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TIDM35PG
RNS Number : 1171A
Friends Life Group plc
27 March 2012
FRIENDS LIFE GROUP plc
(formerly FRIENDS PROVIDENT HOLDINGS (UK) plc)
Preliminary results for the year ended
31 December 2011
Good progress towards building a sustainable business
Highlights
Significant strategic momentum in 2011
-- Acquisition of Bupa Health Assurance and completion of final elements of AXA UK Life transaction
-- Continued progress on separation and integration with successful launch of Friends Life brand in first quarter of 2011
-- Announcement of UK Heritage and Go to Market management structures
-- Development of asset management business announced with GBP6 billion of assets due to be recaptured by mid-2012
-- Transformational outsourcing transaction with Diligenta; enabling increase in synergy target to GBP143 million by 2015
-- Run-rate synergies ahead of target, GBP45 million achieved; outsourcing contractualisinfurther GBP60 million
-- Capital optimisation program delivered GBP281 million of synergies against GBP235 million guidance
-- Strengthened senior management team, with blend of internal promotions and external appointments
Good progress in the UK, International impacted by weak markets
-- IFRS operating profit before tax of GBP722 million (including the benefit of GBP404 million of capital synergies and one-off items)
-- UK operations made good progress reflecting management actions on capital and costs -- UK target Go to Market platforms delivering improved new business profitability -- International and Lombard operations impacted by difficult markets
Resilient capital position maintained
-- IGCA surplus of GBP2.1 billion representing a surplus of 219% -- Balance sheet has low exposure to higher risk European sovereign and corporate debt
Andy Briggs, Chief Executive Officer said; "Significant progress was made in 2011 to build Friends Life's business and deliver on our cash and synergy targets. I have strengthened my management team and brought in valuable experienced professionals in the shape of Tim Tookey our new CFO, and Rosie Harris our new Chief Risk Officer, to help take the Company forward. The ground breaking outsourcing deal with Diligenta, which has now gone live, secures significant savings and removes risk from our business.
The UK 'Go to Market' businesses made good progress on integration and driving improved profitability despite continuing tough economic and trading conditions. The UK Heritage, Retirement Income and Asset Management businesses will transform the way Friends Life operates and position the Group strongly for the future. Meanwhile despite a resilient performance in our core international markets, particularly Asia, profits in our International business have been impacted by economic and other factors. John Van Der Wielen, who joined the Group in November, is undertaking a strategic review of the division to build on the International growth strategy and prosper in all our key global markets.
Friends Life has a clear strategy to build a sustainable and profitable long-term business underpinned by rigorous financial disciplines, with a team to deliver. We will continue to make targeted investments in major initiatives that drive a significant improvement in business performance."
Journalists requiring further information should contact:
+44 (0) 1306 871 Peter Timberlake Friends Life 834 +44 (0) 1306 634 Emma Evans Friends Life 909
Notes to the editors
1. Friends Life Group are the holders of a large number of industry awards, showing continued recognition of the quality of our products and service.
2. This announcement contains certain forward-looking statements with respect to the Friends Life Group and its outlook. These statements and forecasts involve risk and uncertainty because they relate to events and depend on circumstances that may or may not occur in the future. There are a number of factors that could cause actual results or developments to differ materially from those expressed or implied by these forward-looking statements and forecasts. Nothing in this announcement should be construed as a profit forecast.
3. For more information on the Friends Life Group including, photos, awards, fast facts, presentations, and media contacts please visit the media section at www.friendslife.com/media
4. For more information on Resolution Limited, including, photos, awards, fast facts, presentations, and media contacts please visit the media section at www.resolution.gg
Overview
Transformational year
2011 represented a transformational year for the Group as it transitioned from the acquisition phase of the UK Life Project towards the delivery of a focused and integrated life business.
The acquisition of Bupa Health Assurance Limited (since renamed Friends Life BHA Limited) ("BHA") in January 2011 brought with it a well regarded and efficient protection platform as well as a range of market leading individual and group protection products. In addition, the second phase of the acquisition of the AXA UK Life Business was formally completed with the acquisition of Winterthur Life UK Limited ("WLUK") and disposal of the Guaranteed over Fifty ("GOF") and Trustee Investment Plan ("TIP") portfolios in November 2011.
In March 2011, the acquired businesses were rebranded as Friends Life. In August, the Group announced the restructuring, for management purposes, of the UK business into distinct Heritage and 'Go to Market' businesses: Corporate Benefits, Protection and Retirement Income.
In November, the Group set out its intention to develop in-house asset management capabilities with the creation of Friends Life Investments ("FLI") to manage its significant portfolio of fixed income assets. It also announced a transformational 15 year outsourcing partnership with IT and customer service specialist, Diligenta. This outsourcing partnership has allowed the Group to increase its cost savings target from GBP112 million to GBP143 million (30% of UK 2010 baseline costs). On 1 March 2012, the new outsourcing partnership commenced with most of the Group's remaining UK Heritage service operations transferring across to Diligenta.
In December, the Group completed various Part VII transfers combining a number of smaller life companies into Friends Life Limited ("FLL") (formerly Friends Provident Life and Pensions Limited), restructuring the acquired businesses to maximise capital synergies and to continue the restructuring that supports the future direction of the business.
Business performance
The UK operating result has shown significant improvement with good progress towards strategic objectives reflecting both the improved trading performance, as the businesses integrate, and a number of one-off items including the Diligenta outsourcing arrangement.
The Corporate Benefits and Protection businesses have demonstrated improvements in internal rates of return ("IRR") and new business strain ("NBS") with the focus on strategic products platforms and expense reductions driving the overall development of these results and offsetting the impact of adverse pensions persistency. The Retirement Income business continues to exceed its targeted IRR. The performance of the UK Heritage business reflects the challenging market conditions, adverse persistency and provisions established in respect of the Retail Distribution Review ("RDR") partially offset by the positive impact of mortality and morbidity experience.
The good progress in the UK business was offset by a poor performance in the International business; despite a 6% increase in sales volumes, IRR reduced due to an increase in the proportion of the existing lower margin 'Premier' products in Asia and a lower proportion of higher margin German business sales. The continued review of the in-force portfolio, which commenced in the first half of 2011, highlighted further issues and the business's performance was also impacted adversely by the effect of economic markets through an increased cost of guarantees in respect of certain Overseas Life Assurance Business ("OLAB") products. The International management team has been strengthened, a strategic review is well advanced and the business is focused on improving profitability, driving through reductions in new business strain and is working to meet its cash generation target.
Lombard continued to perform well, but again results reflect the economic downturn in Europe, with some adverse impact on sales. Notwithstanding these difficult conditions, Lombard has outperformed its peers.
The following table shows the IRR performance of the key business lines compared with the targets set for 2013.
2010 IRR % (unless otherwise 2013 2011 Full year 2010 stated) Target Full year baseline(i) Full year ---------------------------- -------- ----------- ------------- ----------- UK n/a(ii) 7.7 5.9 7.1 International 20+ 12.7 15.4 15.4 Lombard(iii) 20+ >25.0 >25.0 >25.0 ---------------------------- -------- ----------- ------------- ----------- Blended group new business IRR(iii) 15+ 10.0 8.6 11.2 ---------------------------- -------- ----------- ------------- ----------- New business cash strain (GBPm) 192 278 392 238 ---------------------------- -------- ----------- ------------- -----------
(i) 2010 full year baseline includes an estimate of 12 months BHA and AXA UK Life Business results.
(ii) Target IRRs for the Go to Market businesses are set out in the relevant sections of the UK operating review.
(iii) The 2011 Lombard IRR (and therefore the blended group IRR) now takes account of the Luxembourg regulatory regime in which DAC is an allowable asset.
Market environment
As well as affecting the operational performance, the difficult economic environment in the year has negatively impacted IFRS total profits. Income on shareholder assets and the value of annual management charges ("AMCs") have fallen and reserves for certain guarantees have increased resulting in a reduced operating result.
Capital strength
The Group's robust capital position has been maintained during 2011 with an IGCA surplus as at 31 December 2011 of GBP2.1 billion (31 December 2010: GBP2.3 billion). The movement in the year principally reflects:
-- the surplus generated offset by economic impacts, primarily credit spreads;
-- the impact of the BHA transaction; and
-- dividends paid to Resolution Holdings (Guernsey) Limited ("RHG").
Significant capital synergies were delivered in the year, but much of this benefit has been eroded by widening credit spreads. The Group changed its capital policy in the year from 160% to 150% of Group Capital Resources Requirements (excluding WPICC), reflecting reduced integration risk. The reduction in Pillar 1 capital requirements and increases in Pillar 2 from market movements mean that the Group is now on the cusp of both Pillars biting and accordingly capital management actions in 2012 are focused on the management of both bases.
The Group's balance sheet remains strong and the shareholder exposure to the higher risk government debts of Spain, Portugal, Italy, Ireland and Greece remains low at GBP6 million (31 December 2010: GBP7 million).
Dividends
The directors are recommending an interim dividend for the year to 31 December 2011 of GBP250 million (2010: GBP250 million) payable by 31 March 2012.
Outlook
2011 has been an important year for the Group with the ground work completed and progress made towards the delivery of a sustainable, profitable business which is underpinned by rigorous financial discipline. The Group's strategy has delivered a strong set of results with good progress towards 2013 financial targets. Looking forwards the Group, with the strong management team built over 2011, is now well placed to drive forwards into the chosen core product markets.
Group results
Key performance indicators
The Group's results for 2011 include the post acquisition results of the acquired businesses and are therefore not currently directly comparable from period to period where acquisitions have taken place in the year under review. The 2010 results included Friends Provident for 12 months and the AXA UK Life Business for four months while the 2011 results include Friends Provident and the AXA UK Life Business for 12 months, Bupa Health Assurance Limited ("BHA") for 11 months and Winterthur Life UK Limited ("WLUK") for two months.
The Group uses the following key performance indicators. The Group has also set a number of targets for the life operating businesses which are detailed in the following sections.
GBPm (unless otherwise stated) Full year Full year 2011 2010 ------------------------------------------ ---------- ---------- IFRS based operating profit before tax 722 290 IFRS profit after tax 10 848 IGCA surplus capital (GBPbn) 2.1 2.3 Asset quality(i) for shareholder related assets 97% 95% ------------------------------------------ ---------- ---------- (i) Corporate debt and asset-backed securities at investment grade or above.
-- IFRS based operating profit before tax of GBP722 million (31 December 2010: GBP290 million) benefited from the increased scale of the UK business as well as the actions taken to release negative reserves, the Diligenta outsourcing transaction and other favourable assumption changes. These were offset by the adverse impact on operating profit of poor market conditions (reflected through reduced AMCs, higher cost of guarantees and reduced long-term investment return) and the inclusion of a full year's financing costs.
-- IFRS profit after tax of GBP10 million (31 December 2010: GBP848 million profit) reflects investment market losses as well as the impact of one-off costs relating to separation and integration spend, the Diligenta outsourcing transaction and other project activity. Amortisation and impairment of acquired intangibles includes the one-off impact of adoption of negative reserves and a full year charge for the AXA UK Life Business. The result benefits from the gains recognised on the acquisition of BHA and WLUK whilst the prior year result reflects the much larger gain on the acquisition of the AXA UK Life Business.
-- Group IGCA surplus capital of GBP2.1 billion (31 December 2010: GBP2.3 billion) reflects the GBP350 million dividend paid to RHG and the acquisition of BHA, partially offset by surplus emergence in the year. The IGCA at the end of February increased to GBP2.2 billion, with the impact of positive investment performance partially offset by separation and integration spend.
-- The Group has maintained high asset quality, with 97% of shareholder-related corporate debt and asset-backed securities at investment grade or above (2010: 95%). The Group has no significant shareholder exposure to sovereign debt or corporate bonds of higher risk European economies.
Group IFRS profit
The Group's IFRS results are set out below, including a reconciliation from IFRS based operating profit to the IFRS result after tax. The Group uses the operating profit measure as the Board considers that this better represents the underlying performance of the business and the way in which it is managed.
These results include the results of the acquired Friends Provident business, AXA UK Life Business, BHA and WLUK from the deemed dates of their acquisitions, which were 4 November 2009, 3 September 2010, 31 January 2011 and 7 November 2011 respectively. The results of the GOF and TIP portfolios are included for the period from 3 September 2010 until their disposal on 1 November 2011.
GBPm UK Int'l Lombard Corporate 2011 2010 ----------------------------------------------- ------ ------ -------- ---------- --------- -------- New business strain (112) (36) (33) - (181) (145) In-force surplus 402 97 73 - 572 466 Long-term investment return (5) 1 (1) (21) (26) 13 Principal reserving changes and one-off items 416 (12) - - 404 (13) Development costs (28) (7) (1) - (36) (28) FLG other income and charges (1) (3) - (7) (11) (3) IFRS based operating profit/(loss) before tax 672 40 38 (28) 722 290 Short-term fluctuations in investment return (261) 24 Acquisition accounting adjustments: Amortisation and impairment of acquired in-force business (675) (364) Amortisation of other acquired intangible assets (84) (64) Non-recurring items: Gain on acquisition of businesses 116 883 Costs associated with the business acquisitions (3) (14) Other non-recurring items (293) (68) STICS interest adjustment to reflect IFRS accounting for STICS as equity 31 31 Returns on F&C Commercial Property Trust - 23 ------------------------------------------------------------------------------------- --------- -------- IFRS (loss)/profit before shareholder tax (447) 741 Shareholder tax 457 107 ------------------------------------------------------------------------------------- --------- -------- IFRS profit after tax 10 848 ------------------------------------------------------------------------------------- --------- --------
IFRS based operating profit for 2011 was GBP722 million comprising the operating profit of the life businesses of GBP750 million and GBP28 million of corporate costs for the Group. This result includes GBP404 million of principal reserving changes and one-off items which comprised:
-- GBP221 million one-off benefit in respect of PS06/14;
-- GBP71 million release of expense reserves, including the benefit of the savings secured through the Diligenta outsourcing; and
-- a further GBP124 million of positive UK assumption changes offset by GBP12 million adverse changes in International.
The exclusion of these items and the equivalent one-off changes in 2010 leads to an underlying IFRS based operating profit of GBP318 million for 2011 compared to GBP303 million for 2010. The increase in the size of the Group and the improvements to new business strain (reflecting cost reductions and transition to target platforms) have been offset by the adverse impact of market conditions on operating profit (resulting in lower annual management charges for UK business, higher cost of guarantees for certain International business and lower long-term investment return assumptions), the ongoing negative impact of the adoption of PS06/14 and the poor performance in International. Further details on the operating performance of the Group are included in the relevant business unit operating sections.
Non-operating items
Investment market performance has been volatile throughout 2011 and deteriorated in the second half of the year. As a result negative short-term fluctuations in investment return amounted to GBP261 million, principally relating to variances against the expected return on assets backing the non-profit funds. The major movements comprise:
-- adverse variances as a result of mismatches between the assets backing the Friends Life annuity portfolios and the related liabilities. These variances are a consequence of the Group's asset/liability matching approach which is typically undertaken on a realistic basis. As policyholder liabilities are reported in the results according to their treatment on a regulatory basis the differing approaches create a mismatch;
-- credit default assumptions have been strengthened following the worsening of economic conditions during the second half of 2011 as evidenced by the significant widening of corporate bond spreads; and
-- negative shareholder fluctuations of GBP46 million represent the difference between actual and expected investment returns, due to the Group's higher holding in cash combined with lower than expected rates of return.
Acquisition accounting adjustments, totalling GBP759 million, represent the amortisation and impairment of the intangible assets recognised on the acquisitions. These charges comprise GBP675 million of amortisation and impairment of acquired in-force business, and GBP84 million of amortisation of other intangible assets. The amortisation of acquired in-force business includes a one-off charge of GBP201 million (GBP130 million for the AXA UK Life Business and GBP71 million for BHA) reflecting the accelerated run-off of in-force surplus following the recognition of negative reserves in these businesses.
Non-recurring items include gains on acquisitions of GBP116 million. The completion of the BHA and WLUK acquisitions has resulted in gains of GBP68 million and GBP48 million respectively, offset by acquisition costs of GBP3 million.
The disposal of the GOF and TIP portfolios did not have a significant impact on the Group results.
Other non-recurring costs of GBP293 million include GBP84 million of costs relating to the 15 year outsourcing arrangement with Diligenta; and GBP209 million of other non-recurring costs. These comprise:
-- separation and integration programme costs of GBP128 million;
-- finance transformation costs of GBP55 million including Solvency II;
-- capital optimisation project costs of GBP19 million; and
-- other costs of GBP7 million.
The Diligenta impact of GBP84 million in 2011 reflects the reserving required for transition and service improvement costs in relation to in-force insurance contract business. In accordance with IFRS, no reserves have been established for the investment contracts business. Total implementation costs for both in-force insurance and investment business are expected to be GBP250 million with the remainder incurred over 2012 to 2014.
Interest payable on the FLG STICS of GBP31 million is included as a GBP26 million deduction to corporate long-term investment return in the operating profit analysis, and GBP5 million adverse investment fluctuation. As the STICS are accounted for as equity in IFRS (with interest being recorded as a reserve movement), GBP31 million is added back to the non-operating result to reflect the requirements of IFRS.
A shareholder tax credit of GBP457 million is recognised in the period and is significantly higher than the loss before tax of GBP447 million would imply. The principal differences between the implied and actual shareholder tax credit relate to:
-- GBP69 million one-off shareholder tax credit triggered by the change in pricing basis on certain unit-linked funds to reflect the fact these funds were contracting;
-- GBP60 million shareholder tax credit relating to the reduction in the rate of UK corporation tax;
-- GBP68 million and GBP48 million gains on the acquisitions of BHA and WLUK respectively, which are not taxable (the tax impact of this is GBP31 million); and
-- GBP190 million shareholder credit for tax reliefs, expenses and exemptions predominantly in relation to the life insurance companies in the Group which are taxed on the I minus E basis, an element of which is matched by liabilities which are accounted for within policyholder liabilities and form part of the loss before tax.
The tax credit includes a GBP194 million credit in respect of the amortisation and impairment of AVIF and other acquired intangibles in the year.
The GBP23 million return on F&C Commercial Property Trust in 2010 reflects the market return attributable to third parties for the period up to April 2010. This was the date at which the Group ceased to consolidate the results of this company, as holdings had been reduced to below the level requiring consolidation, hence there is no impact on the 2011 results.
Summary IFRS balance sheet
31 December 31 December GBPm 2011 2010 ------------------------------------------- ------------ ------------ Acquired value of in-force business 4,437 4,685 Other intangible assets 410 455 Financial assets 103,643 99,465 Cash and cash equivalents 8,690 9,057 Other assets 8,132 8,492 ------------------------------------------- ------------ ------------ Total assets 125,312 122,154 ------------------------------------------- ------------ ------------ Insurance and investment contracts 112,455 107,492 Loans and borrowings 972 1,012 Other liabilities 5,737 7,102 ------------------------------------------- ------------ ------------ Total liabilities 119,164 115,606 ------------------------------------------- ------------ ------------ IFRS net assets 6,148 6,548 ------------------------------------------- ------------ ------------ Equity attributable to equity holders of the parent 5,825 6,226 STICS 318 318 Attributable to non-controlling interests 5 4 ------------------------------------------- ------------ ------------ Total equity 6,148 6,548 ------------------------------------------- ------------ ------------
At 31 December 2011, IFRS total equity was GBP6,148 million (31 December 2010: GBP6,548 million), with equity attributable to equity holders of the parent of GBP5,825 million (31 December 2010: GBP6,226 million).
Financial assets are predominantly invested in listed shares, other variable yield securities and corporate bonds and asset-backed securities. Asset quality has been maintained with 96.9% of shareholder-related corporate bonds and asset-backed securities held at investment grade or above.
UK operating review
In August 2011, the Group announced the creation of distinct 'Go to Market' and 'Heritage' UK business units, reflecting the Group's desire to improve the focus on both the profitable products and markets, and the existing in-force customer base. The Go to Market businesses are Corporate Benefits, Protection, and Retirement Income. They represent scale markets where good margins are generally available and where the Group has strong market positions enabling access to those margins. The Heritage business manages products not being marketed actively and the dedicated Heritage management team is focused on retention, cash and capital. The Heritage business unit forms the bulk of the UK business by assets.
2011 Percentage UK funds under management Full year -------------------------------------- ----------- UK Heritage 81% Corporate Benefits 17% Retirement Income 2% -------------------------------------- ----------- Total UK funds under management GBP88bn -------------------------------------- -----------
Profitability of new business
2011 Full year -------------------------------------------- Heritage Go to Market ------------------------------------ 2010 2011 Full 2010 GBPm (unless Corporate Retirement Half year Full otherwise stated) Benefits Protection income Total year baseline year New business cash strain (54) (51) (77) 13 (169) (98) (303) (149) IRR (%) 6.0 8.3 5.5 22.0 7.7 7.0 5.9 7.1 -------------------- --------- ---------- ----------- ----------- ------ -------- ---------- ------- APE 157 440 92 32 721 372 677 472 -------------------- --------- ---------- ----------- ----------- ------ -------- ---------- -------
The Group's new business strategy focuses on products and distribution channels in the UK market where the Group has a strong market position and the potential to access attractive returns. This strategy drives the focus of the Group's UK Go to Market business units whilst steps have been taken to exit or scale back sales in product lines where Friends Life will not be able to generate satisfactory returns (mainly individual pensions and investment bonds). The creation of a UK Heritage business unit will allow more active management of the products no longer actively marketed.
A number of critical steps have now been taken as part of the drive to improve profitability to meet the Group's 2013 targets. The recognition of negative reserves in the acquired AXA UK Life Business and BHA protection books has significantly reduced new business cash strain. In addition, the focus on new business profitability across Friends Life has served to reduce cash strain down to GBP169 million in the year, representing a GBP134 million reduction on the GBP303 million 2010 baseline and demonstrates the significant progress made toward the target set out in early 2011 to reduce UK cash strain by GBP200 million.
A significant proportion of the Go to Market Protection and Corporate Benefits new business is now written on their respective target platforms. The profitability of the selected platforms is already close to or above the target 2013 returns with the target Corporate Benefits platform delivering 9.4% IRR (target: 10%) and the target Individual Protection platform delivering 20.0% IRR (target: 20%). The UK blended new business IRR has improved throughout the year with a progression from 5.9% in the 2010 full year baseline improving to 7.7% at the end of 2011. As a result, Friends Life remains confident of meeting the targeted product metrics by the end of 2013. The relevant sections below contain detailed commentary on the results for each component business within the UK operating segment.
Cost savings
Separation and Integration
The separation and integration programme is progressing well with the BHA acquisition absorbed without interruption in January 2011. The BHA separation was completed at the end of January 2012 with the exit from Bupa transitional service arrangements ("TSAs").
The joint separation plans and operational service provision between AXA and Friends Life continues to work well, with 59% of transitional service arrangements exited by the end of 2011. Further arrangements have been exited early in 2012 and the separation from AXA IT infrastructure, the most significant component of the Friends Life and AXA separation agenda, is well advanced.
