Embedded Value (EEV) basis supplementary information 231 Shareholder information 232 How to contact us
basis results 200 Notes on the supplementary IFRS basis results 201 Risk factors 204 European Embedded Value (EEV) basis supplementary information 208 Notes on the EEV basis supplementary information 230 Statement of directors’ responsibilities in respect of the European
M&G manages £21.6 billion of institutional assets, invested in equities, fixed income, property and private equity.
Locations China Hong Kong India Indonesia Japan Korea Malaysia The Philippines Singapore Taiwan Thailand Vietnam
APE sales grew 10 per cent in 2005 to £900 million.
IFRS operating profit on continuing operations of £362 million, up 27 per cent on prior year.
and Unit Trusts (UTs) ■ Investment Trusts (ITs) ■ Individual Savings Accounts (ISAs) and Personal
Institutional business ■ Segregated fixed interest, pooled pension funds, structured and private finance ■ Segregated and pooled global macro strategy mandates ■ Institutional customers include pension funds, insurance companies and other financial institutions
M&G manages £113 billion of assets for Prudential customers, invested in equities, fixed income, property and private equity.
Locations UK: London, Chelmsford Europe: Germany, Austria, Italy, Spain, France Other: Australia, South Africa
Provident Fund business in Hong Kong ■ CITIC Group for life and fund management business in China ■ ICICI Bank for life and mutual funds business in India ■ In addition, Prudential Corporation Asia has a number of distribution partnerships that include a number of leading banks.
The UK banking business made an operating profit of £60 million, compared to £72 million in 2004.
Third party funds under management of £10.1 billion, up 29 per cent over 2004 on comparable basis.
Registered office: Laurence Pountney Hill London EC4R 0HH Registered number: 1397169
Shareholders’ share of actuarial and other gains and losses of defined benefit pension schemes (47) (12)
Operating earnings per share from continuing operations after related tax and minority interests* 56.6p 43.2p
Operating earnings per share from continuing operations after related tax and minority interests** 32.2p 22.7p
Funds under management £234bn £197bn *EEV basis results 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 and expanded by the Additional Guidance on EEV disclosures published in October 2005. Previously the Group has reported embedded value based supplementary information on the achieved profits basis.
References to ‘statutory IFRS basis’ results throughout this Annual Report reflect results contained in the statutory basis financial statements for 2005. These statements incorporate changes from the basis of preparation for the 2004 financial statements that were included in determining the interim 2005 results. These changes reflect: (i) Measurement changes arising from policies the Group has applied on the adoption of all IFRS standards, other than IAS 32, ‘Financial Instruments: Disclosure and Presentation’, IAS 39, ‘Financial Instruments: Recognition and Measurement’ and IFRS 4, ‘Insurance Contracts’, from 1 January 2004. The 2005 results include the effect of adoption of those three standards from 1 January 2005.
(ii) Changes to the format of the results and other presentational changes that the Group has applied in its 2005 financial statements.
(iii) A discretionary change of policy for the basis of determining longer-term investment returns included in operating profit based on longer-term investment returns.
The pro forma IFRS basis results included in this Annual Report are included as supplementary information and are not results that form part of the Group’s financial statements. The pro forma IFRS results reflect the application of the statutory IFRS changes noted above and the estimated effect on the Group’s results for 2004 if IAS 32, IAS 39 and IFRS 4 had been applied from 1 January 2004 to the Group’s insurance operations.
At a Group level, total insurance sales for the year to 31 December 2005 rose 15 per cent to £2,146 million; operating profit on a
During the year, we welcomed Mark Tucker back to Prudential, as Group Chief Executive. Mark previously worked in most of the
Group’s businesses over nearly 20 years, and this broad knowledge, combined with his drive and energy, have brought greater clarity and confidence about the Group’s longer-term plans and capital management programme, enabling us to map out the steps that we need to take to deliver long-term value to shareholders.
In the United States, we see enormous potential to capitalise on the emerging needs of the ‘baby boomer’ generation which is starting to move into retirement, using our market-leading position in variable annuities, and our strengths in IT, product innovation and relationship-based distribution.
Chairman’s statement 2005 was a good year for Prudential’s businesses around the world
Not only do they underpin the performance of our traditional insurance products, they also provide an attractive enhancement to our range of products enabling us to accommodate the needs of the vast bulk of retail investors. Just as importantly, asset management provides a powerful source of non-capital-intensive profits for the Group.
Across the Group, we continue to share knowledge and skills, and are increasingly looking at resources such as IT on a global basis.
We see considerable scope for further collaboration of this kind in future.
Prudential UK, effective from January this year, following the departure of Mark Wood in October. Keki Dadiseth was appointed as a non-executive director in April last year. He brings to the
The Group’s Restricted Share Plan ends this year. At the Annual
Restricted Share Plan and the current business unit incentive schemes. Recruiting and retaining the highest calibre executives is of course crucial to our long-term success. The new arrangements we have developed aim to be competitive within the broad international marketplace in which we operate, and we hope that shareholders will support them.
+3 per cent Full year dividend per share up by three per cent to 16.32 pence
(2004: £12.2 billion) and funds under management of £234 billion at the end of 2005 (2004: £197 billion).
Consistent with this strategy, and to support closer workings between our UK insurance business and Egg, we announced the terms of an Offer to acquire the 21.7 per cent of shares in Egg that the Group did not already own.
Each of our businesses has operational autonomy within its market and this is critical to our success, since it is the key to our ability to tailor products and services to meet local market needs. However, the review also concluded that there are material synergies that can be achieved through closer working across the Group, consistent with our decentralised approach; and work is underway to identify and capture these, for example by establishing a single global IT infrastructure and support unit with expected cost savings of £20-£25 million per annum.
Finally, the review concluded we must continue to enhance the effectiveness of our capital management processes, to ensure that investment and capital allocation decisions are focused on those areas of activity that will generate the best returns to shareholders.
Prudential is developing compelling positions in the world’s leading retail financial services markets. I am confident of the outlook for the Group and we aim to deliver significant profitable growth.
The Prudential-branded UK insurance business continued to develop its shareholder-backed business successfully and increased APE sales by 10 per cent in the year, to £900 million.
The internal rate of return on new business written in the year was 14 per cent, meeting the target set for 2007 two years early.
We continued in 2005 to increase the scale of our annuity business and at the same time reduce the average duration of the total book.
In October we entered the lifetime mortgage market, a market that is set to grow rapidly to an estimated £7 billion by 2008. Our innovative product has been designed with the customer, adviser and regulator in mind and initial customer interest has been encouraging. We have also made good progress in unit-linked and off-shore bond sales which grew 31 per cent and 15 per cent respectively in the year.
The A-Day proposals offer the opportunity to attract new business as customers increase contributions and consolidate their pension arrangements. We have already launched a new Flexible
Retirement Plan and we will undertake a review of our overall individual pensions offering during 2006. In addition, we have established a unit to communicate directly with our existing pension customers.
In addition, we continued to be successful in gaining access to multi-ties in the year. Prudential is in a strong position to benefit as the IFA market changes over the next 18-24 months and recently achieved a ‘5 star’ IFA service rating for its investment products and ‘4 star’ rating overall, demonstrating strong progress in this important area.
Our central focus in the UK is to use the strong franchises that we have to improve returns. We are targeting growth but also managing for value and we will not commit capital if we do not see the individual product returns that we require emerging over a reasonable timeframe.
Jackson National Life (JNL), the Group’s US operation, is a significant cash-generative business with the market positioning to continue its strong track record of profitable growth in the retirement market.
Georgia book of business acquired in May, transferring 1.5 million policies on to its low cost flexible platform. We fully expect to beat the 12 per cent return target for the transaction.
JNL’s strength in variable annuities, its ability to bring products to market rapidly and its positioning in advice-based distribution channels means it is very well placed to take advantage of the significant retirement savings flows expected from the ‘baby boomer’ generation over the coming years.
JNL’s priorities are to continue to focus on developing their position in the variable annuity market and to expand the business through bolt-on acquisitions that meet targeted rates of return.
Asia saw new business on an APE basis increase by 23 per cent to £731 million with double-digit rates of growth achieved in Korea,
We are maintaining momentum in the expansion of our distribution capability. Agency distribution is the dominant channel throughout the region and 75 per cent of our sales are from this source. Our proprietary agent distribution force across the region reached 170,000 in 2005 with particularly rapid expansion in agent numbers in India and China. We will continue to increase agent numbers in these and other markets as the bedrock on which we build our market share and market leadership positions. We will also maintain a clear focus on improving the productivity of our agent force across the whole region, and this is particularly significant for growth in those countries in which we have been long established.
We see material scope to increase sales volumes through our 40 existing bank distribution relationships and we intend to enter into new partnership agreements. We shall also continue to access direct and broker channels as they develop in individual markets.
As part of our global drive to attain new levels of cost efficiency, in Asia we are developing a ‘regional hub’ basis for sharing back
Group Chief Executive’s review continued £867million New business profit up 15 per cent to £867 million At constant exchange rates
office servicing and call centre facilities to leverage scale advantages beyond the reach of individual business operations. In March 2005 the first regional hub, servicing the Singapore and Malaysian life insurance operations, was launched. We have plans to open an additional hub in China in the second half of 2006, where we already have a regional IT development centre.
Improving capital efficiency is at the heart of the Group’s commitment to deliver sustainable increases in shareholder value and we will maintain a rigorous approach to capital allocation and deployment.
The Group is confident that it has the capital and cash resources to fund its planned organic growth.
Prudential, Egg and M&G on which to build for the future; ■ in the US, JNL is a significant cash-generative business with the market positioning for profitable growth in the retirement market.
It has competitive advantage in the sectors in which it chooses to operate; and the ability to participate in market consolidation through bolt-on acquisitions; ■ in Asia, we have an unrivalled exposure to opportunities for life insurance sales and profit growth across the region, whilst continuing our programme of rapid expansion and profit growth.
We are also expecting the region to become cash positive in 2006; and
■ our asset management businesses have significant growth prospects and are providing solid cash flow generation.
There is tremendous scope to deliver increasing value for shareholders from each individual business operation, and from the Group as a whole which derives both financial advantage and resilience from the diversity of its portfolio of businesses, and the opportunities for collaboration between them.
Group Chief Executive £234 billion Funds under management increased 19 per cent At reported exchange rates
The Group has delivered a good set of results for 2005, as illustrated by the double-digit growth of nearly all the measures shown above.
On an International Financial Reporting Standards (IFRS) basis, operating profit based on longer-term investment returns was up 36 per cent on last year driven by the growth in profits from the long-term and fund management businesses.
Prudential has a diverse international mix of businesses with a significant proportion of its profit generated outside the UK.
In 2005, 72 per cent of NBP and 54 per cent of IFRS operating profit was delivered from overseas operations. In preparing the
Consequently, the Board has for a number of years reviewed the
(CER) basis. This basis eliminates the impact from conversion, the effects of which do not alter the long-term value of shareholders’
APE sales for Prudential UK increased 10 per cent on 2004 to £900 million, driven by strong sales of bulk annuities (up 28 per cent) and unit-linked bonds (up 31 per cent). The Phoenix Life &
Pensions in-force annuity book transaction announced in June 2005 contributed £145 million to the full-year result.
Direct to Consumer channels which increased by 114 per cent and 14 per cent respectively. Despite APE sales of with-profits annuities through the Intermediaries channel increasing 100 per cent year-on-year, total individual annuities sales through this channel decreased 15 per cent reflecting the very competitive pricing environment throughout much of the year.
Results highlights 2004 Percentage 2004 Percentage £m unless otherwise stated 2005 (at CER) change 2005 (at RER) change
Total EEV basis operating profit* 1,712 1,288 33% 1,712 1,274 34%
† Comparative IFRS results are prepared on a ‘pro forma’ basis which reflects the estimated effect on the 2004 results as if IAS 32, IAS 39 and IFRS 4 had been applied from 1 January 2004 to the Group’s insurance operations together with the discretionary change for the basis of determining longer-term investment returns, as disclosed on 2 June 2005. IFRS operating profit is stated excluding goodwill impairment, short-term fluctuations in investments returns and shareholders' share of actuarial and other gains and losses on defined benefit pension schemes.
In the business review and financial review, year-on-year comparisons of financial performance are on a CER basis, unless specifically identified as being on a Reported Exchange Rate (RER) basis.
Total EEV basis operating profits fell 12 per cent on 2004 to £426 million primarily due to a persistency assumption change made at the half year. The charge of £148 million reflects a strengthening of persistency assumptions across all products, primarily in respect of with-profits bonds.
Increased IFRS profits arising from shareholder-backed annuities contributed to the 35 per cent increase in total IFRS operating profits, based on longer-term investment returns. In addition, the very strong investment performance of Prudential’s life fund over recent years resulted in an increase in total IFRS operating profits from the with-profits business attributable to shareholders.
Prudential UK operates through four diversified distribution channels. The Intermediaries channel, which accounted for 29 per cent of APE sales in 2005, distributes a range of medium to longterm savings products primarily through financial advisers and includes sales generated through multi-ties. The Business to
Business channel, which accounted for 28 per cent of 2005 APE
sales, distributes corporate pensions through work-site marketing in partnership with consulting actuaries and employee benefit consultants. The Partnerships channel has responsibility for developing relationships with banks and other distributors, including other insurers and accounted for 30 per cent of APE
The Partnerships channel signed a number of significant new agreements during the year. These included St. James’s Place for annuities; National Australia Bank for annuities and healthcare; Wesleyan’s multi-tie panel for protection; Zurich Financial Services and Openwork for annuities; and the Barclays multi-tie panel.
In addition, Prudential and Royal London reached agreement for all pension annuities arising from vestings of policies written under the Scottish Life brand in the period between January 2005 and December 2010 to be reassured to Prudential as they come into payment.
PruHealth, a healthcare product that links health and fitness to the cost of medical insurance plans, celebrated its first anniversary in the third quarter of 2005. The business has made good progress with sales growing on average more than 30 per cent per month in 2005. Total premium income for the year was £9 million and
Under the terms of the agreement Prudential receives commission, the levels of which to date have been offset against payments received at the time of the original transaction, therefore no profits are recognised on this business at this time. However, under the agreement, Prudential is entitled to receive full commission payments and associated profit, from 2008 onwards.
In addition, Prudential is reviewing its product range to identify where to focus future product developments to enable customers to take better advantage of the new regime.
November in which it proposed significant reform of the UK’s state and private pension systems. Prudential, with its extensive experience of pensions savings, will continue to play an active role in this debate and in helping to shape the new structure.
The Prudential Assurance Company’s (PAC) long-term fund remains very strong. On a realistic basis, with liabilities recorded on a market consistent basis, the free assets were valued at around £8.0 billion at 31 December 2005, before a deduction for the risk capital margin, and the fund is rated AA+ by Standard & Poor’s and
As a result of the strong investment performance achieved in 2005, Prudential UK announced in February 2006 that it will be increasing policy values for the vast majority of with-profits policies maturing in 2006.
The improved margin reflects a favourable business mix; an increase in the spread assumption for fixed index annuities reflecting the spread being achieved; improved average policy sizes for variable and fixed annuities; economic assumption changes, including an increase in the equity risk premium, and benefits derived from product pricing. Pricing benefits include the price increase, introduced in May 2004, on the Perspective II
Total IFRS operating profit of £362 million, based on longer-term investment returns, was up 27 per cent on 2004. The 2004 result benefited from two one-off items, a favourable legal settlement and an accounting adjustment arising from the adoption of new accounting guidance, totalling £29 million. The 17 per cent growth in long-term business operating profit primarily reflects a £119 million increase in spread income and record variable annuity fee income due to significant growth in separate account assets and the returns earned on those assets.
From 1999 to 2005, JNL has increased GAAP assets by a compound annual growth rate of 8.4 per cent from US$42 billion to US$68 billion, statutory premiums, excluding GIC deposits, from
index participation. Variable annuity products differ from the fixed annuity products in that the returns to the customer will depend upon the performance of the underlying fund portfolio. JNL’s variable annuity products offer a range of protection options, such as death and withdrawal benefits which are priced separately by
JNL improved fixed index annuity APE sales by 44 per cent to £62 million during the year, improving its market position to seventh for the year, up from ninth in 2004 (Source: LIMRA). Fixed annuity APE sales of £79 million in 2005 were down 31 per cent on 2004, reflecting the continued low interest rate environment and relatively flat yield curve in the US. JNL has continued to pursue value and hence has been unwilling to compromise entry spreads in this market. JNL was ranked the seventh largest provider of traditional individual deferred fixed annuities during 2005
variable annuity contract, both of which included the full menu of
Investor’, a variable universal life contract. The flexibility of JNL’s technology, and demonstrable competency in execution, have resulted in an ability to quickly and efficiently meet the changing needs of consumers and advisors.
In 2005, NPH increased total revenues by three per cent to £231 million. At June 2005, NPH was ranked the sixth largest independent broker-dealer by revenue (Source: Financial
As a result of capital conservation measures introduced in previous years and further strong earnings, JNL continued to generate significant levels of capital, improving the capital ratio from 8.5 per cent in 2004 to 9.2 per cent in 2005. JNL’s statutory capital, surplus and asset valuation reserve position improved year-on-year by
JNL has completed the integration of the 1.5 million Life of Georgia policies onto its own operating platform. This achievement clearly demonstrates JNL’s operational effectiveness and its increasing capability in consolidating large blocks of business. This acquisition doubled the number of JNL’s in-force life and annuity policies, adding scale to its operating platform and expanding its distribution capability, as well as further diversifying its income streams. This transaction enabled JNL to grow its life business at a higher return and faster rate than could be achieved organically. JNL expects to achieve the target internal rate of return after tax on this transaction of 12 per cent, and will continue to consider further US bolt-on acquisitions as opportunities arise.
With its relationship driven distribution, innovative product manufacturing capability and low cost operating model, JNL is well positioned to take advantage of the evolving opportunities in the
US retirement market. As ‘baby boomers’ retire and shift their focus from asset accumulation to income distribution, one of
‘baby boomers’ reaching 60 this year, will, over the next decade,
However, there are some formidable barriers to successful entry including entrenched incumbents, the pace of change and nature of regulations, mandatory partners in some markets and a shortage of experienced staff. Acquisition opportunities, particularly of scale businesses, are limited and in North Asian markets are likely to involve back books that currently experience negative spread and hence require material provisions under European regulatory capital requirements.
Asian platform, strengthening and protecting its market-leading positions in its established markets (Singapore, Hong Kong and
Philippines, Vietnam), securing strong joint venture partners for the sizable opportunities in India and China (ICICI and CITIC
In all its markets, Prudential has been focused on building proprietary distribution as the most effective way of delivering sustainable new business volumes and managing the customer proposition; typically through growing tied agency and integrated bancassurance arrangements (such as with Standard Chartered
During 2005, the business continued to make very solid progress in a number of key areas.
