Strategic Review

31st Jan 2008 07:05

Friends Provident PLC31 January 2008 31 January 2008Friends Provident plc Strategy to deliver enhanced profitability and disclosure Friends Provident announced in November 2007 that it was conducting a detailedreview of the Group's strategic options in order to maximise value forshareholders. Today, Friends Provident announces the results of this strategicreview which, when implemented, will transform the company into a morestreamlined, more focused and more profitable business. The strategy review has concluded that Friends Provident should focus on itscore strengths of manufacturing and administering life & pensions products inthe UK and in related International markets. This will encompass Protection,Group Pensions and Friends Provident International, a business closely connectedto the UK business by common systems and expertise. The Group will seek toimprove profitability and reduce capital intensity. A substantial reduction inthe cost base will also be implemented. The result will be a Group with improvedreturns and strong capital adequacy. It will also be able to finance its growthwithout recourse to debt or equity markets. The dividend cost will be rebased toa level consistent with the operating cashflow being generated by the business.The dividend per share will be determined in due course. In making thisdecision, the Board will have regard not only to the dividend paying capacity ofthe ongoing business but also to any capital returned to shareholders fromreleases from businesses which do not fit the strategy. In future, the Groupintends to grow dividends in line with cash flow which offers the prospect ofdividend growth in real terms. The key points of the revised strategy are: • A renewed focus on core segments of the UK and International life and pensions market, based on Friends Provident's existing strengths in: - UK protection market - continuing at least to maintain market share and to continue to enter new segments. - UK group pensions and vesting annuity market - enhancing profitability by ceasing to pay initial commission on new schemes and focusing on acquiring larger schemes. - International savings & investment, pensions and protection markets through Friends Provident International - pursuing growth in markets with attractive margins. • The aim of the strategy is: - to improve cashflow and to reduce the capital intensity of the UK business. - to grow the related international business, which has superior returns, faster than the UK. - to provide improved returns for shareholders. The Board expects that, in total, the strategy of reshaping the business once implemented will enhance the overall IRR of new business by approximately 2 per cent and that this can be improved further over time. • Reduction of the Group's cost base reflecting the new scale and focus of its operations. It is expected that the cost base will be reduced by at least £40 million, 15 per cent. of the 2007 operating cost base, by the end of 2009. In addition, development costs will be reduced by around £20m from the 2007 level. • Commitment to manage the business for profit and shareholder value through adopting a more selective approach to writing new business. In particular, it will adopt a tactical approach to Savings & Investment products in the UK offering them only when adequate returns are available. • The Group will not compete in the wealth management market other than by manufacture and administration of Life & Pensions products. This will entail ceasing the development of the Wrap Platform. • The Group owns three businesses which do not fit the revised strategy. They are: F&C Asset Management, Lombard and Pantheon Financial. These businesses are profitable and attractive. The Board intends to explore opportunities for these businesses with a view to maximising value for shareholders. The Board will work with the respective management teams to establish strategies for achieving this while minimising disruption to the businesses. Any capital that is released as a result of these strategies will be returned to shareholders. • In delivering its strategy, Friends Provident confirms that: - The reshaped Group will be adequately capitalised and self-financing. The strategy will improve cash flow and reduce the capital intensity of new business. The previous strategy required the Group to raise finance to support its growth ambitions. The revised strategy requires no new financing and releases capital which provides flexibility to invest in growth, for example in Friends Provident International. - The 2008 dividend cost will be rebased to a level related to the cash flows arising from the ongoing business. The Board expects the dividend paying capacity of the ongoing life and pensions business to be around £90m to £100m annually. F&C, Lombard and Pantheon Financial do not have a material impact as they produce little cash in the short term. The Board will determine the appropriate dividend per share in due course. In reaching this decision, the Board will have regard not only to the dividend paying capacity of the Group but also to any capital returned to shareholders as a result of releases from businesses which do not fit the strategy. - In future, policy will be to grow dividend in line with operating cash flow. This offers the prospects of dividend growth in real terms. - The Group will maintain strong capital adequacy and will aim to maintain an investment grade credit rating. • In managing its operations, the Board will measure performance utilising a wider range of metrics, including shareholder cashflow, cash payback, IFRS earnings, IRR and Embedded Value. The Board intends to disclose this information at the product category level and details of operating and economic assumptions will be included. Separately, Friends Provident has today announced its new business sales resultsfor the fourth quarter of 2007. In light of recent trading and the strategicreview announced today, the Group will be taking a number of charges to reflectthe impact of future actions to be taken and operating assumption changesreflecting recent experience, most notably adverse persistency experience. Thepersistency charge is estimated at £160m. As a result of the trading results andthe persistency charges, Friends Provident would expect to report underlyingprofit before tax for the year ending 31 December 2007 of approximately £300m onan EEV basis (2006: £509m). However, an operating assumption change will be made to include around £20m ofcosts previously shown as development costs as maintenance costs capitalised inthe EEV. In addition, all corporate costs will now be capitalised in thecalculation of embedded value. As a result, we would expect to charge around£280m against underlying EEV profit. In total, therefore, management estimatesthat the reported underlying profit before tax for the year ending 31 December2007 will be approximately £20m on an EEV basis. Achieving this estimate remains subject to the normal year-end reportingprocesses. Embedded Value for the International businesses will be changed to allow for atax charge at UK rates. At the same time the UK tax charge allowed for in theEmbedded Value will be reduced from 30% to 28%. This will result in a net chargeof around £70m. This will be disclosed as a current period tax charge. In summary, the expected impact of these changes are as follows: -------------------------------------------------------------------------------- EEV underlying profit before tax Embedded Value £m £m-------------------------------------------------------------------------------- Persistency assumptions (160) (115)Cost re-categorisation (280) (200)Tax assumptions Nil (70)Total (440) (385)-------------------------------------------------------------------------------- No credit will be taken in the 2007 Embedded Value for the planned operatingexpense savings. As a result of adverse persistency and the expense assumption changes, certainDeferred Acquisition Costs will become impaired. This will be shown as a chargeagainst Underlying Profit on an IFRS basis. Management estimates this chargecould be up to £400m. Sir Adrian Montague, executive chairman, said: "In conducting this strategic review, the Board's main objectives were toenhance shareholder value and to address the challenges the Group hasencountered in the light of changing market conditions. The decisions we areannouncing today, which will take time to implement, consolidate the Grouparound its core life and pensions businesses. Once fully implemented, thesechanges will allow the Group to offer shareholders steady returns from improvedprofitability and cash generation in its UK business, with opportunities forhigher margin growth in selected overseas markets." Jim Smart, chief financial officer, said: "The new strategy will reposition the Group towards those areas where it hastrue competitive advantage, such as protection, pensions and international lifeand pensions markets. A focus on financial rigour will result in a moreselective approach to writing new business in the UK. Crucially, these measures,together with rebasing the dividend to an affordable level, will ensure that theGroup will be self financing and will remain well capitalised. The strategyallows us to aspire to provide dividend growth in real terms from the new leveland any future capital releases will be returned in full to shareholders." Friends Provident is being advised by JPMorgan Cazenove and Goldman Sachs inrelation to the strategic review. - Ends - For further information, please contact: Friends Provident:Sir Adrian Montague +44 (0) 845 641 7814Jim SmartNick Boakes Finsbury:Vanessa Neill +44 (0) 20 7251 3801Alex Simmons Ref: I010 Notes to editors: 1.The management team will be conducting meetings with shareholders after today's announcement. 