share (2005: 2.60p), up2% in line with our stated policy of dividend growth up to the rate ofinflation. The dividend is covered 1.0 times (2005: 1.4 times) by IFRS underlying profitafter tax and minority interests. Growing EEV new business profits are anindicator of future cash generation from the Life & Pensions business and wehave considerable flexibility to generate funding if it is required in thefuture, for example through further securitisations. Distributable reserves of Friends Provident plc and Friends Provident Life andPensions Limited combined exceed £700 million and the cash position is beingactively managed at Group level, reflecting the balance of cash generativebusinesses within the Group. Management's intention is to retain any excesscapital within the Group, reflecting its view that there are significantprospects for growth in both the UK and International businesses, and thatavailable capital can be profitably deployed. SHAREHOLDER CASH GENERATION The cash generated by the business is analysed as follows: __________________________________________________________________________________ Half year ended 30 June 2006 2005 £m £m __________________________________________________________________________________ UK Life & Pensions: - New business strain (175) - Financial reinsurance (net) (12) *- In-force surplus 159 __________________________________________________________________________________ Pre-tax cash operating movement (28) 5 Taxation (1) 39__________________________________________________________________________________ UK Life & Pensions net cash operating movement (29) 44__________________________________________________________________________________ International Life & Pensions: - New business strain (39) - Financial reinsurance (net) - *- In-force surplus 48 __________________________________________________________________________________ Pre-tax cash operating movement 9 - Taxation (1) -__________________________________________________________________________________ International Life & Pensions net cash operating movement 8 -__________________________________________________________________________________ Life & Pensions net cash operating movement (21) 44Other operating surplus/(deficit) - (3)Investment return 34 23 F&C dividend received 18 17 __________________________________________________________________________________ Total cash generated by the business 31 81 Dividend paid (108) (103)__________________________________________________________________________________ Operating cash movement (77) (22)Capital movements (47) (35)__________________________________________________________________________________ Total cash movement (124) (57)__________________________________________________________________________________ *A full analysis of the Life & Pensions net cash operating movement is notavailable for the first half of 2005. The Life & Pensions net cash operating movement has reduced from £44 millionsurplus to £21 million deficit. Both emerging surplus and new business strainhave increased and are expected to continue to do so, as the book of existingbusiness grows and increasing levels of profitable new business are written. Newbusiness strain can be monetised and is not a limiting factor on profitablegrowth. The International operations are self-financing despite being at a fastgrowth stage of development. The primary reason for the shift from positive to negative cash operatingmovement is the non-recurrence of the 2005 UK taxation credit. In 2006 we havenot been able to fully offset life and pension tax losses as a result of reducedinvestment returns, or to surrender such losses to other group companies to thesame extent as in 2005. The run-off of financial reinsurance arrangements for protection business inplace at 31 December 2005 caused a £12m negative impact on the UK cash position.The movement is expected to reverse in the second half of the year reflectingthe effects of reinsurance arrangements which are expected to provide more than£50m of operating cash flow. Total cash generated by the business before dividend and capital items is £31mcompared to £81 million for the first half of 2005. Capital items comprise theLombard earn-out payment of £59 million offset by proceeds of shares issued inrelation to the vesting of employee share options. The final Lombard earn-outpayment is due to be paid in 2007 in respect of the 2006 Lombard results and ispayable in either shares or cash at our option. The dividend paid represents thefinal dividend for 2005. IFRS underlying profit for the Life & Pensions businesses includes a number ofnon-cash and one-off items that do not reflect the ongoing cash generativeproperties of the business. It can be reconciled to the Life & Pensions net cashoperating movement, as follows: __________________________________________________________________________________ Half year ended 30 June 2006 2005 £m £m __________________________________________________________________________________ IFRS Life & Pensions underlying profit before tax: - UK Life & Pensions 55 78 - International Life & Pensions 20 2 __________________________________________________________________________________ IFRS Life & Pensions underlying profit before tax 75 80 Add: Non-recurring items 1 (2)Less: Deferred acquisition costs (93) (68)Add: Other IFRS adjustments* 35 37 Less: Longer term investment return (25) (35)Less: Tax (2) 39 Less: Financial reinsurance (12) (7)__________________________________________________________________________________ Life & Pensions net cash operating movement (21) 44 __________________________________________________________________________________ * Other IFRS adjustments mainly disallow front-end charging and provide forfuture renewal commissions. SHAREHOLDERS' EQUITY The embedded value, on a pro-forma basis, is £3,451 million (31 December 2005:£3,464m). It comprises: ___________________________________________________________________________________ 30 June 31 Dec 2006 2005 Change £m £m ___________________________________________________________________________________ Shareholders' invested net assets -11% 952 1,064 Value of in-force Life & Pensions business +3% 2,083 2,019 Market value of the listed Asset Management business +9% 479 441 Less value of future corporate costs (47) (47)Less net pension liability (16) (13)___________________________________________________________________________________ Pro forma embedded value - 3,451 3,464 ___________________________________________________________________________________ Shareholders' invested net assets Shareholders' invested net assets, combined with the benefit provided by ourfinancial reinsurance arrangements, is a proxy of our net cash position, and isas follows: __________________________________________________________________________________ 30 June 31 Dec 2006 2005 £m £m __________________________________________________________________________________ Shareholders' invested net assets: - Life & Pensions net assets 1,010 1,050 - Corporate net (liabilities)/assets (58) 14 __________________________________________________________________________________ 952 1,064 Financial reinsurance 57 69 __________________________________________________________________________________ Shareholder proxy net cash position 1,009 1,133 __________________________________________________________________________________ The reduction of £124 million is analysed in the Shareholder cash generationsection above. This table does not reflect the additional cash available as aresult of the Box Hill securitisation. We retain significant capacity and have aproven capability to raise cash through further securitisations. This is aneffective cash and capital management tool that we intend to continue toexploit. As at 30 June 2006 the Shareholders' net assets were invested broadly in a mixof 54% equities and 46% fixed interest securities and cash. Value of in-force Life & Pensions business The value of the in-force business has increased by 3% to £2,083 million (31December 2005: £2,019m) due to high levels of new business but offset by thenegative impact of investment return variances net of economic assumptionchanges. The analysis of change in the Life & Pensions embedded value is asfollows: ____________________________________________________________________________________ Life & Value of Pensions in-force Net assets EEV £m £m £m ____________________________________________________________________________________- Free surplus 499 - Required capital 551 ____________________________________________________________________________________Life & Pensions EEV at 31 December 2005 2,019 1,050 3,069 ____________________________________________________________________________________Contribution from new business 293 (204) 89 Profit from existing business: - Expected return 105 1 106 - Experience variances (7) (1) (8)- Operating assumption changes - - - - Expected transfer to net assets (172) 172 - Development costs - (12) (12)Expected return on shareholders' net assets - 27 27 ____________________________________________________________________________________Life & Pensions EEV underlying profit before tax 219 (17) 202 Non-recurring items - 1 1 Investment return variances (80) (311) (391)Effect of economic assumption changes (52) 271 219 ____________________________________________________________________________________Life & Pensions EEV profit before tax 87 (56) 31 Attributed tax (23) 16 (7)____________________________________________________________________________________Life & Pensions EEV profit after tax 64 (40) 24 ____________________________________________________________________________________- Free surplus 461 - Required capital 549 ____________________________________________________________________________________Life & Pensions EEV at 30 June 2006 2,083 1,010 3,093 ____________________________________________________________________________________ Market value of F&C The market value of our 52% shareholding in F&C, our listed Asset Managementbusiness has increased by 9% to £479 million (31 December 2005: £441m). Theshare price increased from £1.75 at 31 December 2005 to £1.90 at 30 June 2006. Reconciliation of IFRS Shareholders' equity to pro forma embedded value The IFRS balance sheet reconciles to the pro forma embedded value as follows: __________________________________________________________________________________ 31 Dec 30 June 2005 2006 Restated £m £m __________________________________________________________________________________Equity attributable to equity holders of the parent on IFRS basis 3,388 3,498 Less IFRS items: - Goodwill (net of provision for future consideration) (257) (198)- Other intangible assets (74) (76)- Acquired PVIF (271) (282)- STICS (794) (810)- Deferred acquisition costs (1,087) (994)- Deferred front end fees 85 85 - IFRS reserving and other adjustments 423 385 Add EEV items: - Value of in-force Life & Pensions business 2,083 2,019 - Provision for future corporate costs (47) (47)- Adjustment of long term debt to market value (73) (134)- Adjustment of F&C to market value 75 18 __________________________________________________________________________________Pro forma embedded value 3,451 3,464 __________________________________________________________________________________ Embedded value per share The pro forma embedded value per share has reduced by 1% to £1.63 (31 December2005: £1.65) with the movement analysed as follows: __________________________________________________________________________________ Half year ended 30 June 2006 2005 __________________________________________________________________________________EEV underlying profit 12p 13p Investment variances and effect of economic assumption changes (6p) 3p Non-recurring items (1p) (1p)Amortisation and impairment of intangible assets (3p) (1p)F&C adjustment to market value 3p (4p)Tax - (5p)Dividend (5p) (5p)Change as a result of business combinations - (6p)Lombard earn-out (3p) -Other (including minority interest in F&C loss) 1p 4p __________________________________________________________________________________Movement in pro forma embedded value per share (2p) (2p)__________________________________________________________________________________ LONG-TERM BORROWINGS Long-term borrowings external to the Group are as follows: __________________________________________________________________________________________ Interest for half year 30 June 30 June 31 Dec Shareholder Coupon 2006 2006 2005 impact % £m £m £m __________________________________________________________________________________________Subordinated liabilities: £215m FP Finance PLC undated subordinated guaranteed bonds callable 2006 100% 9.125 9.8 215 215£10m Lombard undated subordinated loans 100% Various 0.3 10 10£9m F&C subordinated loan 100% 6m LIBOR + 1.05 0.3 9 10Debenture loans: £280m Box Hill Life Finance plc securitisation notes - class A-1 due 2016 60% 3m LIBOR + 0.20 5.9 198 280£100m Box Hill Life Finance plc securitisation notes - class A-2 due 2019 60% 3m LIBOR + 0.23 2.4 100 100£5m Friends Provident Investment Holdings plc loan notes due 2006 nil LIBOR - 0.5 0.1 5 6£230m F&C Commercial Property Trust secured bonds due 2017 nil 5.23 6.1 229 229€35m Lombard financial reinsurance treaty 100% LIBOR + 2 0.7 24 22£18m Friends Provident plc loan notes due 2011 100% LIBOR - 0.75 0.1 18 -Convertible bonds: £290m Friends Provident plc convertible bonds due 2007 100% 5.25 7.6 279 276__________________________________________________________________________________________Total long-term borrowings 33.3 1,087 1,148Subordinated borrowings designated as equity: £300m Friends Provident plc STICS callable 2019 100% 6.875 10.3 297 297 £500m Friends Provident plc STICS callable 2015 100% 6.292 15.7 495 495__________________________________________________________________________________________ Total long-term borrowings including STICS 59.3 1,879 1,940 __________________________________________________________________________________________ Borrowings are valued on an IFRS basis, net of capitalised issue costs. The Group's long-term borrowings, including STICS (which are treated as equityin IFRS), total £1,879 million (31 December 2005: £1,940m). As previously reported, part of the proceeds of the STICS issued in 2005 will beused to fund the redemption of the £215 million undated subordinated guaranteedbonds in November 2006. Of the £280 million class A-1 securitisation notes, £82 million was repaid inApril 2006 as a result of surplus emergence in 2005. F&C intends to refinance the £180m inter-company loan due to be repaid toFriends Provident in November 2006 with external debt. To maintain maximumimplementation flexibility an agreement has been reached to roll over thecurrent loan on a month-by-month basis until the refinancing is in place. FINANCIAL STRENGTH The Group remains