Comparative EEV Basis Results
Prudential PLC
20 June 2006
Embargo: 09.00 Tuesday 20 June 2006
COMPARATIVE EUROPEAN EMBEDDED VALUE BASIS RESULTS FOR THE SIX MONTHS
ENDED 30 JUNE 2005
Prudential plc publishes today its European Embedded Value (EEV) basis results
for the six months to 30 June 2005.
Prudential has previously published EEV basis full year results for 2004 and
2005. Today's announcement completes the disclosure of the comparative EEV basis
results to be included with the interim 2006 results to be published on 28 July
2006.
A summary of the EEV basis results are shown below:
As previously published
Half year Full year Full year
2005 2005 2004
£m £m £m
New business profits 416 867 741
New business margin
- As a percentage of annual premium equivalent of 37% 41% 40%
insurance sales
- As a percentage of present value of new business 4.5% 5.2% 5.0%
premiums
Long-term business operating profit before tax 815 1,743 1,328
Total operating profit before tax 799 1,712 1,274
Total shareholders' funds 9,114 10,301 8,614
- ENDS -
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Notes to Editors:
European Embedded Value basis of reporting.
The EEV basis results have been prepared in accordance with the EEV principles
issued in May 2004 by the CFO Forum.
The CFO Forum is a high-level discussion group formed and attended by the Chief
Financial Officers of major European listed, and some non-listed, insurance
companies. Its aim is to discuss issues relating to proposed new accounting
regulations for their businesses and how they can create greater transparency
for investors. The Forum was created in 2002. For more information go to
www.cfoforum.nl.
Annual Premium Equivalents
Annual Premium Equivalents are calculated as the aggregate of regular new
business amounts and one-tenth of single new business amounts for insurance
products.
*Prudential plc, a company incorporated and with its principal place of business
in the United Kingdom, and its affiliated companies constitute one of the
world's leading financial services groups. It provides insurance and financial
services directly and through its subsidiaries and affiliates throughout the
world. It has been in existence for over 150 years and has £234 billion in
assets under management, (as at 31 December 2005). Prudential plc is not
affiliated in any manner with Prudential Financial, Inc, a company whose
principal place of business is in the United States of America.
Forward-Looking Statements
This statement may contain certain 'forward-looking statements' with respect to
certain of Prudential's plans and its current goals and expectations relating to
its future financial condition, performance, results, strategy and objectives.
Statements containing the words 'believes', 'intends', 'expects', 'plans',
'seeks' and 'anticipates', and words of similar meaning, are forward-looking. By
their nature, all forward-looking statements involve risk and uncertainty
because they relate to future events and circumstances which are beyond
Prudential's control including among other things, UK domestic and global
economic and business conditions, market related risks such as fluctuations in
interest rates and exchange rates, and the performance of financial markets
generally; the policies and actions of regulatory authorities, the impact of
competition, inflation, and deflation; experience in particular with regard to
mortality and morbidity trends, lapse rates and policy renewal rates; the
timing, impact and other uncertainties of future acquisitions or combinations
within relevant industries; and the impact of changes in capital, solvency or
accounting standards, and tax and other legislation and regulations in the
jurisdictions in which Prudential and its affiliates operate. This may for
example result in changes to assumptions used for determining results of
operations or re-estimations of reserves for future policy benefits. As a
result, Prudential's actual future financial condition, performance and results
may differ materially from the plans, goals, and expectations set forth in
Prudential's forward-looking statements. Prudential undertakes no obligation to
update the forward-looking statements contained in this statement or any other
forward-looking statements it may make.
European Embedded Value (EEV) basis supplementary information
Interim Results 2005
Operating profit from continuing operations based on longer-term investment
returns*
Results analysis by business area
Half Year Full Year Full Year
2005 2005 2004
Note £m £m £m
UK operations
New business 5 159 243 241
Business in force 6 (15) 183 245
Long-term business 144 426 486
M&G 83 163 136
Egg 13 44 61
Total 240 633 683
US operations
New business 5 95 211 145
Business in force 6 324 530 237
Long-term business 419 741 382
Broker-dealer and fund management 18 24 15
Curian (6) (10) (29)
Total 431 755 368
Asian operations
New business 5 162 413 355
Business in force 6 90 163 105
Long-term business 252 576 460
Fund management 2 12 19
Development expenses (8) (20) (15)
Total 246 568 464
Other income and expenditure
Investment return and other income 7 20 42 0
Interest payable on core structural borrowings (84) (175) (154)
Corporate expenditure:
Group Head Office (36) (70) (51)
Asia Regional Head Office (14) (30) (29)
Charge for share-based payments for Prudential schemes (4) (11) (7)
Total (118) (244) (241)
Operating profit from continuing operations based on longer-term 799 1,712 1,274
investment returns
Analysed as profits (losses) from:
New business 5 416 867 741
Business in force 6 399 876 587
Long-term business 815 1,743 1,328
Asia development expenses (8) (20) (15)
Other operating results (8) (11) (39)
Total 799 1,712 1,274
*EEV basis operating profit from continuing operations based on longer-term
investment returns excludes goodwill impairment charges, short-term fluctuations
in investment returns, the shareholders' share of actuarial and other gains and
losses on defined benefit pension schemes, the effect of changes in economic
assumptions and changes in the time value of cost of options and guarantees
caused by economic factors. The amounts for these items are included in total
EEV profit. The directors believe that operating profit, as adjusted for these
items, better reflects underlying performance. Profit on ordinary activities and
basic earnings per share include these items together with actual investment
returns. This basis of presentation has been adopted consistently throughout
this supplementary information.
Summarised consolidated income statement - EEV basis
Interim Results 2005
Half Year Full Year Full Year
2005 2005 2004
Note £m £m £m
Operating profit from continuing operations based on longer-term
investment returns
UK insurance operations 144 426 486
M&G 83 163 136
Egg 13 44 61
UK operations 240 633 683
US operations 431 755 368
Asian operations 246 568 464
Other income and expenditure (118) (244) (241)
Operating profit from continuing operations based on longer-term 799 1,712 1,274
investment returns
Goodwill impairment charge (95) (120) -
Short-term fluctuations in investment returns 8 278 1,001 570
Shareholders' share of actuarial and other gains and losses 9 (8) (47) (12)
on defined benefit pension schemes
Effect of changes in economic assumptions and time value of 10 (143) (302) (48)
cost of options and guarantees
Profit from continuing operations before tax (including actual 831 2,244 1,784
investment returns)
Tax 11 (337) (653) (553)
Profit from continuing operations for the period after tax before 494 1,591 1,231
minority interests
Discontinued operations (net of tax) 1 3 (94)
Profit for the period 495 1,594 1,137
Attributable to:
Equity holders of the Company 490 1,582 1,138
Minority interests 5 12 (1)
Profit for the period 495 1,594 1,137
Earnings per share - EEV basis
Interim Results 2005
Note Half Year Full Year Full Year
2005 2005 2004
Continuing operations
From operating profit, based on longer-term investment 12 24.4p 56.6p 43.2p
returns, after related
tax and minority interests of £576m (£1,339m, £916 million)
Based on profit from continuing operations after minority 12 20.7p 66.8p 56.8p
interests of £489m (£1,579m, £1,205m)
Discontinued operations
Based on profit (loss) from discontinued operations after 0.0p 0.1p (3.1)p
minority interests of
£1m (£3m, £(67)m)
Total - based on total profit for the period after minority 20.7p 66.9p 53.7p
interests of £490m (£1,582m, £1,138m)
Average number of shares (millions) 2,361 2,365 2,121
Dividends per share
Interim Results 2005
Half Year Full Year Full Year
2005 2005 2004
Dividends relating to the reporting period:
Interim dividend 5.30p 5.30p 5.19p
Final dividend - 11.02p 10.65p
Total 5.30p 16.32p 15.84p
Dividends declared and paid in the reporting period:
Current year interim dividend - 5.30p 5.19p
Final dividend for prior year 10.65p 10.65p 10.29p
Total 10.65p 15.95p 15.48p
Movement in shareholders' capital and reserves (excluding minority interests) -
EEV basis
Interim Results 2005
Half Year Full Year Full Year
2005 2005 2004
Note £m £m £m
Profit for the period attributable to equity holders of the 490 1,582 1,138
Company
Items taken directly to equity:
Cumulative effect of IAS 32, IAS 39 and IFRS 4, net of applicable (25) (25) -
taxes, at 1 January 2005
Unrealised valuation movement on securities classified as 4 (1) -
available-for-sale at 1 January 2005
Movement on cash flow hedges (7) (4) -
Exchange movements 219 377 (239)
Related tax 30 65 (1)
Proceeds from Rights Issue, net of expenses - - 1,021
Other new share capital subscribed 40 55 119
Dividends (253) (380) (323)
Reserve movements in respect of share-based payments 6 15 10
Treasury shares:
Movement in own shares in respect of share-based payment 1 0 (2)
plans
Movement on Prudential plc shares purchased by unit trusts (5) 3 14
consolidated under IFRS
Net increase in shareholders' capital and reserves 14 500 1,687 1,737
Shareholders' capital and reserves, at beginning of period 8,614 8,614 6,877
(excluding minority interests)
Shareholders' capital and reserves at end of period 13, 9,114 10,301 8,614
(excluding minority interests) 14
Comprising:
UK operations:
Long-term business 4,598 5,132 4,228
M&G:
Net assets 272 245 297
Acquired goodwill 1,153 1,153 1,153
Egg 266 303 273
6,289 6,833 5,951
US operations 3,092 3,418 2,570
Asian operations:
Net assets 1,692 2,070 1,631
Acquired goodwill 197 172 292
Other operations:
Holding company net borrowings (1,443) (1,724) (1,299)
Other net liabilities (713) (468) (531)
13, 9,114 10,301 8,614
14
Net asset value per share
Based on EEV basis shareholders' capital and reserves of £9,114m 382p 432p 363p
(£10,301m, £8,614m)
Number of shares at end of reporting period (millions) 2,384 2,387 2,375
Summarised consolidated balance sheet - EEV basis
30 June 2005
Half Year Full Year Full Year
2005 2005 2004
Note £m £m £m
Total assets less liabilities, excluding insurance funds 160,379 174,258 148,682
Less insurance funds:*
Policyholder liabilities (net of reinsurers' share) and (155,400) (169,064) (144,193)
unallocated surplus of with-profits funds
Less shareholders' accrued interest in the long-term 4,135 5,107 4,125
business
(151,265) (163,957) (140,068)
Total net assets 14 9,114 10,301 8,614
Share capital 119 119 119
Share premium 1,561 1,564 1,558
Statutory basis shareholders' reserves (following adoption 3,299 3,511 2,812
of IFRS)
Additional EEV basis retained profit 4,135 5,107 4,125
Shareholders' capital and reserves (excluding minority 14 9,114 10,301 8,614
interests)
*Including liabilities in respect of insurance products
classified as investment contracts under IFRS 4.