In China, six new cities were added including Wuhan, the provincial capital of Hubei. CITIC-Prudential now has 10 cities operational in China and a further new provincial capital, Jinan in
Bancassurance with Standard Chartered Bank in Hong Kong continues to be especially successful and there is considerable potential particularly in Singapore, Malaysia and Taiwan over the short to medium term. The life business in Japan remains challenging and after piloting a Financial Adviser channel with little success and high running costs this was closed in January 2006; the emphasis is now on developing profitable partnership distribution opportunities.
Total EEV basis operating profit* 576 473 22% 576 460 25%
*Based on longer-term investment returns and excluding fund management operations, development and Asia regional head office expenses.
Prudential remains firmly focused on long-term profitability. In 2005, Prudential’s new business APE mix was 73 per cent linked products compared to the industry total of 29 per cent and new business volumes were in line with 2004. NBP margins in Taiwan were 51 per cent compared to 61 per cent the previous year. The change is due to a higher proportion of capital efficient and popular new retirement-focused regular premium unit-linked savings plans that are investment-orientated.
‘three lines of defence’; the operational management in each business, strong risk management related functions and an independent internal audit function. Prudential’s policies are clear that any breach of regulatory standards attributable to staff malpractice is unacceptable.
In financial terms, 2005 was another strong year. Prudential’s new business APE grew by 23 per cent to £731 million over 2004. The
IFRS operating profits based on longer-term investment returns, increased 64 per cent to £195 million from £119 million in 2004, however, 2005 does include a net £30 million from various non-recurring items including a net £44 million profit as previously disclosed at the half year and subsequently reduced by £14 million of restructuring charges in Japan. Excluding these, growth was 39 per cent reflecting the steady increase in profits from the established markets with total IFRS operating profits of £127 million, up 14 per cent, the emergence of profits on the
IFRS basis from the new business being sold across the region and lower expenses in Japan.
Prudential Asia’s high proportion of profitable, regular premium business combined with sound operational management means cash flows can be predicted with some certainty. As previously announced, the business is on target to fund continued strong growth internally and begin remitting surplus cash back to the
In summary, Prudential has an excellent track record of building a profitable business in Asia and the scale of the opportunity for continued growth is clear.
Prudential’s three asset management businesses are aligned with their respective markets in the UK, Asia and the US. They operate under different brands and with different models, each of which is described further below.
M&G is Prudential’s UK and European fund management business and has £149 billion of funds under management, of which £113 billion relates to Prudential’s long-term business funds. M&G
operates in markets where it has a leading position and competitive advantage, including retail fund management, institutional fixed income, pooled life and pension funds, property and private finance. M&G also manages Prudential’s balance sheet for profit.
included £7 million of non-recurring provision releases. Adjusting for this gives a like-for-like increase in profits of 34 per cent over 2004. This continues a strong upward trend which has seen underlying profits grow from £49 million in 2002 to £138 million last year, reflecting the strengths of M&G’s diversified business, disciplined cost management and the successful development of new sources of revenue.
PRF in 2005 were £24 million, including £17 million as a result of several exceptionally profitable realisations by PPM Capital that are not expected to recur. M&G received £7 million of performance fees for managing Prudential’s long-term and annuity funds, which continued to beat their strategic and competitor benchmarks during the year.
M&G enjoyed a record year for sales during 2005, with gross fund inflows increasing 35 per cent to £7.9 billion. Net fund inflows also grew significantly, almost doubling to £3.9 billion and external funds under management, which represent a quarter of M&G’s total funds, rose by 26 per cent to £36.2 billion.
Austria, Italy, Luxembourg and Switzerland, more than tripled its funds under management during the year. M&G’s South African business saw a doubling of retail funds under management. Retail fund performance continued to be very strong, especially M&G’s equity funds which saw 92 per cent of funds beating their UK
Significant growth in the areas of private finance and property helped net fund inflows increase 59 per cent to £2.5 billion. M&G
continued its successful strategy of generating new revenue streams with attractive margins using expertise developed for internal funds, especially in the area of non-correlated assets such as leveraged loans. M&G broke new ground in this asset class during the year with the launch of Europe’s first pure leveraged loan fund, the M&G European Loan Fund. The success of M&G’s
Collateralised Debt Obligation (CDO) programme also continued during 2005 with the launch of five new CDOs. In property, the development of external vehicles managed by Prudential Property
Investment Managers (PruPIM) for third party clients delivered strong fund inflows.
Total reported third party funds under management of £10.1 billion was up 13 per cent on 2004. In August last year, ICICI increased its stake in Prudential’s India asset management joint venture from 45 per cent to 51 per cent. As a result, Prudential no longer consolidates this business at 100 per cent and the year end numbers are reported at 49 per cent, resulting in a £1.5 billion reduction in funds under management for the year. On a comparable basis, full year 2005 funds under management grew 29 per cent on 2004.
PPM America 2004 Percentage 2004 Percentage £m unless otherwise stated 2005 (at CER) change 2005 (at RER) change *Based on longer-term investment returns.
PPM America, based in Chicago, is Prudential’s North American institutional investment manager, specialising in public and private fixed income and equity, and real estate securities, and, through its affiliate PPM Finance, Inc., commercial mortgage lending. At the end of 2005, PPM America had funds under management of £41 billion (including PPM Finance), of which 68 per cent relates primarily to JNL policyholder assets, 29 per cent to funds managed on behalf of other Prudential UK and Asian affiliates, and three per cent to funds managed for external clients, including CDOs and similar products.
In 2005, PPM America increased IFRS profits by 67 per cent, primarily due to a one-off £5 million revaluation related to investment vehicles managed by PPM America.
Highlights of UK banking business: Net interest income 312 287 9%
Egg is an innovative financial services company primarily offering banking products and services, specifically, unsecured personal loans, credit cards, mortgages and savings accounts. Egg is now one of the world’s largest on-line banks with approximately 3.7 million predominantly young and upmarket customers acquired since launch.
Operating profit from the core UK banking business was £60 million, compared with £72 million in 2004. This result represents a strong performance given a very challenging set of market conditions with sharply reducing growth in unsecured borrowings, narrowing margins following the increase in average base rates and a sharp deterioration across the industry in underlying credit quality.
In particular, the introduction of new measures into the sales processes of payment protection insurance products in 2005 has led to a significant reduction in income from these products across the industry.
Egg has completed the re-focus on its successful core UK banking business over the last 12 months. The exit from France was completed in the first quarter of 2005 with total costs incurred within the provision established in 2004. In October 2005, Egg completed the sale of Funds Direct, its investment wrap platform business. Total operating profit from continuing operations in 2005 includes £10 million of restructuring costs.
This reorganisation aligned Egg’s cost base with its strategic focus on the UK business and contributed to a £17 million reduction in total expenses between 2005 and 2004.
Transaction costs of £7 million were incurred during 2005 in relation to Prudential’s acquisition of the minority shareholdings in Egg.
The immediate benefits from the restructuring implemented in early 2005, together with Egg’s effective cost management contributed to the continued downward trend in Egg’s cost to income ratio. It was 43 per cent for 2005, compared to 49 per cent and 53 per cent for 2004 and 2003 respectively.
The launch of Egg Money in September has further strengthened the brand awareness and reinforced the innovative values of Egg.
On 1 December 2005, the Boards of Prudential and Egg announced a recommended Offer by Prudential for the whole of the issued and to be issued shares of Egg not already owned by the Prudential Group. This represented approximately 21.7 per cent of the existing issued share capital of Egg.
On 20 February 2006, Egg shares were delisted from the Official List.
It is anticipated that the acquisition of the minority will enable
(RER), APE was up 16 per cent on 2004. The strong growth is reflected across all regions with APE up on 2004 by 10 per cent in the UK, 13 per cent in the US and 23 per cent in Asia at CER.
Total gross investment sales for 2005 were £26.4 billion, up six per cent on 2004 at RER. Net investment flows of £5.2 billion were up 58 per cent on last year at RER.
Total investment funds under management in 2005 increased by 24 per cent from £37.2 billion to £46.3 billion at RER, reflecting net investment flows of £5.2 billion and net market and other movements of £3.9 billion.
At 31 December 2005, total insurance and investment funds under management were £234 billion, an increase of 19 per cent up from 2004 at RER.
Present value of new business premiums in 2005 increased by 12 per cent to £16.8 billion. Present value of new business premiums is the preferred basis of disclosing margin under
EEV principles, and from the half year 2006 we will provide commentary on this basis. We will continue to provide detail on the APE basis for the foreseeable future until familiarity with the new basis of reporting is developed.
Embedded Value (EEV) basis for the Group’s long-term business, including asset management operations and service companies that support the long-term businesses. These results are combined with the IFRS basis results of the Group’s other businesses.
Reference to operating profit relates to profit including the expected long-term rate of return on investments, but excludes exceptional items, short-term fluctuations in investment returns and the effect of changes in economic assumptions.
The European Union (EU) requires that all listed European groups prepare their 2005 financial statements in accordance with EU
of reporting. To prepare the market for the changes the Group reported the impact of restating its 2004 results in its Economic and Financial Reporting announcement on 2 June 2005.
The announcement explained that the IFRS changes have been implemented in two stages. First, for the purposes of formal IFRS
adoption from 1 January 2004 all standards other than IAS 32,
Due to the complications for the retrospective application, particularly for the banking industry for financial instruments, the
■ recognition of the shareholders’ share of deficits on defined benefit pension schemes in shareholders’ equity.
Total profit before tax now includes value movements on derivatives that JNL uses for economic hedging together with
The adoption of IFRS does not have a significant impact on the business or the underlying financial position.
Group’s long-term businesses and is a valuable supplement to statutory accounts.
Prudential has adopted EEV methodology for its 2005 year end results. This replaces the achieved profits basis of reporting. The main impact of the change from the achieved profits basis on the results arises from the effects of changes to the assumed level of locked-in capital allocated to each business, the adoption of product specific risk discount rates, and an explicit valuation of the time value of options and guarantees. The EEV results also include the value of future profits from fund management and service operations that support the long-term business. In most other respects the approach that Prudential used for its achieved profits reporting already conforms to the requirements of the
On the EEV basis, the shareholders’ interest in the Group’s longterm businesses comprises: ■ The 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; ■ the locked-in (encumbered) capital; and
Total EEV basis operating profit from continuing operations based on longer-term investment returns was £1,712 million, up 33 per cent from 2004 at CER. At RER, the result was up 34 per cent. This result reflects a combination of strong growth in all the insurance and funds management businesses.
In 2005, the Group has generated record NBP from insurance business of £867 million which was 15 per cent above 2004 at CER, 2004 2004EEV basis operating profit based on longer-term 2005 (at CER) Percentage 2005 (at RER) Percentage investment returns £m £m change £m £m change
Insurance business: Fund management business: US broker-dealer and fund management 24 15 60% 24 15 60%
driven by strong sales momentum across all markets. At RER, NBP
The in-force profit includes a £148 million charge in respect of a persistency assumption change in the UK and a credit in the US of £140 million reflecting an operating assumption change following price increases introduced on two blocks of in-force term life business announced at the half year. In aggregate, net assumption changes were negative £54 million, with net positive experience variances and other items of £79 million.
EEV basis operating profit based on longer-term investment returns of £426 million was down 12 per cent on 2004. 62 per cent of the profit was attributable to the with-profits fund.
Prudential UK’s new business profit remained in line with 2004 at £243 million. This was driven by the 10 per cent increase in APE
sales volumes which was offset by a fall in the new business profit margin (from 30 per cent in 2004 to 27 per cent in 2005 on an APE
The profits arising from the unwind of discount from the in-force book were partially offset by adverse operating assumption changes and other experience variances.
At the half year, persistency assumptions were strengthened across a number of products, primarily in respect of with-profits bonds. This resulted in a charge of £148 million for 2005 on an
The persistency assumptions represent Prudential’s current best estimate of future experience. In the case of Prudence Bond, a product with no set maturity or term and no surrender penalties after five years, future customer behaviour may differ from past experience, making it difficult to anticipate future actual surrenders with certainty.
However, the attractiveness of Prudence Bond as a long-term investment is demonstrated by investment returns that a typical customer has achieved. A Prudence Bond policy will have seen its value increase from £10,000 to £18,137 over the 10 years up to 6
New annuity business written in 2005 has been priced on the new basis for both EEV and IFRS.
Jackson National Life (JNL) new business profit of £211 million was up 45 per cent on 2004, reflecting a 13 per cent increase in
For JNL, the average IRR on new business was 15 per cent which reflects JNL’s strong pricing discipline.
In the US, the in-force profit of £530 million is 123 per cent up on 2004 at CER. The increase was primarily due to increased unwind of discount on the in-force business, an operating assumption change following price increases introduced on two older books of term life business (£140 million), and improved spread variance.
As a discretionary change of accounting policy, implemented at the same time as the adoption of IFRS, the Group has replaced the previous basis of five year averaging of gains and losses on bonds with a method that more closely reflects longer-term returns.
The excess or deficit of actual realised gains and losses for fixed income securities for the period over these components of longerterm returns is included in short-term fluctuations in investment returns as a separate component of total profit for the period.
EEV basis operating profit based on longer-term investment returns from long-term operations (excluding development and regional head office costs) was £576 million for the year, up 22 per cent at CER and 25 per cent at RER on 2004.
APE sales were up 23 per cent on 2004 and the NBP margins were 56 per cent on an APE basis and 10.2 per cent on a present value of premiums basis, compared with 61 per cent and 10.4 per cent respectively in 2004 at CER. The key drivers of lower margins in
Asia’s in-force profit (before development expenses and the Asian fund management business) increased to £163 million in 2005 from £108 million in 2004 at CER. This reflects a higher value related to the unwind of the discount rate as the in-force business builds scale.
In Asia we have target IRRs on new business at a country level of 10 percentage points over the country risk discount rate. Risk discount rates vary from five per cent to 18 per cent depending upon the risks in each country market. These target rates of return are average rates and the marginal return on capital on a particular product could be above or below the target.
We have, however, exceeded the target in each of Asia’s markets in 2005 except for Thailand and Japan, which have yet to reach scale. In aggregate, IRR on new business exceeded 20 per cent on average new business risk discount rates for 2005 of 9.8 per cent.
M&G’s operating profit was £163 million, an increase of 20 per cent on last year. This included £24 million in performance-related fees (PRF), of which £17 million was earned by PPM Capital following another year of extremely profitable realisations on behalf of its clients. These are not expected to recur.
Finance, which manages Prudential’s balance sheet for profit, private finance, including CDOs, and Prudential Property Investment
underlying profits have increased consistently from £49 million in 2002 to £138 million in 2005. Profits growth in 2005 was largely due to the impact of higher asset prices in equity and property markets, combined with the impact of positive net inflows over a period of several years. In addition, discipline continues to be exercised over costs, which have risen only slightly this year after four years in which they were held flat.
The broker-dealer and fund management operations reported profits of £24 million, compared with £15 million in 2004, primarily due to a one-off £5 million revaluation related to an investment vehicle managed by PPM America.
The fund management business in Asia has expanded into new markets in the past few years and is now in nine markets across
Asia. Geographic diversification along with this growth in scale has resulted in a strong upward trend in profits.
Profit from the Asian fund management operations was £12 million for the year, down 37 per cent from 2004 reflecting the exceptional costs of £16 million incurred due to bond fund restructuring required as a result of industry wide issues in Taiwan. Underlying profit from the Asian fund management operations, excluding charges of £16 million, grew by 47 per cent to £28 million, a strong result indicative of the economies of scale the business is now generating. Adjusting for the reporting of India at 49 per cent from 26 August 2005 results in an increase in profits of 55 per cent
The reduction from £72 million for 2004 primarily reflected the fact that although Egg successfully grew income by £31 million in a difficult market and cut £17 million from its cost base, this was more than offset by an increase of £59 million in bad debts due to the changing mix in the portfolio, business growth plus a deterioration in credit quality driven by economic factors across the UK unsecured lending market.
The UK unsecured lending market only grew marginally in 2005 and, indeed, there was a net reduction in credit card balances in the second half of the year. Against this tough market environment,
Egg managed to drive up the return on its credit card portfolio by focusing on growing interest bearing balances and successfully
repricing the card to reflect the higher funding costs, given base rates had risen on average compared to 2004. This contributed to an increase of £32 million in net interest income.
In 2005, a sharp deterioration in credit quality has adversely affected the UK retail banking sector leading to an increase in impairment charges across the sector, including Egg, compared to expectations. The result Egg achieved, which we believe is better than average industry performance, is due to the tactical decision to tighten its lending criteria early in the credit cycle, active portfolio management and its underlying higher quality card portfolio.
Regulatory attention continues to be devoted to the creditor insurance market and we believe the introduction of new measures into the sales processes for payment protection products has led to a reduction of approximately 20 per cent on the commission revenue earned on this product across the banking sector. Egg experienced similar reductions, a solid performance for an on-line bank.
Through the acquisition of the minority interests of Egg and the closer partnership of Egg with Prudential UK life and pension businesses, Prudential expects to achieve total annualised pre-tax cost savings across the combined businesses of £40 million by the end of 2007. Costs of approximately £50 million pre-tax are estimated to be incurred from this restructuring. This will be provided for in 2006.
Asia’s development expenses (excluding the regional head office expenses) increased by 33 per cent at CER to £20 million, compared with £15 million in 2004. These development expenses primarily related to our newer operations and establishing our services hub in Malaysia.
Other net expenditure remained constant over 2004. This reflected other income as a result of the interest earned on the net proceeds from the 2004 Rights Issue offset by higher interest payable. Head office costs (including Asia regional head office costs of £30 million) were £100 million, up £19 million on 2004.
The result before tax and minority interests was a profit of £2,244 million up 26 per cent on 2004. This reflects an increase in operating profit from £1,274 million to £1,712 million, together with a favourable movement of £431 million in short-term fluctuations in investment returns from £570 million to £1,001 million.
This is offset by negative movements, principally £223 million due to changes in economic assumptions and a goodwill impairment charge of £120 million.
In Asia, long-term business short-term investment fluctuations were £41 million, compared to £91 million last year. This mainly reflects improving equity markets in a number of countries.
In the UK, economic assumption changes of negative £81 million reflect the impact of the increase in the future investment return assumption offset by the increase in the risk discount rate. The increases arise because although interest rates have decreased over 2005, the equity risk premium assumption has increased from three per cent to four per cent.
Asia’s negative economic assumption changes of £265 million primarily reflect the effect of lower bond yields in Taiwan which necessitated a reduction in the Fund Earned Rate assumptions. The economic scenarios used to calculate 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. The projections assume that, in the average scenario, the current bond yields of around two per cent trend towards 5.5 per cent at 31 December 2012. Allowance is made for the mix of assets in the fund, our 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 cash flows.
