IFRS operating profit

Group operating profit – IFRS

The Group has delivered a strong performance, generating an IFRS operating profit of £176 million for the half year ended 30 June 2010 (half year ended 30 June 2009 pro forma: £30 million), demonstrating both our ability to deliver high quality returns for shareholders and the strength of our business model.

1 Operating profit is presented before adjusting items

Phoenix Life – operating profit before tax

Operating profit for Phoenix Life is based on expected investment returns on financial investments backing owners' and policyholder funds over the reporting period, with consistent allowance for the corresponding expected movements in liabilities.

Operating profit includes the effect of variances in experience for non-economic items, such as mortality, persistency and expenses, and the effect of changes in non-economic assumptions. Changes due to economic items, for example market value movements and interest rate changes which give rise to variances between actual and expected investment returns, and the impact of changes in economic assumptions on liabilities, are accounted for outside of operating profit. Phoenix Life operating profit is net of policyholder finance charges and policyholder tax.

The owners’ one-ninth share of the policyholder with-profit bonus of £27 million increased by 13 percent on the
pro forma comparative period of £24 million as 2010 bonus rates improved following better market conditions in 2009.

The with-profit funds where internal capital support has been provided had an operating profit of £nil (half year ended 30 June 2009 pro forma: £34 million operating loss). The pro forma comparative period was impacted by negative persistency experience and assumption changes.

The operating profit on non-profit and unit-linked funds was £127 million (half year ended 30 June 2009 pro forma:
£29 million) and this includes margin emergence of £84 million (half year ended 30 June 2009 pro forma: £77 million) and return on surplus assets of £9 million (half year ended 30 June 2009 pro forma: £4 million). The 2010 half year result benefited £16 million from back book management including data cleansing projects and £5 million positive mortality experience whilst the 2009 half year result was impacted by negative experience variances related to expenses and guaranteed annuity option take up rates.

The longer term return on owners’ funds for the first half year of 2010 of £21 million reflects the asset mix of owners’ funds, primarily cash based assets and fixed interest securities. The return has decreased from the pro forma half year ended 30 June 2009 due to lower returns on cash given the current low interest rate environment. Returns on cash are not normalised.

The operating profit for management services of £7 million comprises income from the life companies in accordance with the respective management service agreements less fees payable in relation to the outsourcing of services and other operating costs.

Ignis Asset Management

Operating profit of the asset management business increased from the pro forma comparative period by 38 percent to £22 million. The results benefited from strong sales in retail products and liquidity funds and performance fees from the life companies. Further information on the results of Ignis Asset Management is included in the Group MCEV operating earnings section.

Corporate costs

Corporate office costs and project spend amounted to £16 million (half year ended 30 June 2009 pro forma:
£6 million). The increase in corporate office costs in 2010 reflects the additional ongoing costs associated with our Premium Listing on the LSE. The balance of the charge in both periods relates primarily to the pension schemes.

IFRS profit after tax

IFRS profit after tax is reconciled to operating profit, as follows:

Investment return variances and economic assumption changes on long-term business

The expected return on investments for both policyholder and owners’ funds is based on opening economic assumptions applied to the funds under management at the beginning of the reporting period. Expected investment return assumptions are derived based on market yields on risk-free fixed interest assets at the start of each financial year. Margins are applied on a consistent basis across the Group to gross risk-free yields, to obtain investment return assumptions for equities and properties. The principal assumptions underlying the calculation of the longer term investment return are set out in note 3.3 to the IFRS condensed consolidated interim financial statements.

Overall, the Phoenix Life business had favourable investment return variances and economic assumption changes of £128 million for the half year ended 30 June 2010, primarily driven by improvements in the property market, and strong returns on investments in hedge funds.

Variance on owners’ funds

The favourable variance on owners’ funds of £28 million for the half year ended 30 June 2010 mainly relates to positive returns on interest rate swaps held in the shareholder fund and strong returns on investments in private equity and hedge funds partially offset by losses on interest rate swaps held in the holding companies.

Amortisation of acquired in-force business and other intangibles

Acquired in-force business and other intangibles of £2.7 billion were recognised on the acquisition of the Pearl businesses.

The acquired in-force business is being amortised in line with the run-off of the acquired businesses. Amortisation of acquired in-force business during the period totalled £64 million. Amortisation of other intangible assets totalled
£9 million in the period.

Non-recurring items

Non-recurring items include:

• Costs associated with the Phoenix Life site rationalisation and associated staff reductions and the Group’s transformation programme with its outsourcers of £11 million
• Premium Listing and other restructuring costs of £28 million
• Regulatory change and systems transformation costs of £13 million
• A gain of £29 million following the near finalisation of revised asset shares in the Phoenix & London Assurance with-profit fund as a result of a guaranteed annuity option compromise scheme last year which reduced longevity risk for the Group whilst providing policyholder benefit enhancements. This partially offsets the overall charge of £78 million recognised in the second half of 2009 which was based on estimated asset shares.

Finance costs attributable to owners

1 Finance costs in respect of the Impala and Pearl facility agreements (and associated swap interest) and the Royal London PIK notes and facility

Tax attributable to owners

The Company is exempt from tax in the Cayman Islands on any profits, income, gains or appreciations for a period of 30 years from 11 May 2010 (the previous exemption was for 20 years from 15 January 2008).

With effect from the acquisition of the Pearl businesses in the third quarter of 2009 the Company has been managed and controlled from Jersey, where its permanent office premises are located. As a Jersey resident holding company the Company is subject to a zero percent tax rate on its income. Consequently, tax charged in these accounts primarily represents UK tax on profits earned in the UK, where the principal life companies, excluding Opal Re, have their centre of operations.

The Group received a tax credit of £27 million for the half year ended 30 June 2010, despite a profit before tax attributable to owners of £180 million, primarily as a result of net tax losses on corporate restructurings of the Group life insurance businesses.

Earnings per share

On 5 July 2010, in connection with the Group’s Premium Listing, 32,400,000 contingent rights over shares were restructured through the issue of the same number of ordinary shares to the holders of such rights.
These contingent rights have not been included in the earning per share calculation at 30 June 2010 as none of
the conditions for issuing shares to the contingent right holders were satisfied at that date. If the above shares had been issued on 1 January 2010 instead of 5 July 2010 the impact on basic earnings per share would have been to dilute it from 135.6p to 108.9p per share*.

* Using 164.4 million shares (132 million shares plus 32.4 million shares) and a profit of £179 million as disclosed in note 5 of the IFRS condensed consolidated interim financial statements