Preliminary Results - Part 1

23rd Mar 2006 07:03

Friends Provident PLC23 March 2006 Part 1 23 March 2006Friends Provident plc - Preliminary Announcement for the year ended 31 December2005 Well balanced rapid growthGroup highlights• Record life & pensions new business profits - up 85%• International contribution from new business - fourfold increase• Successfully completed integration of asset management merger - ISIS/F&C +------------------------+------------------------------+----------------------------+| | EEV basis | IFRS basis |+------------------------+----------+---------+---------+---------+--------+---------+| | 2005 | 2004 | Change | 2005 | 2004 | Change |+------------------------+----------+---------+---------+---------+--------+---------+|Underlying profit before| £524m | £392m | +34% | £224m | £171m | +31% ||tax* | | | | | | |+------------------------+----------+---------+---------+---------+--------+---------+|Profit before tax | £600m | £375m | +60% | £367m | £221m | +66% |+------------------------+----------+---------+---------+---------+--------+---------+|Pro forma embedded value| £3,464m | £3,091m | +12% | - | - | - ||* | | | | | | |+------------------------+----------+---------+---------+---------+--------+---------+|New business PVNBP* | £5,397m | £3,178m | +70% | - | - | - |+------------------------+----------+---------+---------+---------+--------+---------+|Contribution from new | | | | | | |+------------------------+----------+---------+---------+---------+--------+---------+|business | £144m | £78m | +85% | - | - | - |+------------------------+----------+---------+---------+---------+--------+---------+|Pro forma embedded value| | | | | | |+------------------------+----------+---------+---------+---------+--------+---------+|per share* | £1.65 | £1.59 | +4% | - | - | - |+------------------------+----------+---------+---------+---------+--------+---------+|Underlying earnings | | | | | | |+------------------------+----------+---------+---------+---------+--------+---------+|per share* | 16.3p | 15.8p | +3% | 8.8p | 10.3p | -15% |+------------------------+----------+---------+---------+---------+--------+---------+|Basic earnings per share| 21.2p | 15.6p | +36% | 6.3p | 7.9p | -20% |+------------------------+----------+---------+---------+---------+--------+---------+|Dividend per share* | 7.7p | 7.55p | +2% | 7.7p | 7.55p | +2% |+------------------------+----------+---------+---------+---------+--------+---------+ Keith Satchell, group chief executive, said: "Friends Provident has delivered another strong set of results, both overseasand in the UK, with increased profits, excellent sales, a strong capitalposition and an increased dividend. "We achieved a good performance in UK life and pensions against a challengingmarketplace, significantly expanded international operations and, with F&C,successfully delivered a highly complex integration. "We have continued our successful transition to become one of the fastestgrowing financial services companies, based in the UK, but with an increasinginternational focus. "In summary, Friends Provident is a strong, well-balanced, profitable businessunderpinned by Five Star service and quality people and the outlook for theGroup continues to be very positive." * See notes to editors. - Ends - For further information, please contact:Nick Boakes Friends Provident plc 0845 641 7814Di Skidmore Friends Provident plc 0845 641 7833Simon Moyse Finsbury Limited 020 7251 3801 Ref: G056 Notes to editors: 1. An interview with Keith Satchell, group chief executive and Philip Moore,group finance director, will be available to view in video, audio and textformats at www.friendsprovident.com and www.cantos.com from 7.00am today. 2. An analyst presentation will take place at 9.30am today at JPMorgan Cazenove,20 Moorgate, London EC2R 6DA. 3. The analyst presentation will be webcast live and can be viewed on theFriends Provident website: www.friendsprovident.com/results 4. The presentation slides will be available from 9.30am today onwww.friendsprovident.com/presentations 5. Friends Provident media image library is available atwww.friendsprovident.com/imagelibrary. A Newscast login is required. Financial reporting dates6. Dividend dates: Shares go ex dividend 5 April 2006 Record date 7 April 2006 Dividend paid 30 May 2006 Financial Reporting Calendar: Friends Provident Life & Pensions Quarter 1 New Business Announcement 28 April 2006 F&C Asset Management plc Quarter 1 Funds Under Management 28 April 2006 F&C Asset Management plc Annual General Meeting 16 May 2006 Friends Provident plc Annual General Meeting 25 May 2006 Friends Provident International Workshop 7 June 2006 F&C Asset Management plc Interim Results 7 August 2006 Friends Provident plc Group Interim Results and Life & Pensions Quarter 2 New Business Announcement 8 August 2006 Friends Provident Life & Pensions Quarter 3 New Business Announcement 31 October 2006 F&C Asset Management plc Quarter 3 Funds Under Management 31 October 2006 7. Underlying profit on an EEV basis represents profit (based on expectedinvestment return) attributable to ordinary shareholders of the parent beforeimpairment of Asset Management goodwill, amortisation and impairment of AssetManagement acquired intangible assets, and non-recurring items. 8. Underlying profit on an IFRS basis represents profit (based on longer-terminvestment return) attributable to ordinary shareholders of the parent andexcludes returns on Group controlled funds attributable to third parties andbefore impairment of goodwill, amortisation and impairment of acquiredintangible assets and acquired present value of in-force business, andnon-recurring items, less interest payable on Step-up Tier one Insurance CapitalSecurities (STICS). 9. Pro-forma embedded value is the shareholders' equity on the EEV basis,adjusted to bring the value of F&C to market value. 10. New business is reported on the Present Value of New Business Premiums(PVNBP) basis, which represents single premiums plus the expected present valueof new business regular premiums. This replaces the Annual Premium Equivalentbasis used previously. 2004 comparatives have been restated accordingly. 11. Dividend per share includes the interim dividend paid in November 2005 andthe proposed final dividend payable in May 2006, which is subject to approval atthe Annual General Meeting. 12. Certain statements contained in this announcement constitute'forward-looking statements'. Such forward-looking statements involve risks,uncertainties and other factors, which may cause the actual results, performanceor achievements, from time to time, of Friends Provident plc, its subsidiariesand subsidiary undertakings or industry results to be materially different fromany future results, performance or achievements expressed or implied by suchforward-looking statements. Such risks, uncertainties and other factors include,among others, adverse changes to laws or regulations; risks in respect oftaxation; unforeseen liabilities from product reviews; asset shortfalls againstproduct liabilities; changes in the general economic environment; levels andtrends in mortality and morbidity; restrictions on access to productdistribution channels; increased competition; and the ability to attract andretain personnel. These forward-looking statements are made only as at the dateof this announcement and, save where required in order to comply with theListing Rules, there is no obligation on Friends Provident plc to update suchforward-looking statements. Commentary GROUP PROGRESS AND OUTLOOK The Friends Provident Group has continued to advance strongly through 2005,increasing its international dimension and achieving a new scale and balance toGroup profits and prospects. Our 2005 financial performance is characterised bygrowing profitability, further diversification of earnings, continued control ofexpenses, effective management of risks, increased cash generation and astrengthened balance sheet. We support the recent moves to introduce more transparent reporting, and this isreflected in the greater level of disclosure in this announcement, including theidentification of the risks we face. Our success is linked to our ability tounderstand and profit from such risks. Our strategy continues to prove itself appropriate to the growth and developmentof the Group, which is organised around its three core business segments of UKLife & Pensions, International Life & Pensions and Asset Management. Record levels of new life and pensions business have been achieved. Our share ofthe UK market has increased although the mix of business has moved towards lowermargin products. The group pensions market was, and remains, the most buoyantfor us and we expect our strong growth in sales to continue. During 2005, twobanks and two building societies were included in the 22 new distributionagreements secured, which will help us build our position in the higher-marginbut very competitive protection market. Overall we have seen the momentum in2005 continuing into 2006 and anticipate increasing our market share, withstable margins across the range of product segments. We expect 2006 marketgrowth to be broadly similar to 2005. More than 40% of life and pensions new business is now coming from the generallymore profitable international cross-border market. The acquisition in January2005 of Lombard has added significantly to our international diversification andfuture growth prospects. Friends Provident International and Lombard have bothmade good progress throughout 2005 across all their regions of operation, andnew business profits now exceed that for the UK for the first time in ourhistory. We anticipate that production will continue to expand, building onwell-established distribution partner relationships, although our primary focusis on profit rather than volume. In asset management, F&C's funds under management at the end of 2005 were £131billion although this was before the previously announced repatriation of £20billion Resolution Life funds and other withdrawals over the first quarter of2006. The integration of ISIS with F&C was successfully completed and theforecast £33 million of ongoing annual cost synergies will be delivered by theend of 2006. Our priority is to grow