Annual report for 2010 to post-demutualisation with ... - Friends Life

Annual report for 2010 to post-demutualisation with profits policyholders3 Management of policyholder benefitsWith profits policies typically contain guarantees, usually in the formof a minimum guaranteed amount to be paid on maturity, retirementor death. This is made up of an initial amount guaranteed at the startof the policy which can then be increased in the form of regularbonuses. In addition, a final bonus payment may be made.3.1 Regular bonusesFinancial markets continued to perform well over 2010. Weincreased the exposure of the With Profit Fund to equity andproperty from 26% at the end of 2009 to 49% by the end of2010 and this increase enabled the Fund to better benefit fromthe stock market growth in the latter half of 2010.As a result the Fund achieved an investment return of 12.9% in2010.When setting regular bonus rates we take a medium tolong‐term view. It remains essential that we set regular bonusrates that are not only fair to customers with plans maturing in2011, but also to customers whose plans mature in the future. Inview of the improved financial position of the Fund and goodinvestment return earned over 2010, we have decided toincrease regular bonus rates modestly for all Pensions andsome Overseas business. For the rest of the business, we haveconcluded that current rates remain appropriate.3.2 Final bonus rates and payouts at maturityWe determine final bonus rates so as to target payouts at anappropriate level compared to underlying investment values, asrequired by our PPFM. The underlying investment value isrepresented by the plan’s asset share. For most plans, assetshare is the total payments made to the With Profit Fundincreased (or decreased) by the investment return achieved bythat part of the With Profit Fund backing asset shares, lesscharges, the cost of guarantees and tax.Current payout levels may be set above or below the long-termtarget level in order to smooth payouts within limits. Over orunder-payments as a result of smoothing are intended to beneutral over the longer term.At this latest declaration (January 2011) we have increasedmost final bonus rates and maintained others unchanged. Therevised final bonus rates result in payouts that continue toreflect smoothed investment returns since inception for plansthat have a claim in the near future. We previously reviewedfinal bonus rates in October 2010 and revised the majority ofthe rates upwards.We also reviewed final bonus rates in July 2010 but decided toleave rates unchanged at that time as investment values werelittle changed from the start of the year following falls in thesecond quarter.3.3 Surrender valuesTreating all policyholders fairly is the underlying principle whensetting surrender values and Market Value Reduction (MVR)levels.MVRs are applied to some policies as a way of ensuring thatthose policyholders leaving or wishing to take money out of theFund do not take more than their fair share at the expense ofthose policyholders who remain. The MVRs applied differdepending on the year and month the policy was taken out.Importantly, MVRs do not apply on maturity or if the policyholderdies.No MVRs have been applied to post-demutualisation businesssince 11 September 2009.3.4 Annual review of payoutsA review is carried out at least once a year to ensure thatclaims have been settled at the intended level. If it is identifiedthat any claims have been paid that are lower than theintended level, then additional payments are made out of theWith Profit Fund, with any overpayments being met byshareholders. No such issues were discovered in 2010 inrespect of post-demutualisation business.4 Management of assets in the With Profit FundWe determine the investment strategy for the With Profit Fund aftertaking into account the current and projected financial position ofthe Fund.We instruct our investment managers, F&C, to carry out thestrategy and we monitor their performance in achieving returnsrelative to an appropriate benchmark. F&C was previously asubsidiary of Friends Provident plc but it was demerged in 2009, andis now an independent, publicly listed, company.During 2010 the return achieved in respect of assets backing assetshares was 12.9%. Asset shares have therefore risen over the yearby a similar percentage.We delegate investment decisions to our investment managers, whooperate within the limits we set out in the mandates. We increasedour limits on exposure to equity significantly during the year. Thisincreased the benefit to the Fund from the stock market growth in2