There have been five site closures announced to date, being Coventry, Manchester Spring Gardens, Basingstoke, Preston and London Crosswall (the former offices of BHA, where employees moved across to Friends Life's One New Change offices at the end of January 2012).
The integration projects remain on plan with GBP45 million run-rate savings achieved by the end of 2011 with cumulative costs of GBP67 million incurred to date (GBP58 million in 2011). This progress represents an acceleration of synergy delivery primarily across Customer Services and IT, and has been delivered through closing legacy products to new business as well as the initial impacts of announced site exits. Cumulative separation project costs of GBP72 million (GBP57 million incurred in 2011) are also in line with plan at this stage of the project.
Diligenta
The Diligenta transaction complements the current outsourcing arrangements already in place with Capita. The service start date of this transformational transaction was 1 March 2012 when the remaining UK Heritage IT and Customer Services functions were outsourced thereby materially de-risking the future expense levels of the UK business together with significantly enhancing the level of synergies available. This certainty of future cost levels for a significant proportion of the business has been recognised in the operating results.
IFRS based operating profit has benefited by GBP71 million in 2011 reflecting the release of maintenance expense reserves. Implementation costs of GBP84 million (which exclude costs relating to investment contracts in accordance with IFRS) have been reserved for and are presented within non-recurring costs. This results in a small net loss included in IFRS profit before tax of GBP13 million.
The Diligenta outsourcing is expected to generate annual cost savings of GBP60 million by 2015. Included in these expected savings is an amount of GBP29 million which relates to IT and Customer Service integration synergies that would otherwise have been delivered as part of the previously announced GBP112 million cost savings target. The contract, therefore, delivers additional expected cost savings of GBP31 million allowing the Group to increase the cost savings target to GBP143 million which will, in turn, drive improved profitability and lower new business strain. The previously committed element of the savings will still be delivered by the end of 2013 with the additional GBP31 million to be delivered by the end of 2015.
The total one-off costs of delivering the outsourcing arrangement are expected to be GBP250 million although GBP20 million of previously expected one-off costs will be avoided, resulting in net additional one-off cost of GBP230 million over 2011 to 2014. Combined with the GBP45 million of other run-rate savings delivered in 2011 and referred to above, a total of GBP105 million of savings has now been achieved or contractualised.
Expenses
The Group has made good progress in reducing the UK cost base during 2011. UK acquisition and maintenance expenses totalled GBP441 million, which includes GBP14 million of temporary cost, primarily VAT on transitional service arrangements as part of the separation of the AXA UK Life Business from AXA UK, and GBP7 million of expenses incurred by the GOF and TIP businesses prior to their transfer back to AXA UK. Including a full year impact of WLUK expenses would increase 2011 underlying UK expenses from GBP420 million to GBP446 million. This represents a reduction on 2010 UK baseline expenses of GBP476 million on a comparable basis, including the effect of inflation during 2011. The full effect of the run-rate savings set out above will be realised in 2012.
Capital optimisation
The Group's strategy to improve cash delivery is materially influenced by the actions taken within the UK business.
Capital optimisation
The recognition of negative reserves has materially reduced the cash strain of the Protection business and the business as a whole. The progress and control of new business strain is also a key lever in the Group's drive to improve cash generation. Further operational improvements will be delivered as the business focuses new business on the highly efficient Protection and Corporate Benefits strategic platforms whilst the outsourcing arrangement with Diligenta has enabled the UK Heritage business to variabilise its cost base, de-risking the inevitably detrimental effect of a fixed cost base on incremental business written on products that are no longer marketed.
The impact of adopting certain elements of PS06/14 guidance in the acquired BHA and AXA UK Life Business significantly benefitted the 2011 IFRS based operating profit. The recognition of negative reserves, and resulting reduced capital requirements on protection products, has effectively accelerated the surplus generated on these products although lower in-force surplus releases are subsequently expected in future as a result. In addition, as the profit profile of these products has changed, the corresponding amortisation of deferred acquisition costs ("DAC") has likewise been accelerated. The resulting one-off benefit to IFRS based operating profit is GBP221 million in the year, with a corresponding benefit of GBP12 million to new business strain and a reduction of GBP40 million in the emerging in-force surplus in 2011. This reduction in in-force surplus is expected to reduce to GBP25 million to GBP30 million in 2012 based on current expectations of in-force run-off. The overall net impact on IFRS based operating profit for 2011 (excluding improvements in new business strain) is GBP181 million. IFRS based profit after tax remains largely unaffected, despite the increased one-off benefit as the earlier recognition of surplus is offset by the accelerated run-off of acquired value of in-force business.
Further capital efficiencies have been delivered in the second half of 2011 through the completion of a number of Part VII transfers. These have successfully transferred business from a number of smaller life companies into FLL. The completion of these transfers has reduced aggregate Pillar 1 capital requirements by around GBP113 million and released GBP181 million of surplus capital. Further Part VII transfers are planned for 2012 with these aiming to reduce the number of UK life companies from the current five down to two by the end of 2013.
Financial results
UK IFRS based operating profit
2011(i) 2011(ii) 2010(iii) Full year Half year Full year GBPm GBPm GBPm ----------------------------------------------- ----------- ----------- ----------- New business strain (112) (66) (89) In-force surplus 402 214 280 Longer-term investment return (5) 4 30 Principal reserving changes and one-off items 416 222 (15) Development costs (28) (10) (21) Other income and charges (1) - 2 ----------------------------------------------- ----------- ----------- ----------- IFRS based operating profit before tax 672 364 187 ----------------------------------------------- ----------- ----------- -----------
(i) 2011 full year results comprise 12 months results for Friends Provident and the AXA UK Life Business, 11 months for BHA and two months for WLUK.
(ii) 2011 half year results comprise six months results for Friends Provident, six months for the AXA UK Life Business and five months for BHA.
(iii) 2010 full year results include 12 months results for Friends Provident and four months for the AXA UK Life Business.
In the year to 31 December 2011 the UK segment delivered IFRS based operating profit before tax of GBP672 million (31 December 2010: GBP187 million), representing an increase of GBP485 million on the prior year. The increase reflects the greater scale of the UK business, in particular a full 12 months of operating profit from the AXA UK Life Business, and improved performance including the recognition of management actions and other reserving benefits.
Despite these operating improvements, on an underlying basis, after removing principal reserving changes and one-off items, the full year profit of GBP256 million is lower than the annualised half year result of GBP284 million. This reduction principally reflects the impact of adverse economic conditions on in-force surplus generation, partially offset by reduced new business strain as the cost reductions and transition to target platforms take effect.
UK new business strain and in-force surplus
Details of new business strain and in-force surplus for the UK business are set out below.
Reconciliation of new business cash strain to IFRS new business strain
2011 2011 2010 Full year Half year Full year GBPm GBPm GBPm ----------------------------------- ----------- ----------- ----------- Total UK new business cash strain (169) (98) (149) DAC/DFF adjustments 60 33 59 Other IFRS adjustments (3) (1) 1 ----------------------------------- ----------- ----------- ----------- Total UK IFRS new business strain (112) (66) (89) ----------------------------------- ----------- ----------- -----------
New business cash strain has benefitted from a number of factors in the year with good progress being made towards the target GBP200 million reduction in UK new business cash strain. IFRS new business strain of GBP112 million reflects some of these benefits with the principal driver of improvement, in the second half of the year, being a reduction in costs as Protection new business is transferred to the target platform.
The implementation of PS06/14 reserving changes and the recognition of negative reserves across the UK Protection portfolio means that DAC is no longer recognised on this business. This change in treatment offsets the reserving benefits which are apparent in cash strain and as a consequence the benefit to IFRS new business strain is reduced. DAC continues to be recognised on pensions and investments business and has moved in line with expectations given the current product mix and levels of new business.
Reconciliation of in-force cash surplus to IFRS in-force surplus
2011 2011 2010 Full year Half year Full year GBPm GBPm GBPm ------------------------ ----------- ----------- ----------- Total UK cash surplus 354 207 268 DAC/DFF adjustments (7) (1) 8 Other IFRS adjustments 55 8 4 ------------------------ ----------- ----------- ----------- Total UK IFRS surplus 402 214 280 ------------------------ ----------- ----------- -----------
UK cash surplus generated in the year of GBP354 million (30 June 2011: GBP207 million) reflects the volatility in the macro economic environment in particular lower average equity markets and lower risk free rates. The lower level of equity markets resulted in a reduction in fees generated on unit-linked funds in the year as well as leading to an increase in reserves to reflect the impact of lower annual management charges in the future. In addition, the fall in risk free rates has resulted in an increased cost of product guarantees, whilst the basis changes to income protection morbidity removed the benefit of the half year positive variance from the full year surplus.
The effect of the negative economic impacts on the IFRS in-force surplus, GBP402 million (30 June 2011: GBP214 million) is partially reduced by the reversal of the increased reserving level referred to above, which is not allowable on the IFRS basis. This is reflected in the proportionally higher size of other IFRS adjustments to the change in cash surplus compared to previous periods.
The GBP7 million net amortisation of DAC and deferred front end fees ("DFF") reflects the relatively small value of these costs that has been capitalised in the post-acquisition period. On the acquisition of the business, the existing capitalised DAC and DFF were eliminated and recognised within the acquired value of in-force ("AVIF"). In the post-acquisition period, as new business is written, the capitalisation of acquisition expenses and front end fees resumed and hence the amortisation charged against in-force surplus will increase each year for pensions and investments business.
Longer-term investment return
2011 2011 2010 Full year Half year Full year GBPm GBPm GBPm --------------------------------------------------------------------------- ----------- ----------- ----------- Longer-term return on life and pension shareholder funds - excluding debt 70 35 76 Longer-term return on life and pension shareholder funds - debt (75) (31) (46) Total (5) 4 30 --------------------------------------------------------------------------- ----------- ----------- -----------
Longer-term investment return has fallen in the second half of 2011 with a net loss of GBP5 million in the year driven by an increase in financing costs. This primarily reflects the increased debt held in the UK business with GBP500 million transferred from Friends Life holding companies in April 2011 and a further GBP200 million transferred in December 2011.
Principal reserving changes and one-off items
Principal reserving changes and one-off items comprise a GBP221 million one-off benefit in respect of PS06/14, GBP71 million release of expense reserves, including the benefit of the savings secured through the Diligenta outsourcing, and a further GBP124 million of assumption changes primarily in respect of favourable mortality and morbidity experience and some positive persistency experience in protection.
UK operating expenses
2010 2011 2011 Full 2010 Full Half year Full year year baseline(i) year GBPm GBPm GBPm GBPm ------------- ------ ------ ------------- ------ Acquisition 178 89 220 130 Maintenance 263 130 256 140 ------------- ------ ------ ------------- ------ 441 219 476 270 Development 28 10 23 21 ------------- ------ ------ ------------- ------ Total 469 229 499 291 ------------- ------ ------ ------------- ------
(i) 2010 full year baseline includes an estimate of 12 months AXA UK Life Business, BHA and WLUK operating expenses.
UK operating expenses, which exclude commission payments and non-recurring costs totalled GBP469 million in the year with acquisition and maintenance expenses amounting to GBP441 million. Acquisition and maintenance expenses remain the focus for the UK business in the drive to reduce expenses by GBP143 million (GBP112 million by the end of 2013) from a 2010 baseline of GBP476 million. 2011 expenses include two months of WLUK operating expenses whilst the baseline includes a full 12 months charge of GBP31 million.
Actions to reduce operating expenses have been progressing well with GBP45 million of run-rate saving being made to date. However given the timing of these savings only a GBP27 million benefit is reflected in the 2011 expense base. These include the implementation of the revised strategy announced in February 2011 resulting in streamlined UK sales and marketing functions and synergies from reorganisation of operations prior to outsourcing services to Diligenta. Offsetting this reduction are a number of temporary increases, including VAT on services provided by AXA UK and short-term increases in Finance and Governance functions to strengthen capabilities during integration, which will not recur beyond 2013 as the integration of the UK businesses completes.
Development costs of GBP28 million mainly comprise GBP7 million of spend on the new Corporate platform, GBP6 million investment into the Retirement Income strategy and GBP4 million in the development of auto-enrolment capabilities including the development of an auto-enrolment hub aimed at reducing the legislative burden on clients. Other development spend includes investment in data modelling for the Protection business as well as other smaller development projects.
UK other income and charges
Other UK IFRS based operating loss of GBP1 million includes the GBP2 million trading profit generated by Sesame Bankhall Group ("SBG"). SBG is the UK's largest distributor of retail financial advice and operates three market leading brands. Sesame is the leading appointed representative network, Bankhall is the largest support service provider for directly regulated IFAs and PMS is the biggest mortgage club for intermediaries. In 2011 SBG retained its position as the UK's largest distributor of mortgages through intermediaries, with over GBP26.1 billion of mortgage applications (an increase of GBP1.9 billion on 2010). This represents a 13.8% share of the entire UK mortgage market (2010: 13.3%).
UK Heritage
Strategic Implementation
The UK Heritage business unit is fundamentally different to the Go to Market propositions, with greater in-force scale, a large set of closed products, complex legacy systems and over four million customers. Consequently the business unit (which was created during the course of 2011) is focused on different value drivers. The three key value drivers for the Heritage business are:
-- management of an efficient cost base in line with business scale;
-- minimisation of capital required for the business; and
-- retention of in-force business.
Good progress is being made in establishing a dedicated management team focused on the Heritage business, consistent with the aim to be the UK's leading legacy business manager, with the knowledge and expertise to maximise the value created from these books. This team is led by Friends Life's Chief Commercial Officer, Evelyn Bourke.
The Heritage business has set out its plans to drive value with the following strategic themes being the starting point.
Outsourcing
The Heritage business, absent further portfolio acquisitions, is not a self perpetuating business. As a result, management of the underlying cost base is critical to cash and profitability. The significant policy administration and IT outsourcing deal with Diligenta which commenced on 1 March 2012, together with the existing outsource arrangement with Capita, mean that materially all of Heritage policy administration is outsourced. The resulting certainty around administration costs reduces the risk of expense assumptions in the embedded value coming under pressure, as the cost base is now more variable and will decrease as the business runs off.
The outsourcing transaction also contractually secures and extends the synergies arising from the combination of the Friends Provident and AXA UK Life Business.
Building an in-house asset manager
Building in-house asset management capability supports the aim of running to an efficient cost base with the expectation that assets can be managed more efficiently internally in the longer term. Friends Life Investments ("FLI") is due to launch in mid 2012, with the in-house capability presenting a significant opportunity to deliver more value from the existing book through optimised investment strategies at lower cost.
As announced in November 2011 the Group has GBP61 billion of externally managed assets which will reach the end of their contractual terms within the next nine years and are available for recapture. The potential fee recapture associated with these assets is in the order of GBP100 million per annum including VAT. In Phase 1, FLI will focus on the recapture of the core non-linked and shareholder assets of the Group. These assets are principally fixed income in nature. It is expected that the Group could recapture fees of the order of GBP10 million per annum (including VAT) from the GBP12 billion of assets targeted in Phase 1. The Group has currently served notice on GBP8 billion of these assets with GBP6 billion expected by the middle of the 2012. Phase 2 principally relates to fixed income assets currently managed in the Group's with-profit and unit-linked funds.
The Group already has significant expertise in fixed income and this was augmented with the recruitment of an experienced fixed interest team in January 2012.
To assist in minimising the additional headcount, the middle and back office support functions will all be wholly outsourced. This will provide future scalability and flexibility whilst assuring cost certainty.
Capital Optimisation Programme
There is a large capital optimisation programme underway to simplify the legal structure of the business and remove capital inefficiencies. Friends Life has five UK life companies within the group and the ultimate result of the programme will be to reduce this to two, broadly aligned to the Heritage business and Go to Market business lines. The Group expects to reach this end state during 2013.
With-profits fund management
A programme to develop and implement a uniform risk management framework for the six with-profits funds within the Heritage business is currently underway. The result will be a consistent plan of management actions across the with-profits funds to mitigate the risk of volatile returns for shareholders whilst ensuring fair treatment of customers.
Customer value management
Friends Life aims to actively engage with its customers to minimise avoidable policy lapses. Initiatives in place include both pro-active and reactive customer communication, aimed at retaining valuable customers within their existing product, or within the Group as a post retirement annuitant.
Fund rationalisation
The Heritage business includes policies invested in a very wide universe of investment funds, as a legacy of the businesses that wrote the original policies. There are opportunities to increase efficiency and reduce risk over the medium term by significantly rationalising the number of funds and this process will begin during 2012.
UK Heritage unit-linked assets under management
Unit-linked funds under management are a significant source of future revenue in the form of annual management charges less investment management fees and trail commission. In 2011, the Group has seen net outflows of both unit-linked pensions and investment business. Unit-linked pensions outflows in the year have been driven by individual pensions business whilst unit-linked investment business, primarily single premium bonds, reflects the maturing of this book with new business having been modest for some years. The Group no longer actively markets any bond products in line with the Group's announcement to withdraw from the individual bond market.
Unit-linked Unit-linked pensions investments GBPbn GBPbn ------------------------------------------------- ------------ ------------- Total Group unit-linked assets under management 31 Dec 2010 30.6 17.1 ------------------------------------------------- ------------ ------------- Go to Market business unit (12.0) - ------------------------------------------------- ------------ ------------- Heritage unit-linked assets under management 31 Dec 2010 18.6 17.1 ------------------------------------------------- ------------ ------------- Acquisition of WLUK 2.4 0.5 Inflows 0.7 0.5 Outflows (2.7) (2.1) Market movements (0.1) 0.3 ------------------------------------------------- ------------ ------------- Heritage unit-linked assets under management 31 Dec 2011 18.9 16.3 ------------------------------------------------- ------------ -------------
At 31 December 2010, total unit-linked pensions funds under management amounted to GBP30.6 billion. Following the creation of the UK Heritage business unit, GBP12.0 billion of these unit-linked pensions funds are now managed in the Corporate Benefits business unit.
New business
Heritage Heritage Heritage Heritage 2011 2011 GBPm (unless otherwise pensions protection investments WP annuities Full Half stated) year year ------------------------ ---------- ------------ ------------- -------------- ------ ------ New business cash strain (31) (2) (23) 2 (54) (30) IRR 2.2% >25.0% 7.6% 18.8% 6.0% 6.8% ------------------------ ---------- ------------ ------------- -------------- ------ ------ APE 108 7 34 8 157 87 ------------------------ ---------- ------------ ------------- -------------- ------ ------
The Heritage business unit specifically focuses on those products no longer actively marketed. It does not actively drive new business, but the book delivers a significant level of ongoing incremental business written across all product types. This business remains important as a contributor to overall Group overheads.
The Group expects new business to reduce in the medium term. In particular new business strain relating to investments business is expected to reduce in future years due to the closure of Bond products to new business during 2011.
Go to Market: Corporate Benefits
The Go to Market Corporate Benefits business is being built on the efficient and scalable New Generation Pension ("NGP") platform and currently administers GBP15.4 billion of assets on behalf of over 15,000 corporate clients. In addition to the current products focused around both trust and contract-based pensions solutions, the launch of the corporate platform in January 2012, with schemes expected to be taken on in the second quarter, will extend the reach of the business into the wider workplace savings market providing complete savings solutions for customers.
The proposition remains highly regarded in the market, retaining first place in the Greenwich 2012 DC survey of leading employee benefits consultants ("EBCs"), and also being rated first in the 2011 NMG Corporate Wealth Programme.
Market environment
Friends Life expects the corporate benefits market to grow strongly and to benefit from the ongoing structural shift from defined benefit to defined contribution schemes, auto-enrolment and demographic changes. However, although growth prospects remain good, the traditional UK industry model is structurally unattractive, delivering poor shareholder returns in a marketplace historically characterised by intense price driven competition, heavy intermediation and commission bias.
The current competitive intensity and "land grab" in advance of RDR is expected to subside post 2013 as the basis of competition switches from price and commission to a quality of proposition. As a result, the number of market competitors is expected to reduce as the competitive intensity takes its toll, particularly with providers who lack scale and who are unlikely to benefit from the uplift in volumes expected from auto-enrolment within the back book.
Strategy implementation
Friends Life expects to compete in this environment and significant progress has been made in 2011 with the execution of the Go to Market strategy. The transition to a lower cost platform is reflected in improving business performance whilst new business momentum and pipeline into 2012 are evident.
Returns in the Corporate Benefits business have historically been low and the Group is focused on improving these through the following four key levers:
Retain and develop existing schemes
Organic growth of the Corporate book will be driven through a focus on key clients and distributors, supported by a strong relationship management function already within the business. Friends Life expects to enhance this client growth with additional structural benefits from consolidation of schemes and closure of defined benefit plans, in addition to the Group's success in the Enhanced Transfer Value market. Worksite marketing and member education activities will drive further growth. This is already evidenced in the strong levels of new business generated in 2011 against a difficult economic backdrop.
Selectively take on new schemes
The selective acquisition of new schemes will be driven by a limited number of key distribution relationships in Friends Life's target market. Within this, the focus is on mid to large schemes where Friends Life expects to be able to achieve the target returns and most efficiently deploy the new business team. The launch of the new corporate platform in 2012 will add a further strong proposition to Corporate Benefits market leading offering.
Reduce costs
Friends Life remains focused on reducing costs across the organisation. Having already restructured the distribution function, work continues on building a lean front-office business. In addition, the migration of assets from the Embassy platform on to the market leading NGP platform will reduce operational costs further. The outsourcing deal with Diligenta provides further cost savings and certainty as the market enters a period of profound change.
Position Friends Life for auto-enrolment and RDR
As the corporate market continues to develop, the Friends Life offering is moving in line with it. Friends Life recently announced a link with Tata Consultancy Services ("TCS") to develop an auto-enrolment hub to reduce the legislative burden on clients. This will further drive retention and growth in the existing book and the acquisition of new clients whilst taking advantage of the opportunity presented by auto enrolment. The launch of the new corporate platform broadens the proposition from a retirement savings business into a wider workplace marketing business. Additionally, the removal of commission bias within the market with the advent of RDR in 2013 will enable the Corporate Benefits business to form relationships across the whole of the distribution landscape with minimal change to the offering.
The implementation of these elements will enhance new business IRRs and support the delivery of the 2013 new business financial targets set out early in 2011.
Financial performance
2013 Corporate Benefits all platforms Full year 2011 2011 GBPm (unless otherwise stated) target Full year Half year ---------------------------------- ----------- ----------- ----------- New business cash strain (75) (51) (35) IRR 10%+ 8.3% 6.6% ---------------------------------- ----------- ----------- ----------- APE n/a 440 219 ---------------------------------- ----------- ----------- -----------
The contribution from Corporate Benefits new business shows a strong financial performance in the second half reflecting both improved mix of business and the delivery of synergy savings.
Overall returns have been enhanced by better than expected results on the acquired AXA UK Life Business platforms, primarily driven from cost savings. These business lines are now no longer loss making and will be migrated onto the target platform in 2012, realising further efficiencies and improvements in performance.
