Profits from shareholder-backed annuity business are most sensitive to: ■ The extent to which the duration of the assets held closely match the expected duration of the liabilities under the contracts, assuming close matching, the impact of short-term asset value movements for interest rate movements will broadly offset changes in the values of liabilities caused by movements in valuation rates of interest; ■ actual versus expected default rates on assets held; ■ the difference between long-term rates of return on corporate bonds and risk-free rates; ■ the variance between actual and expected mortality experience; and
■ the extent to which expected future mortality experience gives rise to changes in the measurement of liabilities.
A decrease in assumed mortality rates of 1 per cent would decrease gross profits by approximately £33 million. A decrease in credit default assumptions of five basis points would increase gross profits by £65 million. A decrease in renewal expenses (excluding investment management expenses) of 5 per cent would increase gross profits by £12 million. The effect on profits would be approximately symmetrical for changes in assumption that are directionally opposite to those explained above.
Profits from unit-linked and similar contracts primarily arise from the excess of charges to policyholders, for management of assets under the Company’s stewardship, over expenses incurred. The former is most sensitive to the net accretion of funds under management as a function of new business and lapse and mortality experience. The accounting impact of the latter is dependent upon the amortisation of acquisition costs in line with the emergence of margins (for insurance contracts) and amortisation in line with service provision (for the investment management component of investment contracts). By virtue of the design features of most of the contracts which provide low levels of mortality cover the profits are relatively insensitive to changes in mortality experience.
UK insurance operations are, except for pension annuity business, not generally exposed to interest rate risk. For pension annuity, business liabilities are exposed to fair value interest rate risk. However, the net exposure to the PAC WPSF (for PAL) and shareholders (for liabilities of PRIL) is very substantially ameliorated by virtue of the close matching of assets with appropriate duration.
With the exception of most unitised with-profit bonds and other whole of life contracts the majority of the contracts of the UK insurance operations have a contract term. However, in effect, the maturity term of contracts reflects the earlier of death, maturity, or lapsation. In addition, with-profit contract liabilities as noted in note D2(d) above include projected future bonuses based on current investment values.
IFRS, i.e. those containing significant insurance risk, and investment contracts, which do not, is as follows: Insurance contracts Investment contracts
Investments: Financial investments: Loans and receivables – 3,577 3,577 – 3,577
Policyholder liabilities: Investment contract liabilities without discretionary participation features (GIC and annuity certain) – 1,502 1,502 – 1,502
Core structural borrowings of shareholder-financed operations – 145 145 – 145
Policy reserves and liabilities on non-linked business: Reserves for future policyholder benefits and claims payable 971
JNL provides long-term savings and retirement products to retail and institutional customers throughout the US. JNL offers individual fixed annuities, fixed index annuities, immediate annuities, variable annuities, individual and variable life insurance and institutional products.
The policy provides that at JNL’s discretion it may reset the interest rate, subject to a guaranteed minimum. The minimum guarantee varies from 1.5 per cent to 5.5 per cent (2004: 1.5 per cent to 5.5 per cent) depending on the jurisdiction of issue and the date of issue, with 73 per cent (2004: 73 per cent) of the fund at 3 per cent or less. The average guarantee rate is 3.3 per cent (2004: 3.3 per cent).
Fixed index annuities account for 7 per cent (2004: 6 per cent) of JNL’s policy and contract liabilities at 31 December 2005. Fixed indexed annuities vary in structure, but generally are deferred annuities that enable policyholders to obtain a portion of an equity-linked return but provide a guaranteed minimum return. These guaranteed minimum rates are generally set at 3 per cent.
The primary difference between VAs and interest-sensitive or fixed index annuities are investment risk and return. If a policyholder chooses a VA, the rate of return depends upon the performance of the selected fund portfolio. Policyholders may allocate their investment to either the fixed or variable account. Investment risk on the variable account is borne by the policyholder, while investment risk in the fixed account is borne by JNL through guaranteed minimum fixed rates of return. At 31 December 2005, approximately 19 per cent
(guaranteed minimum income benefit (GMIB)), or at specified dates during the accumulation period (guaranteed minimum withdrawal benefit (GMWB)). JNL hedges these risks using equity options and futures contracts as described in note D3(c).
JNL’s life insurance products accounted for 9 per cent (2004: 10 per cent) of JNL’s policy and contract liabilities at 31 December 2005.
