Preliminary Results - Part 2

23rd Mar 2006 07:04

Friends Provident PLC23 March 2006 Part 2 Contents EEV resultsSummary consolidated income statement on an EEV basisEarnings per share on an EEV basisConsolidated statement of recognised income and expense on an EEV basisConsolidated movement in ordinary shareholders' equity on an EEV basisSummary consolidated balance sheet on an EEV basisValue of in-force Life & Pensions business on an EEV basisPro forma embedded valueNotes to the EEV results IFRS resultsConsolidated income statement on an IFRS basisConsolidated underlying profit before tax on an IFRS basisConsolidated balance sheet on an IFRS basisConsolidated statement of recognised income and expense on an IFRS basisSummary consolidated cash flow statement on an IFRS basisNotes to the IFRS results Summary consolidated income statement on an EEV basisFor the year ended 31 December 2005 2005 2004 Notes £m £mContribution from new business 144 78Profit from existing business:expected return 196 166experience variances 22 17operating assumption changes 16 4Development costs (25) (16)Expected return on shareholders' netassets within the Life & Pensions business 81 105Life & Pensions underlying profit 2a 434 354Asset Management underlying profit 108 40Expected return on net pension liability (2) 8Expected return on corporate net assets (7) -Corporate costs (12) (10)Operating assumption changes for corporate costs 3 -Underlying profit before tax 524 392Investment return variances 550 197Effect of economic assumption changes (238) (128)Non-recurring items 4 (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)Profit before tax 600 375Tax (196) (95)Profit after tax 404 280Attributable to:Ordinary shareholders of the parent 441 282Minority interest (37) (2) 404 280 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. Earnings per share on an EEV basisFor the year ended 31 December 2005 2005 2004 Notes pence penceBased on EEV profit after tax attributable to ordinaryshareholders of the parent 5 21.2 15.6Based on underlying profit on an EEV basis, after tax,attributable to ordinary shareholders of the parent 5 16.3 15.8 Consolidated statement of recognised income and expense on an EEV basisFor the year ended 31 December 2005 2005 2004 £m £mActuarial losses on defined benefit plans net of tax (28) (8)Foreign exchange adjustments (9) 2Net loss recognised directly in equity (37) (6)Profit after tax 404 280Total recognised income and expense for the year 367 274Attributable to:Ordinary shareholders of the parent 417 277Minority interest (50) (3) 367 274 Consolidated movement in ordinary shareholders' equity on an EEV basisFor the year ended 31 December 2005 2005 2004 £m £mTotal recognised income and expense for the year attributable toordinary shareholders of the parent 417 277Dividends on equity shares (157) (134)Share based payments 14 4Conversion option on convertible bond 51 -Profit on deemed disposal of F&C - 37Increase in EEV reserves for the year 325 184Increase as a result of business combinations 148 362Share based payments 5 3Unclaimed shares on demutualisation - 15Net addition to ordinary shareholders' equity 478 564At 1 January 2,968 2,404At 31 December 3,446 2,968 Summary consolidated balance sheet on an EEV basisAt 31 December 2005 2005 2004 £m £mLife & Pensions - long-term funds 621 627Life & Pensions - shareholders' funds 429 354Life & Pensions net assets 1,050 981Corporate net assets 14 70Shareholders' invested net assets 1,064 1,051Attributable net asset value of the Asset Management businessnet of minority interest 423 486Net pension liability of Friends Provident Pension Scheme (13) (5)Shareholders' net worth 1,474 1,532Provision for future corporate costs (47) (48)Value of in-force Life & Pensions business 2,019 1,484Ordinary shareholders' net assets on an EEV basis 3,446 2,968Called-up share capital 214 199Share premium account 2,038 1,799EEV reserves 1,194 970Ordinary shareholders' equity on an EEV basis 3,446 2,968 The above table provides a segmental analysis. See also note 2(c). Value of in-force Life & Pensions business on an EEV basisAt 31 December 2005 2005 2004 £m £mValue of in-force allowing for market risk (excluding timevalue of options and guarantees) 2,215 1,652Time value cost of options and guarantees (including theimpact of non-market risks) (75) (77)Cost of regulatory solvency capital, plus excess economiccapital requirements (34) (41)Provision for operational risks (87) (50)Value of in-force Life & Pensions business 2,019 1,484 Pro forma embedded valueAt 31 December 2005 2005 2004 £m £mOrdinary shareholders' equity on an EEV basis 3,446 2,968Adjustment to the value of the listed Asset Managementbusiness to market value 18 123Pro forma embedded value 3,464 3,091 Pro forma embedded value per share £1.65 £1.59 Notes to the EEV results 1. Methodology 1.1 Basis of preparation The EEV results presented in this document have been prepared in accordance withthe European Insurers' Chief Financial Officers Forum's EEV principles issued inMay 2004 and the Additional Guidance issued in 2005. They provide supplementaryinformation for the year ended 31 December 2005. The comparative figures for 31 December 2004 were presented in the EEVrestatement on 12 October 2005. Certain comparatives have been restated toensure consistency in preparation and presentation of these results. The EEV basis of reporting is designed to recognise profit as it is earned overthe term of the policy. The total profit recognised over the lifetime of thepolicy is the same as that recognised under the IFRS basis of reporting, but thetiming of recognition is different. The reported embedded value provides an estimate of the value of shareholders'interest in the covered business, excluding any value that may be generated fromfuture new business. This value comprises the sum of the shareholders' networth, the provision for future corporate costs and the value of existingbusiness. The shareholders' net worth is the net assets attributable toshareholders, and is represented by the sum of required capital and freesurplus. The value of existing business is the present value of the projectedstream of future distributable profits available to shareholders from theexisting business at the valuation date, on a best estimate basis allowing forrisk, adjusted for the cost of holding required capital. The supplementary information should be read in conjunction with the Group'sIFRS results. These contain information regarding the Group's financialstatements prepared in accordance with IFRS issued by the InternationalAccounting Standards Board and adopted for use in the EU. The EEV principles have been followed in respect of non-covered business. Inother respects the IFRS basis of reporting has been applied unless the EEVprinciples permit otherwise. In particular the principles have been applied toreflect Step-up Tier one Insurance Capital Securities (STICS) as debt ratherthan as equity. In addition, a pro forma embedded value is reported showing ordinaryshareholders' funds on an EEV basis adjusted to include the F&C listedsubsidiary at market value. Shareholders' net assets on an EEV basis for the Group consist of the following: •Life & Pensions net assets; •the Group's share of its investment in the Asset Management business (including the net pension liability) on an IFRS basis; •corporate net liabilities; •the net pension liability of FPPS on an IAS 19 basis but including holdings in non-transferable securities issued by the Group (both net of deferred tax); •a provision for future corporate costs; •the present value of future profits attributable to shareholders from existing policies of the Life & Pensions business. The shareholders' net worth includes the corporate debt of the Group. This debtis valued at market value, consistent with the EEV guidance. EEV and other balance sheet items denominated in foreign currencies have beentranslated to sterling using the appropriate closing exchange rate. The newbusiness contribution and other income statement items have been translatedusing an average exchange rate for the relevant period. 1.2 Covered business The covered business incorporates the Life & Pensions business defined aslong-term business by UK and overseas regulators. F&C is not included in the definition of covered business. 1.3 Allowance for risk The allowance for risk in the shareholder cash flows is a key feature of the EEVprinciples. The EEV guidance sets out three main areas available to allow forrisk in an embedded value: • the risk discount rate; • the allowance for the cost of financial options and guarantees; • the cost of holding both prudential reserves and any additional required capital. The market-consistent approach has been used to allow for risk in all threeareas. 1.4 Deriving risk discount rates A market-consistent embedded value has been calculated for each product line byvaluing the cash flows in line with the prices of similar cash flows traded onthe open market. In principle, each cash flow is valued using the discount rate consistent withthat applied to such a cash flow in the capital markets. For example, an equitycash flow is valued using an equity risk discount rate, and a bond cash flow isvalued using a bond risk discount rate. If a higher return is assumed forequities, the equity cash flow is discounted at this higher rate. In practice, for liabilities where the payouts are either independent or movelinearly with market movements, a method known as the 'certainty equivalentapproach' has been applied whereby all assets are assumed to earn the risk-freerate and all cash flows are discounted using the risk-free rate. This gives thesame result as applying the method in the previous paragraph. A market-consistent cost of financial options and guarantees and amarket-consistent cost of holding required capital have also been calculated.The cost of financial options and guarantees includes additional allowance fornon-market risk within the With Profits Fund. An additional provision has beenmade for operational risks. These are described in more detail below. For presentational purposes, a set of risk discount rates has been derived foreach product line, and for in-force and new business, by calculating the riskdiscount rate under a traditional embedded value approach that gives the samevalue as that from the market-consistent embedded value determined above. Thesederived risk discount rates are a function of the assumptions used (eg equityrisk premium, corporate bond spreads). However, as the market-consistentapproach is used, these assumptions do not impact the level of embedded value: ahigher equity risk premium results in an exactly compensating higher riskdiscount rate. 1.5 Financial options and guarantees The material financial options and guarantees are those in the Friends ProvidentLife & Pensions Limited (FPLP) With Profits Fund, in the form of the benefitsguaranteed to policyholders and the guaranteed annuity rates associated withcertain policies. The risk to shareholders is that the assets of the With Profits Fund areinsufficient to meet these guarantees. While shareholders are entitled to only asmall share of profits in the With Profits Fund (via one ninth of the cost ofbonus), they can potentially be exposed to the full cost if fund assets areinsufficient to meet policyholder guarantees. The time value cost of thisasymmetry, known as the burn-through cost, is modelled stochastically, as itwill only occur in some adverse scenarios. The burn-through time value cost iscalculated as the difference between the average value of shareholder cash flowsunder a number of market-consistent scenarios, and the intrinsic shareholdervalue using risk-free assumptions included within the deterministic model. The burn-through cost has been assessed using a stochastic model derived fromthe current Realistic Balance Sheet (RBS) model. This model has been calibratedto market conditions at the valuation date. Allowance has been made under thedifferent scenarios for management actions, such as altered investment strategy,consistent with the RBS model. The burn-through cost would be markedly higherwithout the hedging activities we have undertaken. Whilst the EEV guidance suggests that, as a minimum, allowance is made in thecost of financial options and guarantees for stochastic variation in futureeconomic conditions, we have also allowed for variation in non-market risks, asthese risks can also serve to increase the burn-through cost. The burn-throughcost at 31 December 2005 of £75m (2004: £77m), is split between £40m (2004:£44m) market risk and £35m (2004: £33m) non-market risk. The non-market risksinclude lapses, annuitant longevity, and operational risk within the WithProfits Fund. The allowance for non-market risks is made by consideration of theimpact of extreme scenarios from our economic capital model. Significant amounts of new with-profits business are no longer written and theguarantee levels offered are lower, hence there is no material impact of theburn-through cost in the contribution to profits of new business. 