The effect of change in the time value of cost of options and guarantees was positive £47 million for the year, consisting of £31 million, £11 million and £5 million for the UK, the US
The result after tax, minority interests and discontinued operations was £1,582 million. The tax charge of £653 million compares with a tax charge of £553 million in 2004. Minority interests in the Group results were £12 million.
operating profit from continuing operations as a percentage of opening embedded value.
Reference to operating profit relates to profit including investment returns at the expected long-term rate of return but excludes short-term fluctuations in investment returns, actuarial gains and losses of defined benefit pension schemes and exceptional items.
In the UK, IFRS operating profit increased 35 per cent to £400 million in 2005. This reflected a nine per cent increase in profits attributable to the with-profits business, a consequence of bonus declarations announced in February 2005 and February 2006, a 44 per cent increase in profits arising from annuities business, and IFRS profits arising from the Phoenix Life and Pensions transaction completed in June 2005.
In the US, IFRS operating profit of £362 million was up 27 per cent on 2004. IFRS operating profit for long-term business was £348 million, up 17 per cent from £298 million in 2004. The
US operations’ results are based on US GAAP, adjusted where necessary to comply with IFRS as the Group’s basis of presenting operating profit is based on longer-term investment returns. In determining the US results, longer-term returns for fixed income securities incorporate a risk margin reserve (RMR) charge for longer-term defaults and amortisation of interest-related realised gains and losses.
The 2004 result benefited from two one-off items, a favourable legal settlement of £28 million (£21 million after related charge to amortisation of deferred acquisition costs) and a positive £8 million adjustment arising from the adoption of new accounting guidance
in SOP 03-01, ‘Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration Contracts and for
Separate Accounts’. This adjustment relates to a change in the method of valuing certain liabilities.
The improvement in non-long-term business profits was primarily driven by reduced losses recorded by Curian, down to £10 million from £29 million in 2004, as the business continues to build scale.
India which are relatively new businesses rapidly building scale; Thailand and Taiwan which are marginally loss making; and Japan where the loss increased over 2004 due to restructuring costs incurred during the year.
The development of the Japanese life business has been slower than expected and, following its restructuring and the annual impairment review, Prudential concluded that the purchased goodwill associated with this business of £120 million should be written off.
2005 (at CER) Percentage 2005 (at RER) Percentage IFRS operating profit based on longer-term investment returns £m £m change £m £m change
The Board recommends a full year dividend per share for 2005 of 16.32 pence, an increase of three per cent over the full year 2004 dividend of 15.84 pence.
funds £5,194 million; subordinated long-term and perpetual debt of £2,098 million; other core structured borrowings £1,093 million and the unallocated surplus of with-profits funds of £11.4 billion.
All of the Group’s hybrid debt which qualifies in this way is held at the Group level and is therefore taken as capital into the parent solvency test under the Financial Conglomerates Directive (FCD).
Group’s policy to take advantage of favourable market conditions as they arise to do so.
Prudential manages its assets and liabilities locally, in accordance with local regulatory requirements and reflecting the differing types of liabilities Prudential has in each business. As a result of the diversity of products Prudential offers and the different regulatory environments in which it operates, Prudential employs different methods of asset/liability management on both an in-force and new business basis. Stochastic modelling of assets and liabilities is undertaken in the UK, the US and Asia to assess economic capital requirements for different confidence intervals and time horizons.
Our commitment to our shareholders is to maximise the value of
On the EEV basis, which recognises the shareholders’ interest in long-term businesses, shareholders’ funds at 31 December 2005 were £10.3 billion, an increase of £1.7 billion from the 2004 year end level after restating for relevant IFRS changes. This 20 per cent increase primarily reflects: total EEV basis operating profit of £1,712 million; a £1,001 million favourable movement in shortterm fluctuations in investment returns; and the positive impact of £442 million for foreign exchange movements. These were offset by: a £302 million negative movement due to changes in economic assumptions; a tax charge of £653 million; dividend payments of £325 million made to shareholders (net of scrip dividend); and the impairment charge of £120 million in respect of purchased goodwill associated with the Japanese life business.
At year end 2005, the embedded value for the Asian long-term business as a whole was £2.0 billion. The established markets of Hong Kong, Singapore and Malaysia contribute £1.8 billion to the embedded value generated across the region with Korea
Thailand and the Philippines in aggregate contribute £211 million in embedded value. Growth in embedded value for the Asian business as a whole has been partially offset by a negative embedded value in Taiwan of £311 million which includes the associated cost of economic capital, and reflects the low interest rate environment in Taiwan.
The current mix of business in Taiwan is weighted heavily towards unit-linked and protection products, representing 73 per cent and 16 per cent of new business APE in 2005, respectively. As a result, interest rates have little effect on new business profitability and a one per cent reduction in assumed interest rates would reduce new business margins in Taiwan by only two percentage points.
IFRS basis at 31 December 2004. The increase primarily reflects: profit after tax and minority interests of £748 million and positive foreign exchange movements of £268 million, offset by dividend payments to shareholders (net of scrip dividend) of £325 million.
Cash remitted by business units: UK life fund transfer* 194 208
comprising the shareholders’ statutory life fund transfer of £198 million relating to the 2004 bonus declarations, of which £194 million was remitted from the UK and £4 million from Asia, together with other remittances from subsidiaries of £319 million.
US$150 million from JNL. The reduced transfer from M&G is due to a higher level of reinvestment in 2005 in new activities together with a remittance of surplus cash in 2004.
After net dividends and interest paid, there was a net cash inflow of £79 million (2004: £198 million).
During 2005, the Group holding company paid £66 million in respect of corporate activities and received £107 million in respect
In aggregate this gave rise to a decrease in cash of £298 million
As a result of the bonus declarations made in February 2005 and February 2006, the shareholder transfer is expected to be £223 million in 2006.
Cash invested to support the UK business in 2006 is expected to be less than 2005, up to £230 million depending on the mix of business written and the opportunities available.
Net core structural borrowings at 31 December 2005 were £1,611 million compared with £1,236 million at 31 December 2004. This reflects the net cash outflow of £298 million, exchange conversion losses of £92 million and IFRS adjustments of negative £15 million.
After adjusting for holding company cash and short-term investments of £1,128 million, core structural borrowings of shareholder-financed operations (excluding Egg) at the end of 2005 totalled £2,739 million, compared with £2,797 million at the end of 2004. This decrease reflected the repayment of
Core long-term loans at the end of 2005 included £1,830 million at fixed rates of interest with maturity dates ranging from 2007 to perpetuity. £1,010 million of the core borrowings were denominated in US dollars, to hedge partially the currency exposure arising from the Group’s investment in JNL.
Prudential has in place an unlimited global commercial paper programme. At 31 December 2005, commercial paper of £408 million, US$1,538 million and €228 million has been issued under this programme. Prudential also has in place a £5,000 million medium-term note (MTN) programme. At 31 December 2005, subordinated debt outstanding under this programme were £435 million and €520 million, and senior debt outstanding was
US$18 million. In addition, the holding company has access to £1,500 million committed revolving credit facilities, provided by 15 major international banks and a £500 million committed securities lending liquidity facility. These facilities have not been drawn on during the year. The commercial paper programme, the MTN programme, the committed revolving credit facilities and the committed securities lending liquidity facility are available for general corporate purposes and to support the liquidity needs of the parent company.
The Group’s insurance and asset management operations are funded centrally. Egg, as a separate bank, is responsible for its own financing. The Group’s core debt is managed to be within a target level consistent with its current debt ratings. At 31 December 2005, the gearing ratio (debt, net of cash and short-term investments, as a proportion of EEV shareholders’ funds plus debt) was 13.5 per cent compared with 12.5 per cent at 31 December 2004.
During 2005, the unallocated surplus, which represents the excess of assets over policyholder liabilities for the Group’s with-profits funds on a statutory basis, grew from £8.3 billion at 1 January (after the effect of adoption of IFRS and the realistic reporting regime in the UK) to £11.4 billion at 31 December. This reflects an increase in the cumulative retained earnings arising on with-profits business that have yet to be allocated to policyholders or shareholders. The change in 2005 predominantly reflects the positive investment return earned by the PAC with-profits fund as a result of investment gains in the UK equity market.
The FCD, which affects groups with significant cross-sector activities in insurance and banking/investment services, came into force for Prudential from 1 January 2005. Prior to this, since 1 January 2001 Prudential was required to meet the solvency requirements of the Insurance Groups Directive (IGD), as implemented by the FSA. The FSA has implemented the FCD by applying the sectoral rules of the largest sector, hence a group such as Prudential is classified as an insurance-led conglomerate and is required to focus on the capital adequacy requirements of the IGD, the Consolidated Life Directive and the Insurance
Due to the geographically diverse nature of Prudential’s operations, the application of these requirements to Prudential are complex. In particular, for many of our Asian operations, the assets, liabilities and capital requirements have to be recalculated based on FSA regulations as if the companies were directly subject to FSA regulation.
The EU is continuing to develop a new prudential framework for insurance companies, ‘the Solvency II project’. The main aim of this framework is to ensure the financial stability of the insurance industry and protect policyholders through establishing solvency requirements better matched to the true risks of the business. Like
Internal Market Director-General, with formal ‘Level 1’ agreement by the European Parliament and Council on framework directive made after a full consultation process. The detailed regulatory requirements are negotiated at ‘Level 2’ with the EC receiving guidance from the European Insurance and Occupational Pensions
The PAC long-term fund is rated AA+ by Standard & Poor’s and
The table below shows the change in the investment mix of
For the main UK with-profits fund 83 per cent of fixed income securities are investment grade with 25 per cent rated AA or above. For Prudential Annuities Limited 95 per cent of the fixed income securities are investment grade with 48 per cent rated
AA or above. For Prudential Retirement Income Limited 98 per cent of total assets are investment grade with 57 per cent rated
(equity plus property) was nearly 74 per cent which reflects an approximate 10 per cent increase in the equity exposure over the year with a corresponding reduction in the bond and, to a lesser extent, the property exposure – a strategy driven by the perceived attractive pricing of equities relative to other assets in the earlier part of 2005, which led us to move back into equities. To some extent this is a retracing of the substantial (and successful) equity reduction strategy implemented towards the end of the late 90s
Index (Total Return) of 18.5 per cent, 2.2 per cent and 7.9 per cent. These returns demonstrate the benefits of the fund’s strategic asset allocation and long-term outperformance.
JNL’s financial strength is rated AA by Standard & Poor’s (negative outlook) and A1 by Moody’s.
Prudential Corporation Asia maintains solvency margins in each of its operations so that these are at or above the local regulatory requirements. Across the region less than 20 per cent of nonlinked funds are invested in equities.
Prudential Assurance’s main long-term business with-profits fund paid compensation of £24 million in 2005 in respect of mortgage endowment product mis-selling claims and held provisions of £63 million at 31 December 2005 to cover further claims. These compensation payments and provisions have had no impact on policyholders’ asset shares. As a result, policyholders’ bonuses and the shareholders’ share of these bonuses are unaffected, resulting in no impact on the Group’s profit before tax.
A provision of £6 million was held at 31 December 2005 by shareholders’ funds to cover potential compensation in respect of mis-selling claims for Scottish Amicable mortgage endowment products sold since the acquisition of Scottish Amicable in 1997. In addition, a provision of £50 million was held at 31 December 2005
for the closed Scottish Amicable Insurance Fund (SAIF) in respect of mortgage endowment products sold prior to acquisition. This provision has no impact on shareholders. No further Scottish
■ absorbing the costs of significant events, or fundamental changes in its long-term business without affecting bonus and investment policies.
Hence policyholders’ pay-out values have been unaffected by personal pension mis-selling.
The assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing. This review was completed on 30 June 2002 and consequently the assurance has not applied to new business issued since 1 January 2004. Therefore the maximum amount of capital support available under the terms of the assurance will reduce over time as claims are paid on the policies covered by it.
(for subsidiary accounting in the UK), and IAS 19 for the Group financial statements. FRS 17 and IAS 19 are very similar. As at 31 December 2005 the shareholders’ share of the deficit of these schemes amounted to £153 million net of related tax relief.
Defined benefit schemes in the UK are generally required to be subject to full actuarial valuation every three years to assess the appropriate level of funding for schemes having regard to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds. PSPS was last actuarially valued as at 5 April 2002 and this valuation demonstrated the Scheme to be 110 per cent funded, with an excess of actuarially determined assets over liabilities of 10 per cent, representing a fund surplus of £376 million.
PSPS Scheme has been apportioned in the ratio 80/20 between the life fund and shareholder-backed operations. During the year, additional analysis has been undertaken and the ratio reassessed as 70/30. At 31 December 2005, the total share of the deficits on
PSPS and the much smaller Scottish Amicable scheme attributable to the PAC life fund amounted to £296 million net of related tax relief.
A significant part of the Group’s business involves the acceptance and management of risk. The Group’s risk management model requires the primary responsibility for risk management at an operational level to rest with business unit chief executives. The second line of defence of risk comprises oversight functions reporting to the Group Chief Executive, Group Chief Risk Officer and Group Risk function together with business unit risk functions and risk management committees. The third line of defence comprises independent assurance from Internal Audit reporting to business unit and Group audit committees.
Prudential’s primary with-profits sub-fund is part of PAC’s longterm fund. The return to shareholders on virtually all with-profits products is in the form of a statutory transfer to PAC shareholders’
funds which is analogous to a dividend from PAC’s long-term fund and is dependent upon the bonuses credited or declared on policies in that year. Prudential’s with-profits policyholders currently receive 90 per cent of the distribution from the main with-profits sub-fund as bonus additions to their policies and shareholders receive 10 per cent as a statutory transfer.
The profits from almost all of Prudential’s new non-participating business accrue solely to shareholders. Such business is written in the non-profit sub-fund within PAC’s long-term fund, or in various shareholder-owned direct or indirect subsidiaries, the most significant of which is Prudential Retirement Income Limited (PRIL), which also writes all new immediate annuities arising from vesting deferred annuity policies in the with-profits sub-fund of PAC.
(GMIB). GMWBs provide a guaranteed return of the principal invested by allowing for periodic withdrawals which are limited to a maximum percentage of the initial premium. GMIBs provide for a minimum level of benefits upon annuitisation regardless of the value of the investments underlying the contract at the time of annuitisation. The GMIB is reinsured.
The life insurance products offered by Prudential Corporation Asia include a range of with-profits (participating) and non-participating term, whole life and endowment and unit-linked policies. Prudential also offers health, disablement, critical illness and accident cover to supplement its core life products.
Unit-linked products tend to have higher profits on the EEV basis of reporting than traditional non-linked products as expenses and charges are better matched and solvency capital requirements are lower. At the end of 2005 Prudential Corporation Asia offered unitlinked products in 10 of the 12 countries in Asia in which it operates.
In addition to the life products described above, Prudential offers mutual fund investment products in India, Taiwan, Japan, Singapore,
Malaysia, Hong Kong, Korea and Vietnam, allowing customers to participate in debt, equity and money market investments. The
However, the products sold by the life insurance industry are by their nature long-term, as it commits to service the products for many years into the future. In many cases policies require customers to continue to pay further premiums in the future. The profit on these insurance sales is generated over a significant number of years and IFRS basis profits do not, in Prudential’s opinion, properly reflect the inherent value of these future profit streams.
Embedded Value (EEV) Principles which are designed to improve the transparency and consistency of embedded value reporting.
Member companies, of which Prudential is one, agreed to adopt the principles for supplementary reporting no later than the financial year end commencing 1 January 2005. Prudential has fully adopted the Principles for the first time in respect of full year 2005 results.
The EEV basis not only provided a good indicator of the value being added by management in a given accounting period but it also demonstrates whether shareholder capital is being deployed to best effect. Indeed insurance companies in many countries use comparable bases of accounting for management purposes.
basis which, at a given point in time, is the value of future cash flows expected to arise from the current book of long-term insurance business plus the net worth of the Company. In determining these expected cash earnings, Prudential makes full allowance for the risks attached to their emergence and associated cost of capital and takes into account recent experience in assessing likely future persistency, mortality and expenses.
The change in value is typically analysed as shown in the EEV basis shareholders’ funds chart into the following components: the value added from new business sold during the year; the change in value from existing business already in place at the start of the year; short-term fluctuations in investment returns; change in the time value of cost of options and guarantees and economic assumption changes; other items (for example, profit from other Group operations, tax, foreign exchange, exceptional items); and dividends.
The value added from new business (being the present value of the future cash flows arising from new business written in the year)
As indicated above, EEV basis results are prepared by first of all making assumptions about all relevant factors including levels of future investment return, expenses, surrender levels and mortality.
These best estimate 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. The risk discount rate is determined using the actual yield on long-term government bonds plus a risk margin. The projected future cash flows are prepared on a set of assumptions specific to product group, and the actual outcome may be different from that projected.
Where the actual outcome is different, this will be reflected in the experience variances for that year.
The total profit that emerges over the lifetime of an individual contract as calculated using the EEV basis is the same as that calculated under the IFRS basis. However, since the EEV basis reflects discounted future cash flows under this methodology the profit emergence is advanced, thus more closely aligning the timing of the recognition of benefits with the efforts and risks of current management actions, particularly with regard to business sold during the year.
The assumptions used for the EEV basis of accounting are set out on pages 212 to 214 in the notes that accompany the supplementary EEV basis information. An indication of the sensitivity of the results to changes in the key assumptions of interest rate and investment return is provided on pages
The EEV basis profits emerging in each subsequent accounting period will comprise the unwinding of the discount (which arises from discounting future cash flows for one fewer period) and the profit or loss arising from any difference between the actual cash flow and the cash flow which had been assumed in the accounting period under review, together with the effect of any changes of assumption where the directors believe a revision is required to the original estimates of future experience.
The different timing of profit recognition under the two bases is demonstrated in the next chart, which shows the cumulative level of profit recognition for the yearly profits shown in the previous chart. It illustrates that under the EEV basis profits emerge earlier, but the eventual total profit is the same under both bases.
We recognise that our stakeholders increasingly support those companies that define and exhibit sound values around trust, ethics and environmental responsibility.
We also believe that a company’s performance in key areas of conduct such as corporate governance, environmental management and employment practices can have a significant impact on its financial performance.
Over the last year we have therefore reviewed our CR strategy to ensure that it continues to align our business objectives with our stakeholder concerns.
Prudential has developed a Group Governance Framework which is underpinned by a Group Governance Manual and associated processes. This encompasses all key policies and procedures, for example our Group Code of Business Conduct, our CR Policy and our Health and Safety Policy. We set our own codes and policies that often go further than legislative requirements.
Prudential also operates a Group Risk Framework which focuses on reputation issues, including those of a social, ethical and environmental nature. The controls, which are applicable across the Group, are set out in the Group Governance Manual.