2.An analyst presentation will take place at 9.30am today at J P Morgan Cazenove, 20 Moorgate, London, EC2R 6DA. 3.The analyst presentation will be webcast live and can be viewed on the Friends Provident website: www.friendsprovident.com/presentations 4.The presentation slides will be available from 9.30am today on www.friendsprovident.com/presentations 5.For more information on Friends Provident including, photos, awards, fast facts, presentations, and media contacts please visit the media section at www.friendsprovident.com/media 6.Financial reporting dates Friends Provident full year 2007 Life & Pensions new business 31 January 2008 F&C Asset Management plc Quarter 4 Funds Under Management 31 January 2008 F&C Asset Management plc Preliminary Results 6 March 2008 Friends Provident plc Group Preliminary Results 11 March 2008 F&C Asset Management plc Quarter 1 Funds Under Management 25 April 2008 Friends Provident plc Interim Management Statement and Quarter 1 New Business Announcement 29 April 2008 F&C Asset Management plc Annual General Meeting 13 May 2008 Friends Provident plc Annual General Meeting 22 May 2008 F&C Asset Management plc Interim Results (provisional) 6 August 2008 Friends Provident plc Group Interim Results 7 August 2008 Friends Provident plc Interim Management Statement and Quarter 3 New Business Announcement 31 October 2008 F&C Asset Management plc Quarter 3 Funds Under Management 31 October 2008 7.Certain statements contained in this announcement constitute 'forward-looking statements'. Such forward-looking statements involve risks, uncertainties and other factors, which may cause the actual results, performance or achievements, from time to time, of Friends Provident plc, its subsidiaries and subsidiary undertakings or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and other factors include, among others, adverse changes to laws or regulations; risks in respect of taxation; unforeseen liabilities from product reviews; asset shortfalls against product liabilities; changes in the general economic environment; levels and trends in mortality, morbidity and persistency; restrictions on access to product distribution channels; increased competition; and the ability to attract and retain personnel. These forward-looking statements are made only as at the date of this announcement and, save where required in order to comply with the Listing Rules, there is no obligation on Friends Provident plc to update such forward-looking statements. UK and International Life & Pensions Strategy The Strategy is to focus on customer groups and product areas where the Grouphas competitive strengths. In the UK, it has leading positions in Protection andCorporate Pensions. These allow the Group also to sell individual savings andpension products in a tactical way to enhance profits. These strengths areleveraged into international markets via FPI, which has a track record of growthin markets which have superior profitability. In total, this provides anattractive return. The Group will seek to improve profitability in the UK byreducing costs and by being more selective about the new business written. TheGroup will also aim to grow the International business more quickly than the UK.The Board is confident that the Group can deliver this strategy without raisingfurther funds and can look forward to offering shareholders dividend growth inreal terms. Turning to each product area in turn: Protection Friends Provident has a market share of around 8% in Protection. Around twothirds of the business is Life Assurance and a third is Income Protectionincluding Critical Illness cover. In 2006, it had an IRR of 9% and a cashpayback of 9 years. However, with the introduction of new reserving rules (PS06/14), the amount of new business strain is reduced, IRR has improved. Friends Provident has competitive advantage with its efficient e-select systemcollecting data on line from intermediaries and underwriting automatically. Thiskeeps unit costs low and allows the Group to compete in what is an extremelyprice competitive market. Distribution is through IFAs and mortgageintermediaries. The Life Assurance business is highly correlated with themortgage market and so there are short term risks. Nevertheless, there areprospects for medium term growth by entering new segments utilising the Group'scompetitive strengths in technology and customer service. The objective will beat least to maintain market share and financial returns. Pensions Friends Provident has a market leading position in pensions through its GroupPensions product. This position has been built on a superior technologyplatform, high quality service and strong relationships with key distributors.Individual Pensions are also offered through intermediaries. The amount of money being invested in corporate pension schemes like the onesoperated by Friends Provident is growing at over 10% p.a. The market is stilldeveloping as employers switch their pension provision from defined benefit(final salary) to defined contribution (money purchase) and from trust based tocontract based schemes. The rapid pace of growth is thus likely to continue. Webelieve that Friends Provident is well positioned as it has an efficientplatform which processes information from employers automatically, invests fundsswiftly and accurately on behalf of employees and provides both employers andemployees with a highly professional service. As a result funds under managementin Friends Provident's pension business have risen from £2.3bn in 2004 to £7.5bnin 2007. The focus in the past has been to grow the volume of Group Pensions sales todevelop a presence in the market. This has been successful. But the financialconsequence of this strategy has been that it drives a cash loss in the shortterm. Firstly, the acquisition cost of the business has been considerable,incorporating commission payments, statutory reserving and the operational costsof establishing the new pension schemes. Secondly, the income levels availablein the early years are small. Income is earned exclusively from an annual chargerelated to the pension assets under management. Charge levels are low as this isa very competitive market and, at the early stages of the pension funds' lives,the amount of assets is low. This generates a loss on this business in the shortterm. In 2006, new business strain was £126m. In total, around £5bn of assetswere under management which generated income after direct expenses of £21mleading to a cash loss in the year of £105m. Current losses can only be interpreted in the light of the likely future incomethat will be generated from the schemes signed up to date. This consists offuture income as the assets under management grow from further contributionsfrom current members, from new members joining the pension schemes and fromasset market growth. There is no perfect measure which captures all theseeffects as they depend upon a range of assumptions. However, IRR and cashpayback of new business as defined in the EEV basis show the profitability ofnew members and the increments on existing members in any period, makingassumptions about how long they continue to contribute to their pension (paid uprate) and how long they leave their assets under management with the pensionscheme after they leave their employer (lapse rate). In 2006 this shows an IRRof 9% and a cash payback of 17 years. The Board recognises that these are notacceptable and must be improved. The market is, however, likely to remain onewith relatively low profitability and long payback although improvements can bemade to the current returns. New business can broadly be segmented by two dimensions: firstly initialcommission paying schemes versus nil commission schemes and secondly largeschemes versus small schemes. The new business strain on nil commission business is clearly better than oncommission paying business. However, market pricing is such that the annualcharge which can be levied on employees in a nil commission scheme is less. As aconsequence, IRRs and cash payback are only slightly better for nil commissionschemes. The cost of establishing new schemes, including marketing costs and setting upstanding data on the schemes, is largely fixed regardless of the size of theschemes. This makes the larger schemes slightly more profitable than smallerschemes. Again some of this advantage is priced into the annual chargesavailable in the market rates on offer, but IRRs and cash paybacks are slightlybetter for larger schemes. In order to improve the financial characteristics of the business, the strategywill be to cease to pay initial commission on new schemes and to focus onacquiring larger schemes. The main advantages of focusing on these segments aretwofold: firstly, the new business strain will be much less and, secondly, thenumber of schemes will be much smaller and the acquisition costs can be reducedconsiderably by slimming down the sales force. The strategy will be to retain schemes written to date but on terms whichreasonably reflect actual experience. In some cases, experience has been worsethan was assumed at the outset and we reserve the right to renegotiate termswith the relevant intermediary. We estimate that, if the