Annual report for 2010 to post-demutualisation with profits policyholdersthe latter half of 2010. As a result, the equity backing ratio (thepercentage of the Fund invested in equities and property), of 49%,is significantly higher than last year, as shown in the charts below,and has returned to close to the mid 2008 level (51%), reversingthe reductions made in late 2008 to counteract the effects of thefinancial crisis.Fixed interestand other74%Investment split31 December 2009 31 December 2010Equity17%Property9%Fixed interestand other51%Property 8%Equity41%In addition to investing assets to back asset shares, the Fundalso holds investments that back the cost of guarantees. Theseinvestments are in fixed interest assets and derivative contractsthat protect the Fund, and therefore policyholders, from significantchanges in the cost of providing these guarantees. We continuallyreview these derivative contracts to ensure that they appropriatelyreflect the guarantees that have been provided. There are certainasset classes (corporate bonds and property) where there islimited availability of cost effective derivatives to mitigate risk.To overcome this limitation, the Fund made use of a techniqueknown as asset share shorting to help protect against the effectof adverse market conditions. This involves holding fewer assetsin the asset share pool than the amount of asset share liabilities,which gives some downside protection when investment marketsfall in value but foregoes some investment profit when investmentmarkets do well.The With Profit Fund has the resources to meet fully the benefitexpectations of all our with profits policyholders and has sufficientworking capital to enable it to withstand extreme adverse events.Our aim remains that the Fund should be managed such that innormal circumstances shareholder support is not required to meetadverse events.In 2010, we continued our review of the risk appetite of the Fundand, as mentioned last year as a possibility, decided that thereshould be differing investment mixes for the assets backing policiestaken out before and after demutualisation on 9 July 2001. Thisapproach has been taken to ensure a suitable investment mix toalign the risk/reward balance of each section of the Fund and willcome into effect in early 2011.The post-demutualisation business has fewer guarantees and cantherefore afford to take on greater investment risk than the predemutualisationbusiness. We are therefore likely to continue toincrease the proportion of the Fund backing post-demutualisationasset shares invested in equities during 2011 albeit perhaps only toa small degree.5 Asset share chargesWe have made an annual charge to asset shares since the end of2002 to spread the cost of guarantees both now and in the future.As usual we reviewed the charges during the year and as a resultof this investigation we have removed guarantee charges from allproduct lines except for Regular Premium Life contracts where ithas been halved from 0.2% to 0.1% of asset share with effect from1 January 2010.We expect that the accumulated value of the annual guaranteecharges that we make will be equivalent to the cost of theguarantees built up by regular bonuses but if it proves to be largerthan needed we will credit back any excess to asset shares.6 Changes to our PPFMThe PPFM document was updated during 2010 to reflect:• the intention to allow differing investment mixes backing policiestaken out before and after demutualisation on 9 July 2001;• more detail on the way risk is managed including as a possiblepractice the ability to make use of the technique known as assetshare shorting. There are certain asset classes (corporatebonds and property) where the availability of cost effectivederivatives to mitigate risk is limited. To overcome this limitation,the Fund can make use of a technique known as asset shareshorting to help hedge against the impacts of adverse marketconditions. An asset share shorting solution involves holdingfewer assets in the asset share pool than the amount of assetshare liabilities. The remaining assets are held outside the assetshare pool, but within the pool of assets backing the expectedcost of basic benefit guarantees, invested in low risk assets. Therisk that the shorted assets perform better than the low riskassets, causing a loss to the Fund, is offset by the basic benefitguarantee costs reducing in these circumstances, generating aprofit for the Fund.There were no changes to Principles, only Practices. Our PPFMdocument along with a summary of the changes can be found atwww.friendslife.co.uk/withprofits.7 Target rangesSince demutualisation we have sought to target payouts withina range around asset share. Any divergence from time to timereflects the normal smoothing applicable to with profits business.This distinguishes with profits business from the generally morevolatile payouts associated with unit linked plans.3