Notes on the EEV basis supplementary information
1. Purpose and basis of preparation
The preliminary EEV interim financial information for the six month period ended
30 June 2005 has been prepared to provide the comparative financial information
expected to be included in the Group's EEV interim report for the six month
period ending 30 June 2006.
The EEV basis results have been prepared in accordance with the EEV principles
issued by the CFO Forum of European Insurance Companies in May 2004. Where
appropriate the EEV basis results include the effects of adoption of
International Financial Reporting Standards (IFRS).
The EEV results for the Group include the results for the covered business on
the EEV basis. These results are then combined with the IFRS basis results of
the Group's other operations.
With two exceptions, covered business comprises the Group's long-term business
operations. The definition of long-term business operations is consistent with
previous practice and comprises those contracts falling under the definition of
long-term insurance business for regulatory purposes together with, for US
operations, contracts that are in substance the same as guaranteed investment
contracts (GICs) but do not fall within the technical definition. Under the EEV
principles, the results for covered business incorporate the projected margins
of attaching internal fund management.
The exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and in
respect of the Group's defined benefit pension schemes. SAIF is closed to new
business and the assets and liabilities of the fund are wholly attributable to
the policyholders of the fund. As regards the Group's defined benefit pension
schemes, the deficits attaching to the Prudential Staff Pension Scheme (PSPS)
and Scottish Amicable scheme are excluded. These deficits are partially
attributable to the Prudential Assurance Company (PAC) with-profits fund and
shareholder-backed long-term business. Further details are explained in note 2f.
The directors are responsible for the preparation of the supplementary
information in accordance with the EEV Principles.
Previously, the Group has reported supplementary information on the achieved
profits basis for its interim and full year financial reporting. The adoption of
the EEV basis reporting in place of achieved profits basis reporting reflects
developments through the CFO Forum to achieve a better level of consistency and
an improved embedded value methodology, and is applied by the major European
insurance companies in their financial reporting.
2. Methodology
a) Embedded value
Overview
The embedded value is the present value of the shareholders' interest in the
earnings distributable from assets allocated to covered business after
sufficient allowance has been made for the aggregate risks in that business. The
shareholders' interest in the Group's long-term business comprises:
• Present value of future shareholder cash flows from in-force covered business
(value of in-force business), less a deduction for the cost of locked-in
(encumbered) capital;
• locked-in (encumbered) capital; and
• shareholders' net worth in excess of encumbered capital.
The value of future new business is excluded from the embedded value.
Notwithstanding the basis of presentation of results (as explained in notes 4
and 6) no smoothing of market or account balance values, unrealised gains or
investment return is applied in determining the embedded value or the profit
before tax.
Value of in-force business
The embedded value results are prepared incorporating best estimate assumptions
about all relevant factors including levels of future investment return,
expenses, surrender levels and mortality. These assumptions are used to project
future cash flows. The present value of the future cash flows is then calculated
using a discount rate which reflects both the time value of money and the risks
associated with the cash flows that are not otherwise allowed for.
The total profit that emerges over the lifetime of an individual contract as
calculated using the embedded value basis is the same as that calculated under
the IFRS basis and, prior to IFRS adoption, the MSB under UK Generally Accepted
Accounting Principles (GAAP). However, since the embedded value basis reflects
discounted future cash flows under this methodology the profit emergence is
advanced, thus more closely aligning the timing of the recognition of profits
with the efforts and risks of current management actions, particularly with
regard to business sold during the reporting period.
Cost of capital
A charge is deducted from the embedded value for the cost of capital supporting
the Group's long-term business. This capital is referred to as encumbered
capital. The cost is the difference between the nominal value of the capital and
the discounted present value of the projected releases of this capital allowing
for investment earnings (net of tax) on the capital.
The result for the period is impacted by the movement in this cost from period
to period which comprises a charge against new business profit and a release in
respect of the reduction in capital requirements for business in force as this
runs off.
Where the capital is held within a with-profits long-term fund, the value placed
on surplus assets in the fund is already discounted to reflect its release over
time and no further adjustment is necessary in respect of solvency capital.
However, where business is funded directly by shareholders, the capital requires
adjustment to reflect the cost of that capital to shareholders.
Financial options and guarantees
Nature of options and guarantees in Prudential's long-term business
UK insurance operations
The only significant financial options and guarantees in the UK insurance
operations arise in the with-profits sub-fund and SAIF. With-profits products
provide returns to policyholders through bonuses that are smoothed. There are
two types of bonuses: annual and final. Annual bonuses are declared once a year,
and once credited, are guaranteed in accordance with the terms of the particular
product. Unlike annual bonuses, final bonuses are guaranteed only until the next
bonus declaration.
Beyond the generic features described above, and the provisions held in respect
of guaranteed annuities, there are very few explicit options or guarantees of
the with-profits sub-fund such as minimum investment returns, surrender values,
or annuity at retirement and any granted have generally been at very low levels.
Jackson National Life
The principal options and guarantees valued under EEV for Jackson National Life
(JNL) are associated with the fixed annuity and variable annuity lines of
business.
Fixed annuities provide that at JNL's discretion it may reset the interest rate
credited to policyholders' accounts, subject to a guaranteed minimum. The
guaranteed minimum return varies from 1.5 per cent to 5.5 per cent (full year
2005 and 2004: 1.5 per cent to 5.5 per cent), depending on the particular
product, jurisdiction where issued, and date of issue. At 30 June and 31
December 2005, 73 per cent (2004: 73 per cent) of the fund relates to policies
with guarantees of 3 per cent or less. The average guarantee rate for the half
and full year 2005 is 3.3 per cent (2004: 3.3 per cent).
Fixed annuities also present a risk that policyholders will exercise their
option to surrender their contracts in periods of rapidly rising interest rates,
possibly requiring JNL to liquidate assets at an inopportune time.
Variable annuity contracts may contain guarantees of certain minimum payments in
the event of death, withdrawal or annuitisation. These guarantees may be related
to (a) the amount of total deposits made to the contract adjusted for any
partial withdrawals, (b) the total deposits made to the contract adjusted for
any partial withdrawals, plus a minimum annual return, or (c) the highest
contract value on a specified anniversary date adjusted for any withdrawals
following the contract anniversary.