Prudential’s Group Finance Director, Philip Broadley, has Board level responsibility for social, environmental and ethical risk
Adult Continuing Education (NIACE), thousands of adults and children are now benefiting and learning how to make decisions that will have a profound effect on the quality of their lives.
We extended our initiative to Asia in 2004, with an innovative programme called ‘Investing in Your Future’, which focuses on women, who are often responsible for planning for their family’s financial needs. This was first launched in China and rolled out to Vietnam in 2005. During 2006, we will extend this programme into India. To date, more than 5,000 women have graduated from the programme in Asia.
More details of our international financial literacy programme are available in our 2005/06 ‘Learning for Life’ publication.
In 2005, we invested £4.7 million in a wide range of projects around our business, supporting education, welfare and environmental initiatives. This total includes the significant contribution made by many of our people around the Group through volunteering, often linked with professional skills development. It also includes direct donations to charitable organisations of £3.5 million. A detailed breakdown of Prudential’s investment in the community and our policy on not making political donations is laid out on page 59.
In 2005, Prudential’s employees and our businesses around the world made significant financial contributions in response to four separate disasters: the
The money raised has been distributed to the countries hardest hit by the tsunami: Indonesia (the primary recipient); India; Thailand and Sri Lanka.
UK, using PruBus, a qualitative research study. Prudential UK has separately continued to hold monthly MeetPru events, which give our customers the opportunity to meet members of the UK
Informing and empowering consumers to make such decisions will, we believe, build better and more permanent relationships between consumers and providers.
In the UK, via partnerships with diverse organisations such as Citizens Advice, the Personal Finance Education Group
management. The Board discusses Prudential’s performance on this at least once a year. The Board also reviews and approves our
The Corporate Responsibility Committee is a specialist Groupwide committee chaired by the Group Finance Director, and is responsible for reviewing business conduct and social and environmental policy.
appropriate charities to ensure our donations made the most impact. Our support focused on children and the rebuilding and/or improvement of schools and libraries.
In Indonesia, for example, we are working with United Nations Children’s
SRI has focused principally on equity markets, with the property investment community slower to address the issue of sustainability. However, with more than £17.2 billion (as at 31 December 2005) of funds under management,
Protecting the environment is essential for the quality of life of current and future generations. The challenge is to combine continuing economic growth with long-term sustainable development.
has carefully monitored and worked to minimise any negative environmental impact since it moved to its current headquarters in 2000, working with state and local authorities on new projects which protect the environment.
prudential-plc/cr/ A hard copy of the report is available from our CR unit: Laurence Pountney Hill, London
Corporation Asia since January 2004. Previously, he was President and Chief Executive Officer of
Nick Prettejohn has been an executive director of Prudential and Chief Executive, Prudential UK &
Europe since 1 January 2006. He is also a member of the Financial Services Practitioner Panel.
Reconstruction and Renewal process, which reorganised Lloyd’s after the losses of the late 1980s and early 1990s. Following the successful completion of the reorganisation in 1996 he became Managing Director of Lloyd’s Business
36 Prudential plc Annual Report 2005 1. Sir David Clementi MA FCA MBA
Financial Capability Steering Group, and in July 2003 he was appointed by the Secretary of State for Constitutional Affairs to carry out a review of the regulation of legal services in England and
Authority. From 1975 to August 1997 he worked for the Kleinwort Benson Group, latterly as Chief
Mark Tucker was re-appointed as an executive director on 6 May 2005, on which date he also became Group Chief Executive. From May 2004 to March 2005 he was Group Finance Director,
HBOS plc and director of Halifax plc. Previously, he was an executive director of Prudential from 1999 to 2003, and from 1993 to 2003 he was Chief
Actuary at Milliman & Robertson Inc. He has more than 20 years’ experience in the life insurance industry, and holds both a bachelor’s degree in actuarial science and an MBA from the University of Texas. He also holds professional designations of
Fellow of the Society of Actuaries (FSA) and Member of the American Academy of Actuaries (MAAA).
Advisor to Goldman Sachs. In 2005 he was appointed to the Board of Nicholas Piramal India Limited and
School of Business. Before he retired from Unilever in May 2005, he was Director, Home and Personal
Committee. He joined Hindustan Lever Ltd in India 9. Michael Garrett
Independent non-executive director and member of the Remuneration Committee. Aged 63
Head of Japan (1990-1993), and then Zone Director and Member of the Executive Board, responsible for Asia and Oceania, and in 1996 his responsibilities were expanded to include Africa and the Middle
Advisory Council in Switzerland. He remains a director of Nestlé companies in India and Japan, and was appointed Chairman of the Evian Group in 2001, a think tank and forum for dialogue promoting free trade. He also serves as a nonexecutive director on the Boards of the Bobst
Bridget Macaskill has been an independent nonexecutive director of Prudential since September 2003. She rejoined the Board of Prudential having previously resigned due to a potential conflict of interest in March 2001. She is a non-executive director of J Sainsbury Plc and the Federal National
Roberto Mendoza has been an independent nonexecutive director of Prudential since May 2000.
Integrated Finance Limited, and he was the nonexecutive Chairman of Egg plc, which delisted on 20 February 2006. Previously, he was Vice
Chairman and director of JP Morgan & Co. Inc., a non-executive director of Reuters Group PLC and
Committee of the Court of the Bank of England, and a non-executive director of O2 plc. Prior to that, she was Chief Financial Officer of BTR and Invensys, and before that she was a partner at Ernst & Young.
Independent non-executive director and member of the Audit and Nomination Committees. Aged 67
United States and Schneider Electric in France. He is also Chairman of the Leadership Foundation for
Chairman and Chief Executive of BP America Inc., and a Managing Director of the British Petroleum
Deputy Chairman of Cable and Wireless plc and a non-executive director of Liberty International plc.
Until the end of 2005, he was also a non-executive director of Taylor Nelson Sofres plc. He retired as a director of Reuters Group PLC in December 2001, where he was Finance Director from 1990 to 2000.
Apart from the requirement under the Code that shareholders be sent the notice of Annual General Meeting at least 20 working days before the meeting, the Company has complied throughout the financial year ended 31 December 2005 with all the Code provisions set out in Section 1 of the Code. As a result of the late publication of FRS 27, ‘Life Assurance’ which was only released on 13 December 2004, the Company was unable to comply with the 20 working day requirement under the Code and so gave the statutory 21 clear days’ notice of the Annual General Meeting.
As at 31 December 2005, the Board comprised the Chairman, five executive directors and seven independent non-executive directors. Since the year end, Nick Prettejohn has been appointed as an additional executive director with effect from 1 January 2006.
During 2005, the Board met 14 times and held a separate two-day strategy meeting. Each year, one of the Board meetings is held at one of the Group’s business operations to facilitate a fuller understanding of the diversity of the business. In June 2005, a
Board meeting was held in Beijing, following a day of discussion on the Asian business and future market opportunities for Prudential
Corporation Asia across the region. Presentations were given by senior members of the Prudential Corporation Asia management team.
All the directors attended all scheduled Board meetings occurring during their period of appointment, apart from Jonathan Bloomer and Mark Wood, who were not required to attend Board meetings after it had been agreed that they would cease to be directors of the Company. There were four additional Board meetings, and the majority of the directors attended most of those meetings. Where a director was not able to attend any of the additional meetings, their views were canvassed by the Chairman prior to the meeting.
Executive for further delegation by him in respect of matters which are necessary for the effective day-to-day running and management of the business.
The Board is responsible for ensuring that an effective system for succession planning and management development is in place.
Secretary who advises them on all corporate governance matters, on Board procedures, and on compliance with applicable rules and regulations. In order to ensure good information flows, full Board and Committee papers are provided to the directors by the
Company Secretary approximately one week before each Board or Committee meeting. The Company Secretary also supports the
these other commitments are not such as to interfere with the performance of the Chairman’s duties for the Group.
Full biographical details of the members of the Audit Committee, including their relevant experience, are set out on page 37.
Compliance, as well as the external auditor, attended some of the meetings.
Internal Auditor, the Group Chief Risk Officer, the external auditor and the Group Finance Director before each Committee meeting.
A detailed forward agenda has been developed which ensures all matters for which the Committee is responsible are addressed at the appropriate time of the year. The principal business of the
Sarbanes-Oxley procedures; ■ US filings and related external audit opinion; ■ external auditor’s interim management letter, external auditor’s full year memorandum, external audit opinion and final management letter; ■ auditor independence, external auditor’s plans and audit strategy, effectiveness of the external audit process, external auditor’s qualifications, expertise and resources and economic service; ■ framework and effectiveness of the Group’s systems of internal control and Turnbull compliance statement; ■ effectiveness of the Group Risk Framework and half-yearly key risk report; ■ internal audit plan and resources, reassurance on the audit framework and internal audit effectiveness; ■ effectiveness of compliance processes and controls and performance against the Group Compliance Plan; ■ Audit Committee effectiveness and Audit Committee terms of reference; ■ Group Security annual report, report on anti-money laundering and reporting of allegations from whistleblowers; ■ International Accounting Standards (IAS) and practices, including
■ changes in and implementation of Group Accounting Policies in compliance with IAS and practices, including the European
Compliance and Group Security. In addition, the Committee also received presentations from some of the business unit chief executives.
The Committee recognises the need to meet without the presence of executive management. Such a session was held in July 2005 with the external and internal auditors.
Each business unit has its own audit committee whose members and chairman are independent of the individual business unit.
Committee when they arise. They approve the business unit internal audit plans and oversee the adequacy of internal audit resources; receive presentations from external audit; and meet privately with local external audit and the business unit heads of internal audit.
Audit Plc, reported to the Committee on the Company’s progress towards compliance with Section 404.
During the year, the committees reviewed and approved internal audit’s plans, resources and the results of its work. Reporting to the Group Audit Committee by Group Internal Audit is through the formal reports four times during the year and through private meetings, as well as regular private meetings between the
Director. Additionally, the Chairman of the Committee attended the Group’s internal audit conference in September 2005.
Policy ensures that the independence and objectivity of the external auditor is not impaired, and that the Group maintains a sufficient choice of appropriately qualified audit firms. The policy sets out four key principles which underpin the provision of non-audit services by the external auditor, namely that the auditor should not: ■ Audit its own firm’s work; ■ make management decisions for the Group; ■ have a mutuality of financial interest with the Group; or
■ be put in the role of advocate for the Group.
Committee formally considered the need to re-tender the external audit service and concluded that given the significant changes in audit and regulatory requirements, the interests of the Company were better served by retaining the existing auditor through a period of transition. In addition, the Committee concluded that there was nothing in the performance of the auditor requiring a change.
For the year ended 31 December 2005, fees for audit services of £6.8 million were approved by the Committee. All fees for nonaudit services were approved by the Committee, in accordance with the Group’s Auditor Independence Policy, prior to work commencing. The Audit Committee reviewed the non-audit services being provided to the Group by its external auditor at regular intervals in 2005. During the year, fees for non-audit services of £5.6 million were approved by the Audit Committee.
Fees for non-audit services amounted to 45 per cent of total fees paid to KPMG Audit Plc. These fees primarily related to assurance services associated with the implementation of IFRS and EEV
The Committee also considered whether any internal control implications arose from communications received. No internal control implications were raised from calls to the confidential helpline.
The Remuneration Committee normally has scheduled meetings at least three times a year and a number of additional meetings, as required, to review remuneration policy. The Remuneration
Except in relation to the remuneration of the Group Chief Executive, when only the Chairman is consulted, the Remuneration Committee consults the Chairman and the Group Chief Executive about the
They were widened to include monitoring the level and structure of remuneration for a defined population of senior management as determined by the Board. The Committee agreed principles for the level and structure of remuneration for this population. The
During 2005, the Committee held four meetings resulting in the appointment by the Board of Mark Tucker as Group Chief
The Board has approved a procedure whereby directors have the right in furtherance of their duties to seek independent professional advice at the Company’s expense.
Throughout the year all the non-executive directors were considered by the Board to be independent in character and judgement. No non-executive director: ■ Has been an employee of the Group within the last five years; ■ has, or has had within the last three years, a material business relationship with the Group; ■ receives remuneration from the Group other than a director’s fee; ■ has close family ties with any of the Group’s advisers, directors or senior employees; ■ represents a significant shareholder; or
During the year, cross-directorships existed with Roberto Mendoza and Philip Broadley who both sat on the board of Egg plc, the
Company’s subsidiary which, until 20 February 2006, had its own listing on the London Stock Exchange. Under the Company’s
Relationship Agreement with Egg, established prior to its flotation in 2000, the Company agreed with Egg that, absent specific events, the number of Company related directors should represent less than half the total number of directors in office. The Company had the right, whilst it continued to own more than 10 per cent of the voting shares, to nominate one director and also, whilst it continued to own more than 15 per cent of the voting shares, to appoint the Chairman of the board. Jonathan Bloomer was accordingly appointed as the Company’s nominated director and on his retirement from the Board of the Company on 5 May 2005,
Philip Broadley was appointed the Company’s nominated representative on the board of Egg. Roberto Mendoza was appointed as the Chairman of the board of Egg. Consequently,
Chairman and director of Egg. The Board does not consider that this relationship in any way affected Mr Mendoza’s status as an independent director of the Company. On 1 December 2005, the
The number of full Board and Committee meetings attended by each director during 2005 was as follows: Full Audit Remuneration Nomination Board Committee Committee Committee
*During 2005 there were 10 scheduled Board meetings and four additional Board meetings.
***During 2005 there were eight scheduled Remuneration Committee meetings and three additional meetings.
Stock Exchange. On 15 March 2006, the Company owned 96.66 per cent of Egg.
A programme of on-going professional development was undertaken for all directors in 2005, which covered a number of sector-specific and business issues as well as legal, accounting and regulatory changes and developments. A cornerstone of the programme was a series of presentations made to the Board by the Prudential Corporation Asia management team on the Asian business and future market opportunities, during the Board visit to Beijing in June 2005. Throughout their period in office, the directors are continually updated on the Group’s businesses and the regulatory and industry-specific environments in which it operates. These updates can be in the form of written briefings or meetings with senior executives and, where appropriate, external sources. Directors are also advised on appointment of their legal and other duties and obligations as a director of a listed company both in writing and in face-to-face meetings with the Company Secretary.
An evaluation was carried out of the performance of the Board and its Committees, and of the individual directors, for the year 2005, in line with the requirements of the Code. The aim was to improve individual contributions, the effectiveness of the Board and its
Chairman’s performance. The independent consultant prepared its report based on the interviews with directors. The overall results of the evaluation were presented to and reviewed by the
The Company regularly holds discussions with major shareholders and a programme of meetings took place during 2005. Board members also regularly receive copies of the latest analysts’ and brokers’ reports on the Company and the sector, to further develop their knowledge and understanding of external views about the Company. The Chairman and the Senior Independent
The Annual General Meeting will be held at The Auditorium, The
The directors have a duty to report to shareholders on the performance and financial position of the Group and are responsible for preparing the financial statements on pages 62 to
As a provider of financial services, including insurance, the Group’s business is the managed acceptance of risk. The system of internal control is an essential and integral part of the risk management process. Prudential management has established a comprehensive framework of internal controls for the management of risk within the Group and its business units. The Board has overall responsibility for the internal controls. The Board has conducted a review of the effectiveness of the Group’s system of internal control. The focus on aligning the taking of risk with the achievement of business objectives means that the control procedures and systems the
The Group’s internal control framework includes detailed procedures laid down in financial and actuarial procedure manuals.
The Group prepares an annual business plan with three-year projections. Executive management and the Board receive monthly reports on the financial position of the Group and actual performance against plan, together with updated forecasts. The insurance operations of the Group all prepare a financial condition report, which is reported on to the Board.
Business units are required to confirm annually that they have undertaken risk management during the year as required by the
Committee, and it was confirmed that the processes described above and required by the Group Risk Framework were in place throughout the period covered by this report, and complied with
Internal Control: Guidance on the Combined Code (the Turnbull guidance). Business unit internal audit teams execute risk-based audit plans throughout the Group, from which all significant issues are reported to the Group Audit Committee.
The Board believes that good risk management and mitigation protects and enhances the Group’s embedded and franchise value.
Group Chief Executive and the Chief Executive and management of each business unit (the first line of defence). The second line of defence is oversight of the Group Risk Framework by the Group
The Group Risk Framework includes the following Group-level committees: the Group Asset Liability Committee; the Group
The Group Asset Liability Committee is the senior management forum responsible for oversight of market, credit and insurance risks across the Group. It is chaired by the Group Chief Risk Officer and its membership includes senior business unit and Group executives involved in the management of market, credit and insurance risks framework. The Group Asset Liability Committee reports to the Group Chief Executive.
The Group Balance Sheet Management Committee is chaired by the Group Finance Director and reports to the Group
Group and oversight of the Group Risk Framework including monitoring operational risk and related policies and processes as
Risk Committee is chaired by the Group Chief Risk Officer and its membership includes representatives of the business unit and
Group Risk functions. The Group Operational Risk Committee reports to the Group Chief Executive.
Group Risk acts as secretariat and facilitates the agenda of the
The Group is committed to developing its risk management techniques and methodologies, both to maintain high standards of risk management practice, and to fulfil the requirements of regulators. The control system continues to evolve and Group
Risk carry out reviews and research to identify industry best practice together with ensuring that the standards and policies within the Group are progressively developed to improve risk management practice.
The Sarbanes-Oxley Act 2002 (the Act) was passed by the US
In particular, in relation to Section 302 of the Act which covers disclosure controls and procedures, a Disclosure Committee has been established, reporting to the Group Chief Executive, chaired by the Group Finance Director and comprising members of senior management. The objectives of this Committee are to: ■ Assist the Group Chief Executive and the Group Finance Director in designing, implementing and periodically evaluating the
Company’s disclosure controls and procedures; ■ monitor compliance with the Company’s disclosure controls and procedures; ■ review and provide advice to the Group Chief Executive and the
Group Finance Director with regard to the scope and content of all public disclosures of the Company which are of material significance to the market or investors; and
■ review and consider, and where applicable follow up on, matters raised by other components of the disclosure process, including assessments made by the Group Audit Committee, the internal auditor or the external auditor of the Company’s internal controls to the extent they are relevant to the disclosure process.
Listing Regime, effective from 1 July 2005, and evaluates whether or not a particular matter would constitute ‘inside information’ and therefore would require to be disclosed to the market.
During 2005 the Group Human Resources Director was invited to provide the Committee with her views and advice on matters considered by the Committee. The Committee appointed Deloitte to provide consultancy and market data and Freshfields Bruckhaus
This report has been approved by the Board and, as required by
Regulations), a resolution will be put to shareholders at the Annual
KPMG Audit Plc have audited the sections contained in pages 52 to 57 as required by the Companies Act 1985.
