Preliminary Audited Results - year end 31 Dec 09

RNS Number : 0698J

Resolution Limited

24 March 2010

 

24 March 2010

 

RESOLUTION LIMITED

 

Preliminary audited results for the year ended 31 December 2009

 

·; Acquisition of Friends Provident Group plc completed on 4 November 2009, 65.5% of market consistent embedded value (MCEV).

·; MCEV of 144.6 pence per share at 31 December 2009 (2008: 101.9 pence per share).

·; Profits are dominated by the timing of the Friends Provident acquisition, whose profits are included from 5 November 2009:

o IFRS based operating profit before tax £20 million (2008: loss £1 million). Operating EPS(1) 3.21 pence (2008: (0.11) pence).

o MCEV operating profit before tax £41 million (2008: loss £1 million). Operating EPS 2.78 pence (2008: (0.11) pence).

·; Friends Provident MCEV operating profit before tax for 12 months £206 million (2008: £364 million).

·; Cash of £180 million to be paid up from operating companies to UK shareholder holding company.

·; Estimated IGD surplus at year end of £1.0 billion, excluding £307 million of cash resources held by Resolution Limited.

·; Proposed final dividend of 2.72 pence per share in respect of 2009 (2008: nil). Target dividend of 4.08 pence per share for 2010.

 

Michael Biggs, Chairman of Resolution Limited, commented:

"We see 2010 as a decisive year for many financial services groups as they redefine their business models in the aftermath of the global financial crisis and in the face of increasing regulatory burdens.

Resolution is in dialogue with a number of the owners of UK life assurance and asset management businesses whilst, at the same time, remaining highly disciplined on delivering the mid-teens return we seek on behalf of public market investors.

Our priority is to build on the inherent value we see in Friends Provident by bringing to it the synergies and the benefits of scale which will arise from our future acquisitions." 

 

___________________________

(1) EPS calculated after tax

 

Enquiries:

Michael Biggs, Resolution Limited  +44 (0)1481 745 368 John Tiner, Resolution Operations LLP +44 (0) 20 3372 2902

Investors / analysts Steve Riley, Resolution Operations LLP +44 (0)20 3372 2908

Media Alex Child-Villiers, Temple Bar Advisory +44 (0)7795 425 580

Forward-looking statements

This announcement contains certain forward-looking statements with respect to Resolution Limited, its subsidiary undertakings and their outlook, plans and current goals. In some cases, these forward-looking statements can be identified by the use of forward-looking terminology, including the terms "targets", "believes", "estimate", "anticipates", "expects", "intends", "may", "will" or "should" or, in each case, their negative or other variations or comparable terminology. By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend upon circumstances that may or may not occur in the future. Forward-looking statements are not guarantees of future performance. Resolution Limited's actual performance, results of operations, internal rate of return, financial condition, liquidity, distributions to shareholders and the development of its acquisition, financing and restructuring and consolidation strategies may differ materially from the impression created by the forward-looking statements contained in this document. Forward- looking statements in this announcement are current only as of the date of this announcement. Resolution Limited undertakes no obligation to update the forward-looking statement it may make. Nothing in this announcement should be construed as a profit forecast.

Media

There will be a conference call today for wire services at 7.30am (GMT) hosted by John Tiner, Chief Executive. Dial in telephone number: +44 (0)1452 555 566 Passcode: 63485618.

Analysts / Investors

A presentation to analysts will take place at 9.30am (GMT) at the City Presentation Centre, 4 Chiswell Street, Finsbury Square, London, EC1Y 4UP. Dial in telephone number: 0845 634 0041 Passcode: 2624620. An audio cast of the presentation and the presentation slides will be available on Resolution's website, www.resolution.gg.

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

Financial calendar
First quarter interim management statement	6 May 2010
Annual General Meeting	18 May 2010
Interim results 2010	18 August 2010
2009 final dividend
Ex-dividend date	7 April 2010
Dealing days for calculating the price of the new shares to be offered pursuant to scrip dividend scheme for the final dividend	7 April 2010 to 13 April 2010
Record date	9 April 2010
Final time and date for receipt of the mandate forms and dividend election input messages	5.00pm, 7 May 2010
Payment of dividend and first day of dealing in the new shares	28 May 2010
Website
www.resolution.gg

 

Chairman's statement 

Overview

This is Resolution's first full year of trading following its listing in December 2008. Resolution came to the stock market with the objective of providing opportunities for public market investors to participate in value creation from a series of restructuring and consolidation projects in financial services, both in the UK and Western Europe.

Through the year, we made progress with our first project in UK life assurance and asset management, completing the acquisition of Friends Provident in November 2009. Acquired for 65.5% of market consistent embedded value (MCEV), this was an attractive entry price into the sector.

Resolution's results in 2009 are dominated by the acquisition of Friends Provident. Whilst only two months' profits from the acquisition are included within the consolidated accounts, the embedded value on a market consistent embedded value basis is a key market metric as a guide to value. For Resolution, this stood at 144.6 pence per share at 31 December 2009.

In the Board's view, business models of financial services groups will continue to be redefined in the aftermath of the global financial crisis and outcomes are being heavily influenced by capital and regulatory changes in the UK and internationally. For many financial services groups, this is leading to a reassessment and spin-off of non-core or sub-scale assets which will provide many of our opportunities, as these groups pursue improved capital returns, higher growth and scale benefits.

Strategy

Resolution has undertaken to make acquisitions only where it considers them capable, in aggregate over a restructuring project, of generating returns consistent with a mid-teens percentage gross internal rate of return over the medium term.

Resolution expects to acquire a portfolio of businesses within each restructuring project it undertakes, making acquisitions where it believes the financial returns of a target company or business could be significantly improved by the implementation of one or more of the following strategies:

·; restructuring the acquired entities, where appropriate, into their separate underlying businesses;

·; combining underlying businesses with other sub-scale or undervalued businesses in the same sector to achieve improved economies of scale;

·; improving cost efficiencies and performance;

·; operating capital-efficient and appropriate balance sheets for the restructured businesses; and

·; selling or demerging some of these businesses.

Whilst the UK Life Project is Resolution's first and priority project, Resolution Operations LLP (ROL) regularly undertakes research on behalf of Resolution enabling the Company to progress opportunities in a range of financial services sectors and geographies.

Acquisition of Friends Provident

During July 2009, Resolution started discussions with the board of Friends Provident with a view to acquiring the group. On 11 August 2009, the Friends Provident board recommended the acquisition to its shareholders. The acquisition was completed on 4 November 2009 with 1.75 billion new ordinary shares in Resolution being issued and £312 million being paid in cash to shareholders in Friends Provident.

The acquisition of Friends Provident brings with it:

·; an attractive franchise which can benefit from consolidation;

·; an experienced management team;

·; a strong capital position; and

·; a good fit with future possible acquisitions.

Corporate governance

Resolution has always been a proponent of strong corporate governance. In particular, Resolution is strongly supportive of pre-emption rights to shareholders in respect of future share issues for cash. As a Guernsey company with a secondary listing, Resolution was not required to comply with all of the corporate governance requirements and shareholder rights of UK publicly listed companies, but had committed to do so where appropriate. Following the acquisition of Friends Provident, Resolution transferred to a primary listing, at which point the voluntary commitments to comply with the Combined Code and certain parts of the Listing Rules, which only apply to primary issuers, became obligations.

Directors

Sir Mervyn Pedelty and Gerhard Roggemann were appointed as independent non-executive directors of Resolution on 5 November 2009. Both had previously been independent non-executive directors of Friends Provident. Sadly, Sir Mervyn died on 26 January 2010. He was a man of considerable talents and his contribution will be greatly missed. He had been a director at Friends Provident since October 2006.

Following the end of the year, Resolution was pleased to announce the appointment to the Board of three further independent non-executive directors, with experience and expertise across the European financial services industry. Jacques Aigrain, Gerardo Arostegui and Mel Carvill joined the Board with effect from 1 February 2010.

Staff

I would also like to take this opportunity to welcome the staff of Friends Provident to Resolution.

Dividend policy

Resolution expects that returns for shareholders will derive mainly from capital appreciation of their ordinary shares and the return of proceeds from disposals. However, in connection with the acquisition of Friends Provident, Resolution considered it appropriate to commence paying annual dividends of 4.08 pence per share from 2010, with one-third being paid as an interim dividend and two-thirds as a final dividend. Consistent with this policy, the Board is proposing a final dividend of 2.72 pence per share in respect of 2009 subject to the approval of shareholders at the annual general meeting. The dividend will be paid on 28 May 2010. The dividend will continue to be paid as long as the Friends Provident business is able to support it. The Board intends to review the dividend policy after each subsequent acquisition.

Subject to shareholders resolving to amend the Articles of Incorporation at the Company's annual general meeting, the Directors are also proposing to offer a scrip alternative in respect of the 2009 final dividend and any other dividends declared and/or paid by the Company over the next five years. The scrip alternative will give shareholders the opportunity to receive new ordinary shares in the Company instead of the relevant cash dividend to which they would otherwise have been entitled.

Resolution Operations LLP

Resolution has an operating agreement with ROL, which has a highly experienced management team. ROL provides a number of important services to Resolution. These include: (i) assisting Resolution with the origination and completion of new acquisitions; (ii) assessing Resolution's funding requirements; (iii) advising on the reorganisation of completed acquisitions and monitoring their progress; and (iv) assisting with the disposal of assets. The directors of Resolution are, however, responsible ultimately to shareholders for consideration of these matters and for overseeing the delivery of all services provided by ROL. In view of the importance of these activities, ROL, through its Chief Executive, John Tiner, has been requested by the Board to provide an operating report. This is included immediately after my statement.

Outlook

Resolution has deep financial services expertise both on its Board and through the relationship with the ROL management team. We are highly focused on delivering value to our investors consistent with an aggregate mid-teens percentage gross internal rate of return. The Board believes 2010 will be a decisive year for the re-shaping of many financial services groups. We continue to have conversations with the owners of these life assurance and asset management businesses in the UK. We believe that these conversations will result in generating attractive opportunities for Resolution and its investors.

Michael Biggs

Chairman

 

Operating Report by RESOLUTION OPERATIONS llp

Overview

2009 was a very active year for the Company: it launched its first restructuring project - the UK Life Project - with the acquisition of Friends Provident, confirmed the thesis that consolidation in the sector is the route to sustainable and transparent returns for investors, maintained close dialogue with owners of other UK life assurance businesses and researched other financial services markets to identify restructuring opportunities. This activity was against a background of extreme equity and bond market volatility, particularly in the first half of the year and the emergence of a more onerous regulatory environment which is likely to impact market structures over the medium term.

The Company's restructuring activities may include both consolidating sub-scale businesses to become financially sustainable over the longer term and with a strong market presence in selected markets, and deconsolidating conglomerates where shareholder value can be enhanced by combining the component parts with existing companies on a sector by sector basis. The Company expects that each of its restructuring projects will close with a value realising event, such as an IPO. Acquisitions will only be considered when the Company believes them capable of contributing to project returns consistent with a mid-teens percentage gross internal rate of return over the medium term.

In 2008 the Company appointed ROL to advise and assist the Company in prosecuting its objectives including sourcing, negotiating and closing acquisitions, implementing its restructuring and consolidation plans and securing funding for acquisitions including raising new equity and debt capital.

ROL considers that there are significant opportunities for the Company to meet its objectives and target returns over the medium term and is actively seeking out these opportunities, which might otherwise be inaccessible to the public markets.

Market update

The global financial crisis initially caused material market dislocation. Markets have subsequently recovered but are volatile, as uncertainty over the strength and sustainability of the recovery and the inevitability of further regulatory changes weigh on sentiment. The financial services industry is subject to significant re-structuring partly as a response to the financial crisis and partly by stakeholders arguing forcefully to change the current and long-standing position of poor returns. While the rally in asset prices has stabilised some companies, we continue to be confident that inherent weaknesses in business models and comparatively better opportunities for some companies in higher growth markets of the world will provide a rich source for restructuring activity in the UK and Western Europe.

UK Life Project

Strategic rationale

At the time the Company was floated on the London Stock Exchange in December 2008, it identified the UK life assurance and asset management sectors as being most likely to provide restructuring opportunities in the near term. The Company and ROL believe there are inherent structural weaknesses in the UK life assurance sector (which have persisted for some time) but which can be unwound and so generate value for shareholders through consolidation to achieve scale, realisation of synergies and from the imposition of strong financial disciplines focussed on cash.

These structural weaknesses include:

·; The growth of the sector in the 1980's and 1990's which was fuelled by the long bull market, favourable inflation trends, and favourable demographics of baby-boomer savings, followed by a 10 year period which has been characterised by stagnated growth, with new business being driven by churn, and little effective action to reposition the sector to meet the needs of customers and investors;

·; Product structures in the industry, many of which have long pay-back periods, poor returns and increasing complexity. The businesses themselves have cost bases that are too high and too inflexible. The recurrence of negative experience variances and the poor cash generation of the businesses result in the lack of growth in, or erosion of, the Net Asset Value (NAV). Investors are disappointed on dividends and thus exhibit apathy towards the sector.

Today the UK life and savings industry faces a very different underlying economic environment to that experienced during the boom years for the sector, with low inflation and low GDP growth. Alongside these economic trends, some competitors continue to promote and write business which is not in the interests of their owners, too much of the supply chain is absorbed by distributors, regulatory demands continue to grow and there is pressure generally for greater transparency and disclosure. In addition, expense coverage is often hard to sustain and cost bases are relatively inflexible with a resulting risk to embedded values.

From both an investor and public policy point of view these challenges demand a response and, in ROL's view, participants face three choices:

·; Attempt to maintain the status quo and keep churning existing books of business. This would see companies absorb short term risk and negative cash flow to force out competition in order to stabilise returns. Inherently, this is a high risk strategy; or

·; Retreat to niche products, albeit with an excess of providers chasing a limited business opportunity. This is unlikely to be effective for larger companies with a consequently higher cost base; or

·; Consolidate. The industry could use the benefits of consolidation to "right-size" businesses, develop market leadership positions in carefully selected focussed products and provide shareholders with stable cash-based returns. We believe this to be the most logical response, but recognise that it requires the most financial discipline.

ROL sees the benefits of consolidation as being underpinned by synergies which will emerge from cost reductions, the acquisition of new business infrastructure at attractive prices, the efficiency impact on new business returns, financial management and the potential for revenue enhancement.

In terms of new business, in our view, the focus will be on products where the life assurance industry has a natural competitive advantage such as in annuities, protection, guaranteed savings and collectivised workplace based savings. Essential to creating a business which can meet the needs of customers, investors and business partners will be maintaining levels of discipline over costs, pricing and financial management, which the industry has not been accustomed to in the past, and also unencumbered new thinking about products and structures which meet customers' needs. It seems likely that by adopting this model, over the medium term these will be fewer market participants, but that they will be making acceptable and sustainable returns.

Resolution plans to play a leading role in the consolidation of open UK life assurance companies. It anticipates making a small number of acquisitions in building a business, measured by MCEV, of around £10 billion and which has a clear cash flow profile emerging from the in-force business and strong market positions in selected products which produce acceptable levels of profitability and cash flow.

Resolution launches its UK Life Project

In the execution of this strategy, the Company's first acquisition has been of Friends Provident. In the first one hundred days following that acquisition, ROL, on behalf of the Company, conducted a detailed review of its business and operating infrastructure. As a consequence the Company now has a clear view of where financial and operational improvements need to be made, where opportunities for growing market share through acquisition exists and where synergies can be realised. The Company has been strongly supportive of the actions already in train at the time of its acquisition relating to cost reduction and the priority being given to cash generation. These combine to support Resolution's dividend commitment made at the time of the acquisition.

The Company has not identified any significant surprises in the context of the due diligence performed prior to Friends Provident recommending its offer in August last year. The Company acquired the business at a price equal to approximately 65% of MCEV and the aggregate impact of new business during the year has been cash positive.

Future acquisitions

ROL continues to see further opportunities for the Company to execute on its consolidation strategy. Both before and since the acquisition of Friends Provident, we have had many conversations with potential vendors and have conducted due diligence on a number of assets on behalf of the Company. Our financial discipline and vendors' timetables have prevented us from recommending a subsequent transaction to the Company. We continue to be in close dialogue with potential vendors and these reaffirm our confidence about the successful execution of the Company's consolidation strategy. We continue to believe that the 18 month period post the first deal will be the acquisition period of the restructuring project and that the subsequent 2 years will be the period during which the enlarged business will be created and then repositioned to be directly owned by the public markets.

The Company has a number of financing options including cash, debt, pre-emptive issues of equity, and vendor financing. The Company and ROL are particularly conscious that the Company shareholders committed capital initially with a view to substantially increasing their investments in the Company, via the pre-emption rights granted to them, in order to finance future acquisitions. We believe that ROL is very aligned with the Company and its shareholders to realise value while always maintaining the focus on returns.

Research and development in other sectors

Beyond UK life assurance, our research and development work suggests that there are substantial opportunities in the asset management sector, both as a pure play project and because of the synergy benefits arising from life assurance. We will continue to maintain close monitoring of the asset management sector and dialogue with potential vendors and advise the Company accordingly. We will also continue our research work on other sectors and in geographies further afield.

Conclusion

Resolution has been created by public market investors to bring them restructuring opportunities across the financial services industry. The first project - the UK Life Project - has been launched and ROL is committed to helping the Company realise its strategy in the life assurance and asset management sectors. ROL continues to be confident that appropriate acquisitions will be sourced and the benefits of consolidation realised.

ROL has worked closely with the senior management of Friends Provident over the past several months, including Simon Clamp the Managing Director of the UK business. All at Resolution and Friends Provident, where he had worked for 8 years, were deeply saddened by his early death in March of this year. Our thoughts are with his wife and family.

John Tiner

Chief Executive, Resolution Operations LLP

 

Business Review

Summary

Friends Provident, a UK listed life assurance business, was acquired by Resolution on 4 November 2009. The 2009 results therefore incorporate the results of Resolution for the full year but only include Friends Provident for the period from the acquisition date to the end of the year. Resolution was incorporated on 9 October 2008 and therefore comparative amounts in these financial statements, unless explicitly stated otherwise, only include the period from that date until the end of 2008 in relation to the income statement.

In order to provide a wider understanding of the acquired business, this review includes an evaluation of Friends Provident's operating performance on an IFRS basis for the full year with comparatives for the whole of 2008. Reflecting the current composition of the Group, Resolution has adopted MCEV reporting, which is being provided as supplementary information. Consistent with the provision of IFRS information, MCEV results are also being provided for the full year together with comparatives for 2008.

Following the acquisition of Friends Provident the segmental presentation of results has been reviewed. There are now three operating segments for financial reporting and management purposes. These are the UK, International (comprising Friends Provident International Limited (FPIL), the overseas life assurance business within the UK life and pensions subsidiaries and Friends Provident's share in AmLife) and Lombard (Lombard International Assurance SA). Also, in order to facilitate an understanding of the operating performance of the enlarged business, the Group has established a new measure, operating profit, on an IFRS and an MCEV basis.

As announced on 9 March 2010, Resolution completed its work on the acquisition balance sheet which included the alignment of operating assumptions and a review of the assets acquired and liabilities assumed as at 4 November 2009. On an IFRS basis the net assets of Friends Provident attributable to Resolution's ordinary shareholders on 4 November 2009 was £3,214 million. This gave rise to a gain on acquisition of £1,202 million before deduction of £16 million in respect of acquisition expenses. The gain mainly arises from the inclusion of the acquired value of in-force business and other intangible assets in the acquisition balance sheet.

On an MCEV basis, the embedded value of Friends Provident at the acquisition date was £3,070 million. When combined with Resolution's net assets of £310 million at that same date this equated to £1.40 per ordinary share.

The offer for Friends Provident, based on the Resolution share price at the announcement date, was £1,858 million which represented 69% of the adjusted 30 June 2009 embedded value. The subsequent increase in Resolution's share price and the £312 million paid to Friends Provident shareholders (against a maximum offer of £500 million) resulted in the fair value of the purchase consideration increasing to £2,012 million. This represented 65.5% of the actual acquired embedded value of £3,070 million. The original offer price equated to 60.5% of the same figure.

The IFRS based operating profit for the Group before tax was £20 million of which the Friends Provident business contributed £33 million and Resolution itself made an IFRS based operating loss of £13 million (2008: operating loss £1 million) for the year. IFRS profit before tax from continuing operations was £1,168 million including the £1,202 million gain on the acquisition of Friends Provident and the £16 million of acquisition expenses. Net assets per share on an IFRS basis at 31 December 2009 was £1.47.

Group MCEV operating profit for the year was £41 million and total profit before tax was £85 million (both only incorporating the post acquisition results of the Friends Provident business). On a standalone basis, the MCEV operating profit of Friends Provident for the full year was £206 million and the total profit before tax was £604 million. The Friends Provident embedded value at the acquisition date of £3,070 million increased to £3,181 million as at 31 December 2009. Trading performance in the short post-acquisition period was consistent with that experienced in the period before acquisition in all material respects. The embedded value for the Group at 31 December 2009 was £3,488 million, giving net assets per share for the Group on an MCEV basis of £1.45.

Against a backdrop of challenging market conditions, Friends Provident has delivered on its core strategy. Sales discipline has been maintained during the year with the withdrawal from the unfunded commission segment of the group pension market and the UK and corporate cost base has been reduced. Friends Provident has a strong balance sheet with a stable IGD surplus, limited exposure to equities and a good quality bond and asset-backed security portfolio.

Cash generation in the life and pensions businesses has been strong with cash generated from operations supporting financing costs of £52 million and £91 million of dividends from Friends Provident.

On an annual premium equivalent (APE) basis 2009 sales for Friends Provident were £873 million, compared to £1,005 million for 2008. This reflects Friends Provident's decision in 2008 to withdraw from cash intensive, less profitable lines of business in the UK (benefitting new business cash strain by £38 million when measured against 2008), the continuing difficult market conditions experienced by the life insurance industry in 2009 and an ongoing focus on the value and cash flow signature of new business. However, Lombard, the international estate planning life insurer, achieved record sales in 2009.

Friends Provident achieved the targets set in its cost saving strategy which was designed to achieve a run rate of £215 million for its UK operations in 2010. This represents a 20% reduction in absolute terms on its 2007 expense levels. These savings have resulted in a £45 million addition to IFRS operating profit in 2009 and a £154 million positive impact on full year MCEV operating profit.

The Insurance Groups Directive (IGD) surplus at 31 December 2009 for Friends Provident (ie excluding cash held by Resolution) is estimated at £1.0 billion. The surplus has remained relatively stable for Friends Provident throughout the year including the period before the business was acquired by the Company. It remains relatively insensitive to movements in the equity markets because shareholder-related assets do not have significant exposure to equity markets.

Shareholder exposure to the equity markets is limited by the Group's investment policy. Within the Friends Provident business there are £4.1 billion of financial assets to which shareholders have a direct exposure, either through holdings in shareholder funds or in businesses where 100% of the surplus is due to shareholders. Of this amount, £0.1 billion is invested in shares, unit trusts and OEICs, £0.9 billion in government bonds and £3.1 billion in corporate bonds and asset-backed securities.

For the listed corporate bonds and asset-backed securities (ABS) to which shareholders have a direct exposure, either through holdings in shareholder funds or in businesses where 100% of the surplus is due to shareholders, over 95% is at investment grade with a large proportion of the portfolio rated 'A' or above.

In the light of Friends Provident's performance for 2009 the directors are recommending a dividend in line with the Company's dividend policy.

Acquisition of Friends Provident

IFRS basis

Resolution completed the acquisition of Friends Provident on 4 November 2009. The fair value of the consideration for the acquisition was £2,012 million of which £312 million was paid to Friends Provident shareholders in cash and the balance was satisfied by the issuance of 1,752 million new shares in the company at a fair value of 97 pence per share. In addition there were £16 million of acquisition costs. The fair value of the net assets acquired after allowing for non-controlling interests was £3,214 million resulting in an IFRS gain on acquisition of £1,202 million before taking account of the acquisition costs. This is included in other income in the IFRS income statement.

The acquisition balance sheet is set out in summary form below.

				£m
	Acquired value of in-force business			2,943
	Other intangible assets
		Distribution relationships	287
		Brand value	50
		Customer relationships	11
		Computer software	15
				363
	Financial assets		46,290
	Other assets		8,750
	Financial liabilities		(39,953)
	Other liabilities		(14,416)
				671
				3,977
Attributable to non-controlling interests			(278)
Step-up tier 1 insurance capital securities (STICS)			(485)
				(763)
Fair value of net assets acquired attributable to ordinary shareholders				3,214
Fair value of consideration				2,012
Gain on acquisition of Friends Provident				1,202
				3,214

 

In accordance with IFRS, Resolution is required to ascribe fair values to the acquired value of in-force business (VIF) and other intangible assets as well as placing a fair value on the assets acquired and liabilities assumed.

The acquired VIF has been calculated on the basis of assumptions which are consistent with those which have been used in the preparation of the MCEV results. The acquired VIF and other intangibles of £2,943 million and £363 million, respectively, are stated before allowance for policyholder and shareholder taxation. The net of tax figures are £2,338 million and £275 million, respectively.

In order to reflect the acquired VIF and other intangible assets at their fair values in the acquisition balance sheet it is necessary to make a number of adjustments to the pre-acquisition Friends Provident balance sheet. These include the elimination of existing goodwill and other intangible assets which are replaced by new fair values, and the elimination, inter alia, of deferred acquisition costs and deferred revenue as these are subsumed in the acquired VIF.

The valuation of other intangible assets was based on the identification of cash generating units (CGU) which are consistent with segmental reporting. Consequently the three main cash generating units for the purposes of the valuation were UK, International and Lombard.

Distribution relationships have been valued using an income based methodology with the valuation reflecting the net present value of the underlying cash flows for forecast new business from existing distribution relationships over appropriate periods. Brand values have been calculated on a relief from royalty approach reflecting the savings realised by owning the trademarks. Customer relationships have been valued based on the net cash flows for fees and commissions expected to be earned.

The review of the MCEV assets and liabilities, at the acquisition date, confirmed that there were no unexpected changes from the items identified as part of Resolution's pre-acquisition due diligence. Two material items were identified during due diligence: the value of tax liabilities was reduced by £107 million to reflect the reduction in the applicable rate of tax for FPIL, offset by a reduction in the gross value of deferred tax assets totalling £26 million.

The consolidated IFRS net assets per share attributable to ordinary shareholders immediately following the acquisition including the £310 million of net assets of Resolution at that date, based on 2,412,451,145 share in issue, was £1.46.

The valuations of the Friends Provident pension schemes at the acquisition date in accordance with IFRS showed assets approximately equal to liabilities. However, in accordance with IFRS, the recoverable pension surplus on an IAS19 basis has been recognised as at 31 December 2009 (£38 million, net of tax).

MCEV basis

On an MCEV basis, the amount attributable to ordinary shareholders at the acquisition date was £3,070 million. A summarised balance sheet is set out below.

		£m
Acquired value of in-force business		1,864
Other intangible assets		27
Financial and other assets		55,084
Total assets		56,975
Liabilities (including STICS and other debt)		(53,627)
		3,348
Non-controlling interests		(278)
Net MCEV attributable to ordinary shareholders		3,070
Acquisition MCEV per ordinary share		£1.27
Value of the Group at acquisition including £310 million of net assets attributable to Resolution at the acquisition date, per ordinary share		£1.40

The values per share are based on 2,412,451,145 ordinary shares in issue immediately following the acquisition.