1.6 Required capital and the cost of capital Required capital is set at the greater of regulatory capital and economiccapital. Regulatory minimum capital includes prudent reserves as well as asolvency margin. Economic capital is determined from internal models, based onthe company's risk appetite. At a product level, economic capital requirements are higher than regulatorycapital requirements for with-profits and annuity business, and lower thanregulatory capital requirements on unit-linked and protection business. Inaggregate, the economic capital requirements are higher than regulatoryrequirements by approximately £100m (2004: £100m). Capital requirements under EEV amounted to £551m (2004: £741m). This includedshareholder assets required to support the With Profits Fund. For new business, regulatory capital requirements are higher than economiccapital requirements, given the high proportion of unit-linked and protectionnew business, and the contribution to profits from new business is thereforebased on regulatory capital requirements. The EEV includes a deduction for the cost of holding the required capital.Frictional costs, being the tangible costs of holding capital, have been allowedfor on a market-consistent basis. These consist of the total taxation andinvestment expenses incurred on locked-in shareholder capital and reflect thecost to an investor of holding an asset through investment in a life company,rather than investing in the asset directly. No adjustment has been made for any agency cost, this representing the potentialmarkdown to value that investors will apply because they do not have directcontrol over their capital. Any adjustment would be subjective and differentinvestors will have their own views of what adjustment, if any, should be made. 1.7 Non-market risk An investor can diversify away the uncertainty around the return on non-marketrisks, such as mortality and expenses. Hence in a shareholder valuation theallowance for non-market risk is made through the appropriate choice of bestestimate experience assumptions and the impact of non-market risks on the level,and hence the cost, of capital. In choosing best estimate assumptions the allowance for non-market risk has beenreviewed. However, best estimate assumptions may fail to represent the fullimpact on shareholder value where the impact of fluctuations in experience isasymmetric; that is where adverse experience has a higher impact on shareholdervalue than favourable experience. The areas identified as having suchasymmetries are the burn-through cost and operational risk. The impact of variations in non-market risks have been taken into account in theburn-through cost calculation. This allows for asymmetries arising from theprofit sharing mechanism. In addition, a provision of £87m (2004: £50m) has been set up for operationalrisks in the shareholders' funds. This provision has been calculated bycomparing the mean impact of variations in operational risk, as modelled in theeconomic capital calculations, with the existing allowance for operational riskin specific accounting provisions and embedded value projection assumptions. This provision of £87m is equivalent to a 0.4% (2004: 0.4%) increase in the riskdiscount rate for UK Life & Pensions business and 0.8% (2004: 0.8%) forInternational Life & Pensions business, recognising the higher operational risksin international business. This impacts both embedded value and the contributionfrom new business. 1.8 Expenses The EEV guidance requires companies to actively review expense assumptions, andinclude an allowance for holding company (corporate) costs and service companycosts. (a) Corporate costs Corporate costs relate to those costs incurred at the corporate level that arenot directly attributable to the Life & Pensions or the Asset Managementbusinesses. Under EEV methodology, corporate costs are classified as either ongoing costs ordevelopment and one-off costs. For 2005, £6m (2004: £6m) of corporate costs wereregular ongoing corporate costs and £6m (2004: £4m) were development or one-offcosts. The ongoing costs have been capitalised under EEV. The impact is aprovision of £47m (2004: £48m). (b) Service costs Service company costs are included in the EEV expense assumption calculations.Included within these are the fees charged by F&C for investment managementservices to the covered Life & Pensions business. F&C service fee profits in respect of covered Life & Pensions business are notcapitalised under the EEV methodology, as F&C is a separate business segmentwithin the Group and the arrangement between F&C and the Life & Pensionsbusiness is on an arm's length basis. Instead, these profits, approximately £15m(2004: £11m) are brought into the consolidated profit and loss account on anIFRS basis, and F&C is brought into the pro forma embedded value at marketvalue. Productivity gains have been assumed within the EEV in respect of Internationalbusiness. The Lombard EEV has been reduced by £8m (2004: £8m) for a projectedexpense overrun for the period 2006-2009 and a lower rate of expense inflationhas been assumed for Friends Provident International Limited business. Theseallow for anticipated future productivity gains as these businesses grow. 1.9 New business New business within the covered business includes: • premiums from the sale of new contracts; • payments on recurring single premium contracts, including Department of 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 contract and not new business; • non-contractual increments on existing policies; • new entrants in group pensions business. 2. Segmental analysis(a) Life & Pensions EEV profitYear ended 31 December 2005 2005 2004 UK INT Total UK INT Total Notes £m £m £m £m £m £mContribution from new 2(b), 3 64 80 144 58 20 78business (a)Profit from existingbusiness:expected return 170 26 196 155 11 166experience variances 20 2 22 12 5 17operating assumption changes 19 (3) 16 (17) 21 4Development costs (25) - (25) (16) - (16)Expected return onshareholders'net assets within the Life& Pensions business 80 1 81 103 2 105Life & Pensions EEVunderlying profitbefore tax 328 106 434 295 59 354Non-recurring items 4 (10) (3) (13) (29) (3) (32)Investment return variances 3(e) 584 57 641 201 3 204Effect of economic assumptionchanges (223) (13) (236) (122) (6) (128)Life & Pensions EEV profitbefore tax 679 147 826 345 53 398Attributed tax charge 3(f) (204) (28) (232) (103) (5) (108)Life & Pensions EEV profitafter tax 475 119 594 242 48 290 (b) New business marginYear ended 31 December 2005 2005 UK INT TotalContribution from new business £64m £80m £144mVolume of new businessAnnualised Premium Equivalent (APE) £477m £250m £727mMargin - APE 13.4% 32.0% 19.8%Volume of new businessPresent Value of New Business Premiums (PVNBP) £3,192m £2,205m £5,397mMargin - PVNBP 2.0% 3.6% 2.7% 2004 UK INT TotalContribution from new business £58m £20m £78mVolume of new businessAPE £389m £74m £463mMargin - APE 14.9% 27.0% 16.8%Volume of new businessPVNBP £2,641m £537m £3,178mMargin - PVNBP 2.2% 3.7% 2.5% APE equals 100% of annualised regular premium and 10% of single premium. PVNBPequals single premiums plus the expected present value of new business premiumsof regular premium business. (c) Summary consolidated balance sheet on an EEV basisAt 31 December 2005 2005 2004 Segmental Intra-Group Segmental Intra-Group analysis debt(iii) Total analysis debt(iii) Total £m £m £m £m £m £mLife & Pensions - long-term 621 (180) 441 627 (180) 447fundsLife & Pensions - 429 770 1,199 354 275 629shareholders' fundsLife & Pensions net assets 1,050 590 1,640 981 95 1,076Corporate net assets 14 (795) (781) 70 (300) (230)Shareholders' investednet assets 1,064 (205) 859 1,051 (205) 846Attributable net asset valueof theAsset Management businessnet of minority interest 423 205 628 486 205 691(i), (ii)Net pension liability ofFriendsProvident Pension Scheme (13) - (13) (5) - (5)Shareholders' net worth 1,474 - 1,474 1,532 - 1,532Provision for futurecorporatecosts (47) (48)Value of in-force Life &Pensionsbusiness 2,019 1,484Ordinary shareholders' netassetson an EEV basis 3,446 2,968Called-up share capital 214 199Share premium account 2,038 1,799EEV reserves 1,194 970Ordinary shareholders'equityon an EEV basis 3,446 2,968 (i) The attributable net asset value of the Asset Management business includesgoodwill of £333m at 31 December 2005 (2004: £327m) and other intangible assets,net of related tax, of £154m (2004: £217m). (ii) The attributable net asset value of the Asset Management business includesthe value of the net pension liability of that business on an IAS 19 Employeebenefits basis, and is net of related tax. The net pension liability of FriendsProvident Pension Scheme (FPPS) is stated on an IAS 19 basis, but includingholdings in non-transferable securities issued by the Group, and is net ofrelated deferred taxation. (iii) Intra-Group long-term debt is analysed as follows: Debt Interest payable 2005 2004 2005 2004 £m £m £m £mDue from F&C to FPLP long term funds 180 180 11 11Due from F&C to FPLP Shareholders' 25 25 1 -fundDue from FPLP Shareholders' fund to 795 300 30 14FP plc (d) Life & Pensions net assets segmental information by business segment 2005 2004 UK INT Total UK INT Total £m £m £m £m £m £mLife & Pensions net assets 1,028 22 1,050 931 50 981Value of in-force Life & Pensions 1,538 481 2,019 1,289 195 1,484business 2,566 503 3,069 2,220 245 2,465 3. Life & Pensions EEV profit (a) Contribution from new business The contribution from new business is calculated using economic assumptions atthe beginning of the period. The contribution from new business usingend-of-period economic assumptions was £143m (2004: £79m). Derived risk discountrates for new business have been based on end-of-period economic assumptions. The contribution from new business is quoted after cost of required capital andshare incentives. The table below gives the contribution before cost of capitaland share based payments. 2005 2004 £m £mContribution from new business before cost of capitaland sharebased payments 152 86Cost of share based payments (2) (2)Cost of capital (6) (6)Contribution from new business 144 78 (b) Profit from existing business - Life & Pensions Profit from existing Life & Pensions business comprises the expected return onthe value of in-force business at the start of the period plus the impact of anychanges in the assumptions regarding future operating experience, changes in thereserving basis (other than economic assumption changes) and profits and lossescaused by differences between the actual experience for the period and theassumptions used to calculate the embedded value at the end of the period. The expected return on the value of in-force business is the difference betweenthe expected return on the assets backing the liabilities and the expectedchange in the market-consistent value of the liabilities. Effectively, thisapproach is similar to applying an unwind in the risk discount rate to the valueof the in-force business at the beginning of the year. However, the riskdiscount rate to be used is a rate appropriate over the period of return only,which is not necessarily equal to the overall in-force risk discount rateaveraged across all future durations above. (c) Development costs - Life & Pensions Development costs represent investments made to improve future EEV profits, forexample by reducing expenses or increasing future new business volumes. Inparticular, the Life & Pensions costs represent investment in developingadvanced electronic trading systems, e-commerce related activities and newbusiness service automation and improvement. (d) Expected return on shareholders' net assets The expected return on shareholders' net assets held within the Life & Pensionsbusiness comprises the return on the shareholders' net assets held by the lifeassurance companies within that business, using the investment returnassumptions used to calculate the embedded value at the beginning of the period. The expected return on corporate net assets is the longer-term investment returnon assets held by Friends Provident plc and its non-life subsidiaries. Itexcludes the expected return on the net pension liability and the result of theF&C business, which are shown separately in the summary consolidated incomestatement. (e) Investment return variance The split of the investment return variance in the Life & Pensions EEV profit isshown in the table below: 2005 2004 £m £mIn respect of net assets at the start of year 84 25Value of in-force business 373 119Investment return variance after tax 457 144Investment return variance before tax 641 204 (f) Attributed tax charge EEV profits are calculated net of tax and then grossed up at the effective rateof shareholder tax. The full standard rate of UK corporation tax has been usedto gross up after tax profits on UK business and appropriate tax rates have beenused for the International business. The following table provides the analysis of the attributed tax charge: 2005 2004 £m £mContribution from new business 35 19Profit from existing business 69 48Development costs (8) (5)Expected return on shareholders' net assets withinthe Life & Pensions business 24 31Non-recurring items (3) (8)Investment return variances 184 60Effect of economic assumption changes (69) (37)Attributed tax charge 232 108 4. Non-recurring items 2005 2004 £m £mClosure of direct sales operation - 2Life & Pensions integration costs 6 9Provision for past sales 7 14Gross-up for shareholder tax - 7Life & Pensions non-recurring items 13 32Asset Management integration costs 24 19Asset Management Reinvestment Plan costs 22 4Asset Management non-recurring items 46 23Total non-recurring items 59 55 Explanations of the non-recurring items are set out in note 3 to the IFRSfinancial information. 