To achieve this objective, Prudential must continue to use remuneration practices relevant to the different markets in which the Company does business around the world. At the same time, the Remuneration Committee considers remuneration within the context of the UK’s regulatory framework and shareholder views, and is guided by UK corporate governance standards.
■ performance measures will include both absolute financial measures and comparative measures as appropriate to provide a clear alignment between the creation of shareholder value and reward.
The total remuneration levels for the other executive directors are set similarly by reference to levels in their relevant markets. All pay data is externally provided.
During 2005, the Remuneration Committee reviewed the remuneration policy and decided that certain changes in long-term incentives were appropriate. The proposed policy for 2006, including the elements of remuneration and details of proposed new long-term incentive plans are set out in the Notice of Annual
General Meeting 2006 that accompanies this Report and are summarised below. The remuneration policy that applied in 2005 is set out on page 48.
Annual bonuses for 2006 will be based on a combination of Group and business unit financial measures and the individual strategic targets set for each individual director.
Annual bonus awards are not pensionable. The annual incentive for executive directors is aligned with the interests of shareholders in that any part of the annual incentive award made for performance above target will be in the form of a share award.
Michael McLintock’s annual incentive award is in line with remuneration levels in the investment management industry and is based on the profits of M&G, the fund performance of M&G and Group and individual performance.
Our long-term incentive plans are designed to drive the underlying financial performance of the business. The incentive plans recognise that strong business unit performance is critical to Group performance. In order to grow the value of Prudential for shareholders, the Board needs to focus on growing each area of business. Executive directors that run a business unit therefore also participate in a long-term incentive plan geared to their business reflecting those responsibilities. In all cases the performance period is three years; for example, the 2006 awards run from the beginning of 2006 to the end of 2008.
The performance condition for the initial awards will be based on Total Shareholder Return (TSR) out-performance of an index comprised of peer companies. This approach, which focuses on returns above the index, is considered to be more robust than a rank-based approach when the number of comparator companies is relatively few. The approach also ensures that maximum vesting is only achieved if the Company outperforms the average comparator performance by a significant margin.
Corporation Asia to replace the existing incentive plans for these individuals. Michael McLintock will receive 2006 awards under the
The Group Chief Executive and the Group Finance Director will not participate in this plan.
Half of the awards will be denominated and delivered in shares.
Value. This is the increase in shareholders’ capital and reserves on a European Embedded Value (EEV) basis (using the European
This measure has been chosen on the basis that it is transparent and reflects the creation of value for shareholders. Shareholder
Report, on a constant exchange rate basis for the relevant business and adjusted for capital injections and dividends in the period.
The growth parameters for the awards will be relevant to each region. For 2006 awards under the new Business Unit Performance
Plan, the proposed targets are as follows: Vesting between each performance point is on a straight-line sliding scale basis.
*In the case of the Chief Executive M&G, this is the M&G Chief Executive LTIP as described in the section on 2005 business-specific long-term incentive plans on page 49.
Compound annual growth in Shareholder Capital Value per annum over three years
Percentage of award that vests UK & Europe JNL Asia 0% <8% <8% <15%
Shares earned and deferred under the annual incentive plan are included in the guideline.
At least half the shares released from long-term incentive awards after tax would be retained by the executive director until the guideline is met.
Nick Prettejohn joined as a director from 1 January 2006. He was paid £265,000 to compensate for loss of bonus for 2005 and £183,490 for the loss of a long-term incentive award due in 2005 from his previous employer. In order to compensate him for the loss of substantial amounts of outstanding long-term remuneration, he will have rights to Prudential plc shares that vest as set out below: In normal circumstances, releases are conditional on Nick
If there is a change of control of Prudential he may become entitled to retain any unvested awards.
The long-term incentive plans operating in 2005 are described below. All the outstanding long-term awards held by the executive directors are detailed on pages 53 to 55.
The Restricted Share Plan (RSP) rewards Prudential’s achievement of Total Shareholder Return (TSR) relative to other companies that were in the FTSE 100 at the beginning of each three-year performance period.
For any awards under the RSP to vest, the Remuneration Committee must be satisfied with the Company’s underlying financial performance over the performance period. At the end of each performance period, depending on the Company’s performance, executive directors may be granted a right to receive shares at no cost to the individual.
In 2005 for Mark Tucker the maximum conditional award was 200 per cent of basic salary as was the award for Jonathan Bloomer. For
In 2005 Clark Manning participated in a cash-based long-term plan that rewards the growth in appraisal value of JNL. The award payout equals an initial award value adjusted by the Prudential plc share price change over the performance period. In order for any award to be made under the 2005 plan the growth rate over the performance period must be eight per cent per annum compound or greater. At this level of performance the initial award value is
US$864,240. If the on-target performance level of 11.5 per cent per annum compound is achieved the initial award value is doubled. If the annual growth rate is at least 17.5 per cent the payout increases to a maximum of three times the initial award value. For performance between these points payouts are on a straight line sliding scale.
Executive Long-Term Incentive Plan that provides a cash reward through phantom M&G share awards and options, whose value depends on the profit and fund performance of M&G over the performance period. The change in the phantom share price equals the change in M&G profit, modified up or down by the investment performance of M&G, over the performance period.
For 2005 the face value of the share award was £225,000.
Incentive Plan which is a cash-based plan that measures an index of added value geared to new business profit growth in our Asian businesses. For the 2005 award the plan will only pay out if the growth rate is greater than 15 per cent per annum compound over the performance period. At this level of performance a payment of 50 per cent of basic salary is made. The on-target payout is 100 per cent of salary, for which an annual growth rate of 35 per cent is
TSR relative to the index at the end of the third year Percentage of award that vests
required. If an annual growth rate of 50 per cent or more is achieved, the maximum of 150 per cent of basic salary is paid.
In 2005 Mark Wood participated in a cash-based long-term plan that rewards the growth in appraisal value of Prudential UK &
Europe over the performance period. This plan only paid out if the growth rate was greater than eight per cent per annum compound over the performance period. At this level of performance a payment of 50 per cent of basic salary would be made. The ontarget payout was 75 per cent of basic salary for which a growth rate of 11.5 per cent was required. If a growth rate of 17.5 per cent or more were achieved the maximum of 100 per cent of basic salary was payable. For performance between these points payouts were on a straight-line sliding scale basis.
Executive directors receive certain benefits, principally participation in medical insurance schemes, the provision of a cash allowance for a car (except for Clark Manning and Mark Norbom), and, in some cases the use of a car and driver and security arrangements. Mark Norbom also receives expatriate allowances.
Except for Clark Manning, the executive directors are eligible to participate in either the Company’s UK or International Savings-
Executive directors are entitled to participate in arrangements in certain M&G investment products on the same terms as available to external investors, apart from the minimum level of investment.
In addition, the Company provides certain protections for directors and senior managers against personal financial exposure that they may incur in their capacity as such. This includes qualifying third party indemnity provisions (as defined under section 309B of the
Company and of associated companies (as defined under section 309A of the Companies Act 1985), both at the time the Directors’
Report was approved under section 234A of the Companies Act 1985 and during 2005.
Non-executive directors are not eligible to participate in annual incentive plans, long-term incentive plans or pension arrangements.
The Board reviews the fees annually and the last change was made
Audit Committee. The additional Remuneration Committee chairmanship fee is £20,000 per annum, although the Chairman of the Remuneration Committee waived the last increase to the chairmanship fee and receives only £10,000 per annum.
Shares are purchased each quarter and are held at least until retirement from the Board.
FTSE 100 index, which is a broad equity market index of UK
TSR over the performance period is the growth in value of a share plus the value of dividends paid, assuming that the dividends are reinvested in the Company’s shares on the day on which they were paid.
**Changes to interests in shares were either due to acceptance of the Offer by Prudential for shares in Egg (Egg shareholders were entitled to receive 0.2237 new Prudential shares for every Egg share held) or due to purchases under the Share Incentive Plan, under which shares are purchased on a monthly basis on predetermined purchase days.
Notes 1. Philip Broadley’s shareholding at 1 January 2005 includes 65 shares received as a result of a scrip dividend which were not reported in the 2004 Annual Report.
4. Roberto Mendoza’s shareholding at 1 January 2005 includes 1,427 shares received as a result of the Rights Issue which were not reported in the 2004 Annual Report.
5. Mark Norbom’s interests in shares included 1,265.50 American Depositary Receipts (representing 2,531 ordinary shares) at 1 January 2005 and 1,306.263 American Depositary Receipts (representing 2,612 ordinary shares) at 31 December 2005.
The interests of directors in shares of the Company’s subsidiary, Egg plc, which was listed until 20 February 2006, are shown below, including changes between 31 December 2005 and 15 March 2006.
Mark Tucker (from 6 May 2005; notes 10 and 11) 509 503 118 1,130 –
Total non-executive directors 482 482 465 *Benefits include cash allowances for cars.
Notes 1. In addition to the emoluments in the table, under the terms of his termination of employment, Jonathan Bloomer was paid a total of £1,600,000.
2. It is intended that a deferred share award valued at £209,090 from his 2005 annual bonus will be made to Philip Broadley. This is included in the 2005 bonus figure.
3. Clark Manning’s bonus figure excludes a contribution of £6,926 from a profit sharing plan that has been made into a 401k retirement plan which is included in the table on pension contributions on page 57.
4. In 2005 a deferred share award valued at £435,547 from his 2004 annual bonus was made to Michael McLintock. This is included in the 2004 total and further details are shown in the section on other share awards on page 55.
5. It is intended that a deferred share award valued at £554,732 from his 2005 annual bonus will be made to Michael McLintock. This is included in the 2005 bonus figure.
10. It is intended that a deferred share award valued at £243,453 from his 2005 annual bonus will be made to Mark Tucker. This is included in the 2005 bonus figure.
11. Mark Tucker is eligible to be paid a housing allowance of £11,017 per month until 30 April 2006. This is included in the benefits figure.
12. Mark Wood’s salary and benefits in the table are the total up to 16 October 2005 which was the last day he was an executive director. In 2005 a deferred share award valued at £168,550 from his 2004 annual bonus was made to Mark Wood. This is included in the 2004 total and further details are shown in the section on other share awards on page 55.
13. Keki Dadiseth was appointed as a director of Prudential plc with effect from 1 April 2005, and as a member of the Audit Committee with effect from 5 May 2005.
14. In accordance with an agreement that the Company entered into with Keki Dadiseth, he did not retain his director’s fee for his first two months of his appointment; instead his fee was paid to Unilever PLC, where he served as an executive director until May 2005. For those first two months, no portion of the fees which were paid to Unilever in lieu of payment to him was applied to the purchase of shares in the Company. With effect from June 2005, Prudential paid non-executive director fees to Keki Dadiseth, and a portion of those fees were used to purchase shares in the Company, as is the practice for all of Prudential's non-executive directors.
15. In addition the Company pays an allowance of £10,391 per annum to Keki Dadiseth in respect of his accommodation expenses in London whilst on the Company's business, in lieu of reimbursing hotel costs, as is the usual practice for directors who are not resident in the UK.
The Remuneration Committee reviewed each executive director’s individual contribution and the continuing strong operating performance of the Group in 2005 against the 2005 business plans and was satisfied that the bonus payments made for the year are fully justified.
Executive directors who are released to serve as non-executive directors of other external companies retain the earnings resulting from such duties. In 2005, Michael McLintock earned £45,000 from an external company. Other directors served as non-executive directors on the Boards of companies in the educational and cultural sectors without receiving a fee for those services.
The section below sets out the outstanding awards under the Restricted Share Plan and the additional long-term plans for the executive directors who run specific businesses.
The awards made in respect of 2004 and 2005 under the RSP run to 31 December 2006 and 31 December 2007 respectively. As at 31 December 2005, TSR performance under these plans was ranked respectively at percentile positions 70 and 47 on the basis of TSR performance.
In determining the 2005 conditional awards the shares were valued at their average share price during the preceding calendar year, and the price used to determine the number of shares was 437.2 pence (2004: 398.3 pence).
Notes 1. For the awards made in 2002 under the RSP, the Company’s TSR was ranked at 89th percentile at the end of the three-year performance period on 31 December 2004 and as a result the 2002 awards lapsed.
2. For the 2003 and 2004 conditional RSP awards to Jonathan Bloomer, the ranking of the Company’s TSR in the month prior to his leaving date was 72nd and 65th respectively and as a consequence the awards lapsed.
4. For the 2003 conditional RSP award the ranking of the Company’s TSR at the end of the three-year performance period ending on 31 December 2005 was 71st and as a result no release will be made from this award.
5. For the 2003 conditional RSP award to Mark Wood, the ranking of the Company’s TSR in the month prior to his date of resignation of his directorship was 67th percentile and as a result no release will be made from this award.
7. For the 2005 conditional RSP award to Mark Wood, the ranking of the Company’s TSR in the month prior to his date of resignation of his directorship was 27th percentile and as a result, subject to non-competition and non-solicitation conditions, 27.5 per cent of his award will be released. This percentage takes into account pro-rating for his service during the three-year performance period.
Rights RSP rights Market price RSP rights granted exercised RSP rights Exercise on date Earliest Latest
Year of outstanding at during during outstanding at Price paid price of exercise exercise exercise right grant 1 Jan 2005 2005 2005 31 Dec 2005 for award (pence) (pence) date date
Jonathan Bloomer 2000 59,650 59,650 – – Nil 536.5 17 Mar 00 05 Nov 05
Details of all outstanding awards under other long-term incentive plans up to and including 2005 are set out in the table below and described on page 49. Except where stated, the performance period for all awards was three years.
Clark Manning Phantom JNL options 2001 660 83 – 31 Dec 04
Notes Clark Manning Clark Manning’s 2001 cash long-term incentive plans had four-year performance periods respectively with payouts in both cases depending on JNL US GAAP net income in the final year. For the 2001 award the results led to payments of US$675,900 for the share element and US$151,800 for the option element. The face values of the awards for Clark Manning are converted at the average exchange rate for 2005 which was US$1.8192 = £1 (2004: US$1.8326 = £1). Upon joining the Board, Clark Manning also participated in the 2002 JNL Chief Executive LTIP which has a performance period of three years. The performance conditions are the same as described in the business-specific long-term incentive plans section on page 49. The compound growth rate of the JNL appraisal value was below the threshold for a payment to be made in respect of the award. For the 2003 Business cash LTIP the growth rate in appraisal value was 12.83 per cent and a payment of US$2,703,461 was made.
Mark Wood Mark Wood’s 2002 and 2003 cash long-term incentive plans had the same performance conditions as described for his business-specific long-term incentive plan described on page 49. For the 2002 award the compound growth rate of the UK appraisal value was below the threshold for a payment to be made in respect of the award.
Mark Wood resigned as a director effective 17 October 2005 and his employment with the Group terminated on 1 February 2006. Under the terms of the termination of his contract, payments will be made in 2006 from his 2003, 2004 and 2005 LTIP awards, taking into account performance and pro-rating for service during each respective performance period. Subject to non-competition and non-solicitation conditions, these payments are respectively £235,000 by 31 March 2006, £180,556 on or before 31 July 2006 and £103,056 on or before 31 December 2006.
The table below sets out the share awards that have been deferred from annual incentive plan payouts and awards to Mark Norbom relating to his appointment. The values of the deferred share awards are included in the bonus and total figures in the directors’
Notes 1. The value of the 2004 deferred share award from the annual incentive plan is included in the total 2004 figures in the directors’ remuneration table on page 52.
Year of Options exercise Options Options Options price at exercise for Rights Earliest Latest initial outstanding Exercised date forfeit granted outstanding at 31 Dec 2005 price Issue on exercise exercise grant at 1 Jan 2005 in 2005 (pence) in 2005 in 2005 31 Dec 2005 (pence) (pence) 11 Nov 2004 date date
2. The highest and lowest share prices during 2005 were 551.5 pence and 445 pence respectively.
executive directors are offered a combination of HM Revenue and Customs approved pension schemes and supplementary provision.
Executive directors employed in the UK are eligible to participate in HM Revenue and Customs approved pension schemes on the same basis as other employees who joined at that time, providing benefits based on basic salary up to the HM Revenue and Customs earnings cap.
The schemes include defined benefit and defined contribution arrangements. Philip Broadley participates in a non-contributory scheme that provides a pension of one-sixtieth of Final Pensionable Earnings for each year of service on retirement at age 60, as did Mark Wood. Michael
McLintock participates in a contributory scheme that provides a target pension of two-thirds of Final Pensionable Earnings on retirement at age 60 for an employee with 30 years or more potential service, for which his contribution is four per cent of basic salary. Jonathan Bloomer was only eligible to receive a lump sum death benefit of four times basic salary up to the earnings cap from the pension scheme.
No employees with employment offers after 30 June 2003 were eligible for membership of the defined benefit schemes.
Sir David Clementi is provided with a salary supplement, part of which is a contribution to a personal pension, and life assurance of four times his annual fees.
From 1 January 2006, Nick Prettejohn is provided with pension benefits the same as those described above in the policy to apply after
Years of Accrued earned to earned to made by to FURBS or pensionable benefit at 31 Dec 31 Dec 2005 2004 directors other pension
Age at service at 31 Dec 2005 20042 20043 B A during 2005 arrangements5
Sir David Clementi 56 – – – – – – – 126
Jonathan Bloomer 51 – – – – – – – 113
Clark Manning 47 – – – – – – – 14
The Directors’ Report of Prudential plc for the year ended 31 December 2005 comprises these pages and the sections of the Annual Report referred to in these pages.
The consolidated income statement is shown on page 62 and the consolidated balance sheet on pages 65 and 66 shows the state of affairs of the Group at 31 December 2005. The Company’s balance sheet appears on page 186. Information prepared on the European
Embedded Value basis of financial reporting is provided on pages 204 to 229. A summary of the results is shown on page 60.
Changes in the Company’s share capital during 2005 are given in note H11 on pages 159 and 160.
The directors recommend that the shareholders declare a final dividend for 2005 of 11.02 pence per share payable on 26 May 2006 to shareholders on the register at the close of business on 24 March 2006. The interim dividend for 2005 was 5.3 pence per share. The total dividend for the year, including the interim dividend and the recommended final dividend, amounts to 16.32 pence per share compared with 15.84 pence per share for 2004. The total cost of dividends in respect of 2005 was £393 million.
Keki Dadiseth, Mark Tucker and Nick Prettejohn were appointed as directors on 1 April 2005, 6 May 2005 and 1 January 2006 respectively. In accordance with the Articles of Association,
The following information is given principally in respect of employees of the Group in the UK. The policy towards employees overseas is the same but the practical application of the policy varies according to local requirements.
Group’s businesses attract, retain and promote the best available talent. All the businesses work to embed these principles in all aspects of their management practices and to ensure that this is evident to employees in their day-to-day work.