These guarantees generally protect the policyholder's value in the event of poor
equity market performance.
JNL also issues fixed index annuities that enable policyholders to obtain a
portion of an equity-linked return while providing a guaranteed minimum return.
The guaranteed minimum returns would be of a similar nature as those described
above for fixed annuities. In the case of the potential equity participation,
JNL hedges this risk by purchasing futures and options on the relevant index.
Asian operations
Subject to local market circumstances and regulatory requirements, the guarantee
features described above in respect of UK business broadly apply to similar
types of participating contracts written in the PAC Hong Kong branch, Singapore
and Malaysia. Participating products have both guaranteed and non-guaranteed
elements.
Non-participating long-term products are the only ones where the insurer is
contractually obliged to provide guarantees on all benefits. The most
significant book of non-participating business in the Group's Asian operations
is Taiwan's whole of life contracts. For these contracts there are floor levels
of policyholder benefits that accrue at rates set at inception which are set by
reference to minimum returns established by local regulation at the time of
inception. These rates do not vary subsequently with market conditions. Under
these contracts the cost of premiums are also fixed at inception based on a
number of assumptions at that time, including long-term interest rates,
mortality assumptions and expenses. The guaranteed maturity and surrender values
reflect the pricing basis.
Time value
The value of financial options and guarantees comprises two parts. One is given
by a deterministic valuation on best estimate assumptions (the intrinsic value).
The other part arises from the variability of economic outcomes in the future
(the time value).
Where appropriate, a full stochastic valuation has been undertaken to determine
the value of the in-force business including the cost of capital. A
deterministic valuation of the in-force business is also derived using
consistent assumptions and the time value of the financial options and
guarantees is derived as the difference between the two.
The economic assumptions used for the stochastic calculations are consistent
with those used for the deterministic calculations. Assumptions specific to the
stochastic calculations such as equity volatility and credit losses reflect
local market conditions and are based on a combination of actual market data,
historic market data and an assessment of long-term economic conditions. Common
principles have been adopted across the Group for the stochastic asset models,
for example, separate modelling of individual asset classes but with allowance
for correlation between the various asset classes. Details of the key
characteristics of each model are given in note 3.
b) Level of encumbered capital
In adopting the EEV principles, Prudential has based encumbered capital on its
internal targets for economic capital subject to it being at least the local
statutory minimum requirements. Economic capital is assessed using internal
models, but when applying EEV Prudential does not take credit for the
significant diversification benefits that exist within the Group. For
with-profits business written in a segregated life fund, as is the case in the
UK and Asia, the capital available in the fund is sufficient to meet the
encumbered capital requirements.
• UK: economic capital requirements for annuity business are fully met by Pillar
I requirements being 4 per cent of mathematical reserves (as used for achieved
profits reporting), which are also sufficient to meet Pillar II requirements;
• US: level of capital that has previously been locked in for achieved profits
reporting, namely 235 per cent of the risk-based capital required by the
National Association of Insurance Commissioners at the Company Action Level
(CAL), is sufficient to meet the economic capital requirement;
• Asia: economic capital target is substantially higher than local statutory
requirements in total. Economic capital requirements vary by territory, but in
aggregate, the encumbered capital is equivalent to the amount required under the
Financial Conglomerates Directive (FCD).
The table below summarises the levels of encumbered capital as a percentage of
the relevant statutory requirement:
Capital as a percentage of
relevant statutory requirement
UK business (excluding annuities) 100% of EU minimum
UK annuity business 100% of EU minimum
Jackson National Life 235% of CAL
Asian operations 100% of FCD
c) Risk discount rates
Overview
Under the CFO Forum Principles, discount rates used to determine the present
value of future cash flows are set equal to risk-free rates plus a risk margin.
The risk margin should reflect any risk associated with the emergence of
distributable earnings that is not allowed for elsewhere in the valuation.
Prudential has selected a granular approach to better reflect changes in risk
inherent in each product group. The risk discount rate so derived does not
reflect a market beta but instead reflects the risk of volatility associated
with the cash flows in the embedded value model.
Since financial options and guarantees are explicitly valued under the EEV
methodology, discount rates under EEV are set excluding the effect of these
product features.
For Prudential's UK annuity business, which is well matched, the predominant
risks are credit risk and longevity risk. For this line of business the achieved
profits methodology for embedded values has been carried over and the risk
discount rate has been derived by comparison to a market consistent valuation.
Allowance for risk
The risk allowance in the risk discount rate is determined as follows:
Market risk
Under Capital Asset Pricing Methodology (CAPM) the discount rate is determined
as:
Discount rate = risk-free rate + (beta x equity risk premium)
Under CAPM, the beta of a portfolio or product measures its relative market
risk.
The risk discount rates reflect the market risk inherent in each product group
and hence the volatility of product cash flows. They are determined by
considering how the profits from each product are impacted by changes in
expected returns on various asset classes, and by converting this into a
relative rate of return it is possible to derive a product specific beta.
CAPM does not include any allowance for non-market risks since these are assumed
to be fully diversifiable. For EEV purposes, however, a risk margin is added for
non-diversifiable non-market risks and to cover Group level risks.
Product-level betas are calculated at least annually. They are combined with the
most recent product mix to produce appropriate betas and risk discount rates for
each major product grouping.
Diversifiable non-market risks
No allowance is required for non-market risks where these are assumed to be
fully diversifiable. The majority of non-market risks are considered to be
diversifiable.
Non-diversifiable, non-market risks
Finance theory cannot be used to determine the appropriate component of beta for
non-diversifiable non-market risks since there is no observable risk premium
associated with it that is akin to the equity risk premium. Recognising this, a
pragmatic approach has been used.
A constant margin of 50 basis points has been added to the risk margin derived
for market risk to cover the non-diversifiable non-market risks associated with
the business.
d) Management actions
In deriving the time value of financial options and guarantees, management
actions in response to emerging investment and fund solvency conditions have
been modelled. Management actions encompass, but are not confined to, the
following areas:
• Investment allocation decisions;
• levels of reversionary bonuses and credited rates; and
• total claim values.
Bonus rates are projected from current levels and varied in accordance with
assumed management actions applying in the emerging investment and fund solvency
conditions.
In all instances the modelled actions are in accordance with approved local
practice and therefore reflect the options actually available to management. For
the PAC with-profits sub-fund, the actions assumed are consistent with those set
out in the Principles and Practices of Financial Management.
e) With-profits business and the treatment of the estate
For the PAC with-profits sub-fund, the shareholders' interest in the estate is
derived by increasing terminal bonus rates so as to exhaust the estate over the
lifetime of the in-force with-profits business. In those few extreme scenarios
where the total assets of the life fund are insufficient to meet policyholder
claims in full, the excess cost is fully attributed to shareholders.
f) Pension costs
The Group operates three defined benefit schemes in the UK. The principal scheme
is the Prudential Staff Pension Scheme (PSPS). The other two much smaller
schemes are the Scottish Amicable and M&G schemes. There is also a small scheme
in Taiwan.
Under IFRS the deficits attaching to these schemes are accounted for in
accordance with the provisions of IAS 19. The deficits represent the difference
between the market value of the schemes' assets and the discounted value of
projected future benefit payments to retired members and deferred pensioners
and, to the extent of service to date, current employed members.
For PSPS the deficit is allocated between the PAC with-profits sub-fund and
shareholder-backed operations by reference to the activities of the members of
the scheme during their period of service. For the 2004 year end and half year
2005 the deficit was allocated in the ratio 80/20. For the 2005 year end,
following further detailed consideration of the sourcing of previous
contributions by Group companies and funds, this ratio has been altered to 70/30
for the allocation of the deficit between the with-profits sub-fund and
shareholder-backed operations. Additional details on the effect of the movement
on the deficits of the Group's defined benefit pension schemes is set out in
note 9.
Under the EEV basis the IAS 19 basis deficit is initially allocated in the same
manner. The shareholders' 10 per cent interest in the PAC with-profits sub-fund
estate is determined after deduction of the portion of the IAS 19 basis deficits
attributable to the fund. Adjustments under EEV in respect of accounting for
deficits on deferred benefit schemes are reflected as part of other operations,
as shown in note 13.
Separately, the projected cash flows of in-force covered business include
contributions to the defined benefit schemes for future service based on the
contribution basis to the schemes applying at the time of preparation of
results.
g) Debt capital
Core structural debt liabilities are carried at market value.
3. Assumptions
a) Best estimate assumptions
Best estimate assumptions are used for the projections, where best estimate is
defined as the mean of the distribution of all possible outcomes. The
assumptions are reviewed actively and changes are made when evidence exists that
changes in future experience are reasonably certain.