Under a funding agreement, the policyholder either makes a lump sum deposit or makes specified periodic deposits. JNL agree to pay a rate of interest, which may be fixed but which is usually a floating short-term interest rate linked to an external index. The average term of the funding arrangements is one to two years. Funding agreements terminable by the policyholder with less than 90 days notice account for less than 1 per cent (2004: 2 per cent) of JNL total policyholder reserves.
Medium-term note funding agreements are generally issued to support trust instruments issued on non-US exchanges or to qualified investors (as defined by SEC rule 144A). Through the funding agreements, JNL agrees to pay a rate of interest, which may be fixed or floating, to the holders of the trust instruments.
JNL’s main exposure to market risk is through its exposure to interest rate risk because approximately 88 per cent (2004: 88 per cent) of its general account investments support interest-sensitive and fixed index annuities, life business and surplus and 12 per cent (2004: 12 per cent)
support institutional business. All of these types of business contain considerable interest rate guarantee features and, consequently, require that the assets that support them are primarily fixed income or fixed maturity.
■ the risk of mismatch between the expected duration of certain annuity liabilities and prepayment risk and extension risk inherent in mortgage-backed securities.
National Association of Insurance Commissioners (NAIC). The categories range from Class 1 (the highest) to Class 6 (the lowest). Performing securities are designated as Classes 1 to 5. Securities in or near default are designated Class 6. Securities designated as Class 3, 4, 5 and 6 are non-investment grade securities. Generally, securities rated AAA to A by nationally recognised statistical ratings organisations are reflected in Class 1, BBB in Class 2, BB in Class 3 and B and below in Classes 4 to 6. If a designation is not currently available from the
NAIC, JNL’s investment advisor, PPM America, provided the designation for the purposes of disclosure below.
NAIC designation: The following table shows the quality of the non-SEC Rule 144A traded private placement portfolio: Carrying value £m % of total
standards and the ABI SORP are met, it is permissible to reflect the local basis of provisioning. In the case of JNL, except for adjustments for certain items, the carrying values of insurance assets and liabilities are consolidated into the Group accounts based on US GAAP. The exceptions are for IFRS accounting in 2004 for fixed index annuities, which include embedded derivatives that are supported by equity call options and VA GMWB benefits, and VA GMIB benefits. For 2004, before the adoption of IAS 39, the call options were valued at amortised cost whilst the VA benefits were recognised as a portion of accumulated assessments related to expected excess benefits under MSB. For 2005, in line with US GAAP, these are carried at fair value following the adoption of IAS 39 using the Black-Scholes option valuation methodology.
■ any probable future loss on the contract (i.e. premium deficiency).
Capitalised acquisition costs and deferred income for these contracts are amortised over the life of the book of contracts. The present value of the estimated gross profits is computed using the rate of interest that accrues to policyholder balances (sometimes referred to as the contract rate). Estimated gross profits include estimates of the following elements, each of which will be determined based on the best estimate of amounts of the following individual elements over the life of the book of contracts without provision for adverse deviation for: ■ Amounts expected to be assessed for mortality less benefit claims in excess of related policyholder balances; ■ amounts expected to be assessed for contract administration less costs incurred for contract administration; ■ amounts expected to be earned from the investment of policyholder balances less interest credited to policyholder balances; ■ amounts expected to be assessed against policyholder balances upon termination of contracts (sometimes referred to as surrender charges); and
The assumptions used for calculating the direct GMIB liability at 31 December 2005 and 2004 are consistent with those used for calculating the GMDB liability.
JNL regularly evaluates estimates used and adjusts the additional GMDB and GMIB liability balances, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised.
Most GMWB features are considered to be embedded derivatives under IAS 39. Therefore, provisions for these benefits are recognised at fair value, with the change in fair value included in operating profit based on longer-term investment returns. Certain GMWB features guarantee payments over a lifetime and, therefore, include mortality risk. Provisions for these GMWB amounts, which are not significant, are valued consistent with the GMDB valuation method discussed above.
D3: US operations continued The fair values of the GMWB and GMIB reinsurance derivatives are calculated based on actuarial assumptions related to the projected cash flows, including benefits and related contract charges, over the expected lives of the contracts, incorporating expectations regarding policyholder behaviour in varying economic conditions. As the nature of these cash flows can be quite varied, stochastic techniques are used to generate a variety of market return scenarios for evaluation. The generation of these scenarios and the assumptions as to policyholder behaviour involve numerous estimates and subjective judgements, including those regarding expected market volatility, correlations of market returns and discount rates, utilisation of the benefit by policyholders under varying conditions, and policyholder lapsation. At each valuation date, JNL assumes expected returns based on risk-free rates as represented by the LIBOR forward curve rates as of that date and market volatility as determined with reference to implied volatility data and evaluations of historical volatilities for various indices. The risk-free spot rates as represented by the LIBOR spot curve as of the valuation date are used to determine the present value of expected future cash flows produced in the stochastic process.