5. Earnings per share Basic and underlying earnings per share 2005 2004 Per Per Earnings share Earnings share £m pence £m penceProfit after tax attributable to ordinary shareholders of the parent 441 21.2 282 15.6Investment return variances (550) (26.4) (197) (10.9)Variation in value of option on convertible debt 9 0.4 10 0.5Effect of economic assumption changes 238 11.4 128 7.1Amortisation and impairment of Asset Managementacquired intangible assets 168 8.1 21 1.2Non-recurring items 59 2.8 55 3.0Tax charge on items excluded from underlying 46 2.2 1 0.1profitMinority interest on items excluded from underlying profit (72) (3.4) (14) (0.8)Underlying profit after tax attributable toordinary shareholders of the parent 339 16.3 286 15.8 2005 2004 millions millions Weighted average number of ordinary shares 2,082 1,808 6. Equity attributable to equity holders of the parent Ordinary shareholders' equity on an EEV basis reconciles to equity attributableto equity holders of the parent on an IFRS basis as follows: 2005 2004 £m £mOrdinary shareholders' equity on an EEV basis 3,446 2,968 Less items only included on an EEV basis:Value of in-force Life & Pensions business (2,019) (1,484)Provision for future corporate costs 47 48Adjustment of long term debt to market value 134 35 Add items only included on an IFRS basis:Goodwill (net of provision for future consideration) 198 191Other intangible assets 76 2Acquired PVIF 282 138STICS treated as equity 810 299Deferred acquisition costs 994 765Deferred front end fees (85) (37)IFRS reserving adjustments (337) (160)Other (48) (47)Equity attributable to equity holders of the parenton an IFRS basis 3,498 2,718 7. EEV assumptions 7.1 Principal economic assumptions - deterministic Economic assumptions are actively reviewed and are based on the market yields onrisk-free assets at the valuation date. Assumptions 2005 2004UK and International (excluding Lombard): % %Risk-free rate (i) 4.1 4.6Investment returns before tax:Fixed interest 3.8-4.7 4.1-5.2Equities 7.1 7.6Properties 6.1 6.6Future expense inflation:UK business 3.9 3.9International business 3.15 3.6UK corporation tax rate 30 30Risk discount rate (average):In-force (UK business) 7.4 8.0In-force (International business) 6.3 6.9Risk discount rate:New business (UK business) 6.5 6.6New business (International business) 6.0 6.4 (i) For UK and FPI business the risk-free rate is set with reference to the giltyield curve at the valuation date. For annuity and with-profits business, a termdependent rate allowing for the shape of the yield curve is used as this cansignificantly impact value. For other business, a rate based on the annualised15-year gilt yield is used. 2005 2004 Lombard: % %Risk-free rate 3.6 4.1Investment returns before tax 4.9 5.2Future expense inflation 3.5 3.5Tax rate 25.8 25.8Risk discount rate (average) - in-force 6.3 6.9Risk discount rate (average) - new business 6.3 6.9 The key exchange rates used in respect of Lombard business were a closingexchange rate of 1 Euro = £0.687 (2004: 1 Euro = £0.707) and an average exchangerate over the year of 1 Euro = £0.685. Margins are added to the risk-free rates to obtain investment return assumptionsfor equity and property. For corporate fixed interest securities the investmentreturn assumptions are derived from an AA-bond yield spread, limited to theactual return on the underlying assets. As we have followed a market-consistentapproach, these investment return assumptions affect only the derived riskdiscount rates and not the embedded value result. Maintenance expenses are assumed to increase in the future at a rate of 1% perannum for UK business and 0.25% per annum for International business (excludingLombard) in excess of the assumed long-term rate of retail price inflation. Thisis derived from the difference between the risk-free rate of return and theaverage of the FTSE Actuaries over 5-year index-linked gilt at 5% and 0%inflation. For Lombard the risk-free rate is the average of the 10-15 year and the over 15year yields using the EuroMTS indices. The investment return assumption is theweighted average (based on asset mix) of returns of fixed interest securities,equities and cash. The Lombard investment return assumption is shown gross oftax, but net of fund management charges. Average derived risk discount rates are shown below for the embedded value andthe contribution from new business. The average derived risk discount rate forin-force has reduced over 2005 due mainly to a lower risk free rate and a lowerrisk margin on annuities. A more detailed split of the derived risk discount rates is given in thefollowing table. Derived risk discount rates by product type31 December 2005 International UK With-profits UK Annuity Other UK Sterling EuroEmbedded Value % % % % % Risk-free rate 4.1 4.1 4.1 4.1 3.6Market risks 3.0 6.0 1.7 1.3 1.9(non-options)Options - market risks 4.0 - - - -Options - non-market 3.3 - - - -risksOther non - market risks 0.4 0.4 0.4 0.8 0.8Risk discount rate 14.8 10.5 6.2 6.2 6.3 Contribution from new business: International UK Sterling Euro % % %Risk-free rate 4.1 4.1 3.6Market risks 2.0 1.1 1.9Non-market risks 0.4 0.8 0.8Risk discount rate 6.5 6.0 6.3 These tables show that with-profits and annuity business is subject to moreinvestment risk than the remaining business, and so the appropriate riskdiscount rates are higher. 7.2 Principal economic assumptions - stochastic The cost of options and guarantees is determined using The Smith Model economicscenario generator. The model is calibrated to market conditions at thevaluation date and correlations between the asset classes are derived fromhistoric data, consistent with the model used for the Realistic Balance Sheet. Risk-free rates are calibrated to the gilt yield curve. Equity volatility is calibrated to replicate the implied volatility of FTSE 100put options held by the With Profits Fund. Property holdings are modelled as a mix of equity and gilt assets, calibrated toderive a level of running yield and volatility as observed in historical data. Sample implied volatilities by asset class Term (years)31 December 2005 5 15 25 3515-year risk-free zero coupon bonds 8.7 5.0 4.4 5.015-year corporate bonds 9.8 7.9 7.7 7.6Equity 17.7 19.8 21.6 21.7Property 14.9 17.2 19.2 19.3 Bonus rates are set at levels which fully utilise the assets supporting thein-force business over its lifetime and are consistent with the economicassumptions and the Group's bonus policy. 7.3 Other assumptions Other assumptions are regularly reviewed having regard to past, current andexpected future experience, and any other relevant data. These are set so as tobe best estimate assumptions. The assumed rates of mortality, morbidity, lapse, surrender, conversion topaid-up and early retirement, which are reviewed annually, have been derivedfrom analyses of the Group's recent operating experience and industry studies.In particular, improvements in annuitant mortality have been assumed to followthe medium cohort for males and 75% of this for females. Allowance forcommission is based on the Group's recent experience. 8. Sensitivity analysis The table below shows the sensitivity of the embedded value and the contributionfrom new business to changes in assumptions for 2005. For each sensitivity otherfuture experience assumptions remain unchanged, except where changes in economicconditions directly affect them. The assumptions underlying the statutoryreserving calculations remain unchanged in all sensitivities. Change in Change in embedded new business value contribution Notes £m £m1% increase in risk discount rates (i) (171) (43)1% increase in equity and property expected (ii) n/a n/areturns1% reduction in risk-free rates, with corresponding change in fixed-interest asset values 54 510% reduction in market values of equity andproperty assets (for embedded value) (iii) (157) n/a£100m reduction in capital requirements(for embedded value) (iv) (7) n/a50% increase in capital requirements(for new business contribution) n/a (3)10% reduction in expenses 44 910% reduction in lapses 53 205% reduction in annuitant mortality (55) (2)5% reduction in mortality and morbidity(excluding annuities) 23 4 (i) Although not directly relevant under a market-consistent valuation where therisk discount rate is a derived disclosure only, this shows the impact of achange in the average derived risk discount rate, to enable adjustments to bemade to reflect differing views of risk. (ii) As a market-consistent approach is used, equity and property expectedreturns only affect the derived risk discount rates and not the embedded valueor contribution to profits from new business. (iii) The movement in embedded value comprises a £93m decrease in shareholders'invested net assets and a £64m reduction in the value of in-force Life &Pensions business. (iv) Required capital is set at the greater of regulatory capital and economiccapital. In aggregate the economic capital requirements are higher than theregulatory capital requirements by £100m. This sensitivity shows the impact onembedded value and contribution from new business of using the regulatorycapital requirements. Consolidated income statement on an IFRS basisFor the year ended 31 December 2005 2005 2004 Notes £m £m Revenue Gross earned premiums 2 977 977Premiums ceded to reinsurers 2 (56) (50)Net earned premiums 2 921 927 Fee and commission income and incomefrom service activities 2 483 301Investment income 6,287 3,151Total revenue 7,691 4,379 Claims, benefits and expenses Gross claims and benefits paid 1,569 1,501Amounts receivable from reinsurers (37) (31)Net claims and benefits paid 1,532 1,470 Insurance contracts liabilities 514 480Investment contracts liabilities 3,822 1,373Transfer to fund for future appropriations 187 42Movement in net assets attributable to unit 136 71holdersMovement in policyholder liabilities 4,659 1,966 Acquisition expenses 285 204 Administrative and other expenses 759 468Finance costs 89 50Total claims, benefits and expenses 7,324 4,158 Share of profit of associates and joint venture - - Profit before tax from continuing operations 367 221 Policyholder tax (218) (98) Profit before shareholder tax fromcontinuing operations 149 123Total tax expense (178) (59)Policyholder tax 218 98Shareholder tax 40 39Profit after tax from continuing operations 189 162Profit after tax from discontinued operations 13 8 18Profit for the year 197 180 Attributable to:Equity holders of the parent: (i)Ordinary shareholders 132 143Other equity holders 37 21 169 164Minority interest 28 16Profit for the year 197 180Earnings per share (ii) 6Basic earnings per share 6.3 pence 7.9 pence (i) All profit attributable to equity holders of the parent is from continuingoperations.(ii) Earnings per share from discontinued operations is £nil (2004: £nil). Consolidated underlying profit before tax on an IFRS basisFor the year ended 31 December 2005 2005 2004 Notes £m £mProfit before tax from continuing operations 367 221Policyholder tax (218) (98)Returns on Group-controlled funds attributable tothird parties (57) -Profit before tax attributable to ordinaryshareholders' of the parent 92 123Non-recurring items 3 59 55Amortisation of Asset Management acquired intangible 7 56 21assetsAmortisation of acquired present value of in-force 7 28 10businessAmortisation of Life & Pensions acquired intangible 7 7 -assetsImpairment of acquired intangible assets 7 112 -Interest payable on Step-up Tier one InsuranceCapitalSecurities 10 (37) (21)Short-term fluctuations in investment return (102) (27)Variation in value of option on convertible debt 9 10Underlying profit before tax 224 171Earnings per share 6Underlying earnings per share 8.8 pence 10.3 pence Underlying profit before tax represents profit (based on longer-term investmentreturn) attributable to ordinary shareholders of the parent and excludes returnson Group controlled funds attributable to third parties and before impairment ofgoodwill, amortisation and impairment of acquired intangible assets and acquiredpresent value of in-force business, and non-recurring items, less interestpayable on Step-up Tier one Insurance Capital Securities (STICS). Management consider that underlying profit better reflects the ongoingperformance of the Group and focus on this measure of profit in internalmonitoring of the Group's IFRS results. Consolidated balance sheet on an IFRS basis At 31 December 2005 2005 2004 Notes £m £mAssets Intangible assets 7 1,590 1,388Property and equipment 73 168Investment properties 1,912 1,527Investments in associates and joint venture 14 5Financial assets 42,091 31,112Deferred acquisition costs 994 776Reinsurance assets 183 112Current tax assets 25 49Insurance and other receivables 590 519Cash and cash equivalents 2,614 2,249Total assets 50,086 37,905 Liabilities Insurance contracts 14,637 14,047Fund for future appropriations 420 256Financial liabilities- Investment contracts 27,857 18,001- Interest bearing loans and borrowings 1,155 966Net asset value attributable to unit holders 751 576Provisions 364 185Deferred tax liabilities 288 165Current tax liabilities 177 156Insurance payables, other payables and deferred 497 755incomeTotal liabilities 46,146 35,107 Equity attributable to equity holders of the parentAttributable