Annual report for 2010 to post-demutualisation with profits policyholdersFor most of our business we target payouts using a sample assetshare methodology. For this business we manage payouts within+/- 20% of the sample asset share target, effectively givingtarget ranges of 80% to 120% of asset share for maturities andsurrenders. Our analysis of both maturity and surrender claimsduring 2010 confirmed that the vast majority of policy paymentsduring the year still fell within our target ranges.8 Policyholder communication8.1 Progress noticesMost policyholders receive an annual progress notice givingdetails of the units added to their policy and other importantinformation relating to their policy and the management of theWith Profit Fund. Holders of mortgage endowments receive afurther annual notice setting out the progress their policies aremaking towards repaying the target mortgage.8.2 With Profits SummariesOn 31 December 2005 we first published With ProfitsSummaries to give with profits policyholders more detail ofhow we manage our with profits business. These were mailedto policyholders during 2006 with any progress notice. Therehave been no material changes to the With ProfitsSummaries since. If we make a material change to thesummaries in the future then we will distribute updated versionswith a future progress notice. The With Profits Summarieswere consumer-tested for clarity and ease of understandingduring 2008 and were revised in February 2009 based on thefeedback received. The changes were not material and noother changes have been made to these documents since2009. They are available at www.friendslife.co.uk/withprofits oron request.8.3 Other communicationsFurther information is provided atwww.friendslife.co.uk/withprofits covering:• With Profits Summary Supplementary Information• Bonus news releases• With Profits Committee report• PPFMIn addition policyholders have access to individual quotationsand projections on request through our customer helpline on0845 602 9199.We believe that there is an appropriate frequency of proactivecommunication and a good range of information sourcesavailable to with profits policyholders and we are committed tomaintaining a consistently high quality of service.9 Other aspects of the PPFMFor post-demutualisation business, charges are set out in plandocuments. The approach to taxation and rules for transfers toshareholder funds are set out in the Scheme. Investigations havebeen carried out to confirm that these Scheme requirements havebeen adhered to and an annual certificate will be provided to theFinancial Services Authority.In 2009 we reviewed and ratified our decision that the With ProfitFund should remain open to new business. No formal review wascarried out in 2010, but a further review is likely to be carried out in2011.10 Acquisition of AXADuring 2010 FPLP’s parent company Resolution purchased themajority of AXA’s UK life business. This was not initially purchased byFPLP, although in March 2011 the two AXA life companies, AXA SunLife plc and Sun Life Assurance Society plc, have been transferredinto the ownership of FPLP. However, the FPLP With Profit Fundwill continue to be managed separately from the AXA with profitsbusiness.11 ConclusionIt is our opinion that:• FPLP has complied with its obligations relating to the PPFM;• the manner in which discretion was exercised over the periodwas appropriate; and• competing rights, interests or expectations of policyholders (orgroups of policyholders) and shareholders have been addressedappropriately.Trevor MatthewsChief Executive31 March 2011David HynamExecutive Director4

ANNEXAnnual report for 2010 from the With ProfitsActuary to the post-demutualisation withprofits policyholders of Friends Provident Lifeand Pensions Limited (“the Firm”)I have reviewed the Firm’s annual report to post-demutualisationwith profits policyholders. I have also reviewed the discretionexercised by the Firm during 2010 in so far as this affects theinterests of post-demutualisation with profits policyholders. Postdemutualisationwith profits policyholders are those having withprofits policies written after 8 July 2001 by:• Friends Provident Life and Pensions Limited• Friends Provident Pensions Limited• Friends Provident Life Assurance LimitedThis report is made solely for the purpose of section 4.3.16A(4)of the FSA Supervision manual. It is made solely to the Firm’spost-demutualisation with profits policyholders, and accordingly, tothe fullest extent permitted by law, I do not accept or assume anyresponsibility to any other person in connection with this report.Respective responsibilities of With ProfitsActuary and directorsThe directors are responsible for