With the exception of the GMDB, GMIB and GMWB features of VA contracts, the financial guarantee features of JNL’s contracts are in most circumstances not explicitly valued under the standard US GAAP basis of calculation, but the impact of any interest guarantees would be reflected as they are earned in the current account value (i.e. the US GAAP liability).
The sensitivity of this value to changes in key assumptions is as follows: £m
Interest rates (including consequential changes for assumed investment returns for all asset classes, market values of debt securities, and all risk discount rates): Equity/Property yields – 1% rise 42
D3: US operations continued (h) Sensitivity of IFRS basis profit or loss and equity to changes that have a material effect
■ spread returns for the difference between investment returns and rates credited to policyholders.
For VA 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 the fee income and the required level of provision for guaranteed minimum death benefit claims.
Except to the extent of mortality experience, which primarily affects profits through variations in claim payments and GMDB reserves, the profits of JNL are relatively insensitive to changes in insurance risk.
D4: Asian operations (a) Summary balance sheet at 31 December 2005
The policyholder liabilities (net of reinsurance of £8 million) and unallocated surplus shown in the table above reflect the following balances: £m
This amount covers a range of with-profit, unit-linked and non-participating contracts.
The life insurance products offered by the Group’s Asian operations include a range of with-profits and non-participating term, whole life, endowment and unit-linked policies. The Group’s Asian operation also offers health, disability, critical illness, and accident coverage to supplement its core life products.
The terms and conditions of the contracts written in the Asian operations and, in particular, the products’ options and guarantees, vary from territory to territory depending upon local market circumstances.
In general terms, the Group’s Asian participating products provide savings and protection where the basic sum assured can be enhanced by a profit share (or bonus) from the underlying fund as determined at the discretion of the insurers. The Asian operations’ non-participating term, whole life and products offer savings with protection where the benefits are guaranteed or determined by a set of defined market related parameters. Unit-linked products combine savings with protection, the cash value of the policy depends on the value of the underlying unitised funds. Accident and Health (A&H) policies provide mortality or morbidity benefits and include health, disability, critical illness and accident coverage. A&H products are commonly offered as supplements to main life policies but can be sold separately.
Cash value and interest rate guarantees are of three types: ■ Maturity values
The main variable that determines the amounts payable under the contracts is the duration of the contracts, which is determined by death or surrender. The sensitivity of the IFRS result for these contracts is shown in section (h) below.
Whole life contracts with floor levels of policyholder benefits that accrue at rates set at inception are also written in the Korean life operations, though to a much less significant extent than in Taiwan. The Korean business has non-linked liabilities and linked liabilities at 31 December 2005 of £193 million and £91 million respectively. The business is much less sensitive to returns than Taiwan with the higher proportion of linked and health business.
For the traditional business in Taiwan, the economic scenarios used to calculate the IFRS results reflect the assumption of a phased progression of bond yields from current rates to long-term expected rates. The projections assume that the current bond yields of around 2 per cent (3 per cent) trend towards 5.5 per cent (5.5 per cent) at 31 December 2012 (2010).
The Group’s Asian businesses cede only minor amounts of business outside the Group with immaterial effects on reported profit. During 2005, reinsurance premiums for externally ceded business were £37 million and reinsurance recoverable insurance assets were £8 million in aggregate.
The 2005 results for Asian operations are affected in two significant ways for changes of basis or assumption.
Singapore risk-based capital framework, with one that, although still including provisions for adverse deviation, more accurately estimates the liability. This has resulted in a change of estimate and reduction in the liability of £73 million.
(2004: 7.3 per cent, 9.75 per cent, and 12.25 per cent respectively).
For Taiwan the same assumptions are applied as under IFRS (see section (d) above).
D4: Asian operations continued The sensitivity of this value to changes in key assumptions is as follows: £m
(h) Sensitivity of IFRS basis profit or loss and equity to changes that have a material effect
A 10 per cent increase in these rates and those of other Asian operations would have reduced reported profit before tax attributable to shareholders and shareholders’ equity, excluding goodwill attributable to Asian operations, by £23 million and £101 million respectively.