revised strategy had been fully implemented, newbusiness strain would have been around £65m, IRR would have been 11% but cashpayback would still have been 15 years. These are improved compared with themetrics achieved by the old strategy and must also be viewed in the light of theadditional profitable opportunities which writing this business makes availablein annuities and in selling retirement savings overseas where returns aresuperior. In the short term, new business volumes will be less than achieved in 2007,since around two thirds of new business comes either from the target segment orfrom existing schemes. The initial profitability of the new strategy will bebelow the illustration given above since the fixed overheads of the businesswill have to be absorbed by less business so reducing reported IRR. In addition,it will take two years to achieve the cost savings envisaged by the strategy. Wewould thus envisage the metrics improving at least to the illustrative levelsshown above over the next two years. The new business strain and the IRR are clearly an improvement on the currentstrategy but need to be improved further. We will aim to do this but the levelof success will in large part depend upon market rates. But in the short term,the revised strategy is more affordable and returns will be marginally improved. The Group has been successful in selling individual pensions using the sameplatform as for Group Pensions. This business will continue to be written whereit can improve overall returns. We will thus be more selective about thebusiness we write. Annuities Friends Provident focuses on offering competitively priced annuities tocustomers who have saved up for a pension with the company. By focusing on thisgroup of customers, Friends Provident does not need to support the largeacquisition costs that an open market offer would entail. In this way,competitive rates can be offered. Currently over 40% of customers with vestingpensions buy an annuity from Friends Provident. In 2006, this business generated£17m of cash. Our objective will be to increase the take up rate. Vestingsshould also grow as the Group and Individual Pensions books grow. Savings & Investments Friends Provident offers Investment Bonds through intermediaries. These offercustomers the opportunity to invest in a range of mutual and insurance fundsfrom a number of providers within an insurance policy wrapper. The profitability of these products is currently extremely poor. With revisedlapse assumptions, this business will have produced almost no Value of NewBusiness (VNB) in 2007 despite new business amounting to over £500m (PVNBP). Thestrategy will seek to improve profitability by reducing acquisition costs andbeing more selective about the terms of the business written. Friends Provident will continue to sell Investment Bonds and will devise newproducts to attract pension savings and income drawdown prior to annuitypurchase. It is in these areas that the Board believes the Group has expertiseand a franchise which will allow it to succeed. The Group's previous strategy was to develop a franchise in Wealth Managementbeyond manufacturing and administering Life and Pensions products. This wouldhave required considerable investment. The key development which was deemednecessary to enter this market was a Wrap platform. This would have providedintermediaries with a system to help them provide wealth management services totheir customers, achieved by keeping records of all their assets, offeringvarious wrappers such as pensions and ISAs and projection tools which wouldassist in financial planning. This development has proved to be more expensive,to be more complex and to have taken longer than originally envisaged. Theamount of income available is also very uncertain. The Board has thus concludedthat continuing this investment is unlikely to represent good value forshareholders. It is also not clear that the Group has, or can acquire, thenecessary attributes to become a successful wealth management company. Thereforethe Group's strategy does not incorporate an ambition to compete in thesemarkets other than by manufacturing and administering life and pensionsproducts. Accordingly, the Group will cease further development of the Wrapplatform. With Profits Book Although new sales are minimal at present, the with profits book still providesa considerable if declining stream of income for the Group. The book generated£82m of cash in 2006. The strategy will be to improve efficiency to offset thereduction in income. This will be achieved both by growing new business on theshared administrative platform and by reducing the direct costs of the withprofits operation. We will investigate closing the with profits book to newbusiness which will, at the margin, simplify operations and will allow us toconcentrate on running off the book in the most efficient manner. Any suchdecision will only be taken after considering the impact on customers to ensurethat we continue to treat them fairly. International Friends Provident acquired the international operations of Royal & Sun Alliancein 2002 and, since then, renamed Friends Provident International has achieved acompound annual growth rate of sales of 28%. In 2007, its sales on an APE basiswere £186m. On a PVNBP basis they were £1,235m. Value of New Business marginsare around 3%. FPI offers a broad range of products including investment bonds, regular savingsproducts and protection contracts. It operates through intermediaries,principally in Asia, the Middle East, the UK and Europe. A recent developmentwas the launch of a range of personal pensions in Germany. FPI fits well with the UK business as it uses many of its attributes includingproducts, and expertise in dealing through intermediaries and product design. Inaddition, through its shared IT platform, it is able to leverage technologycapabilities. The business is also inherently more profitable than its UKcounterpart. In 2006, its IRR was 20% and cash payback was 6 years. The Group's strategy will be to continue to grow the business using theattributes of the UK business to enhance both the growth rate and the return ofthe business portfolio. In future, international development will be prioritised. This will includedeveloping improved IT applications to offer enhanced services for customers andintermediaries. It will also include development in some of the newerterritories in which the business is now operating: Singapore, Dubai andGermany. We are also exploring entry into a number of other territories,provided they offer appropriate financial returns. Distribution The Group has a number of stakes in IFAs and owns two outright: Sesame andPantheon Financial. The Group's strategy is to continue to deal through intermediaries. By having anownership stake in the success of relevant intermediary businesses, co-operationis fostered and the Group can learn how its products and systems can be improvedto help intermediaries run their businesses more effectively. It is thereforeadvantageous for the Group to maintain a direct interest in distribution whereit is relevant to the products that the Group seeks to distribute. In addition, the nature of intermediary distribution may change in the future.The Retail Distribution Review is the latest development in this area. Whetherit produces change and, if so, the nature of that change, is uncertain. Whilethis uncertainty persists, maintaining a direct interest in distribution alsogives the Group better insight into the effect of any changes on intermediaries. To this end, Sesame fits the strategy as it is a large distributor of mortgagesand protection policies. Its target market segment is also attracted toinsurance bonds and pensions. The business is profitable and is trading in linewith the Board's expectations when it was acquired. Pantheon Financial, on the other hand, does not fit the new strategy. The other minority stakes in intermediaries will be maintained and kept underreview as part of normal operations. Wealth Management Businesses The Group owns three attractive businesses which operate in wealth managementmarkets. They are Lombard, F&C Asset Management and Pantheon Financial. Wealthmanagement, other than product manufacture and administration of Life & Pensionsproducts, is not part of the revised strategy. As a consequence, the Boardintends to explore opportunities for these businesses with a view to maximisingvalue for shareholders. It is important to emphasise that these businessesremain profitable and open for business as usual: they simply do not fit withour new strategy. We will work with the respective management teams to identifythe appropriate strategy to maximise value for shareholders and to secure thefuture success of the businesses themselves. There are a range of strategies forachieving this and we will not be rushed into a disorderly process which damagesthe stability of the businesses and hence shareholder value. We are howeveraware of the need to achieve stability and certainty as quickly as possible butwe will do this in an orderly fashion. Any capital releases which result fromthese strategies will be returned to shareholders. Lombard Lombard is a cross border wealth management business operating out ofLuxembourg. It was purchased in January 2005 for a consideration of £404m. Itspecialises in tax and estate planning solutions for HNWIs and UHNWIs. Itsprivatbancassurance business is built around first class distribution partners,innovative solutions, exceptional service and a strong management