Operations’ Employee Forum promote communication and consultation throughout their respective businesses and provide for dialogue on a range of issues of interest to their staff.
Share Option Scheme (ISSOS) for employees has been operating since 2000 in Hong Kong, Malaysia and Singapore; since 2001 in
Prudential is committed to supporting the communities where it is an employer. In 2005 the Group spent £4.7 million in support of the community. Within this, direct donations to charitable organisations amounted to £3.5 million, of which £2.3 million came from European Union (EU) operations. This is broken down as follows: Education £1,068,000; Social and Welfare £1,039,000; Environment and Regeneration £91,000; Cultural £84,000 and
Staff Volunteering £56,000. The aggregate figure for charitable donations from Prudential’s non-EU subsidiaries (Jackson National
The Company’s Annual General Meeting will be held on 18 May 2006 at The Auditorium, The Mermaid Conference Centre,
A resolution for the re-appointment of KPMG Audit Plc as auditor of the Company until the end of the 2007 Annual General Meeting will be put to the Annual General Meeting on 18 May 2006.
Sections 198 to 208 of the Companies Act 1985 from Legal &
Fidelity Investments of holdings of 4.02 per cent, 3.10 per cent and 3.13 per cent respectively of the Company’s ordinary share capital.
Profit after tax attributable to equity holders of the Company £748m £517m
Dividends per share declared and paid in reporting period 15.95p 15.48p
Supplementary IFRS basis information Based on Based on statutory IFRS pro forma basis results IFRS results £m £m
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (50) (7)
Dividends per share in respect of the reporting period (including interim dividend of 5.30p
Operating earnings per share from continuing operations after related tax and minority interests 56.6p 43.2p
EEV basis results The EEV basis results are extracted from supplementary information and are not results that form part of the Group’s financial statements.
Summary of statutory and supplementary IFRS and EEV basis results Year ended 31 December 2005
Finance costs: interest on core structural borrowings of shareholder-financed operations F4 (208) (187)
Basic (based on 2,365m and 2,121m shares respectively): Based on profit from continuing operations attributable to the equity holders of the Company 31.5p 27.5p
Based on profit (loss) from discontinued operations attributable to the equity holders of the Company 0.1p (3.1)p
Diluted (based on 2,369m and 2,124m shares respectively): Based on profit from continuing operations attributable to the equity holders of the Company 31.5p 27.5p
Based on profit (loss) from discontinued operations attributable to the equity holders of the Company 0.1p (3.1)p *Profit before tax represents income net of post-tax transfers to unallocated surplus of with-profits funds, before tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders’ profits.
Total items recognised directly in equity 333 (292) (3) 38 1 39
Reserve movements in respect of share-based payments 15 15 (1) 14
Change in minority interests arising principally from purchase and sale of venture investment companies and property partnerships of the PAC
Transfer to retained earnings in respect of shares issued in lieu of cash dividends H11 (51) 51 0 0
Movement on Prudential plc shares purchased by unit trusts consolidated under IFRS 3 3 3
Items recognised directly in equity: Total items recognised directly in equity (160) (160) (160)
Movement on Prudential plc shares purchased by unit trusts consolidated under IFRS 14 14 14
Changes arising from adoption of IFRS A5 53 53 30 83
Other non-investment and non-cash assets: Property, plant and equipment H6 910 967
Investments of long-term business, banking and other operations: Investment properties H7 13,180 13,303
Unallocated surplus of with-profits funds: Reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds H12 11,357
Total policyholder liabilities and unallocated surplus of with-profits funds 170,342 145,211
Core structural borrowings of shareholder-financed operations: Subordinated debt (other than Egg) H13 1,646 1,429
Other borrowings: Operational borrowings attributable to shareholder-financed operations G1, H13 6,432 6,421
Total equity and liabilities 207,377 180,006 *The presentation of insurance and investment contract liabilities to policyholders reflects the adoption of IAS 32, IAS 39 and IFRS 4 at 1 January 2005. The comparative liabilities for 2004 reflect the previous UK GAAP basis.
Changes in operating assets and liabilities: Banking customer accounts (861) (330)
Interest income and expense and dividend income included in profit before tax (8,410) (7,371)
A1: Nature of operations Prudential plc (the Company) together with its subsidiaries (collectively, the Group or Prudential) is an international financial services group with its principal operations in the UK, the US and Asia. The Group operates in the UK through its subsidiaries, primarily The
Group Limited and Egg plc. In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company (JNL). The Group also has operations in Hong Kong, Malaysia, Singapore, Taiwan and other Asian countries. Prudential offers a wide range of retail financial products and services and fund management services throughout these territories. The retail financial products and services principally include life insurance, pensions and annuities as well as collective investments and deposit and mortgage banking services.
Long-term business products written in the UK and Asia are principally with-profits deposit administration, other conventional and unitised with-profits policies and non-participating pension annuities in the course of payment. Long-term business also includes linked business written in the UK and Asia. The principal products written by JNL are interest-sensitive deferred annuities and whole-life policies, variable annuities, guaranteed investment contracts, fixed index deferred annuities and term life insurance.
The parent company financial statements present information about the Company as a separate entity and not about the Group.
Reporting Standards (IFRS) as adopted by the European Union (EU). The Company has elected to prepare its parent company financial statements in accordance with UK Generally Accepted Accounting Principles (GAAP). These are presented on pages 186 to 195.
The Group has applied all IFRS and interpretations adopted by the EU at 31 December 2005, and has early adopted the amendment to
The accounting policies set out below have, unless otherwise stated, been applied consistently to all periods presented in these Group financial statements and in preparing an opening IFRS balance sheet at 1 January 2004 for the purposes of the transition to IFRS. The principal exception is that, as more fully explained below, financial instruments and insurance accounting is determined on different bases in 2005 and 2004 due to the basis of application of the transitional provisions of IFRS 1, ‘First-time Adoption of International
A3: Critical accounting policies, estimates and judgements (a) Critical accounting policies
Three standards, IAS 32, ‘Financial Instruments: Disclosure and Presentation’, IAS 39, ‘Financial Instruments: Recognition and
Accordingly, the amounts recorded for revenue and expenses and assets and liabilities of certain items reflected in the Group’s financial statements are not on a consistent basis in 2005 compared to amounts recorded for the comparative period. The main area where this inconsistency applies is valuation and accounting presentation of fair value movements of derivatives and debt securities of JNL
(as described below). In addition, the measurement of assets and liabilities and income and expenses of those UK unit-linked contracts, and those with similar features, that do not contain significant insurance risk, is altered.
In the UK, for the 2004 comparative results, with the exception of minor accounting adjustments, the technical provisions reflect the
UK regulatory basis of reporting that has applied previously for many years. This effectively constitutes the Peak 1 basis under the current
with-profits funds are: ■ Derecognition of deferred acquisition costs and related deferred tax; and
(as set out in note H2) and the reported level of unallocated surplus of with-profits funds (as set out in note H12).
regulated with-profits funds, for the 2005 results, options and guarantees are valued on a market consistent basis. The basis is described in note D2(d)(ii). For other operations a market consistent basis is not applied under the accounting basis described in note A4. Details of the guarantees, basis of setting assumptions, and sensitivity to altered assumptions are described in notes D3 and D4.
Under IAS 39, derivatives are required to be carried at fair value. Unless hedge accounting is applied, value movements on derivatives are recognised in the income statement.
US financial reporting standard FAS 133 was first applied for US GAAP reporting. Taking account of these considerations the Group has decided that, except for certain minor categories of derivatives, it is not appropriate to seek to achieve hedge accounting under IAS 39 by completely reconfiguring the structure of JNL’s derivative book. As a result of this decision the total income statement results are more volatile as the movements in the value of JNL’s derivatives are reflected within it.
This impact would, however, be mostly mitigated by an equal and offsetting transfer to the liability for unallocated surplus as the majority of these investments are held by the UK with-profits fund. Further information on these instruments is provided in note G1.
In estimating the future cash flows, the Group looks at the expected cash flows of the assets and applies historical loss experience of assets with similar credit risks which have been adjusted for conditions in the historical loss experience which no longer exist, or for conditions which are expected to arise. The estimated future cash flows are discounted using the financial asset’s original or variable effective interest rate and exclude credit losses that have not yet been incurred.
The Group applies the requirements of IAS 19, ‘Employee Benefits’ to its defined benefit pension schemes. The economic participation in the deficits attaching to the main Prudential Staff Pension Scheme (PSPS) and the smaller Scottish Amicable Pension Scheme (SAPS) are shared between the PAC with-profits sub-fund (WPSF) and shareholder operations. The economic interest reflects the source of contributions over the scheme life, which in turn reflects the activity of the members during their employment. In the case of PSPS, at 31 December 2004, the attribution between WPSF and shareholders’ funds was in the ratio 80/20. In 2005, following extensive analysis, this ratio was revised to 70/30. For SAPS the ratio for both 2005 and 2004 is estimated to be 50/50 between the WPSF and shareholders’ funds.
Description of the accounting policies applied in the 2005 financial statements is complicated by the basis of adoption and application of IFRS standards for 2005 and the 2004 comparative results. Accordingly, the policies set out in note A4(b) below should be read in the context of this background information.
For 2004, the income statement includes premiums and claim payments on all contracts that were then classified under previous
GAAP as insurance, including deposit style ‘investment contracts’ where the insurance risk in the contracts is insignificant. For 2005, the recognition basis in the income statement remains the same except for investment contracts, as defined under IFRS 4, which do not contain discretionary participation features, where the accounting reflects the deposit nature of the arrangement. Consequently, premiums and claims on these contracts are not recognised in the income statement.
or, in some cases, US GAAP has been applied but with the necessary changes to comply with UK GAAP.
UK GAAP has been applied for 2004. Investment contracts with discretionary participation features are also accounted for in accordance with UK GAAP in 2005, in common with insurance contracts. For 2005, investment contracts without discretionary participation features are accounted for on a basis that reflects the hybrid nature of the arrangements whereby the deposit component is accounted for as a financial instrument under IAS 39 and the service component is accounted for under IAS 18, ‘Revenue’.
The Group has adopted a policy of presenting an analysis of profit before tax attributable to shareholders that distinguishes operating profit based on longer-term investment returns from other constituent elements of the total profit. It should be noted that the comparative analysis for 2004 is prepared on an inconsistent basis from that in 2005 as a result of the delayed adoption of insurance contract and financial instrument standards as referred to above, from 1 January 2005, as permitted under IFRS 1 transition rules.
The allowance for loan losses was maintained at a level considered adequate to absorb losses in the mortgage loan portfolio.
Loans to policyholders were carried at unpaid principal balances and fully collateralised by the cash value of policies.
Deposits with credit institutions were carried at fair value. Changes in fair value were included in investment income for the year.
With the principal exception of derivatives held by JNL, these instruments were carried at fair value with changes in fair value included in investment income. Derivative instruments of JNL and certain other minor holdings were accounted for at amortised cost.
Debt securities intended to be held for continuing use were carried at cost less any provision for permanent diminution in value. Discount or premiums on purchase were amortised through the profit and loss account over the period from date of purchase to date of maturity.
Debt securities, which were held for resale, were stated at their net realisable value.
(ii) Financial investments on an available-for-sale basis – this comprises assets that are designated by management and/or do not fall into any of the other categories. These investments are carried at fair value. Interest income is recognised on an effective interest basis in the income statement. Unrealised gains and losses relating to changes in fair value are recognised in equity. Upon disposal or impairment, accumulated unrealised gains and losses are transferred from equity to the income statement as realised gains or losses.
(iii) Loans and receivables – this comprises investments that have fixed or determinable payments and are not designated as fair value through profit and loss or available-for-sale. These investments include loans collateralised by mortgages, deposits, loans to policyholders and other unsecured loans and receivables. These investments are carried at amortised cost using the effective interest method.
The Group has designated certain financial assets as fair value through profit and loss as these assets are managed and their performance is evaluated on a fair value basis. These assets represent all of the Group’s financial assets except all loans and receivable and debt securities held by JNL and Egg. Debt securities held by JNL and Egg are accounted for on an available-for-sale basis. The use of the fair value option is consistent with the Group’s risk management and investment strategies.
The Group uses the trade date method to account for regular way purchases and sales of financial assets with the exception of Egg’s loans and advances to customers which are on a settlement day basis.
The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or group of financial assets not held at fair value through profit and loss is impaired. A financial asset or group of financial assets is impaired and impairment losses are incurred only if there is objective evidence of impairment as a result of one or more events that have occurred after the initial recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. Objective evidence that a financial asset or group of financial assets is impaired includes observable data that comes to the attention of the Group. For assets designated as available-for-sale, the impairment is measured as the difference between the amortised cost of the asset and its fair value, removed from the available-for-sale reserve within equity and recognised in the income statement.
(in part, or in full), and this recovery can be objectively related to an event occurring after the impairment, then the previously recognised impairment loss is reversed through the income statement (in part, or in full).
The Group may designate certain derivatives as hedges. This includes fair value hedges, cash flow hedges and hedges of net investments in foreign operations. If the criteria for hedge accounting are met then the following accounting treatments are applied from the date at which the designation is made and the accompanying requisite documentation is in place: (i) Hedges of net investments in foreign operations – the effective portion of any change in fair value of derivatives or other financial instruments designated as net investment hedges are recognised in equity. The ineffective portion of changes in the fair value of the hedging instrument is recorded in the income statement. The gain or loss on the hedging instrument recognised directly in equity is recognised in the income statement on disposal of the foreign operation.
(ii) Fair value hedges – movements in the fair value of the hedged item attributable to the hedged risk are recognised in the income statement.
Embedded derivatives are held by various Group companies including JNL and Egg. They are embedded within other non-derivative host financial instruments to create hybrid instruments. Where economic characteristics and risks of the embedded derivatives are not closely related to the economic characteristics and risks of the host instrument, and where the hybrid instrument is not measured at fair value with the changes in fair value recognised in the income statement, depending on the classification of the host instrument, the host is then measured in accordance with the relevant requirements of IAS 39.
The loaned securities are not derecognised; rather, they continue to be recognised within the appropriate investment classification. The
Claims paid include maturities, annuities, surrenders and deaths. Maturity claims are recorded on the policy maturity date. Annuity claims are recorded when the annuity becomes due for payment. Surrenders are recorded when paid, and death claims are recorded when notified.
Costs of acquiring new business, principally commissions, marketing and advertising costs and certain other costs associated with policy issuance and underwriting that are not reimbursed by policy charges are specifically identified and capitalised as deferred acquisition costs
For 2005, the recognition basis in the income statement remains the same except for investment contracts which do not contain discretionary participating features, where the accounting reflects the deposit nature of the arrangement, with premium and claims reflected as deposits and withdrawals taken directly to the balance sheet.
Annual bonuses are declared and credited each year to with-profits policies. The annual bonuses increase policy benefits and, once credited, become guaranteed. Annual bonuses are charged to the profit and loss account in the year declared. Final bonuses are declared each year and accrued for all policies scheduled to mature and death benefits expected to be paid during the next financial year. Final bonuses are not guaranteed and are only paid on policies that result from claims through the death of the policyholder or maturity of the policy within the period of declaration or by concession on surrender. No policyholder benefit provisions are recorded for future annual or final bonus declarations.
For accumulating with-profits business, the calculation of the long-term business provision was based on a gross premium bonus reserve valuation. In general terms, a gross premium valuation basis is one in which the premiums brought into account are the full amounts receivable under the contract. The method included explicit estimates of premiums, expected claims, future regular bonuses, costs of maintaining contracts and future renewal expenses. Cash flows were discounted at the valuation rate of interest. The methodology for UK companies is included in the FSA rules. The discount rate was based on the expected return on the assets deemed to back the liabilities as prescribed by the FSA rules.
For PAC business, the provision was taken as the lower of: ■ The accumulated fund or the value at the bid price of the notional number of units allocated to policyholders, in both cases excluding final bonus; and
FRS 27 is underpinned by the FSA’s Peak 2 basis of reporting. This Peak 2 basis, which came into effect for the first time for 2004 regulatory reporting, requires the value of liabilities to be calculated as: ■ A with-profits benefits reserve (WPBR); plus
A4: Significant accounting policies continued The cost of guarantees, options and smoothing is very sensitive to the bonus, market value reduction (MVR) and investment policy the
The management actions assumed are consistent with management’s policy for with-profits funds and the disclosures made in the publicly available Principles and Practices of Financial Management.
■ replacement of MSB liabilities for with-profits business with adjusted realistic basis liabilities.
regulatory returns, but after excluding the element for the shareholders’ share of the future bonuses. This latter item is recognised as a liability for the purposes of regulatory returns but, for accounting purposes under FRS 27, consistent with the current basis of financial reporting, shareholder transfers are recognised only on declaration.
Other insurance contracts (contracts which contain significant insurance risk as defined under IFRS 4)
Other UK insurance contracts, including unit-linked contracts, that contain significant insurance risk, are accounted for consistently in 2004 and 2005. Segregated accounts are established for linked business for which policyholder benefits are wholly or partly determined by reference to specific investments or to an investment-related index. The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year. Mortality rates used in establishing policyholder benefit provisions were based on published mortality tables adjusted to reflect actual experience.
Results of overseas subsidiaries are determined initially using local GAAP bases of accounting with subsequent adjustments where necessary to comply with the Group’s accounting policies.
asset is established, is dependent on certain key assumptions. For single premium deferred annuity business, the key assumption is the expected long-term spread between the earned rate and the rate credited to policyholders. For variable annuity business, the key assumption is the expected long-term level of equity market returns which, for 2005 and 2004, was 8.4 per cent per annum implemented using a mean reversion methodology. These returns affect the level of future expected profits through their effects on fee income and the required level of provision for guaranteed minimum death benefit claims.
Although the basis of valuation of Prudential’s overseas operations is in accordance with the requirements of the Companies Act 1985 and ABI SORP, the valuation of policyholder benefit provisions for these businesses may differ from that determined on a UK MSB for
In the normal course of business, the Group seeks to reduce loss exposure by reinsuring certain levels of risk in various areas of exposure with other insurance companies or reinsurers. An asset or liability is recognised in the consolidated balance sheet representing premiums due to or payments due from reinsurers, and the share of losses recoverable from reinsurers. The measurement of reinsurance assets is consistent with the measurement of the underlying direct insurance contracts.
Gains arising on the purchase of reinsurance contracts by JNL are deferred and amortised over the contract duration. Any loss is recognised in the income statement immediately.
A4: Significant accounting policies continued Where the Group exercises significant influence or has the power to exercise significant influence over an entity, generally through ownership of 20 per cent or more of the entity’s voting rights, but does not control the entity then this is considered to be an investment in an associate. With the exception of those referred to below, the Group’s investments in associates are recorded at the Group’s share of the associate’s net assets. The carrying value of investments in associates is adjusted each year for the Group’s share of the entities’ profit or loss. This does not apply to investments in associates held by the Group’s insurance or investment funds including the venture capital business or mutual funds and unit trusts, which are carried at fair value through profit and loss.