The main differences between the IFRS and MCEV balance sheets are:

·; Acquired value of in-force business - IFRS £2,943 million MCEV £1,864 million;

·; Other intangible assets - IFRS £363 million, MCEV £27 million;

·; STICS - presented as a non-controlling interest under IFRS at full principal value but considered a liability under MCEV reporting and shown at market value; and

·; Various tax adjustments including deferred tax which is discounted under MCEV reporting but is presented at its full value on an IFRS basis.

There are two adjustments that account for a significant part of the difference in the value of acquired in-force business. The first is the IFRS reporting requirement to value the business allowing for policyholder and shareholder taxation which increases the IFRS value of the acquired value of in-force business at acquisition by £605 million. The second relates to certain actuarial reserve adjustments that are required under IFRS, notably actuarial funding adjustments for business written by FPIL. Other intangible assets differ under the two reporting bases as the Group has decided to exclude such assets under its MCEV accounting policies except for relatively small amounts related to the distribution businesses and computer software.

The offer announced for Friends Provident on 11 August 2009 resulted in an estimated consideration at that time of £1,858 million. The offer represented 69% of Friends Provident's published embedded value as at 30 June 2009, as adjusted for the demerger of F&C Asset Management (F&C) and the payment of the second interim dividend in July 2009.

As a result of an increase in the Resolution share price between offer and completion from 88.25 pence to 97.00 pence and payments to shareholders taking cash under the offer of £312 million (against a maximum available amount of £500 million), the actual value of the consideration paid at completion was, as previously noted, £2,012 million excluding acquisition costs. The actual consideration represented 65.5% of the acquisition MCEV at completion.

Attribution of profit

The Company acquired Friends Provident through a limited partnership holding structure to facilitate alignment of the interests of Resolution and The Resolution Group (the separate financial services advisory group of which ROL is a part) by way of an incentive structure which rewards the founders and staff of The Resolution Group for capital value created in the limited partnership.

Resolution is the general partner of the limited partnership and holds a 99.99% capital interest in it. The remaining 0.01% capital interest is held directly and indirectly by RCAP Guernsey LP which is ultimately owned by the founders and staff of The Resolution Group. Resolution is entitled to 100% of the profit of the limited partnership until its deployed equity capital (plus an agreed return) is returned to it. Thereafter, it is entitled to 90% of the profit.

IFRS results

The Group's IFRS results are set out below, including a reconciliation from operating profit to IFRS profit before tax:

		FPH(i) 5 November to 31 December 2009	RSL(ii) Year ended 31 December 2009	Consolidated RSL Year ended 31 December 2009	RSL(iii) Period ended 31 December 2008
		£m	£m	£m	£m
UK		20	-	20	-
International		9	-	9	-
Lombard		4	-	4	-
Corporate		-	(13)	(13)	(1)
IFRS based operating profit before tax		33	(13)	20	(1)
Short term fluctuations in investment return		(2)	-	(2)	-
Returns on Commercial Property Trust		23	-	23	-
Policyholder tax not attributable to shareholders		1	-	1	-
Acquisition accounting adjustments:
Amortisation of acquired in-force business		(59)	-	(59)	-
Amortisation of other intangible assets		(10)	-	(10)	-
Non-recurring items:
Gain on the acquisition of Friends Provident		1,202	-	1,202	-
Acquisition costs		-	(16)	(16)
Other		4	-	4	-
STICS interest adjustment to reflect IFRS accounting for STICS as equity		5	-	5	-
IFRS profit before tax		1,197	(29)	1,168	(1)

 

i) Friends Provident Holdings (UK) Limited (FPH) is the parent company of the Friends Provident group. The results above are the consolidated results of FPH for the stated period.

ii) Resolution Limited (RSL) includes the unconsolidated results of the Company for the stated period.

iii) RSL was incorporated on 9 October 2008.

IFRS based operating profit excludes, inter alia, acquisition related accounting adjustments and items of a non-recurring nature. It does however include a longer term investment return. Interest payable on the Friends Provident Group plc (FPG) step-up tier 1 insurance capital securities is treated as an operating expense although in the IFRS primary statements it is required to be accounted for as equity with the interest being recorded as a dividend movement through reserves.

IFRS based operating profit for the year was £20 million with Resolution incurring a loss of £13 million while the Friends Provident business contributed a profit of £33 million for the post acquisition period. The loss incurred by Resolution reflects the fact that the only source of income was interest earned on invested funds. The low level of interest earned on these funds is attributable to the cautious investment approach which continued to be followed throughout the year. Resolution's loss also reflects the operational costs, in particular, the payments made to ROL and Northern Trust under the respective operating agreements, the cost of directors' emoluments, the costs associated with the asset management agreement and due diligence costs.

The post acquisition IFRS based operating profit for Friends Provident was £33 million of which the majority is attributable to the UK life and pensions business. The UK result includes a positive contribution of £13 million related to the impact of credit spreads and reserving changes on annuity business with an additional £10 million from other favourable variances.

MCEV results

	FPH	RSL	RSL consolidated
	5 November to 31 December 2009	Year ended 31 December 2009	Year ended  31 December 2009
	£m	£m	£m
Life and pensions
Value of new business	52	-	52
Expected existing business contribution	28	-	28
Operating experience variances	(25)	-	(25)
Operating assumption changes	1	-	1
Other operating variances	-	-	-
Development costs	(5)	-	(5)
Life and pensions covered business operating profit before tax	51	-	51
Other income and charges	3	-	3
Life and pensions operating profit before tax	54	-	54
Corporate income and charges	-	(13)	(13)
Operating profit before tax	54	(13)	41
Economic variances	40	-	40
Amortisation of non-covered business acquired intangible assets	(1)	-	(1)
Non-recurring items and non-operating variances	5	-	5
Profit / (loss) from continuing operations before tax	98	(13)	85

 

The FPH results for the post acquisition period include a high proportion of Friends Provident's value of new business (VNB) for 2009 of £133 million due to the seasonal nature of Lombard new business, which is heavily weighted towards the final months of the year. The adverse operating experience variances of £25 million reflected a persistency variance of £13 million and exceptional costs of £9 million with the balance arising from a number of smaller items, including some operational risk charges. Operating assumption changes would ordinarily be made at the end of the year but were not significant in the post acquisition period due to these assumptions being fully reviewed in preparing the Friends Provident balance sheet as at the date of the acquisition.

 

MCEV balance sheet

	Net worth £m	VIF £m	Total £m
Gross life and pensions MCEV
UK	1,607	1,011	2,618
International	73	402	475
Lombard	(63)	503	440
Gross life and pensions MCEV	1,617	1,916	3,533
FPH and other (i)	153	-	153
Gross FPH MCEV	1,770	1,916	3,686
STICS	(318)	-	(318)
Lower tier 2 subordinated debt	(187)	-	(187)
Net FPH MCEV	1,265	1,916	3,181
RSL	307	-	307
Net Group MCEV	1,572	1,916	3,488

 

(i) includes IFA distribution and management services businesses.

At 31 December 2009, net Group MCEV was £3,488 million giving MCEV per share of £1.45. The ratio of debt to gross Group MCEV was 12.6%. FPH net MCEV was £3,181 million excluding the £307 million net assets held by Resolution Limited.

 

GROUP CASH AND CAPITAL

Group capital management

Economic capital

The Group manages its capital on an economic basis using risk-based internal models. Additionally within each life company, capital is managed to be in excess of 125% of Pillar 2 capital including any Individual Capital Guidance.

Based on a review of the Group's capital position at 31 December 2009, the Group has released a total of £215 million from the long term funds to shareholders funds. In light of this transfer, as explained in the following section on shareholder cash resources, a total of £180 million will be paid from the shareholder funds to FPG. The Group is focussed on improving the efficiency and fungibility of its capital and cash resources. Additional initiatives under consideration for 2010 include optimisation of corporate structure from a distributable reserves and capital requirements perspective. As part of this, the Group will also explore whether there is any benefit to capital efficiency from fund mergers and will revisit the current arrangement for distribution of surplus on non profits business written in the Friends Provident Life and Pension Limited (FPLP) with-profits fund (currently 60% to the FPLP non-profit business written in the with-profits fund for the benefit of shareholders and 40% to the with-profits fund of FPLP) in light of the fact that the securitised loan notes are due for repayment in the second quarter of 2010. The review of this arrangement is at an early stage and no discussions have yet been held with the FPLP With-Profits Committee. 

Regulatory capital

In addition, the Group monitors the Pillar 1 position of the life companies and maintains capital in excess of 150% of the statutory (Pillar 1) capital requirements. At 31 December 2009, the Pillar 1 surplus was £1,251 million, comprising capital resources of £1,932 million and capital resource requirements of £681 million, resulting in a coverage ratio of 284%. 

Insurance Groups Directive

In addition to individual company requirements FPH, as the ultimate European Economic Area (EEA) parent insurance undertaking, is required to meet the requirements of the Insurance Groups Directive (IGD). The Group's capital policy is to maintain a ratio of broadly 150% for FPH capital resources against capital resource requirements, excluding the with-profits insurance capital component (WPICC).

The capital position of FPH remains strong with an estimated IGD surplus of £1.0 billion (31 July 2009: £0.9 billion). The IGD coverage ratio was 213%, reflecting capital resources of £1.9 billion (net of WPICC) and capital resource requirements net of WPICC of £0.9 billion.

There has been a small increase in the estimated IGD surplus from the estimated surplus of £0.9 billion at 31 July 2009, which was stated after allowing for the F&C demerger. Payment of an interim dividend in October to Friends Provident shareholders, interest and costs relating to the Friends Provident acquisition were offset by transfers from the long term funds to shareholder funds. 

The IGD surplus is a prudent measure and excludes surplus capital not immediately available to shareholders, such as surplus capital in the long-term funds (£436 million at 31 December 2009 of which £360 million is held in the with-profits funds of FPLP and FPLA). As the calculation is prepared to include the subsidiaries of the highest EEA parent company, the net assets of Resolution as a Guernsey based parent company of £307 million are also excluded. 

A significant stress test to the IGD surplus has been carried out, comprising a fall in equity and property market values of 30% and 20% respectively, a widening of credit spreads of 300 basis points and a rise in risk-free rates of 100 basis points. The estimated IGD surplus as at 31 December 2009 under these combined stresses was £0.8 billion. The equity stress was not a material driver of the movement as shareholder funds have limited exposure to equities.

A reconciliation of the Group's IFRS net assets, regulatory capital surplus and Insurance Groups Directive position is shown below:

	Capital resources	Capital requirements	Surplus
	£m	£m	£m
IFRS equity attributable to equity holders of the parent	3,536	-	3,536
Equity attributable to STICS holders	483	-	483
Subordinated debt	11	-	11
Unallocated surplus	273	-	273
Non-regulated entities (i)	(281)	-	(281)
Regulatory prudence:
- inadmissible assets and valuation differences (ii)	(2,090)	-	(2,090)
Life and pensions capital	1,932	681	1,251
FPLP with-profits fund:
- resources calculated on a regulatory basis (iii)	1,136	818	318
Long-term fund surplus (iv)	(436)	-	(436)
Entities excluded from capital statement (v)	(108)	16	(124)
Other	12	(2)	14
Estimated FPH IGD surplus	2,536	1,513	1,023
Surplus excluding WPICC (£613 million)	1,923	900	1,023

 

(i) FPH corporate centre, IFA distribution businesses and Resolution holding undertakings (on an IFRS basis).

(ii) Largely goodwill, intangible assets and deferral of acquisition costs less actuarial funding (for which credit cannot be taken on an IFRS basis).

(iii) FPLP with-profits fund resources are calculated on a realistic basis under IFRS and a regulatory basis under the IGD.

(iv) Long-term fund surplus capital over and above capital requirements is excluded from capital resources on an IGD basis.

(v) Estimated FPH IGD surplus includes FPH corporate centre and IFA distribution businesses (on a regulatory basis).

Solvency II

The EU Solvency II Directive is expected to introduce a significant change to the capital requirements for insurers from 2012. The Group has been closely engaged in the development of the new regime for some time and is monitoring the impact on its balance sheet of the draft advice from the EU supervisory body CEIOPS on Implementation Measures which are due to be finalised during the next year. Like others in the industry, the Group is concerned at the excessive prudence in many of these proposals. The Group has also been closely engaged in the development of the tax proposals arising as a result of Solvency II. Whilst it is still too early to predict the final outcome, the Group sees increasing evidence that the European Commission is aware of the potential dangers of excessive prudence on capital adequacy in an industry which, in the EU at least, has stood up well to the recent economic circumstances. The Group therefore is still confident there will be an outcome in which the new requirements are unlikely to lead to a need to raise capital above the levels indicated by its current Individual Capital Assessment (ICA) requirements.

The Group has an established Solvency II programme designed to ensure it is ready to meet the new requirements and has had ongoing dialogue with the FSA in relation to the pre-application process which they are operating later in 2010 for internal model approval under the Solvency II regime.

Group shareholder cash resources

Friends Provident has previously reported shareholder cash resources as a measure of the tangible assets available to the life and pensions business and attributable to shareholders. Shareholder cash resources are based on shareholders' invested net assets included within the embedded value, but adjusted to include securitisation and financial reinsurance balances and to exclude intangible assets. 

This presentation has been retained for comparability in explaining the cash flows of the Group, including, for 2009, the cash flows of Resolution. Additional analysis has been included to give clarity on the extent to which these resources represent cash that is not required to meet the Group's capital management requirements (as explained above). 

Movement in shareholder cash resources

The Group has shareholder cash resources at 31 December of £1,397 million. £677 million of this is used to support the capital requirements of the business, and £210 million represent assets not immediately available for distribution or loan from the life companies. This leaves cash resources available to shareholders of £510 million, of which £307 million is held at Group level.

The table below shows the movements in cash resources as if the shareholder cash resources of Friends Provident had been held by Resolution from the start of the year.

 

	RSL/RHG(i)	FPH and its group companies	Life operating businesses	2009 Total	Friends Provident 2008 Total
	£m	£m	£m	£m	£m
Shareholder cash resources at 1 January	654	-	-	654	1,429
Adjusted for acquisition of Friends Provident	(323)	258	639	574	-
At 1 January, adjusted for acquisition	331	258	639	1,228	1,429
Generated in-force surplus	-	-	309	309	243
New business strain	-	-	(263)	(263)	(303)
Net cash surplus	-	-	46	46	(60)
Taxation	-	-	60	60	27
Impact on annuity business of bond spreads	-	-	176	176	(217)
Other net income/one-offs	(28)	-	13	(15)	(20)
Operating total	(28)	-	295	267	(270)
Investment return	4	(6)	51	49	49
Non-recurring items	-	(49)	(9)	(58)	(78)
Gain on STICS exchange	-	113	-	113	-
Securitisation and Fin Re	-	-	(76)	(76)	-
F&C retained shares and dividend		28	-	28	16
Acquisition of subsidiaries	-	(3)	(17)	(20)	(21)
Interest paid on STICS and subordinated debt	-	(6)	(46)	(52)	(52)
Other, including tax on non-operating items	-	8	1	9	(23)
Movement in shareholder cash resources before dividends	(24)	85	199	260	(379)
Dividends	-	(91)	-	(91)	(153)
Shareholder resources at 31 December	307	252	838	1,397	897

 

(i) Resolution Holdings (Guernsey) Limited is the parent company of FPH

The combined Resolution and Friends Provident pro forma shareholder cash resources, adjusted for the acquisition, have increased by £169 million from £1,228 million at 1 January 2009 to £1,397 million at 31 December 2009. This represents strong cash generation and a tax credit in the life operating companies totalling £106 million, supported by significant one-offs. There were also a number of financing items including a debt exchange and anticipated repayment of the outstanding securitisation, acquisition of a German distribution business, and payment of £91 million in dividends during the year.

At 1 January 2009, Resolution held £654 million of short term investments. Of this, £312 million was paid to Friends Provident shareholders who received cash under the cash option as part of the acquisition and £11 million of the total £16 million acquisition expenses were paid in the year. Additional cash payments made by the Group holding companies include the annual fee payable to ROL, legal and professional costs (including £4 million in respect of the listing in 2008) and Directors' fees.

The movements in cash resources for FPH and the other holding companies within Friends Provident are as follows:

·; Non-recurring items of £49 million include £34 million of transaction costs relating to the acquisition by Resolution paid by Friends Provident and £13 million of F&C demerger costs;

·; Gain on STICS exchange of £113 million represents the gain realised, net of tax and expenses, on the exchange of £322 million of STICS for £162 million of new subordinated debt. As shareholder cash resources are shown net of the book value of debt, this gain increases shareholder cash resources;

·; F&C dividend and retained shares of £28 million comprises £10 million dividend receipt from F&C in May 2009 and £18 million in respect of retained shares sold to finance the costs of the demerger;

·; Acquisition of subsidiaries comprises the net impact on cash resources of the acquisition of Financial Partners Business AG (a distribution business based in Germany) of which £17 million was borne by life operating business; and

·; Dividends of £91 million comprise the second interim dividend in respect of 2008 of £61 million paid in July 2009 and the £30 million interim dividend in respect of 2009 paid in October 2009.

The movements in cash resources for the life operating businesses are as follows:

The pre-tax in-force surplus net of new business strain for the life and pensions business improved to £46 million from a negative £60 million in 2008. This turnaround was driven by reduced new business strain, particularly in the UK where 2008 included a higher proportion of commission paying pensions business.

	Year ended 31 December 2009				Year ended 31 December 2008
	UK	Int'l	Lombard	Total	UK	Int'l	Lombard	Total
	£m	£m	£m	£m	£m	£m	£m	£m
In-force surplus	165	89	55	309	131	67	45	243
New business strain	(113)	(99)	(51)	(263)	(151)	(104)	(48)	(303)
Total	52	(10)	4	46	(20)	(37)	(3)	(60)

 

Lower new business strain in the UK reflected lower volumes of business, the decision early in 2008 to withdraw from less attractive product lines such as commission-paying pensions, and the cost savings programme reducing acquisition expenses by £16 million. The International and Lombard new business strain figures were similar to 2008. In-force surplus improved in each of the UK, International and Lombard businesses as a result of positive investment market conditions reversing some reserving impacts from 2008. 

Taxation of £60 million represents charges on income and credits on losses valued in the tax calculations for life companies within the Group. These do not directly reflect aggregate cash surplus but depend on the taxable income and expenditure of each life operating company. A smaller recurring benefit is expected in future years. Of the £60 million impact on shareholder cash resources, £11 million represents actual cash received in the year, with the remainder comprising movement in net tax assets/ liabilities within shareholder cash resources.

Shareholder cash resources have benefitted by £176 million due to the recovery in corporate bond assets backing annuities. Other one-off amounts include the reserving effects of positive expense basis changes offset by negative mortality and persistency basis changes totalling £13 million.

The life businesses have outstanding securitisation loan notes issued in 2004. The loan notes are repaid from surplus arising on a defined book of in-force life and pensions business, on which the surplus is due 60% to the non-profit business written in the with-profits fund for the benefit of shareholders and 40% to the FPLP with-profits fund under the terms of Friends Provident's demutualisation scheme. The shareholders' share of this surplus is included in the UK in-force surplus shown above. £71 million represents the amount expected to be paid to note holders in respect of surplus emerging during the year. Whilst the original expectation, based on projections at that time, was that the securitisation would be fully repaid by 2011, sufficient surplus has emerged in 2009 to enable the remaining balance to be repaid one year early. This has been allowed for in the shareholder cash resources and the payment will be made in April 2010 in line with the securitisation agreements. Following this repayment, all future surplus emerging from the Defined Book policies will accrue 60% to the FPLP non-profit fund (for the benefit of shareholders) and 40% to the FPLP with-profit fund. A further £5 million repayment of loan issued to support FPLA business written in Germany will reduce the outstanding balance of the financial reinsurance to £6 million.

Payment of STICS and subordinated debt costs represents interest payments of £17 million in respect of the 2003 STICS, £23 million in respect of the 2005 STICS and £12 million in respect of the FPG lower tier 2 debt. Following the completion of the financial restructuring referred to above, the expected annual interest cost is £51 million comprising £14 million in respect of the 2003 STICS, £17 million in respect of the 2005 STICS and £20 million in respect of the lower tier 2 debt. Following the acquisition of Friends Provident, the alternative coupon satisfaction mechanism (ACSM) feature of the STICS, in light of the new structure, no longer functions as originally intended. Resolution and FPG are currently reviewing options to allow reinstatement of the ACSM feature in a manner that meets the original intention for the instruments. The ACSM feature is designed to facilitate the repayment of deferred interest in the event that a coupon should be deferred. No coupons on these securities have been deferred.

Components of shareholder cash resources

Shareholder cash resources are based on shareholders' invested net assets on an embedded value basis, adjusted to include securitisation and financial reinsurance balances and to exclude intangible assets. As such, they include a number of non-cash assets and include allowance for repayment of debt, as shown below. 

	RSL/ RHG	FPH and its group cos	Life operating businesses	Total
	£m	£m	£m	£m
Cash	314	217	660	1,191
Gilts	-	-	179	179
Corporate bonds	-	-	386	386
Total cash resources	314	217	1,225	1,756
Equities	-	-	8	8
ABS	-	-	97	97
Other assets	(7)	(125)	308	176
STICS	-	800	(800)	-
Shareholder cash resources before debt	307	892	838	2,037
Shareholder debt	-	(640)	-	(640)
Net shareholder cash resources	307	252	838	1,397

 

The cash resources of the Group's Guernsey holding companies of £314 million are invested in accordance with the investment mandate set out at the time of the Company's listing. In summary, the objective is to provide capital, liquidity and, subject to these constraints, a competitive investment return by investing in a diversified portfolio of short-term securities, investments and obligations. The securities must have a short-term credit rating of at least A1/P-1 (or its equivalent) from a recognised credit rating agency at the time of purchase and at least 80% of the investments must be maintained at a credit rating of A1+/ P1 (or its equivalent). Treasury bills are to have a maximum maturity of six months and, in the case of all other investments, 100 days.

Friends Provident cash resources include:

·; other liabilities of £125 million in FPH and other holding companies within Friends Provident largely represents loans of £112 million from the life operating businesses, where the offsetting asset is included in the £308 million of other assets within the life operating businesses;

·; other assets of £308 million in the life operating businesses largely comprises the £112 million loan receivable from FPH referred to above, £120 million of loans to the FPLP with-profits fund (£71 million of which will be repaid following repayment of securitisation loan notes in 2010), £69 million loan to the Friends Provident pension scheme and £70 million of other assets including loans to subsidiaries of FPLP, taxation and other debtors;

·; the reclassification of £800 million in respect of the STICS where proceeds from the issue of the 2003 (£300 million) and 2005 (£500 million) STICS (subsequently restructured at a FPG level) were injected into FPLP and have been used to support growth of long term life insurance business; and

·; shareholder debt which comprises £478 million of STICS and £162 million of subordinated debt.

Group shareholder cash resources of £1,397 million are based on the shareholder invested net assets within the Group's MCEV of £1,572 million. The adjustments to shareholder invested net assets comprise:

·; inclusion of financial reinsurance (treated as debt under MCEV) as available capital for shareholder cash purposes. 

·; exclusion of intangible assets of non-covered business from shareholder cash resources (in MCEV they are included on an IFRS basis)

·; inclusion of corporate debt at book value for the purposes of shareholder cash resources (included at market value under MCEV principles).

 

Deployment of shareholder cash resources

Shareholder cash resources include resources required to cover the Group's capital policy. In addition to capital retained to cover the capital policy, an element of capital resources is currently retained in life operating businesses and is not necessarily available for alternative Group purposes. This may be due to dividend traps in individual entities or buffers held to provide working capital. 

Core deployment of the shareholder cash resources is shown below. 

	RSL/RHG	FPH and its group cos	Life operating businesses	Total
	£m	£m	£m	£m
Resources covering capital requirements	-	164	513	677
Illiquid assets	-	54	21	75
Liquid assets retained in life businesses	-	11	124	135
Available to shareholders	307	23	180	510
Shareholder cash resources	307	252	838	1,397

 

Resources covering capital requirements reflect the quantum of shareholder cash resources required to maintain capital in excess of 150% of the statutory (Pillar 1) capital requirements whilst capital is also managed to be in excess of 125% of Pillar 2 capital including any Individual Capital Guidance. 

Illiquid assets primarily comprise intercompany loans.

Liquid assets retained in life companies of £135 million represents cash resources which cannot be released as dividends due to working capital requirements, or dividend blocks.

At 31 December 2009, £510 million of cash resources is available to shareholders, including £180 million held in operating businesses. 

Dividends totalling £180 million will be paid to FPG by the operating businesses before the end of April 2010. This dividend will be used to:

(i) meet the interest payment of approximately £19 million due on the FPG lower tier 2 subordinated debt on 21 May 2010; and

 

(ii) pay £65 million to Resolution Holdings (RHG) to fund the final dividend payment in respect of 2009 to be paid by Resolution in May 2010.

 

The majority of the cash will be retained in FPG or FPH and used for general corporate purposes. However approximately £35 million is expected to be paid up to RHG in due course to finance the interim dividend that the Company expects to pay in the third quarter of 2010. During the first quarter of 2010 a number of operating companies within Friends Provident have completed capital reductions. Completion of these capital reductions has removed dividend blockages, which will allow certain internal financing loans within Friends Provident to be repaid, and allow further dividends to be paid by Friends Provident operating companies. 

Completion of the annual statutory valuation of the "Defined Book" policies in connection with the December 2004 £380 million securitisation transaction revealed sufficient surplus emerging in 2009 to repay both the deficit from 2008 and the outstanding floating rate notes. The final tranche of floating rate notes, with a face value of £123 million, will be repaid in full in the second quarter of 2010. Following this repayment, all future surplus emerging from the Defined Book policies will accrue 60% to the FPLP non-profit fund (for the benefit of shareholders) and 40% to the FPLP with-profit fund.

A thorough review of the corporate structure of the Friends Provident group is currently being undertaken to determine the most capital efficient structure going forward. It is anticipated that the conclusions of this work may lead to a project being established to merge a number of the UK regulated life assurance companies within Friends Provident, probably via a Part VII transfer process. As part of this process, Resolution intends to explore with the FPLP board and With-Profits Committee whether it would be possible to structure a transaction on mutually acceptable terms for the FPLP non-profit fund to acquire the 40% interest held by the FPLP with-profit fund in future surpluses emerging from the Defined Book policies. As at 31 December 2009, after the emergence of surplus in 2009 which will be used to repay the final floating rate notes, the VIF in respect of the Defined Book policies was approximately £320 million.

In addition to the review of corporate structure, a review of shareholder cash resources is being undertaken to ensure that the admissibility, liquidity and capital efficiency of these assets is optimised within the parameters of the Group's stated capital management policy and target credit rating. It is intended that surplus resources, that are not held to support the capital requirements of the operating businesses, should wherever possible be held by FPH. To the extent that resources may not be required to support the capital management of the operating businesses, but are required to support the Insurer Financial Strength ratings, it is intended that they be held by FPG.

Asset quality and exposure

Direct shareholder exposure to equities through the non-profit and shareholder funds is minimal with the main financial asset exposure being to corporate bonds and asset backed securities, where 95% is at or above investment grade. Over 95% of the overall portfolio of listed corporate bonds and asset backed securities is also at investment grade.

The with-profits funds' exposure to equities is partially hedged. The net exposure of the with-profits funds to equity movements at 31 December 2009 was £1.2 billion with a further exposure to property of £0.7 billion.