team. Since Friends Provident acquired Lombard, assets under management have grownfrom €5.8bn to €13.1bn, embedded value has grown from €223m to €480m and newbusiness has grown from €1,892m in 2004 to €2,873m in 2007. During this period,Lombard has strengthened its position as the leader in privatbancassurance.Growth prospects remain excellent. The Board recognises the considerable value created by the Lombard team over thelast three years, as it continues to pursue its successful niche strategy, whileremaining an autonomous entrepreneurial business. Friends Provident willtherefore work closely with the management of Lombard in identifying a suitablestrategy for maximising value for shareholders while preserving Lombard'sindependence and unique business model. F&C Asset Management The Group's asset management operations are conducted by F&C Asset Management inwhich the Group has a 52% holding. In total, F&C manages around £33bn on behalfof Friends Provident and its customers under the terms of long term contractswhich have a variety of unexpired terms some of which are up to 7 years. Having taken actions to strengthen investment performance, F&C's strategy is todevelop new revenue streams in higher margin product areas. The Board of FriendsProvident supports this strategy. The group's asset accumulation products such as pensions and investment bondsall offer open architecture so customers can access mutual funds from theirpreferred asset manager. The Board has concluded that, although it will beadvantageous for Friends Provident and F&C to continue to co-operate in productdevelopment and distribution, it is not necessarily essential for FriendsProvident to maintain its ownership to do so. Consequently, the Board hasdetermined that the most appropriate way forward is to review its ownership of F&C with a view to maximising value of its stake for the benefit of shareholders.The Board will work with the Board and management of F&C to establish the bestway of achieving this. Pantheon Financial Pantheon Financial provides comprehensive financial advice to private andcorporate clients tailoring its service to meet specific requirements. It is anational independent adviser committed to providing a high quality,multi-disciplined service to clients. All members of the group have a wealth of knowledge and an excellent trackrecord with many years experience within the individual and corporate financialmanagement professions. It has successfully created a platform that enablesclients to access wealth management services, executive benefit solutions andinvestment opportunities from a large range of providers. The business has established its credentials by attracting a client base of bothindividual and corporate bodies, including long-term relationships with FTSE-100companies, their directors and senior executives. The business was acquired for £33m in May 2007. It is profitable and has goodgrowth prospects. The Board will work with management to identify a strategy tomaximise value for shareholders recognising the business need to preserve itsindependence and to enable it to continue to execute its growth strategy. Cost Reduction Delivery of the new strategy will require a new organisational structure. Newprocesses for decision making will be introduced to ensure disciplines over useof capital and target returns are adhered to. This process will commenceimmediately. The current operating cost base of the business is £272m. In addition, in 2007,£48m was incurred and categorised as development cost. The cost base will needto be reduced to reflect the new levels of business which we would expect towrite as we focus on fewer business lines. This focus will however permit anamount of simplification to be brought to business processes and functions. TheBoard aims to find at least £40m of savings from the operating cost base. Thesesavings should be realised by the end of 2009 and are likely to entail £60m ofimplementation costs in 2008. In addition, the new strategy will enabledevelopment cost to be reduced by at least £18m. The savings will come from all functions in the business by focusing onincreasing efficiency, by cutting out duplication, by considering alternativesourcing strategies. Details of the initiatives will be announced in due coursebut the main areas of saving will include Marketing & Distribution, which can berationalised to reflect the Group's more focused strategy, IT, Customer Serviceand from other Head Office functions. The aim will be to achieve the savingswithout adversely affecting service quality. The Board anticipates that theheadcount in the business will be reduced by around 600 over the period. The Board will also consider outsourcing where that offers better value and doesnot degrade the quality of customer service. No such plans have yet beenestablished. In future, the Board anticipates development expenditure will be exceptional andwill be related to new products or territories. Around £10m of the currentdevelopment spend falls into this category. Expenditure on updating or upgradingcurrent products, systems or processes will be included in maintenanceexpenditure. Accordingly, an allowance of around £20m p.a. will be capitalisedand deducted from Embedded Value. In addition, around £6m of corporate costs inrelation to group businesses which were previously held outside the EmbeddedValue will be capitalised and deducted from Embedded Value. In total, this willreduce Embedded Value by around £200m. Cash Flow and Funding The UK business of Friends Provident has in recent years been absorbing morecash than it generates to support the previous strategy of growing sales inGroup Pensions and Savings & Investments. In 2006, New Business Strain was £295mand the In Force Surplus emerging from the business was £233m leaving a deficitof £62m. Both the New Business Strain and the In Force Surplus have fallen overthe past few years owing to one off regulatory changes. By reducing commissionand acquisition costs, the strategy will cut new business strain in the UK toaround £100m. Once the strategy is implemented and cost savings are realised, the UK businessshould generate an In Force Surplus of around £160m of cash per annum. Dependingon new business results, this might reasonably be expected to grow by around£10m to £20m p.a. The UK business should thus generate over £60m of cash per annum. This togetherwith the £50m annual net income expected to be generated by the ShareholderFunds, gives a dividend paying capacity of £90m to £100m. The International business is capable of growing organically with relativelymodest cash investment over the next few years. Periodic additional investmentwill be required to expand the business into new territories. This can be paidfor from Shareholder Funds. The Group currently has around £1.1bn of Shareholder Funds which are invested inCash and Bonds. This is required in part to support statutory capitalrequirements and to have adequate headroom to allow for operational andfinancial risks which may emerge while implementing the strategy. In the Group's previous strategy, Shareholder Funds were required to supportstatutory capital, to allow for risk and to fund the planned sales growth in theUK but were insufficient to fund the dividend in full. The Group thereforerequired to raise further debt to fund the remainder of the dividend and tosupport growth in the International business. In the revised strategy, the risks are lower and the business strategy isself-funding so there is no need to raise further finance and there is,flexibility to invest in, for example, Friends Provident International. Any decision on the businesses which do not fit the strategy will not have asignificant effect on the short term Group cash flows as none providessignificant cash to the Group. The business will aim to maintain an investment grade credit rating. Gearing isrelatively low which gives scope to borrow further if required. There arehowever no current plans to raise any further debt or equity. Dividend Policy The Board intends to propose a final dividend for 2007 in line with the currentdividend policy. The Board will then seek to rebase the cost of dividend to alevel related to the size and cash generation of the ongoing business. The Boardexpects the dividend paying capacity of the life and pensions business to bearound £90m to £100m p.a. . The Board will determine the appropriate dividend per share in due course. Inreaching this decision, the Board will have regard not only to the dividendpaying capacity of the Group but also to any capital returned to shareholders asa result of releases from businesses which do not fit the strategy. In future, the policy will be to grow the dividend in line with operatingcashflow. The Board believes that this offers the prospect of dividend growth inreal terms. Financial Summary The strategy should have the effect of improving total returns. In 2006, overallIRR on new business was 12.7%. At Group level, the new strategy, onceimplemented, should be deliver a 2 percentage point increase in new businessIRR. In the initial stages, the reported IRR will reduce as a result of the moreprudent definition of acquisition and maintenance costs and of the fact that thecurrent overhead will be allocated over a smaller business. As the cost savingsemerge, this effect will reverse. Additionally, the combination of the focus onwriting more profitable business in the UK and growing the higher returninternational business faster than the UK will enrich the portfolio liftingoverall