Assumptions required in the calculation of the value of options and guarantees,
for example relating to volatilities and correlations, or dynamic algorithms
linking liabilities to assets, have been set equal to the best estimates and,
wherever material and practical, reflect any dynamic relationships between the
assumption and the stochastic variables.
b) Principal economic assumptions
Deterministic
In most countries, the long-term expected rates of return on investments and
risk discount rates are set by reference to period end rates of return on fixed
interest securities. This 'active' basis of assumption setting has been applied
in preparing the results of all the Group's UK and US long-term business
operations. For the Group's Asian operations, the active basis is appropriate
for business written in Japan, Korea and US dollar denominated business written
in Hong Kong.
An exception to this general rule is that for countries where long-term fixed
interest markets are underdeveloped, investment return assumptions and risk
discount rates are based on an assessment of longer-term economic conditions.
Except for the countries listed above, this basis is appropriate for the Group's
Asian operations.
Expected returns on equity and property asset classes are derived by adding a
risk premium, also based on the long-term view of Prudential's economists in
respect of each territory, to the risk-free rate. In the UK the equity risk
premium is 3.0 per cent (full year 2005: 4.0 per cent, 2004: 3.0 per cent) above
risk-free rates. The equity risk premium in the US is 3.0 per cent (full year
2005: 4.0 per cent, 2004: 3.0 per cent). In Asia, equity risk premiums range
from 2.75 per cent to 5.25 per cent (full year 2005: 3.0 per cent to 5.75 per
cent, 2004: 2.8 per cent to 5.3 per cent). Assumptions for other asset classes,
such as corporate bond spreads, are set consistently as best estimate
assumptions.
The investment return assumptions as derived above are applied to the actual
assets held at the valuation date to derive the overall fund-earned rate.
The table below summarises the principal financial assumptions:
30 Jun 31 Dec 31 Dec 2004
2005 2005
% % %
UK insurance operations
Risk discount rate:
New business 7.4 7.55 7.1
In force 6.9 7.7 7.1
Pre-tax expected long-term nominal rates of investment return:
UK equities 7.2 8.1 7.6
Overseas equities 7.0 to 7.9 8.1 to 7.3 to 8.3
8.75
Property 6.5 6.4 6.3
Gilts 4.2 4.1 4.6
Corporate bonds 5.1 4.9 5.5
Expected long-term rate of inflation 2.8 2.9 2.9
Post-tax expected long-term nominal rate of return:
Pension business (where no tax applies) 6.6 7.1 6.8
Life business 5.8 6.3 5.9
US operations (Jackson National Life)
Risk discount rate:
New business 5.8 6.9 6.1
In force 5.3 6.1 5.8
Expected long-term spread between earned rate and rate credited
to policyholders for single premium deferred annuity business 1.75 1.75 1.75
US 10-year treasury bond rate at end of period 4.0 4.4 4.3
Pre-tax expected long-term nominal rate of return for US equities 7.0 8.4 7.3
Expected long-term rate of inflation 2.2 2.4 2.6
Asian operations
Hong Taiwan
Kong
China (note India Indonesia Japan Korea Malaysia Philippines Singapore (note Thailand Vietnam
iii) ii)
30 30 Jun 30 30 Jun 30 30 30 Jun 30 Jun 30 Jun 30 Jun 30 Jun 30 Jun
Jun Jun Jun Jun
2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005
% % % % % % % % % % % %
Risk
discount
rate:
New 10.0 4.7 16.0 18.75 4.9 7.5 9.15 16.25 6.4 9.7 13.5 15.5
business
In force 10.0 5.1 16.0 18.75 4.9 7.5 8.7 16.25 6.65 9.5 13.5 15.5
Expected
long-term
rate of 3.0 2.25 5.25 7.75 0.0 2.75 3.0 5.25 2.25 2.25 3.75 4.5
inflation
Government 7.25 4.9 10.25 13.0 1.7 4.4 7.0 10.5 5.0 5.5 7.75 9.75
bond yield
Hong Taiwan
Kong
China (note India Indonesia Japan Korea Malaysia Philippines Singapore (note Thailand Vietnam
iii) ii)
31 31 Dec 31 31 Dec 31 31 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
Dec Dec Dec Dec
2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005
% % % % % % % % % % % %
Risk
discount
rate:
New 12.0 5.9 16.5 17.5 5.0 10.3 9.4 16.5 6.7 9.0 13.75 16.5
business
In force 12.0 6.15 16.5 17.5 5.0 10.3 9.0 16.5 6.8 9.4 13.75 16.5
Expected
long-term
rate of 4.0 2.25 5.5 6.5 0.0 2.75 3.0 5.5 1.75 2.25 3.75 5.5
inflation
Government 9.0 4.8 10.5 11.5 1.8 5.8 7.5 10.5 4.5 5.5 7.75 10.5
bond yield
Hong Taiwan
Kong
China (note India Indonesia Japan Korea Malaysia Philippines Singapore (note Thailand Vietnam
iii) ii)
31 31 Dec 31 31 Dec 31 31 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
Dec Dec Dec Dec
2004 2004 2004 2004 2004 2004 2004 2004 2004 2004 2004 2004
% % % % % % % % % % % %
Risk
discount
rate:
New 10.0 4.7 16.0 18.75 5.0 7.1 9.0 16.25 6.3 7.1 13.5 15.5
business
In force 10.0 5.0 16.0 18.75 5.0 7.1 8.7 16.25 6.4 8.2 13.5 15.5
Expected
long-term
rate of 3.0 2.25 5.25 7.75 0.0 2.75 3.0 5.25 2.25 2.25 3.75 4.5
inflation
Government 7.25 4.9 10.25 13.0 1.9 3.9 7.0 10.5 5.0 5.5 7.75 9.75
bond yield
Asia Asia Asia total
total total
30 June 31 Dec 31 Dec
2005 2005 2004
% % %
Weighted risk discount rate (note i)
New business 9.4 9.8 8.0
In force 7.2 8.4 7.9
Notes
(i) The weighted discount rates for the Asian operations shown above have been
determined by weighting each country's discount rates by reference to the EEV
basis operating result for new business and the closing value of in-force
business.
(ii) For traditional business in Taiwan, the economic scenarios used to
calculate the half year 2005 EEV basis results reflect the assumption of a
phased progression of the bond yields from the current rates to the long-term
expected rates. In preparing the half year 2005 EEV basis results the same basis
has been applied as was used and disclosed for the full year 2005 results. This
basis is that the projections assume that, in the average scenario, the current
bond yields of around 2 per cent trend towards 5.5 per cent at 31 December 2012.
Allowance is made for the mix of assets in the fund, future investment strategy
and the market value depreciation of the bonds as a result of the assumed yield
increases. This gives rise to an average assumed Fund Earned Rate that trends
from 2.3 per cent to 5.4 per cent in 2013 and falls below 2.3 per cent for seven
years due to the depreciation of bond values as yields rise. Thereafter, the
Fund Earned Rate fluctuates around a target of 5.9 per cent. This compares to a
grading of 3.4 per cent at 31 December 2004 to 5.9 per cent by 31 December 2012
for the 2004 results. Consistent with our EEV methodology, a constant discount
rate has been applied to the projected cashflows.
(iii) The assumptions shown are for US dollar denominated business which
comprises the larger proportion of the in-force Hong Kong business.
(iv) Assumed equity returns
The most significant equity holdings in the Asian operations are in Hong Kong,
Singapore and Malaysia. The mean equity return assumptions for those territories
at 30 June 2005 were 7.3 per cent (31 December 2005: 8.6 per cent, 2004: 7.3 per
cent), 9.75 per cent (31 December 2005: 9.3 per cent, 2004: 9.75 per cent) and
12.25 per cent (31 December 2005: 12.8 per cent, 2004: 12.25 per cent)
respectively. To obtain the mean, an average over all simulations of the
accumulated return at the end of the projection period is calculated. The annual
average return is then calculated by taking the root of the average accumulated
return minus 1.
Stochastic
The economic assumptions used for the stochastic calculations are consistent
with those used for the deterministic calculations described above. Assumptions
specific to the stochastic calculations such as the volatilities of asset
returns reflect local market conditions and are based on a combination of actual
market data, historic market data and an assessment of longer-term economic
conditions. Common principles have been adopted across the Group for the
stochastic asset models, for example, separate modelling of individual asset
classes but with allowance for correlation between the various asset classes.
Details are given below of the key characteristics and calibrations of each
model.