The Group's financial assets as at 31 December 2009, excluding cash and property, are summarised as follows:

	Unit- linked	With- profit	Non- profit	Share- holder	Year ended 31 December 2009 Total
	£bn	£bn	£bn	£bn	£bn
Shares, unit trusts and OEICs	27.7	2.6	0.1	-	30.4
Gilts	1.8	3.7	0.7	0.1	6.3
Corporate bonds and asset backed securities	3.5	4.4	2.7	0.4	11.0
Derivatives	-	0.1	-	-	0.1
Deposits	0.4	-	-	-	0.4
Loans	-	-	-	0.1	0.1
Total	33.4	10.8	3.5	0.6	48.3

 

Shares, unit trusts and OEICs comprise unit trusts and OEICs £17.2 billion, listed equity securities £11.6 billion and unlisted equity securities £1.6 billion.

Corporate bonds and asset backed securities comprise listed corporate bonds of £9.1 billion, unlisted corporate bonds of £0.6 billion and asset backed securities of £1.3 billion. Listed corporate bonds and asset backed securities are analysed by fund and credit rating as follows:

 

	Unit- linked	With- profit	Non- profit	Share- holder	Year ended 31 December 2009 Total
	£m	£m	£m	£m	£m
AAA	162	1,377	292	80	1,911
AA	170	631	1,800	80	2,681
A	340	1,443	401	128	2,312
BBB	161	430	79	27	697
Sub-BBB or rating not available	2,093	561	118	42	2,814
Total	2,926	4,442	2,690	357	10,415

The corporate debt and asset backed securities portfolio for non-profit and shareholder funds hold over 95% of these assets at investment grade (i.e. BBB- rated or better). Defaults on corporate bonds in 2009 were £9 million with no defaults on asset backed securities.

Liquidity

The liquidity of the Group remains strong. Friends Provident has an undrawn £300 million funding facility with a consortium of banks. This facility runs until April 2011 and provides the Group with considerable flexibility.

FPLP financial strength ratings

Current ratings of Friends Provident Life and Pensions businesses are:

Standard & Poor's: A- (strong) with a stable outlook

Fitch's rating: A (strong) with a negative outlook

Moody's rating: A3 (strong) with a stable outlook

The Group targets financial strength ratings in the single A range and expects them to remain there for the foreseeable future.

Dividend policy

Resolution has not paid any dividends to date. However, following the acquisition of Friends Provident, Resolution announced that it expected to pay a dividend of 4.08 per share each year with one third payable as an interim dividend and two thirds as a final dividend commencing with a final dividend in respect of 2009. The total cost of this dividend would be approximately £98 million for the full year of which £33 million would be paid as an interim dividend and £65 million as a final dividend.

Accordingly, a final dividend in respect of 2009 of 2.72 pence per share is being recommended by the Board. The record date is 9 April 2010 and, if approved by the shareholders, the dividend will be paid on 28 May 2010. A scrip alternative will, if also approved by shareholders, be available in relation to the final dividend.

The dividend will continue to be paid as long as the Friends Provident business is able to support it. The dividend policy will be reviewed following each future acquisition.

 

Friends Provident IFRS based operating profit

FPG was the parent company of Friends Provident until its acquisition on 4 November 2009. The following analysis of the IFRS based operating results excludes the impact of any acquisition accounting adjustments and is based on FPG's consolidated accounts for the year ended 31 December 2009.

	Year ended 31 December 2009	Year ended 31 December (i) 2008
	£m	£m
UK	269	(243)
International	(8)	(11)
Lombard	11	8
IFRS based operating profit before tax	272	(246)

 

(i) The comparative amounts have been restated to present asset management as a discontinued operation outside of operating profit.

IFRS based operating profit before tax for the year has increased significantly from a loss of £246 million in 2008 to a profit of £272 million, largely due to a turnaround in the UK results. The UK results reflect the significant impact of improvement in corporate bond assets benefitting the result by £176 million. The success of the expense reduction strategy provided a £45 million addition to profit while adverse persistency experience reduced profit by £23 million. The 2008 result was dominated by the widening of credit spreads, and consequent fall in market value of assets in 2008 resulting in a charge of £217 million for the year.

UK operating profit

Details of UK operating profit are set out below.

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
New business strain	(92)	(100)
In-force surplus	140	157
Investment return and other items	36	(1)
Principal reserving changes and one-off items	5	(72)
Effect of credit spreads and reserving changes assets and liabilities for annuities	176	(217)
Other	4	(10)
IFRS based operating profit before tax	269	(243)

 

The full year UK IFRS based operating profit was £269 million compared to a loss of £243 million in 2008, with both results significantly impacted by the credit spreads on the assets backing the annuities.

 

UK new business strain

New business strain consists of three elements:

·; the cash strain arising during the year;

 

·; IFRS adjustments, reflecting the difference between regulatory and IFRS reserving bases; and

 

·; an allowance for the deferral of acquisition costs (DAC), to the extent that it is allowed by IFRS.

 

Details of these elements for the main product lines are set out in the following table.

	Year ended 31 December 2009				Year ended 31 December 2008
	Cash strain	IFRS adjustments	DAC movements	IFRS strain	Cash strain	IFRS adjustments	DAC movements	IFRS strain
	£m	£m	£m	£m	£m	£m	£m	£m
Protection	(55)	-	-	(55)	(38)	-	-	(38)
Pensions	(55)	(1)	22	(34)	(106)	1	47	(58)
Annuities	-	-	-	-	1	-	-	1
Investments	(3)	(2)	2	(3)	(8)	(3)	6	(5)
Total	(113)	(3)	24	(92)	(151)	(2)	53	(100)

Cash new business strain mainly consists of acquisition expenses, commissions paid, and reserves established on a prudent basis in respect of the business written. Both cash strain and the DAC movement reduced in 2009 reflecting the effects of the withdrawal from unfunded commission paying product lines. The conservative policy of not taking credit for DAC on protection business has been continued.

Protection new business strain increased during the year, as a result of a review of the allocation of sales and marketing infrastructure expenses across different product lines, which resulted in a greater proportion of these costs being allocated to protection, away from pension products.

UK in-force surplus

Details of UK in-force surplus are set out below.

	Year ended 31 December 2009				Year ended 31 December 2008
		IFRS	DAC			IFRS	DAC
	Cash surplus	Adjustments	Movement	IFRS surplus	Cash surplus	Adjustments	Movement	IFRS surplus
	£m	£m	£m	£m	£m	£m	£m	£m
Protection	39	2	-	41	25	4	-	29
Pensions	54	(1)	(18)	35	41	17	(19)	39
Annuities	(1)	-	-	(1)	(1)	-	-	(1)
Investments	11	12	(20)	3	2	43	(19)	26
With-profit fund	62	-	-	62	64	-	-	64
UK Total	165	13	(38)	140	131	64	(38)	157

 

Surplus emerging from the with-profit funds has remained stable. UK in-force surplus has decreased in the year, reflecting positive one-offs in 2008 relating to investment products, and the impact of negative one-offs on protection business.

UK investment return and other items

This balance comprises:

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
Longer-term return on life and pension shareholder funds	26	48
Distribution businesses	4	10
Non-recurring items	6	(59)
Total	36	(1)

 

The UK longer-term investment return fell from £48 million to £26 million because of the lower value of UK life and pensions shareholder assets during the year and lower expected rates of return. The longer-term rates of investment return are assumed to be as follows: equities 6.7% p.a. (2008, 8.0% p.a.), gilts 3.7% p.a. (2008, 5.0% p.a.) and other fixed interest 6.7% p.a. (2008, 5.5% p.a.).

The profit from the UK distribution businesses, Sesame Bankhall Group and Pantheon Financial, was £4 million against £10 million for 2008. Sesame completed the acquisition of the Bankhall Group in October 2009 to form the new group, the UK's largest approved representative business, directly regulated service business and mortgage advisor services provider. Trading conditions for distribution businesses remained challenging in 2009 while the 2008 results benefitted from some one-off items.

The non-recurring items in 2008 include a write down of investment DAC, charges related to improved modelling and project costs.

Principal reserving changes and one-off items

Principal reserving changes and one off items had a beneficial impact of £5 million, compared to a charge of £72 million in 2008. Within the 2009 item is a £45 million release of reserves, resulting from the expense efficiency improvements as a result of the cost saving strategy, offset by a strengthening of reserves due to worse persistency of £23 million, and an additional reserve of £23 million to cover VAT on investment expenses following the demerger of F&C Asset Management (F&C currently manage £27 billion of assets on behalf of Friends Provident life companies. Fees paid to F&C in 2009 amounted to £26 million of which £18 million was in respect of funds managed under agreements with a one year revolving notice period and the remainder was in respect of funds managed under agreements which run until June 2014). The increase in reserves due to persistency is largely in relation to worsening experience in the individual protection market, as the recessionary environment impacted IFA behaviour and market pricing.

Effect of credit spreads and reserving changes on assets and liabilities for annuities

The narrowing of credit spreads and reserving changes on assets and liabilities related to annuities increased IFRS operating profit of the UK life and pensions business by £176 million for the year. This compares to a negative impact of £217 million in 2008 from the widening of credit spreads. For the annual financial statements in 2008 the discount rate used to value annuity liabilities was set at the risk-free rate (gilts) plus 50% of the spread above the risk-free rate implied by market prices of the corporate bonds held to back the annuity reserves, with a cap of 250 basis points applied to each individual bond. As corporate bond market conditions have eased, spreads have narrowed and the reserving basis has been updated to reflect changed market conditions.

UK operating expenses

The operating expenses of the UK business, which excludes both commission payments and non-recurring costs, but including what were previously Friends Provident corporate costs, are set out in the table below.

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
Acquisition	107	123
Maintenance	97	108
Development	15	-
Other	4	14
Total	223	245

 

UK operating costs are £22 million below 2008, as a result of the cost savings initiatives set out following the Friends Provident 2008 strategic review, which aimed to reduce UK operating expenses to a run rate of £215 million by the end of 2010. At the end of 31 December 2009 the targeted £80 million of required cost savings to achieve this target in 2010 had been achieved. The total cost of implementing these savings, plus a number of other strategic changes, was approximately £81 million. £32 million of this was incurred in 2008, with the remaining £49 million incurred in 2009. The 2009 cost is reflected as a non-recurring item and therefore does not impact on operating profit. The other significant pre-acquisition expenses also reflected as non-recurring and therefore not included in operating profit are the Friends Provident costs of the Resolution acquisition (£34 million), the costs of the demerger of F&C Asset Management (£13 million) and termination costs related to share option schemes (£8 million) arising from the acquisition.

The targeted run rate of £215 million is anticipated to comprise acquisition costs of £105 million (split £60 million direct and £45 million overheads), maintenance costs of £85 million (split £30 million direct and £55 million overheads) together with £25 million of development costs.

International

The International segment has achieved quarter on quarter growth throughout 2009 with full year sales of £183 million (2008: £210 million). Although demand in Hong Kong, one of its main markets, remains well below the peak level of early 2008, there are signs of improvement with an increase in market share for linked business.

The 2009 results include a contribution of £11 million from AmLife Insurance Berhad (AmLife), an associated undertaking based in Malaysia, for which a 30% share was acquired in November 2008.

The Group acquired Finance Partner Business AG, a distribution business based in Germany, in December 2009. This had previously been a major independent distributor for Friends Provident International.

The International business incurred an operating loss of £8 million for 2009. The results were adversely impacted by reserving changes and one-off items.

The analysis of the operating result is set out in the table below.

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
New business strain	(28)	(24)
In-force surplus	36	17
Investment return and other items	3	(9)
Principal reserving changes and one-off items	(30)	5
Share of results of AmLife Insurance Berhad	11	-
IFRS based operating loss before tax	(8)	(11)

 

Principal reserving changes and one-off items

Principal reserving changes and one-off items reduced operating profit by £30 million, compared to an increase in operating profit of £5 million in 2008. The main impact in 2009 is an additional £20 million expense reserve set up largely in respect of growing German business, reflecting the additional expected investment in operational infrastructure, proposition and distribution capability. The 2009 results were also impacted by a number of smaller negative items.

AmLife Insurance Berhad

AmLife performed well during the year and the Group's share of the profits was £11 million. This included approximately £6 million arising from reserving changes of a one-off nature as a result of a change in local regulations.

Operating expenses

Operating expenses which excludes both commission payments and non-recurring costs, are set out in the table below. These have been tightly controlled throughout the year. Small inflationary increases were offset by a £5 million fall in development costs as project spend was deferred in the light of the global economic downturn.

 

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
Acquisition	26	25
Maintenance	20	18
Development	4	9
Other	1	-
Total	51	52

 

Lombard

Lombard, the international estate planning life assurer, where business is traditionally weighted towards the fourth quarter, achieved record sales of £273 million in 2009 (2008: £246 million). Lombard had a particularly strong last quarter in the Italian market and its Swiss operations also contributed significantly. This, together with a strong contribution from Belgium, more than offset weaker sales in Spain and Germany, although the recent legal and fiscal uncertainty in these markets has now been largely clarified.

IFRS operating profit for the year was £11 million, against £8 million for the preceding year. An analysis of operating profit is set out below.

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
New business strain	(31)	(28)
In-force surplus	50	41
Investment return and other items	(6)	(2)
Principal reserving changes and other one-off items	(2)	(3)
IFRS based operating profit before tax	11	8

 

New business strain increased in line with the growth in new business. The significant increase in in-force surplus reflects the growth of the in-force base.

Lombard operating expenses

The operating expenses of Lombard, which excludes both commission payments and non-recurring costs, are set out in the table below.

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
Acquisition	44	36
Maintenance	19	16
Development	3	3
Other	-	3
Total life and pensions	66	58

 

The increase in Lombard operating costs is due primarily to exchange rate movements, in particular due to the fall of Sterling against the Euro. In local currency terms, expenses have remained flat in 2009 when measured against expenses of the preceding year.

 

Market consistent embedded value

MCEV is an alternative accounting basis to IFRS for life assurance companies. MCEV basis reporting is designed to recognise profit as it is earned over the lifetime of each policy and reflects the future cashflows that are expected to arise from sales in the year together with the effect of updating previous assumptions on existing business with actual experience. The total profit recognised under both MCEV and IFRS will be the same over the life of each policy, it is the timing of the recognition of that profit which differs.

Resolution is presenting its embedded value results and financial position in accordance with the MCEV Principles published by the European Insurance CFO Forum issued in June 2008, and re-issued in amended form in October 2009. The amendments in October 2009 primarily related to the allowance of an illiquidity premium on contracts with predictable cashflows. Results for 2008 for Friends Provident plc were calculated and reported on a European Embedded Value (EEV) basis. This basis used a market-consistent approach and only assumption and presentational changes have been required to achieve full compliance with the MCEV Principles. These changes do not have a material impact on the previously reported results and consequently it is not necessary to restate the 2008 Friends Provident results.

Alignment with the MCEV Principles is in addition to normal year end activity. This encompasses a review of all operating assumptions together with a review of the Friends Provident approach to statutory reserving for annuities and accounting treatment of tax assets at the end of 2009. Following the alignment with the MCEV Principles and the aforementioned reviews, Resolution considers that Friends Provident's annuity reserving and reporting bases remain towards the more conservative end of the spectrum.

Alignment with MCEV Principles

Reference rates and illiquidity premium

Under the MCEV Principles, the reference rate (previously termed the 'risk-free rate' under EEV) is based on the swap yield curve for liquid liabilities and on the swap yield curve plus an illiquidity premium for illiquid liabilities, such as annuities. The market consistent approach used previously under EEV Principles assumed the reference rate was based on the gilt yield curve, with no illiquidity premium.

Following the re-issue of the updated MCEV Principles, the Group reviewed its embedded value assumptions and elected to include an illiquidity premium for its UK immediate annuity business. For 2009, the reference rate is based on the swap yield curve, increased by an illiquidity premium of 75bps for in-force annuity business at the year end, 100bps for the value of new annuity business written during the year and 80bps for the two months ended 31 December 2009.

Cost of residual non-hedgeable risks

The MCEV Principles require that an allowance is made for the cost of non-hedgeable risks not already allowed for elsewhere in the MCEV. Under Friends Provident's previous market consistent approach, allowance was made for the cost of non-market risk in a similar way to the allowance for non-hedgeable risks under the MCEV Principles and the difference in costs under the two approaches is not significant.

Corporate costs

Under the MCEV Principles, holding companies' operating expenses relating to the existing covered business are to be allocated to the expense assumptions for the covered business. Friends Provident previously showed a provision for capitalised future costs in the corporate business segment. These costs are now regarded as relating to the life and pensions covered business and the 2008 comparatives have been adjusted to show the provision as a deduction from the value of in-force covered business.

Friends Provident full year MCEV results

MCEV results

The MCEV results of Friends Provident for the years ended 31 December 2009 and 31 December 2008 facilitate the most meaningful interpretation of the performance of the acquired business.

	Year ended 31 Dec 2009
	UK	International	Lombard	Total
	£m	£m	£m	£m
Value of new business	26	47	60	133
Expected existing business contribution	125	23	28	176
Operating experience variances	(68)	(21)	(8)	(97)
Operating assumption changes	11	(8)	(7)	(4)
Other operating variances	8	(18)	16	6
Development costs	(16)	(5)	(2)	(23)
Life and pensions covered business operating profit before tax	86	18	87	191
Other income and charges	15	-	-	15
Operating profit before tax	101	18	87	206
Economic variances				419
Amortisation and impairment of non-covered business intangible assets				(35)
Non-recurring items and non-operating variances				14
Profit from continuing operations before tax				604
Tax on operating profit				(53)
Tax on other activities				(105)
Profit from continuing operations for the year after tax				446
Discontinued operations (net of tax)				(22)
Profit for the year after tax				424

 

 

	Year ended 31 Dec 2008
	UK	International	Lombard	Total
	£m	£m	£m	£m
Value of new business	28	44	67	139
Expected existing business contribution	183	19	36	238
Operating experience variances	10	(21)	9	(2)
Operating assumption changes	(24)	3	(1)	(22)
Other operating variances	(5)	-	24	19
Development costs	-	(9)	(3)	(12)
Life and pensions covered business operating profit before tax	192	36	132	360
Other income and charges	4	-	-	4
Operating profit before tax	196	36	132	364
Economic variances				(743)
Amortisation and impairment of non-covered business intangible assets				(5)
Non-recurring items and non-operating variances				(51)
Loss before tax from continuing operations				(435)
Tax on operating profit				(96)
Tax on other activities				210
Loss from continuting operations for the year after tax				(321)
Discontinued operations net of tax				(288)
Loss for the year after tax				(609)

 

The operating results above and detailed descriptions below are segmented into UK, International and Lombard, reflecting the major distinct operations within the group.

The UK segment comprises UK life and pensions operations, the UK distribution businesses Sesame and Pantheon Financial, and corporate functions and assets. The UK business operates through two trading units sharing a single platform. These units are focused on corporate and individual customers, and known as UK Corporate and UK Individual.

The International segment comprises Friends Provident International Limited (FPIL), overseas business written in UK funds and Friends Provident's share in AmLife. International's major component is Isle of Man-based FPIL, with distribution hubs in Hong Kong, Singapore and Dubai to enable cost-effective delivery of products in markets with more attractive returns than the UK. AmLife is the Malaysian insurance associate in which Friends Provident acquired a 30% stake in December 2008 with AmBank Berhad, a major Malaysian banking group being the main shareholder.

Lombard is based in Luxembourg and specialises in estate planning solutions for wealthy clients throughout Europe and the rest of the world.

UK life and pensions operating profit

	Year ended 31 Dec 2009	Year ended 31 Dec 2008
	£m	£m
Value of new business	26	28
Expected existing business contribution	125	183
Operating experience variances	(68)	10
Operating assumption changes	11	(24)
Other operating variances	8	(5)
Development costs	(16)	-
Life and pensions covered business operating profit before tax	86	192
Other income and charges	15	4
Operating profit before tax	101	196

 

The total MCEV operating profit for the UK is down from £196 million in 2008 to £101 million in 2009. Overall changing assumptions to align with the MCEV Principles accounted for £68 million of the change, as the positive impact of £18 million on the value of new business was more than offset by the reduction in the expected contributions on the value of in-force and on the shareholder net worth.

Value of new business (VNB)

The UK VNB was broadly in line with 2008 at £26 million compared to £28 million taking into account the inclusion of the illiquidity premium in 2009. The key product lines driving the VNB are group pensions, individual protection and annuities.

Present value of new business premiums (PVNBP) margin (defined as VNB as a percentage of PVNBP) has improved slightly, the net result of a number of factors.

	Value of new business			PVNBP margin
	2009 £m	2008 £m		2009 %	2008 %
UK Corporate	10	14		0.7	0.7
UK Individual	16	14		2.1	1.5
UK Total	26	28		1.1	0.9

 

VNB and PVNBP margin depend to a large extent on volume of business, because a large proportion of acquisition costs are fixed. There was an overall decline in volume in the UK of 33%, which had a geared impact on VNB. This impact was however partly offset by a £16 million benefit to value of new business as a result of the cost savings programme.

Group pensions sales in APE were down 27% year-on-year. As a result of the economic environment, increments to existing schemes, which form a major share of reported new business, have reduced significantly. Such increments arise from growth in scheme membership, from the hiring of new employees, and increases in contributions, typically driven by annual salary increases. Both of these factors are affected by rising unemployment and wage constraints in the wider economy. Also, as part of the strategy change in early 2008, Friends Provident revised terms so as not to take on new schemes on an unfunded initial commission basis. 

The following table shows the split of group pensions new business in 2009 between increments on old style business on which initial commission is paid and new style business on which no initial commission is paid.

2009 Actuals	APE	Gross VNB	IRR	New business strain	Undiscounted payback years
	£m	£m	%	£m	Period
Increment with Initial Commission	132	3.9	7.3	33	14
New Style "no initial Commission" business	172	0.9	7.3	18	14
Total	304	4.8	7.3	51	14

 

Individual protection sales in APE were down 9% year on year. Activity in the protection market is closely related to the level of transactions in the housing market, because sales of protection products are often linked to mortgage sales. Market activity in 2009 has not yet recovered from the historic lows reached in 2008 and increased competition has resulted in margin compression.

Friends Provident has continued its activities aimed at expanding distribution and during the course of the year has announced tied distribution agreements with Tesco Bank and Virgin.

Annuity sales reduced slightly year-on-year. The retention rate for non-GAR vesting pension funds was approximately 20%. The 100 basis points illiquidity premium on new annuities, together with the change in reference rate from the gilt yield curve to swaps, resulted in a £19 million increase to the value of new annuity business.

Expected existing business contribution

The reduced expected return on VIF reflects the lower opening VIF, £975 million in 2009 compared to £1,260 million in 2008, together with slightly lower expected rates of return.

The UK expected contribution on shareholders' net worth includes offsetting items for the expected income on shareholder investments, including the use of a one-year return on bonds rather than a long-term average yield, and interest payable on debt instruments which is recharged to the life companies and is fixed in amount.

Operating experience variance

Operating experience variances totalled a negative £68 million in 2009.

 

£39 million (first half 2009: £19 million) of the negative variance in 2009 relates largely to reduced persistency and higher rates of fall off in premium payment on group and individual pensions. This reflects a combination of difficult economic conditions adversely affecting employment levels and income and some effect from Friends Provident's retrenchment from the commission paying group pensions market, as a number of schemes have been churned to commission paying providers. There is also a small adverse effect due to higher lapses on protection due, in part, to some brokers going out of business.

 

There is an £11 million adverse variance in 2009 which is the effect of rewriting schemes on more competitive terms in order to retain them. The charge at the half year was £5 million.

 

In addition, in the year there was a thorough review of the recoverability of tax assets resulting in a £26 million reduction in the balance. This was offset by other positive tax variances giving rise to a net adverse operating experience variance of £14 million.

There was a small overrun on maintenance expenses of £2 million which reflects the assumption being based on the planned cost base in 2010, after the implementation of all the actions to reduce costs.

A number of exceptional offsetting items were incurred in 2009 netting to an expense of £2 million, including £5 million in respect of the closure of the Manchester branch and the costs related to special policyholder mailings.

Operating assumption changes

The effect of operating assumption changes resulted in a favourable £11 million outcome in 2009. The main driver for the positive variance, accounting for £19 million, however is the net effect of the two largely offsetting items being a loss of £135 million in respect of changes in persistency assumptions and a profit of £154 million as the result of expense reductions and redefinition of development costs.

The persistency assumption changes include £29 million due to increasing lapse and paid up rates on group pensions policies following Friends Provident's announcement of its exit from the market for unfunded commission paying group pensions, £23 million on protection where some higher lapsing on certain product lines has been experienced and £19 million in respect of bonds following a noted spike in exits at the later years, when surrender penalties have expired. In addition to this £71 million overall impact of changes applied at the product level, a provision of £70 million has been made for further short term adverse experience both of a recessionary nature and due to short term churning while commission is still payable on group pensions business across the business, £64 million of the provision of £70 million impacts the UK.

Persistency experience at a product level is tracked and reported on a monthly basis together with persistency monitoring, with action taken where the lapse rates are significantly out of line.

Offsetting the year on year positive variance is an adverse impact of £8 million in respect of changes to mortality and morbidity assumptions.

Other operating variances

Other operating variances in the UK amounted to £8 million in 2009. The total figure includes the effects of a number of offsetting items. The component elements include a £26 million benefit from enhanced modelling of the burn through effect in the with-profits funds, effectively by allowing for the equity backing ratio to flex more in extreme adverse conditions. There were a number of small individual modelling changes (for example on annuities and on permanent health insurance (PHI) business) which resulted in a favourable £12 million balance. An adverse £19 million result in respect of an increased allowance for non-hedgeable risk arising from the alignment with MCEV Principles, and the final component was a negative £11 million in respect of modelling the cost of capital ratios based on the target coverage ratios now in use in the business.

Development costs

There is a £16 million outlay due to development costs that are designed to enhance current propositions, which are expected to generate future profits, to ensure that they remain marketable. These costs relate to various systems developments in group pensions designed to enhance the proposition as well as development costs associated with the tied distribution arrangement wtih Tesco Bank.

Other income and charges

Other income and charges had a positive £15 million balance as compared to a positive £4 million favourable balance in 2008. £4 million of the variance relates to the increase in the expected return on the net pension asset and results from a higher opening surplus as reported under IAS19: Employee benefits. A further positive variance of £21 million arises from £18 million of corporate costs reported in 2008 which in 2009 are allocated to covered business and the non-recurrence of £3 million of costs for a development programme terminated in 2008. Offsetting these positive variances are a decrease in the expected return on corporate net assets of £8 million and a reduction of £6 million in the operating profit of Sesame and Pantheon Financial due to the difficult operating environment for distribution businesses in 2009. The expected return on what were previously corporate net assets has decreased by £2 million due to lower invested assets. The remaining £9 million arises from reallocated corporate costs.

Management of the with-profits fund

During 2009 Friends Provident reviewed the operation of the FPLP with-profits fund. Risk appetite has been clarified for the fund, which has been agreed with the FPLP With-Profits Committee, based on an ICA measure of capital with the addition of a £100 million allowance (which runs off over time as the fund declines). A range of actions have been agreed that can be taken in extreme events to keep the fund within appetite while also ensuring that the Group continues to treat customers fairly. Friends Provident will be implementing these various measures in 2010. One measure that has been implemented in the modelling of burn through cost in 2009 is making the equity backing ratio more dynamic in adverse scenarios. As stated previously this added £26 million to MCEV operating profit in 2009.

 

International

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
Value of new business	47	44
Expected existing business contribution	23	19
Operating experience variances	(21)	(21)
Operating assumption changes	(8)	3
Other operating variances	(18)	-
Development costs	(5)	(9)
Life and pensions covered business operating profit before tax	18	36
Other income and charges	-	-
Operating profit before tax	18	36

 

The MCEV operating profit from International is £18 million in 2009, down from £36 million in 2008, principally due to an additional £18 million of adverse operating variances in 2009 which are one off in nature.