organically. The management team andstructure has been reshaped and focus is firmly on investment performance andtargeting new business in higher margin areas. In summary, we are announcing strong results, achieved through a goodperformance in UK life and pensions against a challenging marketplace, expandedinternational operations making excellent headway, with F&C, now with thecomplex integration behind, better structured for future success. UK LIFE & PENSIONS Our view of the market We believe that new market opportunities, such as those linked to the increasingneed for private pension provision, will lead to significant prospects formarket growth in the medium term. In 2005, the overall market grew by 10% and weforecast market growth of 8-10% in 2006. Protection There are some encouraging signs in the housing market. The Bank of Englandreported consistent increases in the number of mortgage approvals in the latermonths of 2005 and several lenders have reported increases in property prices inthe early months of 2006. This suggests that we should start to see a morebuoyant market for protection products emerging in the year ahead. Investments The investment market is changing. There is an increased focus on assetallocation and many consumers with the wealth to invest have less time to managetheir investments. This is leading to a trend for account aggregation for highnet worth clients. With market growth traditionally linked to stock marketconfidence and increases in personal disposable income, we anticipate modestgrowth for 2006. Group pensions It is now clear that the most efficient way to encourage greater privateprovision, and therefore less dependence on the State, is through workplacepensions. The Government's pensions reform agenda will need to address consumerconcerns and, we believe, have the full support of the industry if this is tohave optimum impact on the growing pensions crisis. We expect employer-sponsoredschemes to experience growth and attract new members over the medium term. Individual pensions With debate over the Government's pensions reform agenda likely to increaseawareness of the importance of private provisions, we anticipate steady growthin the individual pension marketplace. Post-retirement With the percentage of adults over retirement age set to increase, the need forpost-retirement income solutions is anticipated to grow. Following changes inlegislation, from 6 April 2006, it will no longer be compulsory for consumers toconvert their pension fund into an annuity and this change is expected toreverse the recent trend of a declining income drawdown market. The risksassociated with annuity business can be considerable, as future profits dependon accurate assumptions regarding, for example, longevity. This market isexpected to grow in 2006, although it is currently not an area of focus forFriends Provident. Our trading performance and outlook UK totalNew business PVNBP increased 21% to £3,192 million growing our share of thismarket from 4.3% to 4.7%. Our trading results reflect our focus on pensions,both group and individual, protection and investments, although 2005 saw amarked change in mix, away from protection and towards group pensions. ProtectionNew business, including income protection, decreased by 8% to £400 million. Thesubdued housing market coupled with a fiercely competitive marketplace has been,and will remain, challenging. Our overall offering is a strong one. We intend toensure that our service remains a differentiator and our pricing is competitive.As 2006 progresses, the numerous distribution agreements secured last yearshould help us build our share of a market expected to expand. InvestmentsNew business increased by 15% to £672 million. Our performance was aided by thegeneral recovery of this market. The majority of new business is transactedonline and our fund range was further extended in 2005 to continue our provisionof 'best of breed' investment opportunities. The outlook for sales remainspositive, with the prospect of stable margins. Group pensionsNew business increased by 48% to £1,577 million. Tendering opportunities,particularly from fee-based Employee Benefit Consultants, and the quality ofschemes under review increased as the year progressed. Our success in winningnew schemes and increasing our market share from 6.8% to 8.8% is based on ourcapability to customise scheme design without compromising good service. Theimminent A-Day changes will add further impetus to an already strong market andto the drive towards defined contribution and contract-based schemes, whichplays to our position in the market. We are very well placed to continue to growour market share throughout 2006, maintaining our focus on larger schemes. Individual pensionsNew business increased by 9% to £301 million. Excluding contracting-out rebatepayments from the Department of Work & Pensions, new business increased by 36%to £193 million. This is a result of our effective relaunch into this market inApril 2005 after the Government reconsidered its stance on charging structures.We are successfully targeting the more profitable single premium market.Although competitor activity is intensifying, we expect to maintain growth atleast in line with the steady growth expected in this market. AnnuitiesNew business decreased by 14% to £242 million. Our approach to this marketsegment remains one of caution, and we follow a strategy of prioritising marginsover volumes. Operational highlights The 2005 operational highlights for UK Life & Pensions were: • 22 new distribution agreements secured, predominantly for protection business • New distribution agreements secured with banks and building societies, extending our distribution reach • A number of large bespoke pension schemes secured • New individual pensions proposition launched • Consistently delivered against our prescribed service levels and quality commitments • Maintained our Five Star ranking for service • Voted the top Life & Pensions e-commerce provider (Financial Adviser Practiv Service Awards) and Advisers Choice (Online Finance Awards) Understanding and management of risks Below are what we perceive to be the key risks facing the business, and ourapproach to managing them: • Changes to the distribution landscape. For example, from unexpected consequences of depolarisation and the emergence of multi-ties. We have secured places on many best advice and multi-tie panels with numerous leading distributor firms and have been able to attract all types of distributors by delivering excellent service, products and technology. • Competitors develop more advanced IT solutions and capture technology leadership. Our operating platforms are leading edge and our structure is designed for continuous development to be achieved. We monitor competitor activity carefully. • Impact of the Pensions Commission's recommendations for changes to the UK approach to private pensions and long-term savings. There is currently uncertainty over the Government's response to these recommendations. We believe that our industry can deliver the Commission's goals more effectively than the State, building on the stakeholder model of pension provision, combined with automatic enrolment and matching employer contributions. We support the 'Partnership Pensions' proposals of the ABI, and believe that Government, employers, the pensions industry and individuals must each play their part in helping to provide a secure and more comfortable retirement for all. • Movements in equity markets. We have set risk appetite for equity risk across the different types of funds and have an investment strategy that reflects this risk appetite, such as the use of hedging strategies and secure assets to back guarantees. INTERNATIONAL LIFE & PENSIONS Our view of the market Friends Provident International (FPI)Through its Isle of Man base, FPI aims to meet the savings, investment andprotection needs of customers in the four core regions of Asia, the Middle East,Continental Europe and the UK. By contrast, a number of competitors(traditionally the offshore subsidiaries of established UK life companies) focuson the UK only or, to a lesser extent, the EU. As well as having a wide geographical reach, FPI is also diversified by producttype and by distribution. The latter is primarily through specialist IndependentFinancial Advisers, although institutional partners feature especially in theMiddle East. In Continental Europe and Scandinavia the strategy is to target asmall number of territories, including Sweden and Gibraltar. Asia produces thelargest volumes of new business, dominated by regular premium savings plans. Inthe UK, FPI's market is almost entirely single premium investment business. In 2005, competitive pressures heightened, especially in the UK and Hong Kong.The UK remains a highly price sensitive market where the challenge is to growthe business at reasonable margins. In Asia the savings market was similarlyunder pressure from new products and a variety of incentives and special offers.Whilst these pressures bring some challenges, the overall outlook remains verypositive, supported by a continuing expansion of the mass affluent and high networth segments, and strong demand for effective tax planning. The mobility ofinternational savers and investors, and the increasing diversity of expatriates,offer opportunities to robust international providers. The relatively lowcapital requirements and higher returns available mean the international crossborder market will remain highly attractive for the Friends Provident Group. LombardLombard's business is focused on the provision of financial and estate planningsolutions, which are tailor-made to meet the needs of high net worth individuals(HNWIs) in Europe and beyond. Distribution is conducted on a partnership basiswith leading specialist advisers to HNWIs, combining the Lombard financialexpertise with the relationship and asset management expertise of thedistribution partner. Distribution is geographically diversified, primarilyacross eight EU member states but with a growing business in Asia and LatinAmerica. This diversification is supported by a unique multi-jurisdictionalexpertise, essential to the planning needs of many clients and the businessneeds of