Overview -- Following further discussions with financial services restructuring company Resolution Ltd. and the management team at Friends Life Group, we have reviewed our assessment of the likelihood of the different exit options from Resolution's U.K. life insurance project, which created Friends Life Group PLC. -- Our base-case assumption remains that the Friends Life Group will continue to focus on both new and in-force insurance activities over the rating horizon due to our assessment of the financial and commercial advantages from this combination. -- We are therefore affirming our ratings on Friends Life Group PLC and its rated operating subsidiaries, which we continue to consider core to the Friends Life Group. At the same time, we are removing the ratings from CreditWatch. -- The negative outlook predominantly reflects the downside risks to the credit profile of the group from the potential exit options under consideration by Resolution Ltd., its ultimate parent. Rating Action On June 29, 2012, Standard & Poor's Ratings Services affirmed its 'BBB' long-term counterparty credit rating on Friends Life Group PLC. At the same time, we affirmed our 'A-' long-term counterparty credit and insurer financial strength ratings on its rated operating subsidiaries, Friends Life Ltd. (FLL; formerly Friends Provident Life and Pensions Ltd.) and Friends Life Company Ltd. (FLC; formerly Axa Sun Life PLC). In addition, all ratings were removed from CreditWatch, where they were placed with negative implications on April 2, 2012. The outlooks on all entities are negative. Rationale The rating actions reflect the continuation of our base-case assumption that the Friends Life Group will focus on both new and in-force insurance activities over the rating horizon. Resolution Ltd. announced in March 2012 that the most likely route for exiting its U.K. life insurance project, assuming no third party is involved, would be to create and separately list two legal entities: a closed fund consolidator (HeritageCo), and an insurer that would seek new business (OpenCo). We have had further discussions with Resolution regarding the strategic rationale and timescales for its six exit options: a cash sale, together or in parts, direct listing as a stand-alone entity, merger with another life company together or in parts, or separate listings of HeritageCo and OpenCo. Of these, three involve some degree of separation. Nevertheless, in our view, there are disadvantages in separating its existing and new business activities. We also anticipate that the synergies created by combining these operations will grow over time as the profitability of writing new business improves. While we recognize that shareholders gain options through the creation of HeritageCo and OpenCo, we think that the degree of linkage between these entities could make a separation less attractive. We also consider that a formal separation depends in part on external factors such as the regulatory and financial market environment that may make such a separation less likely. Our base-case assumption, therefore, is that it is more likely that the group's current identity will remain intact. The rating actions also reflect our view that FLL and FLC will remain "core" to the overall Friends Life Group according to our group methodology. Currently, there are clear and integral linkages between these rated entities and the wider group. In particular, FLL is the main operating entity in the group structure and guarantees the debt issued by Friends Life Group PLC. We understand that the existing business within FLL and FLC will ultimately form part of HeritageCo. While we recognize that realigning the legal entities offers some benefits from an operational, accountability, and transparency perspective, we consider that it also heightens the potential downside risks associated with some of the exit options available to Resolution Ltd. Exit options that involve the separation of new and existing insurance activities will be easier to execute following the split of business into HeritageCo and OpenCo. Downside risk to the ratings stems from the potential loss or relative reduction in the levels of expected synergies between existing and new business on the credit profile of the group. This risk has become more of a rating consideration because Resolution seeks an exit within our outlook horizon of two years. It will crystallize should Resolution choose any exit option that separates HeritageCo and OpenCo such that they do not form part of the same group. It would also arise if an internal review of future new business viability is triggered by the group's failure to deliver on its new business profitability targets. We consider this less likely to occur now, because the group has made progress on its targets in the year to date. Finally, downside risk would also crystallize if the profile of the group changed significantly, making it more of a closed fund consolidator. Thiswould reduce the effect of synergies between HeritageCo and OpenCo. In addition, we view the business risk profile of a closed fund consolidator as being higher risk because of the volatile and uncertain nature of the transactions needed to sustain future cash flows. This would impair our assessment of Friends Life Group's business risk profile. The ratings on U.K.-based FLL and operating subsidiary FLC reflect our view of the group's strong capitalization and strong investment profile. These positive factors are offset by the group's operating performance. Although it is improving, operating performance remains a relative rating weakness. Outlook The negative outlook primarily reflects the downside risks to the credit profile of the group from the potential exit options Resolution is considering. While we continue to assume that it is more likely that the group's current identity will remain intact, the negative outlook captures the downside risks of exit options that involve separation of existing and new business activities. We may lower the ratings if it becomes evident that: -- The combination of new and existing insurance activities within the Friends Life Group is less likely than we currently assume; -- Improvements in new business profitability from the U.K. business will not reach the target levels (in particular, GBP110 million value of new business per year) and improvements in overall operating performance are not continuing (see "Friends Provident Life and Pensions Ltd.," Oct. 28, 2011); -- The profile of the group is becoming more heavily weighted toward that of a closed life fund consolidator, causing the scale of value of new business (SVNB; defined as value of new business divided by value-in-force) to fall; or -- Capitalization is declining from its current strong levels. We may revise the outlook to stable if: -- The risk that new and existing insurance activities will be separated becomes more remote in our view; and -- The group continues to make progress on delivery of initiatives to improve new business profitability, in line with our expectations and the externally communicated targets set by Resolution. Related Criteria And Research All articles listed below are available on RatingsDirect on the Global Credit Portal. -- Holding Company Analysis, June 11, 2009 -- Group Methodology, April 22, 2009 -- Interactive Ratings Methodology, April 22, 2009 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Counterparty Credit Ratings And The Credit Framework, April 14, 2004 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Friends Life Group PLC Counterparty Credit Rating BBB/Negative/-- BBB/Watch Neg/-- Subordinated* BBB+ BBB+/Watch Neg Junior Subordinated* BBB BBB/Watch Neg Friends Life Company Ltd. Friends Life Ltd. Counterparty Credit Rating A-/Negative/-- A-/Watch Neg/-- Financial Strength Rating A-/Negative/-- A-/Watch Neg/-- *Guaranteed by Friends Life Ltd.