Value of new business

FPIL new business APE volumes were 13% lower as new single premium investment was weaker due to the global economic crisis. FPIL achieved quarter on quarter growth throughout 2009, despite the market turbulence.

Friends Provident's 30% share of AmLife sales was £9.1 million APE. The business has achieved strong growth in both its agency sales force and bancassurance distribution in spite of the more challenging macroeconomic backdrop. Reported figures are for Friends Provident's 30% stake in the business. The fall in International volume was offset by the decline in 2009 of Sterling's value against the US Dollar and the Euro, meaning that the end-period economic assumptions were more favourable for VNB reported in Sterling. Value of new business for FPI was therefore flat year-on-year and present value of new business premium (PVNBP) margin improved slightly overall. AmLife has performed well with strong PVNBP margin. 

	Value of new business			PVNBP margin
	2009	2008		2009	2008
	£m	£m		%	%
International (excluding AmLife)	43	44		4.2	3.5
AmLife	4	n/a		6.8	n/a
International total	47	44		4.3	3.5

 

Operating experience variance

Operating experience variances amounted to an adverse variance of £21 million. This total includes £10 million of adverse persistency resulting largely from the impact of the global recession in 2009 with £5 million relating to overseas life assurance business written in Germany where the economic conditions have caused some higher lapse and paid up experience.

A further £9 million of adverse operating variance relates to expense overruns, split £4 million Germany and £5 million across other International operations, with minor other variances netting to an adverse £2 million.

Operating assumption changes

Operating assumption changes net out to negative £8 million and principally reflect increased unit cost assumptions in respect of the German business.

Other operating variances

Other operating variances amount to negative £18 million and are made up of £12 million for modelling changes and £6 million in relation to increased charges for non-hedgeable risk due to the alignment with MCEV Principles.

Development costs

Development costs of £5 million relate mostly to the German business and an amount in respect of enhancing quotation systems in Asia to be in line with regulations, down from £9 million in 2008.

Lombard

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
Value of new business	60	67
Expected existing business contribution	28	36
Operating experience variances	(8)	9
Operating assumption changes	(7)	(1)
Other operating variances	16	24
Development costs	(2)	(3)
Life and pensions covered business operating profit before tax	87	132
Other income and charges	-	-
Operating profit before tax	87	132

The MCEV operating profit from Lombard is £87 million in 2009, down from £132 million in 2008, due to a reduced existing business contribution and some large positive other operating variances in 2008 which did not recur in 2009.

Value of new business

The VNB was £60 million in 2009 down from £67 million in 2008.

	Value of new business		PVNBP margin
	2009	2008	2009	2008
	£m	£m	%	%
Lombard	60	67	2.2	2.7

 

Sales in Lombard are seasonal due to the concentration of European tax year-ends in December and the consequent peak of sales in the fourth quarter. New business volumes in 2009 were 11% higher than in 2008, driven primarily by strong performances in the Italian, Swiss and Belgian markets. Sales were lower in Germany and Spain, where uncertainty with respect to legislation changes impacted 2009 sales. There was strong competition for business in Italy as clients brought assets onshore as a result of a tax amnesty late in the year, so this business was written at a lower than average margin, although there was also little new business strain associated with this business.

Operating experience variances

Operating experience variances were £8 million adverse in 2009 reflecting increased lapse experience of £7 million with the remainder of the experience variance in 2009 comprising shortfalls in surrender fee income. In 2008 operating experience variances benefitted from a large positive effect from a reassessment of tax assets, which were found to be valued too conservatively, amounting to £18 million.

Operating assumption changes

An adverse £7 million operating assumption changes variance is attributable to updating assumptions for partial surrender experience.

Other operating variances

Other operating variances amount to a favourable balance of £16 million, and include £14 million in relation to the movement to non-hedgeable risk, aligning with MCEV Principles. The 2008 positive operating variance of £24 million related to improved modelling of policyholder cashflows

Non-operating items

	Year ended 31 December 2009	Year ended 31 December 2008
	£m	£m
Economic variances	419	(743)
Amortisation and impairment of non-covered business intangible assets	(35)	(5)
Non-recurring items and non-operating variances	14	(51)
Total	398	(799)

 

Investment return variances and the effect of economic assumption changes were £419 million in 2009 with the largest component parts relating to annuity business, as corporate bond spreads narrowed in the second half of the year, giving rise to a £160 million positive investment return variance, and the impact of including an illiquidity premium in line with the MCEV Principles. The economic assumption changes include £274 million for a 120 basis points illiquidity premium at the start of the year on assets backing in-force business, offset by £34 million for changing the reference rate from gilts to the swap curve. Investment return variances were also positive on unit-linked pensions business and Lombard reflecting investment market improvements by the end of the year, partly offset by adverse exchange rate movements.

The increased amortisation charge on non-covered business intangible assets results from impairment of the carrying value of intangible assets in Pantheon Financial.

Non-recurring items include a £107 million positive benefit from the impact of changes in legislation to remove UK tax on overseas dividends, offset by strategy implementation costs of £49 million relating to the delivery of the Friends Provident strategic review, the Friends Provident costs of the Resolution acquisition (£34 million), termination costs related to share option schemes (£8 million) arising from the acquisition and £2 million of sundry other costs.

Closed FSA investigation

The Company announced on 8 May 2009 that the FSA had closed a brief investigation into certain members of the Resolution Operations LLP team and the Chairman relating to their former positions as directors of Resolution plc (now Pearl Group Holding (No.1) Limited). The investigation has had no material impact on the Company.

Principal risks and uncertainties

Resolution is exposed to a large and diverse number of risks from a financial, strategic and operational perspective. A Group level risk management framework is in place comprising formal committees, risk management policies and risk assessment processes. These provide the means, by which the Group identifies, assesses, manages and monitors material risks.

A key aspect of the approach to risk management is the establishment of Group policies that set minimum standards for business units in relation to the risk framework and specific underlying risk areas. Group-wide risk management is advised to the Board by the ROL Chief Risk Officer (CRO) on behalf of the Board.

A detailed review of the Group's inherent exposures to market, credit, insurance and operational risks together with the framework for their management and control, will be included in the financial statements. An overview of the Group's risk management structure will be included as part of the review of corporate governance.

Shown here are the major risks faced by the Group together with an overview of the actions that are being taken to manage them.

Financial Market and Economic Conditions

Businesses in the financial services sector are affected by changing general market conditions which are outside the control of the Group. Since July 2007, market conditions have and continue to be more volatile than in previous periods and there can be no assurance as to the effect of this volatility on the financial services sectors and geographical areas in which the Group may operate. Adverse and extreme developments of the kind experienced in the recent market dislocation and turmoil have affected the financial services sector in a number of ways, in particular in relation to the capital markets and the credit and financial markets as a whole.

The Group has in place a range of risk management tools to support it in the monitoring, evaluation and management of these challenges. More broadly and from a wider acquisition perspective the Group believes that the challenges posed by the current financial services and economic environment has and will continue to create opportunities for market consolidation.

The acquisition of Friends Provident exposes the Group to the risks and uncertainties faced by that business as a result of the global financial crisis and uncertain economic outlook. Continued general deterioration in the UK or other major economies throughout the world where the Group operates, could reduce the level of demand for the products and services and impact operating results. The Group continues to actively monitor these risks and will take proactive action to manage expenses and ensure the retention of existing, profitable business and will work to build the confidence of distributors to continue recommending the Group's products.

Lack of target companies to acquire

The Resolution business strategy is based on the consolidation and restructuring of existing businesses in the financial services sector. The acquisition of Friends Provident represented the start of Resolution's UK Life Project. The Group expects to follow this acquisition with further transactions in these and other sectors. This strategy is dependent to a significant extent on the ability of the Company and its professional advisers to identify suitable acquisition opportunities. If no suitable opportunities are identified that correspond with the Group's strategy for creating value, then further acquisitions may not take place.

In addition to this, the Group operates in a competitive market place where it will have to compete with a number of entities for potential acquisitions. There is a risk that this competition leads to inflated or uneconomic prices limiting the Groups ability to successfully complete acquisitions. The Group expects that it will face competition primarily from strategic buyers, commercial and investment banks and commercial finance companies as well as public and private investment funds.

The Group, through ROL and its other professional advisers, conducts detailed ongoing research into potential target companies. This includes regular engagement and discussions with potential sellers of suitable assets across different sectors and geographies. In addition the Group retains the ability to move swiftly should an appropriate opportunity be identified.

Reliance on ROL

The Group currently depends to a significant degree on ROL and key ROL personnel for the successful implementation of the Group's restructuring strategy, the provision of day-to-day oversight of Friends Provident for the Company and the provision of certain other services to the Company in its role as a holding company. These services are provided in conjunction with the Board which will independently approve every acquisition made by the Company. 

However, there is no guarantee that if ROL ceased to provide services to the Company, the Company would be able to find an adequate replacement on appropriate terms or, if ROL lost key personnel, that ROL would be able to appoint qualified successors to enable it to provide the relevant services to the Group. Whilst ROL may not terminate the agreement under which it provides these services until 10 December 2013 and then only subject to providing the Company with 12 months' written notice (except that the agreement may be terminated by ROL prior to December 2013 (and on shorter notice) upon a change of control of the Company and in certain other limited circumstances), conversely, the Company is not able to remove ROL in the absence of negligence or material default or similar until 10 December 2013. 

The Company has sought to mitigate these risks by aligning the interests of key members of the ROL team through an incentive structure which rewards the founders and staff of The Resolution Group for capital value created on each restructuring project which the Company undertakes. There is also a formal process for evaluating the performance of ROL against the services it has contracted to provide.

Legislation and regulation

The Group operates in a highly regulated financial services market both in the UK and internationally which has a significant impact/influence on both strategic decisions and ongoing day-to-day management of acquired businesses. The current framework of regulation in the UK and throughout the world continue to evolve both due to national (and from a UK perspective European) requirements and in response to the wider recent turmoil in the global financial markets. It is impossible to fully predict the nature of the regulatory changes which may occur in the future or the impact that such changes may have on the Group and its strategic objectives. Unanticipated changes in legal requirements (including taxation) and regulatory regimes, or the differing interpretation and application of regulation over time may have detrimental effects on the Group.

The Group's activities and strategic planning are based upon its understanding of prevailing legislation and regulation, together with an awareness (including impact assessment) of communicated planned future changes. The Group Risk Management framework provides for a consistent and robust approach to the ongoing monitoring of ROL and the Group's subsidiary businesses to ensure that the Group continues to meet its legal and regulatory obligations. Where appropriate the Group and its subsidiary businesses engage with regulatory and legislative authorities to provide input in the evaluation of proposed changes.

Future Developments in the Life Assurance market

Following the acquisition of Friends Provident, the Group has an increased exposure to the UK life assurance and savings market and the associated economic, legislative and regulatory challenges therein. These include:

·; customer uncertainty driven by the recent financial crisis has led to increasing distribution challenges and a protracted period of low growth in asset values or low interest rate returns, may lead to changes in consumer behaviour that are prejudicial to the traditional life and pensions distribution model;

·; much of the new UK life and pensions business is derived from independent distributor firms and specific partnership arrangements. The FSA is consulting on a number of proposals regarding potential changes to existing financial advisory practices, in particular the Retail Distribution Review that could have a significant impact on the provision of advice within the retail distribution market with a consequent negative result for the Group in terms of future new business volumes; and

·; fundamental changes in regulation, notably the EU Solvency II Directive, may have a significant impact on the Group and the life assurance sector more generally. Significant Friends Provident resource is being allocated to fully understand this impact and appropriately manage the required change process to meet the new regulatory requirements from the FSA in relation to Solvency II.

The Group devotes significant resource and time, supported by ROL, to understanding the potential impact of these challenges at an individual business and wider Group strategy level.

The timing and scale of the occurrence of insured events

The business conducted by the Group involves the underwriting of events whose occurrence cannot be accurately predicted. For example, in the UK, Friends Provident issues life assurance policies that provide protection in the event of death and annuities that depend on longevity. Extreme events affecting mortality or morbidity may affect the companies' solvency, profitability and earnings. The management of these insurance risks will be covered in the full financial statements.

Other assumptions

In addition to pricing for mortality and morbidity risks, as part of the processes to determine the value of long term liabilities, the Group makes assumptions about other factors including future lapse rates, interest rates, expense levels and counterparty defaults. Assumptions are subject to rigorous and ongoing review. This includes the use of stress testing of key parameters forming part of the processes used to calculate required capital holdings. However, extreme movements in financial markets and in the broader economic environment may require certain assumptions to be recalibrated, impacting the earnings and other financial metrics.

Directors' responsibility statement pursuant to Disclosure and Transparency Rule 4 (extracted from the 2009 Annual Report and Accounts)

The Annual Report and Accounts contains the following statements regarding responsibility for the financial statements and the business review included in the Annual Report and Accounts.

"Each of the Directors of the Company confirms that to the best of their knowledge:

(a) the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit and loss of the Company and the Group as a whole; and

(b) the business review included in the Annual Report and Accounts includes a fair review of the development and performance of the business and the position of the Company and Group as a whole, together with a description of the principal risks and uncertainties that they face."

 

IFRS Financial Information

Consolidated income statement

For the year ended 31 December 2009

		2009	2008(ii)
	Notes	£m	£m
Revenue
Gross earned premiums	2	133	-
Premiums ceded to reinsurers	2	(15)	-
Net earned premiums	2	118	-
Fee and commission income and income from service activities		126	-
Investment return		1,267	-
Total revenue		1,511	-
Other income	2	1,186	-
Claims, benefits and expenses
Gross claims and benefits paid		(211)	-
Amounts receivable from reinsurers		32	-
Net claims and benefits paid		(179)	-
Change in insurance contract liabilities		129	-
Change in investment contract liabilities		(1,189)	-
Transfer to unallocated surplus		(3)	-
Movement in net asset value attributable to unit-holders		(31)	-
Movement in policyholder liabilities		(1,094)	-
Acquisition expenses		(74)	-
Administrative and other expenses		(167)	(1)
Finance costs		(20)	-
Total claims, benefits and expenses		(1,534)	(1)
Share of profit of associates and joint venture		5
Profit/(loss) before tax from continuing operations		1,168	(1)
Policyholder tax	3	(1)	-
Profit/(loss) before shareholder tax from continuing operations		1,167	(1)
Total tax credit	3	21	-
Policyholder tax	3	1	-
Shareholder tax	3	22	-
Profit/(loss) for the period		1,189	(1)
Attributable to:
Equity holders of the parent (i)		1,161	(1)
Non-controlling interests		28	-
Profit/(loss) for the period		1,189	(1)
		2009	2008(ii)
Earnings per share		pence	pence
Basic earnings per share from continuing operations	5	124.35	(0.11)
Diluted earnings per share from continuing operations	5	124.13	(0.11)

 

(i) All profit attributable to equity holders of the parent is from continuing operations.

(ii) Period from incorporation on 9 October 2008 to 31 December 2008.

 

Consolidated statement of comprehensive income 

For the year ended 31 December 2009

 

	Equity holders of the parent	Non- controlling interest	2009 Total	2008 Total (iii)
	£m	£m	£m	£m
Profit/ (loss) for the period	1,161	28	1,189	(1)
Actuarial gains on defined benefit pension schemes	25	-	25	-
Foreign exchange adjustments(i)	(2)	-	(2)	-
Revaluation of owner occupied properties	1	-	1	-
Shadow accounting(ii)	(4)	-	(4)	-
Gain on available-for-sale financial assets	-	-	-	1
Aggregate tax effect of above items	5	-	5	-
Other comprehensive income, net of tax	25	-	25	1
Total comprehensive income, net of tax	1,186	28	1,214	-

 

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

(ii) Shadow accounting includes £1 million in respect of the revaluation of owner occupied properties and £3 million in respect of foreign exchange adjustments on translation of overseas subsidiaries held by the with profits fund of Friends Provident Life & Pensions Limited.

(iii) Period from incorporation on 9 October 2008 to 31 December 2008.

 

Consolidated IFRS based operating profit

For the year ended 31 December 2009

		2009	2008
	Notes	£m	£m(ii)
Profit/ (loss) before tax from continuing
operations		1,168	(1)
Policyholder tax	3	(1)	-
Returns on Group-controlled funds attributable to third parties		(23)	-
Profit/ (loss) before tax excluding return generated within policy holder funds		1,144	(1)
Non-recurring items	2	(1,190)	-
Amortisation of acquired present value of in-force business		59	-
Amortisation of other acquired intangible assets		10	-
Interest payable on step-up tier one insurance capital securities (STICS)	4	(5)	-
Short-term fluctuations in investment return		2	-
Operating profit/(loss) before tax		20	(1)
Tax on operating profit/(loss)		10	-
Non-controlling interest in operating profit		-	-
Operating profit after tax attributable to ordinary shareholders of the parent(i)		30	(1)
Earnings per share		2009 pence	2008 pence
Operating earnings per share	5	3.21	(0.11)

 

(i) IFRS based operating profit from continuing operations and includes a based on longer-term investment return but excludes: (a) policyholder tax; (b) returns attributable to non-controlling interests in policyholder funds; (c) significant non-recurring items; and (d) amortisation and impairment of present value of acquired in-force business and other acquired intangible assets and is stated after deducting interest payable on STICS. Operating profit is considered to be a better measure of the performance of the Group and this measure of profit is used internally to monitor the Group's IFRS results.

 

(ii) Period from incorporation on 9 October 2008 to 31 December 2008.

 

Consolidated statement of financial position

At 31 December 2009

		2009	2008
	Notes	£m	£m
Assets
Pension scheme surplus		38	-
Intangible assets		3,251	-
Property and equipment		47	-
Investment properties		1,546	-
Investments in associates and joint venture		30	-
Deferred tax assets		12	-
Financial assets	6	48,315	653
Deferred acquisition costs		46	-
Reinsurance assets		1,972	-
Current tax assets		4	-
Insurance and other receivables		444	-
Cash and cash equivalents		5,386	1
Total assets		61,091	654
Liabilities
Insurance contracts		12,107	-
Unallocated surplus		273	-
Financial liabilities:
- investment contracts		40,495	-
- loans and borrowings		590	-
- amounts due to reinsurers		1,610	-
Net asset value attributable to unit-holders		668	-
Provisions		72	-
Deferred tax liabilities		489	-
Current tax liabilities		15	-
Insurance payables, other payables and deferred income		456	4
Total liabilities		56,775	4
Equity attributable to equity holders
of the parent
Attributable to equity holders of the parent:
- Share capital		2,349	650
- Other reserves	7	1,187	-
		3,536	650
Attributable to non-controlling interest		780	-
Total equity		4,316	650
Total equity and liabilities		61,091	654

 

 

Consolidated statement of changes in equity

For the year ended 31 December 2009

	Attributable to equity holder of the parent
	Share  capital	Other reserves	Total	Non-controlling interests	Total
	£m	£m	£m	£m	£m
At 1 January 2009	650	-	650		650
Profit for the period	-	1,161	1,161	28	1,189
Other comprehensive income	-	25	25	-	25
Total comprehensive income	-	1,186	1,186	28	1,214
Interest paid on STICS	-	-	-	(7)	(7)
Dividends paid to non-controlling interests	-	-	-	(4)	(4)
Appropriations of profit	-	-	-	(11)	(11)
Tax relief on STICS interest	-	1	1	-	1
Issue of share capital	1,699	-	1,699	-	1,699
Acquired through business combinations	-	-	-	763	763
At 31 December 2009	2,349	1,187	3,536	780	4,316

 

Period from incorporation on 9 October 2008 to 31 December 2008

	Attributable to equity holders of the parent
	Share capital	Capital reserve	Retained earnings	Total	Non-controlling interests	Total
	£m	£m	£m	£m	£m	£m
At 9 October 2008	-	-	-	-		-
Loss for the period	-	-	(1)	(1)	-	(1)
Other comprehensive income	-	1	-	1	-	1
Total comprehensive income	-	1	(1)	-	-	-
Issue of share capital	650	-	-	650	-	650
At 31 December 2008	650	1	(1)	650	-	650

 

Consolidated cash flow statement

For the year ended 31 December 2009

	2009	2008(i)
	£m	£m
Operating activities
Profit/(loss) for the period	1,189	(1)
Adjusted for:
- other income, net of related costs	(1,186)	-
- net realised and unrealised gains on assets at fair value	(810)	-
- finance costs	20	-
- amortisation of intangible assets	69	-
- depreciation of property and equipment	1	-
- movement in deferred acquisition costs	(46)	-
- total tax credit	(21)	-
- purchase of shares and other variable yield securities	(8,828)	-
- sale of shares and other variable yield securities	7,717	-
- purchase of loans, debt securities and other fixed income securities	(4,082)	-
- sale of loans, debt securities and other fixed income securities	3,751	-
- sale of investment properties	46	-
- decrease in insurance contract liabilities	(158)	-
- increase in investment contract liabilities	2,936	-
- increase in allocated surplus	2	-
- decrease in provisions	(17)	-
- net decrease in receivables and payables	(50)	1
Pre-tax cash inflow from operating activities	533	-
Tax received	11	-
Net cash inflow from operating activities	544	-
Investing activities
Acquisition of subsidiaries, net of cash acquired	4,271	-
Purchase of investment securities	(4,203)	(658)
Disposal of investment securities	4,855	6
Other income net of related costs	4	-
Additions to internally generated intangible assets	(1)	-
Net disposal of property and equipment	3	-
Net cash inflow/(outflow) from investing activities	4,929	(652)
Financing activities
Proceeds from issue of ordinary share capital, net of transaction costs	(4)	653
Finance costs	(17)	-
STICS interest	(7)	-
Net movement in other borrowings, net of expenses	(45)	--
Dividends paid to non-controlling interest	(3)
Net cash (outflow)/in-flow from financing activities	(76)	653
Increase in cash and cash equivalents	5,397	1
Balance at beginning of period	1	-
Exchange adjustments on the translation of foreign operations	(12)	-
Balance at end of period	5,386	1

(i) Period from incorporation on 9 October 2008 to 31 December 2008.

 

Notes to the consolidated accounts

1. Basis of preparation

The financial statements of the Company as at and for the year ended 31 December 2009 comprise the consolidated financial statements of the Company and its subsidiaries (together referred to as the Group) and the Group's interests in associates and jointly controlled entities.

The Company was incorporated on 9 October 2008 and the consolidated income statement for 2008 therefore covers the period from incorporation to 31 December 2008. The presentation currency of the Group is £million Sterling.

On 4 November 2009 the Company acquired all of the share capital of Friends Provident Group plc, a life insurance business which at that date was listed on the London Stock Exchange. 

The consolidated financial statements of the Group have been prepared under International Financial Reporting Standards as adopted by the European Union. The results in this preliminary announcement have been prepared in accordance with IFRS applicable at 31 December 2009 and have been taken from the Group's Annual Report and Accounts.

This preliminary announcement does not constitute the Company's statutory accounts for 2009 or 2008 but is derived from those accounts. The auditor has reported on the 2009 and 2008 financial statements and the reports were unqualified.

The preparation of the financial statements under IFRS requires management to make judgements, estimates and assumptions that affect the application of policies and reported amounts of assets and liabilities, income and expenses. The estimates and associated assumptions are based on historical experience and other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgements about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods, if the revision affects both current and future periods.

The IASB has issued revisions to two existing standards. A revised version of IFRS 3: Business combinations is applicable to accounting periods beginning on or after 1 July 2009 and an amendment to IAS 27: Consolidated and separate financial statements is also applicable for annual periods beginning on or after 1 July 2009 but with earlier adoption being permitted. IFRS 3 (revised) introduces a number of changes in accounting for business combinations:

·; Transaction costs are expensed as incurred;

·; Subsequent changes in the value of contingent consideration are recorded in the income statement;

·; partial disposals involving loss of control will impact the income statement; and

·; post-acquisition deferred tax assets are adjusted through the income statement.

 

The standard also permits an entity to have a choice on a transaction-by-transaction basis on measuring the non-controlling interests at fair value or at the respective share of the total net assets.

At the same time as IFRS 3 was revised, the IASB amended IAS 27. IAS 27 requires that a change in the ownership interest of a subsidiary (without loss of control) is accounted for as an equity transaction. These revisions have been adopted by the Company in respect of the 2009 financial statements. They have not materially changed the 2009 results for the Group although the requirement to expense transaction costs has increased expenses and reduced the gain on the acquisition of the Friends Provident Group by a similar amount.

In addition to the above, IAS 1 was amended in 2008 with effective application required from 1 January 2009. The introduction of IAS 1 (revised): Presentation of financial statements prohibits the presentation of items of income and expenses (that is 'non-owner changes in equity') in the statement of changes in equity, requiring 'non-owner changes in equity' to be presented separately from owner changes in equity. All 'non-owner changes in equity' are required to be shown in a performance statement. Entities can choose whether to present one performance statement (the statement of comprehensive income) or two statements (the income statement and statement of comprehensive income). The Group has elected to present two statements: a consolidated income statement and a consolidated statement of comprehensive income.

New standards, interpretations and amendments to existing standards endorsed by the EU but not currently adopted by the Company, will be adopted when they become effective as follows:

IAS 39: Financial instruments: recognition and measurement - Eligible hedged items (amendment)

The amendment is effective for financial years beginning on or after 1 July 2009. The amendment clarifies which risks associated with a portion of the cash flows or fair value of a financial instrument an entity is permitted to designate as a hedge item.

IAS 28: Investment in Associates and IAS 31: Interests in Joint Ventures have been revised and are effective for financial years beginning on or after 1 July 2009. IAS 28 requires that when significant influence is lost, the cost of the retained investment is measured at fair value at the date that significant influence is lost. IAS 31 similarly requires that any retained interest in an investment in a joint venture, following a partial disposal, is to be measured at fair value, and that this shall be used as deemed cost for subsequent accounting. 

None of the above amendments and revisions are expected to materially impact the financial statements.

Improvements to IFRS (2009)

The majority of these amendments are effective from 1 January 2010 but are not expected to have a material effect on amounts reported.

The financial statements also comply with the Statement of Recommended Practice issued by the Association of British Insurers in December 2005 (as amended in December 2006) insofar as these requirements do not contradict IFRS requirements.

The Group presents its balance sheet in order of liquidity. Where applicable, for each asset and liability line item that combines amounts expected to be recovered or settled both within and beyond 12 months after the balance sheet date, disclosure of the amount due beyond 12 months is made in the respective note.

Financial assets and financial liabilities are not offset, unless there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the assets and settle the liability simultaneously. Income and expenses are not offset in the income statement unless required or permitted by an accounting standard or interpretation, as specifically disclosed in the accounting policies of the Group.

 

2. Segmental information

a) Summary

Segmental information is presented on the same basis as internal financial information used by the Group to evaluate operating performance. The segmental information as at 31 December 2009 includes the Friends Provident balances as at the year end. Segmental information relating to revenue, net income products and services for the year ended 31 December 2009 includes Friends Provident balances from 5 November 2009. No segmental information is presented in respect of 2008 as the Group only had a corporate segment for the period from incorporation to 31 December 2008.

The Group's management and internal reporting structure is based on the following operating segments which have been established subsequent to the acquisition of Friends Provident:

·; UK comprising UK life and pensions business and including Sesame and Pantheon;

·; International comprising Friends Provident International Limited, the overseas life assurance business within the UK life and pensions subsidiaries and the Group's share of AmLife Berhad; and

·; Lombard International Assurance SA (Lombard).