Similar principles to those explained for UK with-profits business apply to profit emergence for the Group’s Asian with-profit business.
The in-force business of Taiwan life operation includes traditional whole of life policies where the premium rates have been set by the regulator at different points for the industry as a whole. Premium rates were set to give a guaranteed minimum sum assured on death and a guaranteed surrender value on early surrender based on prevailing interest rates at the time of policy issue. Premium rates also included allowance for mortality and expenses. The required rates of guarantee have fallen over time as interest rates have reduced from a high of 8 per cent to current levels of around 2 per cent. The current low level of bond rates in Taiwan gives rise to a negative spread against the majority of these policies. The current cash costs of funding in-force negative spread in Taiwan is around £30 million a year.
Taiwan business are determined on the US GAAP basis as applied previously under UK GAAP. Under this basis the policy liabilities are calculated on sets of assumptions, which are locked in at the point of policy inception, and a deferred acquisition cost is held in the balance sheet.
basis results would be a charge of some £120-130 million. If the rate was to further reduce the incremental increase in liabilities would be of a similarly commensurate size. The effects of changes in any one year reflect the combination of the short-term and long-term factors described above.
For the Korean and Japan life business exposures described in section (b) above, the results are comparatively unaffected by changes of assumption. The accounts basis value of liabilities for both operations are of a similar order of magnitude to those that apply for the purposes of Group solvency calculations under the Financial Conglomerates Directive (FCD).
The Group’s capital position for life assurance businesses with reconciliations to shareholders’ funds is shown below. Available capital for each fund or group of companies is determined by reference to local regulation at 31 December 2004 and 2005. Parent company and shareholders’ Other UK equity of
SAIF (note i) fund (note ii) JNL subsidiaries operations M&G Egg and funds Group
Held outside long-term funds: Held in long-term funds (note iii) 0 0 0 558 – – 558 – – – 558
Shareholders’ share in realistic liabilities – (3,473) (3,473) – – – (3,473)
JNL surplus notes (note iv) – – – – 145 – 145
Investment contracts without discretionary participation features (principally unit-linked and similar contracts in the
UK and GIC liabilities of JNL) (note vi) – – 10,502 1,502 22 12,026
Total policyholder liabilities shown in the consolidated balance sheet 14,762 73,184 28,230 31,981 10,828 158,985
Held outside long-term funds: Held in long-term funds (note iii) 0 0 0 515 – – 515 – – – 515
JNL surplus notes (note iv) – – – – 130 – 130
D5: Capital position statement for life assurance businesses continued The Group’s policyholder liabilities at 31 December 2004 comprise: Other UK Total life subsidiaries Asian life assurance
(iv) For regulatory purposes the JNL surplus notes are accounted for as capital.
In common with other large UK regulated with-profits funds, PAC is required to hold capital equivalent to the greater of their regulatory requirement based on EU directives, (i.e. the ‘regulatory peak’) and the new FSA basis calculation of expected liabilities (i.e. the ‘realistic peak’).
Available capital of the WPSF and SAIF of £8.0 billion (2004: £6.0 billion) represents the excess of assets over liabilities on the regulatory realistic basis. Unlike the previously discussed FRS 27 basis, realistic liabilities on the regulatory basis include the shareholders’ share of future bonuses. These amounts are shown before deduction of the risk capital margin (RCM) which is estimated to be £2.4 billion
The FSA’s basis of setting the RCM is to target at a level broadly equivalent to a Standard & Poor’s credit rating of BBB and of judging this by ensuring there are sufficient assets to absorb a 1 in 200 year event. The RCM calculation achieves this by setting rules for the determination of margins to cover defined stress changes in asset values and yields for market risk, credit risk, and termination risk for with-profit policies.
In normal investment conditions, the Company expects changes to regular bonus rates to be gradual over time and changes are not expected to exceed 1 per cent per annum over any year. However, discretion is retained as to whether or not a regular bonus is declared each year, and there is no limit on the amount by which regular bonus rates can be changed.
For the Group’s other material Asian operations the details of the basis of determining regulatory capital and regulatory capital requirements are as follows: Singapore
Basic policy reserves are determined using a net premium method. Both mortality and interest rates are specified. For more recent issues, the valuation rate of interest has been linked to the prevailing market rate on 10-year government bonds.
The capital requirement is determined as 4 per cent of reserves plus a specified percentage of sums at risk. There is an overriding minimum capital requirement of RM100 million.