financially strong and our financial standing has been furtherimproved during the first half of 2006. We continue to manage our business onthe basis of our economic capital whilst ensuring that we also complycomfortably with all other capital requirements. These include the realisticsolvency requirement for our With Profits business, our regulatory solvencyrequirements and our Group solvency requirements as detailed below. The Group continues to have significant further access to additional debtcapital if required, including via securitisation. The need for further capitalresources is monitored as part of ongoing capital management, and we foresee noneed to raise equity capital to fund organic growth. Our actions to reduce financial risk in the business have produced tangiblebenefits, for example with our management of the With Profits Fund and thePension Scheme, as discussed below. FPLP Realistic solvency Surplus assets of the FPLP With Profits Fund on a realistic basis have increasedto £246 million (31 Dec 2005: £236m), with the negative impact of investmentmarkets more than offset by a number of items including reduction in guaranteesdue to lapses and release of provisions. The Risk Capital Margin has reduced to£260 million (31 Dec 2005: £276m), mainly due to better matching of hedgingassets to equity exposure, leaving £14 million (31 Dec 2005: £40m) to be metfrom surplus assets of some £1.8 billion (31 December 2005: £1.8bn) outside ofthe With Profits Fund. The With Profits Fund is nearing the position of fullycovering the Risk Capital Margin without the need for additional shareholdersupport. The With Profits Fund Realistic Balance Sheet is resilient in the event of fallsor rises in investment markets. This is due in large measure to the actions wehave taken to hedge the provisions made to cover the cost of guarantees andoptions, as discussed in the Risk Management section below. The quantum ofshareholder support required is subject to some volatility, although anyvariances will be modest in the context of a £14 billion fund. FPLP Regulatory solvency Solvency is calculated on both a regulatory and a realistic basis. The twocalculations are then compared after applying stress tests to each and the moreonerous requirement is applied. Currently the more onerous requirement for FPLPis the realistic basis. This results in a With Profits Insurance CapitalComponent of £666 million (31 December 2005: £639m) as shown below: ________________________________________________________________________________________ Realistic Regulatory 30 31 30 31 June Dec June Dec 2006 2005 2006 2005 £m £m £m £m ________________________________________________________________________________________Working capital 246 236 Surplus 1,496 1,498 Risk capital Long term insurance capital margin (260) (276) requirements (494) (549) Resilience capital (350) (350)________________________________________________________________________________________Realistic peak (14) (40) Regulatory peak 652 599 With Profits Insurance Capital Component (666) (639) ________________________________________________________________________________________ (14) (40) (14) (40)________________________________________________________________________________________ The Free Asset Ratio (FAR) is a common measure of financial strength. It is theratio of assets less liabilities (including actuarial reserves but before therequired regulatory minimum solvency margin) expressed as a percentage ofactuarial reserves. For FPLP it has increased to an estimated 19.6% (31 December2005: 18.3%) and available assets to meet capital requirements are £3.5 billion(31 December 2005: £3.5bn). Capital requirements provided for in the EEV Shareholder capital requirements provided for in the EEV reflect the economicrisks borne by shareholders and are consistent with the Group's risk appetite.They comprise regulatory capital requirements for shareholder non-profitbusiness, support for with-profits business and additional economic capital asfollows: _______________________________________________________________________________ 30 June 31 Dec 2006 2005 £m £m _______________________________________________________________________________Regulatory capital for non-profit business 385 361 Shareholder support for With Profits Fund 14 40 Contingent loan to With Profits Fund 50 50 Additional economic capital 100 100 _______________________________________________________________________________Total capital requirements provided for in the EEV 549 551 _______________________________________________________________________________ Life & Pensions capital position The total available capital resources, calculated in accordance with FRS 27 on arealistic basis for the FPLP With Profits Fund and on a regulatory basis for allother funds, is £2.4 billion (31 December 2005: £2.5bn). The regulatory capitalrequirement is £0.6 billion (31 December 2005: £0.7bn). Therefore the excesscapital resources over the capital