return. We will report progress period by period. The financial results for 2007 will be affected by a number of write offs andcharges as a consequence of rebasing Embedded Value assumptions, the strategicreview conclusions and derisking the balance sheet. Rebasing Embedded Value Assumptions The group has seen considerable lapse experience this year in its InvestmentBond and Pensions portfolios. We thus anticipate taking a total charge of around£160m in Underlying EEV pre tax profit to reflect this worsening persistency: ----------------------------------------------------------------------------- Pre Tax Persistency Charge 2007 (£m)-----------------------------------------------------------------------------With Profits Bonds (30)Investment Bonds (50)Group Pensions (70)Other (10)Total (160)----------------------------------------------------------------------------- This charge reflects current levels of experience. Given the number ofuncertainties and the length of time over which predictions have to be made,experience could clearly change in future. The With Profit Bond and InvestmentBond books are closed. The key sensitivity for the future is thus to lapses inthe Group Pensions book. The current experience is 3% p.a. The charge aboveresults from a 1% increase in the assumption from that used in 2006. Applying the new lapse assumptions to 2007 new business will reduce Value of NewBusiness in the UK to around £95m to £100m. The decision to revise the definition of development costs such that most willbe now be categorised as maintenance will mean that allowance will be madewithin the embedded value for around £20m of annual cost required to maintaincurrent product propositions. In addition, it is more prudent to assume that theLife & Pensions business should bear the whole cost of the corporate headoffice. This will result in a further £6m of annual cost being capitalised incalculating the provision for corporate costs. As a result of these changes,Embedded Value will be reduced by around £200m and a charge of around £280m willbe made in Underlying Profit on an EEV basis. No credit will be taken for future cost savings in calculating the 2007 EmbeddedValue. Aggregate Impact The effect of the trading performance in the year and the persistency assumptionchanges would take the Underlying Profit on an EEV basis to around £300m. Theadditional embedded value basis changes in respect of development costs andcorporate costs will reduce this by a further £280m. In total, we thereforeestimate that Underlying Profit on an EEV basis will be around £20m (2006:£509m). Achieving this estimate remains subject to the normal year end reportingprocesses. Taxation The UK Embedded Value will be increased by around £30m to allow for the UK taxrate reducing from 30% to 28% following the change in corporation tax rate. TheInternational Embedded Values allow for tax rates of 25% for Lombard and 0% forFPI. The timing and amount of tax which will be charged will depend on how thebusinesses grow, on whether cash is remitted to the UK and on the taxregulations in various jurisdictions. Given these inherent uncertainties, the2007 Embedded Value calculation will use the UK rate of 28% for bothInternational businesses since this is a more prudent reflection of the value toUK shareholders. As a result, the Embedded Value will be reduced by around £20mfor Lombard and around £80m for FPI. In aggregate this will result in a netcharge of around £70m. Immediate Strategic Review Actions As a consequence of the results of the strategic review, the £17m cost of theWrap platform was expensed in 2007. IFRS Results In the IFRS accounts, the result of the lapse rates and a more prudentassessment of the likely future revenue to be earned will result in animpairment in the value of Deferred Acquisition Costs. As a consequence, animpairment charge will be reflected in the 2007 accounts. This has not yet beenfinalised but management estimates that it could amount to up to £300m. Derisking the Balance Sheet During the course of 2007, Friends Provident has taken a number of steps toreduce risk in the balance sheet. Some of these will have an effect on reportedprofit in 2007. In the Shareholder funds, the Equity Backing Ratio has been reduced from 50% tonil. This will reduce expected return on shareholder funds by £5m a year. In the employee pension fund, the Equity Backing Ratio was reduced from 60% to40% and the fund is expected to be in balance on an IAS19 basis. FP has also taken steps to derisk certain Cash Unit Linked Funds which, incurrent market conditions, expose policy holders to liquidity risks which theymight not reasonably have expected. As a consequence, the Shareholder Fundpurchased from the Cash Unit Linked Funds their holdings of Asset BackedSecurities and Floating Rate Notes. At 31 December 2007, these are marked tomodel at £127m, a reduction of £14m from the value when purchased. This chargewill be shown as an Investment Return variance. There is, however, no indicationof impairment. All are investment quality (47% AAA, 48% AA and 5% A). We are notaware of any exposure to US sub prime. The average expected life is around 3years. Future Disclosure The communication of performance in the Life Assurance sector is difficult givenits long term nature. This is compounded by the existence of several reportingbases: the main ones being Embedded Value, IFRS and Cashflow. The Board iscommitted to addressing this by giving greater clarity and more comprehensivedisclosure. We intend to provide enhanced disclosure to assist readers of the accounts ininterpreting performance and risks more effectively. Our preferred measure willbe IFRS. We will however disclose Cashflow, IFRS and EEV results (PVNBP and VNB)for each product. We will also give details of assets under management forInvestment business. We will also disclose more information to assist in interpreting Embedded Value.Full details will be published with the Preliminary Results on 11 March butadditional disclosures will include: a. Value in Force by product category; b. maturity of the Value in Force; c. operating assumptions used in calculating Value in Force; d. sensitivities to changes in the main operating assumptions; e. Internal Rates of Return (IRR) by product category; and f. projected payback on new business by product. The Board is, however, committing to improving performance. The Board willimpose rigorous financial guidelines for new business which will recognise thescarce nature of capital and will seek better financial returns and fasterpayback for its use. This will require better management information. Incentivearrangements will also be amended in due course to reflect the additionalperformance metrics to ensure that employees' interests are best aligned withthose of shareholders. Disclosures in the new format of the 2006 results are shown in the Appendix. Conclusions The Board recognises that the Group's recent results are unacceptable and mustbe improved. The Board is convinced that the measures it is proposing to take are not onlynecessary but also appropriate for a business of the size and profile of FriendsProvident. Capital is a scarce resource for the business, particularly as theWith Profits Book is maturing. Against this background, the reinvestment of thecash emerging into new business must clearly make superior returns forshareholders or it should be returned. This is the frame of reference that theBoard intends to adopt. The Board believes that there are selectiveopportunities in the UK to make superior returns and that this opens up goodinvestment opportunities internationally. The Board believes the combinationshould improve profitability and should be achievable within the cash resourcesthat the business generates from its own operations. The new strategy is a significant change for the business and will take much of2008 to implement. The Board, however, recognises that shareholders want to seetangible progress and will provide regular updates. The first scheduled updatewill be with the Interim Results in August 2008. The Board is convinced that thechosen strategy is the right one for Friends Provident. It focuses on themarkets in which the Group has demonstrable strengths and offers the bestopportunity to rebuild and enhance value for shareholders. Appendix Key Performance Indicators Embedded Value has in the past been the Group's preferred measure. However, itsuffers from several flaws which make it unsatisfactory as a measure of shortterm performance. Firstly, it relies on a range of operating assumptions aboutthe company and about customer behaviour which in the past have not beendisclosed. Secondly, its maturity has not been disclosed so the reader of theaccounts has little ability to predict when Embedded Value will turn into cash.Finally, it makes little allowance for non-market risks such as major changes inlegislation or customer behaviour and hence there is a risk that the futureprofits it indicates are not certain to be realised. Embedded value is, however, useful for estimating the potential future value ofthe business written in the year and for valuing the future flow of cash whichmay emerge from the book of business. But it can only do so effectively ifproper disclosure of the underlying cash flow profiles, assumptions andsensitivities are provided. We intend to attempt to do this to the extent thatthis is practicable. IFRS has difficulty in representing accurately insurance business, particularlywith profits business. Commission and certain