The profitability of business written on the target NGP platform remains robust, delivering an IRR of 9.4%. Performance in the first half of the year included DWP rebates which are weighted towards the first half of the year while the full year result takes account of the revised persistency assumptions, and the benefit of the Diligenta outsourcing transaction.
2011 saw strong overall volumes with APE of GBP440 million principally driven by increments and new entrants to existing schemes. Market concerns around the merger with the acquired AXA UK Life Business and a restructure of the sales team in January 2011 impacted adversely on new scheme wins, although performance picked up strongly throughout the year, with a good pipeline of new business in place for 2012.
Corporate Benefits target platform 2011 2011 GBPm (unless otherwise stated) Full year Half year ------------------------------------ ----------- ----------- New business cash strain (38) (23) IRR 9.4% 8.8% ------------------------------------ ----------- ----------- APE 356 176 ------------------------------------ ----------- -----------
This platform, which forms the core of the Go to Market business is expected to achieve the 10% target return during 2012 as the cost synergies and migration of business onto the more efficient NGP platform take effect.
Corporate Benefits funds under management
Following the changes made to the Group management structure in 2011, the Corporate Benefits business manages a total of GBP15.4 billion customer assets including GBP2.5 billion of assets in respect of the acquired WLUK business administered on the Embassy system. These Embassy assets are due to migrate onto the NGP platform in 2012.
Total Corporate benefits GBPbn -------------------------------------------------------- ---------------- Group pension assets under management as reported 31 December 2010 17.0 -------------------------------------------------------- ---------------- Transfer to UK Heritage (4.7) -------------------------------------------------------- ---------------- Corporate Benefits assets under management 31 December 2010 12.3 -------------------------------------------------------- ---------------- Acquired WLUK assets(i) 2.5 Inflows 2.3 Outflows (1.3) Market movements (0.4) -------------------------------------------------------- ---------------- Corporate Benefits assets under management 31 December 2011 15.4 -------------------------------------------------------- ----------------
(i) WLUK assets included from 7 November 2011 with movements included for the final two months of 2011
(ii) Corporate benefits assets under management include GBP0.3 billion of unitised with-profits business managed on the NGP platform
Despite poor equity market conditions group pensions assets for the Corporate Benefits business now stand at GBP15.4 billion with net inflows in the year of GBP1.0 billion. Of this, net outflows of GBP0.2 billion related to the closed individual pension lines on the NGP platform, with the core Corporate Benefits business generating net flows of GBP1.2 billion. This increase in assets, combined with the reduction in the cost base drives strong underlying business performance. Although overall assets have grown, there have also been significant outflows of business as a result of scheme losses. These have primarily been lost to commission paying providers and this level of outflow is not expected to continue after the RDR comes into effect. This recent experience has been recognised within the MCEV operating result with an additional provision of GBP82 million set up to allow for further short term adverse persistency impacts on VIF.
The outlook for 2012 is positive with a strong new business pipeline and the start of auto-enrolment for Friends Life's larger customers in the second half of the year. The development of an auto enrolment proposition will support employers and aid further growth and client retention. The continued development towards these market changes is progressing well and the Group remains confident of achieving the 2013 financial targets.
Go to Market: Protection
The Friends Life Protection business brings together the Friends Provident individual and group protection propositions with those acquired from the AXA UK Life Business and BHA. The Group now has comprehensive market coverage with the proposition operating across a wide range of distribution channels.
The individual protection business provides life, critical illness and income protection cover to individuals and businesses. These products are distributed through IFAs, banks, estate agents and leading brands such as Tesco, Virgin and the AA.
The group protection business provides group income protection, group life and group critical illness products, which are distributed through EBCs and IFAs. In July 2011 the acquired propositions were integrated and all new business is now written on the strategic platform.
Market environment
The UK protection market is mature and concentrated, and has remained stable over the last five years generating in force premiums in the region of GBP6.6 billion per annum. The developments made to date have placed Friends Life well into the top five market participants with the Group having significant scale in this market. Despite this position of relative strength the focus on profitability remains paramount with a selective approach to those channels and products which offer acceptable levels of return.
The protection market will be affected by a number of significant regulatory changes over the next two years including the RDR, gender neutral pricing, life tax changes and Solvency II.
Protection products are out of scope for the RDR, and the industry consensus view expects the market to experience a short term 'bounce' as intermediaries manage their cash flow and transition their businesses. Friends Life supports this view and, supported by the breadth of the Group's distribution footprint, is well placed to benefit.
Changes regarding gender neutral pricing and life tax will have an effect on the price of protection, with this impact varying by provider. Friends Life operates a value based proposition focused on product quality, as opposed to commoditised volume players focused on price, and expects to be less sensitive to any general price increase in the market, allowing the business to communicate clearly and confidently to the Group's target partners.
The impact of these changes has been factored into the Protection strategy from the start and the Group believes the protection business and the wider Friends Life protection proposition are well positioned to benefit from these changes.
Strategy implementation
The acquisition of BHA has transformed the Group's protection product range and platform options. The implementation of the Go to Market Protection strategy is progressing well and focuses on the proposition's following key competitive advantages.
Customer solutions
The combination of the three acquired protection businesses has enhanced the Group's range of protection products with the business retaining the best elements of these. Building on this strength the Go to Market protection business is able to offer a higher value customer offering, which enables the products to be priced at a premium. This includes:
-- Market leading income protection and critical illness cover, with a breadth of illnesses covered;
-- A flexible exemption based approach to underwriting, with pricing for exemptions and other innovative underwriting features such as tele-underwriting; and
-- Value added benefits such as Bupa HealthLine and Best Doctors.
Operational excellence
The strategy announced earlier in 2011 confirmed the selection of the low cost and efficient BHA platform, with good progress made to date in consolidating these platforms in the market. This development enabled the integration of the Group Protection proposition in July 2011 and culminated in the launch of the Friends Life Protect+ menu proposition in October 2011 for the Individual business. This has brought together the best features of the three historic intermediary propositions. The Protection business now has market leading individual critical illness and income protection offerings, both with a Defaqto five star rating, whilst loss making former Friends Provident and AXA UK Life Business intermediary products have been closed to new business. The transition to the Group's target end state will continue into 2012 with the controlled distribution partners due to migrate to the strategic platforms over the course of the year.
Selective distribution
The business continues to build on the existing distribution partnerships whilst managing the performance of existing relationships. The active management of these relationships across the breadth of different channels de-risks the impact of changes to distribution as the market responds to the Retail Distribution Review.
Supporting this, the implementation of a new tripartite partnership between Friends Life, Sesame Bankhall Group and Connells, one of the UK's largest estate agencies and property services groups, has come into force in March 2012. The arrangement encompasses a new single tie arrangement between Friends Life and Connells as well as a long-term partnership between Sesame Bankhall Group and Connells.
Financial expertise
The business has strong technical expertise in pricing, reinsurance and claims management enabling us to deliver good profitability and efficient use of capital. Leverage of this expertise will drive strategic change and deliver improved profitability in the targeted time scales.
Regulatory requirements, such as gender neutral pricing will cause changes in pricing for Individual Protection. There is a strategic focus on analysing business mix and price points in order to optimise business performance and profitability in the market during and after the changes. Reinsurance negotiations have already given increased margin flexibility and work with reinsurers continues in order to consider other innovations. Claims management is consolidated with technical and investigative expertise that works across the Individual and Group business. This expertise enables efficient claims management as well as innovations such as early intervention and early rehabilitation for Group Protection, giving both product differentiation and cost benefits.
Financial performance
Protection all platforms 2013 Full year 2011 2011 GBPm (unless otherwise stated) target Full year Half year --------------------------------- ----------- ----------- ----------- New business cash strain (30) (77) (43) IRR 20.0% 5.5% 3.9% --------------------------------- ----------- ----------- ----------- APE n/a 92 50 --------------------------------- ----------- ----------- -----------
Profitability of new business has improved significantly in the year with the change in focus, towards the higher value critical illness and income protection products as well as the migration to the lower cost strategic platform the key drivers of this improvement.
The new business strain continues to be reduced with strain in the second half of GBP34 million down on the GBP43 million recorded in the period to 30 June. The changes made to allow credit for negative reserves materially improved new business strain compared to 2010. New business strain is expected to continue to decrease in 2012 as profitability improves towards target.
Protection IRR has improved to 5.5% (30 June 2011: 3.9%) with the improvement in profitability expected to continue in 2012 as a full year impact from the changes made in the second half of 2011 and the migration of the controlled partners to the strategic platform during 2012 take effect.
Protection volumes in the second half of 2011 amount to GBP42 million APE (30 June 2011: GBP50 million) as the increase in pricing, launch of the Protect+ proposition and targeted focus on critical illness and income protection marginally reduced volumes.
Individual protection target platform 2011 2011 GBPm (unless otherwise stated) Full year Half year --------------------------------------- ----------- ----------- New business cash strain (8) (2) IRR 20.0% >25.0% --------------------------------------- ----------- ----------- APE 22 10 --------------------------------------- ----------- -----------
Profitability of business written on the target platform remains above the targeted level of 20% in the period, although the transition to the target platform and changes in product mix may result in some fluctuation from period to period.
Go to Market: Retirement Income
The Group has identified Retirement Income as a key strategic Go to Market business unit with this founded on the acquired elements of the Friends Provident and AXA UK Life Business. The Group expects the retirement income market to provide an excellent opportunity for the business to grow in what continues to be a growing and profitable market segment.
Historically the Group has generated sales from internal vestings with the vast majority of these reflecting the retirement of Friends Life pension policyholders. The Group's strategy for the annuity market was reviewed in 2011 and will target the creation of a more sophisticated proposition to vesting policyholders alongside the development of capabilities to support participation in the open market.
Market environment
The annuity market continues to show underlying growth with 2011 market figures expected to show growth on 2010. Expectations for future growth in this market remain strongly positive, driven by the approaching retirement of the baby boomer generation as well as the continued movement from defined benefit to defined contribution pension products in the accumulation phase.
The removal of compulsory annuitisation, previously set at age 75, is widely expected to have a limited impact. The need for individuals to meet minimum income requirements before they can take advantage of this option is likely to restrict the additional flexibility to those individuals with large retirement funds.
Growth in the open market option ("OMO") market continues to benefit from the overall regulatory and industry drive to publicise the benefits of the OMO, including access to impaired annuities. The proportion of vesting pensions using the OMO continues to rise (57% in the third quarter of 2011). The share of vestings represented by impaired annuities also continues to rise and now stands at 29% of the annuity market (50% of open market annuities).
Competition within the annuity market has reduced over recent years as the number of providers looking to compete at the top of the open market has reduced and providers have looked to reflect the impact of expected higher capital requirements under Solvency II in their pricing.
Strategy implementation
Friends Life is well placed to grow its share of the annuity market with the existing book generating GBP2 billion of maturing pensions each year. As previously announced, Friends Life's immediate objective is to retain a larger proportion of this vesting population with an aspiration in the longer term to become a top three provider in this segment. The improvement in retention rates is expected to be sufficient to achieve the Retirement Income new business financial targets with the potential entry into the OMO market being additive to these.
Implementation of the strategy will focus on building the enhanced range of capabilities including the following five key initiatives:
Development of sophisticated pricing and underwriting
The recruitment of an experienced Managing Director and Director of Longevity in the first half of 2011 will further advance the business's underwriting capabilities, allowing a highly targeted pricing approach.
Optimising and developing the investment strategy
The announcement in November 2011 of the creation of an internal asset management business, FLI, which will, in particular, improve the management of fixed income assets in respect of annuity business. The development of FLI is progressing well with the recruitment of an experienced team of fixed income investors in January 2012. This team will enable the Group to deliver an investment strategy aimed at optimising returns and improving capital efficiencies on its annuity portfolio.
Provision of a broader product proposition
Friends Life currently has a relatively narrow range of annuity products. The development and building of pricing and longevity capabilities will allow the proposition to extend into more complex lifestyle annuities.
Improving customer engagement
2012 plans include the launch of an enhanced annuity product and the introduction of pilot initiatives to enhance customer engagement, phased throughout the year.
Development of capabilities to support an open market offering
As a whole these developments will enhance the current vesting annuity proposition and will enable the Retirement Income business unit to achieve its financial targets. These developments will also underpin the development of an option for the business to enter the OMO market in the future.
Financial performance
2013 Full year 2011 2011 GBPm (unless otherwise stated) target Full year Half year -------------------------------- ----------- ----------- ----------- New business cash strain n/a 13 10 IRR 15%+ 22.0% >25.0% -------------------------------- ----------- ----------- ----------- APE n/a 32 16 -------------------------------- ----------- ----------- -----------
Annuity new business IRR of 22.0% remains well above target level of 15% but has been adversely affected in the second half of 2011.
Retention rates, at around 25% of vesting funds, have been maintained over the year and, whilst the implementation of the strategic initiatives is expected to improve this position towards the targeted 50% level, this improvement is not expected to be seen until later in 2012.
2011 sales volumes of GBP32 million are in line with the performance seen in the first half of 2011 where sales of GBP16 million were achieved.
International operating review
The International segment comprises:
-- Friends Provident International Limited ("FPIL"), an Isle of Man based company manufacturing unit-linked regular contribution savings and single premium bond products with a focus on high net worth expatriate individuals via distribution hubs in Hong Kong, Singapore and Dubai;
-- Overseas Life Assurance Business ("OLAB"), the overseas branch business of Friends Life Limited, benefiting from EU freedom of services rules which allow regulated EU insurers to trade anywhere within its borders;
-- Financial Partners Business AG ("fpb"), a German distributor of OLAB unit-linked pensions business;
-- a 30% interest in AmLife Insurance Berhad ("AmLife"), a Malaysian life insurance company, majority owned by AmBank Berhad, a major Malaysian banking group; and
-- a 30% interest in AmFamily Takaful Berhad ("AmFamily") which was established in December 2011 as a Malaysian family takaful business.
2011 2010 GBPm (unless otherwise stated) Full year Full year ---------------------------------------- ----------- ----------- IFRS based operating profit before tax 40 95 New business cash strain (89) (83) IRR 12.7% 15.4% APE 252 238 ---------------------------------------- ----------- -----------
The International results for 2011 have been impacted by a number of adverse one-off items and challenging market conditions. IRR has been adversely affected by changes in business mix, operating assumption changes and modelling improvements despite higher sales. In addition, a full review of FPIL actuarial models and assumptions has taken place during the year as part of a business-wide controls improvement project. This has resulted in one-off charges, some of which were reported at half year, to IFRS operating profit. A strategic review of the business is well advanced and details of this will be included in a market update in the second half of 2012.
Market environment
All core markets have delivered a resilient sales performance, in particular Asia, where demand remains strong, despite uncertainty in the International environment. The economic environment in Europe has been challenging and is expected to remain so in 2012.
The largest market is the North Asian region, predominantly Hong Kong. This is a relatively mature and competitive market, although it continues to grow strongly, with an established IFA distribution segment servicing affluent local nationals, corporate clients and expatriates. FPIL is one of the market leaders in offshore IFA distributed business with very strong distribution relationships, supported by strong service and leading propositions which include a wide choice of funds available through FPIL's range of unit-linked products. Quality of distribution relationships, service, commitment to overseas markets, systems capability and proposition development are fundamental to success in the region. The region has strong growth prospects for the future.
The South Asia region is serviced through Singapore. This region has continued to grow well although GDP growth in 2011 at 5-6% is lower than 2010. Singapore continues to evolve as a wealth management hub to rival Hong Kong and offers good growth potential.
The United Arab Emirates and the wider Middle Eastern region are relatively under-developed in terms of market penetration, but with wealthy high net worth individuals in those markets and good growth prospects.
In Germany, the business participates, through OLAB, in the unit-linked individual pensions market, a growth segment where the business has a well regarded product set. Whilst the market environment is challenging in the short term, as low investment market confidence drives consumers towards traditional with-profits business, the unit-linked sector has good medium-term prospects through demand for private sector savings and investments and the move from state to private pensions provision. This market and the product choices offered by local players are still dominated by with-profits type investment products. However, the trend towards lower guaranteed rates of return continues to reduce the attractiveness of traditional product structures, whilst the impact of Solvency II is expected to limit market participants' ability to provide traditional with-profits product offerings. OLAB is well positioned to benefit from these changes as the German unit-linked pensions market continues to evolve.
AmLife participates in the Malaysian market through both an agency and the bancassurance channel. This is a fast moving market which is currently closed to further entrants through the rationing of available licences. AmFamily was established in 2011 but is not expected to contribute materially to results in 2012.
Overall the International business is well established to take advantage of the opportunities that will arise in growth markets.
Strategy implementation
The Friends Life strategy is to grow the value of the International business and its component parts by improving its overall growth prospects and returns through diversification and focus on higher margin products. As the business grows, maintaining discipline over margins, the level of cash generation is expected to improve and the level of adverse one-off modelling impacts in this year's results is not expected to recur. The business has a target of achieving GBP20 million sustainable cash generation and 20% IRR by 2013.
The business has continued to invest in building capability, developing propositions and product structures to improve profitability and persistency. Investment has commenced in developing a new administration platform for the business with increased international capability and developing regional infrastructure in the core Hong Kong region. The roll-out of the new FPIL regular premium product is underway which is expected to improve profitability and IRR. It is planned to launch in Singapore and the Middle East in the second quarter of 2012, and in Hong Kong in the final quarter of this year. It will be available in all regions by the end of 2012.
The business is engaging in a strategic review and will give further details of its objectives and strategy at the International investor day in the second half of 2012.
Financial performance
New business profitability
The International IRR has reduced from 15.4% to 12.7%. This was in part due to changes in the mix of business sold, with a larger proportion of lower margin longer term Premier business sold in 2011 compared to 2010, proportionally lower single premium OLAB sales (which are generally higher margin).
The business has a target to deliver IRR of 20% by 2013. Improvements will be driven by the roll-out of the new FPIL regular premium Premier product as mentioned above, a focus on other high IRR product lines, and a review of the cost base as part of the strategic review.
New business volumes
APE by region (GBPm, actual exchange 2011 2010 % change rates) Full year Full year -------------------------------------- ----------- ----------- --------- North Asia 103 95 9 South Asia 26 19 35 Middle East 46 46 (1) Europe (excluding UK) 32 35 (11) UK 18 14 29 Rest of the world 21 19 11 AmLife (Malaysia) 6 10 (38) APE total (at actual exchange rates) 252 238 6 -------------------------------------- ----------- ----------- --------- APE total (at constant exchange rates) 257 238 8 -------------------------------------- ----------- ----------- ---------
The International business sales volumes continued the growth seen in the first half of 2011, with sales at actual exchange rates up 6%, driven by strong North and South Asian markets. UK sales have also increased from a low base and there has been modest growth in Germany within a difficult market. Other European sales are down. Sales at constant exchange rates increased by 8%.
This performance is reflected in the underlying businesses with FPIL sales at actual exchange rates increasing by 9% whilst OLAB sales decreased by 3%.
Funds under management
1 January Market Funds under management 2011 Net inflows/ and other 31 December (GBPbn) restated(i) Inflows Outflows (outflows) movements 2011 ------------------------ ------------- -------- --------- ------------- ----------- ------------ FPIL 5.3 1.1 (0.5) 0.6 (0.3) 5.6 OLAB 0.5 0.1 (0.1) - - 0.5 AmLife 0.1 - - - - 0.1 ------------------------ ------------- -------- --------- ------------- ----------- ------------ International total 5.9 1.2 (0.6) 0.6 (0.3) 6.2 ------------------------ ------------- -------- --------- ------------- ----------- ------------
(i) Funds under management at 1 January 2011 have been restated to include OLAB unitised with-profit funds of GBP0.2 billion previously accounted for within the UK business segment.
Funds under management as at 31 December 2011 total GBP6.2 billion and have increased by 5% during the year. As a result of record levels of new business sales, the business has generated positive net inflows of GBP0.6 billion but these have been offset by market falls, particularly in the Far East, of GBP0.3 billion, mainly in the second half of the year.
IFRS based operating profit
2011 2010 Full year Full year GBPm GBPm ----------------------------------------- ----------- ----------- New business strain (36) (28) In-force surplus 97 120 Long term investment return 1 1 Principal reserving changes and one-off items (12) 2 Development costs (7) (6) Other (3) 6 ----------------------------------------- ----------- ----------- IFRS based operating profit before tax 40 95 ----------------------------------------- ----------- -----------
IFRS based operating profit has reduced by GBP55 million to GBP40 million mainly because of an GBP8 million increase in new business strain, a GBP23 million reduction in in-force surplus and GBP12 million of adverse principal reserving and one-off items (a GBP14 million adverse movement from the prior year). These items are explained below.
New business strain
Reconciliation of new business cash strain to IFRS
2011 2010 Full year Full year GBPm GBPm -------------------------- ----------- ----------- New business cash strain (89) (83) DAC/DFF adjustments 224 210 Other IFRS adjustments (171) (155) -------------------------- ----------- ----------- IFRS new business strain (36) (28) -------------------------- ----------- -----------
DAC adjustments relate to the deferral of acquisition costs including initial commission and enhanced allocations. DFF relates to the deferral of establishment charges on portfolio bond business. Both DAC and DFF adjustments have increased in line with sales volumes.
Other IFRS adjustments include the elimination of financial reinsurance (at a higher level in 2011), which is not permitted under IFRS. This line also includes the elimination from IFRS new business strain of actuarial funding and sterling reserves on investment business.
The net increase in IFRS new business strain of GBP8 million mainly results from higher sales and the impact of lower interest rates, which have increased reserving requirements.
In-force surplus
Reconciliation of in-force cash surplus to IFRS
2011 2010 Full year Full year GBPm GBPm ------------------------ ----------- ----------- In-force cash surplus 79 106 DAC/DFF adjustments 1 7 Other IFRS adjustments 17 7 ------------------------ ----------- ----------- IFRS in-force surplus 97 120 ------------------------ ----------- -----------
In-force cash surplus has reduced by GBP27 million due to a combination of adverse economic variances, experience variances, and repayment of financial reinsurance, which have more than offset the growth in the back book.
The DAC/DFF adjustments have decreased because of a higher DAC run off due to the larger block of post acquisition business compared to 2010. Other IFRS adjustments include the elimination of financial reinsurance (at a higher level in 2011).
The net decrease in IFRS surplus of GBP23 million primarily results from the falls in investment market levels leading to higher reserving for return of premium guarantees on German pensions largely resulting from lower interest rates, and the higher DAC run-off on the larger post-acquisition book.
Principal reserving changes and one-off items
Adverse principal reserving changes and one-off items amount to GBP12 million primarily comprise improved modelling of return of premium guarantee on paid up policies in German pensions business.