requirement remains at £1.8 billion (31December 2005: £1.8bn). The bulk of the Group's capital is held outside the WithProfits Fund and, consequently, can be deployed around the Group with arelatively high degree of flexibility. Group solvency The Group is required to comply with the Insurance Groups Directive, whichrequires a very prudent measure of excess capital resources as it excludes anysurplus capital within the long-term fund. This is formally measured on anannual basis, and at 31 December 2005 Group capital resources exceeded Groupcapital requirements by £792m. Credit ratings External agencies, such as Standard and Poor's, Moody's and Fitch regularlyperform independent assessments of the financial strength of life companies andpublish their ratings. In July 2006, Moody's upgraded FPLP's rating from A2 to A1 (strong) with astable outlook, reflecting improvements in capital strength and risk management,and its opinion that our strong business performance is sustainable. BothStandard & Poor's and Fitch maintained FPLP's rating at A+ (strong) with astable outlook. Risk management We have a leading risk management capability and continue to look foropportunities in this area. Our vision for risk management is for considerationof risk and confident risk-taking to be embedded in all activities. Riskappetite is set by the Board and we seek risks that we can manage so as to makesuperior returns while avoiding, mitigating or transferring unattractive risks.To bring our risk profile into line with the risk appetite set by the Board wehave taken a number of specific actions including: • Managing the proportion of equity and property backing asset shares in the With Profits Fund. At 30 June 2006 this proportion was 53% (31 December 2005: 52%). • Hedging against falls in the investment markets within the With Profits Fund. The bulk of with-profits policyholders have minimum guarantees that protect them against significant falls in investment prices. The cost of these guarantees is met by working capital within the With Profits Fund, and backed by shareholders. A series of equity options and futures has been introduced, and is monitored on a daily basis, to hedge against falls in investment markets. This increases the resilience of the With Profits Fund, significantly reducing the risk of the With Profits Fund working capital being insufficient to fund its liabilities, and therefore calling on shareholder support. • Hedging against interest rate falls in the With Profits Fund. A number of policies in the With Profits Fund have guaranteed annuity options. The cost of these guarantees rises as interest rates fall, and falling interest rates in recent years as well as increasing longevity have therefore seen the cost of funding such guarantees increase. We have put in place a series of interest rate swaps and swaptions to minimise the impact of any interest rate falls. This measure enhances the resilience of the With Profits Fund minimising the risk of the fund requiring shareholder support. • Tax management. The Group has a clearly defined tax strategy, with a formal risk strategy in planning for transactions, maximising tax relief values at the earliest opportunity, and managing the tax liabilities of the Group. • Using inflation swaps in the Friends Provident Pension Scheme to protect the fund from the impact of falls in real interest rates. Experience since they were put in place in 2003 has resulted in these assets having a value of £83 million as at 30 June 2006. (representing approximately 10% of total scheme liabilities), resulting in the scheme's deficit being one of the smallest of comparable FTSE 100 company schemes. • Stabilising Friends Provident's pension scheme exposure. We have proposed closing Friends Provident's defined benefit pension scheme to new entrants from 1 July 2007. In addition, the employer contributions will be increased from 15% to 20% of member salaries from July 2006 to reduce the deficit. Employees will be able to choose to accrue benefits for retirement at different ages depending on level of employee contributions. FUTURE CONSIDERATION FOR LOMBARD The strong performance from Lombard in 2005 resulted in the maximum earn-outconsideration for the year, which was paid in cash and loan notes in April 2006.Under IFRS a provision of £87 million (2005: £146m) has been established for thefinal 2007 payment, which will be based on the 2006 Lombard results and assumesa growth rate in new business profits of 15% on 2005. Under the assumption of nogrowth in new business profits the provision would be £70 million, whileassuming 25% growth would result in a provision of £104 million. The maximumremaining payout would be €160 million (£109 million). No provision has beenmade for the final 2007 payment on an EEV basis due to the uncertainty of theamount of future earn-out that is reflected in EEV earnings to date and becausethe EEV impact is dependent on whether the amount is settled in shares or netassets. Lombard