acquisition costs are deferred andamortised. We will disclose an underlying IFRS profit figure excludingpolicyholder items which shows the movements in deferred acquisition costs. Cashflow is the most important metric for Friends Provident as it is one of thekey issues which the Board will be addressing. The key measures which the Board intends to measure its performance will be: At Group level: • Underlying IFRS Profit - will show short term performance• Underlying IFRS Earnings - will show dividend cover by earnings• Shareholder Cashflow - will show the cash being consumed in writing new business and being generated by the current book of business• Embedded Value - will show the value of the cash flows which the business is likely to generate in future• Value of New Business - will show the theoretical future value of the cash flows from the business written in the year• Underlying profit on an EEV basis - will show the effect of expected returns and any variances from assumptions used in prior years' VNB• Internal Rate of Return - will show the potential profitability of the business written in the year• Cash Payback - will show the cash characteristics of business written in the year At Product level: • Annual Premium Equivalent of New Business - will show a more consistent measure of sales without the inherent basis distortions of the PVNBP measure which will be shown as supplementary information• Present Value of New Business Premiums (PVNBP)• Value of New Business (VNB)• Internal Rate of Return• Cash Payback• Assets under management (for investment products)• Profit on an underlying IFRS basis The following tables show some of these key metrics as at 31 December 2006. Fulldisclosures of the 2007 figures will be given in the preliminary results. IRR and Cash Payback by Product------------------------------------------------------------------------------ Cash Payback IRR 2006 2006 (%) (years)------------------------------------------------------------------------------UK Life & Pensions Protection 9.3 9 Investments 8.2 16 Pensions 8.9 17 Annuities N/a N/a------------------------------------------------------------------------------UK Total 10.3 12 International Life & Pensions Friends Provident International 20.1 6 Lombard 29.4 4------------------------------------------------------------------------------International Total 25.7 4------------------------------------------------------------------------------Group Total 12.7 9------------------------------------------------------------------------------ Operating Cash Generation by Product Category ------------------------------------------------------------------------------ New business In force Net Cash 2006 2006 2006 (£m) (£m) (£m)------------------------------------------------------------------------------UK Life & Pensions With Profits fund (FPLP) - 82 82 Protection (129) 102 (27) Investments (36) 7 (29) Pensions (126) 21 (105) Annuities (4) 21 17 (295) 233------------------------------------------------------------------------------UK Net Total (62)------------------------------------------------------------------------------ International Life & Pensions Friends Provident International (25) 61 36 Lombard (40) 38 (2) (65) 99------------------------------------------------------------------------------International Net Total 34------------------------------------------------------------------------------F&C Dividend 28Investment Return 32Tax 34Cash from Operations 66One offs (PS06/14, morbidity) 274Cash before Financing Items 340------------------------------------------------------------------------------ IFRS underlying profit before tax by proposition ------------------------------------------------------------------------------ New business In force Profit 2006 2006 2006 (£m) £m) (£m) ------------------------------------------------------------------------------UK Life & Pensions With Profits fund (FPLP) - 82 82 Protection (27) 58 31 Investments (16) 3 (13) Pensions (59) 17 (42) Annuities - 21 21------------------------------------------------------------------------------ (102) 181 79One off items 6 (39) (33)------------------------------------------------------------------------------ (96) 142------------------------------------------------------------------------------Underlying UK profit 46------------------------------------------------------------------------------International Life & Pensions Friends Provident International (6) 31 25 Lombard (22) 35 13 (28) 66 38------------------------------------------------------------------------------One off items 0 32 32 (28) 98------------------------------------------------------------------------------Underlying International profit 70Return on Shareholder Funds 53Asset management 89Corporate items (14)Ongoing Underlying Profit 244Principal Reserving Changes 156Underlying IFRS Profit 400------------------------------------------------------------------------------ Assets Under Management - Investment Products ----------------------------------------------------------------------- AUM 2006 (£m)-----------------------------------------------------------------------UK Life & Pensions Investments 3,061 Pensions 5,488-----------------------------------------------------------------------International Life & Pensions Friends Provident International 3,882 Lombard 7,760----------------------------------------------------------------------- Value of In-force by maturity Key basis assumptions--------------------------------------------------------------------------------------31 December 2006 (£m) Year of emergence of surplus Total 1-5 6-10 11-15 16-20 21-25 26-30 31-35 36-40 41+--------------------------------------------------------------------------------------UKWith ProfitsFund 386 188 116 47 22 9 3 1 0 0Protection 379 250 83 30 11 4 1 0 0 0Investments 188 72 59 30 15 7 3 1 1 0Pensions 436 127 116 86 56 31 14 5 1 0Annuities 29 25 2 1 1 0 0 0 0 0UK other 73 32 28 12 1 0 0 0 0 0--------------------------------------------------------------------------------------UK total 1,491 694 404 206 106 51 21 7 2 0-------------------------------------------------------------------------------------- 47% 27% 14% 7% 3% 1% 0% 0% 0% InternationalFPI 212 116 56 26 10 3 1 0 0 0Lombard 328 129 76 49 30 19 11 7 4 3--------------------------------------------------------------------------------------Internationaltotal 540 245 132 75 40 22 12 7 4 3-------------------------------------------------------------------------------------- 46% 24% 14% 7% 4% 2% 1% 1% 1% --------------------------------------------------------------------------------------Total VIF 2,031 939 536 281 146 73 33 14 6 3-------------------------------------------------------------------------------------- 46% 26% 14% 7% 4% 2% 1% 0% 0% Principal European Embedded Value assumptions and experience The value of in force business (VIF) is calculated based on our best estimate ofcash flows arising from the book of life and pensions business at the end of thereporting period. A significant number of assumptions are made concerning: thebehaviour of customers (for example, persistency); mortality; the level ofexpenses required to maintain the book of business; tax and regulatoryenvironment and the future economic environment. The assumptions made are a reflection of our best estimate of the likelybehaviours, outcomes or circumstances in the future. The estimate is made,typically, on an annual basis following experience investigations based on thedata available at the time both from our own book of business and from relevantexternally sourced information. The aim is to set assumptions for this year-end at a level that reflects recentor current experience, unless there are reliable indicators that suggest theiradoption would result in a significant variance compared to these assumptions inthe future. The material assumption changes for this year-end are discussed below. Group Pension Paid Up Policies (PUP) A pensions policy becomes paid up when a member and his or her employer ceasesto make new contributions but leaves the funds then in the policy with FriendsProvident to manage. Typically this occurs when an employee leaves theiremployer. Assumptions about the length of time contributions are made arecrucial in calculating the amount of funds which will be under management andhence the income which can be earned. PUP rates have been observed to be increasing on shorter duration policies. As aresult, for policy durations up to 4 years, PUP rates have been increasedbetween 1% and 3% per year to give an arithmetic average rate of around 16% overthis period, with rates of 17%, 17%, 16% and 15% applying over each of the firstfour years. The PUP rate assumption for policies of duration over 5 years has beenmaintained at 12% p.a. There is no significant experience beyond this durationand the ultimate PUP rate for this business therefore remains uncertain. Theintention will be to maintain the assumptions for this business in line with ourobserved experience. An increase in the PUP rate assumption for policies ofduration over 5 years from 12% p.a. to 14% p.a. would reduce the VIF by £7m. Group Pension Lapses A pensions policy lapses when a member removes his or her fund from ourmanagement and transfers to another provider. This typically happens when anemployee leaves his or her employer and transfers the fund to a new employer orto a personal pension. Our most recent experience for lapses is that approximately 3% p.a. of thein-force business is lapsing at a policy