Operating expenses
2011 2010 Full year Full year GBPm GBPm ------------- ----------- ----------- Acquisition 30 28 Maintenance 31 22 Development 7 6 Other - 1 ------------- ----------- ----------- Total 68 57 ------------- ----------- -----------
International operating expenses, which exclude commission payments and non-recurring costs, have increased to GBP68 million from GBP57 million, as follows:
-- acquisition costs reflect the marketing and proposition support for the growth in sales volumes;
-- maintenance costs have increased as a result of increased customer service costs to support the larger in-force book, and strengthening the controls and governance infrastructure to meet the needs of the growing business; and
-- development costs are higher due to the increased investment in the business, including the development of the German business and the commencement of a project to move to a significantly improved administration platform for the business.
Lombard operating review
Lombard is the leading pan-European life assurance business specialising in compliant estate planning solutions for high and ultra-high net worth individuals ("HNWIs"). Based in Luxembourg the business offers innovative solutions and superior service, through a well-established distribution network of private banks, high-end IFAs and independent specialist financial advisers to HNWIs across Europe and selected markets in Latin America and Asia. Solutions offered by Lombard are typically based on single premium, whole of life, unit-linked life assurance structures with all but minimal levels of life exposure reinsured. The business is well placed to benefit from increasing demands for fully compliant financial solutions for HNWIs.
2011 2010 GBPm (unless otherwise stated) Full year Full year -------------------------------- ----------- ----------- IFRS based operating profit 38 33 New business cash strain (20) (6) IRR(i) >25.0% >25.0% APE 237 302 -------------------------------- ----------- -----------
(i) The 2011 Lombard IRR now takes account of the Luxembourg regulatory regime in which DAC is an allowable asset.
IFRS based operating profit at GBP38 million is 15% above 2010, benefiting from higher in-force fee income, in line with higher levels of funds under management ("FUM") during the period whilst global operating expense level have been controlled.
2011 sales volumes (APE) were GBP237 million, 22% below 2010, results being affected by significantly adverse macroeconomic conditions in Europe and the lack of strong external drivers to generate new business compared to previous years. In the current context, relative to most competitors, these results are strong. The last quarter of the year saw higher sales than in the fourth quarter of 2010 with fourth quarter 2011 APE of GBP100 million up from GBP89 million in the same period of 2010.
Funds under management have continued to grow significantly in 2011, despite the material fall of equity markets. FUM at 31 December 2011 reached EUR20.9 billion (GBP17.4 billion), 4.5% (EUR898 million) up on 2010 year end (EUR20.0 billion; GBP17.1 billion).
Market environment
2011, and especially the second half of the year, has been characterised by significant adverse macroeconomic conditions in Europe, with falls in most equity markets, a sovereign debt crisis and uncertainties in respect of potential fiscal constraints in some European countries.
While Lombard's performance is not directly linked to investment markets this continued market uncertainty has led to clients postponing actions to structure their investments and manage intergenerational transfer of their wealth.
In contrast, 2010 was an exceptional period for the cross-border life insurance market with this being particularly evident in the first nine months of 2010, driven by significant external factors and there were no other similar event drivers in 2011.
Despite the European economic environment Lombard has performed relatively well in the year compared to its peers. New business sales performance in the Luxembourg life insurance market is down by 34% in 2011, significantly below levels achieved by Lombard. In this context, Lombard's market share increased from 16% in 2010 to 19% in 2011.
The current external environment remains highly uncertain across Europe, and there is no sign of short-term macroeconomic recovery. In these exceptional circumstances, we expect 2012 sales to remain affected. However, notwithstanding the challenging short-term market conditions, the longer term drivers of the demand for compliant "Privatbancassurance" solutions remain compelling.
Strategy implementation
There are three core elements of Lombard's strategy and these have progressed in 2011:
-- Strengthening of sales force: strengthen Lombard sales force in key markets with a 20% increase in sales consultants in place during 2011. This action, together with training and development initiatives and professionalisation of sales management, enhances Lombard's presence in key geographical markets;
-- Investment in marketing and deepening partner relationships: expand and enhance marketing and product development capability to enable further valuable support to existing and potential partners. Lombard is undertaking due diligence exercises with selected key partners to continue the tailoring of its service offering to suit their precise needs and those of their clients (thereby enhancing Lombard's franchise and protecting margins); and
-- Operating model: consistent with the needs of Lombard's partners and clients, this initiative is seeking to further improve the maintenance and servicing of policies whilst streamlining Lombard's operating model. This will contribute to enhancing competiveness and improving profitability whilst reducing business model risk.
It is envisaged that these initiatives will contribute to the delivery of the financial outcomes (strong growth in profitable new business and cash generation) with IRR above 20% by 2013 and GBP30 million dividend from 2014.
Financial performance
Performance during the year has been impacted by a number of factors including:
-- the absence of strong policy drivers to generate new business which Lombard experienced in the first half of 2010;
-- Northern Europe primarily impacted by the negative economic environment and lower activity among IFAs especially in Belgium; and
-- market uncertainties in respect of a number of potential fiscal changes and significantly adverse macroeconomic conditions in Europe, resulting in clients delaying decisions and affecting investor confidence.
Despite these factors, five markets (Spain, Italy, Finland, France and Asia) showed volumes significantly above 2010 business levels in 2011. These improvements reflect the benefits from sales force enhancement and continued deepening of relationships with partners in these markets. The growth in these regions also highlights the strength of Lombard's geographic diversification compared with its competitors.
New business in Italy was supported by strong partnerships developed at the time of the tax amnesty ("Scudo fiscale"), combined with the increasing importance of life-assurance for long-term estate planning.
2011 has been characterised by a stronger diversification between markets and seasonality of new business is in line with 2010 with H1/H2 at 41%/59% (2010: 45%/55%).
Overall, business in 2011 is below 2010 levels, with sales volumes of GBP237 million APE, 22% below 2010 although IRR at more than 25% remains above the target level.
APE performance per region is as follows:
2011 2010 Full Full year year Change APE by region (actual exchange rates) GBPm GBPm % ------------------------------------------- ------ ------ ------- UK and Nordic 52 72 (28) Northern Europe 42 119 (64) Southern Europe 115 94 22 Rest of world 28 17 66 ------------------------------------------- ------ ------ ------- Total including large cases 237 302 (22) ------------------------------------------- ------ ------ ------- Of which: large cases (greater than EUR10 million) 83 90 (8) ------------------------------------------- ------ ------ ------- Total excluding large cases 154 212 (27) ------------------------------------------- ------ ------ -------
APE seasonality since 2007 is as follows:
H1 APE H2 APE FY APE H1/ H2 split GBPm GBPm GBPm (%) ------ ------- ------- ------- ------------- 2007 65 134 199 33/67 2008 70 176 246 28/72 2009 47 226 273 17/83 2010 135 167 302 45/55 2011 97 140 237 41/59 ------ ------- ------- ------- -------------
IFRS based operating profit
2011 2010 Full year Full year GBPm GBPm ---------------------------------------- ----------- ----------- New business strain (33) (28) In-force surplus 73 66 Investment return and other items (1) (4) Development costs (1) (1) ---------------------------------------- ----------- ----------- IFRS based operating profit before tax 38 33 ---------------------------------------- ----------- -----------
Lombard generated operating profit before tax of GBP38 million, 15% up on 2010 supported by increased income from the in-force book. The in-force surplus has benefited from significant net fund inflows in 2010 and 2011, more than offsetting negative investment return in 2011, and compensating for increased new business strain.
New business strain and in-force surplus
Reconciliation of new business strain to IFRS
2011 2010 Full year Full year GBPm GBPm -------------------------- ----------- ----------- New business cash strain (20) (6) DAC/DFF adjustments (13) (21) Other IFRS adjustments - (1) -------------------------- ----------- ----------- IFRS new business strain (33) (28) -------------------------- ----------- -----------
New business cash strain is higher than 2010 despite sales volumes being down on the prior year. This has been driven by a reduced benefit from year one annual management charges as lower sales volumes were written in the first nine months of the year. In addition the lower sales volumes in the year reduced the proportion of acquisition expense capitalised within cash strain.
On an IFRS basis a lower proportion of acquisition costs can be deferred. As cost deferral in 2011 new business cash strain is lower than the prior year the corresponding reversal is also reduced in arriving at the IFRS new business strain.
Reconciliation of in-force surplus to IFRS
2011 2010 Full year Full year GBPm GBPm ----------------------- ----------- ----------- In-force cash surplus 41 30 DAC/DFF adjustments 32 36 IFRS in-force surplus 73 66 ----------------------- ----------- -----------
In-force cash surplus is up 37% on 2010, benefiting from growth in the in-force book. Average funds under management have increased significantly between 2010 and 2011 despite negative market performance in the second half of 2011. Continued positive net fund inflows over the last two years have driven this growth with funds under management growing from GBP14.4 billion at the start of 2010 to GBP17.4 billion at the end of 2011.
Lombard funds under management GBPbn -------------------------------- ------- 31 December 2010 17.1 -------------------------------- ------- Inflows 2.4 Outflows (1.1) Market movements (1.0) -------------------------------- ------- 31 December 2011 17.4 -------------------------------- -------
Operating expenses
2011 2010 Full year Full year GBPm GBPm ------------- ----------- ----------- Acquisition 42 47 Maintenance 25 19 Development 1 1 Other - 2 ------------- ----------- ----------- Total 68 69 ------------- ----------- -----------
The operating expenses of Lombard, which exclude both commission payments and non-recurring costs, are set out in the table above.
Lombard has maintained tight control of expense levels which, despite an increase in average funds under management of 13%, have remained in line with 2010.
Acquisition expenses were lower than 2010 as a result of lower sales volume which have translated into lower sales and partner incentives costs.
Development costs consist of expenses related to new product and market development.
Corporate operating review
The Group corporate segment includes the corporate holding and principal service companies of the Group.
Financing and interest costs
The Group has a number of debt instruments and the operating cost of financing these for the year ended 31 December 2011 are presented below.
In April 2011, the Group issued a GBP500 million external lower tier two ("LT2") debt instrument with a coupon of 8.25% and a maturity of 2022; this is guaranteed on a subordinated basis by FLL. From the proceeds of this debt, GBP400 million was used to repay the internal LT2 debt issued to Resolution Holdings (Guernsey) Limited ("RHG"). A further repayment of GBP100 million was made in May 2011, leaving an outstanding value of GBP200 million as at 31 December 2011 year end.
Market value IFRS Finance GBPm of debt(i) cost(ii) ----------------------------------------------- ------------- ------------- GBP200 million internal LT2 subordinated debt 2020 200 (33) GBP162 million external LT2 subordinated debt 2021 182 (24) GBP500 million external LT2 subordinated debt 2022 450 (29) STICS 2003 142 (12) STICS 2005 185 (14) ----------------------------------------------- ------------- ------------- Total (112) ----------------------------------------------- ------------- -------------
(i) Market value is based on listed offer price, at 31 December 2011, excluding accrued interest and before tax on market valuation.
(ii) Finance cost is operating profit impact, before tax.
In so much as these debts have been raised to support the ongoing growth and development of the life operating businesses the cash raised has been loaned to the UK operating segment. The external cost attributable to each segment is shown below.
GBPm ---------------------- ------ Corporate segment (36) UK operating segment (76) ---------------------- ------ (112) ---------------------- ------
Corporate IFRS based operating result
2011 2010 Full year Full year GBPm GBPm --------------------------------------------- ----------- ----------- Investment return and other items excluding debt 91 47 Expected return on debt (112) (61) Other (7) (11) --------------------------------------------- ----------- ----------- IFRS based operating loss before tax (28) (25) --------------------------------------------- ----------- -----------
The corporate result is primarily driven by the expected return on the debt held in the Group, offset by the investment return on shareholder assets. The increase in the expected return on debt reflects the additional GBP500 million external LT2 subordinated debt raised in April 2011 (followed by GBP500 million partial repayment of the internal LT2 subordinated debt with RHG as described above). The increased investment return on other assets reflects the higher level of assets at holding company level driven by receipt of dividends from life companies in the year, partly offset by payment of dividends to RHG.
Other corporate costs of GBP7 million, includes GBP2 million of costs in relation to the FLG long-term incentive scheme. The current year charge reflects key changes in the senior management team during the year and other joiners and leavers to the scheme. The additional net costs of GBP5 million relate primarily to corporate overhead costs, being holding company and Group costs incurred in supporting the non-covered business and future new covered business.
Completion of AXA UK Life Business acquisition
The acquisition of WLUK was completed with an effective acquisition date for accounting purposes of 7 November 2011. This marks the completion of acquisition agreed with AXA UK, the first phase of which initiated in September 2010 with the acquisition of the AXA UK Life Business.
Due to the complex structure of the AXA UK Life Business the assets acquired included certain portfolios of insurance business (the GOF and TIP portfolios) which were to be retained by AXA UK. The terms of this transfer were agreed as part of the transaction and these portfolios were transferred back to AXA UK on 1 November 2011 via Part VII transfer for consideration, including interest, of GBP285 million.
Similarly the shares of WLUK, initially retained by AXA UK, were acquired by the Group for consideration of GBP248 million once the business lines to be retained by AXA UK had been removed.
The net impact of these transactions on the IFRS balance sheet was GBP2 million.
Net impact of WLUK and GOF/TIP transactions
GBPm --------------------------------------------------------- ------ Consideration received for GOF/TIP (including interest) 285 Less: GOF/TIP net assets (including interest) (285) Wrong pocket payments (i) (50) --------------------------------------------------------- ------ (50) Consideration paid for WLUK (248) WLUK net assets 296 --------------------------------------------------------- ------ 48 --------------------------------------------------------- ------ Net impact of transactions (ii) (2) --------------------------------------------------------- ------
(i) Reflects net surplus emerging in the pre-transaction companies, prior to completion of the respective acquisition and disposal.
(ii) In IFRS, the GBP50 million wrong pocket payment is included in administrative expenses and the gain on the WLUK acquisition is included in other income.
WLUK IFRS acquisition balance sheet as at 7 November 2011 and gain on acquisition
Assets GBPm Liabilities GBPm ---------------------------------- ------ ---------------------------------------------- ------ Intangible assets 268 Insurance and investment contract liabilities 7,322 Financial assets and cash 6,955 Other liabilities 92 Current assets 487 Total assets 7,710 Total liabilities 7,414 ---------------------------------- ------ ---------------------------------------------- ------ Net identifiable assets acquired 296 ---------------------------------- ------ ---------------------------------------------- ------ Fair value of net assets acquired - cash paid 248 Gain on the acquisition of WLUK (excluding transaction costs) 48 ------------------------------------------------------------------------------------------ ------
In accordance with IFRS the Group ascribed fair values to the acquired value of in-force business ("AVIF") and other intangible assets as well as placing a fair value on the assets acquired and liabilities assumed.
The AVIF and other intangibles of GBP239 million and GBP29 million, respectively, are presented gross of tax.
Cash and capital
Group capital management
The Friends Life Group manages its capital on both regulatory and economic capital bases, focusing primarily on capital efficiency and the ease with which cash and capital resources can be transferred between entities. In managing capital, the Friends Life Group considers the following:
-- establishing targets for the main UK life companies at the greater of 150% of Pillar 1 CRR (excluding WPICC) and 125% of Pillar 2 CRR including ICG - the capital required to mitigate the risk of insolvency to a 99.5% confidence level over a one year period;
-- at the FLG level, to hold sufficient capital to meet 150% (formerly 160%) of the Group CRR (excluding WPICC);
-- maintaining financial strength within companies sufficient to support new business growth targets, including rating agency requirements;
-- the need to have strong liquidity to cover expected and unexpected events, which includes access to an undrawn facility with a consortium of banks;
-- managing, in particular, the with-profits business of the Group in accordance with agreed risk appetites and all regulatory requirements; and
-- transfers from long-term business funds and dividends from entities that support the cash generation requirements of the Group, balanced with the need to maintain appropriate capital within the businesses for the reasons outlined above.
The Group's capital policy has been to maintain sufficient Group capital resources to cover 160% of Group CRR. This coverage ratio was put in place at the time of the AXA UK Life Business acquisition and has now been reduced to 150%, reflecting the good progress made towards integrating these businesses.
As part of the integration of the AXA UK Life Business, a number of initiatives have been undertaken including fund mergers and the optimisation of the corporate structure, to ensure capital efficiency and to maximise the fungibility of capital resources. Further activities are being implemented in 2012 in order to create additional efficiencies in the Group's capital structure.
In 2010, the Group undertook the five yearly test of the FLC re-attributed inherited estate ("RIE") with this resulting in a transfer of GBP1,010 million to the shareholders' fund. As at 31 December 2011, a further GBP484 million has been transferred to the shareholders' fund, in line with the results of the end 2010 test and the surplus arising in the non profit fund over the period. These assets will remain in the shareholders' fund to provide capital support to the with-profits funds to the extent required by the Scheme, and to support with-profits and non profit funds to the extent required by FLC's capital policy.
Solvency II
The implementation of the EU Solvency II Directive, the proposed new EU insurance regulatory requirements, continues to be a key focus of attention for the Group. The aim of the new regulation is to place the management of risk at the heart of running a successful and sustainable insurance company. The Group has been closely following the emerging regulations and monitoring their potential impact on the Group balance sheet. There is still a lack of clarity over certain key issues, particularly in respect of the treatment of matching premium and contract boundaries, which could have a material impact on future capital requirements. The Group continues to be closely involved with the industry in lobbying on key areas where uncertainty remains.
Friends Life has established a Solvency II programme to manage the implementation of the new regulatory requirements. It is progressing well and the Group is well placed for the implementation of Solvency II. A key deliverable of the programme is an integrated financial reporting platform across acquired businesses.
Insurance Groups Capital Adequacy
In addition to individual company requirements FLG, as the ultimate European Economic Area ("EEA") parent insurance undertaking, is required to meet the IGCA requirements of the Insurance The Group's capital policy is to maintain sufficient Group capital resources to cover 150% of Group CRR (excluding WPICC). This policy was changed at the end of 2011 from 160% of Group CRR (excluding WPICC) reflecting progress on the integration of the UK Life businesses.
The balance sheet remained strong at the Group level, with an IGCA surplus of GBP2.1 billion at 31 December 2011, with Group capital resources being 219% of Group CRR (excluding WPICC). Group capital resources were GBP1.2 billion in excess of the amount required to satisfy the Group capital policy of holding 150% of Group CRR (excluding WPICC).
The IGCA surplus would reduce by around GBP0.2 billion for a 40% fall in equity markets from 31 December 2011 levels and would reduce by slightly less if interest rates were to fall by 200bps across the yield curve. The IGCA surplus would reduce by approximately GBP0.5 billion if credit spreads were to rise by 200bps.
The movement in IGCA surplus over the period largely reflects the surplus emerging in the period of GBP403 million. This includes a GBP103 million benefit from the 2011 capital optimisation project ("COP") and GBP157 million benefit (on an IGCA basis) of negative reserves released for FLC and BHA business and is after adverse economic variances of GBP316 million.
The acquisition of BHA and WLUK less the disposal of the GOF and TIP portfolios has decreased the IGCA surplus by GBP154 million. The acquisition of BHA reduced IGCA surplus by GBP132 million (GBP169 million cost of investment offset by a GBP37 million IGCA surplus at the respective acquisition date). The acquisition of WLUK reduced IGCA surplus by GBP237 million (GBP248 million cost of investment offset by a GBP11 million IGCA surplus at the respective acquisition date) which is offset by GBP215 million increase from the disposal of the GOF and TIP portfolios.
The surplus is also impacted by financing and dividend costs, which include the GBP350 million of dividends paid to Resolution holding companies in the year. GBP500 million of the LT2 subordinated debt issued to RHG has been repaid during the year, following an external debt raising by FLG of GBP500 LT2 subordinated debt, with GBP4 million of associated costs.
Finance costs and other movements include GBP58 million of interest costs on the external LT2 subordinated debt and GBP33 million of interest due on the internal LT2 debt with RHG, partially offset by the reduction in restricted intangible assets of GBP16 million and GBP2 million of other movements.
Management initiatives in the year to optimise the IGCA surplus position delivered a benefit of GBP157 million. This relates to the recognition of negative reserves in the acquired BHA and AXA UK Life businesses. The Part VII transfers implemented in 2011 moved business from some of the smaller life companies into FLL which has reduced aggregate Pillar 1 capital requirements by GBP113 million, thereby increasing excess capital over capital policies by around GBP181 million. Further Part VII transfers are planned for 2012.
Movement in IGCA surplus GBPm ----------------------------------- ------ 1 January 2011 2,317 ----------------------------------- ------ Surplus emerging 143 COP 2011 103 PS06/14 157 BHA acquisition (132) WLUK acquisition/GOF TIP disposal (22) Dividend to RSL (350) External LT2 subordinated debt 496 Repay RSL debt (500) Finance costs and other movements (73) ----------------------------------- ------ 31 December 2011 2,139 ----------------------------------- ------
At 31 December 2011 the capital held to meet Group capital policies was GBP902 million (1 January 2011: GBP1,085 million) and the excess over the capital policies was GBP1,237 million (1 January 2011: GBP1,232 million). The change in Group capital policy from 160% of Group CRR to 150% of Group CRR increased capital in excess of capital policies by GBP172 million.
The IGCA surplus is a prudent measure and excludes surplus capital not immediately available to shareholders, such as surplus capital held in long-term funds to the extent that this is not needed to cover the capital resource requirements of the long-term fund concerned. Following actions taken in 2011 to transfer surplus long-term fund assets to shareholders, there are no remaining restriction to the IGCA surplus in respect of surpluses in the non-profit funds (2010: GBP39 million restriction). The IGCA surplus excludes GBP385 million of UK with-profits funds surpluses. As the calculation is prepared to include the subsidiaries of the highest EEA parent company, the net assets of the Resolution holding companies are excluded.
Management of the with-profits funds
Friends Life Limited
Asset allocation within the with-profits fund is actively managed. For the first half of 2011 the strategic proportion of equities and property backing asset shares (equity backing ratio or "EBR") for the whole fund was set at 50%. Management actions allowed for within the risk management framework were revised and with effect from 30 June 2011 the strategic EBR was increased to 55% for the post-demutualisation business and was maintained at 50% for the pre-demutualisation business.
At 31 December 2011, the EBR was 48% for pre-demutualisation business (31 December 2010: 49%) and 53% for post-demutualisation business (31 December 2010: 49%).
There are no Market Value Reductions ("MVRs") currently in place for the fund.
The risk appetite and risk management framework of the with-profits fund are in line with FLL's commitment to fair treatment of all its customers and the published Principles and Practices of Financial Management underlying the Fund.
Non-profit business in the FLL with-profits fund, the majority of which is annuities, is backed by a mix of gilts and corporate bonds.
Friends Life Company Limited
Asset allocation within the with-profits fund is actively managed. During 2011 the Group was able to continue to reduce MVRs on single premium bonds, and in early 2012 these were removed.
At 31 December 2011 the EBR was close to 66% (31 December 2010: 68%).
There have been no recent changes to investment policy. The fund maintains a stable asset allocation with a target EBR of 65% for assets other than those backing the realistic cost of guarantees, options and non-profit business. Guarantees and options remain backed by a combination of bonds and hedging derivatives (equity put options, interest rate swaps and swaptions). Cash is allocated to back current liabilities.