international private banking partners. This expertise facilitates thewriting of increasing volumes of ultra HNWI business. With private wealth increasing and the requirement to protect it growing, theHNWI/ultra HNWI market is potentially very large and offers the opportunity forLombard to penetrate it more deeply than at present. As Governments seek to increase tax on private wealth, particularly in the HNWIsector, attacks on existing tax planning structures and offshore tax havensintensify. The relative attractions of life assurance as a tax shelter andestate planning solution continue to increase as the advantages of traditionaltax planning structures decline. Life assurance is now recognised by legal/taxexperts as an important planning structure. The competition is mainly companies that have established subsidiaries inLuxembourg and Dublin, primarily to sell back to their home country and thatoffer a lower priced, less value-added service. Lombard will continue to enhancevalue-added services and administration, rather than competing on price. Our trading performance and outlook International total new business increased 311% to £2,205 million. Thissignificant increase is due in large part to the acquisition of Lombard inJanuary 2005, which delivered some two-thirds of our total international newbusiness. On a pro forma basis, the 2005 new business increase was 20%. Friends Provident InternationalNew business increased by 32% to £708 million. Strong performances were achievedin all four operational regions of Asia, the Middle East, Continental Europe,and the specialist UK market. Asia remains the dominant market, accounting for 45% of new business, and ourcontinued commitment to this market, evidenced by our 2004 move to largerpremises in Hong Kong, is being received positively. Growth in the specialist UKmarket and the Middle East was particularly encouraging. In the UK, wesuccessfully focused on deepening our relationship with key distributionpartners, and in the Middle East, we continue to benefit from the new marketingoffice in Dubai. Regular premium business benefited from a marketing campaign in Asia and in theMiddle East. Production of single premium business was bolstered by ourco-branded Portfolio Bond offering with Selestia - one of the leading fundplatforms in the UK. Generally, the proportion of new business resulting fromour strategic partner alliances is increasing. Following the systems harmonisation programme, concluded last year, the majorityof business is now administered on the robust and proven Friends Providentsingle-platform system, enabling higher volumes of future new business to beaccommodated cost effectively. In the final quarter of 2005, two new productswere launched, and a number of further new products and product developments areplanned for this year. We expect to see continued growth across all our keymarkets as we increase our emphasis on Asia and seek more distributionagreements with strategic partners. The prospect is for broadly stable marginsacross all four regions of operation. LombardOn a pro forma basis, new business increased by 15% to £1,497 million, allsingle premium business. A strength of Lombard is its geographicaldiversification across Europe and beyond, and this is reflected in its 2005performance. Growth was achieved in all countries with the exception of Germany,where 2004 new business was exceptional because of a change in tax rules, andFinland, where tax and regulatory changes have had a negative impact. However,Germany remains one of Lombard's largest markets, along with Belgium. In terms of growth, strong performances were achieved in the specialist UKmarket, where the marketing team has been expanded, and in expatriate businessfrom southern Europe. Both benefited from the recovery of investment markets andgood distribution networks. Good growth has also been achieved in France andItaly, albeit from a lower base. Sales were more geographically diverse than in 2004 and this diversity willprovide a strong platform for further growth in 2006 and beyond. Lombard's focusis on deepening relationships with existing private banking partners, althoughnew relationships may be developed where market opportunities demand. Productionemphasis will remain on the core European markets while also seeking to developopportunities in Asia and Latin America. We anticipate that ongoing margins willbe supported by continued focus on innovation and excellent service to supportpremium pricing, although recognising that margins differ between territoriesand case sizes. Operational highlights The 2005 operational highlights for Friends Provident International were: • Major inroads made into core regions, especially the UK market • New savings plans launched in Asia, the Middle East and Sweden • Innovative distribution arrangements established with major fund platforms in the UK (eg Selestia) • Bank and insurance partner relationships strengthened in the Middle East The 2005 operational highlights for Lombard were: • Deepened relationships with existing European partners; Partner relationship management programme set up • New division (Wealth Planning Services) launched to target independent asset managers and other professional advisers • Developed relationships with Swiss private banks to provide estate planning solutions for their international clients • Created promising new distribution partnerships with banks serving clients in Asia and Latin America Understanding and management of risks Below are what we perceive to be the key risks facing the International Life &Pensions business, and our approach to managing them: • Further regulation and fiscal change materially impacts costs, capital requirements, distribution, regulatory responsibility or the market for products. Project teams monitor the implementation of European directives and other legislative changes, seeking to ensure timely, compliant and cost effective solutions. Detailed analyses of the impact on distribution relationships and product offerings are undertaken to determine the required changes in distribution strategies. • The entry of new players increases competition. The activities of competitors are monitored to identify potential challenges. Proactive steps are taken to review product offerings, and to consider our approach to particular territories as the competitive environment changes. • Impact on profitability of changes to lapse rates. Lapse management programmes seek to identify alternatives to surrender for clients. Particular sources of lapse risk are monitored. A focus on service helps to maintain customer satisfaction and prevent surrenders. ASSET MANAGEMENT Our view of the market The asset management industry in Europe is undergoing a period of significantchange. At one end of the market, small, specialist boutiques are flourishingwhilst at the other end of the spectrum, there is evidence of consolidation asfirms seek to achieve the operational and distribution benefits of greaterscale. Financial services institutions are increasingly inclined towards 'openarchitecture' and willing to utilise multiple external asset managers withintheir product structures and distribution networks. This is blurring thedistinction between providers/distributors and competitors/customers but alsoopening up new opportunities. Demand for alternative investments, hedge funds and private equity has increasedas investors seek absolute rather than relative returns and exposure tonon-correlated assets. As the alternatives industry matures, traditionalinstitutional asset managers are developing a presence in this space which hasto-date been dominated by boutiques. We see the next phase of growth inalternatives being primarily driven from institutional investors, such aspension funds, as well as the traditional buyers of such products, being highnet worth individuals. In the institutional marketplace there has been a broad shift away from balancedmandates towards specialist funds. There is also greater awareness of the needto manage pension schemes' investment strategy to cover potential futureliabilities. This is prompting interest in Asset and Liability Management (ALM)and Liability Driven Investment (LDI), particularly in markets such as TheNetherlands where regulatory change is in the pipeline which will requirepension funds to structure their investments to lock in their ability to covertheir liabilities. In the key UK retail marketplace, net retail sales experienced a sharp recoveryduring 2005 with a 73% increase over 2004. This positive trend was not, however,reflected in sales of Individual Savings Accounts which declined by 10%,possibly reflecting the impact of the Government's decision to abolish taxcredits on ISA dividends. The distribution landscape is also changing in the UK as the effects ofdepolarisation start to be felt. Consolidation is occurring in the IFA sector.Many firms are reviewing their business models with some increasingly inclinedto outsource client portfolio management to multi-managers. A further feature of the UK retail market is the growth of platforms such asfund supermarkets and wrap accounts. Combined with the rise of multi-managers,this means that, increasingly, asset managers do not know the identity of theunderlying investor. Our trading performance and outlook Overall, funds under management as at 31 December 2005 were £131 billion,compared with £125 billion at the end of 2004. Across 2005 F&C experienced netoutflows of £6.1 billion assets under management. Insurance Some £5.2 billion of the net outflows related to one insurance client,Resolution Life. This was not related to reasons under F&C control but corporateactivity by Resolution Life. The remaining £20 billion of Resolution Life assetshave been withdrawn during Q1 2006. F&C will receive £27 million in compensationas a result of the termination of this contract. Despite this setback F&C sees further opportunities in the insurance sectorhaving developed a dedicated ALM capability to provide solutions to the specificissues facing insurance businesses. With some insurance clients F&C has acontractual right to manage additional assets acquired through corporateactivity. Insurance clients are also increasingly interested in allocating someassets