The consolidated financial statements of the Group include the assets, liabilities and results of the Company and subsidiary undertakings in which Prudential has a controlling interest, using accounts drawn up to 31 December 2005 except where entities have non-coterminous year ends. In such cases, the information consolidated is based on the accounting period of these entities and is adjusted for material changes up to 31 December. Accordingly, the information consolidated is deemed to cover the same period for all entities throughout the Group. The results of subsidiaries are included in the financial statements from the date acquired to the effective date of disposal.
Actuarial gains and losses as a result of changes in assumptions or experience variances are also charged or credited to the income statement.
Contributions to the Group’s defined contribution schemes are expensed when due. Once paid, the Group has no further payment obligations. Any prepayments are reflected as an asset on the balance sheet.
The Group offers share award and option plans for certain key employees and a Save As You Earn plan (SAYE) plan for all UK and certain overseas employees. The arrangements for distribution to employees of shares held in trust relating to share award plans and for entitlement to dividends depend upon the particular terms of each plan. Shares held in trust relating to these plans are conditionally gifted to employees.
The compensation expense charged to the income statement is primarily based upon the fair value of the options granted, the vesting period and the vesting conditions. The Group revises its estimate of the number of options likely to be exercised at each balance sheet date and adjusts the charge to the income statement accordingly. Where the share-based payment depends upon vesting outcomes attaching to market-based performance conditions, additional modelling is required to take into account these conditions which effectively estimates the number of shares expected to vest. No subsequent adjustment is then made to the fair value charge for awards that do not vest on account of these performance conditions not being met.
company or both are 75 per cent owned subsidiaries of a common parent, the companies are considered to be within the same UK tax group. For companies within the same tax group, trading profits and losses arising in the same accounting period may be offset for purposes of determining current and deferred taxes.
The tax charge for long-term business includes tax expense on with-profits funds attributable to both the policyholders and the shareholders.
For life insurance company acquisitions, the adjusted net assets include an identifiable intangible asset for the present value of in-force business which represents the profits that are expected to emerge from the acquired insurance business. The present value of in-force business is calculated using best estimate actuarial assumptions for interest, mortality, persistency and expenses and is amortised over the anticipated lives of the related contracts in the portfolio. An intangible asset may also be recognised in respect of acquired investment management contracts representing the fair value of contractual rights acquired under these contracts.
Previously under UK GAAP, the Group used operating profit based on longer-term investment returns before amortisation of goodwill as a supplemental measure of its results. For the purposes of measuring operating profit, investment returns on shareholder-financed business were based on the expected longer-term rates of return. For debt securities, the longer-term returns (including losses arising on the recognition of permanent diminutions in value) were averaged over five years for inclusion in operating profit.
The amounts included in operating results for longer-term capital returns for debt securities comprise two components. These are a risk margin reserve based charge for expected defaults, which is determined by reference to the credit quality of the portfolio, and amortisation of interest-related realised gains and losses to operating results based on longer-term investment returns to the date when sold bonds would have otherwise matured. This change has been applied following a comprehensive review of the Group’s accounting policies and is unrelated to the requirements of IFRS. The change is of most importance to the determination of the operating result based on longerterm investment returns of JNL. Total profits are unaffected by the change of basis of determining longer-term investment returns.
A4: Significant accounting policies continued Items excluded from operating profit based on longer-term investment returns
The date of adoption of IFRS is 1 January 2004. As at that date the Group has applied all International Accounting Standards Board (IASB)
The Group has elected not to apply retrospectively the provisions of IFRS 3, ‘Business Combinations’ to business combinations that occurred prior to 1 January 2004. At the date of adoption, therefore, no adjustment was made between UK GAAP and IFRS shareholders’
The Group has taken advantage of the exemption within IFRS that allows comparative information presented in the first year of adoption of IFRS not to comply with the standards IAS 32, IAS 39 and IFRS 4.
Previously, under UK GAAP, all inter-company transactions were eliminated on consolidation except for investment management fees charged by M&G and the Group’s US and Asia fund management operations to long-term business funds.
Entities are consolidated under IFRS if they fall within the scope of IAS 27, ‘Consolidated and Separate Financial Statements’ and the
IFRIC interpretation, SIC 12, ‘Consolidation – Special Purpose Entities’, of the IASB. Under IFRS, certain investment vehicles are newly consolidated due to the requirements differing from UK GAAP.
A5: Changes from previous accounting basis and reconciliation to previously published 2004 results on first-time adoption of IFRS continued Basis of presentation of tax charges
Historically, under Companies Act requirements, tax charges attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies were charged, together with tax charges attributable to the long-term business result attributable to shareholders, as an expense in the long-term business technical account of the profit and loss account. In the non-technical section (i.e. the summary profit and loss section attributable to shareholders) the post-tax balance transferred from the long-term business technical account was grossed up by attributable shareholder tax to derive the pre-shareholder tax long-term business result. Tax charges in the non-technical account reflected the aggregate of the shareholder tax on the long-term business result and on the Group’s other results.
‘profit before tax attributable to shareholders’ is shown after deduction of taxes attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies. Tax charges on this measure of profit reflect the tax charges attributable to shareholders. In determining the tax charges attributable to shareholders, the Group has applied a methodology consistent with that previously applied under UK GAAP reflecting the broad principles underlying the tax legislation of life assurance companies.
Under UK GAAP, the Group applied the provisions of SSAP 24, ‘Pension Costs’. Consistent with the surplus financial position of the PSPS
(which accounts for 90 per cent of the liabilities of the Group’s defined benefit pension schemes) at 5 April 2002, which was at the time when the scheme was last subject to a full triennial actuarial valuation, and the scheme rules over minimum levels of funding, no SSAP 24 basis prepayment or provision has been reported in the Group’s UK GAAP balance sheet. Additional disclosures were made in the notes to the Group’s financial statements concerning the Group’s UK defined benefit schemes, applying the methodology prescribed by FRS 17,
For the PSPS scheme for 2004 it was estimated that 80 per cent of the deficit was attributable to the PAC with-profits sub-fund and 20 per cent to shareholder-backed operations. For 2005, following further detailed consideration of the sourcing of previous contributions by group companies and funds, the ratio has been altered to 70/30 for the allocation of the deficit between the PAC with-profits sub-fund and shareholder-backed operations.
Prior to 1 January 1998, goodwill relating to acquisitions was charged directly to shareholders’ funds. As permitted under the transitional arrangements of FRS 10, ‘Goodwill and Intangible Assets’, amounts previously charged to shareholders’ funds were not reinstated as assets in the UK GAAP balance sheet.
The arrangements for distribution to employees of shares held in trusts relating to share award plans and for entitlement to dividends depend upon the particular terms of each plan. Shares held in trusts relating to non-SAYE plans are conditionally gifted to employees.
Previously, under UK GAAP, compensation for non-SAYE plans was recorded over the periods to which share awards or options were earned based on intrinsic value. No costs were required to be recorded for SAYE plans.
The following table reconciles the income statement for the year ended 31 December 2004 as previously published under UK GAAP to the IFRS basis income statement for that year as presented in the comparatives to the 2005 income statement.
Finance costs: interest on core structural borrowings of shareholder-financed operations (187) (187)
Notes (i) UK GAAP results The UK GAAP basis results shown above reflect those previously recorded in the technical accounts and non-technical account of the Group’s profit and loss account under Companies Act requirements. These results are then reconfigured to be consistent with the format applied for reporting in the Group’s 2005 financial statements under IFRS.
Total changes before tax 92 Related tax attributable to shareholders 6
A5: Changes from previous accounting basis and reconciliation to previously published 2004 results on first-time adoption of IFRS continued Reconciliations of equity and balance sheet
This table reconciles IFRS shareholders’ equity at 1 January 2004, the IFRS transition date, from that previously published under UK GAAP.
Shareholders’ share of deficits (net of tax) of UK defined benefit pension schemes (note ii) (110) (110)
A5: Changes from previous accounting basis and reconciliation to previously published 2004 results on first-time adoption of IFRS continued The following table provides a reconciliation of the summarised balance sheet at 31 December 2004 between previously published
Effect of changes on implementation of IFRS recognition and measurement changes
Newly pension and Grossing-up consolidated schemes measurement and other entities accounting changes format Total IFRS IFRS UK GAAP (note i) (note ii) (note iii) changes changes basis
Banking business liabilities: per UK GAAP balance sheet 11,216 (11,216) (11,216) 0
Borrowings: per IFRS balance sheet: Core structural borrowings of shareholder-financed operations 3,248 3,248 3,248
Borrowings: per UK GAAP balance sheet (subordinated liabilities, debenture loans and other borrowings) 4,673 (4,673) (4,673) 0
Notes (i) Newly consolidated entities Under IAS 27 and SIC 12, the Group is required to consolidate the assets and liabilities of certain entities which have previously not been consolidated. The principal change to shareholders’ equity arises from an adjustment in respect of Prudential plc shares held by unit trusts that are newly consolidated. These shares are accounted for as treasury shares and the cost of purchase of £44 million and £29 million is deducted from shareholders’ equity at 1 January 2004 and 31 December 2004 respectively. The change to the minority share of equity reflects external parties’ interest in consolidated venture investment companies and property partnerships of the PAC with-profits fund. Measurement changes to the carrying value of these companies that are attributable to the PAC with-profits fund share are reflected in unallocated surplus.
(ii) Defined benefit pension schemes accounting Provisions for deficits on the Group’s defined benefit pension schemes are absorbed by the unallocated surplus of the PAC with-profits fund and shareholders’ funds on a basis that reflects the weighted cumulative activity attaching to the contributions paid in the past, and after deduction of deferred tax. The M&G scheme held Prudential Group insurance policies as scheme assets amounting to £125 million at 31 December 2004. The asset and liability are eliminated on consolidation.
Previously, under UK GAAP, the Group’s cash flow statement excluded the cash flows of long-term business funds, except for the transfer to shareholders’ funds. Under IFRS the cash flow statement comprises consolidated cash flows for the Group as a whole, including those of long-term business funds.
The principal effects of adopting these standards arises in the Group’s UK long-term business contracts, JNL’s debt securities and derivative instruments, and Egg’s banking assets, liabilities and derivatives positions.
For those ‘investment’ contracts that do not contain discretionary participating features, IAS 39 and, where the contract includes an investment management element, IAS 18, apply measurement principles to the assets and liabilities attaching to the contract that may diverge from those previously applied under UK GAAP. The changes primarily arise in respect of deferred acquisition costs, deferred income reserves and provisions for future expenses commonly called ‘sterling reserves’.
Under UK GAAP, acquisition expenses are deferred with amortisation on a basis commensurate with the anticipated emergence of margins under the contract. Under IFRS, incremental costs that are directly attributable to securing investment management contracts are recognised as an asset that represents the entity’s contractual right to benefit from providing investment management services and is amortised as the entity recognises the related revenue. IAS 18 further reduces the costs potentially capable of deferral to incremental costs only. Deferred acquisition costs are amortised to the income statement in line with service provision.
Deferred income provisions for front-end fees and similar arrangements are required to be established for investment management contracts under IAS 18 with amortisation over the expected life of the contract in line with service provision. In contrast to UK GAAP, sterling reserves are not permitted to be recognised under IFRS. An additional feature is that investment contracts are closer in nature to a deposit style arrangement between the investors and the Company. Under IFRS, premiums and withdrawals for these contracts are recorded within the balance sheet directly as a movement on the investors liability. After making these and other consequential changes, the IFRS
income statement reflects fee income on the contracts, expenses and taxation rather than the UK GAAP basis profit and loss account.
JNL’s derivatives are, however, recorded in the income statement as required by IAS 39.
The Group has decided not to seek to hedge account for the majority of JNL’s derivatives under IAS 39. To do so would require a wholesale reconfiguration of JNL’s derivative book into much smaller components than currently applied by JNL through its economic hedge programme, accompanied by an extra layer of hedging instruments beyond what is economically rational.
For loans and advances to customers, specific and formulated provisions are raised against non-performing loans and a general provision against the balance. Under IAS 39, an impairment loss is only recognised when there is objective evidence that a debt is impaired.
Wholesale instruments, under UK GAAP, were previously accounted for on an amortised cost basis. Under IAS 39, certain wholesale financial instruments are required to be measured at fair value, and depending on whether they have been classified as fair value through the profit and loss or available-for-sale, the changes in fair value are recognised in the income statement or in equity respectively. The adjustments for wholesale financial instruments also include the impact of designating some of Egg’s derivatives as cash flow hedges.
Other non-investment and non-cash assets: Property, plant and equipment 967 967
(note A5) (note i) (note ii) (note iii) changes Total effect 2005 £m £m £m £m £m £m £m
Policyholder liabilities and unallocated surplus: Insurance contract liabilities 103,582 103,582 103,582
Notes The changes shown above include the impact of remeasurement for: (i) UK insurance operations (a) The reduction in shareholders’ equity of £22 million includes £20 million relating to certain unit-linked and similar contracts that do not contain significant insurance risk and are therefore categorised as investment contracts under IFRS 4.
The unallocated surplus of £8.3 billion at 1 January 2005 post IAS 39 and IFRS 4 adoption, comprises £8.0 billion for the PAC with-profits fund and £0.3 billion for Asian subsidiaries. The £8.0 billion for the PAC with-profits fund represents: £bn
Regulatory basis realistic surplus of with-profits sub-fund and SAIF 6.0 Add back: regulatory basis provision for future shareholder transfers 2.9 Less: other adjustments to align with accounting basis (0.9)
Items excluded from operating profit, but included in total pre-tax profit of continuing operations, include goodwill impairment charges, short-term fluctuations in investment returns (i.e. actual less longer-term returns), actuarial gains and losses on defined benefit pension schemes and exceptional items. For the purposes of distinguishing actuarial gains and losses on defined benefit pension schemes in this analysis, plan assets include Prudential policies held by the scheme. Total profits are unaffected by the change of basis of determining longer-term investment returns.
A7: New accounting pronouncements The following standards, interpretations and amendments have been issued but are not yet effective. This is not intended to be a complete list as only those standards, interpretations and amendments that are anticipated to have a future impact upon Prudential’s financial statements have been discussed.
IFRS 7 replaces IAS 30, ‘Disclosures in the Financial Statements of Banks and Similar Financial Institutions’, which dealt with disclosures for banking operations, and the disclosure requirements of IAS 32, ‘Financial Instruments: Disclosure and Presentation’. The latter therefore becomes a standard dealing wholly with presentation of financial instruments. IFRS 7 is intended to complement the principles for recognising, measuring and presenting financial assets and financial liabilities in IAS 32 and IAS 39, ‘Financial Instruments: Recognition and Measurement’. The objective of IFRS 7 is to require entities to provide disclosures in their financial statements to enable the users of financial statements to evaluate the significance of financial instruments for the entity’s financial position and performance and the nature and extent of risks arising from financial instruments to which the entity is exposed, and how the entity manages those risks.
Revised IFRS 4 ‘Implementation Guidance’ was issued in December 2005 and is effective in conjunction with the adoption of IFRS 7 as discussed above. The revisions relate to disclosures around insurance contracts.
Amendment to IAS 39, ‘Cash Flow Hedge Accounting of Forecast Intra-group Transactions’
Issued in August 2005, the amendments to IAS 39 and IFRS 4 in respect of financial guarantee contracts are effective for annual periods beginning on or after 1 January 2006. These amendments define a financial guarantee contract and address initial and subsequent measurement issues. These amendments apply even if the contract meets the definition of an insurance contract under IFRS 4 although they allow continuation of accounting under IFRS 4 if the contracts were considered to be insurance contracts and documented as such.
B1: Supplementary analysis of profit before tax attributable to shareholders This information is provided as supplementary information under the Group’s accounting policies. It is not required by IFRS standards.
US operations Jackson National Life (note iii) 348 296 Broker-dealer and fund management (including Curian losses of £10m (2004: £29m)) 14 (14)
Asian operations Long-term business (note iii) 195 117 Fund management (note iv) 12 19 Development expenses (20) (15)
Profit from continuing operations before tax attributable to shareholders 998 850
(iii) Effect of changes to assumptions and bases of determining life assurance liabilities The results of the Group’s long-term business operations are affected by changes of assumptions and bases of preparation. These are described in notes D2(f), D3(f) and D4(f).
(iv) Asian fund management business Operating profit for the Asian fund management business was £12 million for 2005. The decrease from the results for 2004 reflects the exceptional cost of £16 million incurred in Taiwan due to bond fund restructuring required as a result of industry-wide regulatory change.
Actuarial losses Actual less expected returns on scheme assets 544 115 Experience gains (losses) on liabilities 1 (17) Losses on changes of assumptions for plan liabilities (based on long-term inflation of 2.8%) (489) (141)
(a) Up to 31 December 2004, the deficits arising on the PSPS had been assessed as being 80 per cent attributable to the PAC with-profits fund and 20 per cent to shareholder operations. In 2005, following additional analysis this apportionment has been altered to a ratio of 70/30.
Based on profit for the year 1,001 (241) (12) 748 31.6p 31.6p
Net of tax Basic Diluted Before tax Tax Minority and minority earnings earnings (note B1) (note F5) interests interests per share per share 2004 £m £m £m £m Pence Pence
Based on profit for the year from continuing operations 850 (240) (26) 584 27.5p 27.5p
Number of shares that would have been issued at fair value on assumed option exercise (9) (10)
Parent company dividends relating to reporting period: Interim dividend (2005: 5.30p, 2004: 5.19p per share) 126 109
A final dividend of 11.02 pence per share was proposed on 15 March 2006. The dividend will be paid on 26 May 2006 to shareholders on the register at the close of business on 24 March 2006. The dividend will absorb an estimated £267 million of shareholders’ funds. A scrip dividend alternative will be offered to shareholders.
Insurance products Investment products gross premiums gross inflows Total £m £m £m £m £m £m *The format of the tables shown above is consistent with the distinction between insurance and investment products as applied for previous financial reporting periods. With the exception of some US institutional business, products categorised as ‘insurance’ refer to those classified as contracts of long-term insurance business for regulatory reporting purposes, i.e. falling within one of the classes of insurance specified in part II of Schedule 1 to the Regulated Activities Order under FSA regulations.
Annual Single Regular premium equivalents £m £m £m £m £m £m
Department of Work and Pensions rebate business 244 265 – – 24 27
GIC – Medium Term Notes 634 672 – – 63 67
Market Gross and other 1 Jan 2005 inflows Redemptions movements 31 Dec 2005 £m £m £m £m £m *The format of the tables shown above is consistent with the distinction between insurance and investment products as applied for previous financial reporting periods. With the exception of some US institutional business, products categorised as ‘insurance’ refer to those classified as contracts of long-term insurance business for regulatory reporting purposes, i.e. falling within one of the classes of insurance specified in part II of Schedule 1 to the Regulated Activities Order under FSA regulations.