consideration: __________________________________________________________________________________Date •m £m__________________________________________________________________________________January 2005 initial consideration 265 187April 2005 first earn-out payment 90 62April 2006 second earn-out payment 85 59April 2007 final earn-out payment (assuming 15% growth in new business profits) 128 87__________________________________________________________________________________Total 568 395__________________________________________________________________________________ The cap on the total payment will be at the lowest of: (i) €600 million; (ii) 1.4 times 2006 year end embedded value; and (iii) the aggregate of 2006 year end embedded value and 2.0 times 2006 new business profits after tax and solvency margin. Summary consolidated income statement on an EEV basis For the half year ended 30 June 2006 _________________________________________________________________________________ Year Half year ended ended 30 June 31 Dec 2006 2005 2005 Notes £m £m £m _________________________________________________________________________________Life & Pensions Contribution from new business 2b, 3a 89 58 144 Profit from existing business: Expected return 106 91 196 Experience variances (8) 16 22 Operating assumption changes - 30 16 Development costs (12) (10) (25)Expected return on shareholders' net assets within the Life & Pensions business 27 44 81 _________________________________________________________________________________Life & Pensions underlying profit 2a 202 229 434 Asset Management underlying profit 51 52 108 Expected return on net pension liability 3 - (2)Expected return on corporate net assets (3) (3) (7)Corporate costs (6) (6) (12)Operating assumption changes for corporate costs - - 3 _________________________________________________________________________________Underlying profit before tax 247 272 524 Investment return variances (327) 207 550 Effect of economic assumption changes 219 (134) (238)Non-recurring items 4 (12) (29) (59)Amortisation of Asset Management acquired intangible assets (22) (28) (56)Impairment of Asset Management acquired intangible assets (45) - (112)Variation in value of option on convertible debt - (9) (9) _________________________________________________________________________________Profit before tax 60 279 600 Tax credit/(charge) 10 (104) (196)_________________________________________________________________________________Profit after tax for the period 70 175 404 _________________________________________________________________________________Attributable to: Ordinary shareholders of the parent 80 175 441 Minority interest (10) - (37)_________________________________________________________________________________Profit after tax for the period 70 175 404 _________________________________________________________________________________ EEV underlying profit is a measure of profit which excludes profit generatedwithin policyholder funds that is not allocated to shareholders. Managementconsider that underlying profit better reflects the ongoing performance of theGroup and focus on this measure of profit in its internal monitoring of theGroup's EEV results. EEV underlying profit is based on expected investment return and excludes: (i)amortisation and impairment of Asset Management acquired intangible assets (ii)effect of economic assumption changes (iii) non-recurring items; and is statedafter deducting interest payable on STICS. Earnings per share on an EEV basisFor the half year ended 30 June 2006____________________________________________________________________________________ Year Half year ended ended 30 June 31 Dec Notes 2006 2005 2005 ____________________________________________________________________________________Basic earnings per share (pence) 5 3.8 8.5 21.2 Underlying earnings per share (pence) 5 8.0 8.5 16.3 ____________________________________________________________________________________ There is no dilution to earnings per share for the half years to 30 June 2006and 30 June 2005. For the 2005 year there was a dilution of 0.2p. Consolidated statement of recognised income and expense on an EEV basis For the half year ended 30 June 2006 ___________________________________________________________________________________ Year Half year ended ended 30 June 31 Dec 2006 2005 2005 £m £m £m ___________________________________________________________________________________Actuarial gains/(losses) on defined benefit plans net of tax 5 7 (28) Foreign exchange adjustments (1) (16) (9)___________________________________________________________________________________Net gain/(loss) recognised directly in equity 4 (9) (37)Profit after tax for the period 70 175 404 ___________________________________________________________________________________Total recognised income and expense for the period 74 166 367 ___________________________________________________________________________________Attributable