to higher margin product areas. Institutional A further £1 billion of institutional outflows were broadly related to threefactors: • an industry trend away from balanced to specialist management • a switch by some clients away from equities and bonds • some instances of disappointing investment performance, particularly in emerging equities All these factors could drive further institutional outflows in 2006. In the UK, institutional sales activity has focused on extending investmentconsultant coverage. F&C has concentrated on promoting composite UK bonds, highalpha UK equities, property, ALM and alternatives. In The Netherlands activity has been focused on two areas where regulatorychange is creating opportunities: Governance and Socially Responsible Investmentand ALM/LDI. UK retailIn the UK retail market F&C saw a 21% increase in net fund sales during 2005reflecting an improvement in investor sentiment. We completed a fundrationalisation programme in the first half of the year and consolidated thefund accounting, trustee and third-party administration. Key product areas werethe ethical Stewardship funds and our multi-manager funds. Corporate bond fundsales slowed as advisers turned their attention to equity products again. The VCT market was boosted by enhanced tax reliefs first introduced in the 2004Budget. We saw a gross increase in VCT sales of 40% in 2005. The investment trust industry experienced considerable corporate activity in2005 and as a leading manager we were not immune from this. Despite the loss ofthe F&C Pacific Investment Trust mandate at the start of 2005, our net assetsfrom investment trusts rose. A highlight was the launch of the F&C CommercialProperty Trust with gross assets principally sourced from Friends Provident of£965 million in March 2005. Over £250 million of new assets were raised as partof the launch. A further positive development was the acquisition of a privateequity fund of funds team from Martin Currie. The deal was accompanied by aninvestment trust mandate which has now been renamed the F&C Private EquityTrust. European wholesaleF&C's strategy for accessing the retail market outside of the UK involvesestablishing wholesale and sub-advisory relationships with local institutions.These enable F&C to benefit from the business growth of its partners and thiswas one of the most successful channels for F&C in 2005. The three key retailmarkets are Portugal (where F&C sub-advises MFI, the mutual fund business ofMillennium BCP), The Netherlands (where it sub-advises mutual funds for Achmea)and Germany (where F&C markets Sicav funds). Assets from these relationships sawa 27% increase during the year. Operational highlights The 2005 operational highlights for Asset Management were: • Integration of F&C/ISIS successfully completed in just 15 months • Annualised cost synergies of £33 million achieved and we will see the full benefits in 2006 • Reorganised the investment management division, replacing the traditional Chief Investment Officer function as custodian of the House Market View with the new role of Head of Investments, which has a broad business management brief as required by a company with over 180 investment professionals • Established an Investment Division Management Committee to ensure greater accountability for performance • Growth in alternatives. Completed fund raising for F&C Amethyst, our flagship hedge fund, and saw growth from F&C Partners LLP, our fund of hedge funds boutique • Launch of the F&C Commercial Property Trust • Purchase of a private equity fund of funds team from Martin Currie and the addition of the F&C Private Equity Trust • Net inflows in some of the higher margin areas such as open ended retail funds, investment trusts and sub advisory Investment Performance - 2005 Key points Performance was mixed over the year with major areas of strength but also someweakness: • We outperformed market benchmarks over the year in high yield, emerging debt, Continental European equities, US smaller companies, UK smaller companies, Japan and Asia ex-Japan • Credit was an area of particular strength with the F&C Long Dated Corporate Bond Fund finishing the year ranked first out of 52 funds and the F&C Corporate Bond Fund ranked second out of 72 funds in their respective sectors over three years, according to the CAPS pooled pension fund survey* • Our ethical funds were relatively disadvantaged against the wider market in 2005 by their natural under weight exposure to oils and financials, but they continued to deliver good absolute returns and were performance leaders against other competitor ethical products • We underperformed in emerging equities, UK equities and Euro government bonds • Balanced portfolios benefited from positive asset allocation decisions * Russell Mellon CAPS Pooled Pension Fund Update to 31 December 2005. The F&CMPF Corporate Bond Fund sits in the UK Bonds - Standard Sector. The F&C MPF LongDated Corporate Bond Fund sits in the UK Bonds - Long Term sector. Calculationbasis: offer to offer, income reinvested at offer, net of fees. Understanding and management of risks Below are what we perceive to be the key risks facing the asset managementbusiness, and our approach to managing them: • Risk of poor investment performance, leading to the loss of key investment mandates. The personnel selection processes during the integration of F&C and ISIS and other actions taken during 2005 have helped us to strengthen the investment team. While investment performance has stabilised or improved in a number of key areas during 2005, there are some product areas to which we are devoting further attention. • Impact of EU and other regulatory developments. The Markets in Financial Instruments Directive and Capital Requirement Directive present medium term challenges for asset management businesses. Programmes are in hand to prepare for implementation and opportunities are taken as they arise to influence the drafting and implementation of the Directives. • Development of operational platforms. Subsequent to our announcement in 2005 to terminate our outsourcing negotiations with Mellon, administrative operations continue on two legacy platforms, one outsourced and one in-house. A project is under way to build a data warehouse to consolidate data, and facilitate service and reporting to clients and management. FINANCIAL REVIEW Our results are presented on two bases: European Embedded Value (EEV) andInternational Financial Reporting Standards (IFRS). EEV basis EEV is the basis we find most useful because it provides a more representativereflection of the performance of the long-term business that fully recognisesthe shareholders' interest in the in-force portfolio. Consequently most of ourfinancial key performance indicators are defined in EEV rather than IFRS terms. EEV replaces, and significantly enhances, the previous Achieved Profit basis bymore explicitly allowing for risk. It has been prepared in accordance with theEEV Principles issued by the European CFO Forum using a robust market-consistentapproach. The 2004 numbers have been restated accordingly. The change to EEV reportingresulted in a 4% reduction in Group embedded value (reflecting the allowance foroptions and guarantees) and a 14% increase in Group underlying profit(reflecting the lower relative risk profile of the Group's new business). Subsequent to the restatement of the 2004 results onto the EEV basis announcedin October 2005, the investment in preference shares of FPLP by the holdingcompany has been reclassified as debt rather than equity to reflect thesubstance of the investment. This reduced the 2004 EEV underlying profit and theEEV profit before tax by £6 million. The expected return on shareholders' netassets of the life and pensions business was reduced by the value of thepreference share coupon grossed up for attributable tax (£20 million), whilstthe return on corporate net assets increased by the value of the couponreceivable (£14 million), and the tax charge reduced by the value of theattributable tax (£6 million). Group profitability on the EEV basis +---------------------------------------------+---------------+----------+----------+| | Change | 2005 | 2004 |+---------------------------------------------+---------------+----------+----------+| | | £m | £m |+---------------------------------------------+---------------+----------+----------+|EEV underlying profit before tax: | | | |+---------------------------------------------+---------------+----------+----------+|- UK Life & Pensions | +11% | 328 | 295 |+---------------------------------------------+---------------+----------+----------+|- International Life & Pensions | +80% | 106 | 59 |+---------------------------------------------+---------------+----------+----------+|- Asset Management | +170% | 108 | 40 |+---------------------------------------------+---------------+----------+----------+|- Corporate items | | (18)| (2)|+---------------------------------------------+---------------+----------+----------+|EEV underlying profit before tax | +34% | 524 | 392 |+---------------------------------------------+---------------+----------+----------+|Other profit items | | 76 | (17)|+---------------------------------------------+---------------+----------+----------+|EEV profit before tax | +60% | 600 | 375 |+---------------------------------------------+---------------+----------+----------+|EEV profit after tax | +44% | 404 | 280 |+---------------------------------------------+---------------+----------+----------+| | | | |+---------------------------------------------+---------------+----------+----------+|Contribution from Life & Pensions new | +85% | 144 | 78 ||business | | | |+---------------------------------------------+---------------+----------+----------+|Life & Pensions new business margin | | 2.7% | 2.5% |+---------------------------------------------+---------------+----------+----------+|Life & Pensions return on embedded value | | 11.2% | 11.0% |+---------------------------------------------+---------------+----------+----------+| | | | |+---------------------------------------------+---------------+----------+----------+|Weighted average number of shares | | 2,082m | 1,808m |+---------------------------------------------+---------------+----------+----------+|Underlying