Non-profit business in the with-profits fund is backed by a mix of gilts and corporate bonds (some with credit default swap protection to hedge the default risk).
Friends Life Assurance Society Limited
Asset allocation within the with-profits fund is actively managed. During 2011 the Group was able to continue to reduce MVRs on single premium bonds, and in early 2012 these were removed.
At 31 December 2011 the EBR was close to 52% (31 December 2010: 54%).
The investment policy of FLAS was reviewed in 2010. The strategy now is to target a stable EBR of 50% for assets backing policy asset shares. The allocation for assets backing guarantees and options comprises gilts and hedging derivatives (equity put options, sold equity futures, interest rate swaps and swaptions). The target allocation for assets backing the realistic with-profits estate is gilts only, although currently some property and corporate bond holdings still remain.
Non-profit business in the with-profits fund, the majority of which is annuities, is backed by a mix of gilts and corporate bonds (some with credit default swap protection to hedge the default risk).
Winterthur Life UK Limited
Asset allocation within the with-profits fund is actively managed. MVRs may apply to certain products on a case by case basis.
At 31 December 2011 the EBR was close to 50%.
The investment policy of WLUK is to target a stable EBR of 50% for assets backing policy asset shares. The allocation for assets backing guarantees and options comprises gilts, corporate bonds and hedging derivatives (equity put and call options, sold equity futures, interest rate swaps and swaptions). The target allocation for assets backing the realistic with-profits estate is gilts only.
Non-profit business in the with-profits fund, the majority of which is annuities, is backed by a mix of gilts and corporate bonds.
Certain of the with-profit deferred annuity business in the Fund is backed by gilts and corporate bonds only.
Asset quality and exposure
The Group's financial assets as at 31 December 2011, excluding cash, are summarised as follows:
31 December 31 December 2011 2010 Unit-linked With-profit Non-profit Shareholder Total Total GBPbn GBPbn GBPbn GBPbn GBPbn GBPbn -------------------------- ------------ ------------ ----------- ------------ ------------ ------------ Shares, unit trusts and OEICs 53.4 7.1 0.1 - 60.6 60.4 Government securities 8.5 8.5 2.2 0.3 19.5 16.1 Corporate bonds and asset backed securities 5.7 9.0 7.2 0.3 22.2 21.5 Derivatives - 0.8 0.1 - 0.9 0.4 Deposits 0.4 - - - 0.4 0.4 Loans - - - - - 0.7 -------------------------- ------------ ------------ ----------- ------------ ------------ ------------ Total 31 December 2011 68.0 25.4 9.6 0.6 103.6 - -------------------------- ------------ ------------ ----------- ------------ ------------ ------------ Total 31 December 2010 65.5 24.3 8.3 1.4 - 99.5 -------------------------- ------------ ------------ ----------- ------------ ------------ ------------
The vast majority of the Group's exposure to sovereign debt holdings is to UK gilts. The Group has GBP6 million shareholder exposure (including shareholder fund exposure to non-profit and with-profit funds) to the higher risk government debts of Spain, Portugal, Italy, Ireland and Greece (31 December 2010: GBP7 million).
In addition the Group's shareholder exposure to various corporate securities issued by companies domiciled in Spain, Portugal, Italy, and Ireland is GBP370 million (31 December 2010: GBP444 million). The Group's shareholder exposure to Greek corporate securities is less than GBP1 million. 64% by value of these corporate securities are issued by non-financial companies, which are in many cases less exposed to their domicile economy than to other countries. Where the Group holds securities issued by financial companies, 44% of these are not linked to the institution's domestic economy. In all cases the company's financial strength and the ability of the domicile government to provide financial support in the event of stress has been considered.
Total Spain Portugal Italy Ireland Greece GBPm GBPm GBPm GBPm GBPm GBPm -------------------------------- ------ ------ --------- ------ -------- ------- Sovereign debt 6 - - 6 - - Corporate exposure - Domestic banks 65 29 - 33 3 - - Domestic non-bank financials 26 - - 13 13 - - Non-domestic banks 40 40 - - - - - Domestic non-financials 205 64 10 108 23 - - Non-domestic non-financials 34 34 - - - - Total 31 December 2011 376 167 10 160 39 - -------------------------------- ------ ------ --------- ------ -------- ------- Total 31 December 2010(i) 451 159 14 228 50 - -------------------------------- ------ ------ --------- ------ -------- ------- (i) Restated to include two non-domestic financials totalling GBP39 million.
The Group's shareholder exposure to bank debt securities across the various geographic regions is shown below.
GBPm Shareholder Seniority Rating UK Euro USA France PIIGS(i) ROW Total -------------- --------------- ------ ----- ---- ------- --------- ---- ------------ Senior AAA 28 561 18 17 - 6 630 AA 19 57 - - - 29 105 A 129 5 268 7 21 22 452 BBB - - 14 - 3 - 17 Below BBB/NR - 3 - - - - 3 ------------------------------ ------ ----- ---- ------- --------- ---- ------------ Senior Total 176 626 300 24 24 57 1,207 ------------------------------ ------ ----- ---- ------- --------- ---- ------------ Secured AAA 270 - - 35 24 - 329 AA 3 - - - - - 3 A 5 - 10 - - - 15 BBB 1 - 8 - - - 9 Below BBB/NR - - - - - 2 2 ------------------------------ ------ ----- ---- ------- --------- ---- ------------ Secured Total 279 - 18 35 24 2 358 ------------------------------ ------ ----- ---- ------- --------- ---- ------------ Subordinated AA - 9 - - - - 9 A 194 30 33 16 36 84 393 BBB 191 1 29 23 21 43 308 Below BBB/NR 69 - - - - - 69 ------------------------------ ------ ----- ---- ------- --------- ---- ------------ Subordinated Total 454 40 62 39 57 127 779 ------------------------------ ------ ----- ---- ------- --------- ---- ------------ Cash Cash Total 669 267 324 235 39 207 1,741 -------------- --------------- ------ ----- ---- ------- --------- ---- ------------ Grand Total 1,578 933 704 333 144 393 4,085 ------------------------------- ------ ----- ---- ------- --------- ---- ------------
(i) Portugal, Ireland, Italy, Greece, Spain.
Shareholder exposure to corporate bonds and asset backed securities is analysed by fund and credit rating as follows:
Unit-linked With-profit Non-profit Shareholder 31-Dec-11 31-Dec-10 GBPbn funds funds funds funds Total Total Corporate bonds and asset-backed securities 5.7 9.0 7.2 0.3 22.2 21.5 less: policyholder exposure 5.7 7.9 - - 13.6 13.3 -------------------------- ------------ ------------ ----------- ------------ ---------- ---------- Shareholder exposure - 1.1 7.2 0.3 8.6 8.2 -------------------------- ------------ ------------ ----------- ------------ ---------- ---------- AAA - 0.2 0.8 0.1 1.1 1.3 AA - 0.2 2.8 - 3.0 2.8 A - 0.4 2.5 0.1 3.0 2.7 BBB - 0.2 1.0 0.1 1.3 1.0 Sub-BBB or rating not available - 0.1 0.1 - 0.2 0.4 -------------------------- ------------ ------------ ----------- ------------ ---------- ---------- % Investment Grade 96.9% 95.1% -------------------------- ------------ ------------ ----------- ------------ ---------- ----------
Over 96% of the corporate bond and asset-backed securities to which the shareholder funds are exposed are investment grade. The Group controls its exposures to corporate issuers by rating, type of instrument and type of issuer. The sub-investment grade bonds held in investment portfolios are monitored closely in order to maximise exit values. Where asset-backed securities and other complex securities are held, the Group monitors closely its exposures to ensure that the relevant structure, liquidity and tail credit risks are well understood and controlled.
There has been one default in the period, Titan ABS, with a market value loss of GBP1.7 million in 2011. No other defaults have been experienced in the year. The Group holds default reserves to cover the risk of defaults and credit rating downgrades on corporate bonds that back all annuity business within Friends Life group. The reserves reflect assumed defaults over the outstanding terms to maturity of the bonds. The shareholder share of default reserves at 31 December 2011 was GBP0.6 billion (31 December 2010: GBP0.4 billion). This represents a haircut of 35% of the overall corporate bond spreads over gilts of equivalent term (31 December 2010: 46%).
Liquidity
The liquidity of the Group remains strong.
The Group has an undrawn GBP500 million funding facility with a consortium of banks. This facility is due to run until June 2013 but can be extended at the option of the Group for a further two years.
Financial strength ratings
A number of the Group's life businesses are attributed financial strength ratings.
Standard Fitch Moody's & Poor's --------------------------------------- ------------ ------------ ----------- Friends Life Limited A+ (strong) A3 (strong) A-(strong) Friends Life Company Limited A+ (strong) A2 (strong) A-(strong) Friends Life Assurance Society Limited A+ (strong) A2 (strong) NR --------------------------------------- ------------ ------------ -----------
The Group targets financial strength ratings in the single A range and expects them to remain there for the foreseeable future.
Consolidated income statement
For the year ended 31 December 2011
2011 2010 Notes GBPm GBPm ---------------------------------------------------------- ------ -------- ------- Revenue Gross earned premiums 3 2,128 1,288 Premiums ceded to reinsurers 3 (599) (241) ----------------------------------------------------------- ------ -------- ------- Net earned premiums 3 1,529 1,047 Fee and commission income and income from service activities 3 771 751 Investment return 1,803 8,424 Total revenue 4,103 10,222 ----------------------------------------------------------- ------ -------- ------- Other income 3 134 891 ----------------------------------------------------------- ------ -------- ------- Claims, benefits and expenses Gross claims and benefits paid 3,859 2,004 Amounts receivable from reinsurers (643) (322) Net claims and benefits paid 3,216 1,682 ----------------------------------------------------------- ------ -------- ------- Change in insurance contracts liabilities (216) 891 Change in investment contracts liabilities (495) 5,863 Transfer (from)/to unallocated surplus (484) 4 Movement in net asset value attributable to unit-holders (48) 139 Movement in policyholder liabilities (1,243) 6,897 ----------------------------------------------------------- ------ -------- ------- Acquisition expenses 591 392 Administrative and other expenses 1,741 1,028 Finance costs 158 129 Total claims, benefits and expenses 4,463 10,128 ----------------------------------------------------------- ------ -------- ------- Share of loss of associates and joint venture (1) - ----------------------------------------------------------- ------ -------- ------- (Loss)/profit before tax from continuing operations (227) 985 Policyholder tax 5 (220) (244) (Loss)/profit before shareholder tax from continuing operations (447) 741 ----------------------------------------------------------- ------ -------- ------- Total tax credit/(charge) 5 237 (137) Policyholder tax 5 220 244 Shareholder tax 5 457 107 ----------------------------------------------------------- ------ -------- ------- Profit for the year 10 848 ----------------------------------------------------------- ------ -------- ------- Attributable to: Equity holders of the Company(i) (21) 794 Step-up Tier one Insurance Capital Securities ("STICS") holders(ii) 31 1 ----------------------------------------------------------- ------ -------- ------- 10 795 Non-controlling interests Equity attributable to STICS holders(ii) - 30 Other - 23 Profit for the year 10 848 ----------------------------------------------------------- ------ -------- ------- (i) All profit attributable to equity holders of the Company is from continuing operations.
(ii) On 15 December 2010, the STICS ceased to be non-controlling interests following an intra-group transfer of these equity instruments from Friends Life FPG Limited ("FPG") (formerly Friends Provident Group Limited) to the Company.
The consolidated income statement includes the results of Friends Life BHA Limited ("BHA") from the date of acquisition on 31 January 2011 and the results of Winterthur Life UK Limited ("WLUK") from the date of acquisition of 7 November 2011. The consolidated income statement for the year ended 31 December 2010 includes the results of the acquired AXA UK Life Business from 3 September 2010.
Consolidated statement of comprehensive income
For the year ended 31 December 2011
Equity holders of the Company -------------------- Ordinary STICS share holders holders (iii) Total GBPm GBPm GBPm --- ---------------------------------- --------- (Loss)/profit for the period (21) 31 10 --------------------------------------- --------- --------- --------- --------- ------ Actuarial loss on defined benefit schemes (34) - (34) Foreign exchange adjustments(i) (10) - (10) Shadow accounting(ii) (1) - (1) Aggregate tax effect of above items 2 - 2 --------------------------------------- --------- Other comprehensive loss, net of tax (43) - (43) --------------------------------------- --------- --------- --------- --------- ------ Total comprehensive (loss)/income, net of tax (64) 31 (33) --------------------------------------- --------- --------- --------- --------- ------ For the year ended 31 December 2010 --------- Equity holders Non-controlling of the Company interests -------------------- -------------------- Ordinary STICS STICS share holders holders holders (iii) (iii) Other Total GBPm GBPm GBPm GBPm GBPm --- ---------------------------------- Profit for the period 794 1 30 23 848 --------------------------------------- --------- --------- --------- --------- ------ Actuarial losses on defined benefit schemes (46) - - - (46) Foreign exchange adjustments(i) (6) - - - (6) Shadow accounting(ii) (3) - - - (3) Aggregate tax effect of above items 25 - - - 25 --------------------------------------- Other comprehensive loss, net of tax (30) - - - (30) --------------------------------------- --------- --------- --------- --------- ------ Total comprehensive income, net of tax 764 1 30 23 818 --------------------------------------- --------- --------- --------- --------- ------ (i) Foreign exchange adjustments relate to the translation of overseas subsidiaries.
(ii) Shadow accounting includes GBP(3) million (2010: GBPnil) in respect of the revaluation of owner occupied properties and GBP2 million (2010: GBP(3) million) in respect of foreign exchange adjustments on translation of overseas subsidiaries held by the with-profits fund of Friends Life Limited ("FLL") (formerly Friends Provident Life and Pensions Limited).
(iii) On 15 December 2010, the STICS ceased to be non-controlling interests following an intra-group transfer of these equity instruments from FPG to the Company.
Consolidated statement of IFRS based operating profit
For the year ended 31 December 2011
2011 2010 Notes GBPm GBPm -------------------------------------------------------- ------ ------ ------ (Loss)/profit before tax from continuing operations (227) 985 Policyholder tax (220) (244) Returns on Group-controlled funds attributable to third parties - (23) --------------------------------------------------------- ------ ------ ------ (Loss)/profit before tax excluding returns generated within policyholder funds (447) 718 Non-recurring items 3(b) 180 (801) Amortisation and impairment of acquired present value of in-force business 7 675 364 Amortisation of intangible assets 7 84 64 Interest payable on Step-up Tier one Insurance Capital Securities ("STICS") (31) (31) Short-term fluctuations in investment return 261 (24) --------------------------------------------------------- ------ ------ ------ IFRS based operating profit before tax 722 290 Tax on operating profit 38 16 --------------------------------------------------------- ------ ------ ------ IFRS based operating profit after tax attributable to ordinary shareholders from continuing operations 760 306 --------------------------------------------------------- ------ ------ ------
IFRS based operating profit excludes: (a) investment variances from expected investment return for non-linked business which is calculated on a long-term rate of return; (b) returns attributable to non-controlling interests in policyholder funds; (c) significant non-recurring items; and (d) amortisation and impairment of present value of acquired in-force business and other intangible assets and is stated after policyholder tax and the deduction of interest payable on STICS. Given the long-term nature of the Group's operations, IFRS based operating profit is considered to be a better measure of the performance of the Group and this measure of profit is used internally to monitor the Group's IFRS results.
Consolidated statement of financial position
As at 31 December 2011
2011 2010 Notes GBPm GBPm ------------------------------------------------------ ------ -------- -------- Assets Pension scheme surplus 20 22 Intangible assets 7 4,847 5,140 Property and equipment 58 46 Investment properties 3,015 3,189 Investments in associates and joint venture 37 32 Deferred tax assets - 4 Financial assets 8 103,643 99,465 Deferred acquisition costs 643 358 Reinsurance assets 3,213 2,637 Current tax assets 6 22 Insurance and other receivables 1,140 976 Cash and cash equivalents 8,690 9,057 Assets of operations classified as held for sale - 1,206 Total assets 125,312 122,154 ------------------------------------------------------ ------ -------- -------- Liabilities Insurance contracts 37,264 35,081 Unallocated surplus 652 1,098 Financial liabilities Investment contracts 75,191 72,411 Loans and borrowings 9 972 1,012 Amounts due to reinsurers 1,800 1,666 Net asset value attributable to unit-holders 1,173 1,173 Provisions 228 221 Deferred tax liabilities 872 1,115 Current tax liabilities 20 11 Insurance payables, other payables and deferred income 992 893 Liabilities of operations classified as held for sale - 925 Total liabilities 119,164 115,606 ------------------------------------------------------ ------ -------- -------- Equity attributable to equity holders of the Company Share capital 515 515 Other reserves 5,310 5,711 ------------------------------------------------------ ------ -------- -------- 5,825 6,226 STICS holders 318 318 ------------------------------------------------------ ------ -------- -------- 6,143 6,544 Attributable to non-controlling interests 5 4 -------- Total equity 6,148 6,548 ------------------------------------------------------ ------ -------- -------- Total equity and liabilities 125,312 122,154 ------------------------------------------------------ ------ -------- --------
The financial statements were approved by the Board of directors on 26 March 2012.
Consolidated statement of changes in equity
For the year ended 31 December Attributable to equity holders 2011 of the Company ---------------------------------------- ---------------- STICS Share Other holders Non-controlling capital reserves Total (i) interest Total -------------------------------- --------- ---------- ------ --------- ---------------- ------ GBPm GBPm GBPm GBPm GBPm GBPm -------------------------------- --------- ---------- ------ --------- ---------------- ------ At 1 January 2011 515 5,711 6,226 318 4 6,548 -------------------------------- --------- ---------- ------ --------- ---------------- ------ (Loss)/profit for the year - (21) (21) 31 - 10 Other comprehensive loss - (43) (43) - - (43) -------------------------------- --------- ---------- ------ --------- ---------------- ------ Total comprehensive (loss)/income - (64) (64) 31 - (33) -------------------------------- --------- ---------- ------ --------- ---------------- ------ Dividends on equity shares - (350) (350) - - (350) Interest paid on STICS - - - (31) - (31) -------------------------------- --------- ---------- ------ --------- ---------------- ------ Appropriations of profit - (350) (350) (31) - (381) Tax relief on STICS interest - 7 7 - - 7 Issued during the year - - - - 1 1 Share-based payments - 6 6 - - 6 -------------------------------- --------- ---------- ------ --------- ---------------- ------ At 31 December 2011 515 5,310 5,825 318 5 6,148 -------------------------------- --------- ---------- ------ --------- ---------------- ------ For the year ended 31 December Attributable to equity holders Non-controlling 2010 of the Company interest ---------------------------------------- ------------------ Share Other Total STICS STICS Other Total capital reserves holders holders (i) (i) -------------------------------- --------- ---------- ------ --------- ---------- ------ ------ GBPm GBPm GBPm GBPm GBPm GBPm GBPm -------------------------------- --------- ---------- ------ --------- ---------- ------ ------ At 1 January 2010 250 3,099 3,349 - 318 297 3,964 -------------------------------- --------- ---------- ------ --------- ---------- ------ ------ Profit for the year - 794 794 1 30 23 848 Other comprehensive loss - (30) (30) - - - (30) -------------------------------- --------- ---------- --------- ---------- ------ ------ Total comprehensive income - 764 764 1 30 23 818 -------------------------------- --------- ---------- ------ --------- ---------- ------ ------ Dividends on equity shares - (65) (65) - - (7) (72) Interest paid on STICS - - - (1) (30) - (31) -------------------------------- --------- ---------- ------ --------- ---------- ------ ------ Appropriations of profit - (65) (65) (1) (30) (7) (103) Tax relief on STICS interest - 9 9 - - - 9 Disposals of businesses - - - - - (309) (309) Issue of share capital 2,165 - 2,165 - - - 2,165 Capital reduction (1,900) 1,900 - - - - - Share-based payments - 4 4 - - - 4 Transfer of STICS to the Company - - - 318 (318) - - -------------------------------- --------- ---------- ------ --------- ---------- ------ ------ At 31 December 2010 515 5,711 6,226 318 - 4 6,548 -------------------------------- --------- ---------- ------ --------- ---------- ------ ------
(i) On 15 December 2010, the STICS ceased to be non-controlling interests following an intra-group transfer of these equity instruments from FPG to the Company.
Consolidated statement of cash flows
For the year ended 31 December 2011
2011 2010 GBPm GBPm --------------------------------------------------------- --------- --------- Operating activities Profit for the period 10 848 Adjusted for: Other income (gain on acquisition) (116) (883) Net realised and unrealised losses/(gains) on assets at fair value 1,595 (6,379) Finance costs 158 129 Amortisation and impairment of intangible assets 759 428 Depreciation of property and equipment 4 4 Movement in deferred acquisition costs (285) (312) Total tax (credit)/charge (237) 137 Purchase of shares and other variable yield securities (22,585) (21,985) Sale of shares and other variable yield securities 22,705 19,029 Purchase of loans, debt securities and other fixed income securities (33,973) (33,869) Sale of loans, debt securities and other fixed income securities 34,380 34,880 Purchase of investment properties (43) (67) Sale of investment properties 305 81 (Decrease)/increase in insurance contract liabilities (101) 925 (Decrease)/increase in investment contract liabilities (2,057) 7,372 (Decrease)/increase in unallocated surplus (484) 2 Decrease in provisions (1) (5) Net movement in receivables and payables (59) 668 Pre-tax cash (outflow)/inflow from operating activities (25) 1,003 Tax received (25) 15 --------------------------------------------------------- --------- --------- Net cash (outflow)/inflow from operating activities (50) 1,018 Investing activities Acquisition of subsidiaries, net of cash acquired 12 969 Disposal of held for sale assets 285 - Investment in associate (6) - Additions to internally generated intangible assets (4) (4) Purchase of property and equipment (net) (16) (1) --------------------------------------------------------- --------- --------- Net cash inflow from investing activities 271 964 Financing activities Proceeds from issue of ordinary share capital - 1,665 Proceeds from issue of long-term debt 496 729 Repayment of long-term debt (500) (123) Finance costs (131) (126) STICS interest (31) (31) Net movement in other borrowings, net of expenses (36) 15 Dividends paid to equity holders of the parent (350) (65) Proceeds from increase in non-controlling interests 1 - Dividends paid to non-controlling interests - (7) --------------------------------------------------------- --------- --------- Net cash (outflow)/inflow from financing activities (551) 2,057 (Decrease)/increase in cash and cash equivalents (330) 4,039 --------------------------------------------------------- --------- --------- Balance at beginning of year 9,057 5,073 Exchange adjustments on the translation of foreign operations (37) (55) Balance at end of year 8,690 9,057 --------------------------------------------------------- --------- ---------
Notes to the consolidated accounts
1. Accounting policies
1.1 Basis of preparation
On 1 July 2011 the Company, formerly known as Friends Provident Holdings (UK) plc changed its name to Friends Life Group plc ("FLG") ("the Company" or "Friends Life"). The financial statements of the Company as at and for the year ended 31 December 2011 comprise the consolidated financial statements of the Company and its subsidiaries (together referred to as "the Group") and the Group's interests in associates and jointly controlled entities.