(ii) SAIF The decrease of £677 million, reflects the impact of FSA actuarial guidance note GN 45 as explained in note D2(f).
(iii) JNL The increase of £461 million reflects an underlying increase of £252 million (applying the 2005 year end exchange rate of 1.72) and £209 million of exchange translation gain.
For JNL, capital retention is maintained at a level consistent with an appropriate rating by Standard & Poor’s. Currently JNL is rated AA.
For Asian subsidiaries, the amounts retained within the companies are at levels that provide an appropriate level of capital strength in excess of the local regulatory minimum. For ring-fenced with-profit funds the excess of assets over liabilities is retained with distribution tied to the shareholders’ share of bonuses through declaration of actuarially determined surplus. The Group’s Singapore and Malaysian businesses may remit dividends to the Group, in general, provided the statutory insurance fund meets the capital adequacy standard required under local statutory regulations.
A stochastic approach models the inter-relationship between asset and liability movements, taking into account asset correlation, management actions and policyholder behaviour, under a large number of alternative economic 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. The fund’s policy on management actions, including bonus and investment policy continue to be set in order that they are consistent with the available capital and the targeted risk of default.
Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency.
E: Banking operations The Group undertakes banking operations through one of its principal subsidiaries, Egg. Financial information in respect to Egg has been included in this note. The results from Jackson Federal Bank, another Group banking subsidiary that was sold in October 2004, have also been included in discontinued operations in the income statement below up to the date of disposal.
The Group has presented the income statement and balance sheet for banking operations in a format that demonstrates the characteristics and principal operations specific to a bank. The format is different to that of the Group consolidated income statement and balance sheet; however, total profit (loss) for the year and net assets remain the same. To understand how the amounts presented from banking operations are consolidated in the Group financial statements, refer to the primary segmental information for the income statement in note F1 and the primary segmental information for the balance sheet in note B5.
Impairment losses on loans and cash advances to customers E5 (241) (183)
Of the profit (loss) for the year in 2005 and 2004, a profit of £9 million and a loss of £20 million, respectively, are attributable to minority interests in Egg.
The exposure to specific risks is monitored by the Executive Committee through separate committees: retail credit committee is responsible for retail credit risk, wholesale credit committee is responsible for wholesale credit risk, operational risk committee is responsible for operational risk; and asset and liability committee (ALCO) for liquidity, market and currency risk.
E4: Maturities of assets and liabilities and liquidity risk Liquidity risk is defined for Egg as not having sufficient financial resources available to meet its obligations as they fall due, or if such resources can only be secured at excessive cost. Egg uses various methods including predictions of daily cash positions to monitor and manage liquiditity risk. Maturity mismatches between lending and funding are managed within internal risk policy limits. It ensures that it holds sufficient assets, which are immediately realisable into cash without significant exposure to market risk or costs, to cover a realistic estimate of retail funds that could be withdrawn. While a significant proportion of retail savings balances are on instant access terms, in practice the majority of such funds represent a relatively stable and consistent funding base for Egg.
Cash and balances with central banks 7 – – – – 7
Securities purchased under agreement to resell 200 – – – – 200
Loans and advances to customers 0 3,343 40 1,421 2,626 7,430
E4: Maturities of assets and liabilities and liquidity risk continued From From From
Cash and balances with central banks 14 – – – – 14
Loans and advances to banks 344 270 2 – – 616
The aggregate loss on loans at the end of the year and the charge during the year have been included in the consolidated financial statements.
Balance at the end of the year 335 250 *The other movements reflect a release of provisions for bad and doubtful debts following the sale of the Egg France unsecured lending portfolio.
*Egg has also classified £71 million of debt securities as fair value through profit and loss.
At 31 December 2005, Egg held £539 million of assets and £2,640 million of liabilities with foreign currency exposure.
E7: Credit risk Egg takes on exposure to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. To limit this risk,
Egg places limits on the amount of risk accepted in relation to a particular borrower, groups of borrowers, and to particular geographical segments. The acceptable risk levels are monitored regularly, and reviewed where appropriate. From Egg’s perspective, the most important step in managing credit risk is the initial decision whether or not to extend credit. Egg’s retail and wholesale credit committees define the policies, procedures and sets limits for accepting credit risk.