EEV earnings per share | +3% | 16.3p | 15.8p |+---------------------------------------------+---------------+----------+----------+|EEV earnings per share | +36% | 21.2p | 15.6p |+---------------------------------------------+---------------+----------+----------+|Dividend per share | +2% | 7.7p | 7.55p |+---------------------------------------------+---------------+----------+----------+ Group EEV underlying profit before tax has increased by 34% to £524 million(2004: £392m), with significant increases in profits from all three businesssegments. This is particularly noticeable in our Asset Management andInternational Life & Pensions businesses where the ISIS/F&C merger and Lombardacquisition have made major contributions, but the results have also benefitedfrom organic growth. Group EEV profit before tax has increased by 60% to £600 million (2004: £375m).In addition to the above factors this takes into account the good investmentreturns achieved during the year offset by the impacts of economic assumptionchanges, non-recurring and other items, which are discussed below. The significant increases in the Asset Management and International Life andPensions underlying profits have led to an increase in their proportions of theGroup's underlying profit (excluding corporate items) to 20% each (2004: 10% and15% respectively). Commentary on the segmental results is given below. Corporate items include the expected return on the net pension liability of £2million negative (2004: £8m positive), the expected return on corporate netassets of £7 million negative (2004: £nil), corporate costs of £12 million(2004: £10m) and operating assumption changes for corporate costs of £3 millionpositive (2004: £nil). The negative expected return on corporate net assetsarises because the interest payable on the 2003 STICS exceeds the couponreceivable on the investment by the parent in FPLP preference shares. The contribution from Life & Pensions new business has increased by 85% to £144million (2004: £78m). The new business margin as a percentage of PVNBP hasincreased slightly from 2.5% to 2.7% as a consequence of the mix changing infavour of higher margin International business, offsetting lower UK margins. Theproportion of new business profits arising from the International segment hasincreased from 26% to 55% reflecting the changing profile of the Group,following the Lombard acquisition in January 2005. The Life & Pensions return on embedded value has increased from 11.0% to 11.2%due mainly to the increasing size of the International business as a result ofthe Lombard acquisition. The UK return is 9.4% (2004: 9.5%) compared to theInternational return of 21.5% (2004: 27.6%). The higher International returnreflects the much higher proportion of International new business profit toembedded value compared with the UK business. The other profit items excluded from underlying profit but included in profitbefore tax are shown in the table: 2005 2004 £m £mInvestment return variances 550 197Effect of economic assumption changes (238) (128)Non-recurring items (59) (55)Amortisation of Asset Management acquired intangible (56) (21)assetsImpairment of Asset Management acquired intangible (112) -assetsVariation in value of option on convertible debt (9) (10)Other profit items 76 (17) The major items are: • Strong stock market returns and growth in fixed interest market values during 2005 have generated a £550 million investment return variance (2004: £197m) over and above the expected return. • The effect of changes in economic assumptions (mainly a 0.5% reduction in the risk free rate of return) has decreased profits by £238 million (2004: £128m). • Non-recurring items comprise: F&C integration costs of £24 million, F&C Reinvestment Plan costs of £22 million relating to the share schemes put in place at the time of the merger to lock in and incentivise senior staff, FPI integration costs of £6 million and a net mis-selling charge of £7 million. • The amortisation of Asset Management intangibles assets of £56 million includes a first full years' amortisation of F&C investment management contracts (2004: £21m). • An impairment review was undertaken at year-end of the investment management contracts, resulting in a write down of £112 million (2004: £nil). This is discussed in the Asset Management section below. UK Life & Pensions UK Life & Pensions EEV underlying profit increased by 11% to £328 million (2004:£295m), due to increased profits from the in-force book and from new businessprofits on the back of strong volume growth. The return on embedded value, based on underlying profit after tax, is 9.4%(2004: 9.5%), with improved experience being offset by a lower rate of return onshareholder net assets and higher development costs, as explained below. The contribution from UK new business has increased by 10% to £64 million (2004:£58m). The contribution is stated net of the cost of solvency capital of £5million (2004: £5m) and share based payments of £2 million (2004: £2m). Growthin new business volumes has been offset by the effect of a different businessmix. In particular, 48% growth in group pensions business volumes, which tend tobe lower margin, coupled with an 8% decrease in higher margin protectionbusiness, caused by the flat housing market and increased competition, hasresulted in the overall UK new business margin reducing from 2.2% to 2.0%. The contribution from the in-force business increased by 39% to £209 million(2004: £150m). The expected return on the value of the in-force increased by 10%to £170 million (2004: £155m), reflecting the increase in the value of thein-force business over 2004. The positive experience variances of £20 million(2004: £12m) resulted from several items, the largest of which was improvedmorbidity experience on income protection business. The positive net operatingassumption change of £19 million (2004: £17m negative) was mainly due torevising morbidity assumptions on income protection business and updating WithProfits Fund realistic balance sheet non-economic assumptions (such as theproportion of cash taken by deferred annuitants with guaranteed annuity optionsat the time of vesting), offset by further strengthening of annuitant mortality. Development costs have increased from £16 million to £25 million reflectingadditional investment in our e-commerce propositions and infrastructure tosupport our new distribution relationships. We expect this development spend tocontinue at this higher level for 2006 as we look to deliver future cost andservice improvements. The expected return on shareholders' net assets decreased by 22% to £80 million(2004: £103m). The decrease is due to the reduction in shareholders' investednet assets during the course of 2004 as a consequence of funding growth in newbusiness, a decrease in the expected rate of return and the impact of nowcalculating our expected return on the long term debt outside the life fundsbased on the actual coupon payable. Operating expenses* have increased by 6% to £251 million (2004: £236m). We havedemonstrated continued success in keeping costs broadly stable over the lastfour years, whilst delivering impressive new business growth and award winningservice. Since 2002 operating expenses have increased by only 2% in the contextof an approximate 43% increase in PVNBP. Our technology provides the ability toprocess higher volumes of new business with little additional cost, and this,combined with an enhanced service capability, provides a source of genuinecompetitive advantage. More than 70% of our new business is transacted on-line. *Operating expenses exclude: commission, deferred acquisition cost adjustments,non-recurring items, investment fees, amortisation and impairment ofintangibles, and expenses of policyholder investments which are consolidatedunder IFRS. International Life & Pensions International Life & Pensions EEV underlying profit has increased by 80% to £106million (2004: £59m), mainly as a result of strong new business profits,including the impact of Lombard, which was acquired in early January 2005. The return on embedded value based on underlying profit after tax has reducedfrom 27.6% (for FPI) to 21.5% for the enlarged operation. The fall resultsmainly from the non-recurrence of FPI operating assumption changes in 2004 of£21 million, largely offset by the positive impact of the Lombard acquisition. The contribution from International new business has quadrupled from £20 millionto £80 million, driven primarily by the inclusion of Lombard. The contributionis stated net of the cost of solvency capital of £1 million (2004: £1m). Themargin has reduced slightly from 3.7% to 3.6%. The Lombard contribution is £58million (2004 pro forma: £49m) with the increase due to 15% higher new businessvolumes at slightly higher margins, as a result of favourable product mix andincreasing economies of scale. The growth of the FPI contribution to £22 million(2004: £20m) was driven by 32% growth in new business. Most of this growth wasin respect of the lower margin Portfolio Bond business and the consequent changein mix has caused the FPI margin to reduce. The profit from existing business is £25 million (2004: £37m). This comprisesthe expected return on the value of the in-force business, which increased to£26 million (2004: £11m) due to the inclusion of Lombard, positive experiencevariances of £2 million (2004: £5m), and operating assumption changes of £3million negative (2004: £21m positive). The latter was due to strengthening ofthe mortality basis. The expected return on shareholders' net assets was £1 million (2004: £2m). Thiscomprises the return on the shareholders' net assets held within the businessconsistent with the investment return assumptions used to calculate the embeddedvalue at the start of the period. Asset Management The financial results of our Asset Management business represent a first full 12months of the enlarged company, F&C Asset Management plc, following the mergerof F&C Group (Holdings) Limited and ISIS Asset Management plc in October 2004.Underlying profits increased by 170% to £108 million (2004: £40m) drivenprimarily by the merger. Underlying earnings per share increased by 24% to 15.9p(2004: 12.8p) Net