UK insurance operations
• Interest rates are projected using a two-factor model calibrated to actual
market data;
• the risk premium on equity assets is assumed to follow a log-normal
distribution;
• the corporate bond return is calculated as the return on a zero-coupon bond
plus a spread. The spread process is a mean reverting stochastic process; and
• property returns are modelled in a similar fashion to corporate bonds, namely
as the return on a riskless bond, plus a risk premium, plus a process
representative of the change in residual values and the change in value of the
call option on rents.
The rates to which the model has been calibrated are set out below:
Mean returns have been derived as the annualised arithmetic average return
across all simulations and durations.
Standard deviations have been calculated by taking the annualised variance of
the returns over all the simulations, taking the square root and averaging over
all durations in the projection. For bonds the standard deviations relate to the
yields on bonds of the average portfolio duration. For equity and property, they
relate to the total return on these assets. The standard deviations applied are
as follows:
Standard
deviation
Half Year
2005
%
Government bond yield 2.0
Corporate bond yield 5.5
Equities:
UK 18.0
Overseas 16.0
Property 15.0
Jackson National Life
• Interest rates are projected using a log-normal generator calibrated to actual
market data;
• corporate bond returns are based on Treasury securities plus a spread that has
been calibrated to current market conditions and varies by credit quality; and
• variable annuity equity and bond returns have been stochastically generated
using a regime-switching log-normal model with parameters determined by
reference to historical data. The volatility of equity fund returns ranges from
18.6 per cent to 28.1 per cent, depending on risk class, and the volatility of
bond funds ranges from 1.4 per cent to 1.7 per cent.
Asian operations
The same asset return model, as used in the UK, appropriately calibrated, has
been used for the Asian operations. The principal asset classes are government
and corporate bonds. Equity holdings are much lower than in the UK whilst
property is not held as an investment asset.
The stochastic cost of guarantees are only of significance for the Hong Kong,
Singapore, Malaysia and Taiwan operations.
The mean stochastic returns are consistent with the mean deterministic returns
for each country. The volatility of equity returns ranges from 18 per cent to 25
per cent, and the volatility of government bond returns ranges from 1.8 per cent
to 6.4 per cent.
c) Demographic assumptions
Persistency, mortality and morbidity assumptions are based on an analysis of
recent experience but also reflect expected future experience. Where relevant,
when calculating the time value of in-force business, policyholder withdrawal
rates vary in line with the emerging investment conditions according to
management's expectations.
d) Expense assumptions
Expense levels, including those of service companies that support the Group's
long-term business operations, are based on internal expense analysis
investigations and are appropriately allocated to acquisition of new business
and renewal of in-force business. Exceptional expenses are identified separately
and reported separately. No productivity gains have been assumed.
Asia development and Regional Head Office expenses are charged to EEV basis
results as incurred. No adjustment is made to the embedded value of covered
business as the amounts of expenditure that relate to operating expenses are not
material. Similarly corporate expenditure for Group Head Office, to the extent
not allocated to the PAC with-profits fund, is charged to the EEV basis result
as incurred.
e) Inter-company arrangements
There are no inter-company arrangements such as reinsurance or loans associated
with covered business for which adjustment has been required in preparing the
EEV basis results.
f) Taxation and other legislation
Current taxation and other legislation has been assumed to continue unaltered
except where changes have been announced and the relevant legislation passed.
g) Fund management and service companies
The value of future profits or losses from fund management and service companies
that support the Group's covered businesses are included in the profits for new
business and the in-force value of the Group's long-term business.
4. Accounting presentation
a) Analysis of profit before tax
To the extent applicable, presentation of the EEV profit for the period is
consistent with the basis the Group applies for analysis of IFRS basis profits
before shareholder taxes between operating and non-operating results. Operating
results reflect the underlying results of the Group's continuing operations
including longer-term investment returns. Operating results include the impact
of routine changes of estimates and non-economic assumptions. Non-operating
results include certain recurrent and exceptional items that primarily do not
reflect the performance in the period of the Group's continuing operations.
b) Investment return
Profit before tax
With the exception of debt securities held by JNL, investment gains and losses
during the period (to the extent that changes in capital values do not directly
match changes in liabilities) are included directly in the profit for the period
and shareholders' funds as they arise.
In the case of JNL, market value movements on debt securities are initially
recorded as movements in shareholder reserves, reflecting the available-for-sale
categorisation under IFRS. Similarly the value movements on derivatives are
recorded in the income statement. However, it is assumed that fixed income
investments will normally be held until maturity. Therefore, unrealised gains
and losses on these securities are not reflected in either the EEV or statutory
basis results and, except on realisation or impairment of investments, only
income received and the amortisation of the difference between cost and maturity
values are recognised to the extent attributable to shareholders. This is
consistent with the basis of valuation of future cash flows of in-force
business, which inter alia, reflects spread basis earnings which are not
directly affected by short-term value movements in fixed income securities.
Similar principles apply to value movements on JNL's derivatives that are fair
valued for IFRS reporting with value movements booked in the IFRS income
statement.
Investment returns reflect those earned on a market basis over the period
without smoothing, but after appropriate adjustments for movements in the
additional shareholders' interest recognised on the EEV basis.
Operating profit
Investment returns, including investment gains, in respect of long-term
insurance business are recognised in operating results at the expected long-term
rate of return. For the purposes of calculating longer-term investment return to
be included in operating results of UK operations, where equity holdings are a
significant proportion of investment portfolios, values of assets at the
beginning of the reporting period are adjusted to remove the effects of
short-term market volatility.
For the purposes of determining the long-term returns for debt securities of
shareholder-backed operations, a risk margin charge is included which reflects
the expected long-term rate of default based on the credit quality of the
portfolio. Interest-related realised gains and losses are amortised to the
operating results over the maturity period of the sold bonds. For equity-related
investments of JNL, a long-term rate of return is assumed, which reflects the
aggregation of risk-free rates and equity risk premium.
c) Pension costs
Profit before tax
Movements on the shareholders' share of deficits of the Group's defined benefit
pension schemes adjusted for contributions paid in the period are recorded
within the income statement. Consistent with the basis of distribution of
bonuses and the treatment of the estate described in notes 2d) and 2e), the
shareholders' share incorporates 10 per cent of the proportion of the deficits
attributable to the PAC with-profits sub-fund. The deficits are determined by
applying the requirements of IAS 19.
Actuarial gains and losses
Actuarial gains and losses comprise:
• The difference between actual and expected return on the scheme assets;
• experience gains and losses on scheme liabilities; and
• the impact of altered economic and other assumptions on the discount value of
scheme liabilities.
These items are recorded in the income statement but, consistent with the IFRS
basis of presentation, are excluded from operating results.
For the full year 2005 results, as previously disclosed, additional
non-recurrent gains and losses in respect of the Group's defined benefit pension
schemes have been recorded. These are explained in note 9.
d) Effect of changes in economic assumptions and time value of cost of options
and guarantees
Movements in the value of in-force business caused by changes to economic
assumptions and the time value of cost of options and guarantees, (which is
primarily due to economic experience over the period and changes in economic
assumptions) are recorded in non-operating results.
e) Results for fund management operations
The results of the Group's fund management operations include the profits from
management of internal and external funds. For EEV basis reporting, Group
shareholders' other income is adjusted to deduct the expected margin for the
period on management of covered business. The deduction is on a basis consistent
with that used for projecting the results for covered business. Group operating
profit accordingly includes the variance between actual and expected profit in
respect of covered business.
f) Capital held centrally for Asian operations
In adopting the EEV principles Prudential has decided to set encumbered capital
at its internal targets for economic capital. In Asia, the economic capital
target is substantially higher than the local statutory requirements in total.
Accordingly, capital is held centrally for Asian operations. For the purposes of
the presentation of the Group's operating results, it is assumed that the
centrally held capital is lent interest free to the Asian operations. In turn
the results of the Asian operations include the return on that capital and Group
shareholders' other income for EEV basis reporting is consequently reduced.
g) Taxation
The EEV profit for the period for covered business is calculated initially at
the post-tax level. The post-tax profit is then grossed up for presentation
purposes at the effective rate of tax. In general, the effective rate
corresponds to the corporation tax rate on shareholder profits of the business
concerned. Under achieved profits, except for JNL, this basis also applied. For
JNL, under achieved profits pre-tax results were determined by applying the risk
discount rate to pre-tax cash flows adjusted for the impact of capital charges.
h) Foreign currency translation
Foreign currency profit and losses have been translated at average exchange
rates for the period. Foreign currency assets and liabilities have been
translated at period end rates of exchange. The purpose of translating the
profit and losses at average exchange rates, notwithstanding the fact that EEV
profit represents the incremental value added on a discounted cash flow basis,
is to maintain consistency with the methodology applied for IFRS basis
reporting.