to: Ordinary shareholders of the parent 80 174 417 Minority interest (6) (8) (50)___________________________________________________________________________________Total recognised income and expense for the period 74 166 367 ___________________________________________________________________________________ Summary consolidated balance sheet on an EEV basis At 30 June 2006 ___________________________________________________________________________________ 30 June 30 June 31 Dec 2006 2005 2005 £m £m £m ___________________________________________________________________________________Life & Pensions - long-term funds 661 723 621 Life & Pensions - shareholders' funds 349 324 429 ___________________________________________________________________________________Life & Pensions net assets 1,010 1,047 1,050 Corporate net (liabilities)/assets (58) (46) 14 ___________________________________________________________________________________Shareholders' invested net assets 952 1,001 1,064 Attributable net asset value of the Asset Management business net of minority interest 404 466 423 Net pension (liability)/asset of Friends Provident Pension Scheme (16) 3 (13)___________________________________________________________________________________Shareholders' net worth 1,340 1,470 1,474 Provision for future corporate costs (47) (48) (47)Value of in-force Life & Pensions business 2,083 1,827 2,019 ___________________________________________________________________________________Ordinary shareholders' net assets on an EEV basis 3,376 3,249 3,446 ___________________________________________________________________________________Called-up share capital 214 214 214 Share premium account 2,050 2,035 2,038 EEV reserves 1,112 1,000 1,194 ___________________________________________________________________________________Ordinary shareholders' equity on an EEV basis 3,376 3,249 3,446 ___________________________________________________________________________________ Consolidated movement in ordinary shareholders' equity on an EEV basis For the half year ended 30 June 2006 _________________________________________________________________________________ Year Half year ended ended 30 June 31 Dec 2006 2005 2005 £m £m £m _________________________________________________________________________________Total recognised income and expense for the period attributable to ordinary shareholders of the parent 80 174 417 Dividends on equity shares (108) (103) (157)Share based payments (impact on EEV reserves) 5 9 14 Earn-out payments (59) - - Conversion option on convertible bond - 51 51 _________________________________________________________________________________(Decrease)/increase in EEV reserves for the period (82) 131 325 Increase as a result of business combinations - 148 148 Share based payments (impact on share capital and share premium) 12 2 5 _________________________________________________________________________________Net change to ordinary shareholders' equity (70) 281 478 At beginning of period 3,446 2,968 2,968 _________________________________________________________________________________At end of period 3,376 3,249 3,446 _________________________________________________________________________________ Value of in-force Life & Pensions business on an EEV basis At 30 June 2006 ________________________________________________________________________________ 30 June 30 June 31 Dec 2006 2005 2005 £m £m £m ________________________________________________________________________________Value of in-force allowing for market risk (excluding time value of options and guarantees) 2,288 2,014 2,215 Time value cost of options and guarantees (including the impact of non-market risks) (82) (75) (75)Cost of regulatory solvency capital, plus excess economic capital requirements (39) (39) (34)Provision for operational risks (84) (73) (87)________________________________________________________________________________Value of in-force Life & Pensions business 2,083 1,827 2,019 ________________________________________________________________________________ Pro forma embedded value At 30 June 2006 ________________________________________________________________________________ 30 June 30 June 31 Dec 2006 2005 2005 £m £m £m ________________________________________________________________________________Ordinary shareholders' equity on an EEV basis 3,376 3,249 3,446 Adjustment to the value of the listed Asset Management business to market value 75 33 18 ________________________________________________________________________________Pro forma embedded value 3,451 3,282 3,464 ________________________________________________________________________________Pro forma embedded value per share £1.63 £1.57 £1.65 ________________________________________________________________________________ This information is provided by RNS The company news service from the London Stock Exchange MORE TO FOLLOW

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