revenues (excluding investment income attributable to policyholders)generated by the enlarged business were 76% higher at £267 million (2004:£152m). The increase was due mainly to the strong rise in equity markets duringthe final quarter of the year, which was offset by the effect of net fundoutflows for the year of £6.1 billion. Whilst impacting 2005, the net outflowswill have a more significant impact on 2006 revenues. Net revenues includedperformance related management fees of £13 million (2004: £7m). The loss of the Resolution Life contract through corporate activity was a majorfactor impacting our outflows. Resolution outflows in 2005 were approximately £5billion and a further £20 billion has been withdrawn in the first quarter 2006.We have agreed a termination payment with Resolution in respect of this businessof £27 million, which will be received in the first half of 2006. Some of the other institutional business losses, such as emerging equitiesmandates, were at a higher revenue margin than our 2004 average (21 basispoints). When taken together with the disposal of our private equity business,we expect our recurring revenue margin for 2006 to be 20 basis points. Whilstthis short-term setback is disappointing, our focus remains on generating netnew business in higher margin areas. Operating expenses (excluding the Re-Investment Plan costs, amortisation andimpairment of intangible assets, restructuring costs and net operating costs oninvestment and insurance contracts) represent the ongoing costs of running thebusiness and were £151 million (2004: £101m). They benefited from theintegration process which has generate annualised cost savings of £33 million.Based on our budget for 2006 the full synergies will be achieved ahead of targetand as such we should see benefits slightly in excess of the forecast £33million in the 2006 results. Approximately 60% of our costs are staff relatedcosts and headcount has reduced by about 100 during the year. Since the year-endthis has further reduced. The operating margin (the ratio of operating profit to net revenues) hasincreased from 34.0% to 44.1%. Operating profit increased to £118 million (2004:£52m) and is similar to underlying profit but excluding such items as financerevenue, finance costs and investment impairment. The level of fund losses during 2005 and anticipated losses in respect of bothinstitutional and investment trust clients and resultant impact on futurerevenue was significant enough to be considered a potential indicator ofimpairment in respect of the related intangible assets. A full impairment reviewof these assets was therefore undertaken. The value of investment managementcontracts at 31 December 2004 amounted to £590 million. This review determined the recoverable amount of the intangible assets inrespect of the institutional and investment trust fund management contracts waslower than their carrying value and has therefore resulted in a total impairmentcharge of £112 million. These calculations have been based on different riskdiscount rates using F&C's weighted average cost of capital of 8.9% allowing forthe nature of the contracts and the estimated life. The recoverable amountassumes an estimated loss rate of 14% and 5% per annum respectively. We are required to conduct an annual impairment review of the carrying value ofgoodwill although there is no annual amortisation charge. Our reviewdemonstrated that there was no impairment and hence no requirement to write downAsset Management goodwill as at 31 December 2005. IFRS basis We present IFRS results in accordance with the EU regulations requiring allEuropean listed groups to prepare IFRS accounts from 1 January 2005. The keydifferences between the IFRS and EEV bases are in respect of the timing ofprofit recognition. IFRS profits tend to be lower than EEV profits when newbusiness volumes are growing because IFRS does not fully recognise, in the yearof sale, the new business profit expected to arise from future cash flows. IFRS replaces the previous Modified Statutory Solvency (MSS) basis and thecomparative figures have been restated accordingly. IFRS is more cautious thanMSS and prohibits the deferral of some acquisition costs and changes thecalculation of actuarial liabilities for investment products. A fullreconciliation of MSS to IFRS for 2004 will be included in the financialstatements. Following the restatement of the 2004 results under IFRS announced in September2005 the interpretation of provisions within IAS 32 Financial Instruments:Disclosure and Presentation has required the STICS issued in 2003 to bereclassified as equity rather than as a liability. This change has resulted inan increase in reported profit before tax of £21 million as the interest on theSTICS is now reflected as an appropriation of profit. Underlying profit isunaffected. Group profitability on the IFRS basis +------------------------------------------------+----------+-----------+-----------+| | Change | 2005 | 2004 |+------------------------------------------------+----------+-----------+-----------+| | | £m | £m |+------------------------------------------------+----------+-----------+-----------+|IFRS underlying profit before tax: | | | |+------------------------------------------------+----------+-----------+-----------+|- UK Life & Pensions | +28% | 138 | 108 |+------------------------------------------------+----------+-----------+-----------+|- International Life & Pensions | -100% | - | 25 |+------------------------------------------------+----------+-----------+-----------+|- Asset Management | +170% | 108 | 40 |+------------------------------------------------+----------+-----------+-----------+|- Corporate items | | (22)| (2)|+------------------------------------------------+----------+-----------+-----------+|IFRS underlying profit before tax | +31% | 224 | 171 |+------------------------------------------------+----------+-----------+-----------+|Other profit items | | 143 | 50 |+------------------------------------------------+----------+-----------+-----------+|IFRS profit before tax from continuing | +66% | 367 | 221 ||operations | | | |+------------------------------------------------+----------+-----------+-----------+|IFRS profit after tax from continuing operations| +17% | 189 | 162 |+------------------------------------------------+----------+-----------+-----------+| | | | |+------------------------------------------------+----------+-----------+-----------+|Weighted average number of shares | | 2,082m | 1,808m |+------------------------------------------------+----------+-----------+-----------+|IFRS underlying earnings per share | -15% | 8.8p | 10.3p |+------------------------------------------------+----------+-----------+-----------+|IFRS earnings per share | -20% | 6.3p | 7.9p |+------------------------------------------------+----------+-----------+-----------+|Dividend per share | +2% | 7.7p | 7.55p |+------------------------------------------------+----------+-----------+-----------+|Dividend cover on underlying basis | | 1.1 times | 1.2 times |+------------------------------------------------+----------+-----------+-----------+ IFRS underlying profit before tax increased by 31% to £224 million (2004:£171m), mainly because of the increase in the Asset Management underlying profitfollowing the F&C merger last year. The total Life & Pensions IFRS underlyingprofit was 4% up in 2005. The longer-term investment return rates assumed were unchanged from 2004, i.e.equities and property 7.5%, gilts 5.0%, other fixed interest 5.75%. Theprospective rates for 2006 are equities 7.25%, property 6.25%, gilts 4.25% andother fixed interest 4.75%. IFRS profit before tax from continuing operations increased by 66% to £367million (2004: £221m). In addition to the above this takes into account theactual investment returns achieved during the year, offset by the impacts ofnon-recurring and other items which are discussed below. It is also shown grossof policyholder tax and minority interests in accordance with the IFRS rules. UK Life & Pensions underlying profit has increased by 28% to £138 million (2004:£108m). The increase was mainly due to reduced strain on protection business,good surplus on income protection offset by higher group pensions new businessstrain. There were also some positive one-off impacts and basis changes. Thiscomprises the With Profits Fund with-profits business of £7 million (2004: £7m),With Profits Fund other business £60 million (2004: £26m), other life business£8 million (2004: £10m negative) and longer-term investment return £63 million(2004: £85m). International Life & Pensions underlying profit has reduced to £nil (2004:£25m). This decrease relates to FPI where increasing sales of certain products,although economically profitable, lead to IFRS losses. This occurs becauseactuarial funding techniques, which have the effect of reducing new businessstrain, are not recognised under IFRS. Asset Management underlying profit has increased by 170% to £108 million (2004:£40m). For the Asset Management business, underlying profits under IFRS are thesame as discussed as part of the EEV profits section above. Corporate items comprise the expected return on the net pension liability £2million negative (2004: £8m positive), expected return on corporate net assets£6 million negative (2004: £nil), less corporate costs of £14 million (2004:£10m). The other profit items excluded from underlying profit but included in profitbefore tax from continuing operations are shown in the table: 2005 2004 £m £mPolicyholder tax 218 98Returns on Group controlled funds attributable to third 57 -partiesNon-recurring items (59) (55)Amortisation of Asset Management acquired intangible (56) (21)assetsAmortisation of Life & Pensions acquired intangible assets (7) -Amortisation of acquired present value of in-force (28) (10)businessImpairment of acquired intangible assets (112) -Interest payable on STICS 37 21Short-term fluctuations in investment return 102 27Variation in value of option on convertible debt (9) (10)Other profit items 143 50 The non-recurring items, amortisation of acquired intangible assets andimpairment of intangible assets are all discussed in the EEV profits sectionabove. The other main items are: • Policyholder