The consolidated financial statements as at and for the year ended 31 December 2011 have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union ("IFRS"). The results in this announcement have been prepared in accordance with IFRS applicable at 31 December 2011 and have been taken from the Group's Annual Report and Accounts which will be available on the Company's website shortly.
The annual report and accounts complies with the Disclosure and Transparency Rules ("DTR") of the United Kingdom's Financial Services Authority in respect of the requirement to produce an annual report. The announcement is the responsibility of, and has been approved by, the directors.
This announcement does not constitute the Company's statutory financial statements for 2011 or 2010 but is derived from those financial statements. Statutory accounts for 2010 have been filed with the Registrar of Companies. The auditor has reported on the 2011 and 2010 financial statements and the reports were unqualified and did not contain a statement under section 498(2) or 498(3) of the Companies Act 2006. The auditor for 2011 is Ernst & Young LLP (also acted as auditor for 2010).
The principal activity of the Company is that of a holding company for acquisitions in the life assurance and pensions sector.
On 31 January 2011 the Group, through its subsidiary Friends Life Limited ("FLL") (formerly Friends Provident Life and Pensions Limited), acquired all of the share capital of Bupa Health Assurance Limited (subsequently renamed Friends Life BHA Limited, ("BHA")). The consolidated income statement therefore includes the results of BHA from that date.
On 7 November 2011, the Group acquired control of Winterthur Life UK Limited ("WLUK"). This is the date at which the last substantive condition to legal completion was satisfied. The consolidated income statement therefore includes the results of WLUK from that date. The acquisition of WLUK was agreed with AXA UK in 2010 at the same time as the acquisition of Friends ASLH Limited ("FASLH") was negotiated. However, the share capital of WLUK was not legally acquired by the Group until 2011 as the purchase was contingent upon a transfer under Part VII of the Financial Services and Markets Act 2000 of AXA's retained business out of WLUK and FSA approval for change of control being received. These substantive preconditions for the acquisition were fulfilled in November 2011 enabling the Group to acquire WLUK's share capital.
Under the terms of the 2010 FASLH acquisition certain portfolios of business legally owned by the Group as a result of the acquisition were transferred back to AXA UK under the provisions of Part VII of the Financial Services and Markets Act 2000. These portfolios were therefore classified as held for sale for the year ended 31 December 2010. In October 2011 the Part VII transfers were successfully completed.
The 2010 comparatives include the results of the acquired AXA UK Life Business from 3 September 2010.
During November 2011 all of the business of Friends Provident Life Assurance Limited ("FPLA"), BHA and certain portfolios of the business of Friends Life and Pensions Limited ("FLPL") (formerly Friends Provident Pensions Limited) were transferred into FLL, their immediate parent company, under the provisions of Part VII of the Financial Services and Markets Act 2000. The purpose of this internal group reorganisation was to realise capital and operating synergies for the Group.
Prior to the Part VII transfers, the with-profit liabilities of FPLA which were less than GBP500 million were reported in the consolidated financial statements of the Group on a non-realistic basis. Subsequent to the transfer these with-profit liabilities have become liabilities of FLL and are required to be reported on a realistic basis. This change does not impact equity attributable to equity holders of the parent in the consolidated financial statements of the Group but does impact the split of the with-profit liabilities between insurance contracts, investment contracts and unallocated surplus. Aside from this change the Part VII transfers have not generated any other significant impacts on the consolidated financial statements.
The presentation currency of the Group is Sterling. Unless otherwise stated the amounts shown in these financial statements are in millions of pounds Sterling (GBP million).
These financial statements have been prepared on a going concern basis. The directors have undertaken a going concern assessment in accordance with "Going Concern and Liquidity Risk: Guidance for UK Directors of UK Companies 2009", published by the Financial Reporting Council in October 2009. As result of this assessment, the directors are satisfied that the Group and the Company have adequate resources to continue to operate as a going concern for the foreseeable future and have prepared the financial statements on that basis.
The Group has applied all applicable IFRS standards and interpretations adopted by the EU and effective for accounting periods beginning on or after 1 January 2011. Those new standards, changes to existing standards and interpretations adopted by the Group during the year are:
IFRIC 19: Extinguishing Financial Liabilities with Equity Instruments. This interpretation does not have a material impact on the Group.
IAS 24 (revised): Related Party Disclosures. The revised standard clarifies and simplifies the definition of a related party and does not have a material impact on the Group; and
Annual improvements to IFRSs (May 2010). In accordance with the improvement to IFRS 7: Financial Instruments: Disclosures, the Group has disclosed details of collateral held by the Group to mitigate credit risk.
The International Accounting Standards Board (IASB) has issued the following change to IFRS 7 which is effective for accounting periods beginning on or after 1 July 2011 and has been early adopted by the Group:
IFRS 7: Financial Instruments: Disclosures. The amendment enhances the disclosure requirements in relation to transferred financial assets to require information as to any residual risks that remain from an entity's continuing involvement with such assets. Adoption of this amendment has not had a material impact on the Group.
Below is a list of new standards and changes to existing standards that have been issued by the IASB with effective dates for accounting periods beginning after 1 January 2012 or later, but where earlier adoption is permitted. They have not been early adopted by the Group in 2011 as they are yet to be endorsed by the European Union ("EU"). The impact of these new requirements is currently being assessed by the Group.
New standards:
IFRS 9: Financial Instruments: Classification and Measurement. This standard reflects the first phase of the IASB's work on the replacement of IAS 39: Financial Instruments: Recognition and Measurement, and relates to the classification and measurement of financial assets as defined in IAS 39. The adoption of IFRS 9 will have a material impact on the classification and measurement of the Group's financial assets;
IFRS 10: Consolidated Financial Statements. This standard provides a single consolidation model that identifies control as the basis for consolidation for all types of entities. It replaces the requirements in IAS 27: Consolidated and Separate Financial Statements and SIC 12: Consolidation -Special Purpose Entities. IFRS 10 is effective for annual periods beginning on or after 1 January 2013;
IFRS 11: Joint Arrangements. This IFRS establishes principles for the financial reporting by parties to a joint arrangement. It supersedes the requirements in IAS 31: Interests in Joint Ventures and SIC 13: Jointly Controlled Entities- Non-Monetary Contributions by Venturers. IFRS 11 is effective for annual periods beginning on or after 1 January 2013;
IFRS 12: Disclosure of Interests in Other Entities. This IFRS combines, enhances and replaces disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities. IFRS 12 is effective for annual periods beginning on or after 1 January 2013; and
IFRS 13: Fair Value Measurement. This IFRS defines fair value and sets out in a single IFRS, a framework for measuring fair value and requires disclosures about fair value measurements. IFRS 13 is effective for annual periods beginning on or after 1 January 2013.
Amendments to existing standards:
IAS 1: Presentation of Financial Statements. The amendments require companies to group together items within other comprehensive income that may be reclassified to the profit or loss section of the income statement and reaffirm existing requirements that items in other comprehensive income and profit or loss should be presented as either a single statement or two consecutive statements. Amendments are effective for annual periods beginning on or after 1 July 2012;
IAS 12: Deferred Tax. This amendment introduces a rebuttable assumption that where certain assets (including investment property and intangible assets) are measured at either fair value or under a revaluation model, deferred tax should be calculated on the assumption that the asset will be sold at its carrying amount. This amendment is effective for annual accounting periods beginning on or after 1 January 2012; and
IAS 19: Employee Benefits. Eliminates the option to defer the recognition of gains and losses, known as the "corridor method". This is effective for accounting periods beginning on or after 1 January 2013.
The financial statements comply with the Statement of Recommended Practice issued by the Association of British Insurers in December 2005 (as amended in December 2006) insofar as these requirements do not contradict the requirements of IFRS.
The Group presents its balance sheet in order of liquidity. Where applicable, for each asset and liability line item that combines amounts expected to be recovered or settled both within and beyond 12 months after the balance sheet date, disclosure of the amount due beyond 12 months is made in the respective note.
Financial assets and financial liabilities are not offset unless there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis or to realise the assets and settle the liability simultaneously. Income and expenses are not offset in the income statement unless required or permitted by an accounting standard or interpretation, as specifically disclosed in the accounting policies of the Group.
1.2 Changes in accounting policy
1.2.1 Disclosure of collateral held
Adoption of annual improvements to IFRS results in the requirement to disclose details of collateral held by the Group to mitigate credit risk.
1.3 Use of judgements, estimates and assumptions
The Group makes judgements in the application of critical accounting policies that affect the reported amounts of assets and liabilities. The Group also makes key assumptions about the future and other sources of uncertainty. These are continually evaluated and based on historical experience and other factors, including expectations of future events that are considered to be reasonable under the circumstances.
2. Responsibility statement
Each of the directors confirms that to the best of their knowledge:
-- The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS);
-- The financial statements give a true and fair view of the assets, liabilities, financial position and results of the Company and of the Group taken as a whole; and
-- The announcement includes a fair review of the development and performance of the business and the position of the Company and the Group taken as a whole, together with a description of the principal risks and uncertainties they face.
On behalf of the Board
Andy Parsons
Executive Director - Finance
26 March 2012
3. Segmental Information
(a) Summary
Segmental information is presented on the same basis as internal financial information used by the Group to evaluate operating performance. Segmental information relating to revenue, net income, products and services for the year ended 31 December 2011 includes BHA from 31 January and WLUK from 7 November. The segmental information for the year ended 31 December 2010 includes 12 months for the acquired Friends Provident Business and four months for the acquired AXA UK Life Business.
The Group's management and internal reporting structure is based on the following operating segments which all meet the definition of a reportable segment under IFRS 8:
-- UK - comprising the former Friends Provident UK life and pensions business, the acquired AXA UK Life Business (including WLUK), BHA, Sesame Bankhall and, for the period prior to 19 March 2010 when it was disposed, Pantheon Financial Limited;
-- International - comprising Friends Provident International Limited ("FPIL"), the overseas life assurance business within the UK life and pensions subsidiaries and the Group's share of AmLife; and
-- Lombard.
Corporate functions are not strictly an operating segment, but are reported to management, and are provided in the analysis below to reconcile the Group's reportable segments to total profit.
(b) Operating segment information
(i) IFRS based operating profit
For the year ended 31 December 2011
UK Int'l Lombard Corporate Total GBPm GBPm GBPm GBPm GBPm ----- ------ -------- ---------- Life result 706 49 40 - 795 Longer term shareholder investment return (5) 1 (1) (21) (26) Other expense (1) (3) - (7) (11) Development costs (28) (7) (1) - (36) --------------------------------------------- ----- ------ -------- ---------- ------ IFRS based operating profit/(loss) before tax 672 40 38 (28) 722 Tax on operating profit 38 ----- ------ -------- ---------- IFRS based operating profit after tax attributable to ordinary shareholders from continuing operations 760 --------------------------------------------- ----- ------ -------- ---------- ------ For the year ended 31 December 2010 UK Int'l Lombard Corporate Total GBPm GBPm GBPm GBPm GBPm -------------------------------------------- Life result 176 94 38 - 308 Longer term shareholder investment return 30 1 (4) (14) 13 Other income/(expense) 2 6 - (11) (3) Development costs (21) (6) (1) - (28) --------------------------------------------- --------- ------ -------- ---------------- ------ IFRS based operating profit/(loss) before tax 187 95 33 (25) 290 Tax on operating profit 16 --------------------------------------------- --------- ------ -------- ---------------- ------ IFRS based operating profit after tax attributable to ordinary shareholders from continuing operations 306 --------------------------------------------- --------- ------ -------- ---------------- ------
(ii) Reconciliation of IFRS based operating profit before tax to profit before tax from continuing operations
For the year ended 31 December 2011 UK Int'l Lombard Corporate Total GBPm GBPm GBPm GBPm GBPm ---------------- ---------- ---------- ------------- ---------- IFRS based operating profit/(loss) before tax 672 40 38 (28) 722 Non-recurring items(i) (178) (1) (1) - (180) Amortisation and impairment of acquired present value of in-force business (483) (126) (66) - (675) Amortisation and impairment of acquired intangible assets (45) (8) (30) (1) (84) Interest payable on STICS 31 - - - 31 Short-term fluctuations in investment return(iii) (247) (10) (1) (3) (261) ---------------------------------------------------- ---------- ---------- ------------- ---------- ------ Loss before tax excluding profit generated within policyholder funds (250) (105) (60) (32) (447) Policyholder tax 220 - - - 220 Loss before tax from continuing operations (30) (105) (60) (32) (227) ---------------------------------------------------- ---------- ---------- ------------- ---------- ------ For the year ended 31 December 2010 UK Int'l Lombard Corporate Total GBPm GBPm GBPm GBPm GBPm IFRS based operating profit/(loss) before tax 187 95 33 (25) 290 Non-recurring items(ii) (121) (6) - 928 801 Amortisation of acquired present value of in-force business (169) (123) (72) - (364) Amortisation of acquired intangible assets (27) (8) (28) (1) (64) Interest payable on STICS 31 - - - 31 Short-term fluctuations in investment return(iii) 28 2 1 (7) 24 --------------------------------------------------------- --------- ------ ------------- ---------- ------ (Loss)/profit before tax excluding profit generated within policyholder funds (71) (40) (66) 895 718 Policyholder tax 244 - - - 244 Returns on Group-controlled funds attributable to third parties 23 - - - 23 Profit/(loss) before tax from continuing operations 196 (40) (66) 895 985 --------------------------------------------------------- --------- ------ ------------- ---------- ------
(i) UK non-recurring items for 2011 include GBP68 million (GBP67 million net of stamp duty expenses) in respect of the gain on acquisition of BHA and GBP48 million (GBP46 million net of stamp duty expenses) in respect of the gain on acquisition of WLUK. Further details are set out in note 11. This is offset by GBP293 million of non-recurring costs comprising GBP128 million of separation and integration costs in respect of the UK Life project, GBP55 million in respect of Solvency II and finance system developments, GBP84 million of reserve impacts in respect of the outsourcing arrangement with Diligenta and GBP26 million of other costs.
(ii) Corporate non-recurring items for 2010 include GBP883 million (GBP869 million net of stamp duty expenses) in respect of the gain on acquisition of the AXA UK Life Business. Further details are set out in note 11. A further GBP68 million of non-recurring costs comprises GBP34 million of separation and integration costs in respect of the acquired AXA UK Life Business, GBP23 million in respect of Solvency II and finance system developments and GBP11 million of other costs. Segment results also include GBP76 million of non-recurring items which comprises of a management recharge to the life companies for pension scheme contributions. The net impact of the recharge for the Group is GBPnil.
(iii) Includes shareholder investment return short-term fluctuations and investment variances arising from the mismatching of fixed interest assets and liabilities they are backing as well as the impact of credit default assumptions. This latter variance reflects profits or losses in excess of the expected investment return on the assets and the impact of the corresponding economic assumption changes on the liabilities.
(iii) Revenue and expenses
For the year ended 31 December 2011 Elimination of inter segment UK Int'l Lombard Corporate amounts(ii) Total GBPm GBPm GBPm GBPm GBPm GBPm Gross earned premiums on insurance and investment contracts 5,270 1,260 2,373 - - 8,903 Investment contract premiums(i) (3,225) (1,177) (2,373) - - (6,775) ------------------------------------- -------- -------- -------- ---------- ------------- -------- Gross earned premiums 2,045 83 - - - 2,128 Premiums ceded to reinsurers (598) (1) - - - (599) Net earned premiums 1,447 82 - - - 1,529 Fee and commission income 546 114 110 1 - 771 Investment return 2,657 (400) (461) 57 (50) 1,803 ------------------------------------- -------- -------- -------- ---------- ------------- -------- Total revenue 4,650 (204) (351) 58 (50) 4,103 ------------------------------------- -------- -------- -------- ---------- ------------- -------- Intersegment revenue 2 1 - 47 (50) - Total external revenue 4,648 (205) (351) 11 - 4,103 ------------------------------------- -------- -------- -------- ---------- ------------- -------- Other income(iii) 134 - - - - 134 ------------------------------------- -------- -------- -------- ---------- ------------- -------- Net claims and benefits paid 3,209 7 - - - 3,216 Movement in insurance and investment contract liabilities 183 (346) (548) - - (711) Transfer to unallocated surplus (490) 6 - - - (484) Movement in net assets attributable to unit-holders (48) - - - - (48) Acquisition expenses 497 47 47 - - 591 Administrative and other expenses 1,348 177 208 8 - 1,741 Finance costs 115 9 2 82 (50) 158 ------------------------------------- -------- -------- -------- ---------- ------------- -------- Total claims, benefits and expenses 4,814 (100) (291) 90 (50) 4,463 ------------------------------------- -------- -------- -------- ---------- ------------- -------- Intersegment expenses 47 3 - - (50) - Total external claims, benefits and expenses 4,767 (103) (291) 90 - 4,463 Share of loss of associates and joint venture - (1) - - - (1) ------------------------------------- -------- -------- -------- ---------- ------------- -------- Loss before tax from continuing operations (30) (105) (60) (32) - (227) -------- -------- -------- ---------- ------------- Policyholder tax (220) - - - - (220) Shareholder tax 437 (4) 29 (5) - 457 ------------------------------------- -------- -------- -------- ---------- ------------- -------- Segmental result after tax 187 (109) (31) (37) - 10 ------------------------------------- -------- -------- -------- ---------- ------------- -------- (i) Accounted for as deposits under IFRS.
(ii) Eliminations include intersegment fee income and loan interest. Intersegment transactions are undertaken on an arms-length basis.
(iii) Includes gains on acquisitions of BHA (GBP68 million) and WLUK (GBP48 million).
For the year ended 31 December 2010 Elimination of inter segment UK Int'l Lombard Corporate amounts(ii) Total GBPm GBPm GBPm GBPm GBPm GBPm Gross earned premiums on insurance and investment contracts 3,457 1,063 3,021 - - 7,541 Investment contract premiums(i) (2,181) (1,051) (3,021) - - (6,253) ---------------------------------- -------- -------- -------- ------------- Gross earned premiums 1,276 12 - - - 1,288 Premiums ceded to reinsurers (240) (1) - - - (241) Net earned premiums 1,036 11 - - - 1,047 Fee and commission income 373 266 111 1 - 751 Investment return 6,477 569 1,374 22 (18) 8,424 Total revenue 7,886 846 1,485 23 (18) 10,222 Intersegment revenue 3 1 - 14 (18) - Total external revenue 7,883 845 1,485 9 - 10,222 Other income(iii) 8 - - 883 - 891 -------- Net claims and benefits paid 1,678 4 - - - 1,682 Movement in insurance and investment contract liabilities 4,768 694 1,292 - - 6,754 Transfer to unallocated surplus 2 2 - - - 4 Movement in net assets attributable to unit-holders 139 - - - - 139 Acquisition expenses 329 15 48 - - 392 Administrative and other expenses 669 169 208 (18) - 1,028 Finance costs 109 6 3 29 (18) 129 Total claims, benefits and expenses 7,694 890 1,551 11 (18) 10,128 Intersegment expenses 3 1 - 14 (18) - Total external claims, benefits and expenses 7,691 889 1,551 (3) - 10,128 Share of (loss)/profits of associate and joint venture (4) 4 - - - - Profit/(loss) before tax from continuing operations 196 (40) (66) 895 - 985 Policyholder tax (244) - - - - (244) Shareholder tax 98 7 21 (19) - 107 Segmental result after tax 50 (33) (45) 876 - 848 (i) Accounted for as deposits under IFRS
(ii) Eliminations include intersegment fee income and loan interest. Intersegment transactions are undertaken on an arms-length basis.
(iii) Includes gain on acquisition of the AXA UK Life Business of GBP883 million.
(iv) Products and Services
For the year ended 31 December 2011
Individual Other Protection Investment Annuities Pensions Group Pensions (i) Total GBPm GBPm GBPm GBPm GBPm GBPm GBPm Gross earned premiums 1,109 491 407 63 58 - 2,128 Net earned premiums 876 489 46 61 57 - 1,529 Fee and commission income 3 294 - 246 19 209 771 Total external revenue 879 783 46 307 76 209 2,300
For the year ended 31 December 2010
Individual Other Protection Investment Annuities Pensions Group Pensions (i) Total GBPm GBPm GBPm GBPm GBPm GBPm GBPm Gross earned premiums 598 312 327 42 9 - 1,288 Net earned premiums 480 310 207 41 9 - 1,047 Fee and commission income (3) 423 - 145 6 180 751 Total external revenue 477 733 207 186 15 180 1,798
(i) Other includes revenue streams from Sesame Bankhall and Pantheon (for the period prior to its disposal on 19 March 2010).
(v) Assets and liabilities
As at 31 December 2011
Elimination of intersegment UK Int'l Lombard Corporate amounts (i) Total GBPm GBPm GBPm GBPm GBPm GBPm --------- Segment assets 99,262 7,450 18,190 1,725 (1,352) 125,275 Investment in associates and joint venture 5 32 - - - 37 Total assets 99,267 7,482 18,190 1,725 (1,352) 125,312 Total liabilities 94,551 7,189 17,773 1,003 (1,352) 119,164 --------- Other segment information: Capital expenditure 7 - 4 9 - 20 Depreciation 1 - 1 2 - 4 Amortisation 458 134 95 1 - 688 Impairment 71 - - - - 71 ---------
As at 31 December 2010
Elimination of intersegment amounts UK Int'l Lombard Corporate (i) Total GBPm GBPm GBPm GBPm GBPm GBPm Segment assets 96,551 7,184 17,930 1,325 (868) 122,122 Investment in associate and joint venture 5 27 - - - 32 Total assets 96,556 7,211 17,930 1,325 (868) 122,154 Total liabilities 91,237 6,814 17,487 936 (868) 115,606 Other segment information: Capital expenditure 1 - 4 1 - 6 Depreciation 1 - 1 2 - 4 Amortisation 196 131 100 1 - 428 (i) Eliminations mainly comprise intercompany loans
(c) Geographical segmental information
In presenting geographical segment information, segment revenue is based on the geographical location of customers. The Group has defined two geographical areas: UK and the rest of the world.
For the year ended 31 December 2011
Rest of UK the World Total GBPm GBPm GBPm Gross earned premiums 2,042 86 2,128 Fee and commission income 566 205 771 Revenue from external customers 2,608 291 2,899 Investment return 1,803 Premiums ceded to reinsurers (599) Total revenue 4,103 For the year ended 31 December 2010 Rest of UK the World Total GBPm GBPm GBPm Gross earned premiums 1,276 12 1,288 Fee and commission income 398 353 751 Revenue from external customers 1,674 365 2,039 Investment return 8,424 Premiums ceded to reinsurers (241) Total revenue 10,222
4. Staff pension schemes
(a) Introduction
The Group operates a defined benefit scheme: the Friends Provident Pension Scheme ("FPPS"), to which a proportion of the Group's UK Life and Pensions employees belong. In addition, defined contribution schemes are operated by Friends Provident Management Services Limited ("FPMS"), FPI and Sesame Bankhall Group. Lombard does not operate a pension scheme.