 

Corporate functions are not strictly an operating segment, but are reported to management, and are provided in the analysis below to reconcile the Group's reportable segments to total profit.

In presenting geographical segment information, segment revenue is based on the geographical location of customers. Segment assets are based on the geographical location of the assets. The Group has defined two geographical areas: UK and the rest of the world.

b) Operating segment information

Operating profit:

	UK	Int'l	Lombard	Corporate	Total
Year ended 31 December 2009	£m	£m	£m	£m	£m
Life and pensions operating profit	21	9	4	-	34
Longer-term return on shareholders' funds	(4)	-	-	-	4
Other income	(5)	1	-	(13)	(18)
Operating profit before tax	20	9	4	(13)	20
Tax on operating profit					10
Non-controlling interest					-
Operating profit after tax attributable to ordinary shareholders of the parent					30
Operating earnings per share (pence)					3.21

 

Reconciliation of operating profit before tax to profit before tax: Year ended 31 December 2009

	UK	Int'l	Lombard	Corporate	Total
	£m	£m	£m	£m	£m
Operating profit before tax	20	9	4	(13)	20
Non-recurring items (i)	4	-	-	1,186	1,190
Amortisation of acquired present value of in-force business	(27)	(9)	(23)	-	(59)
Amortisation of other acquired intangible assets	(5)	(1)	(4)	-	(10)
Interest payable on STICS	5	-	-	-	5
Short-term fluctuations in Investment return	(1)	(1)	-	-	(2)
Profit before tax excluding profit generated within policyholder funds	4	(2)	(23)	1,173	1,144
Policyholder tax	1	-	-	-	1
Returns on Group-controlled funds attributable to third parties	23	-	-	-	23
Profit/(loss) before tax	20	(2)	(23)	1,173	1,168

 

(i) Non recurring items include:

Corporate: £1,186 million in respect of the gain on acquisition, being the excess of the interest in the fair value of assets acquired over cost arising on the acquisition of Friends Provident Group, net of acquisition costs of £16 million.

 

Revenue and expenses

	UK	Int'l	Lombard	Corporate	Elimination of inter-segment amounts (ii)	Total
Year ended 31 December 2009	£m	£m	£m	£m	£m	£m
Gross earned premiums on insurance and investment contracts	746	150	1,935	-	-	2,831
Investment contract premiums (i)	(615)	(148)	(1,935)	-	-	(2,698)
Gross earned premiums	131	2	-	-	-	133
Premiums ceded to reinsurers	(15)	-		-	-	(15)
Net earned premiums	116	2	-	-	-	118
Fee and commission income	63	46	18	-	(1)	126
Investment return:
- interest income	718	174	380	4	(9)	1,267
Total revenue	897	222	398	4	(10)	1,511
Other income (iii)	-	-	-	1,186	-	1,186
Intersegment revenue	5	-	5	-	(10)	-
Total external revenue	892	222	393	4	-	1,511
Net claims and benefits paid	(178)	(1)	-	-	-	(179)
Movement in insurance and investment contract liabilities	(512)	(197)	(351)	-	-	(1,060)
Transfer to unallocated surplus	(3)	-	-	-	-	(3)
Movement in net assets attributable to unit-holders	(31)	-	-	-	-	(31)
Acquisition expenses	(55)	(14)	(5)	-	-	(74)
Administrative and other expenses	(75)	(17)	(65)	(17)	7	(167)
Finance costs	(23)	-	-	-	3	(20)
Total claims, benefits  and expenses	(877)	(229)	(421)	(17)	10	(1,534)
Intersegment expenses	(10)	-	-	-	10	-
Total external claims,  benefits and expenses	(867)	(229)	(421)	(17)	-	(1,534)
Share of profits of associates and joint venture	-	5	-	-	-	5
Profit before tax from continuing operations	20	(2)	(23)	1,173	-	1,168
Policyholder tax	(1)	-	-	-	-	(1)
Shareholder tax	11	3	8	-	-	22
Segmental result after tax	30	1	(15)	1,173	-	1,189

(i) Accounted for as deposits under IFRS

(ii) Eliminations include inter-segment fee income and loan interest. Inter-segment transactions are undertaken on an arm's-length basis.

(iii) Other income includes £1,186 million related to the gain on acquisition, being the excess of the interest in the fair value of assets acquired over cost arising on the acquisition of the Friends Provident Group, net of acquisition costs of £16 million.

 

Products and services

Year ended 31 December 2009	Protection	Investment	Annuities	Individual pensions	Group pensions	Other(i)	Total
	£m	£m	£m	£m	£m	£m	£m
Gross earned premiums	51	37	42	2	1	-	133
Net earned premiums	37	36	42	2	1	-	118
Fee and commission income	-	54	-	19	-	53	126
Total external revenue	37	90	42	21	1	53	244

(i) Other includes revenue streams from Sesame and Pantheon.

Assets and liabilities

	UK	Int'l	Lombard	Corporate	Elimination of inter-segment amounts (i)		Total
	£m	£m	£m	£m	£m		£m
Segment assets	40,065	5,858	15,367	315	(544)		61,061
Investments in associates and joint venture	7	23	-	-	-		30
Total assets	40,072	5,881	15,367	315	(544)		61,091
Total liabilities	37,060	5,386	14,865	8	(544)		56,775
Other segment information
- Capital expenditure	-	-	2	-	-		2
- Depreciation	-	-	1	-	-		1
- Amortisation	32	10	27	-	-		69

(i) Eliminations mainly comprise intercompany loans

 

c) Geographical segmental information

	UK	Rest of the world	Total
Year ended 31 December 2009	£m	£m	£m
Gross earned premiums	131	2	133
Fee and commission income	85	41	126
Revenue from external customers	216	43	259
Investment return			1,267
Premiums ceded to reinsurers			(15)
Total revenue			1,511

 

3. Taxation

a) Tax recognised in the income statement

	2009
	£m
Current tax
UK corporation tax at 28%	(8)
Total current tax credit	(8)
Deferred tax
Origination and reversal of temporary differences	(13)
Total deferred tax credit	(13)
Total tax credit	(21)
Analysis:
- policyholder tax	1
- shareholder tax	(22)
Total tax credit	(21)

 

Policyholders' tax is tax on the income and investment returns charged to policyholders of linked and with-profits funds. Shareholders' tax is tax charged to shareholders on the profits of the Group. There was no tax charge in respect of 2008.

b) Factors affecting tax charge for period

		2009
	Shareholder profit	Policyholder tax	Profit before tax
	£m	£m	£m
Profit before tax from continuing operations	1,167	1	1,168
Tax from continuing operations multiplied by the standard rate of corporation tax in the UK of 28%	327	-	327
Effects of:
- non-taxable income	(9)	-	(9)
- deductions not allowable for tax purposes	1	-	1
- overseas tax	(1)	-	(1)
- tax relief for share based payments	3	-	3
- utilisation of excess expenses brought forward	5	-	5
- valuations of tax losses	(14)	-	(14)
- with-profits minority interest	(6)	-	(6)
- non-taxable gain on acquisition	(336)	-	(336)
- non-taxable result of Resolution holding companies	8	-	8
- policyholder tax	-	1	1
Total tax credit	(22)	1	(21)

 

4. Appropriations of profit

a) Dividends paid on ordinary shares

No dividends have been paid during the year. As required by IAS 10: Events after the balance sheet date, dividends declared after the balance sheet date are not accrued in these accounts. Subject to the approval of shareholders at the annual general meeting on 18 May 2010, a dividend of 2.72 pence per ordinary share will be paid on 28 May 2010 amounting in total to £65.6 million. Accordingly this amount is not reflected in these financial statements.

b) STICS interest

The STICS are accounted for as equity instruments under IFRS and consequently the interest on the STICS is recorded in the financial statements as though it were a dividend.

Interest on the 2003 STICS is paid in equal instalments in May and November each year at a rate of 6.875%. Interest of £7 million was paid on 21 November 2009 following the acquisition of Friends Provident on 4 November 2009 and is shown as a movement on reserves in these financial statements together with the related tax relief.

Interest on the 2005 STICS is paid annually in June at a rate of 6.292%. Consequently there is no payment between 5 November and the end of the year and therefore no impact on these financial statements.

5. Earnings per share

a) Basic and operating earnings per share from continuing operations

Earnings per share have been calculated based on the profit after tax and on the operating profit after tax, attributable to ordinary equity holders of the parent and the weighted number of shares in issue. The directors consider that operating earnings per share provides a better indication of operating performance.

	2009 Earnings £m	2009 Pence per share	2008 Earnings £m	2008 Pence per share
Profit/(loss) after tax attributable to ordinary equity holders of the parent	1,161	124.35
Short-term fluctuations in investment return	2	0.21	(1)	(0.11)
Non-recurring items	(1,190)	(127.45)	-	-
Amortisation of acquired	69	7.39	-	-
intangible assets			-	-
Tax credit on items excluded from operating proft/(loss)	(12)	(1.29)	-	-
Operating profit/(loss) after tax attributable to ordinary equity holders of the parent	30	3.21	(1)	(0.11)

 

 

b) Diluted basic earnings per share from continuing operations

	2009 Earnings	2009 weighted average number of ordinary shares	Pence per share
	£m
Profit after tax attributable to ordinary equity holders of the parent	1,161	933,670,453	124.35
Dilution	-	1,608,435	(0.22)
Diluted profit after tax attributable to ordinary equity holders of the parent	1,161	935,278,888	124.13

 

Dilutive factors in 2009 comprise the expected impact of the Lombard management incentive scheme. There were no dilutive factors in 2008.

c) Weighted average number of ordinary shares

					2009	2008
					Number	Number
Issued ordinary shares at beginning of period					660,000,000	-
Effect of ordinary shares issued					273,670,453	638,181,818
Weighted number of ordinary shares					933,670,453	638,181,818

 

6. Financial assets

The Group's financial assets are summarised by measurement categories as follows:

	2009		2008
	£m		£m
Fair value through the income statement	48,235		-
Available-for-sale	-		653
Loans at amortised cost(i)	80		-
Total financial assets	48,315		653

 

(i) Includes £68 million due from the Friends Provident Pension Scheme.

a) Analysis of financial assets at fair value through the income statement

	With-profits	Unit-linked	Non-linked annuities	Other	Shareholder	2009 Total
	£m	£m	£m	£m	£m	£m
Shares and other variable	2,568	27,693	-	103	8	30,372
yield securities
Debt securities and other
fixed-income securities:
- government securities	3,654	1,803	424	256	173	6,310
- corporate bonds	4,442	3,471	2,200	501	357	10,971
(including ABS)
Derivative financial instruments	176	8	-	3	(6)	181
Deposits with credit institutions	-	375	-	24	2	401
	10,840	33,350	2,624	887	534	48,235

 

The above unit-linked column includes £584 million of financial assets (£352 million of shares and £232 million of corporate bonds) relating to the non-controlling interests in the OEICs that have been consolidated as the Group holding is not less than 50%.

For unit-linked funds, the policyholder bears the investment risk and any change in net asset value is matched by a broadly equivalent change in the liability.

The majority of financial assets held are readily realisable. However, included in the carrying amounts above, £44,852 million is expected to be realised more than 12 months after the balance sheet date in line with the expected maturity of insurance / investment contract liabilities.

Asset-backed securities (ABS) directly held by the UK life and pensions business (excluding those held by the linked funds) amount to £1,167 million, and 89% of these are at investment grade.

b) Determination of fair value hierarchy

In accordance with the revised requirements of IFRS 7: Financial Instruments: Disclosures, financial assets at fair value have been classified into three categories as set out below. Financial assets at fair value include shares and other variable yield securities, government securities, corporate bonds (including ABS), derivative financial instruments and deposits with credit institutions.

Level 1 - quoted prices (unadjusted) in active markets for identical assets. An active market is one in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Examples include listed equities and bonds in active markets and quoted unit trusts/OEICs.

Level 2 - inputs other than quoted prices included within Level 1 that are observable for the asset, either directly (ie, as prices) or indirectly (ie, derived from prices). This category generally includes assets that are priced based on models using market observable inputs. Examples include certificates of deposit and derivatives.

Level 3 - inputs for the asset that are not based on observable market data. Assets with single price feeds and/or limited trading activity are included in this category. Examples include unlisted equities and private equity.

The majority of the Group's assets held at fair value are valued based on quoted market information or market observable data. Approximately 11% (3% excluding unit-linked) are based on valuation techniques where significant observable market data is not available or the price is not observable from current market transactions. However, the fair value measurement objective of these assets remains the same, that is, an exit price from the perspective of the Group.

The revised requirements of IFRS 7 also require financial liabilities at fair value to be categorised into the above Level 1, 2 or 3 hierarchies. Financial liabilities at fair value include unit-linked contracts, amounts due to reinsurers, net asset value attributable to unit-holders (minority interest in the OEICs that are consolidated) and derivative financial instruments. The classifications take into account the types of inputs used to determine the fair value measurements. For unit-linked funds this has been undertaken on a fund by fund basis. For the net asset value attributable to unit holders, this has been analysed in the same proportion as the underlying consolidated investments categorisation.

An analysis of financial assets and liabilities held at fair value in accordance with the fair value hierarchy is set out below. The table shows both the total financial assets and liabilities and the total excluding unit-linked assets and liabilities, as shareholders have no direct exposure to profits or losses on unit-linked assets (other than through investment management fees).

 

	Including unit-linked assets and liabilities				Excluding unit-linked assets and liabilities
31 December 2009	Level 1	Level 2	Level 3	Total	Level 1	Level 2	Level 3	Total
	£m	£m	£m	£m	£m	£m	£m	£m
Financial assets held at fair value
Shares and other variable yield securities	25,445	207	4,720	30,372	2,283	-	396	2,679
Debt securities and other fixed income securities:
- government securities	6,297	13	-	6,310	4,507	-	-	4,507
- corporate bonds (including ABS)	5,996	4,287	688	10,971	5,195	2,215	90	7,500
Derivative financial instruments	-	181	-	181	-	173	-	173
Deposits with credit institutions	343	58	-	401	-	26	-	26
Total financial assets held at fair value	38,081	4,746	5,408	48,235	11,985	2,414	486	14,885
Financial liabilities held at fair value
Unit-linked investment contracts	-	36,410	-	36,410	-	-	-	-
Amounts due to reinsurers	-	1,610	-	1,610	-	1,610	-	1,610
Net asset value attributable to unit -holders	-	668	-	668	-	-	-	-
Derivative financial instruments	-	54	-	54	-	54	-	54
Total financial liabilities held at fair value	-	38,742	-	38,742	-	1,664	-	1,664

 

c) Transfers between Level 1 and Level 2

During the period, debt securities amounting to £210 million were transferred from Level 1 to Level 2 and £181 million of debt securities were transferred from Level 2 to Level 1. These movements arose from changes in credit rating and availability of current prices. There were no significant transfers between Level 1 and Level 2 for other financial assets.

d) Financial instruments

The following table shows a reconciliation level 3 financial assets which are recorded at fair value.

	At 1 January 2009	Acquisition through business combinations	Total gains/ (losses) in income statement	Purchases	Sales	Transfers from level 1 and level 2	At 31 December 2009	Total losses for the period included in profit or loss for assets held at 31 December 2009
	£m	£m	£m	£m	£m	£m	£m	£m
Financial assets held at far value
- Shares and other variable yield securities	-	5,096	(927)	325	(73)	299	4,720	(930)
- Corporate bonds (including ABS)	-	687	(9)	11	(1)	-	688	(9)
	-	5,783	(936)	336	(74)	299	5,408	(939)

 

e) Level 3 sensitivity analysis

	Carrying amount	Effect of reasonably possible alternative assumptions
31 December 2009	£m	£m
Unit-linked investments	4,922	-
Shares and other variable yield securities	396	79
Corporate bonds (including ABS)	90	9
	5,408	88

For unit-linked assets, the policyholder bears the investment risk and any change in asset values is matched by a broadly equivalent change in liability. Consequently there is no significant net impact on shareholder profit from changes to underlying assumptions used to value these assets.

For share and other variable yield securities, although the values are based on the latest information available, this information is not up to date and the current prices could reasonably be expected to be higher or lower by approximately 20%.

For corporate bonds it could reasonably be expected that the current prices could be higher or lower by approximately 10% to reflect changes in the credit ratings of the underlying bonds.

f) Loans

	2009
	£m
Mortgage loans	3
Other loan	77
Total loans	80

 

Other loans include £68 million due from the Friends Provident Pension Scheme. The fair value of loans is considered to be the same as their carrying value.

g) Unit-linked net assets

The amounts included in the balance sheet in respect of net assets held within unit-linked funds are as follows:

	2009
	£m
Investment properties	506
Shares and other variable yield securities	27,341
Debt securities and other fixed-income securities	5,042
Derivative financial instruments	8
Deposits with credit institutions	375
Other receivables	120
Cash and cash equivalents	3,126
Total assets	36,518
Other payables	(141)
Total unit-linked net assets	36,377

 

The impact of consolidating OEICs in which the Group has a holding in excess of 50% has been excluded from the above analysis of unit-linked net assets.

 

7. Other reserves

Other reserves included in equity attributable to equity holders of the parent are as follows:

	Capital reserve	Retained earnings	Foreign currency  translation reserve	Total
	£m	£m	£m	£m
At 1 January 2009	1	(1)	-	-
Profit for the period	-	1,161	-	1,161
Actuarial gain on defined benefit schemes	-	30	-	30
Tax relief on STICS interest	-	1	-	1
Foreign exchange adjustments			(5)	(5)
At 31 December 2009	1	1,191	(5)	1,187

 

8. Business combinations

Acquisition of Friends Provident Group plc

On 4 November 2009 the Group through its subsidiary, Friends Provident Holdings (UK) Limited, acquired Friends Provident Group plc (Friends Provident), a UK-listed life and pensions business by acquiring all of the shares and voting interests of Friends Provident Group plc. The acquisition was implemented by way of a scheme of arrangement under Part 26 of the UK Companies Act 2006. The acquisition is consistent with the Group's first project, namely the consolidation of businesses in the UK life and asset management sectors.

In the period from the acquisition to 31 December 2009 Friends Provident contributed revenue of £1,507 million and profit after tax of £18 million. If the acquisition had occurred on 1 January 2009, consolidated revenue would have been £6,678 million, and consolidated profit after tax for the period before any acquisition accounting adjustments would have been £148 million. In determining these amounts, management has assumed that the fair value adjustments which arose on the date of acquisition would have been the same if the acquisition had occurred on 1 January 2009.

The following summarises the major classes of consideration transferred, and the recognised amounts of assets acquired and liabilities assumed at the acquisition date:

 

Fair value of purchase consideration	£m
Issue of 1,752,451,145 ordinary shares	1,700
Cash paid	312
Fair value of purchase consideration	2,012
Direct costs relating to the acquisition	16
Fair value of net assets acquired	3,214
Excess of the interest in the fair value of assets acquired over cost	1,186

The fair value of the ordinary shares issued was based on the listed share price of the Company at close of business on 3 November 2009 of 97 pence per share.

 

Identifiable assets acquired and liabilities assumed:

Amounts in £m	Pre-acquisition carrying amounts	Fair value adjustments	Recognised values on acquisition
Intangible assets: - acquired value of in-force - distribution relationships - customer relationships - brands - computer software - goodwill	325 - 11 90 15 398	2,618 287 - (40) - (398)	2,943 287 11 50 15 -
Property and equipment	50	-	50
Investment properties	1,460	-	1,460
Investments in associates and joint venture	45	(21)	24
Deferred tax assets	13	-	13
Financial assets	46,290	-	46,290
Deferred acquisition costs	1,290	(1,290)	-
Reinsurance assets	1,995	-	1,995
Current tax assets	2	-	2
Insurance and other receivables	601	-	601
Cash and cash equivalents	4,605	-	4,605
Insurance contracts	(12,264)	-	(12,264)
Unallocated surplus	(271)	-	(271)
Financial liabilities: - investment contracts - loans and borrowings - amounts due to reinsurers	(37,681) (616) (1,648)	12 (20) -	(37,669) (636) (1,648)
Net asset value attributable to unit-holders	(624)	-	(624)
Provisions	(84)	-	(84)
Deferred tax liabilities	(27)	(481)	(508)
Current tax liabilities	(65)	-	(65)
Insurance payables, other payables and deferred income	(737)	137	(600)
Net identifiable assets	3,173	804	3,977
Attributable to non-controlling interest			(763)
Attributable to equity holders of the parent			3,214

Pre-acquisition carrying amounts were determined based on applicable IFRSs immediately before the acquisition. The values of assets, liabilities and contingent liabilities recognised on acquisition are their estimated fair values.

In determining the fair value of acquired value in-force (AVIF), the Group applied pre-tax discount rates to the associated cash flows for each principal CGU of 9% for UK, 6.5% for Lombard and 7.4% for International

In determining the fair value of other intangibles acquired, the Group applied a range of pre-tax discount rates of between 11.4% - 12.9% to the associated projected cash flows for each principal CGU.

The acquisition fair value exercise has been completed as at the financial year end and therefore provisional accounting has not been applied for this transaction.

The gain of £1,202 million recognised as a result of the acquisition is attributable mainly to the purchase price not fully reflecting the embedded value of the Friends Provident's life assurance businesses. In particular, the present value of acquired in-force business amounting to £2,943 million has been included in the acquisition balance sheet along with other intangible assets of £1,363 million. This gain is shown in other income in the consolidated income statement.

Non-controlling interests arising from the acquisition of Friends Provident amount in total to £763 million, being the total of the STICS and the holding in the F&C Commercial Property Trust. These STICS are included at their principal value being the amount that would be payable, excluding any interest that might be outstanding, if Friends Provident Group plc, a subsidiary undertaking, were to exercise its option to repay them in accordance with the relevant terms of the securities.

 

9. Post balance sheet events

On 19 March 2010, the Group disposed of its stake in Pantheon Financial Limited which has gross assets of £4.3 million to James Kaberry, the current CEO. The disposal does not have a material impact on the results or financial position of the Group.

Consolidated income statement - MCEV basis

For the year ended 31 December 2009

				FPH	Resolution Limited (ex. FPH) (i)	Resolution Limited	Resolution Limited		FPG	FPG Restated
				5 November to 31 December 2009	Year ended 31 December 2009	Year ended 31 December 2009	Period ended 31 December 2008		Year ended 31 December 2009	Year ended 31 December 2008
			Note	£m	£m	£m	£m		£m	£m
Life and pensions
Value of new business			6	52		52			133	139
Expected existing business contribution				28		28			176	238
Operating experience variances				(25)		(25)			(97)	(2)
Operating assumption changes				1		1			(4)	(22)
Other operating variances				-		-			6	19
Development costs			10	(5)		(5)			(23)	(12)
Life and pensions covered business operating profit before tax			3	51		51			191	360
Other income and charges				3		3			15	4
Life and pensions operating profit before tax				54		54			206	364
Corporate income and charges				-	(13)	(13)	(1)		-	-
Operating profit before tax				54	(13)	41	(1)		206	364
Economic variances			3	40		40			419	(743)
Amortisation and impairment of non-covered business acquired intangible assets				(1)		(1)			(35)	(5)
Non-recurring items and non-operating variances			3	5		5			14	(51)
Profit /(loss) from continuing operations before tax				98	(13)	85			604	(435)
Tax on operating profit				(15)		(15)			(53)	(96)
Tax on other activities				1		1			(105)	210
Profit /(loss) from continuing operations after tax				84	(13)	71	(1)		446	(321)
Discontinued operations (net of tax)				-	-	-			(22)	(288)
Profit/(loss) for the period				84	(13)	71			424	(609)
Attributable to:
Equity holders of the parent				84	(13)	71	(1)		427	(577)
Non-controlling interests				-	-	-	-		(3)	(32)
Profit/(loss) for the period				84	(13)	71	(1)		424	(609)

(i) 'Resolution Limited (ex.FPH)' refers to the Group excluding the acquired assets of Friends Provident.

 

Earnings per share - MCEV basis

				Resolution Limited		Resolution Limited
				Year ended 31 December 2009		Period ended 31 December 2008
			Note	pence		pence
Operating earnings per share on MCEV basis after tax, attributable to equity holders of the parent
- Basic			4	2.78		(0.11)
- Diluted			4	2.78		(0.11)
Earnings per share on MCEV basis after tax, attributable to equity holders of the parent
- Basic			4	7.60		(0.11)
- Diluted			4	7.59		(0.11)

MCEV operating profit is from continuing operations and is based on expected investment return and excludes: (i) amortisation and impairment of non-covered business acquired intangible assets (ii) effect of economic variances (including the impact of economic assumption changes) (iii) significant non-recurring items; and is stated after deducting interest payable on STICS. Operating profit is considered to be a better measure of the performance of the Group and this measure of profit is used internally to monitor the Group's MCEV results.

Consolidated statement of comprehensive income - MCEV basis

For the year ended 31 December 2009

		FPH	Resolution Limited (ex. FPH)(i)	Resolution Limited	Resolution Limited	FPG	FPG Restated
		5 November to 31 December 2009	Year ended 31 December 2009	Year ended 31 December 2009	Period ended 31 December 2008	Year ended 31 December 2009	Year ended 31 December 2008
		£m	£m	£m	£m	£m	£m
Profit/(loss) for the period		84	(13)	71	(1)	424	(609)
- Actuarial gains/(losses) on defined benefit schemes net of tax		29	-	29	-	(72)	55
- Foreign exchange adjustments		(3)	-	(3)	-	(51)	137
- Gain on available-for-sale assets		-	-	-	1	-	-
Other comprehensive income/(loss) for the period, net of tax		26	-	26	1	(123)	192
Total comprehensive income/loss for the period		110	(13)	97	-	301	(417)
Attributable to:
Equity holders of the parent		110	(13)	97	-	324	(411)
Non-controlling interests		-	-	-	-	(23)	(6)

 

(i) 'Resolution Limited (ex.FPH)' refers to the Group excluding the acquired assets of Friends Provident.

Consolidated statement of changes in equity - MCEV basis

For the year ended 31 December 2009

			Resolution Limited	Resolution Limited	FPG	FPG Restated
			Year ended 31 December 2009	Period ended 31 December 2008	Year ended 31 December 2009	Year ended 31 December 2008
			£m	£m	£m	£m
Opening ordinary shareholders' equity			650	-	3,039	3,647
Acquired value of Friends Provident as at 4 November 2009			3,070	-	-	-
Cost of acquisition of Friends Provident			(2,012)	-	-	-
Transaction costs			(16)
Total comprehensive income/expense for the period			97	-	324	(411)
Issue of share capital			1,699	650	-	-
Dividends on equity shares			-	-	(91)	(153)
Share based payments (impact on MCEV reserves)			-	-	15	11
De-merger of F&C			-	-	(100)	-
Release of de-mutualisation provision			-	-	6	-
Acquisition of subsidiaries and associate			-	-	-	(55)
Increase/(decrease) in MCEV reserves for the period			2,838	650	154	(608)
Closing ordinary shareholders' equity			3,488	650	3,193	3,039

 

The ordinary shareholders' equity of FPG at 31 December 2009 of £3,193 million is £12 million higher than the ordinary shareholders' equity of Friends Provident Holdings at 31 December 2009 of £3,181 million, due to an intangible asset relating to the IFA and distribution businesses which is not recognised at the level of Friends Provident Holdings or Resolution Limited.