to ordinary shareholders:Share capital 10 214 199Share premium 10 2,038 1,799Other reserves 10 436 421 2,688 2,419Attributable to other equity holders 10 810 299 3,498 2,718 Minority interest 10 442 80 Total equity 10 3,940 2,798 Total equity and liabilities 50,086 37,905 Consolidated statement of recognised income and expense on an IFRS basisFor the year ended 31 December 2005 Equity holders Equity Total of the parent holders of equity (ordinary the parent holders of Minority shares) (STICS) the parent interest Total £m £m £m £m £mActuarial losses on definedbenefit schemes net of tax (18) - (18) (10) (28)Foreign exchange adjustments (7) - (7) (1) (8)Net income recogniseddirectly in equity (25) - (25) (11) (36)Profit for the year 132 37 169 28 197Total recognised income andexpense for the year 107 37 144 17 161 For the year ended 31 December 2004 Equity holders Equity Total of the parent holders of equity (ordinary the parent holders of Minority shares) (STICS) the parent interest Total £m £m £m £m £mActuarial losses on definedbenefit schemes net of tax (7) - (7) (1) (8)Foreign exchange adjustments 2 - 2 - 2Net income recogniseddirectly in equity (5) - (5) (1) (6)Profit for the year 143 21 164 16 180Total recognised income andexpense for the year 138 21 159 15 174 Summary consolidated cash flow statement on an IFRS basisFor the year ended 31 December 2005 2005 2004 £m £mOperating activitiesProfit after tax 197 180Net (decrease)/increase in operational assets and (896) 803liabilitiesNet cash (outflow)/inflow from operating activities (699) 983Investing activitiesAcquisition of subsidiaries, net of cash acquired 603 (182)Disposal of subsidiaries, net of cash acquired 44 -Purchase of internally generated intangible assets (13) (13)Purchase of property and equipment (10) (41)Net cash inflow/(outflow) from investing activities 624 (236)Financing activitiesFinance costs (82) (55)STICS interest (21) (21)Proceeds from issue of long term debt, net of expenses 229 374Issue of STICS, net of expenses 495 -Net movement in other borrowings, net of expenses 5 17Issue of share capital, net of expenses - 255Dividends paid to equity holders of the parent (157) (134)Dividends paid to minority interest (29) (5)Net cash inflow from financing activities 440 431Increase in cash and cash equivalents 365 1,178Balance at beginning of year 2,249 1,071Balance at end of year 2,614 2,249 Included within cash and cash equivalents are deposits maturing in less thanthree months amounting to £1,799m (2004: £1,769m). Under UK GAAP these itemswere included in investments. Notes to the IFRS results1. Basis of preparation The financial information included in this announcement has been extracted fromthe Group's financial statements prepared in accordance with InternationalFinancial Reporting Standards as adopted by the European Union (EU). The Group has chosen to early adopt the amendment to IAS 39 FinancialInstruments, in respect of the fair value option and IAS 19 Employee Benefits,as amended in December 2004. In addition the Group has applied FRS 27 LifeAssurance, as an improvement to its accounting policies as permitted by IFRS 4Insurance Contracts. The Group has prepared its financial statements under IFRS as adopted for use inthe EU for the first time and consequently has applied IFRS 1 First-TimeAdoption of International Financial Reporting Standards. There have been anumber of changes of accounting policies that have arisen as a result ofimplementing IFRS although the net impact on profit has not been material withprofit for the year after tax in 2004 increasing from £177m under UK GAAP to£180m under IFRS. The impact on equity has been to increase equity at 1 January2004 from £1,965m under UK GAAP to £2,292m under IFRS. The main change in equityhas been the reclassification of £299m of STICS from debt to equity. The financial information set out above does not constitute the company'sstatutory accounts for the years ended 31 December 2005 or 2004. Statutoryaccounts for 2004, which were prepared under UK GAAP, have been delivered to theregistrar of companies. The auditors have reported on the 2004 accounts; theirreport was unqualified and did not contain a statement under section 237(2) or(3) of the Companies Act 1985. The statutory accounts for 2005, which are beingprepared under accounting standards adopted by the EU will be finalised on thebasis of the financial information presented by the directors in thispreliminary announcement and will be delivered to the registrar of companies indue course. 2. Segmental information (a) Summary Segment information is presented in respect of the Group's business. Thedirectors consider that the primary format, business segments, is based on theGroup's management and internal reporting structure. Inter-segment pricing is determined on an arm's length basis. Segment results,assets, and liabilities, include items directly attributable to a segment, aswell as those that can be allocated on a reasonable basis. Segment capitalexpenditure includes purchases of property and equipment, investment propertiesand intangible assets. (b) Business segments (primary segment) The Group comprises the following main business segments: • UK Life & Pensions (including corporate items) • International Life & Pensions • Asset Management (i) Revenue and expenses Year ended 31 December 2005 Elimination International of inter UK Life & Life Asset segment Pensions & Pensions Management amounts Total £m £m £m £m £mGross earned premiums 969 8 - - 977Less premiums ceded toreinsurers (56) - - - (56)Net earned premiums 913 8 - - 921Fee and commissionincome and income fromservice activities 116 124 276 (33) 483Investment income 5,191 921 175 - 6,287Total revenue 6,220 1,053 451 (33) 7,691Net claims and benefitspaid 1,528 4 - - 1,532Movement in insurance andinvestment contractliabilities 3,291 888 157 - 4,336Transfer to fund for futureappropriations 187 - - - 187Movement in net assetsattributable to unitholders 136 - - - 136Acquisition expenses 207 67 11 - 285Administrative andother expenses 326 96 370 (33) 759Total allocated claims,benefits andexpenses 5,675 1,055 538 (33) 7,235Segmental results 545 (2) (87) - 456Inter segmentrevenue/(expense) (33) - 33 - -Finance costs (89)Share of profit aftertax ofassociates and jointventure -Policyholder tax (218)Shareholder tax 40Profit after tax fromcontinuing operations 189 Discontinued operations are shown in note 13 and the profit after tax amountedto £8m. Year ended 31 December 2004 Elimination International of inter UK Life & Life Asset segment Pensions & Pensions Management amounts Total £m £m £m £m £mGross earned premiums 970 7 - - 977Less premiums ceded toreinsurers (50) - - - (50)Net earned premiums 920 7 - - 927Fee and commission incomeand income fromservice activities 103 80 153 (35) 301Investment income 2,928 118 105 - 3,151Total revenue 3,951 205 258 (35) 4,379Net claims and benefitspaid 1,469 1 - - 1,470Movement in insurance andinvestment contractliabilities 1,625 138 90 - 1,853Transfer to fund for futureappropriations 42 - - - 42Movement in net assetsattributable to unitholders 71 - - - 71Acquisition expenses 152 47 5 - 204Administrative andother expenses 334 17 152 (35) 468Total allocated claims,benefitsand expenses 3,693 203 247 (35) 4,108Segmental results 258 2 11 - 271Inter segmentrevenue/(expense) (35) - 35 - -Finance costs (50)Share of profit after taxof associates andjoint venture -Policyholder tax (98)Shareholder tax 39Profit after tax fromcontinuing operations 162 Discontinued operations are shown in note 13 and the profit after tax amountedto £18m. (ii) Assets and liabilities Year ended 31 December 2005 UK International Elimination of Life & Life & Asset inter segment Pensions Pensions Management amounts Total £m £m £m £m £mSegment assets 38,586 9,766 1,936 (216) 50,072Investments inassociatesand joint venture 14 - - - 14Total assets 38,600 9,766 1,936 (216) 50,086Total liabilities 36,163 8,974 1,225 (216) 46,146 Year ended 31 December 2004 UK International Elimination of Life & Life & Asset inter segment Pensions Pensions Management amounts Total £m £m £m £m £mSegment assets 33,340 2,737 2,035 (212) 37,900Investments inassociates andjoint venture - - 5 - 5Total assets 33,340 2,737 2,040 (212) 37,905Total liabilities 31,092 2,602 1,625 (212) 35,107 3. Non-recurring items Non-recurring items borne by shareholders 2005 2004 £m £mClosure of direct sales operation (i) - 2Life & Pensions integration costs (ii) 6 9Provision for past sales (iii) 7 14Gross up for shareholder tax - 7Life & Pensions non-recurring items 13 32Asset Management integration costs (iv) 24 19Asset Management Reinvestment Plan costs (v) 22 4Asset Management non-recurring items 46 23Total non-recurring items 59 55 (i) The charge of £nil (2004: £2m) represents expenses relating to thereorganisation of the Appointed Representatives sales channel. (ii) Costs of £6m (2004: £9m) have been incurred relating to integrationactivity following the acquisition of Friends Provident International Limited(FPI) in August 2002. (iii) A total of £14m (2004: £30m) has been charged in respect of the cost toshareholders of mortgage endowment complaints and historic business reviews.This is offset by a credit of £7m (2004: £16m) in respect of the reviewconducted into pension transfers and opt-outs. (iv) Asset Management integration costs include £22m (2004: £18m) which wereincurred integrating, rationalising and reorganising the Asset Managementbusiness following the acquisition of F&C Group (Holdings) Limited. (v) The charge of £22m (2004: £4m) represents the cost of issuing shares toemployees under the 2004 Reinvestment Plan. 4. Staff pension schemes (a) Introduction The Group operates several defined benefit schemes: the Friends ProvidentPension Scheme (FPPS), to which the majority of the Group's UK Life & Pensionsemployees belong, and various schemes operated by F&C. In addition, the Groupoperates two defined contribution schemes: the scheme operated by F&C and thescheme operated by FPI. Lombard does not operate a pension scheme. (b) Total schemes Under IAS 19 Employee Benefits, the pension liability is recognised inprovisions in the balance sheet and has been grossed up for deferred tax. Themarket value of the scheme's assets exclude units held in the internal linkedfunds (classified as non-transferable assets). This presentation has no impacton shareholders' equity as the internal investment contract liability is alsoexcluded. However, non-transferable assets are taken into account in determiningthe pension liability in the actuarial valuation. A reconciliation of the Grouppension liability included in the consolidated balance sheet and the net pensionliability as determined by actuarial valuations is set out below. 2005 2004 £m £mDeficit in the FPPS scheme (59) (41)Deficit in the F&C schemes (48) (18)Group pension liability included in provisions (107) (59)Non-transferable assets 40 34Deferred tax 20 7Net pension liability (47) (18)Analysis of net pension liabilityFPPS (13) (5)F&C (34) (13)Net pension liability (47) (18)Amounts recognised in the income statementFPPS scheme (17) (9)F&C schemes (4) (2) (21) (11)Amounts recognised in the statement ofrecognised income and expense FPPS scheme (9) (6)F&C schemes (31) (3)Deferred tax 12 1 (28) (8) (c) Friends Provident Pension Scheme The FPPS is a UK defined benefit scheme to which the majority of the Group's UKLife & Pensions employees belong. The scheme's assets are administered by F&C. (i) Major assumptions used by the Scheme Actuary 2005 2004 % % Inflation assumption 2.85 2.90 Rate of increase in salaries* 3.50 3.50 Rate of increase in pensions in payment 2.70 2.75 Discount rate 4.75 5.50 * Plus allowance for salary scale increases (ii) Mortality assumptions To recognise the increasing longevity of pensioners, the mortality assumptionbasis was changed to the medium cohort basis for 2005. 'Medium' relates to threescenario tables produced by the Continuous Mortality Investigation Bureau of theInstitute of Actuaries to reflect the uncertainty of future longevity experienceof annuitants; 'short', 'medium', and 'long', which vary based on how long theimprovements in mortality are projected to last. 