The principal exchange rates applied are:
Local Closing Average for Closing Average Closing Average for Opening
currency: £ Rate at 30 Half Year rate at 31 for Full rate at rate at
Jun 2005 2005 Dec 2005 Year 2005 Full year 1 Jan 2004
31 Dec 2004
2004
Hong Kong 13.93 14.6 13.31 14.15 14.92 14.27 13.90
Japan 198.62 198.56 202.63 200.13 196.73 198.08 191.85
Malaysia 6.81 7.12 6.49 6.89 7.30 6.96 6.80
Singapore 3.02 3.08 2.85 3.03 3.13 3.10 3.04
Taiwan 56.67 58.88 56.38 58.47 60.84 61.10 60.78
US 1.79 1.87 1.72 1.82 1.92 1.83 1.79
5. Operating profit and margins from new business
a) Profit
Half Full Full
Year Year Year
2005 2005 2004
Pre-tax Tax Post-tax Pre-tax Tax Post-tax Pre-tax Tax Post-tax
£m £m £m £m £m £m £m £m £m
UK insurance 159 (48) 111 243 (73) 170 241 (72) 169
operations
Jackson National 95 (33) 62 211 (74) 137 145 (51) 94
Life (note i)
Asian operations 162 (52) 110 413 (124) 289 355 (105) 250
Total 416 (133) 283 867 (271) 596 741 (228) 513
(i) Jackson National Life
net of tax profit
Before capital 68 150 106
charge
Capital charge (6) (13) (12)
After capital 62 137 94
charge
In determining the EEV basis value of new business written in the period the
policies incept, premiums are included in projected cash flows on the same basis
of distinguishing annual and single premium business as set out for statutory
basis reporting.
Included within pre-tax new business profits shown in the table above are
profits arising from fund management business falling within the scope of
covered business of:
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
UK insurance operations 5 7 10
Jackson National Life 1 2 4
Asian operations 3 10 3
9 19 17
b) Margins
Present
value
Annual of new
premium business Pre-tax new
New business premiums equivalent premiums business New business
margin
Single Regular (APE) (PVNBP) contribution (APE) (PVNBP)
Half Year 2005 £m £m £m £m £m % %
UK insurance 4,510 90 541 4,797 159 30 3.3
operations
Jackson National Life 2,700 5 275 2,749 95 35 3.5
Asian operations 401 273 313 1,734 162 52 9.3
Total 7,611 368 1,129 9,280 416 37 4.5
Present
value
Annual of new
premium business Pre-tax new
New business premiums equivalent premiums business New business
margin
Single Regular (APE) (PVNBP) contribution (APE) (PVNBP)
Full Year 2005 £m £m £m £m £m % %
UK insurance 7,085 191 900 7,593 243 27 3.2
operations
Jackson National Life 5,009 14 515 5,135 211 41 4.1
Asian operations 837 648 731 4,039 413 56 10.2
Total 12,931 853 2,146 16,767 867 41 5.2
Present
value
Annual of new
premium business Pre-tax new
New business premiums equivalent premiums business New business
margin
Single Regular (APE) (PVNBP) contribution (APE) (PVNBP)
Full Year 2004 £m £m £m £m £m % %
UK insurance 6,357 181 817 7,012 241 30 3.4
operations
Jackson National Life 4,408 12 453 4,506 145 32 3.2
Asian operations 662 510 576 3,404 355 62 10.4
Total 11,427 703 1,846 14,922 741 40 5.0
New business premiums reflect those premiums attaching to covered business
including premiums for contracts classified as investment products for IFRS
basis reporting. New business premiums for regular premium products are shown on
an annualised basis. Department of Work and Pensions rebate business is
classified as single recurrent premium business. Internal vesting annuity
business is classified as new business where the contracts include an open
market option.
New business margins are shown on two bases, namely the margins by reference to
Annual Premium Equivalents (APE) and the Present Value of New Business Premiums
(PVNBP). APEs are calculated as the aggregate of regular new business premiums
and one tenth of single new business premiums. PVNBPs are calculated as
equalling single premiums plus the present value of expected new business
premiums of regular premium business, allowing for lapses and other assumptions
made in determining the EEV new business contribution.
The table of new business margins above excludes SAIF new business.
New business contributions are determined by applying the economic and
non-economic assumptions applying at the end of the reporting period. The
contributions represent profits at the end of the reporting period.
6. Operating profit from business in force
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
UK insurance operations
Unwind of discount and other expected returns (note 181 424 351
i)
Cost of strengthened persistency assumption (note ii) (148) (148) (73)
Mortality related cost of capital charge (note iii) - (47) -
Other items (note iv) (48) (46) (33)
(15) 183 245
Jackson National Life
Unwind of discount and other expected returns: (note
i)
On value of in-force and required capital 67 160 123
On surplus assets (over target surplus) 23 52 36
Spread experience variance 47 89 41
Amortisation of interest-related realised gains and 26 53 54
losses
Profit on repricing Term contracts 136 140 -
Profit (loss) from changes to other operating 11 10 (4)
assumptions
Other 14 26 (13)
324 530 237
Asian operations
Unwind of discount and other expected returns (note 85 162 120
i)
Change in operating assumptions 7 (9) (24)
Experience variances and other items (2) 10 9
90 163 105
Total 399 876 587
Notes
(i) For UK insurance and Asian operations, unwind of discount and other expected
returns is determined by reference to the value of in-force business, required
capital and surplus assets at the start of the period as adjusted for the effect
of changes in economic and operating assumptions reflected in the current
period. For the unwind of discount for UK insurance operations included in
operating results based on longer-term returns a further adjustment is made. For
UK insurance operations the amount represents the unwind of discount on the
value of in-force business at the beginning of the period (adjusted for the
effect of current period assumption changes), the expected return on smoothed
surplus assets retained within the main with-profits fund and the expected
return on shareholders' assets held in other UK long-term business operations.
Surplus assets retained within the main with-profits fund are smoothed for this
purpose to remove the effects of short-term investment volatility from operating
results. In the balance sheet and for total profit reporting, asset values and
investment returns are not smoothed. For JNL the return on surplus assets is
shown separately.
(ii) The £148 million cost of strengthened persistency assumption relates to a
number of products, primarily in respect of with-profits bonds. The £73 million
cost of strengthened persistency assumption for 2004 relates to the closed book
of personal pension policies sold by the now discontinued direct sales force.
(iii) The £47 million charge for full year 2005 primarily relates to the cost of
capital attaching to liability strengthening on the regulatory basis for annuity
business.
(iv) Other charges of £48m for half year 2005 reflect adverse expense experience
variances, the costs of new regulatory requirements and restructuring and other
items. The full year 2005 other charges of £46 million include £45 million of
costs associated with complying with regulatory requirements including
Sarbanes-Oxley, product and distribution development, £19 million of negative
experience variances and other net positive items of £18 million. In determining
the appropriate expense assumptions for full year 2005 account has been taken of
the cost synergies that are expected to arise with some certainty from the
initiative announced on 1 December 2005 from UK insurance operations working
more closely with Egg and M&G. Without this factor there would have been a
charge for altered expense assumptions of approximately £55 million. The £33
million charge for other items for 2004 includes £21 million of costs associated
with complying with new regulatory requirements and restructuring and £12
million of negative experience variances.
7. Investment return and other income
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
IFRS basis 45 87 44
Less: allocation of investment return on centrally held capital (10) (21) (22)
in respect of Asian business to operating result of Asian
operations
Less: projected fund management result in respect of covered (15) (24) (22)
business incorporated in opening EEV value
EEV basis 20 42 0
8. Short-term fluctuations in investment returns
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
Long-term business:
UK insurance operations (note i) 267 994 408
Jackson National Life (including mark to market value of core 16 65 103
structural borrowings) (note ii)
Asian operations 24 41 91
Share of investment return of funds managed by PPM America that 0 0 9
are consolidated into Group results but attributable to external
investors
Share of profits of venture investment companies and property 3 1 9
partnerships of the PAC with-profits fund that are consolidated
into Group results but are attributable to external investors
Movement in mark to market value of core structural borrowings (19) (65) (63)
held centrally
Other operations (13) (35) 13
Total 278 1,001 570
Notes
(i) Short-term fluctuations in investment returns represent for UK insurance
operations the difference between actual investment returns in the period
attributable to shareholders and the expected returns as described in note 3.