 

Consolidated statement of financial position - MCEV basis

At 31 December 2009

			Resolution Limited	Resolution Limited	FPH	FPG Restated
			2009	2008	2009	2008
		Notes	£m	£m	£m	£m
Assets
Pension surplus			38	-	38	74
Value of in-force covered business		7, 9	1,916	-	1,916	1,634
Intangible assets			43	-	43	484
Property and equipment			47	-	47	66
Investment properties			1,546	-	1,546	1,493
Investment in associates and joint venture			22	-	22	26
Deferred tax assets			12	-	12	15
Financial assets			48,315	653	48,315	44,372
Deferred acquisition costs			-	-	-	12
Reinsurance assets			1,972	-	1,972	1,964
Current tax assets			4	-	4	4
Insurance and other receivables			494	-	514	762
Cash and cash equivalents			5,386	1	5,073	5,183
Total assets			59,795	654	59,502	56,089
Liabilities
Insurance contracts			12,098	-	12,098	12,677
Unallocated surplus			295	-	295	385
Financial liabilities
- Investment contracts			39,848	-	39,848	34,695
- Loans and borrowings			917	-	917	1,189
- Amounts due to reinsurers			1,610	-	1,610	1,792
Net asset value attributable to unit holders			668	-	668	668
provisions			72	-	72	108
Deferred tax liabilities			37	-	23	168
Current tax liabilities			15	-	15	90
Insurance payables, other payables and deferred income			450	4	478	908
Total liabilities			56,010	4	56,024	52,680
Equity attributable to:
Equity holders of the parent		7	3,488	650	3,181	3,039
Non-controlling interests			297	-	297	370
Total equity			3,785	650	3,478	3,409
Total equity and liabilities			59,795	654	59,502	56,089

 

GROUP MCEV ANALYSIS OF EARNINGS

For the year ended 31 December 2009

Resolution Limited

				FPH	Resolution Limited (ex.FPH) (i)	Resolution Limited	Resolution Limited
				5 November to 31 December 2009	Year ended 31 December 2009	Year ended 31 December 2009	Period ended 31 December 2008
		Covered business	Non-covered business	Total	Non-covered business	Total business	Total business
		£m	£m	£m	£m	£m	£m
Opening Group MCEV		-	-	-	650	650	-
Opening adjustments:
- Acquired/divested businesses						-	-
- Acquired value of Friends Provident		2,964	106	3,070	-	3,070
- Cost of acquisition		-	-	-	(2,012)	(2,012)	-
- Transaction costs		-	-	-	(16)	(16)	-
Adjusted opening Group MCEV		2,964	106	3,070	(1,378)	1,692
Operating MCEV earnings		37	2	39	(13)	26	(1)
Non-operating MCEV earnings		32	13	45	-	45	-
Total MCEV earnings		69	15	84	(13)	71	(1)
Other movements in IFRS net equity		-	29	29	-	29	1
Closing adjustments:
- Capital and dividend flows		(2)	3	1	1,698	1,699	650
- Foreign exchange variances		(3)	-	(3)		(3)	-
Closing Group MCEV		3,028	153	3,181	307	3,488	650

 

(i) 'Resolution Limited (ex.FPH)' refers to the Group excluding the acquired assets of Friends Provident.

 

For the year ended 31 December 2009

Friends Provident

				Year ended 31 December 2009			Year ended 31 December 2008
		Covered business	Non-covered business	Total	Covered business	Non-covered business	Total
	Notes	£m	£m	£m	£m	£m	£m
Opening Group MCEV		2,495	544	3,039	2,781	866	3,647
Opening adjustments		-	-	-	-	-	-
Adjusted opening Group MCEV		2,495	544	3,039	2,781	866	3,647
Operating MCEV earnings		142	11	153	253	15	268
Non-operating MCEV earnings		362	(91)	271	(581)	(296)	(877)
Total MCEV earnings		504	(80)	424	(328)	(281)	(609)
Other movements in IFRS net equity		-	(72)	(72)		58	58
Closing adjustments:
- Capital and dividend flows		56	(103)	(47)	(56)	(83)	(139)
- Foreign exchange variances		(28)	(23)	(51)	86	51	137
- Acquired/ divested businesses		1	(101)	(100)	12	(67)	(55)
Closing Group MCEV		3,028	165	3,193	2,495	544	3,039

 

1. BASIS OF PREPARATION

Introduction

Following its acquisition of Friends Provident on 4 November 2009, Resolution Limited is presenting the results and financial position for its life and pensions business on the market consistent embedded value basis and for its other businesses on the International Financial Reporting Standards basis. The MCEV basis is in compliance with the European Insurance CFO Forum MCEV Principles (MCEV Principles), issued in June 2008, and re-issued in amended form in October 2009. The amendments in October 2009 primarily related to the allowance of an illiquidity premium on contracts with predictable cashflows.

This MCEV supplementary information presents information for Resolution Limited including Friends Provident from the date of acquisition (FPH). The information also presents the MCEV results of the Friends Provident group (FPG) for the full year to 31 December 2009 with 2008 comparatives.

Prior year comparatives for the Friends Provident results

Friends Provident's embedded value results at 31 December 2008 were presented under the CFO Forum's European Embedded Value Principles (EEV Principles) published in May 2004. Those results adopted a market consistent approach in all material aspects. As a result, only assumption and presentational changes were required to align with the updated MCEV Principles. Details of these assumption changes are set out below, together with the revised presentation used for Friends Provident's results at 31 December 2009.

Reference rates

Under the MCEV Principles, the reference rate (previously termed the 'risk-free rate') is based on the swap yield curve for liquid liabilities and on the swap yield curve plus an illiquidity premium for illiquid liabilities. The market consistent approach used previously by Friends Provident under the EEV Principles assumed the reference rate was based on the gilt yield curve, with a nil allowance for an illiquidity premium. 

Following the re-issue of the updated MCEV Principles, the Group reviewed its embedded value assumptions and elected to include an illiquidity premium for its UK immediate annuity business. For 2009, the reference rate is based on the swap yield curve, increased by an illiquidity premium of: 75bps for in-force annuity business at the year end; 100bps for the value of new annuity business written during the year; and 80bps for the two months ended 31 December 2009.

The impacts of moving from the gilt yield curve to the swap yield curve and the increased illiquidity premium are included within the analysis of 2009 full year Friends Provident MCEV earnings under economic variances. Further details of the illiquidity premium can be found in note 10.

Cost of residual non-hedgeable risks

The MCEV Principles require that an allowance is made for the cost of non-hedgeable risks not already allowed for elsewhere in the MCEV. Under Friends Provident's previous market consistent approach, allowance was made for the cost of non-market risk in a similar way to the allowance for non-hedgeable risk under the MCEV Principles and the difference in costs under the two approaches is not significant. The impact of the change in approach is included within the analysis of 2009 full year Friends Provident MCEV earnings under other operating variances.

Holding companies' operating expenses

Under the MCEV Principles, holding companies' operating expenses relating to the existing covered business are to be allocated to the expense assumptions for the covered business. Friends Provident previously showed a provision for capitalised future costs in the corporate business segment. These costs are now regarded as relating to the life and pensions covered business and the 2008 comparatives have been adjusted to show the provision as a deduction from the value of in-force covered business.

Segmental analysis

Following the acquisition of Friends Provident and in line with IFRS 8: Operating segments, the Group has reviewed its segmental analysis under IFRS and MCEV reporting bases. This review resulted in certain changes to the segmental analysis, which are discussed in note 13. 

Where material, comparative figures for 2008 have been amended to reflect the revised segmentation.

Application of IFRIC 14

A review has been undertaken of the application of IFRIC 14 'The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction', in the context of the Friends Provident Pension Scheme. In addressing the circumstances under which a pension surplus should be recognised it has been concluded that the previous interpretation was not consistent with generally accepted practice and that the 2008 comparatives should therefore be restated.

The impact of the change in treatment is that the items set out below in respect of 2008, and reported in the Group's accounts for that year, have been restated as follows:

(i) Recognition of a net pension surplus of £74 million in the consolidated statement of financial position and a corresponding increase in other reserves; and

(ii) an increase of £74 million in actuarial gains/(losses) on defined benefit schemes and related tax in the consolidated statement of comprehensive income.

The economic benefit available is recognised net of tax at a rate of 35%. The amendment to 2008 comparative information has no impact on profit for the year. A surplus of £4 million was previously recognised at 31 December 2007 and is unaffected by the change in application.

The MCEV results were approved by the Board of Directors on 23 March 2010.

MCEV methodology

Overview

The MCEV basis of reporting is designed to recognise profit as it is earned over the term of a life insurance policy. The total profit recognised over the lifetime of the policy is the same as that recognised under the IFRS basis of reporting, but the timing of recognition is different.

Covered business

Covered business comprises the following:

·; all life and pensions business written by Friends Provident's life insurance subsidiaries; and

·; Friends Provident's 30% share in AmLife Insurance Berhad, a Malaysian based life insurance business.

These businesses are collectively referred to as "life and pensions covered business". 

The STICS and lower tier two subordinated debt, are formally allocated to covered business on the basis that all obligations to make payments in respect of this debt are guaranteed by FPLP. The STICS and lower tier two subordinated debt are included within the MCEV at market value, based on listed bid price.

Non-covered business

The Group's non-covered business includes the IFA distribution businesses, the management services businesses, the net pension asset of Friends Provident Pension Scheme (FPPS) on an IAS 19 basis and the corporate net assets. Until the demerger of F&C in July 2009, Friends Provident non-covered business included asset management business.

Segmental reporting under MCEV

The covered business within Friends Provident has been split into the following segments in line with IFRS reporting:

·; UK, which includes the life and pensions businesses within the UK and the STICS and lower tier two subordinated debt;

·; International, which includes Friends Provident International Limited, the overseas life assurance business within the UK life and pensions subsidiaries and Friends Provident's share in AmLife; and

·; Lombard.

A reconciliation between the segmentation shown under MCEV and IFRS reporting is shown in note 13.

New business

New business within the life and pensions covered business includes:

·; premiums from the sale of new policies;

·; payments on recurring single premium policies, including Department for Work and Pensions rebate premiums, except existing stakeholder-style pensions business where, if a regular pattern in the receipt of premiums for individuals has been established, the regular payment is treated as a renewal of an existing policy and not new business;

·; non-contractual increments on existing policies; and

·; new entrants to existing schemes in the group pensions business.

The MCEV new business definition is consistent with the quarterly new business disclosures.

Calculation of embedded value

The MCEV provides an estimate of the value of shareholders' interest in the covered business, excluding any value that may be generated from future new business. The MCEV comprises the sum of the shareholders' net worth of the life and pensions covered business and the value of in-force covered business. The shareholders' net worth of the life and pensions covered business includes the listed debt of the STICS and lower tier two subordinated debt at market value.

The reported Group MCEV provides an estimate of the total consolidated MCEV of the Group and comprises the MCEV in respect of the life and pensions covered business, plus the IFRS net assets in respect of the non-covered business, excluding intangible assets relating to future new business.

a) Shareholders' net worth

The shareholders' net worth of the life and pensions covered business consists of free surplus and required capital. 

Free surplus is the market value of any assets allocated, but not required to support, the in-force covered business at the valuation date.

Required capital is the market value of assets, attributed to the covered business over and above that required to back liabilities for covered business, whose distribution to shareholders is restricted. The Group's required capital is set at the greater of regulatory capital and requirements arising from internal capital management policies, which include economic risk capital objectives, and change of control requirements. The economic risk capital is determined from internal models, based on the Group's risk appetite. The level of required capital (as a percentage of the EU minimum solvency margin) is shown in note 10.

b) Value of in-force covered business

The value of in-force covered business consists of:

·; present value of future profits less

·; time value of financial options and guarantees; and

·; frictional costs of required capital; and

·; cost of residual non-hedgeable risks.

Present value of future profits (PVFP)

The value of existing business is the present value of the future distributable profits available to shareholders from the in-force covered business. Future profits are projected using best estimate non-economic assumptions and market consistent economic assumptions.

The non-economic assumptions include: the behaviour of customers (for example persistency), mortality, the level of expenses required to maintain the book of business, tax and the regulatory environment. The assumptions are a reflection of best estimates of the likely behaviours, outcomes, or circumstances in the future. The estimates are made, typically, on an annual basis following experience investigations based on the data available at the time both from the book of business and externally sourced information. The aim is to set assumptions at a level that reflects recent or current experience.

The economic assumptions are market consistent whereby, in principle, each cashflow is valued in line with the price of similar cash flows that are traded in the capital markets. For example, an equity cashflow is valued using an equity risk discount rate, and a bond cashflow is valued using a bond risk discount rate. If a higher return is assumed for equities, the equity cashflow is discounted at this higher rate.

In practice, for liabilities where the payouts are either independent or move linearly with market movements, a method known as the 'certainty equivalent approach' has been applied whereby all assumed assets earn the reference rate and all cashflows are discounted using the reference rate. This gives the same result as applying the method in the previous paragraph.

Time value of financial options and guarantees (TVOG)

The PVFP is based on a single deterministic projection of future economic assumptions. However, a single projection does not fully reflect the potential for extreme events and the resulting impact of options and guarantees on the shareholder cashflows. While the PVFP allows for the intrinsic value of an option or guarantee under a single set of economic assumptions, it does not reflect the potential range of future economic scenarios on the shareholder cashflows. Stochastic modelling techniques are used to assess the impact of potential future economic scenarios on an option or guarantee and to determine the average value of shareholder cashflows under a number of market consistent scenarios. 

The TVOG is calculated as the difference between the average value of shareholder cashflows under a number of market consistent scenarios, and the intrinsic value under a single projection within the PVFP.

The material financial options and guarantees are those in the FPLP with-profits fund, in the form of the benefits guaranteed to policyholders and the guaranteed annuity rates associated with certain policies. The risk to shareholders is that the assets of the with-profits fund are insufficient to meet these guarantees. While shareholders are entitled to only a small share of profits in the with-profits fund (via one ninth of the cost of bonus), they can potentially be exposed to the full cost of fund assets being insufficient to meet policyholder guarantees. The TVOG has been assessed using a stochastic model derived from the current Realistic Balance Sheet (RBS) model. This model has been calibrated to market conditions at the valuation date. Allowance has been made under the different scenarios for management actions, such as altered investment strategy, consistent with the RBS model. The TVOG would be markedly higher without the hedging activities and management actions currently undertaken.

Only modest amounts of new with profits business are written and the guarantee levels offered are lower, hence there is no material impact in respect of the TVOG on the value of new business.

Frictional costs of required capital

The value of in-force covered business includes a deduction for the additional costs to an investor of holding the assets backing required capital through investment in a life company, rather than investing in the asset directly. These additional frictional costs comprise taxation and investment expenses on the assets backing the required capital. 

The frictional costs of required capital are calculated as the difference between the market value of assets backing required capital and the present value of future releases of that capital allowing for future investment return (net of frictional costs) on that capital. The calculation allows for the run-off of the required capital over time using projections of the run-off of the underlying risks and regulatory requirements.

Details of the level of required capital are set out in note 10.

Cost of residual non-hedgeable risks (CNHR)

The main area of non-hedgeable risk relates to non-financial risks, such as insurance and operational risks, where no deep, liquid market exists to fully mitigate the risk. Allowance for non-financial risk is made directly within:

·; the PVFP via an appropriate choice of best estimate assumptions and with the impact of variability of the risk on the level, and hence cost, of required capital; and

·; the TVOG for the impact of variations of non-financial risks on the possibility of shareholders needing to meet the guarantees within the FPLP With Profits Fund.

The CNHR covers those non-hedgeable risks not already allowed for fully in the PVFP or in the TVOG. The most significant of these risks are those for which the impact of fluctuations in experience is asymmetric; where adverse experience has a higher impact on shareholder value than favourable experience and the best estimate assumptions do not reflect this asymmetry. The areas identified as having the potential for material asymmetry are operational risk, persistency risk and reinsurance counterparty default risk.

The CNHR has been calculated by considering the financial cost to shareholders of the impact of asymmetric risks and with regard to the results of risk-based capital modelling. The risk-based capital is calculated using internal models, consistent with those used in the Group's Individual Capital Assessment, with:

·; a 99.5% confidence level over one year;

·; allowance for diversification between non-hedgeable risks;

·; no allowance for diversification between non-hedgeable and hedgeable risks; and

·; no allowance for diversification between covered and non-covered business.

The CNHR impacts both the value of existing business and new business. 

Participating Business

Future regular bonuses on participating business are projected in a manner consistent with current bonus rates and expected future market consistent returns on assets deemed to back the policies.

Future terminal bonuses are assumed to be set at a level to exhaust all the assets deemed to back the policies over the future lifetime of the in force with profit policies.

The PVFP includes the shareholder's share of future profits from the FPLP with-profits fund, based on the assumed bonus rates.

There may be some extreme future economic scenarios in which total assets in the FPLP with-profits fund are not sufficient to pay all policyholder claims and the resulting shortfall would be met by shareholders. Stochastic modelling techniques are used to assess the impact of future economic scenarios on the with profits funds' ability to pay all policyholder claims and to determine the average additional cost to shareholders arising from future projected shortfalls. This cost to shareholders has been included in the TVOG.

Consolidation adjustments

The effect of transactions and reinsurance arrangements between life insurance subsidiary companies has been included in the results split by segment in a consistent manner. No elimination is required on consolidation.

Goodwill and intangibles

Goodwill and intangibles relating to the non-covered business are included on the IFRS basis. Intangible assets relating to the value of future new business, such as distribution relationships and brand value, have been excluded from the Group MCEV.

Exchange rates

The results and cashflows have been translated at the average exchange rates for that period and the assets and liabilities have been translated at the period end rates.

Details of the exchange rates used are shown in note 10.

 

2. Analysis of life and pensions MCEV earnings

This section provides an analysis of the movement in the MCEV for the life and pensions covered business only. All of the Group's covered business is wholly contained within Friends Provident and hence this analysis does not show the earnings in respect of the non-covered businesses of Friends Provident or Resolution Limited. 

The following table shows the movement in the MCEV for the life and pensions covered business of Resolution Limited for the year ended 31 December 2009 and hence includes the results of Friends Provident for the post acquisition period. The analysis is shown separately for free surplus, required capital and the value of the in-force covered business. All figures are shown net of attributed tax.

Resolution Limited

For the year ended 31 December 2009

				FPH	Resolution Limited
				5 November to 31 December 2009	Year ended 31 December 2009
	Free surplus	Required capital	VIF	MCEV	MCEV
Net of tax	£m	£m	£m	£m	£m
Opening MCEV	-	-	-	-	-
Opening adjustments:
- Acquired/divested businesses	279	821	1,864	2,964	2,964
Adjusted opening MCEV	279	821	1,864	2,964	2,964
Value of new business	(47)	7	78	38	38
Expected existing business contribution:
- Expected existing business contribution (reference rate)	(1)	3	9	11	11
- Expected existing business contribution (in excess of reference rate)	(1)	(1)	12	10	10
Transfers from VIF and required capital to free surplus	40	(3)	(37)	-
Experience variances	(10)	-	(13)	(23)	(23)
Operating assumption changes	4	-	(3)	1	1
Other operating variances	-	-	-	-	-
Operating MCEV earnings	(15)	6	46	37	37
Economic variances	19	(1)	9	27	27
Other non-operating variances	5	-	-	5	5
Total MCEV earnings	9	5	55	69	69
Closing adjustments:
- Capital and dividend flows	(2)	-	-	(2)	(2)
- Foreign exchange variances	-	-	(3)	(3)	(3)
Closing MCEV	286	826	1,916	3,028	3,028

 

The Friends Provident results for the post acquisition period ended 31 December 2009 include a high proportion of Friends Provident's value of new business for 2009 of £104 million (net of tax) due to the seasonal nature of Lombard new business, which is heavily weighted towards the final months of the year. The adverse operating experience variances of £23 million (net of tax) reflect a persistency variance of £10 million and exceptional costs of £6 million with the balance arising from a number of smaller items, including operational risk charges. Operating assumption changes would ordinarily be made at the end of the year but were limited in size in the post acquisition period due to these assumptions being fully reviewed in calculating the Friends Provident balance sheet as at the date of the acquisition.

The following tables show the movement in the MCEV for the life and pensions covered business of Friends Provident on a standalone basis for the years ended 31 December 2009 and 31 December 2008. All figures are shown net of attributed tax.

Friends Provident

For the year ended 31 December 2009

	Free surplus	Required capital	VIF	MCEV
Net of tax	£m	£m	£m	£m
Opening MCEV	(46)	907	1,634	2,495
Value of new business	(239)	28	315	104
Expected existing business contribution:
- Expected existing business contribution (reference rate)	(1)	14	43	56
- Expected existing business contribution (in excess of reference rate)	1	(12)	82	71
Transfers from VIF and required capital to free surplus	291	(15)	(276)	-
Experience variances	13	(1)	(102)	(90)
Operating assumption changes	110	(90)	(19)	1
Other operating variances	(4)	-	4	-
Operating MCEV earnings	171	(76)	47	142
Economic variances	123	(2)	176	297
Other non-operating variances	(27)	-	92	65
Total MCEV earnings	267	(78)	315	504
Closing adjustments:
- Capital and dividend flows	56	-	-	56
- Foreign exchange variances	8	(3)	(33)	(28)
- Acquired/divested businesses	1	-	-	1
Closing MCEV	286	826	1,916	3,028

 

For the year ended 31 December 2008

	Free surplus	Required capital	VIF	MCEV
Net of tax	£m	£m	£m	£m
Opening MCEV	340	668	1,773	2,781
Value of new business	(224)	31	292	99
Expected existing business contribution from existing business:
- Expected existing business contribution (reference rate)	12	25	95	132
- Expected existing business contribution (in excess of reference rate)	(3)	(7)	43	33
Transfers from VIF and required capital to free surplus	267	(12)	(255)	-
Experience variances	(235)	203	22	(10)
Operating assumption changes	(53)	-	38	(15)
Other operating variances	-	-	14	14
Operating MCEV earnings	(236)	240	249	253
Economic variances	(51)	(9)	(493)	(553)
Other non-operating variances	(33)	-	5	(28)
Total MCEV earnings	(320)	231	(239)	(328)
Closing adjustments:
- Capital and dividend flows	(56)	-	-	(56)
- Foreign exchange variances	(22)	8	100	86
- Acquired/divested businesses	12	-	-	12
Closing MCEV	(46)	907	1,634	2,495

 

Further details of the calculation and analysis of the value of new business are discussed in note 6.

Detailed business commentary relating to the analysis of MCEV earnings is shown in note 3. Note 3 shows the analysis of MCEV earnings by business segment and on a gross of tax basis, with attributed tax shown separately. This presentation is consistent with the presentation of the IFRS results and the internal management reporting used to monitor the Group's MCEV earnings.

3. Segmental analysis of life and pensions MCEV earnings

The table below shows a further breakdown of the MCEV earnings for the life and pensions covered business. 

All earnings are shown on a gross of tax basis with attributed tax shown separately.

Resolution Limited life and pensions covered business for the year ended 31 December 2009

		FPH				Resolution Limited
		5 November to 31 December 2009				Year ended 31 December 2009
		UK	Int'l	Lombard	Total	Total
Gross of tax		£m	£m	£m	£m	£m
Value of new business		-	9	43	52	52
Expected existing business contribution		19	5	4	28	28
Operating experience variances		(12)	(6)	(7)	(25)	(25)
Operating assumption changes		1	-	-	1	1
Other operating variances		-	-	-	-	-
Development costs		(3)	(2)	-	(5)	(5)
Life and pensions covered business operating profit before tax		5	6	40	51	51
Economic variances		10	10	14	34	34
Other non-operating items		6	-	-	6	6
Life and pensions covered business profit before tax		21	16	54	91	91
Attributed tax on operating profit		(2)	(1)	(11)	(14)	(14)
Attributed tax on other activities		(4)	-	(4)	(8)	(8)
Life and pensions covered business profit after tax		15	15	39	69	69

 

Friends Provident life and pensions covered business for the year ended 31 December 2009

	FPG				FPG
	Year ended 31 December 2009				Year ended 31 December 2008
	UK	Int'l	Lombard	Total	UK	Int'l	Lombard	Total
Gross of tax	£m	£m	£m	£m	£m	£m	£m	£m
Value of new business	26	47	60	133	28	44	67	139
Expected existing business contribution	125	23	28	176	183	19	36	238
Operating experience variances	(68)	(21)	(8)	(97)	10	(21)	9	(2)
Operating assumption changes	11	(8)	(7)	(4)	(24)	3	(1)	(22)
Other operating variances	8	(18)	16	6	(5)	-	24	19
Development costs	(16)	(5)	(2)	(23)	-	(9)	(3)	(12)
Life and pensions covered business operating profit before tax	86	18	87	191	192	36	132	360
Economic variances	449	(54)	32	427	(585)	46	(201)	(740)
Other non-operating items	(62)	111	0	49	(31)	(1)	-	(32)
Life and pensions covered business profit/(loss) before tax	473	75	119	667	(424)	81	(69)	(412)
Attributed tax on operating profit	(29)	5	(25)	(49)	(57)	(9)	(41)	(107)
Attributed tax on other activities	(107)	2	(9)	(114)	138	(14)	67	191
Life and pensions covered business profit/(loss) after tax	337	82	85	504	(343)	58	(43)	(328)

 

UK

The life and pensions covered business operating profit for the UK is down from £192 million in 2008 to £86 million in 2009. Overall changing assumptions to align with the MCEV Principles accounted for £59 million of the change, as the positive impact of £18 million on the value of new business was more than offset by the reduction in the expected contributions on the value of in-force and on the shareholder net worth.

Value of new business

Further details of the calculation and analysis of the value of new business are discussed in note 6.

Expected existing business contribution

The expected existing business contribution is presented as the sum of two components:

·; The expected earnings assuming the opening assets earn the beginning of period reference rate; plus

·; the additional expected earnings (in excess of the beginning of period reference rate) consistent with management's expectation for the business.

The reference rate is based on the one-year swap return plus, for UK immediate annuity business only, an illiquidity premium equivalent to 120 bps at the beginning of the year.

The additional earnings are the excess over the reference rate and reflect management's long term expectation of asset returns, based on an assumed asset mix.

The reduced expected contribution from the value of in-force of £117 million (2008: £143 million) reflects the lower opening value of in-force, £975 million in 2009 compared to £1,260 million in 2008, and slightly lower expected rates of return.

The UK expected contribution on shareholders' net worth of £8 million (2008: £40 million) includes offsetting items for the expected income on shareholder investments, including the use of a one-year return on bonds rather than a long-term average yield, and interest payable on debt instruments which is, recharged to the life companies and is fixed in amount.

Operating experience variances

Operating experience variances relate to variances between actual experience and that anticipated in the projection assumptions. Operating experience variances totalled £(68) million (2008: £10 million) and comprise the following elements:

·; £(39) million arising from reduced persistency and higher rates of fall off in premium payment on group and individual pensions (H1 2009: £(19) million). This reflects a combination of difficult economic conditions adversely affecting employment levels and income and some effect from Friends Provident's retrenchment from the commission paying group pensions market, as a number of schemes have been churned to commission paying providers. There is also a small adverse effect due to higher lapses on protection due in part to some brokers going out of business.

·; £(11) million arising from the effect of rewriting schemes on more competitive terms in order to retain them. The charge at the half year was £5 million.

·; £(26) million arising from a reduction in tax assets following a thorough review of the recoverability of tax assets, offset by positive tax variances of £12 million.

·; £(2) million arising from a small overrun on maintenance expenses which reflects the assumption being based on the planned cost base in 2010, after the implementation of all the actions to reduce costs

·; £(2) million arising from a number of exceptional offsetting expenses were incurred in 2009, including £5 million in respect of the closure of Manchester branch and a number of other one off items, including special policyholder mailings to clarify fund mandates.Operating assumption changes

The effect of operating assumption changes totalled £11 million (2008: £(24) million), including a loss of £135 million in respect of changes to persistency assumptions and a profit of £154 million as a result of expense reductions and redefinition of development costs.