On an IAS 19 basis, a gross surplus of GBP52 million has been recognised in respect of the FPPS at 31 December 2011 (GBP66 million at 31 December 2010). The latest funding arrangement was entered into in June 2010. This agreement was based on an actuarial valuation as at 30 September 2008, which showed a deficit on a funding basis of GBP65 million. Deficit reduction contributions of GBP20 million per annum for the next four years were subsequently agreed with the Trustee, and commenced in July 2010. An updated triennial valuation has been carried out as at 30 September 2011 and the results of this are currently being considered by the Trustee. The valuation, once approved, will serve to assist the Trustee and the Group in determining future levels of funding.
Under IFRIC 14: The Limit on a Defined Benefit Asset, Minimum Funding Requirement, deficit reduction contributions are considered to be a minimum funding requirement and, to the extent that the contributions payable will not be available after they are paid into the scheme, a liability is recognised when the obligation arises. An additional liability of GBP32 million has been recognised (GBP44 million at 31 December 2010), reflecting the 35% tax that would arise on any notional refund in respect of the resultant IAS 19 surplus of GBP92 million (GBP40 million deficit reduction contributions plus the current surplus of GBP52 million). A deferred tax asset of GBP10 million (2010: GBP16 million) has also been recognised to reflect tax relief at a rate of 25% (2010: 27%) that is expected to be available on the deficit reduction contributions, once paid into the Scheme.
Employees of the acquired AXA UK Life Business (including WLUK) and BHA have been placed into new defined contribution arrangements for service accruing after the acquisition date. The pension obligations for service accruing up to the date of the acquisition are not borne by the Group, as these obligations have remained with AXA UK plc and Bupa Finance plc respectively.
(b) FPPS defined benefit scheme overview
The FPPS is a UK defined benefit scheme to which some of the UK Life and Pensions employees from the acquired Friends Provident business belong. The Scheme's assets, which are administered by three external investment managers, are held under the control of the Trustee and used to secure benefits for the members of the Scheme and their dependants in accordance with the Trust Deed and Rules.
The Trustee board consists of a chairman who is appointed by the employer and six additional directors of which three are employer-appointed directors, two member-selected directors and one pensioner-selected director.
An analysis of the amounts recognised in the financial statements in respect of the FPPS is set out below.
2011 2010 GBPm GBPm Amounts recognised in the consolidated statement of financial position IAS 19 pension surplus (excluding deficit reduction contribution) 52 66 Authorised payments surplus charge (penal tax) at 35% of available surplus following deficit reduction contributions (32) (44) Net pension surplus (excluding deficit reduction contribution) 20 22
Movement in IAS 19 pension surplus
2011 2010 GBPm GBPm Pension surplus at 1 January 66 59 Current service cost(i) (7) (13) Interest cost(i) (57) (55) Expected return on pension assets(i)(ii) 63 60 Augmentations and termination benefits(i) - (3) Employer contributions 33 41 Actuarial losses (46) (23) Pension surplus at 31 December (excluding authorised payments surplus charge) 52 66 Deficit reduction contributions 40 60 Available surplus subject to authorised payments surplus charge 92 126
(i) Recognised in the consolidated income statement. The total loss recognised in the income statement for the year ended 31 December 2011 is GBP1 million (2010: loss of GBP11 million).
(ii) The actual return on plan assets was GBP185 million (2010: GBP104 million).
Analysis of pension surplus and related deferred tax asset
As at 31 December 2011
Pension Deferred surplus tax GBPm GBPm Gross IAS 19 pension surplus and related deferred tax liability 52 (13) Irrecoverable element of deficit reduction contributions (authorised payments surplus charge on available surplus) (32) - Restriction of liability due to authorised payments surplus charge - 13 Tax relief available on deficit reduction contributions -- 10 Net pension surplus and related deferred tax asset 20 10
As at 31 December 2010
Pension Deferred surplus tax GBPm GBPm Gross IAS 19 pension surplus and related deferred tax liability 66 (18) Irrecoverable element of deficit reduction contributions (authorised payments surplus charge on available surplus) (44) - Restriction of liability due to authorised payments surplus charge - 18 Tax relief available on deficit reduction contributions - 16 Net pension surplus and related deferred tax asset 22 16
Amounts recognised in the consolidated income statement
2011 2010 GBPm GBPm Interest cost (57) (55) Current service costs (7) (13) Augmentations and termination benefits - (3) Expected return on plan assets 63 60 Total amounts recognised in the income statement (1) (11) Actual return on plan assets 185 104
Amounts recognised in the consolidated statement of comprehensive income
2011 2010 GBPm GBPm Actuarial losses (46) (23) Reverse authorised payments surplus charge on opening surplus 44 21 Irrecoverable element of deficit reduction contributions (authorised payments surplus charge on available surplus) (32) (44) Actuarial losses on defined benefit schemes (34) (46) Taxation 2 25 Actuarial losses on defined benefit schemes after tax (32) (21)
A tax charge of GBP6 million (2010: GBP16 million credit) in respect of deficit reduction contributions and credits of GBP8 million (2010: GBP9 million) in respect of other movements in the pension scheme are included in the aggregate tax line of the consolidated statement of comprehensive income.
5. Taxation
(a) Tax charged to the income statement
2011 2010 GBPm GBPm Current tax UK corporation tax at 26.5% (2010: 28%) 52 16 Adjustments in respect of prior periods (11) (15) Overseas taxation 18 7 Total current tax charge 59 8 Deferred tax Origination and reversal of temporary differences (322) 121 Adjustments in respect of prior periods 26 8 Total deferred tax (credit)/charge (296) 129 Total tax (credit)/charge (237) 137 Analysis: Policyholder tax 220 244 Shareholder tax (457) (107) Total tax (credit)/charge (237) 137
Policyholder tax is tax on the income and investment returns charged to policyholders of linked and with-profits funds. Shareholders' tax is tax charged to shareholders on the profits of the Group. During the year legislation was enacted to bring in a phased decrease in the rate of corporation tax to 26% on 1 April 2011 and 25% on 1 April 2012. Under IFRS deferred tax is calculated using rates substantively enacted by the balance sheet date and as such the reduction to a 25% rate has been taken into account in deferred tax balances. Further incremental rate reductions have been announced but not substantively enacted by the balance sheet date. For further information please refer to note 13.
(b) Factors affecting tax charge for period
2011 2010 GBPm GBPm (Loss)/profit before tax from continuing operations (227) 985 (Loss)/profit before tax from continuing operations multiplied by the standard rate of corporation tax in the UK of 26.5% (2010: 28%) (60) 275 Effects of: Non-taxable income (232) (115) Deductions not allowable for tax purposes 22 46 Tax on reserving adjustments 41 7 Overseas tax (6) - Utilisation of excess expenses brought forward - (8) Valuation of tax losses (123) (42) With-profits minority interest(i) - (8) Adjustments in respect of prior periods (8) (7) Non taxable gain on acquisition (31) (247) Reduction in corporation tax rate from 27% to 25% (2010: 28% to 27%) (60) (8) Policyholder tax 220 244 Total tax (credit)/charge (237) 137
(i) The effect of with-profits minority interest in 2010 related to tax on F&C Commercial Property Trust prior to deconsolidation.
6. Appropriations of profit
(a) Dividends paid on ordinary shares
Dividends paid during the year and recognised in reserves:
2011 2010 GBPm GBPm Interim dividend in respect of prior year 350 65
The distributable reserves of the Company at 31 December 2011 are GBP3,696 million (2010: GBP3,478 million).
As required by IAS 10: Events After the Balance Sheet Date, dividends declared after the balance sheet date are not accrued in these accounts. The directors are recommending an interim dividend of GBP250 million to be paid on or before 31 March 2012.
(b) STICS interest
Interest on the 2003 STICS is paid in equal instalments in May and November each year at a rate of 6.875%. During the year ended 31 December 2011, interest of GBP14 million (31 December 2010: GBP14 million) was paid to the 2003 STICS holders.
Interest on the 2005 STICS is paid annually in June at a rate of 6.292%. During the year ended 31 December 2011, interest of GBP17 million (31 December 2010: GBP17 million) was paid to the 2005 STICS holders.
These interest payments are shown as movement in reserves in these financial statements together with the related tax relief.
7. Intangible assets
Movements in intangible assets are as follows:
For the year ended 31 December 2011
AVIF Other Total Cost GBPm GBPm GBPm ---------- At 1 January 2011 5,107 528 5,635 Acquisition of subsidiaries(i) 411 37 448 Other additions - 4 4 Disposals - (5) (5) Foreign exchange adjustments 3 (4) (1) ---------- At 31 December 2011 5,521 560 6,081 ---------- Amortisation and impairment ---------- At 1 January 2011 422 73 495 Amortisation charge for the period(ii) 604 84 688 Impairment charge(ii) 71 - 71 Disposals - (5) (5) Foreign exchange adjustments (13) (2) (15) At 31 December 2011 1,084 150 1,234 ---------- Carrying amounts as at December 2011 4,437 410 4,847
For the year ended 31 December 2010
AVIF Other Total Cost GBPm GBPm GBPm At 1 January 2010 2,938 382 3,320 Acquisition of AXA UK Life Business 2,192 150 2,342 Other additions - 4 4 Foreign exchange adjustments (23) (8) (31) At 31 December 2010 5,107 528 5,635 Amortisation At 1 January 2010 59 10 69 Amortisation charge for the period(ii) 364 64 428 Foreign exchange adjustments (1) (1) (2) At 31 December 2010 422 73 495 Carrying amounts at 31 December 2010 4,685 455 5,140 (i) Acquisitions in 2011 related to BHA and WLUK, see note 11.
(ii) Amortisation and impairment charges are included within administrative and other expenses in the consolidated income statement.
A detailed exercise was undertaken to identify intangible assets as part of the acquisition of BHA on 31 January 2011 and WLUK on 7 November 2011. As a result of the BHA review it was decided that the acquired business represented an additional cash generating unit ("CGU"). Intangible assets identified within BHA related to the acquired value of in-force business ("AVIF") and software totalling GBP180 million. Intangible assets identified within WLUK related to AVIF and distribution channels and customer relationships totalling GBP268 million and are included in the UK - AXA UK Life Business CGU.
In determining the fair value of identified intangible assets, appropriate approaches to valuation were applied, given the nature of the intangible assets acquired.
Intangible assets relating to customer relationships and distribution channels have been valued using an income approach method, specifically the Multi-period Excess Earnings Method ("MEEM"). The principle behind the MEEM is that the value of an intangible asset is equal to the present value of the after-tax cash flows attributable only to that intangible asset. Other intangibles include in-house developed IT systems and databases which have been valued using a replacement cost approach which assesses the cost of reproducing the equivalent technology in its current form.
For each type of asset, the useful economic life was determined, being the period over which the asset is expected to contribute directly or indirectly to future cash flows. The value of the assets will be amortised over the respective useful economic lives.
The "AXA" and "Bupa" brands and associated brands that existed within the acquired businesses have been retained by AXA and Bupa respectively and as such no value has been attributed to them.
The "Friends" brand has been retained by the Group and during the course of the year, a rebranding exercise was carried out to change all inherited brands to "Friends Life".
On acquisition of a portfolio of insurance contracts and/or investment contracts, either directly or through the acquisition of a subsidiary undertaking, the net present value of the Group's interest in the expected pre-tax cash flows of the in-force business is capitalised in the balance sheet as the AVIF. AVIF is shown gross of policyholder and shareholder tax of GBP995 million (2010: GBP1,076 million), with the offsetting balance included in deferred taxation. The AVIF is based on the value of in-force business calculated on a market consistent embedded value basis.
(a) AVIF
AVIF is allocated to CGUs, which represent the lowest level within the Group at which AVIF is monitored for internal management purposes. An analysis of AVIF by CGU is set out below:
Net book Cost Impairment Amortisation value As at 31 December 2011 GBPm GBPm GBPm GBPm UK - Friends Provident (Life and Pensions including Sesame Bankhall) 1,304 - (202) 1,102 UK - AXA UK Life Business (including WLUK) 2,431 - (394) 2,037 UK - BHA 172 (71) (12) 89 International 1,014 - (250) 764 Lombard 600 - (155) 445 Total 5,521 (71) (1,013) 4,437 Net book Cost Amortisation value As at 31 December 2010 GBPm GBPm GBPm UK - Friends Provident (Life and Pensions including Sesame Bankhall) 1,304 (116) 1,188 UK - AXA UK Life Business 2,192 (80) 2,112 International 995 (132) 863 Lombard 616 (94) 522 Total 5,107 (422) 4,685 (b) Other intangibles
Other intangible assets are made up of the following:
Net book Cost Amortisation value As at 31 December 2011 GBPm GBPm GBPm Distribution channels and customer relationships 444 (112) 332 Brand 49 (19) 30 Software 54 (19) 35 Goodwill 13 - 13 Total 560 (150) 410 Net book Cost Amortisation value As at 31 December 2010 GBPm GBPm GBPm Distribution channels and customer relationships 419 (54) 365 Brand 49 (10) 39 Software 47 (9) 38 Goodwill 13 - 13 Total 528 (73) 455
(c) Impairment
All identifiable intangible assets are reviewed at each reporting date, or where impairment indicators are present, to assess whether there are any circumstances that might indicate that they are impaired. If such circumstances exist, impairment testing is performed and any resulting impairment losses are charged to the income statement. As at 31 December 2011, based on an impairment review of each of the CGUs, the Directors are satisfied that none of the Group's intangible assets are impaired, except as stated below.
Impact of negative reserves
During the period, Friends Life Company Limited ("FLC") and the acquired BHA business revised their reserving methodology by allowing for negative reserves on protection business as allowed for in the FSA Policy Statement 06/14. This resulted in:
-- a reduction in policyholder liabilities of GBP243 million and a write-off of DAC on protection business of GBP22 million in FLC resulting in a one-off benefit to IFRS based operating profit of GBP221 million;
-- an acceleration of AVIF amortisation of GBP130 million in FLC and an AVIF impairment of GBP71 million in the acquired BHA business resulting in a one-off adverse impact on non-operating profit of GBP201 million; and
-- a reduction in the emerging surplus and new business strain of GBP28 million.
The net impact on profit before tax was a loss of GBP8 million.
The impairment arose from the implementation of negative reserves, which resulted in an earlier recognition of surplus and the recoverable amount of the AVIF being assessed to be lower than the carrying value. The AVIF asset which has been impaired is included in the UK segment (disclosed in Note 3).
For the purpose of the AVIF impairment test, the calculation of the recoverable amount is consistent with its measurement at initial recognition and is based on a current adjusted MCEV VIF balance for pre-acquisition business only, which represents a reasonable basis for determining future profits generated by the asset acquired.
8. Financial assets
The Group's financial assets are summarised by measurement categories as follows:
2011 2010 GBPm GBPm -------------------------------------- ------- ------ Fair value through profit or loss: Designated on initial recognition 102,763 98,332 Held for trading 875 456 Loans at amortised cost 5 677 Total financial assets 103,643 99,465 -------------------------------------- ------- ------
Derivative financial instruments are classified as held for trading in accordance with IAS 39. All other financial assets recognised at fair value through profit or loss are designated as such on initial recognition.
(a) Analysis of financial assets at fair value through profit or loss
As at 31 December 2011
With- Unit- Non- profits linked Annuities linked Share-holder Total GBPm GBPm GBPm GBPm GBPm GBPm ----------------------------------- --------- -------- ---------- -------- ------------- -------- Shares and other variable yield securities 7,107 53,493 - 108 9 60,717 Debt securities and other fixed- income securities: Government securities: Loaned government securities(i) - - - 198 - 198 Other government securities 8,469 8,507 1,069 993 274 19,312 Corporate bonds 9,020 5,665 5,969 1,214 287 22,155 Derivative financial instruments 762 7 97 9 - 875 Deposits with credit institutions - 381 - - - 381 Total financial assets held at fair value 25,358 68,053 7,135 2,522 570 103,638 ----------------------------------- --------- -------- ---------- -------- ------------- --------
(i) On 11 May 2011, the Group provided a GBP200 million collateralised loan to Barclays Bank plc which matures on 31 July 2012. UK government securities were loaned and the assets remain on balance sheet as substantially all the risks and rewards of ownership are retained by the Group. The Group holds collateral in respect of these arrangements.
As at 31 December 2010
With- Unit- Annuities Non- Share-holder Total profits linked linked GBPm GBPm GBPm GBPm GBPm GBPm Shares and other variable yield securities 8,114 52,017 - 241 8 60,380 Debt securities and other fixed-income securities: Government securities 6,937 7,644 659 716 189 16,145 Corporate bonds 8,885 5,445 5,634 922 569 21,455 Derivative financial instruments 393 24 39 5 (5) 456 Deposits with credit institutions 3 349 - - - 352 Total financial assets held at fair value 24,332 65,479 6,332 1,884 761 98,788
As at 31 December 2011, the fair value of the collateral received from the counterparties was GBP850 million (2010: GBP306 million). No collateral received from the counterparties has been sold or re-pledged. The fair value of loans is considered to be the same as their carrying value.
The above unit-linked column and with-profits column include GBP1,129 million (2010: GBP964 million) of financial assets (GBP818 million of shares, GBP219 million of government securities and GBP92 million of corporate bonds) relating to the minority interests in the OEICs that have been consolidated as the Group holding is 50% or more.
For unit-linked funds, the policyholders bear the investment risk and any change in asset values is matched by a broadly equivalent change in the liability.
The majority of financial assets held are readily realisable, however, amounts of GBP93,863 million (2010: GBP87,707 million) are not expected to be realised until more than 12 months after the balance sheet date in line with the expected maturity of insurance/investment contract liabilities.
Asset backed securities ("ABS") (excluding those held by the linked funds) amount to GBP3,060 million (2010: GBP2,505 million) and 94% (2010: 92%) of these are at investment grade.
(b) Determination of fair value hierarchy
In accordance with the requirements of IFRS 7, financial assets at fair value have been classified into three categories as set out below. Financial assets at fair value include shares and other variable yield securities, government securities, corporate bonds (including ABS), derivative financial instruments and deposits with credit institutions.
Level 1 - quoted prices (unadjusted) in active markets for identical assets. An active market is one in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Examples include listed equities and bonds in active markets and quoted unit trusts/OEICs.
Level 2 - inputs other than quoted prices included within Level 1 that are observable for the asset, either directly (i.e. as prices) or indirectly (i.e. derived from prices). This category generally includes assets that are priced based on models using market observable inputs. Examples include certain corporate bonds, certificates of deposit and derivatives.
Level 3 - inputs for the asset that are not based on observable market data. Assets with single price feeds and/or limited trading activity are included in this category. Examples include unlisted equities and private equity investments.
The majority of the Group's assets held at fair value are valued based on quoted market information or market observable data. Approximately 4% (5% excluding unit-linked assets) are based on valuation techniques where significant observable market data is not available or the price is not observable from current market transactions. However, the fair value measurement objective of these assets remains the same, that is, an exit price from the perspective of the Group.
The fair values of these assets are generally provided by external parties. During the year, the Group has performed independent reviews of pricing models to ensure that appropriate methodologies have been applied. The approach taken for each class of specific unlisted investment is as follows:
The valuation of the holdings in private equity limited partnerships and companies is based on the most recent underlying valuations available at the reporting date as adjusted for contributions, distributions and known diminutions in value of individual underlying investments in the period since valuations were performed. The valuation technique is not supported by observable market values. Valuation of private equity holdings are prepared in accordance with International Private Equity and Venture Capital Board ("IPEV") guidelines.
The fair value of the investments in property limited partnerships is taken as the Group's appropriate share of the net asset value of the partnerships. The net asset value is based on the latest external market valuation of the underlying property investments, which is updated at least every six months. The valuation would be adjusted in the event of a significant market movement in the period between the last market valuation and the reporting date.
Private loans are valued using discounted cash flows, which are carried out by investment managers and reviewed by management. The interest rate used when calculating the present value is derived from the UK Gilts Curve, adjusting the spread by the movement in the most appropriate IBoxx GBP Corp Curve associated with the loan rating, where available. All spreads are reviewed on a quarterly basis and any spreads that appear inappropriate taking into consideration loan details (loan sector, maturity and rating), available market proxies, comparable instruments and underlying securities are recalibrated accordingly.
The Group has invested in a mortgage loan issued by AXA Equitable in the US. The mortgage loan is secured against the property. The loan is valued by external real estate advisors using discounted cash flows. The discount rate used in the calculation is determined by adding an appropriate spread (based on property type, prevailing interest rates and current mortgage spread over US treasuries) to the yield of an appropriate US Treasury Bond with the maturity closest to the maturity of the loan. The loan is denominated in US dollars.
IFRS 7 also requires financial liabilities at fair value to be categorised into the above Level 1, 2 or 3 hierarchies. Financial liabilities at fair value include unit-linked contracts, amounts due to reinsurers, net asset value attributable to unit-holders (minority interest in the OEICs that are consolidated) and derivative financial instruments. The classifications take into account the types of inputs used to determine the fair value measurements. For unit-linked funds this has been undertaken on a fund-by-fund basis. For the net asset value attributable to unit holders, this has been analysed in the same proportion as the underlying consolidated investments categorisation.
The Group has financial liabilities which contain a discretionary participation feature of GBP9,426 million (2010: GBP9,123 million) that form part of its with-profits funds. Products giving rise to these liabilities are mainly investment or pension contracts with a unitised with-profits element. The Group is unable to measure the fair value of these financial liabilities reliably due to the lack of a robust basis to measure the supplemental discretionary returns arising on with-profits contracts and because there is not an active market for such instruments. These liabilities have therefore been excluded from the fair value hierarchy analysis below.
An analysis of financial assets and liabilities held at fair value in accordance with the fair value hierarchy is set out below. The table shows both the total financial assets and liabilities and the total excluding unit-linked assets and liabilities, as shareholders have no direct exposure to profits or losses on unit-linked assets (other than through investment management fees).