(ii) Short-term fluctuations for JNL comprise:
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
Actual investment return on investments less long-term returns
included within operating profit:
Actual realised gains less default assumption and amortisation 2 5 51
of interest-related realised gains and losses for fixed maturity
securities
Actual less long-term return on equity-based investments and 53 58 22
other items
Investment return related (loss) gain due primarily to changed (29) 4 36
expectation of profits on in-force variable annuity business in
future periods based on current period equity returns*
Mark to market value of core structural borrowings (10) (2) (6)
16 65 103
*This adjustment arises due to market returns being (lower) higher than the
assumed long-term rate of return. This gives rise to (lower) higher than
expected period end values of variable annuity assets under management with a
resulting effect on the projected value of future account values, and hence
future profitability.
9. Actuarial and other gains and losses on defined benefit pension schemes
The charge of £8 million (full year 2005: £47 million, 2004: £12 million)
included in total profit reflects the shareholders' share of actuarial and other
gains and losses on the Group's defined benefit pension schemes. On the EEV
basis, this includes a 10 per cent share of the actuarial gains and losses on
the share of the deficit attributable to the PAC with-profits fund for the
Prudential Staff and Scottish Amicable Pension Schemes. The 2005 full year
charge of £47 million includes a charge of £43 million for altered renewal
expense assumptions arising from the prospective increase in employer
contributions for the Prudential Staff Pension Scheme for future service of
active members (as distinct from deficit funding).
10. Effect of changes in economic assumptions and time value of cost of
options and guarantees
The profits (losses) on changes in economic assumptions and time value of cost
of options and guarantees resulting from changes in economic factors for
in-force business included within the profit on ordinary activities before tax
arise as follows:
Half Year Full Year Full Year
2004
2005 2005
Change in Change in Change in
time value time value time value
Change in of cost of Change in of cost of Change in of cost of
economic options economic options economic options
and and and
assumptions guarantees Total assumptions guarantees Total assumptions guarantees Total
£m £m £m £m £m £m £m £m £m
UK insurance 29 1 30 (81) 31 (50) 40 46 86
operations
Jackson 33 1 34 (3) 11 8 (53) 6 (47)
National Life
Asian (207) 0 (207) (265) 5 (260) (113) 26 (87)
operations
(note i)
Total (145) 2 (143) (349) 47 (302) (126) 78 (48)
Note
(i) Consistent with prior periods for the Taiwan operation, the projections
include an assumption of phased progression of the bond yields of around 2 per
cent towards 5.5 per cent at 31 December 2012 as described in note 3b(ii). This
takes into account the effect on bond values of interest rate movements. The
principal cause of the £207 million (full year 2005: £265 million) charge for
the effect of changed economic assumptions is the reduction in short-term earned
rates in Taiwan. This reduction has the effect of delaying the emergence of the
expected long-term rate.
11. Taxation charge
The tax charge comprises:
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
Tax on operating profit from continuing operations
Long-term business:
UK insurance operations 45 127 142
Jackson National Life 126 204 116
Asian operations* 61 162 119
232 493 377
Other operations (11) (130) (27)
Total tax charge on operating profit from continuing operations 221 363 350
Tax on items not included in operating profit
Tax charge on short-term fluctuations in investment returns 107 343 189
Tax credit on actuarial and other gains and losses of defined (2) (14) (5)
benefit pension schemes
Tax charge (credit) on effect of changes in economic assumptions 11 (39) 19
and time value of cost of options and guarantees
Total tax charge on items not included in operating profit from 116 290 203
continuing operations
Tax charge on profit on ordinary activities from continuing 337 653 553
operations (including tax on actual investment returns)
*Including tax relief on development expenses.
The profit for the period for covered business is in most cases calculated
initially at the post-tax level. The post-tax profit for covered business is
then grossed up for presentation purposes at the effective rates of tax
applicable to the countries and periods concerned. In the UK this is the UK
corporation tax rate of 30 per cent. For JNL the federal rate of 35 per cent is
applied to gross up movements on the value of in-force business. Effects on
statutory tax for the period affect the overall tax rate. For Asia, similar
principles apply subject to the availability of taxable profits.
12. Earnings per share (EPS)
Half Full Full Year
Year Year 2004
2005 2005
£m £m £m
Operating EPS from continuing operations:
Operating profit before tax 799 1,712 1,274
Tax (221) (363) (350)
Minority interests (2) (10) (8)
Operating profit after tax and minority interests from continuing 576 1,339 916
operations
Operating EPS from continuing operations 24.4p 56.6p 43.2p
Total EPS from continuing operations:
Total profit before tax 831 2,244 1,784
Tax (337) (653) (553)
Minority interests (5) (12) (26)
Total profit after tax and minority interests from continuing 489 1,579 1,205
operations
Total EPS from continuing operations 20.7p 66.8p 56.8p
Average number of shares (millions) 2,361 2,365 2,121
13. Shareholders' funds - segmental analysis
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
UK operations
Long-term business operations (notes ii and iii):
Smoothed shareholders' funds (note i) 4,369 4,558 4,067
Actual shareholders' funds less smoothed shareholders' funds 229 574 161
EEV basis shareholders' funds 4,598 5,132 4,228
M&G (note vii):
Net assets of operations 272 245 297
Acquired goodwill (note v) 1,153 1,153 1,153
Egg (note vii) 266 303 273
6,289 6,833 5,951
US operations
Jackson National Life (net of surplus note borrowings of £184m
(2005: £183m, 2004: £162m) note vi):
Before capital charge:
Excluding assets in excess of target surplus 2,345 2,566 1,817
Assets in excess of target surplus 750 899 769
3,095 3,465 2,586
Capital charge (note iv) (79) (117) (80)
After capital charge 3,016 3,348 2,506
Broker-dealer, fund management and Curian operations (note vii) 76 70 64
3,092 3,418 2,570
Asian operations
Long-term business (note ii):
Net assets of operations - EEV basis shareholders' funds 1,646 1,988 1,565
Acquired goodwill (note v) 136 111 231
Fund management (note vii):
Net assets of operations 46 82 66
Acquired goodwill (note v) 61 61 61
1,889 2,242 1,923
Other operations
Holding company net borrowings (note vi) (1,443) (1,724) (1,299)
Pension scheme deficits (net of tax) attributable to shareholders (157) (142) (152)
(note vii)
Other net liabilities (note vii) (556) (326) (379)
(2,156) (2,192) (1,830)
Total 9,114 10,301 8,614
Notes
(i) UK long-term business smoothed shareholders' funds reflect an adjustment to
the assets of the PAC with-profits sub-fund, for the purposes of determining the
unwind of discount included in operating profits, to remove the short-term
volatility in market values of assets. Shareholders' funds in the balance sheet
are determined on an unsmoothed basis.
(ii) A charge is deducted from the result for the period and balance sheet value
for the cost of capital for the Group's long-term business operations. The cost
is the difference between the nominal value of solvency capital and the present
value, at risk discount rates, of the projected releases of this capital and the
investment earnings on the capital. Where solvency capital is held within a
with-profits long-term fund, the value placed on surplus assets in the fund is
already discounted to reflect its release over time and no further adjustment is
necessary in respect of solvency capital.
(iii) The proportion of surplus allocated to shareholders from the UK
with-profits business has been based on the present level of 10 per cent. Future
bonus rates have been set at levels which would fully utilise the assets of the
with-profits fund over the lifetime of the business in force.
(iv) In determining the cost of capital of JNL, it has been assumed that an
amount equal to 235 per cent of the risk-based capital required by the National
Association of Insurance Commissioners (NAIC) at the Company Action Level must
be retained. The impact of the related capital charge is to reduce JNL's
shareholders' funds by £79m (2005: £117 million, 2004: £80 million).
(v) Under IFRS, subject to impairment testing, goodwill is no longer amortised
from the date of adoption i.e. 1 January 2004. Acquired goodwill of the Japan
life business has been subject to an impairment charge included in the half year
2005 results of £95m (full year 2005: £120 million).
Goodwill attaching to venture fund investment subsidiaries of the PAC
with-profits fund that are consolidated under IFRS are not included in the table
above as the goodwill attaching to these companies is not relevant to the
analysis of shareholders' funds.
(vi) Net core structural borrowings of shareholder-financed operations comprise:
Half Year Full Year Full Year
2005 2005 2004
£m £m £m
Holding company cash and short-term investments 1,319 1,128 1,561
Core structural borrowings - central funds (2,762) (2,852) (2,860)
Holding company net borrowings (1,443) (1,724) (1,299)
Core structural borrowings - Jackson National Life (184) (183) (162)
(1,627) (1,907) (1,461)
The altered carrying value of core structural borrowings under EEV reflects the
application of market values rather than IFRS basis values.