The persistency assumption changes of £(135) million include:

·; £(29) million due to increasing lapse and paid up rates observed on group pensions policies following Friends Provident's announcement of its exit from the market for unfunded commission paying group pensions;

·; £(23) million on protection where some higher lapse experience has been observed on certain product lines; and

·; £(19) million in respect of bonds where a higher number of exits has been observed at the five year point, when surrender penalties have expired.

In addition to this £(71) million overall impact of changes applied at the product level, a provision of £64 million has been made for further short term adverse experience both of a recessionary nature and due to short term churning while commission is still payable on group pensions business.

Offsetting the year on year positive variance of £19 million is £(8) million in respect of changes to mortality and morbidity assumptions.

Other operating variances

Other operating variances of £8 million (2008: £(5) million) include the effects of a number of offsetting items:

·; £26 million benefit resulting from enhanced modelling of the burn through effect in the with profits fund, effectively by allowing for the Equity Backing Ratio to flex more in the extreme adverse conditions;

·; £12 million arising from a number of small individual modelling changes;

·; £(19) million due the increased allowance for non-hedgeable risk arising from the alignment with MCEV Principles; and

·; £(11) million in respect of modelling the cost of capital ratios based on the target coverage ratios now in use in the business.

Development costs

Development costs of £16 million (2008: nil) relate to costs that are designed to enhance current propositions, which are expected to generate future profits, to ensure that they remain marketable. These costs relate to various systems developments in group pensions designed to enhance the proposition as well as development costs associated with the tied distribution arrangement with Tesco Bank.

International

The life and pensions operating profit for International is £18 million in 2009, down from £36 million in 2008, principally due to an additional £18 million of adverse other operating variances in 2009 which are one off in nature.

Value of new business

Further details of the calculation and analysis of the value of new business are discussed in note 6.

Existing business contribution

The expected contribution of £23 million (2008: £19 million) has increased as a result of growth in the value of in-force business over 2008, and subsequently higher opening value.

Operating experience variance

Operating experience variances of £(21) million (2008: £(21) million) comprise:

·; £(10) million of adverse persistency resulting largely from the impact of the global recession in 2009 with £(5) million relating to higher lapse and paid up experience in Germany;

·; £(9) million due to expense overruns, split £(4) million Germany and £(5) million in other international operations; plus

·; £(2) million of minor other variances.

 

Operating assumption changes

Operating assumption changes of £(8) million (2008: £3 million) principally reflect increased unit cost assumptions in respect of the German business.

Other operating variances

Other operating variances of £(18) million (2008: nil) comprise £(12) million for modelling changes and £(6) million in relation to increased charges for non-hedgeable risk due to the alignment with MCEV Principles.

Development costs

Development costs of £5 million (2008: £9 million) relate mostly to the German business and are due to enhancing quotation systems to be in line with regulations.

Lombard

The MCEV operating profit from Lombard is £87 million in 2009 compared to £132 million in 2008, due to a reduced existing business contribution and some large positive other operating variances in 2008 which did not recur in 2009.

Value of new business

Further details of the calculation and analysis of the value of new business are discussed in note 6.

Existing business contribution

The expected contribution of £28 million (2008: £36 million) has fallen due to adverse movements in the Euro/Sterling exchange rate.

Operating experience variances

Operating experience variances of £(8) million (2008: £(21) million) reflect increased lapse experience of £(7) million with the remainder of the experience variance in 2009 comprising shortfalls in surrender fee income. In 2008 operating experience variances benefitted from a large positive effect from a reassessment of tax assets, which were found to be valued too conservatively, amounting to £18 million.

Operating assumption changes

Operating assumption changes of £(7) million (2008: £(1) million) relate to updating of assumptions for partial surrender experience.

Other operating variances

Other operating variances of £16 million (2008: £24 million) include £14 million in relation to the movement to charge for non-hedgeable risk, aligning with MCEV Principles. The 2008 positive operating variance of £24 million related to improved modelling of policyholder cashflows.

Economic variances

Economic variances combine the impact of changes to economic assumptions with the investment return variances over the year.

Total economic variances of £427 million (2008: £(740) million) include the impacts of key economic assumption changes made over the year, namely: introducing the swap yield curve as the reference rate to align with the updated MCEV Principles and including an illiquidity premium on existing UK annuity business. The impacts of these assumption changes have been assessed based on economic assumptions at the start of the year. The introduction of the swap yield curve at the start of the year reduced the MCEV earnings by £34 million and the inclusion of an illiquidity premium of 120bps at the start of the year increased the MCEV earnings by £274 million. The subsequent movements in the swap yield curve and in the illiquidity premium over the year are included as part of the economic variances over the year.

The other key economic variances are:

·; £160 million due to the net effect of the positive impact of narrowing of corporate bond spreads on actual investment returns offset by both the allowance for the illiquidity premium in the expected return on the annuity business and the impact of updating the economic assumptions at the end of the year;

·; £49 million due to the net effect of positive investment returns on UK unit-linked business off-set by changes to economic assumptions; and

·; £(22) million due to the net effect of positive investment returns on the International and Lombard businesses, offset by adverse exchange rate movements that reduced the value of future annual management charges.

Other non-operating items

Total other non-operating items of £49 million (2008: £(32) million) include:

·; £(13) million in respect of life company tax losses utilised against the corporate tax charge on the STICS interest;

·; £6 million in respect of reserving changes on AmLife business as a result of a charge in local regulations;

·; £(49) million in respect of costs associated with the implementation of the Strategic Review, that have been allocated to the life and pensions businesses;

·; £107 million in respect of the change in the tax rate from 28% to 0% on Isle of Man business; and

·; £(2) million relating to one-off project costs.

 

4. EARNINGS PER SHARE

Earnings per share have been calculated based on MCEV operating profit after tax and profit after tax attributable to ordinary shareholders. The directors consider the operating earnings per share figure gives a better indication of operating performance.

 

Basic and operating earnings per share

		Year ended 31 December 2009		Period ended 31 December 2008
		Earnings	Per share	Earnings	Per share
		£m	pence	£m	pence
Profit/(loss) after tax attributable to ordinary equity holders		71	7.60	(1)	(0.11)
Economic variances		(40)	(4.28)	-	-
Amortisation of non-covered business acquired intangible assets		1	0.11	-	-
Non-recurring items and non-operating variances		(5)	(0.54)	-	-
Tax credit on items excluded from operating profit/(loss)		(1)	(0.11)	-	-
Operating profit profit/(loss) tax attributable to ordinary equity holders		26	2.78	(1)	(0.11)

The calculation of basic earnings per share uses a weighted average of 933,670,453 (2008: 638,181,818) ordinary shares in issue. The actual number of shares in issue at 31 December 2009 was 2,412,451,145 (2008: 660,000,000).

 

Diluted basic earnings per share

		Year ended 31 December 2009
		Earnings	Weighted average number of ordinary shares	Per share pence
		£m	number
Profit after tax attributable to ordinary equity holders		71	933,670,453	7.60
- Dilution		-	1,608,435	(0.01)
- Diluted profit after tax attributable to equity holders		71	935,278,888	7.59

 

Dilutive factors in 2009 comprise the expected impact of the Lombard management incentive scheme. There were no dilutive factors in 2008.

 

5. Reconciliation of equity attributable to ordinary shareholders

Ordinary shareholders' equity on a MCEV basis reconciles to equity attributable to ordinary shareholders on an IFRS basis as follows:

		Resolution Limited	Resolution Limited		FPH	FPG
		2009	2008		2009	2008
		£m	£m		£m	£m
Equity attributable to ordinary shareholders on an IFRS basis		3,536	650		3,229	2,437
Less items only included on an IFRS basis:
- IFRS reserving and other IFRS adjustments		485	-		485	553
- deferred front end fees		8	-		8	115
- deferred acquisition costs		(46)	-		(46)	(1,211)
- acquired PVIF (net of tax)		(2,285)	-		(2,285)	(265)
- other intangible assets (net of tax)		(244)	-		(244)	(74)
- goodwill on covered business		-	-		-	(404)
Add items only included on a MCEV basis:		-	-		-	-
Adjustment for long-term debt to market value (net of tax)		118	-		118	254
Net worth on a MCEV basis		1,572	650		1,265	1,405
- Value of in-force covered business		1,916	-		1,916	1,634
Equity attributable to ordinary shareholders on a MCEV basis		3,488	650		3,181	3,039

 

6. NEW BUSINESS

The tables below set out the analysis of new business in terms of volumes and profitability.

New business volumes have been shown using two measures:

·; Present Value of New Business Premiums. PVNBP is equal to the total single premium sales received in the period plus the discounted value of regular premiums expected to be received over the lifetime of new contracts, and is expressed at point of sale.

·; Annual Premium Equivalent. APE is calculated as the new regular premium per annum plus 10% of single premiums.

The MCEV new business definition is consistent with the quarterly new business disclosures.

The premium volumes and projection assumptions used to calculate the present value of regular premiums within PVNBP are the same as those used to calculate the value of new business.

The value of new business is calculated using economic assumptions at the beginning of the period for all products except immediate annuities. For annuity business, as the contribution is sensitive to the interest rate at outset, the appropriate rate for each month's new business is used. The value of new business for annuities has been valued assuming an illiquidity premium of 100bps for the year ended 31 December 2009 (2008: nil) and 80bps for the two months ended 31 December 2009.

The value of new business is calculated using operating assumptions at the end of period for all products. The operating assumptions are consistent with those used to determine the embedded value.

The value of new business is shown after the effects of the frictional costs of holding required capital and share based payments, and after the effect of the costs of residual non-hedgeable risks on the same basis as for the in-force covered business.

Resolution Limited new business value from 5 November to 31 December 2009

		New business premiums		APE	Average annual premium multiplier (i)	PVNBP	Post-tax Value of new business	Pre-tax Value of new business	New business margin
		Single	Regular
		£m	£m	£m		£m	£m	£m	%
UK		113	48	59	4.0	303	1	1	0.3
International		66	32	39	4.9	222	7	8	3.6
Lombard		1,877	-	188	-	1,877	31	43	2.3
Total		2,056	80	286	4.3	2,402	39	52	2.2

 

(i) Defined as (PVNBP less total amount of single premiums)/ (total annualised amount of regular premiums)

 

New business premiums

Friends Provident new business value for the year ended 31 December 2009

		New business premiums		APE	Average annual premium multiplier (i)	PVNBP	Post-tax Value of new business	Pre-tax Value of new business	New business margin
		Single	Regular
		£m	£m	£m		£m	£m	£m	%
UK Corporate
- Group pensions		474	262	310	4.1	1,544	4	6	0.4
- Group protection		-	9	9	3.0	26	3	4	15.4
UK Individual
- Individual protection		-	41	41	6.2	253	(8)	(11)	(4.3)
- Individual pensions		163	6	22	3.9	185	4	5	2.7
Annuities		232	-	23	-	232	17	23	9.9
Investments		28	-	3	5.5	29	(1)	(1)	(3.4)
UK total		897	318	408	4.3	2,269	19	26	1.1
International		321	160	192	4.8	1,091	43	47	4.3
Lombard		2,735	-	273	-	2,735	43	60	2.2
Non-UK total		3,056	160	465	4.8	3,826	86	107	2.8
Total		3,953	478	873	4.5	6,095	105	133	3.9

 

(i) Defined as (PVNBP less total amount of single premiums)/ (total annualised amount of regular premiums)

The value of new business for annuities shown in the table above has been valued assuming an average illiquidity premium of 100bps over the 12 months to 31 December 2009. 

Friends Provident new business value for the year ended 31 December 2008

		New business premiums		APE	Average annual premium multiplier (i)	PVNBP	Post-tax Value of new business	Pre-tax Value of new business	New business margin
		Single	Regular
		£m	£m	£m		£m	£m	£m	%
UK Corporate
- Group pensions		450	377	422	4.0	1,964	10	14	0.7
- Group protection		-	7	7	3.6	25	-	-	(0.7)
UK Individual
- Individual protection		-	45	45	6.0	272	6	9	3.3
- Individual pensions		301	11	41	3.8	343	6	8	2.3
Annuities		265	-	27	-	265	(1)	(1)	(0.4)
Investments		70	1	8	4.0	74	(1)	(2)	(2.7)
UK total		1,086	441	550	4.2	2,943	20	28	0.9
International		430	167	210	5.0	1,273	31	44	3.5
Lombard		2,463	-	246	-	2,463	48	67	2.7
Non-UK total		2,893	167	456	5.0	3,736	79	111	3.0
Total		3,979	608	1,006	4.4	6,679	99	139	2.1

 

(i) Defined as (PVNBP less total amount of single premiums) / (total annualised amount of regular premiums)

UK

The UK value of new business was broadly in line with 2008 at £26 million compared to £28 million, after taking account of the inclusion of an illiquidity premium on annuities. The key product lines driving the value of new business are group pensions, individual protection and annuities.

PVNBP margin (defined as value of new business as a percentage of PVNBP) has improved slightly, the net result of a number of factors.

VNB and PVNBP margin depend to a large extent on volume of business, because a large proportion of acquisition costs are fixed. There was an overall decline in volume in the UK of 33%, which had a geared impact on VNB. This impact was however partly offset by a £16 million benefit to value of new business as a result of the cost savings programme.

Group pensions sales in APE were down 27% year-on-year. As a result of the economic environment, increments to existing schemes, which form a major share of reported new business, have reduced significantly. Such increments arise from growth in scheme membership, from the hiring of new employees, and increases in contributions, typically driven by annual salary increases. Both of these factors are affected by rising unemployment and wage constraints in the wider economy. Also, as part of the strategy change in early 2008, Friends Provident revised terms so as not to take on new schemes on an unfunded initial commission basis.

Individual protection sales in APE were down 9% year on year. Activity in the protection market is closely related to the level of transactions in the housing market, because sales of protection products are often linked to mortgage sales. Market activity in 2009 has not yet recovered from the historic lows reached in 2008 and increased competition has resulted in margin compression.

Friends Provident has continued its activities aimed at expanding distribution and during the course of the year have announced tied distribution agreements with Tesco Bank and Virgin.

Annuity sales reduced slightly year-on-year. The allowance for an illiquidity premium on new annuities, together with the change in reference rate from the gilt yield curve to swaps, resulted in a £19 million increase to the value of new business.

International

FPIL new business APE volumes were 13% lower as new single premium investment was weaker due to the global economic crisis. FPIL achieved quarter on quarter growth throughout 2009, despite the market turbulence. Although demand in Hong Kong remains well below the peak level of early 2008, there are signs of recovery. FPIL has significantly increased its market share of linked business in this market from 6.0% for the full year 2008 to 11.2% for the first nine months of 2009. In December FPLP completed the purchase of Financial Partners Business AG, the distribution partner in Germany.

Friends Provident's 30% share of AmLife sales was APE of £9.1 million, with a value of new business of £4 million (gross of tax) and a strong new business margin of 6.8%. The business has achieved strong growth in both its agency sales force and bancassurance distribution in spite of the more challenging macroeconomic backdrop.

The fall in FPIL volume was offset by the decline in 2009 of Sterling's value against the US dollar and Euro, resulting in end of period economic assumptions being more favourable for VNB reported in Sterling. Value of new business for FPIL was therefore flat year-on-year, with an overall improved PVNBP margin.

Lombard

Sales in Lombard are seasonal due to the concentration of European tax year-ends in December and the consequent peak of sales in the fourth quarter. New business volumes in 2009 were 11% higher than in 2008, driven primarily by strong performances in the Italian, Swiss and Belgian markets. Sales were lower in Germany and Spain, where uncertainty with respect to legislation changes impacted 2009 sales. There was strong competition for business in Italy as clients brought assets onshore as a result of a tax amnesty late in the year, so this business was written at a lower than average margin, although there was also little new business strain associated with this business.

New business key performance metrics

New business written requires an initial capital investment to meet the set-up costs and capital requirements.

The internal rate of return (IRR) provides a measure of the return to shareholders on this initial capital investment. It is equivalent to the discount rate at which the present value of the after-tax cashflows expected to be earned over the lifetime of the business written is equal to the initial capital invested, including setting aside the required capital, to support the writing of the business.

The cash payback on new business is the time elapsed until the total of expected (undiscounted) cashflows is sufficient to recoup the initial capital invested, including the release of the required capital, to support the writing of new business.

The value of new business is shown after the effects of the frictional costs of holding required capital, and after the effect of the costs of residual non-hedgeable risks on the same basis as for the in-force covered business.

New business key performance metrics

		For the year ended 31 December 2009			For the year ended 31 December 2008
		Pre-tax Value of new business	IRR on new business	Cash payback on new business	Pre-tax Value of new business	IRR on new business	Cash payback on new business
		£m	%	yrs	£m	%	yrs
UK Corporate
- Group pensions		6	7.6	24	14	7.8	23
- Group protection		4	8.5	15	0	1.3
UK Individual
- Individual protection		(11)	1.8		9	8.6	13
- Individual pensions		5	14.0	10	8	12.6	11
Annuities		23	56.9	4	(1)	35.6
Investments		(1)	(0.9)		(2)	2.7
UK total		26	9.3	19	28	9.9	19
Non-UK
International (excluding AmLife)		43	14.2	7	44	15.3	6
AmLife		4	17.8	8	n/a	n/a	n/a
Lombard		60	18.8	7	67	22.6	5
Non-UK total		107	16.2	7	111	19.0	6
Total		133	12.5	11	139	12.9	11

 

7. Segmental analysis of Group MCEV

Year ended 31 December 2009

			Resolution Limited 31 December 2009									FPG
			Free surplus	Required capital	Total net worth	PVFP	TVOG	Frictional costs	Non-hedgeable risks	Total VIF	Total	31 December 2008
												Total
			£m	£m	£m	£m	£m	£m	£m	£m	£m	£m
UK			844	763	1,607	1,187	(41)	(70)	(65)	1,011	2,618	2,200
International			48	25	73	429	-	(1)	(26)	402	475	363
Lombard			(101)	38	(63)	530	-	(5)	(22)	503	440	381
Gross MCEV life and pensions covered businesses			791	826	1,617	2,146	(41)	(76)	(113)	1,916	3,533	2,944
STICS			(318)	-	(318)	-	-	-	-	-	(318)	(449)
Lower tier 2 subordinated debt			(187)	-	(187)	-	-	-	-	-	(187)	-
Net MCEV of life and pensions covered business			286	826	1,112	2,146	(41)	(76)	(113)	1,916	3,028	2,495
Asset management			-	-	-	-	-	-	-	-	-	150
IFA and distribution			33	-	33	-	-	-	-	-	33	70
Management services			(1)	-	(1)	-	-	-	-	-	(1)	20
FPH (2008: FPG)			121	-	121	-	-	-	-	-	121	304
Net Group MCEV of FPH			439	826	1,265	2,146	(41)	(76)	(113)	1,916	3,181	3,039
Resolution Limited			307	-	307	-	-	-	-	-	307	-
Net Group MCEV of Resolution Limited attributable to equity holders of parent			746	826	1,572	2,146	(41)	(76)	(113)	1,916	3,488	3,039

 

At 31 December 2008, Resolution Limited had £650 million of free surplus comprising the net assets of the Group holding company.

a) Net worth

The STICS and lower tier two subordinated debt are included within the MCEV at market value, as detailed in note 10.

b) PVFP

The PVFP includes a deduction of £64 million from the UK and £6 million from International, as a one year provision against worsening 2010 persistency experience arising from recessionary conditions.

c) TVOG

The TVOG at 31 December 2009 of £41 million (2008: £72 million), is split between £14 million (2008: £30 million) market risk and £27 million (2008: £42 million) non-market risk. The non-market risks include lapses, annuitant longevity, and operational risk within the with-profits fund. The allowance for non-market risks is made by consideration of the impact of extreme scenarios from the Group's economic capital model.

d) Frictional costs of holding required capital

The projected required capital is derived from the Group's capital management policy which is to hold the greater of 150% of the EU minimum required margin and 125% of the Individual Capital Assessment. At 31 December 2008 the required capital was set at 100% of the EU minimum required margin plus £400 million.

e) Cost of residual non-hedgeable risks (CNHR)

The cost of residual non-hedgeable risk of £113 million is presented as an equivalent annual cost of capital charge of 2% on projected risk-based Group required capital for all non-hedgeable risk. In line with management's view of the business, no allowance has been made for diversification benefits within the non-hedgeable risks of the covered business.

8. Segmental analysis of Group MCEV earnings

The tables below show a further breakdown of the Group MCEV earnings for each of Resolution Limited and Friends Provident respectively, comprising the MCEV earnings for the life and pensions covered business and the IFRS earnings for the respective non-covered businesses.

All figures are shown net of attributed tax.

Resolution Limited

Year ended 31 December 2009

					FPH	Resolution Limited (ex.FPH)	Resolution Limited	Resolution Limited
	Covered business			Non-covered business	5 November to 31 December 2009	Year ended 31 December 2009	Year ended 31 December 2009	Period ended 31 December 2008
	UK	Int'l	Lombard		Total	Non-covered business	Total business	Total business
	£m	£m	£m	£m	£m	£m	£m	£m
Opening Group MCEV	-	-	-	-	-	650	650	-
Opening adjustments:
- Acquired/divested businesses
- Acquired value of Friends Provident	2,099	458	407	106	3,070	-	3,070	-
- Cost of acquisition	-	-	-	-	-	(2,012)	(2,012)	-
- Transition costs	-	-	-	-	-	(16)	(16)	-
Adjusted opening Group MCEV	2,099	458	407	106	3,070	(1,378)	1,692	-
Operating MCEV earnings	3	5	29	2	39	(13)	26	(1)
Non-operating MCEV earnings	12	10	10	13	45	-	45	-
Total MCEV earnings	15	15	39	15	84	(13)	71	(1)
Other movements in IFRS net equity	-	-	-	29	29	-	29	1
Closing adjustments:
- Capital and dividend flows	(1)	2	(3)	3	1	1,698	1,699	650
- Foreign exchange variances	-	-	(3)	-	(3)	-	(3)	-
Closing Group MCEV	2,113	475	440	153	3,181	307	3,488	650

 

Friends Provident

 

	FPG Year ended 31 December 2009					FPG Year ended 31 December 2008
	Covered business			Non-covered business		Covered business			Non-covered business
	UK	Int'l	Lombard		Total	UK	Int'l	Lombard	Other	Total
	£m	£m	£m	£m	£m	£m	£m	£m	£m	£m
Opening Group MCEV	1,751	363	381	544	3,039	2,180	262	339	866	3,647
Operating MCEV earnings	57	23	62	11	153	135	27	91	15	268
Non-operating MCEV earnings	280	59	23	(91)	271	(478)	31	(134)	(296)	(877)
Total MCEV earnings	337	82	85	(80 )	424	(343)	58	(43)	(281)	(609)
Other movements in IFRS net equity	-	-	-	(72)	(72)	-	-	-	58	58
Closing adjustments:
- Capital and dividend flows	25	30	1	(103)	(47)	(86)	31	(1)	(83)	(139)
- Foreign exchange variances	-	-	(28)	(23)	(51)	-	-	86	51	137
- Acquired/divested businesses	-	-	1	(101)	(100)	-	12	-	(67)	(55)
Closing Group MCEV	2,113	475	440	165	3,193	1,751	363	381	544	3,039

 

The Group MCEV for FPH of £3,181 million at 31 December 2009 is £12 million lower than the Group MCEV for FPG of £3,193 million at 31 December 2009 as a result of £12 million of goodwill relating to the IFA and distribution businesses which is not recognised at the level of FPH or Resolution Limited.

9. Maturity profile of value of in-force business by proposition

 

As at 31 December 2009

£m	Total	1-5	6-10	11-15	16-20	21-25	26-30	31-35	36-40	41+
UK
With Profits Fund	211	87	53	36	20	10	4	1	-	-
Protection	152	60	43	27	15	6	1	-	-	-
Investments	94	52	24	11	4	2	1	-	-	-
Pensions	463	130	137	95	56	28	12	4	1	-
Annuities	31	7	5	5	4	4	3	2	1	-
UK other	60	59	1	-	-	-	-	-	-	-
UK total	1,011	395	263	174	99	50	21	7	2	-
Non-UK
International	402	220	98	52	23	8	1	-	-	-
Lombard	503	230	112	71	42	24	13	6	3	2
Non-UK total	905	450	210	123	65	32	14	6	3	2
Total VIF	1,916	845	473	297	164	82	35	13	5	2

10. MCEV ASSUMPTIONS

10.1 Economic assumptions - deterministic calculations

Economic assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each reporting period.

Reference rates - risk free

The risk free reference rate is determined with reference to the swap yield curve appropriate to the currency of the cashflows.

For annuity business the swap yield curve is extrapolated where necessary to provide rates appropriate to the duration of the liabilities.

		Reference rate - risk free
		31 December 2009	31 December 2008
UK
Non -annuity business		4.30%	3.70%
Annuity Business
- Term 1 year		1.01%	0.88%
- Term 5 years		3.48%	3.95%
- Term 10 years		4.26%	4.38%
- Term 15 years		4.59%	5.05%
- Term 20 years		4.54%	4.52%
International		4.30%	3.70%
Lombard		3.72%	4.23%

 

Reference rate - Illiquidity premium adjustment

The updated MCEV Principles recognise that the inclusion of an illiquidity premium within the reference rate is appropriate where the liabilities are not liquid.

In this regard, the methodology adopted for the valuation of immediate annuities in the UK uses a reference rate that has been increased above the swap yield curve to allow for an illiquidity premium. This reflects the fact that, for these products, the backing asset portfolio can be held to maturity and earns risk-free returns in excess of swaps. Any illiquidity premia in respect of assets backing other product types are recognised within the MCEV as and when they are earned.

The illiquidity premium has been evaluated by considering a number of different sources of information and methodologies. There are two main approaches being commonly used to determine the illiquidity premium within the life insurance industry:

·; a 'negative basis trade', which attributes a component of the difference between the spread on a corporate bond and a credit default swap (for the same issuing entity, maturity, seniority and currency) as being the illiquidity premium; and

·; structural models - such as that used by the Bank of England in their analysis of corporate bond spreads - that use option pricing techniques to decompose the spread into its constituent parts including default risk, credit risk premium and a residual illiquidity premium.

Both of these methods have been used to help inform the extent of the illiquidity premium within the asset portfolios backing immediate annuity business.

No illiquidity premium has been applied for any other covered business.

The reference rate has been adjusted for immediate annuities as set out in the table below.

	Embedded value
			2009			2008
	31 December 2009	31 December 2008	First 10 months	Last 2 months	Full year	Full year
UK immediate annuities	75bps	0bps	105bps	80bps	100bps	0bps

 

An illiquidity premium of 120 bps was assumed in calculating the impact at 1 January 2009 of revising the assumptions basis following the issue of the updated MCEV Principles. The impact of the fall in the illiquidity premium from 120bps at 1 January 2009 to 75bps at 31 December 2009 is included under economic variances in the analysis of MCEV earnings.

Expected asset returns in excess of reference rates

Margins are added to the reference rates to obtain investment return assumptions for equity, property and corporate bonds. These risk premia reflect management's long term expectations of asset returns in excess of the reference rate from investing in different asset classes. No risk premia are added for cash or government bonds.

As a market consistent approach has been followed, these investment return assumptions affect the expected existing business contribution and the economic variances within the analysis of MCEV earnings, but do not affect the opening or closing embedded values. In addition, they will affect the additional disclosures of the implied discount rates and payback periods.

