FRIENDS LIFE GROUP PLC REPORT AND ACCOUNTS FOR THE YEAR ENDED 31 DECEMBER 2011 REGISTERED NUMBER: 06986155 REGISTERED OFFICE: Pixham End Dorking Surrey RH4 1QA WorldReginfo - f6d91396-e21d-489e-9a4b-b46355eed759 REPORT OF THE DIRECTORS The directors present their report to the shareholder for the year ended 31 December 2011. On 1 July 2011 Friends Provident Holdings (UK) plc changed its name to Friends Life Group plc ("FLG", "the Company" or "Friends Life"). The Company's ultimate parent company is Resolution Limited, a Guernsey-based public company with a primary listing on the London Stock Exchange. Principal activities The principal activity of the Company is that of a holding company for acquisitions in the life assurance and pensions sector. The Company was formed in 2009 as the intermediate holding company for the acquired businesses of Friends Provident, AXA UK Life Business and BUPA Health Assurance ("BHA"). The combination of the Company and its subsidiary companies is referred to as the Group. The Group's principal activities comprise manufacturing and administering life and pensions products in the UK and related international markets. These encompass the UK protection market, the UK group pensions and vesting annuity market and international savings & investments, pensions and protection markets. As detailed in note 3 on page 73, for management purposes, the Group is split into three operating segments: (i) UK, comprising the Friends Provident UK Life and Pensions Business, the AXA UK Life Business and BHA; (ii) International, comprising Friends Provident International and the overseas life assurance businesses within the UK Life and Pension Subsidiaries; and (iii) Lombard. Particulars of the main subsidiaries and associates are shown in note 17 and note 18 respectively. Friends Provident International Limited ("FPI"), which is based in the Isle of Man, has branches in Dubai, Hong Kong and Singapore. Lombard International Assurance S.A. is based in Luxembourg and has branches in Switzerland and Finland. Directors The directors of the Company as at 31 December 2011 and up to the date of these financial statements, together with their dates of appointment if appointed during the year, are listed below: Sir Malcolm Williamson Chairman David Allvey Senior Independent Director Evelyn Bourke Executive Director Andy Briggs Executive Director (appointed 1 June 2011) Clive Cowdery Non-executive Director Peter Gibbs Independent Director (appointed 15 July 2011) David Hynam Executive Director Nick Lyons Independent Director Ian Maidens Alternate to Clive Cowdery Jim Newman Alternate to John Tiner Andy Parsons Executive Director Mary Phibbs Independent Director (appointed 27 July 2011) Robin Phipps Independent Director Belinda Richards Independent Director Gerhard Roggemann Non-executive Director Derek Ross Independent Director Karl Sternberg Independent Director John Tiner Non-executive Director Tim Tookey Executive Director (appointed 5 March 2012) Trevor Matthews resigned and Andy Briggs was appointed as Chief Executive Officer ("CEO") on 1 June 2011 . Tim Tookey was appointed as a director of the Company on 5 March 2012 and will become Chief Financial Officer ("CFO") on 30 March 2012 when Andy Parsons steps down from the FLG Board ("the Board"). All directors must be elected at the Annual General Meeting ("AGM") following appointment. Andy Briggs, Peter Gibbs, Mary Phibbs and Tim Tookey will offer themselves for election at the next AGM. In addition, one third of the board members must retire by rotation every year and, if appropriate, seek re-election. The directors retiring by rotation at the next AGM and seeking re-election are Clive Cowdery and John Tiner. FRIENDS LIFE GROUP PLC 1 WorldReginfo - f6d91396-e21d-489e-9a4b-b46355eed759 BUSINESS REVIEW 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 £112 million to £143 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 rate 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") provisions 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. FRIENDS LIFE GROUP PLC 2 WorldReginfo - f6d91396-e21d-489e-9a4b-b46355eed759 BUSINESS REVIEW Business Performance The following table shows the IRR performance of the key business lines compared with the targets set for 2013. 2010 2013 2011 Full year 2010 IRR % (unless otherwise 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 (£m) 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 £2.1 billion (31 December 2010: £2.3 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