tax and Returns on Group controlled funds attributable to third parties (the latter mainly representing the minority interest held in F&C Commercial Property Trust, which is 58% owned by the Group's long term funds) are excluded from underlying profit as neither is attributable to shareholders. • The increase in the amortisation of present value of acquired in-force business to £28 million (2004: £10m) is due to the inclusion of Lombard in 2005. • Within the calculation of underlying IFRS profit (as in EEV) we account for the STICS as debt to reflect the economic reality. However we are required under the IFRS rules to account for STICS as equity in calculating IFRS profit before tax. We therefore add back the STICS interest that was deducted in calculating underlying profit. • Short-term fluctuations in investment return of £102 million (2004: £27m) reflects the better than expected stock market returns achieved in 2005. The total dividend for 2005 of 7.7 pence per share (including the proposed finaldividend of 5.1 pence per share) represents an increase over 2004 of 2%. This iscovered 1.1 times (2004: 1.2 times) by IFRS underlying profit after tax andminority interests, although this is not a good indicator of dividend-payingcapacity as it does not reflect distributable reserves or cash generation. Shareholders' equity The embedded value, on a pro-forma basis, has increased by 12% to £3,464 million(2004: £3,091m). It comprises: Change 2005 2004 £m £mShareholders' invested net assets +1% 1,064 1,051Value of in-force Life & Pensions business +36% 2,019 1,484Market value of the listed Asset Management -28% 441 609businessLess provision for future corporate costs (47) (48)Less net pension liability (13) (5)Pro forma embedded value +12% 3,464 3,091 The pro forma embedded value per share has increased by 4% to £1.65 pence (2004:£1.59p) with the increase generated as follows: 2005 2004 Pence PenceEEV underlying profit 27 23Investment variances 30 11Effect of economic assumption changes (12) (7)Non-recurring items (3) (3)Amortisation and impairment of intangible assets (9) (1)F&C adjustment to market value (5) (1)Tax (10) (6)Dividend (8) (8)Change as a result of business combinations (6) (3)Unclaimed shares on demutualisation - 4Other (including minority interest in F&C loss) 2 -Net increase in pro forma embedded value per share 6 9 Shareholders' invested net assets Shareholders' invested net assets, which are the best indication of our net cashposition, have increased by £13 million. We reduced our equity exposure towardsthe end of 2005 as part of our risk management initiatives. At year-end the netassets were invested 58% in equities and 42% in fixed income securities and cash(2004: 73% and 27% respectively). The movement is analysed as follows: 2005 £mUK Life & Pensions:New business strain (261)In-force surplus 253Taxation 102International Life & Pensions:New business strain* (63)In-force surplus** 71Taxation (2)Life & Pensions net cash operating surplus*** 100 2005 2004 £m £mLife & Pensions net cash operating surplus*** 100 (89)Other operating deficit (8) (2)Investment return 87 79F&C dividend received 27 11Net movement before dividend and capital items 206 (1)Dividend paid (157) (134)Capital items (36) (11)Total movement 13 (146) * Including Lombard's new business strain of £33 million. ** Including Lombard's in-force surplus of £29 million. *** The analysis of the Life & Pensions net cash operating surplus is publishedfor the first time. The Life & Pensions operating surplus improved to £100 million (2004: £89mdeficit), split £94 million UK and £6 million International. Both businessesgenerated surplus on the in-force business to broadly fund the new businessstrain. In addition the UK business has a tax credit of £102 million due mainlyto the utilisation of life and pension tax losses built up in prior yearsagainst the increased investment return in 2005 and the amount received fromGroup non-life companies for the surrender of current year tax losses. The taxcredit is expected to recur in 2006 but at a significantly lower level. Otheroperating deficit includes mainly corporate costs net of tax. Total cash generated before dividend and capital items was substantiallyincreased on 2004 at £206 million (2004: £1m negative). Dividends paid amountedto £157 million (2004: £134m) and capital items included £39 million in respectof acquisition of Lombard, representing the negative net assets acquired andexpenses incurred. Value of in-force Life & Pensions business The value of the in-force business has increased by 36% to £2,019 million (2004:£1,484m) primarily because of strong new business results and good investmentreturns. The pro forma increase after allowing for the value of the Lombard VIFon acquisition (£186 million) was 21%. Market value of F&CThe market value of our 52% shareholding in F&C, our listed Asset Managementbusiness reduced by 28% to £441 million (2004: £609m). The share price declinedfrom £2.46 at 31 December 2004 to £1.75 at 31 December 2005. Long-term borrowings +--------------------------------------------------+-----------------+--------+------+| | Coupon | 2005| 2004 || | | | |+--------------------------------------------------+-----------------+--------+------+| | % | £m| £m || | | | |+--------------------------------------------------+-----------------+--------+------+|Subordinated liabilities: | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|£215m FP Finance PLC undated subordinated | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|guaranteed bonds callable 2006 | 9.125 | 215| 215|| | | | |+--------------------------------------------------+-----------------+--------+------+|£10m Lombard undated subordinated loans | Various | 10| -|| | | | |+--------------------------------------------------+-----------------+--------+------+|£10m F&C subordinated loan | 6m LIBOR + 1.05 | 10| 9|| | | | |+--------------------------------------------------+-----------------+--------+------+|Debenture loans: | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|£280m Box Hill Life Finance plc securitisation | | | ||notes | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|- class A-1 due 2016 | 3m LIBOR + 0.20 | 280| 280|| | | | |+--------------------------------------------------+-----------------+--------+------+|£100m Box Hill Life Finance plc securitisation | | | ||notes | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|- class A-2 due 2019 | 3m LIBOR + 0.23 | 100| 100|| | | | |+--------------------------------------------------+-----------------+--------+------+|£6m Friends Provident Investment Holdings | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|plc loan notes due 2006 | LIBOR - 0.5 | 5| 5|| | | | |+--------------------------------------------------+-----------------+--------+------+|£230m F&C Commercial Property Trust | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|secured bonds due 2017 | 5.23 | 229| -|| | | | |+--------------------------------------------------+-----------------+--------+------+|£23m Lombard financial reinsurance treaty | LIBOR + 2 | 23| -|| | | | |+--------------------------------------------------+-----------------+--------+------+|Convertible bonds: | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|£290m Friends Provident plc convertible bonds due | 5.25 | 276| 311||2007 | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|Total long-term borrowings | | 1,148| 920|| | | | |+--------------------------------------------------+-----------------+--------+------+| | | | || | | | |+--------------------------------------------------+-----------------+--------+------+|Subordinated borrowings designated as equity: | | || | | |+-------------------------------------------------+------------------+--------+------+|£300m Friends Provident plc STICS callable 2019 | 6.875 | 297| 297|| | | | |+-------------------------------------------------+------------------+--------+------+|£500m Friends Provident plc STICS callable 2015 | 6.292 | 495| -|| | | | |+-------------------------------------------------+------------------+--------+------+|Total long-term borrowings including STICS | | 1,940| 1,217|| | | | |+-------------------------------------------------++-----------------+--------+------++-------------------------------------------------++-----------------+--------+------+ Borrowings are valued on an IFRS basis, net of capitalised issue costs. The Group's long-term borrowings, including STICS (which are treated as equityin IFRS), have increased to £1,940 million (2004: £1,217m), principally becauseof the issue of £500 million STICS in June 2005 less issue expenses of £5million. These will be used to pre-fund the redemption of the £215 millionundated subordinated guaranteed bonds in 2006 and to support future growth. Inaddition, £230 million secured bonds were issued by the F&C Commercial PropertyTrust (a policyholder investment) in February 2005 and some borrowings wereacquired as part of the Lombard acquisition. The convertible bonds are separated into a liability component and an embeddedderivative, being the option to convert to equity. At December 2004 the embeddedderivative was treated as liability and included at fair value within theoverall value of the convertible bonds. In May 2005 we renounced our right toredeem the convertible bonds in cash. This removes the need to reflect anyfurther changes to the option value in the IFRS income statement. Thereafter theembedded derivative is classified as equity and is held at its fair value at May2005. Of the £280 million class A-1 securitisation notes, £82 million is expected tobe repaid in April 2006 as a result of surplus emergence in 2005. Financial strength The Group remains financially strong and our financial standing has been furtherimproved during 2005. We continued to manage our business financially on thebasis of our economic capital whilst ensuring that we also comply comfortablywith all other capital requirements. These include the realistic solvencyrequirement for our with-profits business, our regulatory solvency and our Groupsolvency requirements as detailed below. Over the past three years we have developed an economic capital model, which hashelped our drive for improved capital efficiency and