For equities and property, the long term rate of return is derived using a ten year swap rate plus a risk premium of 3% for equities (2008: 3%) and 2% for property (2008: 2%)

For corporate bonds, the return is based on the excess of actual corporate bond spreads on the reporting date, less an allowance for defaults, over the one-year reference rate.

Expense inflation

Maintenance expenses for UK and International business (excluding Lombard) are assumed to increase in the future at a rate of 1% per annum in excess of the assumed long-term rate of inflation. This is derived from the difference between the risk-free rate of return based on FT Actuaries 15 year gilt index and the average of the FTSE Actuaries over five-year index-linked gilt yield at 5% and 0% inflation.

Maintenance expenses for Lombard are assumed to increase in the future at a rate of 0.75% per annum in excess of the assumed long-term rate of inflation. This is derived from an inflation swap curve based on a Euro-zone price index taking into account the run-off profile of the business.

		Expense inflation
		31 December 2009	31 December 2008
UK		4.7%	3.7%
International		4.7%	3.7%
Lombard		3.3%	3.2%

 

Required capital

Required capital under MCEV amounted to £826 million (2008: £908 million).The projected required capital is derived from the Group's capital management policy which is to hold the greater of 150% of the EU minimum required margin and 125% of the Individual Capital Assessment and any Internal Capital Guidance. At 31 December 2008 the required capital was equivalent to 100% of the EU minimum capital requirement plus £400 million.

Taxation

The opening and closing embedded values in respect of covered business are determined on an after tax basis. The tax assumptions used are based upon the best estimate of the actual tax expected to arise. The attributable tax charge and profit before tax are derived by grossing up the profit after tax at the appropriate tax rates for each of the UK, Isle of Man, Luxembourg and Malaysia. Deferred tax is provided on the mark-to-market revaluation of the STICS and lower tier 2 subordinated debt allocated to the life and pensions covered business. 

For non-covered business, attributed tax is consistent with the IFRS financial statements.

		Tax rates
		31 December 2009	31 December 2008
UK		28.0%	28.0%
International
- OLAB (UK)		28.0%	28.0%
- FPIL (Isle of Man)		0.0%	28.0%
- AmLife (Malaysia)		25.0%	25.0%
Lombard		28.6%	28.6%

For the Isle of Man business, it is assumed that all distributable profits will be remitted as dividends to the UK. Following the enactment of the Finance Act 2009 in July 2009, the assumed tax rate relating to Isle of Man business has been reduced to 0% (2008: 28.0%).

Exchange rates

The results and cashflows of all businesses, except Lombard and AmLife, are calculated in Sterling. The results and cashflows for Lombard are calculated in Euros (€) and those of AmLife in Malaysian Ringgits (RM).

The exchange rates used in respect of Lombard business were a closing exchange rate of €1 = £0.888 (2008: €1 = £0.959) and an average exchange rate over the year of €1 = £0.896 (2008: €1 = £0.772).

The exchange rates used in respect of AmLife business were a closing exchange rate of RM 1= £0.1800 (2008: RM1 = £0.1983) and an average exchange rate over the year of RM 1 =£0.1887. The 30% share in AmLife was acquired in December 2008.

Other economic assumptions

Bonus rates on participating business have been set at levels consistent with the economic assumptions.

The distribution of profit between the policyholders and shareholders within the FPLP with-profits fund assumes that the shareholder interest in conventional with-profit business continues at the current rate of one-ninth of the cost of bonus, and that the shareholder interest in the non-profit business within that fund continues at the current rate of 60% of future profits.

 

10.2 Economic assumptions - stochastic calculations

Model

The time value of financial options and guarantees is determined using The Smith Model Plus economic scenario generator and is calculated using 6,300 simulations. The model is consistent with the model used for the Realistic Balance Sheet and is calibrated to market conditions at the valuation date using the gilt risk-free curve (extrapolated to a long term assumption of 4% above 35 years) and implied volatilities in the market. Correlations between the asset classes are derived from historic data.

Swaption implied volatilities

		31 December 2009 Swap term					31 December 2008 Swap term
Option term		10yrs %	15 yrs %	20 yrs %	25 yrs %		10 yrs %	15 yrs %	20 yrs %	25 yrs %
UK Sterling
10 years		15.4	14.9	14.2	13.9		17.2	16.4	16.1	15.9
15 years		15.7	15.0	14.0	13.6		16.9	16.6	16.1	15.9
20 years		16.3	15.2	13.9	13.3		18.1	17.6	16.5	16.2
25 years		15.7	14.3	12.9	12.3		20.4	19.2	17.3	16.6

 

Equity and property implied volatilities

Equity volatility is calibrated to market implied volatility and is a reasonable fit to the implied volatility of the FTSE 100 put options held by the FPLP with profits fund. Property holdings are modelled assuming an initial volatility of 15% and a running yield of 6.7%. Sample implied volatilities are shown in the table below.

 

		31 December 2009			31 December 2008
Option term		Equity %	Property %		Equity %	Property %
5 years		25.0	15.9		32.1	16.8
10 years		27.0	17.0		34.6	18.8
15 years		29.0	18.4		36.6	20.5

 

10.3 Other assumptions

Demographic assumptions

Other assumptions (for example mortality, morbidity and persistency) are a reflection of the best estimate of the likely behaviours, outcomes or circumstances in the future. Typically the estimates are made on an annual basis following experience investigations based on the data available at the time both from the book of business and externally sourced information. The aim is to set assumptions at a level that reflects recent experience, unless there are reliable indicators that suggest their adoption would result in a significant variance compared to these assumptions in the future. In some instances, there may be little or no direct experience to use in setting assumptions and the future outcome is therefore uncertain.

Future improvements in annuitant mortality have been assumed to be in accordance with the 'medium cohort' projections (with certain amendments) published by the Continuous Mortality Investigation in 2002. The amendments are to use 75% of these projections for females and to introduce a minimum annual rate of improvement in future mortality - for males this is assumed to be 1% pa and for females 0.75% pa.

Expense assumptions

The management expenses (including those relating to holding companies) attributable to the covered businesses have been analysed between expenses relating to the acquisition of new business, maintenance of in-force business (including investment management expenses) and development expenses.

Future maintenance expense assumptions reflect the expected ongoing expense levels required to manage the in-force business. Productivity gains have only been included to the extent they have been achieved by the end of the reporting period.

Future projected short-term expense overruns in the International and Lombard businesses have been allowed for by reducing the PVFP for these businesses. The International PVFP has been reduced by £4 million (2008: £nil) for a projected overrun to 2012, and the Lombard PVFP has been reduced by £6 million (2008: £15 million) for a projected overrun to 2013.

Development costs of £23 million (2008: £12 million) have been excluded from the calculation of unit costs and have been recognised in experience variances. Development costs reported in 2009 relate to investment in activities expected to create value in the future, but where that expected value cannot be anticipated within the current year's financial results until the value is realised. The development costs reported in 2008 included costs in relation to development of wholly new products or entry into wholly new markets. Following the acquisition by Resolution, a review of development costs has been undertaken which resulted in changes to the assessment and allocation of development costs. 

Development costs

		FPH 5 November to 31 December 2009	FPG Year ended 31 December 2009	FPG Year ended 31 December 2008
		£m	£m	£m
UK		3	16	-
International		2	5	9
Lombard		-	2	3
Total		5	23	12

 

Non-hedgeable risks

A charge equivalent to 2% has been applied to the projected risk-based group required capital for all non-hedgeable risks over the remaining lifetime of in-force business.

In line with management's view of the business, no allowance has been made for diversification benefits within the non-hedgeable risks of the covered business.

Other assumptions

The STICS and lower tier two subordinated debt are included within the MCEV at market value, based on listed bid price. The IFRS value of the STICS is the principal less capitalised issue costs plus accrued interest. The IFRS value of the subordinated debt is at amortised cost.

 

			Resolution Limited For the year ended 31 December 2009
			Principal	IFRS value	MCEV at market value	Mark to market value adjustment (net of tax)
			£m	£m	£m	£m
STICS 2003			210	209	140	(50)
STICS 2005			268	274	178	(66)
Lower tier two subordinated debt			162	189	187	(2)
Total			640	672	505	(118)

 

 

			FPG For the year ended 31 December 2008
			Principal	IFRS value	MCEV at market value	Mark to market value adjustment (net of tax)
			£m	£m	£m	£m
STICS 2003			300	299	171	(93)
STICS 2005			500	511	278	(161)
Lower tier two subordinated debt			-	-	-	-
Total			800	810	449	(254)

 

 

11. Implied discount rates

For presentational purposes, a set of risk discount rates has been derived for each product line, and for in-force and new business, by calculating the implied discount rate under a traditional embedded value approach that gives the same value as that from the market consistent embedded value determined above. These implied discount rates are a function of the assumptions used (for example equity risk premium and corporate bond spreads). However, as the market consistent approach is used, these assumptions do not impact the level of embedded value: a higher equity risk premium results in an exactly compensating higher risk discount rate.

Average implied discount rates are shown below for the embedded value and the value of new business. The average implied discount rate for the in-force business has decreased over 2009, as a result of the narrowing of corporate bond spreads more than offsetting the increase in the risk-free rate.

A more detailed split of the implied discount rates is given in the following table.

		31 December 2009
		UK					Non-UK
		UK with-profits business	Other UK	Annuities	Average UK		Int'l	Lombard
Embedded value		%	%	%	%		%	%
Reference rate		4.3	4.3	5.0	4.3		4.3	3.7
Market risks (non-options)		3.5	2.7	3.7	2.9		1.9	2.3
Options -market risks		3.7	-	-	0.4		-	-
Options -non- market risks		7.0	-	-	0.8		-	-
Other non-market risks		0.6	0.6	0.6	0.6		1.2	0.5
Implied discount rate		19.1	7.6	9.3	9.0		7.4	6.5

 

The reference rate for annuities includes an illiquidity premium of 75bps at 31 December 2009.

Annuities are excluded from the 2008 comparatives as the allowance for illiquidity premium in the 2008 statutory valuation resulted in a negative value of in-force business under MCEV and hence a meaningless implied discount rate. The equivalent average UK implied discount rate (excluding annuities) would be 8.9%.

		31 December 2008
		UK			Non-UK
		UK with-profits business	Other UK	Average UK	Int'l	Lombard
Embedded value		%	%	%	%	%
Reference rate		3.7	3.7	3.7	3.7	4.2
Market risks (non-options)		4.7	3.0	3.2	1.0	1.7
Options -market risks		8.0	-	0.9	-	-
Options -non- market risks		11.2	-	1.2	-	-
Other non-market risks		0.4	0.4	0.4	0.8	0.8
Implied discount rate		28.0	7.1	9.4	5.5	6.7

 

Implied discount rates for new business have been based on end-of-period economic assumptions.

			31 December 2009				31 December 2008
			UK		Int'l	Lombard	UK		Int'l	Lombard
Value of new business			%		%	%	%		%	%
Risk free rate			4.5		4.3	3.7	3.7		3.7	4.2
Market risks			2.9		1.3	1.8	3.8		0.1	1.2
Non-market risks			0.8		0.4	0.7	0.4		0.8	0.8
Implied discount rate			8.2		6.0	6.2	7.9		4.6	6.2

 

12. Sensitivity analysis

The table below shows the sensitivity of the embedded value and the value of new business to changes in assumptions. The sensitivities below apply to covered business only and include the impact on both shareholder net worth and VIF.

For each sensitivity, the other future experience assumptions remain unchanged, except where changes in economic assumptions directly affect them. The assumptions underlying the statutory reserving calculations remain unchanged in all sensitivities. There are no additional management actions or changes in policyholder behaviour assumed within any of the sensitivities.

Sensitivities shown in a single direction have broadly symmetrical impacts. 

At 31 December 2009, all of the Group's covered business is wholly contained within Friends Provident and the results of the sensitivities for Friends Provident at 31 December 2009 are equal to the results below for Resolution Limited at 31 December 2009.

 

		Resolution Limited (covered business only) Year ended 31 December 2009
		Change in MCEV (net of tax)					Change in value of new business (gross of tax)
Impact on MCEV		UK	Int'l	Lombard	Total		UK	Int'l	Lombard	Total
		£m	£m	£m	£m		£m	£m	£m	£m
Base MCEV		2,113	475	440	3,028		26	47	60	133
Market risk
100bp increase in reference rates		(54)	(6)	(9)	(69)		(2)	(4)	1	(5)
100bp decrease in reference rates		64	5	3	72		2	4	(2)	4
Removal of illiquidity premium for immediate annuities		(129)	-	-	(129)		(22)	-	-	(22)
10% decrease in equity /property capital values at the valuation date, without a corresponding fall/rise in dividend/ rental yield (i)		(54)	(18)	(23)	(95)		n/a	n/a	n/a	n/a
25% increase in equity/property volatility at the valuation date		(9)	-	-	(9)		n/a	n/a	n/a	n/a
25% increase in swaption implied volatility at the valuation date		(3)	-	-	(3)		n/a	n/a	n/a	n/a
100bps increase in corporate bond spreads (ii)		(115)	-	(10)	(125)		(8)	-	-	(8)
100bps decrease in corporate bond spreads (ii)		96	-	9	105		8	-	-	8
10% adverse movement in Sterling/ overseas exchange rate (iii)		(10)	(21)	(42)	(73)		n/a	n/a	n/a	n/a
Insurance and other risk
1% increase in risk discount rate (iv)		(102)	(24)	(37)	(163)		(14)	(6)	(8)	(28)
Reduction to EU minimum capital or equivalent (v)		n/a	n/a	n/a	25		2	-	-	2
10% decrease in maintenance expenses		50	10	4	64		4	2	2	8
10% proportionate decrease in lapse rates		27	19	27	73		5	3	4	12
10% proportionate decrease in PUP rates		12	5	-	17		4	2	-	6
5% decrease in mortality / morbidity - life assurance
- Before reinsurance		48	3	1	52		10	1	-	11
- After reinsurance		16	3	1	20		3	1	-	4
5% decrease in mortality / morbidity - annuity business
- Before reinsurance		(35)	-	-	(35)		(2)	-	-	(2)
- After reinsurance		(23)	-	-	(23)		(2)	-	-	(2)

 

i) The movement in embedded value from a reduction in market values comprises a £3 million (2008: £4 million) fall in the value of shareholders' net worth and a £93 million (2008: £86 million) reduction in the value of in-force covered business. Conversely, the effect of an increase in market values comprises a £3 million (2008: £4 million) rise in the value of shareholders' invested net assets and a £93 million (2008:£94 million) increase in the value of in-force covered business.

ii) The corporate bond spread sensitivities of an increase/(decrease) of 100bps assume an increase/(decrease) in the illiquidity premium for immediate annuities of 30bps for in-force business and 40 bps for the value of new business.

(iii) Currency risk is expressed in terms of total overseas exposure; the Group's principal currency exposures other than sterling are the Euro and US Dollar.

(iv) Although not directly relevant under a market consistent valuation where the risk discount rate is a derived disclosure only, this shows the impact of a change in the average implied discount rate, to enable adjustments to be made to reflect differing views of risk.

(v) Required capital is set at the greater of regulatory capital and requirements arising from internal capital management policies. In aggregate, the required capital is higher than the regulatory requirement by £350 million (2008: £400 million). This sensitivity shows the impact on embedded value and value of new business of using the lower regulatory capital requirement.

At 31 December 2008, Resolution Limited had no covered business and hence the sensitivities did not apply. The results of the sensitivities for Friends Provident at 31 December 2008 as previously reported are shown below and are prior to the changes in the segmental analysis discussed in note 13.

 

		Friends Provident Year ended 31 December 2008
		Change in MCEV (net of tax)					Change in value of new business (gross of tax)
		UK	Int'l	Lombard	Total		UK	Int'l	Lombard	Total
		£m	£m	£m	£m		£m	£m	£m	£m
Base MCEV		1,679	363	381	2,423		28	44	67	139
Market risk
100bp increase in risk free rates		(107)	(7)	(9)	(123)		(3)	(4)	-	(7)
100bp decrease in risk free rates		103	6	8	117		3	4	(1)	6
Reduction to risk free rates for immediate annuities		-	-	-	-		-	-	-	-
10% decrease in equity /property capital values at the valuation date, without a corresponding fall/rise in dividend/ rental yield		(56)	(10)	(24)	(90)		n/a	n/a	n/a	n/a
25% increase in equity/property volatility at the valuation date		n/a	n/a	n/a	n/a		n/a	n/a	n/a	n/a
25% increase in swaption implied volatility at the valuation date		n/a	n/a	n/a	n/a		n/a	n/a	n/a	n/a
100bps increase in corporate bond spreads		(113)	(2)	(3)	(118)		n/a	n/a	n/a	n/a
10% adverse movement in Sterling/ overseas exchange rate		(15)	(11)	(43)	(69)		n/a	n/a	n/a	n/a
Insurance and other risk
1% increase in risk discount rate		(105)	(14)	(35)	(154)		(18)	(7)	(10)	(35)
Reduction to EU minimum capital or equivalent		n/a	n/a	n/a	16		n/a	n/a	n/a	n/a
10% decrease in maintenance expenses		52	7	9	68		6	3	2	11
10% proportionate decrease in lapse rates		15	13	26	54		8	4	6	18
10% proportionate decrease in PUP rates		14	3	-	17		7	2	-	9
5% decrease in mortality / morbidity - life assurance
- Before reinsurance		49	3	1	53		9	1	-	10
- After reinsurance		14	3	1	18		2	1	-	3
5% decrease in mortality / morbidity - annuity business
- Before reinsurance		(46)	-	-	(46)		(2)	-	-	(2)
- After reinsurance		(29)	-	-	(29)		(2)	-	-	(2)

 

13. Segmental analysis

Changes to prior year segmental analysis

Following the acquisition by Resolution and in line with IFRS 8, the Group has reviewed its segmental analysis under IFRS and MCEV reporting bases. Under EEV reporting, Friends Provident presented its embedded value results under three business segments: UK Life and Pensions, International Life and Pensions and Other. 

The review resulted in the following changes to the segmental analysis of covered business previously used by Friends Provident: 

·; The International Life and Pensions segment now excludes the Lombard business which is shown separately under Lombard In addition, the International segment now includes Friends Provident's 30% share of AmLife.

·; The provision for future corporate costs was previously included in the Other segment and has now been allocated to the covered business of the UK segment.

·; The mark to market adjustment for the STICS was previously included in the Other segment and has now been allocated to the covered business of the UK segment.

The following table shows the amendments required to the Friends Provident's previously published embedded value figures for 2008 in order to reflect the revised segmental reporting adopted by the Group.

MCEV vs EEV Classification/Segmentation

	MCEV Classification
	Covered Business			Non-	Total
				Covered	MCEV
31 December 2008	UK	Int'l	Lombard	Business
EEV Classification
Gross of tax	£m	£m	£m	£m	£m
UK Life and Pensions Business	1,609	-	-	70	1,679
International Life and Pensions	-	363	381		744
Other				542	542
Closing MCEV at 31 December 2008	1,609	363	381	612	2,965
- Provision for Corporate Costs	(97)	-	-	97	-
- Allocation of STICS mark to market adjustment and accrued interest liability	239	-	-	(239)	-
Opening MCEV at 1 January 2009	1,751	363	381	470	2,965
Additional pension scheme asset recognised				74	74
Restated opening MCEV at 1 January 2009	1,751	363	381	544	3,039

 

Reconciliation of MCEV and IFRS segmentation

The covered business segments within MCEV are consistent with the IFRS business segments.

The split of the MCEV by IFRS business segment for Friends Provident is shown in the tables below:

 

Comparison of MCEV and IFRS classification and segments

Friends Provident Group at 31 December 2009

	MCEV Classification
	Covered business			Non-covered business	Total MCEV by IFRS segments
31 December 2009	UK	Int'l	Lombard
IFRS segment	£m	£m	£m	£m	£m
UK	2,113	-	-	158	2,271
International	-	475	-	1	476
Lombard	-	-	440	6	446
Total MCEV (by MCEV segments)	2,113	475	440	165	3,193

 

Friends Provident Group at 31 December 2008

	MCEV Classification
	Covered business			Non-covered business	Total MCEV by IFRS segments
	UK	Int'l	Lombard
31 December 2008	£m	£m	£m	£m	£m
IFRS segment
UK	1,751	-	-	537	2,288
International	-	363	-	-	363
Lombard	-	-	381	7	388
Total MCEV (by MCEV segments)	1,751	363	381	544	3,039

 

Friends Provident Holdings at 31 December 2009

	MCEV Classification
	Covered business			Non-covered business	Total MCEV by IFRS segments
	UK	Int'l	Lombard
31 December 2009	£m	£m	£m	£m	£m
IFRS segment
UK	2,113	-	-	146	2,259
International	-	475	-	1	476
Lombard	-	-	440	6	446
Total MCEV (by MCEV segments)	2,113	475	440	153	3,181

 

DEFINITIONS

Annual premium equivalent (APE) represents annualized new regular premiums plus 10% of single premiums.

Asset quality is the percentage of corporate bonds and asset backed securities in the shareholder and non-profit funds at investment grade compared to the total of such assets in these funds.

Board denotes Resolution Limited board.

Cash payback on new business is the time at which the value of the expected cashflows, after tax, is sufficient to have recouped the capital invested to support the writing of the business. The cashflows are discounted at the appropriate risk-discount rate, and calculated on the same assumptions and expense basis as those used for the contribution from new business.

Company or Resolution denotes Resolution Limited.

Company Secretary Northern Trust International Fund Administration Services (Guernsey) Limited.

Contribution from new business is the present value of future cashflows expected to arise from the new business sold during the year. It is calculated using economic assumptions at the beginning of the period, and is quoted after the cost of required capital, share based payments and including an apportionment of fixed acquisition expenses across products.

Group denotes Resolution Limited and its subsidiary undertakings, which do not include any member of The Resolution Group.

Group embedded value on an MCEV basis is the equity attributable to equity holders of the parent as shown in the consolidated statement of financial position - MCEV basis.

IGD surplus capital resources are the Insurance Groups Directive surplus capital as defined by the FSA. It is calculated as the surplus of the available resources over the capital resources requirement. It excludes the surplus capital held within the long-term funds except to the extent that they cover that fund's own capital resource requirements.

IFRS based operating profit is the profit (or loss) based on longer-term investment return excluding: (i) policyholder tax, (ii) returns attributable to minority interests in policyholder funds, (iii) non-recurring items, (iv) amortisation and impairment of acquired intangible assets and present value of acquired in-force business; and is stated after deducting interest payable on STICS.

IFRS profit/(loss) after tax is the profit/(loss) after tax as shown in the consolidated income statement.

Internal rate of return on new business (IRR) is equivalent to the discount rate at which the present value of the after tax cashflows expected to be earned over the lifetime of the business written is equal to the capital invested to support the writing of the business. With the exception of investment return, all assumptions and expenses are consistent with those used for calculating Contribution from new business. IRR assumes best estimate investment returns after an allowance for default risk, whereas Contribution from new business assumes (market consistent) risk-free rates. IRR also takes into account the funding and release of regulatory capital requirements.

Margins are defined as the pre-tax contribution from new business generated by each product type, divided by the new business volume for that product.

MCEV operating profit is the MCEV profit (or loss) based on expected investment return excluding: (i) amortization and impairment of non-covered business acquired intangible assets, (ii) effect of economic variances including economic assumption changes, (iii) significant non-recurring items; and is stated after deducting interest payable on STICS.

MCEV profit after tax is the MCEV profit (or loss) after tax as shown in the consolidated income statement - MCEV basis.

Pillar 1 surplus is the excess of capital resources over capital resource requirements calculated in accordance with regulatory requirements.

Pillar 2 surplus is the excess of capital resources over the capital calculated on an economic basis required to ensure that the regulated entities can meet their liabilities, with a high likelihood, as they fall due. The result is reviewed and may be modified by the FSA. Pillar 2 requirements are not generally disclosed.

Present value of new business premiums (PVNBP) represents new single premiums plus the expected present value of new business regular premiums.

Pro forma MCEV is the shareholders' equity on a MCEV basis, including the pre-acquisition period.

Shareholder cash generation is a measure of the cash generated available to cover dividends, increases in regulatory capital requirements and other capital items.

Shareholder cash resources (SCR) are a measure of the tangible assets available to the life and pensions business and attributable to shareholders. The movement in SCR therefore provides a view of the sustainability of the business model. SCR are based on shareholders' invested net assets included within the embedded value, but adjusted to include securitisation and financial reinsurance balances and to exclude intangible assets.

The Resolution Group means Resolution Operations LLP, Resolution Financial Markets LLP, RCAP Guernsey LP, Resolution Capital Limited and their respective subsidiary undertakings. For the avoidance of doubt, neither the Group nor the Company are part of The Resolution Group.

UK Life Project denotes the Company's restructuring project in respect of companies and/or business which have substantial operations consisting of life assurance and/or asset management activities and which are listed in, or undertake a significant part of their business in UK and/or Western Europe.

 

ABBREVIATIONS

ABI	Association of British Insurers
ABS	Asset-Backed Securities
ACC	Audit and Compliance Committee
ACSM	Alternative Coupon Satisfaction Mechanism
AGM	Annual General Meeting
APE	Annual Premium Equivalent
AVIF	Acquired Value of In-Force
BCM	Resolution Limited Board Control Manual
BRCC	FPH Board Risk and Compliance Committee
CEO	Chief Executive Officer
CFO	Chief Financial Officer
CGU	Cash Gearing Unit
CNHR	Cost of Non-Hedgeable Risk
CRO	Chief Risk Officer
CSR	Corporate Social Responsibility
DAC	Deferred Acquisition Costs
DPF	Discretionary Participation Features
EEA	European Economic Area
EEV	European Embedded Value
EPS	Earnings Per Share
EU	European Union
EURIBOR	Euro Interbank Offered Rate
F&C	F&C Asset Management plc
FPG	Friends Provident Group plc (including MCEV disclosures, all subsidiary undertakings)
FPH	Friends Provident Holdings (UK) Limited (including, for MCEV disclosures, all subsidiary undertakings in the period post-acquisition)
FPIL	Friends Provident International Limited
FPLA	Friends Provident Life Assurance Limited
FPLP	Friends Provident Life and Pensions Limited
FPP	Friends Provident Pensions Limited
FPPS	Friends Provident Pension Scheme
FRC	Financial Risk Committee
FRS	Financial Reporting Standards
FSA	Financial Services Authority
IAS	International Accounting Standards
ICA	Individual Capital Assessment
ICG	Individual Capital Guidance
IFA	Independent Financial Adviser
IFRS	International Financial Reporting Standards
IRR	Internal Rate of Return
IASB	International Accounting Standards Board
LDI	Liability Driven Investment
LIBOR	London Interbank Offered Rate
LTIP	Friends Provident Long-Term Incentive Plan
MCEV	Market Consistent Embedded Value
MVR	Market Value Reduction
OLAB	Overseas Life Assurance Business
ORC	Operational Risk Committee
PHI	Permanent Health Insurance
PPFM	Principles and Practices of Financial Management
PVIF	Present Value of In-force
PVNBP	Present Value of New Business Premiums
PVFP	Present Value of Future Profits
RBS	Realistic Balance Sheet
RCM	Risk Capital Margin
RHG	Resolution Holdings (Guernsey) Limited
ROL	Resolution Operations LLP
RPI	Retail Prices Index
STICS	Step-up Tier one Insurance Capital Securities
TCF	Treating Customers Fairly
TSR	Total Shareholder Return
TVOG	Time Value of financial Operations and Guarantees
UKLA	UK Listing Authority
VIF	Value of In-Force
VNB	Value of New Business
WPC	With Profits Committee
WPICC	With Profits Insurance Capital Component