(vii) With the exception of the share of pension scheme deficits attributable to
the PAC with-profits fund, the amounts shown for the items in the table above
that are referenced to this note have been determined on the statutory IFRS
basis. The deficit for the defined benefit pension scheme reflects the statutory
net of tax IFRS provision of £110m (full year 2005: £113 million, 2004: £105
million), augmented by £47m (2005: £29 million, 2004: £47 million) for the
shareholders' share of the net of tax deficit attributable to the PAC
with-profits fund.
14. Reconciliation of movement in shareholders' funds
Long-term business operations Total
UK long-term
insurance Asian business Other Group
operations JNL operations operations operations total
£m £m £m £m £m £m
Operating profit (including investment
return
based on long-term rates of returns)
Long-term business:
New business (note 5) 159 95 162 416 416
Business in force (note 6) (15) 324 90 399 399
144 419 252 815 815
Asia development expenses (8) (8) (8)
M&G 83 83
Egg 13 13
Asian fund management operations 2 2
US broker-dealer and fund management 18 18
Curian (6) (6)
Other income and expenditure (118) (118)
Operating profit (loss) from continuing 144 419 244 807 (8) 799
operations
Goodwill impairment charge (95) (95)
Short-term fluctuations in investment 270 16 24 310 (32) 278
returns (note 8)
Actuarial and other gains and losses on (8) (8)
defined
benefit pension schemes (note 9)
Effect of changes in economic
assumptions and time
value of cost of options and guarantees 30 34 (207) (143) (143)
(note 10)
Profit (loss) on ordinary activities
before tax
(including actual investment returns) 444 469 61 974 (143) 831
Tax on profits (losses) from continuing
operations (note 11):
Tax on operating profit (45) (126) (61) (232) 11 (221)
Tax on short-term fluctuations in (80) (9) (18) (107) 0 (107)
investment returns
Tax on actuarial and other gains and
losses
on defined benefit pension schemes 2 2
Tax on effect of changes in economic
assumptions
and time value of cost of options and (9) (12) 10 (11) (11)
guarantees
Total tax (charge) credit (134) (147) (69) (350) 13 (337)
Discontinued operations (net of tax) 1 1
Minority interests (3) (3) (2) (5)
Profit (loss) for the period 307 322 (8) 621 (131) 490
Transition adjustment, net of tax, on (25) (25)
adoption of IAS 32, IAS 39 and IFRS 4
at 1 January 2005
Unrealised valuation movements on 4 4
securities classified as
available-for-sale
Movement in cash flow hedges (7) (7)
Exchange movements 186 76 262 (43) 219
Related tax 30 30
Development costs included above (net 4 4 (4)
of tax) borne centrally
Intra group dividends (including (33) (139) (36) (208) 208
statutory transfer)
External dividends (253) (253)
Reserve movements in respect of 6 6
share-based payments
Investment in operations (note i) 104 146 53 303 (303)
Adjustment for net of tax losses of (3) (3) 3
Curian subsidiary owned by JNL
Adjustment for economic capital for (7) (7) 7
Asian operations held centrally
Adjustment for net of tax fund
management projected
profits of covered business (8) (2) (1) (11) 11
Treasury shares:
Movement in own shares in respect of 1 1
share-based payment plans
Movement in Prudential plc shares
purchased by unit trusts
consolidated under IFRS (5) (5)
Proceeds from issues of share capital 40 40
by parent company
Net increase in shareholders' capital 370 510 81 961 (461) 500
and reserves
Shareholders' capital and reserves at 1 4,228 2,506 1,565 8,299 315 8,614
January 2005
Shareholders' capital and reserves at
30 June 2005
(note 13) 4,598 3,016 1,646 9,260 (146) 9,114
Notes
(i) Investment in operations reflects increases in share capital. This includes
certain non-cash items as a result of timing differences.
Long-term business operations Total
UK long-term
insurance Asian business Other Group
operations JNL operations operations operations total
EEV basis shareholders' funds at 30 £m £m £m £m £m £m
June 2005
Analysed as:
Statutory IFRS basis shareholders' 1,080 2,858 928 4,866 113 4,979
funds
Additional retained profit on an EEV 3,518 158 718 4,394 (259) 4,135
basis
EEV basis shareholders' funds at 30 4,598 3,016 1,646 9,260 (146) 9,114
June 2005 (ii)
Comprising:
Free surplus 164 750 (272) 642
Required capital 586 1,136 931 2,653
Value of in-force business before
deduction of
cost of capital and of guarantees 4,099 1,343 1,517 6,959
Cost of capital (163) (79) (516) (758)
Cost of time value of guarantees (88) (134) (14) (236)
4,598 3,016 1,646 9,260
Long-term business operations Total
UK long-term
insurance Asian business Other Group
operations JNL operations operations operations total
EEV basis shareholders' funds at 31 £m £m £m £m £m £m
December 2005
Analysed as:
Statutory IFRS basis shareholders' 1,141 2,899 1,034 5,074 120 5,194
funds
Additional retained profit on an EEV 3,991 449 954 5,394 (287) 5,107
basis
EEV basis shareholders' funds at 31 5,132 3,348 1,988 10,468 (167) 10,301
December 2005 (ii)
Comprising:
Free surplus 148 899 (212) 835
Required capital 710 1,198 974 2,882
Value of in-force business before
deduction of
cost of capital and of guarantees 4,529 1,511 1,771 7,811
Cost of capital (192) (117) (539) (848)
Cost of time value of guarantees (63) (143) (6) (212)
5,132 3,348 1,988 10,468
(ii) Included in the EEV basis shareholders' funds of long-term business
operations of £9,260 million (31 December 2005: £10,468 million, 31 December
2004: £8,299 million) is £170 million (31 December 2005: £174 million, 31
December 2004: £200 million) in respect of fund management business falling
within the scope of covered business as follows:
Half Year Full Year Full Year
2005 2004
2005
£m £m £m
UK insurance operations 127 120 123
Jackson National Life 11 12 20
Asian operations 32 42 57
170 174 200
Special Purpose Review Report of KPMG Audit Plc to Prudential Plc ('the
Company') on its Preliminary European Embedded Value ('EEV') Interim
Supplementary Information for the six months to 30 June 2005
We have reviewed the preliminary EEV interim supplementary information for the
six month period ended 30 June 2005 ('the preliminary EEV interim supplementary
information'). The preliminary EEV interim supplementary information has been
prepared in accordance with the European Embedded Value Principles issued in May
2004 by the European CFO Forum using the methodology and assumptions set out in
notes 2 and 3.
The EEV supplementary information presented for the 12 month periods ending 31
December 2005 and 2004 which has previously been published, is excluded from the
scope of this report.
This report is made solely to the Company in accordance with the terms of our
engagement. Our work has been undertaken so that we might state to the Company
those matters we have been engaged to state in this report and for no other
purpose. To the fullest extent permitted by law, we do not accept or assume
responsibility to anyone other than the Company for our work, this report, or
for the opinions that we have formed.
Respective responsibilities of directors and KPMG Audit Plc
As described in the basis of preparation, the directors of the Company are
responsible for the preparation of the preliminary EEV interim supplementary
information on an EEV basis in accordance with the EEV principles.
Our responsibilities under the terms of our engagement are to report to the
Company our review conclusion as to whether we are aware of any material
modifications that should be made to the preliminary EEV interim supplementary
information.
Basis of review conclusion
We conducted our review having regard to Bulletin 1999/4: Review of interim
financial information issued by the Auditing Practices Board for use in the
United Kingdom. A review consists principally of making enquiries of group
management and applying analytical procedures to the preliminary EEV interim
supplementary information and underlying financial data and, based thereon,
assessing whether the EEV Principles have been consistently applied unless
otherwise disclosed. A review is substantially less in scope than an audit
performed in accordance with Auditing Standards and therefore provides a lower
level of assurance than an audit. Accordingly we do not express an audit opinion
on the preliminary EEV interim supplementary information.
Review conclusion
On the basis of our review we are not aware of any material modifications that
should be made to the preliminary EEV interim supplementary information as
presented for the six month period ended 30 June 2005.
Emphasis of matter
Without qualifying our opinion we draw your attention to the following matter.
The Company has prepared the EEV basis supplementary information for the six
month period ended 30 June 2005 to provide the comparative supplementary
information expected to be included in the Company's EEV basis supplementary
information to be included in the interim report for the six months ending 30
June 2006.
KPMG Audit Plc
Chartered Accountants
London
19 June 2006
This information is provided by RNS
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