'Cohort' refers to the ideasuggested by some surveys that mortality varies by year of birth. With respectto FPPS the mortality assumptions are projected forward, to take account offuture improvements in mortality, according to each individual's year of birth. For 2004, the PM/FA92 tables were used for mortality assumptions. The tables,published in 1999, are based on investigations carried out between 1991 and1994. With respect to FPPS these are projected forward, to take account offuture improvements in mortality, to 2040 for all future pensioners and 2010 forall current pensioners. For future pensioners the projections are rated down oneyear. The cost of strengthening mortality assumptions in 2005 to the medium cohortbasis was £35m. The mortality assumptions provide the following life expectancies of membersretiring at the age of 60: +-------------------------------------------+-------------------+-----------------+| | 2005 | 2004 |+-------------------------------------------+-------------------+-----------------+|Life expectancy | | |+-------------------------------------------+-------------------+-----------------+|Basis - future pensioners | PM/FA92BMC* | PM/FA92C2040-1 |+-------------------------------------------+-------------------+-----------------+|Basis - current pensioners | PM/FA92BMC* | PM/FA92C2010 |+-------------------------------------------+-------------------+-----------------+|Expected age at death of future male | 88 | 87 ||pensioner | | |+-------------------------------------------+-------------------+-----------------+|Expected age at death of future female | 90 | 90 ||pensioner | | |+-------------------------------------------+-------------------+-----------------+|Expected age at death of current male | 87 | 84 ||pensioner | | |+-------------------------------------------+-------------------+-----------------+|Expected age at death of current female | | |+-------------------------------------------+-------------------+-----------------+|pensioner | 90 | 87 |+-------------------------------------------+-------------------+-----------------+* projected according to individual's year of birth (d) F&C Asset Management plc pension schemes The assumptions used for the F&C Pension schemes are broadly consistent withthose used for FPPS. The total deficit on these schemes was £48m after allowingfor a strengthening of the mortality assumption in 2005 to the medium cohortbasis at a cost of £18m. 5. Appropriations of profit (a) Dividends paid and proposed on ordinary shares Dividends paid during the year and recognised in reserves +---------------------------------------------------+------------+-----------------+| | 2005 | 2004 |+---------------------------------------------------+------------+-----------------+| | £m | £m |+---------------------------------------------------+------------+-----------------+|Final dividend in respect of 2004 and paid in May | | |+---------------------------------------------------+------------+-----------------+|2005 of 5.0p per share (in respect of 2003 and paid| | |+---------------------------------------------------+------------+-----------------+|in May 2004 of 4.9p per share) | 103 | 84 |+---------------------------------------------------+------------+-----------------+|Interim dividend in respect of 2005 and paid in | | |+---------------------------------------------------+------------+-----------------+|November 2005 of 2.6p per share (in respect of 2004| | |+---------------------------------------------------+------------+-----------------+|and paid in November 2004 of 2.55p per share) | 54 | 50 |+---------------------------------------------------+------------+-----------------+|Total dividends paid | 157 | 134 |+---------------------------------------------------+------------+-----------------+ After the balance sheet date the dividends set out below were proposed by thedirectors. In accordance with IAS 10 these have not been provided as a liabilityat the balance sheet date. +---------------------------------------------------+---------+--------------------+| | 2005 | 2004 |+---------------------------------------------------+---------+--------------------+| | £m | £m |+---------------------------------------------------+---------+--------------------+|Final dividend in respect of 2005 payable in May | | |+---------------------------------------------------+---------+--------------------+|2006 of 5.10p per share (in respect of 2004 paid in| | |+---------------------------------------------------+---------+--------------------+|May 2005 of 5.00p per share) | 107 | 103 |+---------------------------------------------------+---------+--------------------+ The 2005 final dividend is based on 2,099m shares in issue. The 2004 finaldividend was based on 2,057m shares which included the 113m shares issued on 11January 2005 in respect of the Lombard acquisition. (b) STICS interest STICS interest paid during the year and recognised in reserves +---------------------------------------------------+---------+--------------------+| | 2005 | 2004 |+---------------------------------------------------+---------+--------------------+| | £m | £m |+---------------------------------------------------+---------+--------------------+|Interest on 2003 STICS at 6.875% | | |+---------------------------------------------------+---------+--------------------+|Paid in May 2005 (May 2004) | 10 | 10 |+---------------------------------------------------+---------+--------------------+|Paid in November 2005 (November 2004) | 11 | 11 |+---------------------------------------------------+---------+--------------------+|Total interest paid | 21 | 21 |+---------------------------------------------------+---------+--------------------+ 6. Earnings per share (a) Basic and underlying earnings per share from continuing operations Earnings per share have been calculated based on the profit after tax and on theunderlying profit after tax, attributable to ordinary shareholders' of theparent. The directors believe that the underlying earnings per share figuregives a better indication of operating performance. +-------------------------------------+----------+----------+----------+----------+| | 2005| 2005| 2004| 2004|| | | | | |+-------------------------------------+----------+----------+----------+----------+| | Earnings| Per share| Earnings| Per share|| | | | | |+-------------------------------------+----------+----------+----------+----------+| | £m| pence| £m| pence|| | | | | |+-------------------------------------+----------+----------+----------+----------+|Profit after tax attributable to | | | | ||ordinary | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|shareholders of the parent | 132 | 6.3 | 143 | 7.9 || | | | | |+-------------------------------------+----------+----------+----------+----------+|Short-term fluctuations in investment| (102)| (4.9)| (27)| (1.5)||return | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|Variation in value of option on | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|convertible debt | 9 | 0.4 | 10 | 0.6 || | | | | |+-------------------------------------+----------+----------+----------+----------+|Non-recurring items | 59 | 2.8 | 55 | 3.0 || | | | | |+-------------------------------------+----------+----------+----------+----------+|Amortisation and impairment of | | | | ||acquired | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|intangible assets | 203 | 9.8 | 31 | 1.7 || | | | | |+-------------------------------------+----------+----------+----------+----------+|Minority interest on items excluded | | | | ||from | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|underlying profit | (72)| (3.4)| (14)| (0.8)|| | | | | |+-------------------------------------+----------+----------+----------+----------+|Tax credit on items excluded from | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|underlying profit | (46)| (2.2)| (11)| (0.6)|| | | | | |+-------------------------------------+----------+----------+----------+----------+|Underlying profit after tax | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|attributable to ordinary | | | | || | | | | |+-------------------------------------+----------+----------+----------+----------+|shareholders of the parent | 183 | 8.8 | 187 | 10.3 || | | | | |+-------------------------------------+----------+----------+----------+----------+ +------------------------------------------------+-----------+--------------------+| | 2005 | 2004 || | | |+------------------------------------------------+-----------+--------------------+| | millions | millions || | | |+------------------------------------------------+-----------+--------------------+|Weighted average number of ordinary shares | 2,082 | 1,808 || | | |+------------------------------------------------+-----------+--------------------+ (b) Earnings per share from discontinued operations Discontinued operations have no impact on profit after tax attributable toequity holders. Earnings per share from discontinued operations is therefore£nil. 7. Intangible assets +----------------------------+-----------+---------+-------------+-------+--------+| | | | Investment | | |+----------------------------+-----------+---------+-------------+-------+--------+| | |Acquired | management | | |+----------------------------+-----------+---------+-------------+-------+--------+| | Goodwill | PVIF | contracts | Other | Total |+----------------------------+-----------+---------+-------------+-------+--------+| | £m | £m | £m | £m | £m |+----------------------------+-----------+---------+-------------+-------+--------+|Cost | | | | | |+----------------------------+-----------+---------+-------------+-------+--------+|At 1 January 2004 | 348 | 264 | 106 | 67 | 785 |+----------------------------+-----------+---------+-------------+-------+--------+|Acquisitions through | | | | | ||business | | | | | |+----------------------------+-----------+---------+-------------+-------+--------+|combinations | 268 | - | 517 | - | 785 |+----------------------------+-----------+---------+-------------+-------+--------+|Other additions | - | - | - | 15 | 15 |+----------------------------+-----------+---------+-------------+-------+--------+|Disposals | (30)| - | (2)| - | (32)|+----------------------------+-----------+---------+-------------+-------+--------+|Foreign exchange adjustments| - | - | 5 | - | 5 |+----------------------------+-----------+---------+-------------+-------+--------+|At 31 December 2004 | 586 | 264 | 626 | 82 | 1,558 || | | | | | |+----------------------------+-----------+---------+-------------+-------+--------+|Acquisitions through | | | | | ||business | | | | | |+----------------------------+-----------+---------+-------------+-------+--------+|combinations | 151 | 230 | - | 109 | 490 |+----------------------------+-----------+---------+-------------+-------+--------+|Other additions | 6 | - | 1 | 14 | 21 |+----------------------------+-----------+---------+-------------+-------+--------+|Disposals | (68)| - | - | (7)| (75)|+----------------------------+-----------+---------+-------------+-------+--------+|Foreign exchange adjustments| 2 | (10)| (7)| (3)| (18)|+----------------------------+-----------+---------+-------------+-------+--------+|At 31 December 2005 | 677 | 484 | 620 | 195 | 1,976|+----------------------------+-----------+---------+-------------+-------+--------+|Amortisation and impairment | | | | | |+----------------------------+-----------+---------+-------------+-------+--------+|At 1 January 2004 | - | 77 | 15 | 29 | 121 |+----------------------------+-----------+---------+-------------+-------+--------+|Amortisation charge for year| - | 10 | 21 | 18 | 49 |+----------------------------+-----------+---------+-------------+-------+--------+|Impairment charge | - | - | - | - | - |+----------------------------+-----------+---------+-------------+-------+--------+|At 31 December 2004 | - | 87 | 36 | 47 | 170 |+----------------------------+-----------+---------+-------------+-------+--------+|Amortisation charge for year| - | 28 | 56 | 25 | 109 |+----------------------------+-----------+---------+-------------+-------+--------+|Impairment charge | - | - | 112 | - | 112 |+----------------------------+-----------+---------+-------------+-------+--------+|Disposals | - | - | - | (5)| (5)|+----------------------------+-----------+---------+-------------+-------+--------+|At 31 December 2005 | - | 115 | 204 | 67 | 386 |+----------------------------+-----------+---------+-------------+-------+--------+| | | | | | |+----------------------------+-----------+---------+-------------+-------+--------+|Carrying amounts | | | | | |+----------------------------+-----------+---------+-------------+-------+--------+|At 1 January 2004 | 348 | 187 | 91 | 38 | 664 |+----------------------------+-----------+---------+-------------+-------+--------+|At 31 December 2004 | 586 | 177 | 590 | 35 | 1,388 |+----------------------------+-----------+---------+-------------+-------+--------+|At 31 December 2005 | 677 | 369 | 416 | 128 | 1,590 |+----------------------------+-----------+---------+-------------+-------+--------+ (a) Goodwill Goodwill is the only intangible asset which has an indefinite useful life. Thegoodwill allocated to each business segment is as follows:+-----------------------------------------------------------------+-------+--------+| | 2005 | 2004 |+-----------------------------------------------------------------+-------+--------+| | £m | £m |+-----------------------------------------------------------------+-------+--------+|UK Life & Pensions | 193 | 259 |+-----------------------------------------------------------------+-------+--------+|International Life & Pensions | 151 | - |+-----------------------------------------------------------------+-------+--------+|Asset Management | 333 | 327 |+-----------------------------------------------------------------+-------+--------+|Total goodwill | 677 | 586 |+-----------------------------------------------------------------+-------+--------+ In accordance with IAS 36 Impairment of assets, goodwill is assessed forpossible impairment each year. This assessment takes place in December of eachyear and compares the carrying value of goodwill for each segment with itsrecoverable amount. The recoverable amount has been taken to be the segment'scalculated value in use. There has been no goodwill impairment charge in 2005 (2004: £nil). The value in use for UK Life & Pensions and International Life & Pensions(Lombard) has