duration of 6 years (i.e. after thefifth anniversary), with lower lapse rates observed in the earlier years. Beyondthis duration there is no significant experience and the ultimate lapse rate forthis business remains uncertain. This experience represents a higher lapse rate than observed in our previousexperience investigation and as a result we have increased the lapse assumptionfrom 2% to 3% p.a. of the in-force business from policy year 6. The intentionwill be to maintain the assumptions on this business in line with our observedexperience. Each 1% p.a. change in the lapse assumption would change VIF by£30m. Bond Lapse Assumptions All of our key investment bond products are showing increased lapse ratesgenerally, ahead of the previous assumptions at policy durations greater than 5years. As a result we have made significant changes to our lapse assumptions atthese policy durations. The product that has most impact on our reported results is the InvestmentPortfolio Bond (both the unit-linked and with-profits versions). Our assumptionsfor lapse rates after the fifth and sixth policy anniversaries were establishedbased on previous experience of similar products at 10% p.a. and 7.5% p.a. ofin-force business respectively. However, experience in late 2006 and during 2007has been for 25% of the unit-linked products to be surrendered between the fifthand sixth policy anniversaries and 35% of the with-profits products. There isonly limited experience of policy durations beyond this on which to base ourassumptions. However, to acknowledge the trend observed, our assumptions for2007 have been increased for policy durations after the fifth anniversary date.The intention will be to maintain the assumptions on this business in line withour observed experience. An increase in the lapse assumption for the year afterthe fifth policy anniversary from 25% to 30% would reduce the VIF by a further£5m. Annuitant mortality Our assumptions for pension annuitants make allowance for improvements in futuremortality based on latest industry projections - a mortality improvement for oneyear is a measure of the reduction in the probability of death between one yearand the next for a given age. For a number of years, our regulatory reservingbases have amended the industry projections to include an improvement 'floor' -a minimum rate of annual improvement below which the projections are not allowedto fall. For the 2007 year-end, we are introducing an improvement floor to our experienceassumptions of 1.0% p.a. for males and 0.75% p.a. for females. This is onconjunction with the 'medium cohort' projection (published by the CMI inDecember 2002) for males and 75% of this projection for females. If the experience improvement floor were increased by a further 0.5% p.a. forboth males and females, this would reduce the VIF by £17m. Accountant's report on a published profit estimate KPMG Audit Plc8 Salisbury SquareLondonEC4Y 8BB 31 January 2008 The DirectorsFriends Provident plcPixham EndDorkingSurreyRH4 1QA JP Morgan Cazenove Limited20 MoorgateLondonEC2R 6DA Goldman Sachs InternationalPeterborough Court133 Fleet StreetLondonEC4A 2BB Dear Sirs Friends Provident plc We report on the profit estimate comprising consolidated underlying profitbefore tax on a European Embedded Value basis of Friends Provident plc ('theCompany') for the year ended 31 December 2007 (the 'Profit Estimate'). TheProfit Estimate and the basis on which it is prepared is set out in the sectionsheaded "Aggregate Impact" and "EEV Methodology" of the announcement (the'Document') issued by the Company dated 31 January 2008. This report is requiredby Rule 28.3(b) of The City Code on Takeovers and Mergers ('the City Code') andis given for the purpose of complying with that rule and for no other purpose. Responsibilities It is the responsibility of the directors of the Company to prepare the ProfitEstimate in accordance with the requirements of the City Code. In preparing theProfit Estimate the directors of the Company are responsible for correctingerrors that they have identified which may have arisen in the unauditedfinancial results and unaudited management accounts used as a basis ofpreparation for the Profit Estimate. It is our responsibility to form an opinion as required by the City Code as tothe proper compilation of the Profit Estimate and to report that opinion to you. Save for any responsibility which we may have to those persons to whom thisreport is expressly addressed and which we may have to Friends Provident plc'sshareholders as a result of the inclusion of this report in the Document, to thefullest extent permitted by law we do not assume any responsibility and will notaccept any liability to any other person for any loss suffered by any such otherperson as a result of, arising out of, or in connection with this report or ourstatement, required by and given solely for the purposes of complying with Rule28.4 of the City Code, consenting to its inclusion in the Document. Basis of preparation of the Profit Estimate The Profit Estimate has been prepared on the European Embedded Value basisstated in the section headed "EEV Methodology" of the Document and is based onthe unaudited financial information for the year ended 31 December 2007. TheProfit Estimate is required to be presented on a basis consistent with theEuropean Embedded Value accounting policies of the Company. Basis of opinion We conducted our work in accordance with the Standards for Investment Reportingissued by the Auditing Practices Board in the United Kingdom. Our work includedevaluating the basis on which the historical financial information for the yearended 31 December 2007 included in the Profit Estimate has been prepared andconsidering whether the Profit Estimate has been accurately computed using thatinformation and whether the basis of accounting used is consistent with theEuropean Embedded Value accounting policies of the Group. We planned and performed our work so as to obtain the information andexplanations we considered necessary in order to provide us with reasonableassurance that the Profit Estimate has been properly compiled on the basisstated. However, the Profit Estimate has not been audited. The actual results reported,therefore, may be affected by revisions required to accounting estimates due tochanges in circumstances, the impact of unforeseen events and the correction oferrors in the financial results. Consequently, we can express no opinion as towhether the actual results achieved will correspond to those shown in the ProfitEstimate and the difference may be material. Our work has not been carried out in accordance with auditing or other standardsand practices generally accepted in the United States of America or otherjurisdictions and accordingly should not be relied upon as if it had beencarried out in accordance with those standards and practices. Opinion In our opinion the Profit Estimate so far as the accounting policies andcalculations are concerned has been properly compiled on the basis stated andthe basis of accounting used is consistent with the European Embedded Valueaccounting principles of the Company. Yours faithfully KPMG Audit Plc JPMorgan Cazenove Limited Goldman Sachs International20 Moorgate Peterborough CourtLondon 133 Fleet StreetEC2R 6DA London EC4A 2BB 31 January 2008 The DirectorsFriends Provident plcPixham EndDorking, SurreyEngland RH4 1QA Dear Sirs, Strategic review results JPMorgan Cazenove Limited and Goldman Sachs International (together, "we") referto the estimate made by Friends Provident plc ("Friends Provident") which isincluded in the announcement issued by Friend Provident on 31 January 2008,regarding the estimate that the reported underlying profit before tax for theyear ending 31 December 2007 will be approximately £20 million on an EEV basis(the "Profit Estimate"). We have discussed the Profit Estimate and the bases and assumptions on which ithas been prepared with you as directors of Friends Provident and with KPMG AuditPlc ("KPMG"), Friends Provident's reporting accountants. We have also discussedthe accounting policies and calculations for the Profit Estimate with KPMG andwe have considered their letter of today's date addressed to you and ourselveson this matter. We have relied upon the accuracy and completeness of all thefinancial and other information discussed with us and have assumed such accuracyand completeness for the purposes of rendering this letter. This letter is provided solely in connection with our obligations under Rules28.3(b) and 28.4 of the City Code on Takeovers and Mergers and for no otherpurpose. We accept no responsibility and, to the fullest extent permitted bylaw, exclude all liability to any other person other than to you, in yourcapacity as directors of Friends Provident, in respect of this letter or thework undertaken in connection with this letter. On the basis of the foregoing, each of us considers that the Profit Estimatereferred to above, for which you as Directors are solely responsible, has beencompiled with due care and consideration by the Directors. Yours faithfully, For JPMorgan Cazenove Limited For Goldman Sachs InternationalT.P. Wise Simon DingemansManaging Director Managing Director EEV Methodology 1 Basis of preparation The underlying EEV results presented in this document have been prepared inaccordance with the European Insurers' Chief Financial Officers Forum's EEVPrinciples issued in May 2004 and the Additional Guidance issued in 2005. EEV underlying profit is based on expected investment return and excludes: (i)amortisation and impairment of Asset Management acquired intangible assets (ii)effect of economic assumption changes (iii) non-recurring items; and is statedafter deducting interest payable on Step-up Tier one Insurance CapitalSecurities (STICS). 