Setting new standards - Friends Life

PARENT COMPANY ACCOUNTS
ABBREVIATIONS AND DEFINITIONS
Notes to the consolidated accounts continued
27. Insurance contracts continued
Post-demutualisation with-profits policyholders are only entitled to surplus from the return on their investments; other sources of surplus
are wholly owned by shareholders including policies written by FPLA and Friends Provident Pensions Limited, where the investment
element is reinsured to the FPLP With-Profits Fund.
(ii) The With-Profits Fund of FPLA is closed to new business. The Fund’s policyholders are entitled to all the surplus of that fund. In addition, FPLA
has a closed unitised with-profits fund. Shareholders are entitled to all profits from the unitised with-profit fund other than investment profits,
which are wholly owned by with-profits policyholders. The investment element of the contract is wholly reinsured to the FPLP With-Profits Fund.
The effect of this fund structure is that investment risk, in respect of assets backing with-profits policies, is largely borne by policyholders;
shareholders bear 10% of the investment risk from conventional with-profits policies. Expense risk is borne by the shareholders, other than in
the FPLA closed fund. Until 2009, the FPLP With-Profits Fund is charged a fixed amount for managing policies, adjusted by an inflation index,
irrespective of actual costs. The charges will be reviewed in 2009 to reflect market rates at the time. Other forms of risk are shared between
shareholders and policyholders as described above.
28. Realistic balance sheet
The main UK with-profits fund is in FPLP and the capital position of this fund has been determined in accordance with the RBS regulations
prescribed by the FSA. There is also a small UK with-profits fund in FPLA. The capital position of this fund has been calculated on a regulatory
basis as this fund is closed to new business, and is significantly below the £500m level that the FSA has determined should be applied for
calculating liabilities under the realistic methodology.
The RBS for FPLP’s with-profits business can be summarised as follows:
2006 2005
£m £m
Total net assets 16,087 17,366
Less non-profit liabilities including share of resilience capital reserves and required minimum margin (2,670) (2,774)
Total regulatory assets 13,417 14,592
Additional assets arising on realistic basis 265 253
Total assets 13,682 14,845
Policyholder liabilities:
Asset shares 11,365 12,342
Financial guarantees (net of charges) 101 149
Options (guaranteed annuities) 747 796
Other liabilities 1,249 1,322
Total liabilities 13,462 14,609
Excess of assets over liabilities 220 236
At 31 December 2006, the surplus of realistic assets over realistic liabilities initially amounted to £254m (2005: £236m) with a Risk Capital
Margin (RCM) of £220m (2005: £276m), the surplus assets have subsequently been reduced by £34m via a reduction in future guarantee
charges leaving the working capital at £220m fully covering the RCM. This results in an excess of realistic assets over realistic liabilities of
£220m (2005: £236m). After adding back the shareholders’ share of future bonuses totalling £95m (2005: £85m) and deducting adjustments to
eliminate double counting of acquired PVIF of £19m (2005: £20m), the excess in accordance with FRS 27 amounted to £296m (2005: £301m).
The main element of the realistic liabilities is the asset shares of with-profits business. This represents the premiums received to date
together with the investment return earned less expenses and charges. This is mainly calculated on an individual policy basis using historic
information and in line with the company’s PPFM. Assets and realistic liabilities are closely matched since the realistic liabilities move with the
value of the underlying assets.
Policyholder liabilities (including options and guarantees) are then valued using a market consistent stochastic model. Included in other
liabilities are provisions for specific items such as mortgage endowment reviews and other liabilities of the fund. Realistic valuations also
allow for future profits of non-profit business written in the With-Profits Fund to be included. In accordance with FRS 27, the value of future
profits of non-profit business has been deducted from policyholder liabilities in the balance sheet.
Friends Provident Annual Report & Accounts 2006 137