been taken from their business plans and represents the presentvalue of future cash flows expected to arise from the continuing use of thepolicies in force. These business plans include forecast sales of new businessfor three years and other assumptions that take into account both pastexperience and market conditions. The key assumptions to which the calculatedvalues in use are most sensitive are set out below: • Investment market conditions: the plans assume modest investment growth. • Policy lapses: the plans assume no change from recent experience. • Sales and margins: the plans assume a modest reduction in margins but an increasing level of sales. • Expenses: the plans assume that expenses will broadly increase in line with inflation. The outcome of the impairment assessment has been that it is considered unlikelythat goodwill in respect of UK Life & Pensions would be impaired given that thevalue in use is significantly higher than the carrying value of goodwill. ForLombard, acquired in January 2005, the levels of new business have indicatedthat there is no requirement for any impairment of goodwill. For the Asset Management segment, the value in use is calculated using a cashflow projection based on the latest annual financial budget approved by theBoard of F&C Asset Management plc. The projection covers a 20-year periodreflecting the long-term nature of business and indefinite life of goodwill. TheAsset Management segment is operated as a single group and so a single value inuse has been prepared. The key assumptions to which the calculated values in useare most sensitive are set out below: • Investment market conditions: the plans assume modest investment growth • Sales and margins: the plans assume modest sales and margin growth although operating margins have been capped as a measure of prudence. • Discount rate: the discount rate applied to the cash flow projections is 8.9% based on F&C's weighted average cost of capital • Expenses: the plans assume cost growth in excess of inflation recognising the impact of staff costs. The outcome of the impairment review is that there is no requirement for anyimpairment of goodwill in the Asset Management segment. In addition, the fair value of the Group's holding in F&C Asset Management plc,at 31 December 2005, based on the quoted bid price of F&C's listed ordinaryshares was £441m. This was in excess of the carrying value of the Group'sholding in the Asset Management business at this date. (b) Acquired PVIF Acquired PVIF is amortised over the lifetime of the in-force policies and isanalysed as follows: +---------------------------+----------------------------+-----------------------------+| | 2005 | 2004 |+---------------------------+-------+-------------+------+-------+--------------+------+| | Cost| Amortisation| Net| Cost| Amortisation| Net|+---------------------------+-------+-------------+------+-------+--------------+------+| | £m| £m| £m| £m| £m| £m|+---------------------------+-------+-------------+------+-------+--------------+------+|UK Life & Pensions | 187 | 91 | 96 | 190| 84| 106|+---------------------------+-------+-------------+------+-------+--------------+------+|International Life & | 297 | 24 | 273 | 74| 3| 71||Pensions | | | | | | |+---------------------------+-------+-------------+------+-------+--------------+------+|Total acquired PVIF | 484 | 115 | 369 | 264| 87| 177|+---------------------------+-------+-------------+------+-------+--------------+------+ Management have assessed acquired PVIF for possible impairment and there is noindication that it has been impaired. (c) Investment management contracts Investment management contracts relate to the Asset Management segment and areamortised over their expected useful economic lives of between 10 and 20 years. During 2005, due to indifferent investment performance in some areas of theAsset Management business as well as other clients of F&C withdrawing funds forstrategic reasons following changes in their own corporate structure, the AssetManagement business experienced a level of fund outflows which was higher thananticipated and led to net new business targets not being met. This level oflost business has had a notable impact on revenues and was significant enough tobe considered an indicator of potential impairment of certain intangible assets,namely the related investment management contracts. In accordance with IAS 36, a full impairment review of these assets wasundertaken. The review resulted in the impairments being recognised (includedwithin Administrative and other expenses in the income statement) in respect ofinvestment management contracts as follows: 2005 2004 £m £mF&C Investment Trust contracts 56 -F&C Institutional contracts 56 -Total impairment recognised in the Income 112 -Statement The above contracts relate to the investment trust management contracts andinstitutional fund management contracts acquired as a result of the creation ofF&C Asset Management plc following the business combination of ISIS AssetManagement plc and F&C Group (Holdings) Limited on 11 October 2004, afterrestating the accounts to comply with IFRS. The recoverable amounts of the assets have been determined based on value in usecalculations using cash flow projections based on the latest annual financialbudget approved by the F&C board. The discount rate applied to the cash flow projections is 9.4% for investmenttrust contracts, 9.4% for institutional contracts with no fixed term, and 8.4%for fixed term institutional contracts. These rates reflect the varying risksand uncertainties inherent in the underlying revenues, using F&C's weightedaverage cost of capital of 8.9%, calculated as at 31 December 2005, as abenchmark. Revenues in the projections have been grown at 6% per annum in respect of F&C'slong-term view of market growth, which is consistent with that experienced overthe longer term across the markets in which the managed assets are invested. Therevenue projections also incorporate an estimated loss rate of 5% per annumcompounded over the projected period in respect of investment trusts, and 14%per annum for institutional contracts with no fixed term. Costs for the first year of the projections are driven by the budgeted F&Coperating margin for 2006 of 40%. Thereafter costs are driven by the overallbusiness projected margins consistent with combined anticipated future inflationand salary increases of 3.5%, with the margin capped at 45% as a measure ofprudence, based on historical performance. Impairment has been determined by comparing the results of the value in usecalculations in respect of the remaining contracts at the year-end to thecarrying value (cost less aggregate amortisation) of the assets at 31 December2005, with any deficits arising constituting impairment to be recognised for theyear. There were no indicators of potential impairment of intangible assets withfinite lives in respect of the comparative period, and as such, no impairmentreview was performed for 2004. (d) Other intangible assets Other intangible assets mainly consist of distribution channel relationships andsoftware development which are amortised over their anticipated useful lives ofbetween 3 and 15 years. The analysis for each segment is as follows: +---------------------------+-----------------------------+---------------------------+| | 2005 | 2004 |+---------------------------+-------+-------------+-------+------+-------------+------+| | Cost| Amortisation| Net| Cost| Amortisation| Net|+---------------------------+-------+-------------+-------+------+-------------+------+| | £m| £m| £m| £m| £m| £m|+---------------------------+-------+-------------+-------+------+-------------+------+|UK Life & Pensions | 77| 54| 23| 68| 41| 27|+---------------------------+-------+-------------+-------+------+-------------+------+|International Life & | 114| 11| 103| 9| 2| 7||Pensions | | | | | | |+---------------------------+-------+-------------+-------+------+-------------+------+|Asset Management | 4| 2| 2| 5| 4| 1|+---------------------------+-------+-------------+-------+------+-------------+------+|Total other | | | | | | |+---------------------------+-------+-------------+-------+------+-------------+------+|intangible assets | 195| 67| 128| 82| 47| 35|+---------------------------+-------+-------------+-------+------+-------------+------+ Included in amortisation is £7m (2004: £nil) in respect of Life & Pensionsacquired intangible assets. Management have assessed other intangible assets for possible impairment andthere is no indication that they have been impaired. 8. Realistic balance sheet The Group has two UK with-profits funds. The main UK with-profits fund is inFPLP and the capital position of this fund has been determined in accordancewith the RBS regulations prescribed by the FSA. There is also a small UKwith-profits fund in FPLA. The capital position of this fund has been calculatedon the existing regulatory basis as this fund is closed, and is significantlybelow the £500m level that the FSA has determined should be applied forcalculating liabilities under the realistic methodology. The RBS for FPLP's with-profits business can be summarised as follows: 2005 2004 £m £mTotal net assets 17,366 16,528Less non-profit liabilities including share of resiliencecapitalreserve and required minimum margin (2,774) (2,636) Total regulatory assets 14,592 13,892Additional assets arising on realistic basis 253 249Total assets 14,845 14,141Policyholder liabilities:asset shares 12,342 12,011financial guarantees (net of charges) 149 222options (guaranteed annuities) 796 736Other liabilities 1,322 1,041Total liabilities 14,609 14,010Excess of assets over liabilities 236 131 The amount of realistic assets for FPLP's With Profits Fund at 31 December 2005amounted to £14,845m (2004: £14,141m) and the amount of realistic liabilities(including options and guarantees) amounted to £14,609m (2004: £14,010m). Thisresults in an excess of realistic assets over realistic liabilities of £236m(2004: £131m). Adding back the shareholders' share of future bonuses totalling£85m (2004: £58m) and deducting adjustments to eliminate double counting ofacquired PVIF of £20m (2004: £16m), the excess in accordance with FRS 27amounted to £301m (2004: £173m). The main element of the realistic liabilities is the asset shares ofwith-profits business. This represents the premiums received to date togetherwith the investment return earned less expenses and charges. This is mainlycalculated on an individual policy basis using historic information and in linewith the company's PPFM. Asset shares are closely matched since they move withthe value of the underlying assets. Policyholder liabilities (including options and guarantees) are then valuedusing a market consistent stochastic model. Included in other liabilities areprovisions for specific items such as mortgage endowment reviews and otherliabilities of the fund. Realistic valuations also allow for future profits ofnon-profit business written in the With Profits Fund to be included. Options and guarantees are features of life assurance and pensions contractsthat confer potentially valuable benefits to policyholders. They are not uniqueto with-profits funds and can arise in non-participating funds. They expose aninsurance company to two types of risk: insurance (such as mortality/morbidity)and financial (such as market prices/interest rates). The value of an option orguarantee comprises two elements: the intrinsic value and the time value. Theintrinsic value is the amount that would be payable if the option or guaranteewas exercised immediately. The time value is the additional value that reflectsthe possibility of the intrinsic value increasing in future, before the expiryof the option or guarantee. Under FSA rules all options and guarantees must bevalued and included in policyholder liabilities. For funds within the FSA'srealistic capital methodology, options and guarantees are valued on amarket-consistent stochastic basis. For other funds, options and guarantees arevalued on a deterministic basis. The majority of the Group's life and pensions options and guarantees are withinFPLP's With Profits Fund. These are valued stochastically and included in therealistic liabilities. There are two main types of guarantees and options in theFPLP With Profits Fund: maturity guarantees and guaranteed annuity options.Maturity guarantees are in respect of conventional with-profits business andrepresent the sum assured and reversionary bonuses declared to date. The cost ofthese guarantees has been calculated at £427m (2004: £533m). For certainwith-profits pension policies issued, there are options that guarantee rates atwhich annuities can be purchased. The cost of these guarantees has beencalculated at £796m (2004: £736m). The cost of the with-profits guarantees is assessed using a market-consistentstochastic model (using The Smith Model as the scenario generator) and iscalculated using 5,000 simulations. The model has been calibrated using the giltrisk-free curve assuming interest rates of between 4.0% and 4.2% (2004: between4.4% and 4.6%), implied volatilities in the market and the capital return iscalibrated to the actual asset portfolio. For equities, a capital returnvolatility of 21% pa (2004: 16%) has been assumed in year 7, increasing to 24%pa (2004: 20%) by year 14, and 26% pa (2004: 23%) by year 