As at 31 December Including unit-linked Excluding unit-linked 2011 Level Level Level Level Level Level 1 2 3 Total 1 2 3 Total GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm ----------------------- ------ ------ ----- ------- ------ ----- ----- ------ Financial assets held at fair value Shares and other variable yield securities 47,808 9,699 3,210 60,717 5,828 272 1,124 7,224 Debt securities and other fixed income securities: Government securities 19,220 285 5 19,510 10,913 85 5 11,003 Corporate bonds 11,952 8,944 1,259 22,155 9,420 6,560 510 16,490 Derivative financial instruments 67 808 - 875 60 808 - 868 Deposits with credit institutions 366 15 - 381 - - - - ----------------------- ------ ------ ----- ------- ------ ----- ----- ------ Total financial assets held at fair value 79,413 19,751 4,474 103,638 26,221 7,725 1,639 35,585 ----------------------- ------ ------ ----- ------- ------ ----- ----- ------ Financial liabilities held at fair value Unit-linked investment contracts - 65,259 - 65,259 - - - - Amounts due to reinsurers - 1,800 - 1,800 - 1,800 - 1,800 Net asset value attributable to unit-holders 1,173 - - 1,173 36 - - 36 Derivative financial instruments 44 243 - 287 26 239 - 265 ----------------------- ------ ------ ----- ------- ------ ----- ----- ------ Total financial liabilities held at fair value 1,217 67,302 - 68,519 62 2,039 - 2,101 ----------------------- ------ ------ ----- ------- ------ ----- ----- ------ As at 31 December Including unit-linked Excluding unit-linked 2010 Level Level Level Level Level Level 1 2 3 Total 1 2 3 Total GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm ---------------------------- ------ ------ ----- ------ ------ ----- ----- ------ Financial assets held at fair value Shares and other variable yield securities 48,139 8,892 3,349 60,380 7,109 271 983 8,363 Debt securities and other fixed income securities: Government securities 16,094 51 - 16,145 8,500 1 - 8,501 Corporate bonds 12,317 8,035 1,103 21,455 9,601 6,051 358 16,010 Derivative financial instruments 54 402 - 456 51 381 - 432 Deposits with credit institutions 351 1 - 352 3 - - 3 ---------------------------- ------ ------ ----- ------ ------ ----- ----- ------ Total financial assets held at fair value 76,955 17,381 4,452 98,788 25,264 6,704 1,341 33,309 ---------------------------- ------ ------ ----- ------ ------ ----- ----- ------ Financial liabilities held at fair value Unit-linked investment contracts - 62,492 - 62,492 - - - - Amounts due to reinsurers - 1,666 - 1,666 - 1,666 - 1,666 Net asset value attributable to unit-holders 1,173 - - 1,173 11 - - 11 Derivative financial instruments 27 138 - 165 27 127 - 154 ---------------------------- ------ ------ ----- ------ ------ ----- ----- ------ Total financial liabilities held at fair value 1,200 64,296 - 65,496 38 1,793 - 1,831 ---------------------------- ------ ------ ----- ------ ------ ----- ----- ------
(c) Transfers between Level 1 and Level 2
During the year, GBP452 million (2010: GBP958 million) of shares and other variable yield securities were transferred from Level 1 to Level 2 and GBP1,413 million (2010: GBP735 million) of corporate bonds, shares and other variable yield securities were transferred from Level 2 to Level 1. These movements arose from changes in the availability of current quoted prices and market activity. There were no significant transfers between Level 1 and Level 2 for other financial assets.
(d) Financial instruments
The following table shows a reconciliation of Level 3 financial assets which are recorded at fair value.
As at 31 December 2011
Shares and other Total financial variable Government Corporate assets held yield securities bonds bonds (including at fair GBPm GBPm ABS) GBPm value GBPm At 1 January 2011 3,349 - 1,103 4,452 Acquisition through business combinations 3 - 26 29 Total (losses)/gains in income statement (82) - 11 (71) Purchases 557 4 120 681 Sales (582) - (86) (668) Net transfer (to)/from Level 1 and Level 2 (4) 1 104 101 Foreign exchange adjustments (31) - (19) (50) At 31 December 2011 3,210 5 1,259 4,474 Total (losses)/gains for the year included in profit or loss for assets held at 31 December 2011 (158) - 11 (147)
Transfers out of Level 3 arise due to availability of prices in an active market.
As at 31 December 2010
Shares and Corporate Total financial other variable bonds (including assets held yield securities ABS) at fair value GBPm GBPm GBPm At 1 January 2010 4,720 688 5,408 Acquisition through business combinations 529 213 742 Total gains in income statement 394 180 574 Purchases 1,100 216 1,316 Sales (889) (99) (988) Net transfers to Level 1 and Level 2 (2,477) (58) (2,535) Foreign exchange adjustments (28) (37) (65) At 31 December 2010 3,349 1,103 4,452 Total gains for the period included in profit or loss for assets held at 31 December 2010 184 139 323
Transfers out of Level 3 arise due to availability of prices in an active market and the refinement of methodology that took place during the year.
(e) Level 3 sensitivity analysis
2011 2010 Effect of Effect of reasonably reasonably possible possible Carrying alternative Carrying alternative amount assumptions amount assumptions GBPm GBPm GBPm GBPm Unit-linked investments 2,835 - 3,111 - Shares and other variable yield securities 1,124 224 983 196 Government bonds 5 1 - - Corporate bonds (including ABS) 510 51 358 36 4,474 276 4,452 232
For unit-linked funds, the policyholders bear the investment risk and any change in asset values is matched by a broadly equivalent change in the liability. Shareholder profits from annual management charges levied on such funds will, however, vary according to the change in asset values leading to some limited investment risk.
For shares and other variable yield securities, where there is no active market, the price at year end could reasonably be expected to be higher or lower by approximately 20%.
For government bonds and corporate bonds, it could reasonably be expected that the current prices could be higher or lower by approximately 10% to reflect changes in the credit ratings of the underlying bonds.
(f) Loans
2011 2010 GBPm GBPm Mortgage loans 2 61 Other loans 3 616 Total loans 5 677
Loan assets of GBP600 million which were held at 31 December 2010 were repaid in March 2011.
(g) Assets backing unit-linked liabilities
The net assets backing unit-linked liabilities are included within the relevant balances in the consolidated statement of financial position and are analysed as follows:
2011 2010 GBPm GBPm Shares and other variable yield securities 53,493 52,017 Debt securities and other fixed-income securities 14,172 13,089 Derivative financial instruments 7 24 Deposits with credit institutions 381 349 Total financial assets held at fair value 68,053 65,479 Investment properties 1,688 1,831 Insurance and other receivables 875 268 Cash and cash equivalents 4,779 4,991 Total assets 75,395 72,569 Other payables (124) (194) Net asset value attributable to unit-holders (1,137) (1,097) Total unit-linked net assets 74,134 71,278
9. Loans and borrowings
The Group's loans and borrowings are as follows:
Coupon % 2011 2010 GBPm GBPm Subordinated liabilities: Lombard undated subordinated loans Various 2 3 Friends Life Group plc subordinated debt due 2021(i) 12.000 183 186 Friends Life Group plc subordinated debt due 2022(ii) 8.250 496 - Reinsurance: Lombard financial reinsurance treaties Various 8 15 Friends Provident International financial reinsurance treaties(iii) Various 64 29 Other: Fixed rate unsecured notes(iv) 9.000 200 700 Amount owed to credit institutions (overdrafts)(v) 19 79 Total loans and borrowings 972 1,012
Unless otherwise stated below, the carrying values of interest-bearing loans and borrowings closely approximate fair value.
(i) The Friends Life Group plc subordinated debt due 2021 is irrevocably guaranteed on a subordinated basis by FLL. This debt is carried at amortised cost based on the fair value at the date of acquisition of Friends Provident by the Company. The fair value of this subordinated debt is GBP182 million.
(ii) On 21 April 2011, the Company issued a GBP500 million Lower Tier 2 (LT2) debt instrument with a coupon of 8.25% and a maturity of 2022, which is guaranteed on a subordinated basis by FLL. This debt is carried at amortised cost being GBP500 million principal less capitalised issue costs of GBP4 million. The fair value of this subordinated debt is GBP450 million.
(iii) FLL has two financial reinsurance contracts with Munich Reinsurance Company UK Limited ("Munich Re") to finance new German unit-linked pensions business written in the years ended 31 December 2010 and 2011 respectively. The total amount owed to Munich Re under these financial reinsurance arrangements as at 31 December 2011 was GBP40 million (31 December 2010: GBP29 million).
On 30 June 2011, FPIL entered into a financial reinsurance agreement with Munich Re to finance new Hong Kong Premier regular premium savings business written since 1 January 2011. The amount owed to Munich Re as at 31 December 2011 was GBP24 million.
(iv) On 14 September 2010, the Company issued fixed rate unsecured loan notes, due in 2020, to Resolution Holdings (Guernsey) Limited ("RHG") with an agreed principal amount of GBP700 million. Following the issue of the subordinated debt, detailed in note (ii), the Company repaid GBP500 million of the principal plus interest due to RHG.
(v) Amounts owed to credit institutions (overdrafts) includes GBP7 million relating to overdrafts held within the OEICs that have been consolidated as the Group's holding is 50% or more. Such overdrafts are fully repayable out of the assets of the OEICs.
(vi) The Group benefits from a GBP500 million (2010: GBP500 million) multi-currency revolving credit facility with Barclays Bank plc, Royal Bank of Canada, HSBC Bank plc and The Royal Bank of Scotland plc, with Barclays Bank plc as agent, entered into on 24 June 2010. The facility is guaranteed by FLL. If a third party, who does not presently have control of the Group, acquires such control, the Group must notify the agent immediately. In this circumstance, the lenders are not obliged to fund utilisation and may notify the agent to cancel their commitments under the facility. This would have the effect of rendering all of their loans repayable within 10 business days from the date of notice. As at the date of this report, the facility remains undrawn.
Total interest-bearing loans and borrowings are repayable as follows:
2011 2010 GBPm GBPm Within one year or on demand 63 123 Between one and two years 19 - Between two and three years 7 3 Between three and four years 3 - In more than five years 880 886 Total loans and borrowings 972 1,012
Included in the carrying amount above, GBP909 million (2010: GBP889 million) is expected to be settled more than 12 months after the balance sheet date.
Total interest expense for financial liabilities not measured at fair value through profit or loss, which arises solely from interest bearing loans and borrowings is GBP98 million (2010: GBP61 million).
10. Contingent liabilities and commitments
(a) Contingent liabilities
In the normal course of its business, the Group is subject to matters of litigation or dispute. While there can be no assurances at this time, based on the information currently available to them, the Directors believe that it is not probable that the ultimate outcome of any of these matters will have a material adverse effect on the financial condition of the Group.
(b) Commitments
Operating leases where the Group is lessee
The Group leases a number of properties under operating leases. These leases typically run for a period of 50 years, with an option of renewal at the end of the lease. Lease terms include annual escalation clauses to reflect current market conditions.
The future minimum rentals payable under non-cancellable leases are as follows:
2011 2010 Land Land and buildings Other Total and buildings Other Total GBPm GBPm GBPm GBPm GBPm GBPm Within one year 6 1 7 7 1 8 Between one and five years 15 1 16 17 1 18 In more than five years 19 - 19 26 - 26 Total operating lease payables 40 2 42 50 2 52
Other commitments
The Group has investment property commitments of GBP20 million (2010: GBP24 million) relating to ongoing construction, renovation costs and costs of acquiring existing properties.
The Group has potential commitments of GBP335 million (2010: GBP517 million) to venture capital vehicles (partnerships and similar vehicles) that allow exposure to private equity investments in UK, US and European markets. All investments are held under agreements between the private equity managers and the Group which have committed the Group to providing an agreed maximum level of funding to the managers to invest. As at 31 December 2011 there are still funds that have yet to be utilised that, under the agreements, are still available to the private equity managers and hence classify as potential commitments.
The Group has entered into a number of outsourcing arrangements which have resulted in financial commitments amounting to GBP1,798 million as at 31 December 2011 (31 December 2010: GBP510 million). The average weighted years remaining on these outsourcing contracts is 15 years as at 31 December 2011 (31 December 2010: 15 years). Included within these amounts is the GBP1.3 billion outsourcing arrangement with Diligenta announced in November 2011.
11. Business combinations
Business combinations in 2011 and 2010 are set out in the note below. These acquisitions are consistent with the UK Life Project of the Group's ultimate parent, Resolution Limited, which aims to generate value by consolidating UK life and asset management businesses.
(a) Acquisition of BHA
In January 2011, the Group through its subsidiary, FLL, acquired 100% of the shares in Bupa Health Assurance Limited (subsequently renamed Friends Life BHA Limited), a life insurance company, from Bupa Investment Limited and its parent Bupa Finance plc. The Group acquired control of BHA on 31 January 2011, the date at which the last substantive condition to legal completion was satisfied, and has consolidated it from that point. The gross consideration paid in cash was GBP168 million compared to an announced price in October 2010 of GBP165 million. The increase in price reflects an additional GBP3 million of capital injected into BHA in December 2010 by British United Provident Association Limited.
In the period from the acquisition to 31 December 2011, BHA contributed revenue of GBP96 million and made a loss after tax of GBP11 million. If the acquisition had occurred on 1 January 2011, management estimate that consolidated revenue would have been GBP104 million, and the consolidated loss after tax for the year would have been GBP12 million. In determining these amounts, management has assumed that the fair value adjustments which arose on the date of acquisition would have been the same if the acquisition had occurred on 1 January 2011.
The following summarises the consideration transferred, and the recognised amounts of assets acquired and liabilities assumed at the acquisition date:
GBPm Cash paid 168 Fair value of purchase consideration 168 Fair value of net assets acquired (236) Excess of the interest in the fair value of assets acquired over costs (68)
The consolidated income statement includes GBP1 million within administrative and other expenses in relation to stamp duty payable on the shares acquired.
Identifiable assets acquired and liabilities assumed
Recognised values on acquisition GBPm Intangible assets: Acquired value of in-force business 172 Other intangible assets 8 Financial assets 83 Reinsurance assets 83 Cash and cash equivalents 90 Other current assets 30 Total identifiable assets 466 Insurance liabilities 157 Deferred tax liabilities 48 Other liabilities 25 Total identifiable liabilities 230 Net identifiable assets acquired and liabilities assumed 236 Attributable to equity holders of the parent 236
(b) Acquisition of WLUK
In November 2011, the Company acquired 100% of the shares in WLUK, a life insurance company, from AXA UK. The acquisition of WLUK was agreed with AXA UK in 2010 at the same time as the acquisition of FASLH was negotiated. However, the share capital of WLUK was not legally acquired by the Group until 2011 as the purchase was contingent upon a transfer under Part VII of the Financial Services and Markets Act 2000 of AXA's retained business out of WLUK and FSA approval for change of control being received. The Group acquired control of WLUK on 7 November 2011, the date at which the last substantive condition to legal completion was satisfied, and has consolidated it from that point.
In the period from the acquisition to 31 December 2011, the impact of WLUK on revenue was GBP(1) million (reflecting a negative investment return of GBP22 million) and it made a loss after tax of GBP1 million. If the acquisition had occurred on 1 January 2011, management estimate that the impact on revenue would have been GBP(32) million, and the loss after tax for the year would have been GBP7 million. In determining these amounts, management has assumed that the fair value adjustments which arose on the date of acquisition would have been the same if the acquisition had occurred on 1 January 2011.
The following summarises the consideration transferred, and the recognised amounts of assets acquired and liabilities assumed at the acquisition date:
GBPm Cash paid 248 Fair value of purchase consideration 248 Fair value of net assets acquired (296) Excess of the interest in the fair value of assets acquired over costs (48)
The consolidated income statement includes GBP2 million within administrative and other expenses in relation to stamp duty payable on the shares acquired.
Identifiable assets acquired and liabilities assumed
Recognised values on acquisition GBPm Intangible assets: Acquired value of in-force business 239 Distribution and customer relationships 29 Property and equipment 3 Investment properties 43 Financial assets 6,617 Reinsurance assets 402 Current tax assets 1 Insurance and other receivables 38 Cash and cash equivalents 338 Total identifiable assets 7,710 Insurance liabilities 2,127 Investment contracts 5,195 Unallocated surplus 38 Provision for other risks and charges 8 Deferred tax liabilities 23 Insurance payables, other payables and deferred income 23 Total identifiable liabilities 7,414 Net identifiable assets acquired and liabilities assumed 296 Attributable to equity holders of the parent 296
For both acquisitions during the year, the values of assets acquired and liabilities assumed, recognised on acquisition are their estimated fair values. No contingent liabilities have been recognised on acquisition.
In determining the fair value of AVIF, the Group applied pre-tax discount rates to the associated cash flows for each acquired business of 6.7% for BHA and 9.0% for WLUK.
In determining the fair value of distribution and customer relationships acquired, the Group applied pre-tax discount rates to the associated cash flows for each intangible asset of 6.7% for BHA and 10.0% for WLUK.
The gains of GBP116 million recognised as a result of these acquisitions are attributable to the purchase price being at a discount to the fair value of the net assets acquired which is based on the market consistent embedded value of WLUK and BHA. The gains are reported within other income in the consolidated income statement.
(c) Acquisition of Friends ASLH Limited ("FASLH") in 2010
On 3 September 2010, the FSA approved the change of control to the Group of FASLH, the AXA UK Life Business. As the sale and purchase agreement in relation to FASLH became unconditional upon obtaining the FSA approval, the Group acquired control of FASLH on 3 September 2010 and has consolidated it from that point. On 15 September 2010, the Group legally completed the purchase of 100% of the shares and voting rights of FASLH.
In the period from the acquisition to 31 December 2010, FASLH contributed revenue of GBP3,339 million and a profit after tax of GBP1 million. If the acquisition had occurred on 1 January 2010, management estimate that consolidated revenue would have been GBP6,670 million, and consolidated profit after tax for the year ending 31 December 2010 would have been GBP109 million. In determining these amounts, management has assumed that the fair value adjustments which arose on the date of acquisition would have been the same if the acquisition had occurred on 1 January 2010.
The following summarises the major classes of consideration transferred, and the recognised amounts of assets acquired and liabilities assumed at the acquisition date:
GBPm Cash paid 2,224 Share capital issued at par value 500 Fair value of purchase consideration 2,724 Fair value of net assets acquired (3,607) Excess of the interest in the fair value of assets acquired over cost (883)
The gain of GBP883 million recognised as a result of the acquisition is attributable to the purchase price being at a discount to the fair value of the net assets acquired which is based on the market consistent embedded value of the AXA UK Life plus the value of customer and distribution intangibles relating to future business with existing customers and distribution channels.
(d) Disposal of GOF and TIP portfolios
The assets and liabilities held for sale at 31 December 2010 related to the Guaranteed Over Fifties ("GOF") and Trustee Investment Plan ("TIP") portfolios of business.
GBPm Intangible assets - AVIF 269 Deferred tax assets 20 Financial assets - shares and other variable yield securities 904 Cash and cash equivalents 13 Assets of operations classified as held for sale 1,206 Insurance contracts 21 Investment contracts 904 Liabilities of operations classified as held for sale 925 Net assets of operations classified as held for sale 281
These were disposed of on 1 November 2011. Disposal proceeds received relating to this transaction were GBP285 million.
The difference between the proceeds received and the net assets classified as held for sale at 31 December 2010 was GBP4 million, and has been recognised in income in the consolidated income statement for the year. It can be summarised as follows:
GBPm Net assets classified as held for sale at 31 December 2010 281 Accrued interest received on disposal proceeds 4 Proceeds received as per above 285
The income statement of the GOF/TIP portfolios has been consolidated on a line by line basis up to the date of disposal in the financial statements. The table below shows the income statement of the held for sale business:
2011 2010 GBPm GBPm Gross earned premiums 71 29 Gross claims and benefits paid (15) (5) Change in insurance contracts liabilities 2 7 Acquisition expenses - (19) Administrative and other expenses (51) (15) Profit before tax from continuing operations 7 (3)
12. Related parties
In the ordinary course of business, the Group and its subsidiaries carry out transactions with related parties, as defined by IAS 24. Material transactions for the year are set out below.
(a) Key management personnel compensation
Key management personnel consists of directors of FLG, and members of the Group's leadership team.
In aggregate the compensation paid to key management is as set out below:
2011 2010 Number Number of employees GBPm of employees GBPm Salary and other short-term employee benefits(i) 27 9.9 22 5.6 Post-employment benefits (excluding defined benefit scheme) 12 0.1 9 0.1 Termination benefits 1 0.8 1 0.3 Total key management personnel compensation charged to the income statement 10.8 6.0 Post employment benefits - defined benefit schemes 1 0.3 2 - Total key management personnel compensation 11.1 6.0
(i) Includes GBP0.8 million (2010: GBP0.4 million) to be paid in deferred shares as part of 2011 (2010) bonus entitlement.
Post-employment benefits - defined benefit schemes comprises the change in value of key management personnel accrued pension benefits from the beginning of the relevant financial year to the end of that year. This is consistent with the amounts disclosed as 'increase in transfer value during the year' in the Remuneration Report of the Board in the Report and Accounts of Resolution Limited. Details of pension schemes and share schemes operated by the Group, and in which key management personnel participate are given in note 4.
There were GBPnil balances outstanding at the year end with key management (2010: GBPnil).
A number of key management personnel, and their close families, have long term insurance policies with the Group. Such policies are on normal commercial terms which are also available to other members of staff. The Board has considered the financial effect of such insurance policies and concluded that they are not material.
All these transactions were completed on terms that were no better than those available to other members of staff.
(b) Other related parties
Details of the Group's pension schemes, whose assets are managed by three external investment managers, are provided in note 4.
Transactions made between the Group and related parties were made in the normal course of business. Loans from related parties are made on normal arm's length commercial terms.
Services provided by related parties 2011 2010 Income Receivable Income Receivable earned at year earned at year in year end in year end GBPm GBPm GBPm GBPm Joint venture 4.3 - 6.0 - Total 4.3 - 6.0 -
13. Post balance sheet events
(a) Changes in the rate of corporation tax
The Chancellor delivered his Budget on 21 March 2012, which announced a further 1% reduction in the rate of corporation tax, effective from 1 April 2012, in addition to the incremental 1% rate reductions previously announced which will take effect on 1 April 2013 and 1 April 2014. The corporation tax rate is therefore expected to be 24% from 1 April 2012, 23% from 1 April 2013 and 22% from 1 April 2014. The benefit to the Group's net assets from the further 3% decrease in the rate is estimated to be approximately GBP94 million in total and will be recognised when the legislation is substantively enacted.
(b) New UK tax regime applicable to life insurance business
HMRC have stated that draft legislation in respect of the new UK tax regime applicable to life insurance business is to be published in the Finance Bill on 29 March 2012. This follows the significant announcements previously made in the 2011 Budget and initial draft legislation published for consultation on 6 December 2011. The legislation is expected to take effect from 1 January 2013.
The Group has made a preliminary analysis of the impact of the new legislation on the deferred tax assets and liabilities as at 31 December 2011. The net overall impact is an additional deferred tax asset of GBP10 million. Under the new tax regime, losses in respect of the Group's pension business will be measured at the full corporation tax rate (currently measured at the basic rate of income tax). The tax value of losses would increase by GBP34 million (based on the latest substantively enacted corporation tax rate of 25%). This is offset by the loss of the deferred tax asset of GBP7 million in respect of life assurance trade losses to the extent that these do not exceed pension business losses in the same entity.
Application of the draft transitional provisions would result in a further deferred tax liability of GBP17 million, which would unwind over 10 years, in accordance with the transitional provisions. This relates to the with-profits fund deficit in FLL which arose in 2002.
Other deferred tax assets and liabilities of the Group as at 31 December 2011 are not expected to be materially affected by the new legislation.
This information is provided by RNS
The company news service from the London Stock Exchange
END
FR LFFILVTIRFIF
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