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 anestimate of the value of shareholders' interest in the covered business,excluding any value that may be generated from future new business. This valuecomprises the sum of the shareholders' net worth, the provision for futurecorporate costs and the value of existing business. The shareholders' net worthis the net assets attributable to shareholders, and is represented by the sum ofrequired capital and free surplus. The value of existing business is the present value of the projected stream offuture distributable profits available to shareholders from the existingbusiness at the valuation date, on a best estimate basis allowing for risk,adjusted for the cost of holding required capital. The results for covered business as reported under EEV principles are combinedwith the results for the remainder of the business reported in accordance withIFRS, except where EEV principles dictate otherwise. In particular the EEVprinciples have been applied to reflect STICS as debt rather than equity. In addition, a pro forma embeddedvalue is reported showing ordinary shareholders' funds on an EEV basis adjustedto include the F&C listed subsidiary 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 and Distribution businesses (including the net pension liability) on an IFRS basis;• corporate net assets;• the net pension asset of FPPS on an IAS 19 basis;• the 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 otherbalance sheet items denominated in foreign currencies have been translated tosterling using the appropriate closing exchange rate. The new businesscontribution and other income statement items have been translated using anaverage exchange rate for the relevant period. 2 Covered business The covered business incorporates the Life & Pensions business defined aslong-term business by UK and overseas regulators. The Asset Management andDistribution businesses are not included in the definition of covered business. 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. 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 rateconsistent with that applied to such a cash flow in the capital markets. Forexample, an equity cash flow is valued using an equity risk discount rate, and abond cash flow is valued using a bond risk discount rate. If a higher return isassumed for equities, 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 assumed assets earn the risk-free rateand all cash flows are discounted using the risk-free rate. This gives the sameresult 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. 5 Financial options and guarantees The material financial options and guarantees are those in the Friends ProvidentLife and 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 burnthrough cost, is modelled stochastically, as it willonly occur in some adverse scenarios. The burnthrough 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 burnthrough cost has been assessed using a stochastic model derived from thecurrent Realistic Balance Sheet (RBS) model. This model has been calibrated tomarket 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 burnthrough cost would be markedly higherwithout the hedging activities undertaken. The allowance for non-market risks is made by consideration of the impact ofextreme scenarios from our economic capital model. Significant amounts of newwith-profits business are no longer written and the guarantee levels offered arelower, hence there is no material impact of the burnthrough cost in thecontribution to profits of new business. 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 assolvency 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. For the year end 2007, a change is proposed to this approach, toensure that we hold a margin of 25% over the higher of regulatory or economic inderiving the EEV. 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. 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 burnthrough cost and operational risk. The impact of variations in non-market risks have been taken into account in theburnthrough cost calculation. This allows for asymmetries arising from theprofit sharing mechanism. In addition, a provision has been set up for operational risks in theshareholders' funds. This provision has been calculated by comparing the meanimpact of variations in operational risk, as modelled in the economic capitalcalculations, with the existing allowance for operational risk in specificaccounting provisions and embedded value projection assumptions. At the end of 2007, this provision is equivalent to a 0.4% increase in the riskdiscount rate for UK Life & Pensions business and 0.8% for International Life &Pensions business, recognising the higher operational risks in internationalbusiness. This impacts both the in-force embedded value and the contributionfrom new business. 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. In 2006 and 2007 £6m of corporate costs wereidentified as development or one-off costs. As it is anticipated that this levelof corporate costs will be incurred in future years, they are now classified asongoing costs and have been deducted from the embedded value. (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 are brought intothe consolidated income statement on an IFRS basis, and F&C is brought into thepro forma embedded value at market value. Productivity gains have been assumed within the EEV in respect of internationalbusiness in anticipation of future business growth. The Lombard EEV has beenreduced by an allowance for a projected expense overrun for the period2008-2012. 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 for Work and Pensions rebate premiums, except existing stakeholder-style pensions business where, if a regular pattern in the receipt of premiums for individuals has been established, the regular payment is treated as a renewal of an existing contract and not new business;• non-contractual increments on existing policies; and• new entrants in the group pensions business. Dealing Disclosure Requirements Under the provisions of Rule 8.3 of the Takeover Code (the 'Code'), if anyperson is, or becomes, 'interested' (directly or indirectly) in 1% or more ofany class of 'relevant securities' of Friends Provident, all 'dealings' in any'relevant securities' of that company (including by means of an option inrespect of, or a derivative referenced to, any such 'relevant securities') mustbe publicly disclosed by no later than 3.30pm (London time) on the Londonbusiness day following the date of the relevant transaction. This requirement will continue until the date on which the offer becomes, or isdeclared, unconditional as to acceptances, lapses or is otherwise withdrawn oron which the 'offer period' otherwise ends. If two or more persons act togetherpursuant to an agreement or understanding, whether formal or informal, toacquire an 'interest' in 'relevant securities' of Friends Provident, they willbe deemed to be a single person for the purpose of Rule 8.3. Under the provisions of Rule 8.1 of the Code, all 'dealings' in 'relevantsecurities' of Friends Provident by an offeror or Friends Provident, or by anyof their respective 'associates', must be disclosed by no later than 12.00 noon(London time) on the London business day following the date of the relevanttransaction. A disclosure table, giving details of the companies in whose 'relevantsecurities''dealings' should be disclosed, and the number of such securities inissue, can be found on the Takeover Panel's website atwww.thetakeoverpanel.org.uk. 'Interests in securities' arise, in summary, when a person has long economicexposure, whether conditional or absolute, to changes in the price ofsecurities. In particular, a person will be treated as having an 'interest' byvirtue of the ownership or control of securities, or by virtue of any option inrespect of, or derivative referenced to, securities. Terms in quotation marks are defined in the Code, which can also be found on thePanel's website. If you are in any doubts as to whether or not you are requiredto disclose a 'dealing' under Rule 8, you should consult the Panel. Friends Provident is being advised by JPMorgan Cazenove and Goldman SachsInternational in relation to the strategic review. JPMorgan Cazenove, which is authorised and regulated in the United Kingdom bythe Financial Services Authority, is acting for Friends Provident and no-oneelse in relation to the matters described in this announcement and will not beresponsible to any other person for providing the protections afforded to theclients of JPMorgan Cazenove nor for providing advice in relation to any of thematters described in this announcement. Goldman Sachs International, which is authorised and regulated in the UnitedKingdom by the Financial Services Authority, is acting for Friends Provident andno-one else in relation to the matters described in this announcement and willnot be responsible to any other person for providing the protections afforded tothe clients of Goldman Sachs International nor for providing advice in relationto any of the matters described in this announcement. This information is provided by RNS The company news service from the London Stock Exchange

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