21. Volatility forproperty returns has been assumed at 15% pa throughout (2004: 15%). The cost of guarantees also depends on management actions that would be takenunder various scenarios. For example, the future level of the equity backingratio (the ratio of funds held in equities and property to total investments)varies in each scenario depending on the ratio of the guarantee cost to theasset share. Similarly, the reversionary bonus rate is set each year such that,by maturity, guaranteed benefits are targeted as a prescribed fraction of thetotal asset share, leaving the remaining portion of the asset share to be paidas terminal bonus. The management actions are in line with the company's PPFMand are programmed into the model. The guarantee cost in respect of guaranteed annuity options is assessed using amarket-consistent stochastic model and values both the current level of theguaranteed annuity rate benefit (allowing for future improvements in annuitantmortality) and the time value due to uncertainty in future interest rates. Theguarantee cost in each scenario is the value of the excess annuity benefitprovided by the options, relative to an annuity purchased in the open market. Inestimating the future open market annuity rate, the model allows for stochasticvariation in interest rates and for future mortality improvements. Thestochastic interest rate assumption reflects that implied by current marketinterest rate derivative prices. Future annuitant mortality has been derivedfrom an analysis of recent operating experience informed by industry studieswith allowance for annuitant mortality improvements. Future improvements aredifficult to assess as there is no industry consensus. Short, medium and longcohort terminology refers to commonly accepted terms of the rate of futureimprovements, and the period over which those improvements are expected tooccur. In general, the medium cohort for realistic reporting has been adopted. The guaranteed annuity options cost also depends upon other factors such aspolicy discontinuance and tax-free cash take-up. The factors are based on recentexperience adjusted to reflect industry benchmarks and to anticipate trends inpolicyholder behaviour. A summary of the other key assumptions is as follows:Policy discontinuances: lapse, early retirement and paid-up rates vary by policytype and period, and have been based on recent experience. Policy lapses forpensions are generally in the range of 0.5% to 2% pa with policy lapses for lifebusiness in the range of 3% to 9% pa (13% for mortgage endowment policies).Paid-up rates for pensions are generally in the range of 7.5% to 10% pa withlife policies generally in the region of 1% pa. These assumptions are unchangedfrom 2004. Early retirement rates vary by age band and policy type and have beenreviewed and amended in 2005 based on recent experience. Tax-free cash option: where a guaranteed annuity option is more valuable thanthe cash equivalent it is assumed that 18%-25% of the benefit is taken astax-free, depending on type of business (2004: 17% for all types of business).This is based on recent experience. There are also guarantees and options in respect of the Group's other lifeassurance business, but these are not considered to be material to the Group'sfuture cash flows. In addition, they have largely been matched with suitableassets and there is no material exposure to market or interest rate changes.Provisions have been established using deterministic scenarios based on prudentassumptions. 9. Capital statement The capital statement in respect of the Group's Life & Pensions business is setout below. This statement shows an analysis of the available capital resourcescalculated on a realistic basis for the FPLP With Profits Fund and on aregulatory basis for all other funds. It also shows the regulatory capitalrequirements and, in total, the overall surplus capital over regulatoryrequirements. In addition the statement provides an analysis of policyholders'liabilities. At 31 December 2005 +--------------------+--------+--------+--------------+---------+-------------+---------+| | UK | UK | |Overseas | Life & | Total |+--------------------+--------+--------+--------------+---------+-------------+---------+| | with- | with- | UK non- | Life & | Pensions | Life & |+--------------------+--------+--------+--------------+---------+-------------+---------+| |profits |profits |participating |Pensions |shareholders'|Pensions |+--------------------+--------+--------+--------------+---------+-------------+---------+| | (FPLP)| (FPLA)| funds | funds | funds |business |+--------------------+--------+--------+--------------+---------+-------------+---------+| | £m | £m | £m | £m | £m | £m |+--------------------+--------+--------+--------------+---------+-------------+---------+|Shareholders' funds | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Outside fund | - | - | - | - | 951 | 951 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Inside fund | - | - | 1,149 | 13 | - | 1,162 |+--------------------+--------+--------+--------------+---------+-------------+---------+| | - | - | 1,149 | 13 | 951 | 2,113 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Other qualifying | | | | | | ||capital | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Subordinated debt | - | - | - | 10 | - | 10 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Preference shares | - | - | - | - | 300 | 300 |+--------------------+--------+--------+--------------+---------+-------------+---------+|FFA | 301 | 119 | - | - | - | 420 |+--------------------+--------+--------+--------------+---------+-------------+---------+| | 301 | 119 | 1,149 | 23 | 1,251 | 2,843 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Regulatory | | | | | | ||adjustments | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Assets | 20 | (1)| (610)| (228)| (8)| (827)|+--------------------+--------+--------+--------------+---------+-------------+---------+|Liabilities | - | - | 275 | 261| - | 536 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Shareholders' share | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+| of future | (85)| - | - | - | - | (85)||bonuses | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Total available | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|capital resources | 236 | 118| 814 | 56 | 1,243 | 2,467 |+--------------------+--------+--------+--------------+---------+-------------+---------+| | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Capital requirement | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|UK realistic basis | 276 | - | - | - | - | 276 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Other regulatory | - | 17 | 332 | 29 | - | 378 ||bases | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+| | 276 | 17 | 332 | 29 | - | 654 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Overall surplus | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|capital over | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|regulatory | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|requirements | | | | | | 1,813 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Analysis of | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|policyholders' | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|liabilities | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|With-profits | 13,519 | 243 | - | - | - | 13,762 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Unit-linked | - | - | 13,853 | 8,871 | - | 22,724 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Non-participating | 2,783 | 39 | 3,128 | 58 | - | 6,008 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Total technical | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|liabilities | 16,302 | 282 | 16,981 | 8,929 | - | 42,494 |+--------------------+--------+--------+--------------+---------+-------------+---------+ At 31 December 2004+--------------------+--------+--------+--------------+---------+-------------+---------+| | UK | UK | |Overseas | Life & | Total |+--------------------+--------+--------+--------------+---------+-------------+---------+| | with- | with- | UK non- | Life & | Pensions | Life & |+--------------------+--------+--------+--------------+---------+-------------+---------+| |profits |profits |participating |Pensions |shareholders'|Pensions |+--------------------+--------+--------+--------------+---------+-------------+---------+| | (FPLP)| (FPLA)| funds | funds | funds |business |+--------------------+--------+--------+--------------+---------+-------------+---------+| | £m | £m | £m | £m | £m | £m |+--------------------+--------+--------+--------------+---------+-------------+---------+|Shareholders' funds | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Outside fund | - | - | - | - | 355 | 355 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Inside fund | - | - | 1,126 | 36 | - | 1,162 |+--------------------+--------+--------+--------------+---------+-------------+---------+| | - | - | 1,126 | 36 | 355 | 1,517 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Other qualifying | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|capital | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Subordinated debt | - | - | 215 | - | - | 215 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Preference shares | - | - | - | - | 300 | 300 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Implicit items | - | - | 110 | - | - | 110 |+--------------------+--------+--------+--------------+---------+-------------+---------+|FFA | 174 | 82 | - | - | - | 256 |+--------------------+--------+--------+--------------+---------+-------------+---------+| | 174 | 82 | 1,451 | 36 | 655 | 2,398 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Regulatory | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|adjustments | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Assets | 15 | (2)| (549)| (198)| (6)| (740)|+--------------------+--------+--------+--------------+---------+-------------+---------+|Liabilities | - | 2 | 244 | 191| - | 437 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Shareholders' share | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+| of future | (58)| - | - | - | - | (58)||bonuses | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Total available | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|capital resources | 131 | 82 | 1,146 | 29 | 649 | 2,037 |+--------------------+--------+--------+--------------+---------+-------------+---------+| | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|Capital requirement | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|UK realistic basis | 279 | - | - | - | - | 279 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Other regulatory | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|bases | 253 | 33 | 264 | 6 | - | 556 |+--------------------+--------+--------+--------------+---------+-------------+---------+| | 532 | 33 | 264 | 6 | - | 835 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Overall surplus | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|capital over | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|regulatory | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|requirements | | | | | | 1,202 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Analysis of | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|policyholders' | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|liabilities | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|With-profits | 13,034 | 261 | - | - | - | 13,295 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Unit-linked | - | - | 10,787 | 2,356 | - | 13,143 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Non-participating | 2,595 | 36 | 2,929 | 50 | - | 5,610 |+--------------------+--------+--------+--------------+---------+-------------+---------+|Total technical | | | | | | |+--------------------+--------+--------+--------------+---------+-------------+---------+|liabilities | 15,629 | 297 | 13,716 | 2,406 | - | 32,048 |+--------------------+--------+--------+--------------+---------+-------------+---------+ 10. Movement in capital and reserves Equity attributable to equity holders of the parent Share Share Other Minority capital premium reserves STICS Total interest Total £m £m £m £m £m £m £mAt 1 January 2005 199 1,799 421 299 2,718 80 2,798Total recognised incomeandexpense for the year - - 107 37 144 17 161Dividends on equity shares - - (157) - (157) (29) (186)Interest paid on STICS - - - (21) (21) - (21)Appropriations of profit - - (157) (21) (178) (29) (207)Issue of share capital - - - - - - -Issue of STICS - - - 495 495 - 495Share based payments - 5 14 - 19 12 31Disposal of subsidiary - - - - - 54 54Change in participation insubsidiary - - - - - 42 42Allotment on acquisitionofLombard 15 234 - - 249 - 249Conversion option - - 51 - 51 - 51Property transfer into - - - - - 266 266trustAt 31 December 2005 214 2,038 436 810 3,498 442 3,940 Equity attributable to equity holders of the parent Share Share Other Minority capital premium reserves STICS Total interest Total £m £m £m £m £m £m £mAt 1 January 2004 172 1,446 376 299 2,293 (67) 2,226Total recognised incomeandexpense for the year - - 138 21 159 15 174Dividends on equity shares - - (134) - (134) (16) (150)Interest paid on STICS - - - (21) (21) - (21)Appropriations