financial risk reduction.Such models form the basis for the FSA to agree the economic capital requirementfor each company based on an assessment of its own risk profile, ie theindividual capital assessment. We have submitted our year-end 2004 economiccapital results to the FSA and, having received feedback, we remain satisfiedwith our methodology. We have continued to make considerable progress in reducing financial risk inthe business and these actions are reaping tangible benefits, for example withour management of the With Profits Fund and the Pension Scheme, as discussedbelow. FPLP Realistic solvency We calculate assets and liabilities of the FPLP With Profits Fund on a realisticbasis. Surplus assets have increased to £236 million (2004: £131m). At December 2005 the Risk Capital Margin was £276 million (2004: £279m), leaving£40 million (2004: £148m) to be met from surplus assets outside of the WithProfits Fund of some £1.8 billion. Our objective remains that, over time, thesurplus assets within the Fund should cover the Risk Capital Margin in full. The With Profits Fund Realistic Balance Sheet is resilient in the event of fallsor rises in investment markets. This is due in large measure to the actions wehave taken to hedge the provisions made to cover the cost of guarantees andoptions. FPLP Regulatory solvencySolvency is calculated on both a regulatory and a realistic basis. The twocalculations are then compared after applying stress tests to each and the moreonerous requirement is applied. During 2005, the more onerous requirement forFPLP has changed from the regulatory basis to the realistic basis. This resultsin a With Profits Insurance Capital Component of £635 million as shown below: +-----------------+--------------+-----------------------------------+-----------------+| |Realistic | | Regulatory |+-----------------+-------+------+-----------------------------------+---------+-------+| | 2005 | 2004 | | 2005 | 2004 |+-----------------+-------+------+-----------------------------------+---------+-------+| | £m | £m | | £m | £m |+-----------------+-------+------+-----------------------------------+---------+-------+|Working capital | 236 | 131 |Surplus | 1,493 | 488 |+-----------------+-------+------+-----------------------------------+---------+-------+|Risk capital | (276)| (279)|Long term insurance capital | (548)| (589)||margin | | |requirements | | |+-----------------+-------+------+-----------------------------------+---------+-------+| | | |Resilience capital | (350)| (300)|+-----------------+-------+------+-----------------------------------+---------+-------+|Realistic peak | (40)| (148)|Regulatory peak | 595 | (401)|+-----------------+-------+------+-----------------------------------+---------+-------+|Additional | | |With Profits Insurance Capital | (635)| - ||capital | | |Component | | |+-----------------+-------+------+-----------------------------------+---------+-------+|requirement | - | (253)| | | |+-----------------+-------+------+-----------------------------------+---------+-------+| | (40)| (401)| | (40)| (401)|+-----------------+-------+------+-----------------------------------+---------+-------+ The Free Asset Ratio (FAR) is a common measure of financial strength. It is theratio of assets less liabilities (including actuarial reserves but before therequired regulatory minimum solvency margin) expressed as a percentage ofactuarial reserves. For FPLP it has increased to an estimated 18.3% at the endof 2005 (2004: 12.2%) and available assets to meet capital requirements haveincreased from £2,281 million to £3,471 million. The main reasons for theincrease are the investment return achieved during the year and the £500 millioncapital raised in June 2005. The quality of our regulatory capital has also improved and the FAR no longerincludes any implicit item or the £215 million subordinated debt callable in2006. Life & Pensions capital positionThe Life & Pensions capital statement in this announcement shows the availablecapital resources compared with the regulatory capital requirements. The totalavailable capital resources, calculated on a realistic basis for the FPLP WithProfits Fund and on a regulatory basis for all other funds, have increased to£2.5 billion (2004: £2.0bn). The regulatory capital requirement is £0.7 billion (2004: £0.8bn). Therefore theexcess capital resources over the capital requirement has increased to £1.8billion (2004: £1.2bn). The improved position is mainly driven by our tier onecapital raising in June 2005. The bulk of the Group's capital is held outside the With Profits Fund and,consequently, can be deployed around the Group with a high degree offlexibility. Group solvencyThe Group is required to comply with the Insurance Groups Directive, whichrequires a very prudent measure of excess capital resources as it excludes anysurplus capital within a long term fund. On this measure Group capital resourcesexceeded the Group capital requirement by over £750 million at 31 December 2005. Credit ratingsExternal agencies, such as Standard and Poor's, Moody's and Fitch regularlyperform independent assessments of the financial strength of life companies andpublish their ratings. Moody's has maintained FPLP's A2 (strong) rating but upgraded the outlook in May2005 from stable to positive. Standard & Poor's has maintained FPLP's ratingunchanged at A+ (strong) with a stable outlook. Fitch has maintained FPLP'srating unchanged at A+ (strong) with a stable outlook. Standard & Poor's upgraded the rating of Friends Provident plc from BBB+ (good)to A- (strong) in May 2005. Financial risk reduction We actively manage financial risk and have taken a number of initiatives toreduce our exposures. With Profits Fund Our overall aim remains to balance risk to shareholders with maximising returnsto policyholders whilst ensuring guarantees are met as they fall due. Particularactivities include: • Managing the proportion of equities and property backing the asset shares. At 2005 year-end this proportion was 51% (2004: 48%) • Active management of bonuses and market value reduction factors • Hedging strategies to mitigate equity market and interest rate risks The gross investment return achieved by the With Profits Fund in 2005 was 16.3%(2004: 10.7%). Other Life & Pensions We carry out other risk mitigation activities outside the With Profits Fund,including cash flow matching and other inflation and interest rate hedging. Pension schemes The principal defined benefit scheme, Friends Provident Pension Scheme is in ahealthy position. At 2005 year-end there was a small deficit equivalent to 2% ofassets, after strengthening the valuation discount rate by 0.75% to 4.75% (at acost of £129 million) and strengthening the mortality basis to medium cohort (ata cost of £35 million). The near fully funded position is partly due to thestrong investment performance during the year (18.5% return contributing asurplus of £74 million) but is also due to the success of ongoing riskmanagement activities: • In 2004 we hedged the risk of inflation and reductions in real yields. The value of this hedge has increased over the course of the year by £82 million as real yields have reduced by 0.6%. • Actions were taken some time ago to reintroduce employer and employee contributions. Provisions Pension schemes The defined benefit pension scheme for the UK Life & Pensions business is theFriends Provident Pension Scheme and is discussed above. At year-end it had asmall deficit of £19 million (2004: £7m deficit), in the context of assets of£888 million. The pension deficit presented in the IFRS accounts differs from this because ofthe IFRS requirement to exclude £40 million (2004: £34m) of managed pension fundinvestments held by a Group company. The defined benefit pension schemes for the Asset Management business are closedto new entrants. At year-end they had a deficit of £48 million (2004: £18mdeficit). In addition the Group operates defined contribution schemes for F&Cand FPI. Lombard does not operate a pension scheme. Mis-selling provisions Provisions have been established for the estimated likely cost of redress,including administration costs, arising from the review of past sales. There issome uncertainty involved in these provisions, which have been calculated on abest estimate basis taking into account recent Group and industry experience. The total provision (including actuarial provision) for endowment complaints hasreduced from £128 million to £109 million with £57 million paid out in the year.This has resulted in a charge of £38 million (2004: £130m), none of which isattributed to shareholders (2004: £14m charged as non-recurring item). Themajority of the mortgage endowment redress provision is expected to be settledwithin the next two years. A review of some past sales by our direct salesforce (which is now closed) isbeing undertaken, mainly in respect of inheritance tax planning policies. Theprovision (including actuarial provision) has increased from £22 million to £33million, with £7 million paid out in the year. This has resulted in a charge of£18 million (2004: £22m), of which £13 million (2004: £19m) is attributable toshareholders. The pensions mis-selling provision amounts to £7 million (2004: £12m) with net£2 million recovered from professional indemnity insurers and £7 millionreleased (2004: £13m released). Current and future consideration for LombardThe strong performance from Lombard in 2005 will result in the payment of themaximum earn-out consideration for the year of €85 million (£58 million). Thispayment will be made in cash and, for certain individuals, in loan notes. A provision of £146 million (2004: £nil) has been established for the expectedfuture earn out payments in respect of the Lombard acquisition. This is based onthe 2005 actual Lombard results and assumes a growth rate in new business of 15%in 2006. Other provisions Other provisions include: future costs relating to vacant properties of £18million (2004: £15m), unclaimed shares following demutualisation of £9 million(2004: £10m) and other provisions of £14 million (2004: £15m). This information is provided by RNS The company news service from the London Stock Exchange MORE TO FOLLOW

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