Review of the Year
Summary and outlook
Trading
Our 2007 trading and financial results are in line with those reported at the end of January 2008, underlining the rationale for our full strategic review and the appropriateness of our new strategic direction. The new strategy is further supported by positive developments in our core businesses.
Annual Premium Equivalent (APE) sales increased 15% in the UK and 18% overseas, delivering an overall increase of 16%. Advances in the UK were driven by our strong position in pensions. Overseas, Friends Provident International (FPI) in particular delivered another strong performance, further cementing its position as an effective engine for growth.
The underlying economics of our 2007 UK trading were not good enough. In particular the cash generated from sales, before one-off adjustments, was less than the cost of shareholder dividends, as was ongoing underlying IFRS profits, again before one-off items.
These results reflect that our product persistency experience was worse than was being assumed, particularly for UK business, and the consequent assumption change reduced EEV profit by £158m overall. Included within this result is an adverse impact of £15m on the contribution from UK new business, which ended down 11% on 2006 levels despite the higher levels of sales. The overall UK internal rate of return (IRR) at 11.7% was helped by regulatory changes but remains at an unsatisfactory level.
New strategy
The new strategy was announced at the end of January this year. Since then, our conversations with management at leading UK intermediary firms have been encouraging, with widespread support for our focus on protection and pensions, and broad support for our market positioning. The strength of our underlying propositions remains an attraction to these intermediaries.
The new strategy is designed to address the poor underlying economics of trading outlined above by elevating profit above volume growth. Its most direct impact is to reduce the capital intensity of the UK business, which will be achieved primarily by ceasing to write new group pension schemes where initial commission is required, and by no longer pursuing an ambition in wealth management beyond the manufacture and administration of life and pensions products. Cash consumption will be reduced further by adopting a more selective approach to individual pensions and to savings & investment products, competing only when the prospective returns make it worth doing so.
Our UK trading focus therefore centres around our established strengths in group pensions and protection business. The improved cash flows anticipated will support investment in FPI, our strategy being to grow the international business faster than the UK. FPI will pursue growth in savings & investment, pensions and protection markets with attractive margins, and this is the trading priority of the Group. The new strategy includes reducing the cost base by at least £40m by the end of 2009.
Once fully implemented, the new strategy is expected to add two percentage points to the overall IRR, with the prospect of further improvement over time. The Group will be self-financing and therefore does not expect any need to access the capital markets.
The three businesses that now fit less comfortably within the new strategy – Lombard, F&C Asset Management and Pantheon Financial – continue to develop successfully. We are working with their respective management teams to establish strategies for maximising shareholder value while minimising disruption to these good businesses.
Swift and efficient implementation of the new strategy is now our focus to ensure that the inherent benefits will emerge as soon as practicable and an update on progress can be expected at the time of interim results in August 2008. In the meantime, we can report that a senior team is in place solely to oversee implementation and good progress is already being made.
Impact of one-off changes and disclosure
An important element of the new strategy is the adoption of improved financial transparency and disclosure, including the segmentation of Life & Pensions underlying profit, and analyses provided by product on both cash and IFRS bases.
Some associated decisions have had the effect of further reducing 2007 profits. In particular, the capitalisation of £20m of development expenses, reclassified as maintenance expenses, reduces IFRS profits by £112m and EEV profits by £238m. A further £68m reduction in EEV profits arises from capitalising corporate costs.
The writing off of intangibles, especially in connection with our withdrawal from Wrap, reduces both EEV and IFRS profits by some £15m. Implementation of the remaining changes arising from the FSA Policy Statement PS06/14 led to a £138m release of shareholder cash.
After a review of the estimated amortisation profile of deferred acquisition costs on protection business the net impact on IFRS profit was negative £34m.
Largely as a result of the reserving changes, the overall IRR for 2007 is 14.4% and this, together with other key metrics, is likely to fall back initially as some of the key financial aspects of the strategic review are implemented.
The 2007 underlying profit on an EEV basis is in line with our announcement of 31 January 2008 and the underlying profit on an IFRS basis is also down, due to the same factors.
Dividend
The Board is recommending a final dividend for 2007 of 5.30 pence per share in line with our current dividend policy. This would bring the total 2007 dividend to 8.00 pence per share, a 2% increase over 2006.
After payment of the final dividend for 2007, we will reduce the overall cost of the dividend to a level that reflects the dividend paying capacity of the Life & Pensions business, expected to be around £90m to £100m, and adopt a policy of growing the dividend in line with operating cashflow in future. The Board believes that this offers the prospect of dividend growth in real terms in the years to come. The Board will determine the appropriate dividend per share in due course. In reaching this decision, the Board will have regard not only to the dividend paying capacity of the business but also to any capital returned to shareholders as a result of releases from businesses which do not fit the strategy.
Outlook
Our new strategy plays to our strengths. Our systems, service and efficiency enable us to compete in the challenging UK marketplace. In protection, we will seek to at least maintain market share and to continue to enter new segments. Overall volumes of new pensions business will fall as a consequence of our more selective approach, but the quality of new business written will increase.
The outlook for International Life & Pensions business remains strong. FPI will benefit from its growing presence in key markets and continued strong demand for its products. We have established firm footholds in a number of territories from which to generate future sales, further supported by our new operations in Singapore, Germany and United Arab Emirates. International markets will remain competitive but developing FPI is a priority of the new strategy and we are confident that the outlook for this business remains positive.
Conclusion
Our core propositions are already strong and continue to be recognised by industry awards. Our belief in, and commitment to, the intermediary community remains at the heart of our strategy and we look forward to deepening our already strong relationships. The international markets will become the key drivers of profitable growth. Quality customer service and our ability to harness technology imaginatively provide competitive advantage. The outcome of the strategic review has repositioned Friends Provident positively and our focus is now firmly on growing the business both transparently and profitably, to the benefit of all key stakeholders.