of profit - - (134) (21) (155) (16) (171)Issue of share capital 17 212 - - 229 - 229Share based payments 1 2 4 - 7 - 7Unclaimed shares ondemutualisation - 15 - - 15 - 15Allotment on acquisitionof F&C 9 124 - - 133 148 281Profit on deemed disposalof F&C - - 37 - 37 - 37At 31 December 2004 199 1,799 421 299 2,718 80 2,798 11. Contingent liabilities and commitments (a) Past sales The Group has made provision for the estimated cost of settling complaints inrespect of past sales. Although the provisions are regularly reviewed, the finaloutcome could be different from the provisions established as these costs cannotbe calculated with certainty and are influenced by external factors beyond thecontrol of management. Such uncertainties include future regulatory actions,media attention and investment performance. The majority of the uncertaintyrelates to endowment mortgages although a number of other products are beingreviewed as an ongoing process. It is expected that the majority of endowmentcases requiring compensation will be settled in the next two years. (b) VAT on investment trust management fees In a current European Court case, a UK investment trust is seeking to establishthat management services to UK investment trusts should be a VAT exempt supply,rather than a taxable supply in accordance with current UK VAT law. If this casewere successful, a number of group companies, in common with other relevant fundmanagers in the UK, would face claims from those investment trusts to which theyhave supplied services for repayment of the VAT they have charged to them. TheAITC (a party to the above litigation) has indicated that it believes claimsdating back as far as 1990 may be lodged with fund managers by investmenttrusts. Companies in the F&C group can submit repayment claims to HM Revenue &Customs, but only dating back as far as 2001, being the maximum time periodpermitted. The Group has begun to receive protective claims from a number of itsinvestment trust clients and has lodged protective claims with HM Revenue &Customs. At present, the directors of F&C are not able to judge the likelihoodthat the VAT court case will be successful, nor are they able to quantify theclaims that may be received or the extent to which such claims could bemitigated and therefore, are not able to quantify the potential liability. (c) F&C acquisition In December 2000, when Eureko BV acquired F&C Group (Holdings) Limited,approximately 73% of the ordinary issued shares of F&C Group Management Limited,a subsidiary company, were held in the form of two bearer share warrants whichcould not be located prior to the completion of the sale. Eureko BV wasindemnified by F&C Group (Holdings) Limited against any losses suffered as aresult of the loss of the old share warrants or the issue of replacement sharewarrants. Since a bearer share warrant issued by a company entitles the bearerto the shares specified in the share warrant, there is a risk that the thirdparty holding the old share warrants may claim that it is entitled to thespecified shares in F&C Group Management Limited. If a third party weresuccessful in establishing a claim in relation to the old share warrants, F&CGroup (Holdings) Limited could be liable to indemnify F&C Group ManagementLimited under the original indemnity arrangements, which could have a materialadverse effect on F&C's business, results of operations and/or financialcondition. Although there is a possibility that a third party may seek to establish that itis entitled to the shares specified in the old share warrants, the directors ofF&C have been informed that Eureko BV has been advised that the prospect of athird party succeeding in such a claim is remote. Under the terms of the 2004merger between ISIS and F&C, Eureko Holdings has given a specific indemnity(guaranteed by Eureko BV) to F&C in respect of losses arising in relation to thelost share warrants to bearer in F&C Group Management Limited (including inrespect of the indemnity granted by F&C Group (Holdings) Limited to F&C GroupManagement Limited) which is capped at approximately £432m. (d) Operating leases where the Group is lessee The Group leases a number of properties under operating leases. These leasestypically run for a period of 50 years, with an option of renewal at the end ofthe lease. Lease terms include annual escalation clauses to reflect currentmarket conditions. The future minimum rentals payable under non-cancellable leases are as follows: +----------------------------+---------+-------+-------+---------+--------+--------+| | | 2005| | | 2004| |+----------------------------+---------+-------+-------+---------+--------+--------+| | Land and| | | Land and| | |+----------------------------+---------+-------+-------+---------+--------+--------+| |buildings| Other| Total|buildings| Other| Total|+----------------------------+---------+-------+-------+---------+--------+--------+| | £m| £m| £m| £m| £m| £m|+----------------------------+---------+-------+-------+---------+--------+--------+|Within one year | 1| 3| 4| 2| 3| 5|+----------------------------+---------+-------+-------+---------+--------+--------+|Between one and five years | 2| 1| 3| 1| -| 1|+----------------------------+---------+-------+-------+---------+--------+--------+|In more than five years | 13| -| 13| 13| -| 13|+----------------------------+---------+-------+-------+---------+--------+--------+|Total operating lease | 16| 4| 20| 16| 3| 19||payables | | | | | | |+----------------------------+---------+-------+-------+---------+--------+--------+ 12. Business combinations - Lombard acquisition On 11 January 2005 the Group acquired 100% of the voting rights of Lombard, anon-listed wealth management group of companies, incorporated in Luxembourg. Thefollowing table summarises the assets and liabilities acquired: Book value on Fair value Fair value on acquisition adjustments acquisition £m £m £mIntangible assetsPresent value of in-force business - 230 230Other intangibles 3 103 106Property and equipment 1 - 1Financial assets 3,719 - 3,719Deferred acquisition costs 70 - 70Deferred tax asset 8 7 15Other receivables 11 - 11Other prepayments and accrued income 8 - 8Cash and cash equivalents 485 - 485Investment contracts (4,187) - (4,187)Interest-bearing loans and borrowings (28) - (28)Provisions (5) 2 (3)Deferred tax liabilities - (86) (86)Other payables (34) - (34)Deferred income (52) - (52) (1) 256 255Goodwill arising on acquisition 151Total 406Discharged by:Issue of 150.2m ordinary sharesin the company 250Future consideration 146Acquisition costs 10Total consideration 406 The fair value of adjustments include £103m of intangible assets (primarilyrelating to distribution relationships) and present value of acquired value ofin-force business of £230m. These have been grossed up for the tax amortisationbenefit. The £250m fair value of shares issued was based on the market price on the dateof exchange. 150,249,291 ordinary shares of Friends Provident plc were issuedfor the acquisition in three individual allotments (1st allotment: 113,477,763shares at £1.645 per share), (2nd allotment: 389,414 shares at £1.733 per share)and (3rd allotment: 36,382,114 shares at £1.705 per share). Future consideration represents future earn-out payments to be made which arevariable on Lombard's performance. Earn-out payments in respect of 2004performance have already been settled in shares; further consideration is due inrespect of earn-out for 2005 and 2006 performance. The payments are dependent onLombard achieving certain performance thresholds for both new business profitsand underlying embedded value. Earn-out payments are payable in shares or cash,at the Group's option. The payment in respect of 2004 was capped at €90m (£62m)and payment in respect of 2005 will be capped at €85m (£58m) with any excesscombined with the final potential payment in respect of the 2006 year. The goodwill of £151m is attributable to the quality, experience and knowledgeof Lombard management and staff, which is expected to generate significant newbusiness value in the foreseeable future. Such experience and knowledgemanifests itself in existing business relationships (and the ability to maintainand further develop these), and processes that are not captured in separatelyidentifiable intangible assets. The diversification of Lombard's business andthe flexible business model and relative unique competitive position also addssignificant value. Illustrations of the future earn-out payments have been made on a range ofscenarios. Each scenario assumes a payment for 2005 of €85m, and a payment for2006 based on a growth in new business profits from a 2005 base. Earn-out payment Total earn-out payments for 2006 for 2005 and 2006Growth in 2006 new business profits •m £m •m £m0% 102 70 187 12815% 128 88 213 14625% 152 104 237 162 For the purpose of calculating the consideration reflected in the financialstatements it has been assumed that growth rate will be 15% in 2006. Theearn-out payments have been calculated in euros and converted to sterling at anexchange rate of 1.4554. The impact of Lombard on the result for 2005 has beento increase revenue by £568m and profit before tax by £8m. 13. Discontinued operations The Group held a controlling interest in ISIS Equity Partners plc, a venturecapital organisation, which controlled a number of underlying unquotedcompanies, primarily through investments by FPLP's With Profits Fund. Under IFRSrules, it was necessary to fully consolidate these companies into the Groupaccounts at 31 December 2004 rather than treat them as investments. The Groupdisposed of its controlling interest in ISIS Equity Partners plc on 30 June 2005and the results of these companies have been shown as discontinued activities.As a result of the disposal, the Group is not required to consolidate itsremaining interest in ISIS Equity Partners plc which is included in investmentsat 31 December 2005. An analysis of the result of the discontinued operations is set out below. Theprofit after tax figure relates solely to the minority interests in theunderlying unquoted companies. +--------------------------------------------------------+------------+-------------+| | 2005*| 2004 |+--------------------------------------------------------+------------+-------------+| | £m | £m |+--------------------------------------------------------+------------+-------------+|Revenue | 165 | 325 |+--------------------------------------------------------+------------+-------------+|Expenses | (151)| (282)|+--------------------------------------------------------+------------+-------------+|Results from trading operations | 14 | 43 |+--------------------------------------------------------+------------+-------------+|Profit on disposal of subsidiaries | 22 | - |+--------------------------------------------------------+------------+-------------+|Loss on discontinuation | (54)| - |+--------------------------------------------------------+------------+-------------+|Transfer from/(to) the FFA | 29 | (17)|+--------------------------------------------------------+------------+-------------+|Profit before tax | 11 | 26 |+--------------------------------------------------------+------------+-------------+|Tax | (3)| (8)|+--------------------------------------------------------+------------+-------------+|Profit after tax from discontinued operations | 8 | 18 |+--------------------------------------------------------+------------+-------------+* six months to 30 June 2005 when the controlling interest was disposed. The net cash flows attributable to the discontinued operations are as follows: +--------------------------------------------------------+------------+-------------+| | 2005*| 2004 |+--------------------------------------------------------+------------+-------------+| | £m | £m |+--------------------------------------------------------+------------+-------------+|Operating activities | (5)| 95 |+--------------------------------------------------------+------------+-------------+|Investing activities | 2 | (75)|+--------------------------------------------------------+------------+-------------+|Financing activities | - | - |+--------------------------------------------------------+------------+-------------+|Net cash inflow | (3)| 20 |+--------------------------------------------------------+------------+-------------+* six months to 30 June 2005 when the controlling interest was disposed. 14. Post balance sheet event On 10 March 2006 an announcement was made by one of F&C's investment trustclients, F&C Latin American Trust PLC that it has decided to appoint a newmanager. Whilst the exact timing on the termination of the management contractis uncertain, it is expected to be imminent. Annualised revenues from this trustare approximately £3m. The expected loss of this business constitutes an indicator of potentialimpairment in the related intangibles asset which was recognised as part of theF&C acquisition, and as such, an impairment review of the investment trustmanagement contracts will be undertaken in 2006. This review will re-assess thecarrying value of the relevant assets, including their estimated remainingeconomic life, and determine whether any further impairment will arise. This information is provided by RNS The company news service from the London Stock Exchange

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