Setting new standards - Friends Life

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FINANCIAL STATEMENTS IFRS FINANCIAL STATEMENTS EEV SUPPLEMENTARY INFORMATION Notes to the EEV results continued 10. EEV assumptions continued Maintenance expenses for UK and International business (excluding Lombard) are assumed to increase in the future at a rate of 1% per annum in excess of the assumed long-term rate of retail price inflation. This is derived from the difference between the risk-free rate of return and the average of the FTSE Actuaries over five-year index-linked gilt yield at 5% and 0% inflation. For Lombard the risk-free rate is the average of the 10–15 year and the over 15 year yields using the EuroMTS indices. The investment return assumption is the weighted average (based on an assumed asset mix) of returns on fixed interest securities, equities and cash. The Lombard investment return assumption is shown gross of tax, but net of fund management charges. Average derived risk discount rates are shown below for the embedded value and the contribution from new business. The average derived risk discount rate for in-force has increased over 2006 due mainly to a higher risk-free rate and a higher risk margin on annuities. There is a reduction in the element of the risk discount rate relating to options on with-profits business which reflects the reduction in burnthrough cost. A more detailed split of the derived risk discount rates is given in the following table. Derived risk discount rates by product type At 31 December 2006 International UK with-profits UK annuity Other UK Average UK Sterling Euro Embedded value % % % % % % Risk-free rate 4.6 4.6 4.6 4.6 4.6 4.1 Market risks (non-options) 2.7 7.6 1.6 2.2 1.4 2.1 Options – market risks 2.6 - - 0.3 - - Options – non-market risks 1.8 - - 0.2 - - Other non-market risks 0.4 0.4 0.4 0.4 0.8 0.8 Risk discount rate 12.1 12.6 6.6 7.7 6.8 7.0 At 31 December 2005 International UK with-profits UK annuity Other UK Average UK Sterling Euro Embedded value % % % % % % Risk-free rate 4.1 4.1 4.1 4.1 4.1 3.6 Market risks (non-options) 3.0 6.0 1.7 2.1 1.3 1.9 Options – market risks 4.0 - - 0.3 - - Options – non-market risks 3.3 - - 0.2 - - Other non-market risks 0.4 0.4 0.4 0.4 0.8 0.8 Risk discount rate 14.8 10.5 6.2 7.1 6.2 6.3 182 Friends Provident Annual Report & Accounts 2006
PARENT COMPANY ACCOUNTS ABBREVIATIONS AND DEFINITIONS Notes to the EEV results continued 10. EEV assumptions continued At 31 December 2006 International UK Sterling Euro Contribution from new business % % % Risk-free rate 4.6 4.6 4.1 Market risks 2.2 1.1 2.1 Non-market risks 0.4 0.8 0.8 Risk discount rate 7.2 6.5 7.0 At 31 December 2005 International UK Sterling Euro Contribution from new business % % % Risk-free rate 4.1 4.1 3.6 Market risks 2.0 1.1 1.9 Non-market risks 0.4 0.8 0.8 Risk discount rate 6.5 6.0 6.3 With-profits and annuity business are subject to more investment risk than the remaining business, and so the appropriate risk discount rates are higher. 10.2 Principal economic assumptions – stochastic The cost of options and guarantees is determined using The Smith Plus Model economic scenario generator. The model is calibrated to market conditions at the valuation date and correlations between the asset classes are derived from historic data, consistent with the model used for the Realistic Balance Sheet. Risk-free rates are calibrated to the gilt yield curve. Equity volatility is calibrated to replicate the implied volatility of FTSE 100 put options held by the FPLP With-Profits Fund. Property holdings are modelled as a mix of equity and gilt assets, calibrated to derive a level of running yield and volatility as observed in historical data. At 31 December 2006 Term (years) Sample implied volatilities by asset class 5 15 25 35 15-year risk-free zero coupon bonds 7.1% 4.7% 4.6% 5.1% 15-year corporate bonds 9.4% 8.6% 8.3% 8.8% Equity 17.1% 18.2% 19.6% 20.8% Property 15.1% 16.4% 17.9% 19.0% At 31 December 2005 Term (years) Sample implied volatilities by asset class 5 15 25 35 15-year risk-free zero coupon bonds 8.7% 5.0% 4.4% 5.0% 15-year corporate bonds 9.8% 7.9% 7.7% 7.6% Equity 17.7% 19.8% 21.6% 21.7% Property 14.9% 17.2% 19.2% 19.3% The volatility represents the variation of return around the average for the particular asset class. Bonus rates are set at levels which fully utilise the assets supporting the in-force business over its lifetime and are consistent with the economic assumptions and the Group’s bonus policy. Friends Provident Annual Report & Accounts 2006 183
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Setting new standards Friends Provi
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ANNUAL REVIEW CORPORATE GOVERNANCE
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Group financial highlights Group
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INTERNATIONAL LIFE & PENSIONS ASSET
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