IFRS. Contracts included in this category are primarily certain unit-linked and similar contracts written in UK insurance operations, and
Details of the primary reporting segments are as follows: Long-term business
with-profits funds’ venture investments managed by PPM Capital and other investment subsidiaries held for the purpose of supporting the Group’s long-term business operations.
This segment consists of products provided by the Group’s online banking subsidiary, Egg. The 2004 comparatives also include amounts from Jackson Federal Bank that was sold in October 2004. The nature of these products and the managing of the business differ from the risks inherent in the other business segments, and the regulatory environment of the banking industry differs from that of the other business segments.
Broker-dealer Long-term and fund Unallocated Intra-group business Banking management to a segment eliminations Total 2004 £m £m £m £m £m £m
Group’s balance sheet by a mixture of primary and secondary segments.
Assets Goodwill: Attributable to PAC with-profits fund 607 – – 607 – – – – 607
Unallocated surplus of with-profits funds (reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds – see
Turnbull guidance). In addition, Internal Audit executes a comprehensive risk-based audit plan throughout the Group, from which all significant issues are reported to the Group Audit Committee.
The Group’s internal control framework includes detailed procedures laid down in financial and actuarial procedure manuals. The Group prepares an annual business plan with three-year projections. Executive management and the Board receive monthly reports on the
The insurance operations of the Group all prepare a financial condition report which is presented to the Board who receive regular reports from the Group Finance Director on the financial position of the Group.
The Group publishes separately within its Group Annual Report a section on key risk factors, which discuss inherent risks in the business and trading environment.
Approximately 82 per cent of the Group’s IFRS basis shareholders’ funds at 31 December 2005 arose in Prudential’s US and Asian operations.
To mitigate the exposure of the US component there are US$1.55 billion of borrowings held centrally. The Group also has entered into a
US$2 billion net investment hedge (see note G3). Net of the currency position arising from these instruments some 46 per cent of the
Liquidity risk is the risk that Prudential may be unable to meet payment of obligations in a timely manner at a reasonable cost or the risk of unexpected increases in the cost of funding the portfolio at appropriate maturities or rates. Liquidity management in each business seeks to ensure that, even under adverse conditions, Prudential has access to the funds necessary to cover surrenders, withdrawals and maturing liabilities.
Operational risk can result from a variety of factors, including failure to obtain proper internal authorisations or maintain internal controls, failure to document transactions properly, failure of operational and information security procedures or other procedural failures, computer system or software failures, other equipment failures, fraud, inadequate training or errors by employees. Compliance with internal rules and procedures designed to manage these risks is monitored by Prudential’s local management boards.
Internal compliance managers who report to the local management boards monitor adherence to local regulatory requirements. The head of Prudential’s Group Compliance function reports directly to the Group Chief Risk Officer who submits regular reports to the Board of Directors.
Prudential faces are equity risk and interest rate risk because most of its assets are investments that are either equity type investments and subject to equity price risk, or bonds, mortgages or cash deposits, the values of which are subject to interest rate risk. The amount of risk borne by Prudential’s shareholders depends on the extent to which its customers share the investment risk through the structure of Prudential’s products.
A stochastic approach models the inter-relationship between asset and liability movements, taking into account asset correlation and policyholder behaviour, under a large number of possible scenarios. These scenarios are projected forward over a period of time, typically 25 years or longer, and the liabilities and solvency position of the fund are calculated in each scenario in each future year. This allows the identification of which extreme scenarios will have the most adverse effects and what the best estimate outcome may be. The fund’s policy on management actions, including bonus and investment policy, are then set in order that they are consistent with the available capital and the targeted risk of default. This differs from a deterministic model, which would only consider the results from one carefully selected scenario.
C: Group risk management continued For businesses that are most sensitive to interest rate changes, such as immediate annuity business, Prudential uses cash flow analysis to create a portfolio of fixed income securities whose value changes in line with the value of liabilities when interest rates change. This type of analysis helps protect profits from changing interest rates. In the UK, the cash flow analysis is used in Prudential’s annuity and banking business while, in the US, it is used for its interest-sensitive and fixed index annuities and stable value products such as Guaranteed
Details of the Group’s use of derivatives are explained in note G3.
For 2004, the IFRS results included in these financial statements continue to reflect UK GAAP requirements in relation to long-term business contracts.
Under IFRS, from 1 January 2005 when the Group adopts IFRS 4, the measurement basis of assets and liabilities of long-term business contracts is dependent upon the classification of the contracts under IFRS. Under IFRS 4, contracts are initially classified as being either
‘insurance’ contracts, if the level of insurance risk in the contracts is significant, or ‘investment’ contracts, if the risk is insignificant.
‘Insurance’ contracts are permitted to be accounted for under previously applied GAAP. The Group has chosen to adopt this approach.
However, as an improvement to accounting policy, permitted by IFRS 4, the Group has applied the measurement principles and disclosures of the UK Standard FRS 27 for 2005 reporting. An explanation of the changes under FRS 27 is provided in note D2. 2004 comparatives are not required to be restated.
‘Investment’ contracts are further delineated under IFRS 4 between those with and without discretionary participation features. For those contracts with discretionary participation features, IFRS 4 also permits the continued application of previously applied GAAP. The Group has adopted this approach, again subject to the FRS 27 improvement.
D1: Group overview continued The insurance contracts of the Group’s shareholder-backed business fall broadly into the following categories: ■ UK insurance operations – bulk and individual annuity business, written by Prudential Retirement Income Limited, Prudential Pensions
■ Prudential Corporation Asia – non-participating term, whole life, and unit-linked policies, together with accident and health policies.
The assets and liabilities of contracts with insignificant insurance risk previously were accounted for under UK GAAP under the provisions of the ABI SORP, as described in note A4. Under IFRS 4, the assets and liabilities of these contracts with insignificant insurance risk and no discretionary participation features are required to be accounted for in accordance with IAS 39 and, where relevant, the provisions of
IAS 18, in respect of attaching investment management features of the contracts. Contracts of the Group whose assets and liabilities are required to be remeasured from 1 January 2005 under these two standards can be summarised as: ■ UK – certain unit-linked savings and similar contracts; ■ Jackson National Life – GICs
The impact on the contracts of UK insurance operations and JNL’s GICs are considered in turn below: (i) Certain UK unit-linked savings and similar contracts
UK contracts are single premium with the initial deferred income reflecting the ‘front end load’ i.e. the difference between the premium paid and the amount credited to the unit fund. Deferred income is amortised to the income statement in line with service provision.
Previously, under UK GAAP, the assets and liabilities of JNL’s insurance contracts, including GICs, have been measured by the application of US GAAP principles with contract liabilities accounted for on an amortised cost basis. Under a traditional GIC, the policyholder makes a lump sum deposit. The interest rate paid is fixed and established when the contract is issued. Funding agreements are of a similar nature but the interest rate may be floating, based on a rate linked to an external index. The US GAAP accounting requirements for such contracts are very similar to those under IFRS on the amortised cost model for liability measurement.
The Group has a broadly based exposure to life assurance risk. This is achieved through the geographical spread of the Group’s operations and, within those operations, through a broad mix of product types. In addition, looking beyond pure insurance risk, the Group considers itself well developed in its approach to assessment of diversification benefits through its ‘economic capital’ project that is used for internal business management. The economic capital project seeks to apply a single yardstick to assess and quantify all risks attaching to the Group’s insurance business and associated capital requirements.
On 2 June 2005, the Group published details of the framework and results to that point of its economic capital project. Under the framework, cash flows and capital requirements for each of the main business units in the UK, US and Asia are projected over many internally consistent stochastically generated simulations. The process, using a group solvency model, captures 80 per cent of the business, the other 20 per cent being modelled on a stand-alone basis and aggregated with the main results using a correlation matrix approach. This is a standard method of aggregation used by banks and other financial institutions.
Using an iterative modelling process, economic capital is calculated as the amount required at the calculation date such that the cumulative number of projected defaults is less than a predetermined rate reflecting Prudential’s internal target solvency level. Prudential’s internal target solvency level has been set as equivalent to the historic default rate on AA-rated bond (equivalent to a cumulative probability of default of 44 out of 1,000 simulations over 25 years). The economic capital framework thus assesses the capital required to meet Prudential’s obligations with at least this level of confidence taking into account extreme events. Prudential’s economic capital model covers all material risks in each business, including (where relevant) financial risks and insurance and business risks.
D1: Group overview continued The 2 June announcement made reference to unaudited economic capital requirements at 31 December 2004. These results remain unaudited in these statements except to the extent of being an accurate representation of the information reported at that time.
As at 31 December 2004, Prudential reported that it required £1.8 billion of capital for the Group to cover the risks to its existing contractual and discretionary insurance liabilities, on an economic basis and its internal target solvency level. This number is after allowance for diversification across risks and geographies and the capturing of future shareholders’ transfers from the business units. This compares to available capital of £3.4 billion on an equivalent basis (i.e. GAAP based shareholders’ equity after adjusting to eliminate goodwill, to include subordinated debt capital and valuation differences). This requirement has been analysed into its contributory parts by risk type as follows: asset liability matching 28 per cent, credit risk 47 per cent, underwriting (mortality, longevity and morbidity) 10 per cent, persistency 2 per cent, and operational 13 per cent. The largest risk exposure on a diversified basis, credit risk, reflects the relative size of the exposure to JNL, Prudential UK shareholder annuities business, and Egg.
Notes D2(b), D3(b) and D4(b) and (h) provide details of guarantee features of the Group’s life assurance products. In the UK guarantees of the with-profits products are valued for accounting purposes on a market consistent basis for 2005 as described in section D2(d)(ii). The UK
These measures include IFRS basis earnings, net shareholder cash flow to or from business units from or to central funds, and movements in the value of discounted future expected cash flows of in-force long-term insurance business. The latter item is commonly referred to as Embedded Value.
The Group prepares and publishes supplementary information in accordance with the European Embedded Value (EEV) principles issued by the CFO Forum of European Insurance Companies in May 2004 and expanded by the addition of Additional Guidance on
EEV Disclosures published in October 2005. Key elements of the EEV principles are the approach applied to allowing for risk and the best estimate assumptions of future cash flows arising from the contracts.
The cash flows subject to valuation are those expected under the contracts such as those arising from premiums, claims, expenses after appropriate estimation of future lapse behaviour and mortality and morbidity experience. The cash flows also include the expected future cash flows on assets covering liabilities and encumbered capital.
Encumbered capital is based on Prudential’s internal target for economic capital subject to it being at least the local statutory minimum requirements. Economic capital is assessed using internal models but does not take credit for the significant diversification benefits that exist within the Group.
Valuation of the future cash flows also takes account of the ‘time value’ of option and guarantee features of the Group’s long-term business contracts. The time value reflects the variability of economic outcomes in the future. Where appropriate, a full stochastic valuation is undertaken to determine the value of the in-force business. Common principles are adopted across the Group for the stochastic asset model classes, for example, separate modelling of individual asset classes but with allowance for correlation between the various asset classes. In deriving the time value of financial options and guarantees, management actions in response to emerging investment and fund solvency conditions are modelled. 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 are consistent with those set out in the Principles and Practices of Financial Management.
D1: Group overview continued The present value of the future cash flows is calculated using a risk 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 risk allowance covers market and non-market risks.
CAPM does not include any allowance for non-market risks since they 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.
(e) Sensitivity of IFRS basis profit or loss and equity to changes that have a material effect
Jackson National Life ■ Variable annuity business – fund management performance and incidence of guarantee features of the contracts; ■ fixed annuity business – spread differential between earned rate and rate credited to policyholder; and
■ fixed index annuity business – spread differential between earned rate and rate credited to policyholder and incidence of equity index participation features.
Asian operations ■ With-profits business – as for UK Insurance operations; ■ unit-linked business – as for UK Insurance operations; and
JNL is sensitive to lapse risk. However, JNL has swaption derivatives in place to ameliorate the effect of a sharp rise in interest rates, which would be the most likely cause of a sudden change in policyholder behaviour.
Under the terms of the Group’s contracts, as for life assurance contracts generally, the contractual maturity date is the earlier of the end of the contract term, death or surrender. The Group has therefore chosen to provide details of liability duration that reflect the actuarially determined best estimate of the likely incidence of these three factors on contract duration. Details are shown in sections D2(i), D3(i) and
D4(i). Effective interest rates, as defined in IAS 32, are not applicable to the Group’s insurance contracts and investment contracts with discretionary participation features.
In the years 2001 to 2005 claims paid on the Group’s life assurance contracts including those now classified as investment contracts under
IFRS 4 ranged from £11.8 billion to £13.8 billion. Indicatively it is to be expected that of the Group’s policyholder liabilities (excluding unallocated surplus) at 31 December 2005 of £159 billion, the amounts likely to be paid in 2006 will be of a similar magnitude.
D2: UK insurance operations (a) Summary balance sheet at 31 December 2005 In order to explain the different types of UK business and fund structure, the balance sheet of the UK insurance operations may be analysed by the assets and liabilities of the Scottish Amicable Insurance Fund, the PAC with-profits sub-fund, annuity business, unit-linked and other business. The assets and liabilities of these funds and subsidiaries are shown in the table below.
Fund Annuities Limited Total Income business operations (note ii) Limited (note iii) (note iv) Limited (note v) Total Total £m £m £m £m £m £m £m £m
Held for sale assets – 728 – 728 – – – 728
Operational borrowings attributable to shareholder-financed operations – – – – – 17 17 17
(iii) Wholly-owned subsidiary of the PAC WPSF that writes annuity business.
With-profits products provide returns to policyholders through bonuses that are ‘smoothed’. There are two types of bonuses: ‘annual’ and
Prudential’s conventional annuities include level, fixed increase and retail price index (RPI) annuities. They are mainly written within the subsidiaries PAL, PRIL, Prudential Pensions Limited and the PAC with-profits sub-fund, but there are some annuity liabilities in the WPSF
Policyholders select an ‘anticipated bonus’ from the specific range Prudential offers for the particular product. The amount of the annuity payment each year depends upon the relationship between the anticipated bonus rate selected by the policyholder when the product is purchased and the bonus rates Prudential subsequently declares each year during the term of the product. If the total bonus rates fall below the anticipated rate, then the annuity income falls.
SAIF is a ring-fenced sub-fund of the PAC long-term fund and was formed following the acquisition of the mutually owned Scottish
Prudential UK insurance operations also have an extensive book of unit-linked policies of varying types and provide a range of other non-profit business such as stakeholder, credit life and non-life long-term contracts. These contracts do not contain significant financial guarantees.
Prudential’s UK annuity business employs fixed income investments (including UK retail price index-linked assets) because the liabilities consist of guaranteed payments for as long as each annuitant is alive. Retail price index-linked assets are used to back pension annuities where the payments are linked to the RPI.
Calculation of the contract liabilities involves the setting of assumptions for future experience. This is done following detailed review of the relevant experience including, in particular, mortality, expenses, tax and economic assumptions. For with-profits business written in the WPSF or SAIF from 2005, for IFRS accounting purposes, a market consistent valuation is performed (as described in section (ii) below).
Assurance Society Scheme until 31 December 2007, when the tariff arrangement terminates. This provides an additional margin in SAIF
For non-profit business excluding unit-linked business, the valuation interest rates used to discount the liabilities are based on the yields as at the valuation date on the assets backing the technical provisions. For fixed interest securities the gross redemption yield is used, for property it is the rental yield, and for equities it is the greater of the dividend yield and the average of the dividend yield and the earnings yield. An adjustment is made to the yield on non risk-free fixed interest securities and property to reflect credit risk. To calculate the non-unit reserves for linked business, assumptions have been set for the gross unit growth rate and the rate of inflation of maintenance expenses, as well as for the valuation interest rate as described above.
The FSA’s Peak 2 calculation under the new realistic regime, which came fully into effect for the first time for 2004 regulatory reporting requires the value of liabilities to be calculated as: ■ The with-profits benefits reserve (WPBR); plus
The assumptions used in the stochastic models are calibrated to produce risk-free returns on each asset class. Volatilities of, and correlations between, investment returns from different asset classes are as determined by the Group’s Portfolio Management Group but aim to be market consistent.
Under this basis of accounting, the future policyholder benefit provisions on conventional with-profit policies was calculated using the net premium valuation method, such that they would be sufficient at the outset of the policy to provide only for the discounted value of the original guaranteed death and maturity benefits on the chosen valuation assumptions. The provisions were then calculated by subtracting the present value of future net premiums from the present value of future benefits (including vested bonuses) using a prudent discount rate.
Under the net premium valuation method, vested bonuses are included in the cash flows assessed but future allocations of bonuses are not included explicitly, although they may be implicitly taken into account in the discount rate used, which is based on the return available on suitable investments. The detailed methodology for UK companies is included in the regulations contained in the FSA rules. In particular, the returns available from equity and property assets are based on expected income and/or earnings and no allowance is made for future capital growth.
The assumptions were determined as prudent best estimates at the date of valuation. Interest rates used in establishing policyholder benefit provisions at 31 December 2004 range from 3 per cent to 5 per cent.
For PAC business the calculation was based on a valuation under which future reversionary bonuses are added to the guaranteed liabilities existing at the valuation date. The assumptions to which the estimation of the technical provisions were particularly sensitive were the assumed future reversionary bonuses, the interest rate used to discount the provisions, the assumed future per policy expenses and the assumed future mortality experience of policyholders.
The contract liabilities for PAL and PRIL are based on the FSA regulatory solvency basis. The valuation is then modified for MSB reporting purposes to remove certain of the margins for prudence within the assumptions, and contingency reserves, both of which are required under the solvency basis applied for regulatory purposes, but not for financial accounting.
The mortality assumptions are set in light of recent population and internal experience. The assumptions used are percentages of standard actuarial mortality tables with an allowance for future mortality improvements. Where annuities have been sold on an enhanced basis to impaired lives an additional age adjustment is made. The percentages of the standard table used are selected according to the source of business. The range of percentages used is set out in the following tables: PAL
The majority of other long-term business written in the UK insurance operations is unit-linked business or other business with similar features. For these contracts the attaching liability reflects the unit value obligation and provision for mortality risk. The latter component is determined by applying mortality assumptions on a basis that is appropriate for the policyholder profile.
The Group’s UK insurance business cedes only minor amounts of business outside the Group. During 2005, reinsurance premiums for externally ceded business were £82 million and reinsurance recoverable insurance assets were £750 million in aggregate. The gains and losses recognised in profit and loss for these contracts were immaterial.