the establishment of governancearrangements designed to ensure that the Firm complies with itsPrinciples and Practices of Financial Management (PPFM) andfor the exercise of discretion in the management of with profitsbusiness. The directors must prepare annual reports to each classof with profits policyholder stating whether, throughout the financialyear to which the report relates, the Firm believes that it hascomplied with the obligations relating to its PPFM. The report mustset out the directors’ reasons for that belief.As With Profits Actuary my responsibilities are primarily toadvise the Firm on key aspects of the discretion to be exercised inrespect of each class of the Firm’s with profits policyholders. In soadvising I am required by statute to cover the implications for thefair treatment of the Firm’s with profits policyholders and to takeinto account their information needs and the extent to which anycommunication may be regarded as clear, fair and not misleading. Iam required to report to the Firm’s governing body once a year onkey aspects of the discretion exercised by the directors during theyear affecting the with profits business of the Firm. The scope ofthat report includes those aspects on which I have already providedadvice to the directors. I am further required to make a writtenreport to the Firm’s post-demutualisation with profits policyholders,to accompany the Firm’s annual report. This report fulfils thatrequirement. My responsibilities as With Profits Actuary are set outin statute and in the actuarial guidance.Basis of opinionI was appointed by the Firm as With Profits Actuary on 1 May2006. My appointment covers all classes of with profits businesswritten by the Firm and by two other UK group companies - FriendsProvident Life Assurance Limited and Friends Provident PensionsLimited but not in respect of the AXA companies acquired by thegroup in 2010.I report to you my opinion as to whether, based on the informationand explanations provided to me by the Firm, and taking intoaccount where relevant the rules and guidance in section 20.4.7of the FSA Conduct of Business Sourcebook, the Firm’s annualreport and the discretion exercised by the Firm in 2010 may beregarded as taking, or having taken, the interests of the Firm’spost-demutualisation with profits policyholders into account in areasonable and proportionate manner.During 2010 I have advised the Firm on key aspects of discretion tobe exercised in respect of:• regular bonus rates applied to with profits policies• final bonus rates to be applied to policies at maturity and on thedeath of a policyholder• charges to asset shares for guarantees• The risk appetite of the Fund and the appropriate investmentstrategy to support this appetite.• investment policy and the level of equity and property assetsbacking With Profit Fund asset shares• surrender value bases (including market value reductions)• new business and its impact on the security of benefits ofexisting business• investment fees to be charged to with profits business• changes to the PPFM and to the With Profits Summaries,which give a brief summary of the PPFM• communications with policyholders• assets required to be retained in the Non-Profit Fund of the Firmto provide capital support to its with profits businessI have carried out a review of key aspects of the discretionexercised by the Firm in 2010 affecting each class of with profitsbusiness of the Firm. Following this review I have formally reportedto the directors that the management of the Firm’s with profitsbusiness during 2010 has complied with the relevant PPFM andthat the exercise of discretion over the period was appropriate andmaintained fairness between different categories of policy andbetween policyholders and the company.I have reviewed the Firm’s annual report to its post-demutualisationwith profits policyholders for 2010.In carrying out my reviews I have sought such information andexplanations as I considered necessary in order to provide me withsufficient evidence to give the opinion required.5

OpinionIn my opinion the Firm’s annual report for 2010 and the discretionexercised by the Firm during 2010 takes, or has taken, the interestsof the Firm’s post-demutualisation with profits policyholders intoaccount in a reasonable and proportionate manner.M A Collins FIAWith Profits ActuaryFriends Provident Life and Pensions Limited31 March 2011Friends Life is a business name of Friends Provident Life and Pensions LimitedFriends Provident Life and Pensions LimitedRegistered Office: Pixham End, Dorking, Surrey RH4 1QAIncorporated company limited by shares and registered in England number 4096141www.friendslife.com Telephone 0845 602 9189Policyholder Report (FPLP post) 03.11