The following table identifies the geographical concentrations of credit risk, stated in terms of total assets and off balance sheet items, held by Egg at 31 December 2005 and 2004: £m £m
The following is a breakdown of the credit risk borne by Egg for financial assets and off-balance sheet items at 31 December 2005: £m
Off-balance sheet items (including unutilised credit limits on credit cards) 9,104
Egg enters into securities lending arrangements, including repurchase agreements, and over-the-counter derivative transactions as part of normal operating activities. Assets are pledged as collateral to support these activities. Collateral in respect to repurchase agreements was £30.9 million and £nil at 31 December 2005 and 2004, respectively. Collateral in respect to over-the-counter derivative transactions was £5.2 million and £2.3 million at 31 December 2005 and 2004, respectively. See note G4 where amounts related to Egg have been included in the disclosure of these transactions on a Group basis.
F1: Segmental information The Group’s primary and secondary segments are described in detail in note B5.
The segment results for the year ended 31 December 2005 are as follows: £m £m
Long-term business, including post-tax transfers to unallocated surplus of with-profits funds (36,968) (30,531)
Profit for the year 760 516 *Profits 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.
Within segment results above, the share of after tax loss of associates that are equity accounted for of £nil (2004: £(1) million) is allocated entirely to the banking segment.
Fee income from investment contract business, fund management, banking and broker-dealer services (note i) 926 653
Notes (i) As a result of the adoption of IFRS 4 on 1 January 2005, premiums received in respect of investment contracts without discretionary participation features are not recognised as income; instead these amounts are accounted for directly in the balance sheet as deposit liabilities. Only fee income associated with such contracts is accounted for in the income statement in 2005. In 2004, deposits and related fees on these contracts were included within long-term business premiums. In 2004, the long-term business premiums also include premiums from insurance contracts and investment contracts with discretionary participation features.
Notes (i) Acquisition costs in 2005 comprise amounts related to insurance contracts of £1,307 million, and investment and investment management contacts of £106 million. These costs include amortisation of £392 million and £9 million, respectively.
(ii) Total depreciation and amortisation expense amounted to £541 million (2004: £540 million). Of this amount, £401 million (2004: £386 million) relates to amortisation of deferred acquisition costs of insurance contracts and investment management contracts, which primarily is borne by the long-term business segment. Of the remainder of the depreciation and amortisation charge of £140 million (2004: £154 million), £101 million (2004: £107 million) related to long-term business, £28 million (2004: £29 million) to banking, £8 million (2004: £15 million) to fund management and £3 million (2004: £3 million) to central companies.
(2004: £154 million) and of £33 million (2004: £33 million) on Egg subordinated debt.
Benefit from a previously unrecognised tax loss, tax credit or temporary difference from a prior period (2) 0
Benefit from a previously unrecognised tax loss, tax credit or temporary difference from a prior period 5 2
Write-down or reversal of a previous write-down of a deferred tax asset 2 0
For the purposes of explaining the relationship between tax expense and accounting profit, it is appropriate to consider the sources of profit and tax by reference to those that are attributable to shareholders and policyholders, as follows: Attributable Attributable Attributable Attributable to to to to shareholders policyholders Total shareholders policyholders Total £m £m £m £m £m £m
The tax charge for linked and with-profits business includes tax expense on unit-linked and with-profits funds attributable to policyholders, the unallocated surplus of with-profits funds and the shareholders’ profits. Different rules apply under UK tax law for taxing pension business and life insurance business and there are detailed rules for apportioning the investment return and profits of the fund between the types of business. The investment return referable to pension business, and some other less significant classes of business, is exempt from taxation but tax is charged on the profit that the shareholders derive from writing such business at the corporate rate of tax. The rules for taxing life assurance business are more complex. This is because the UK regime seeks to tax the investment return less management expenses (I-E) on this business as it arises. However, a calculation of the shareholder profit from writing life insurance business also has to be made and this performs two main functions. Firstly, the shareholder profit is compared with the I-E profit and if the shareholder profit is higher, then relief for expenses in the I-E has to be restricted until the I-E profit equals the shareholder profit. If on the other hand I-E profit is the greater, then an amount equal to the shareholder profit is taxed at the corporate rate of tax with the remainder of the I-E profit being taxed at the lower policyholder rate of tax. The purpose of this approach is to ensure that the Company is always as a minimum taxed on the profit that it has earned. The shareholders’ portion of the long-term business is taxed at the shareholders’ rate with the remaining portion taxed at rates applicable to the policyholders.
As described above UK long-term business is taxed on a basis that affects policyholders, unallocated surplus of with-profits funds and shareholders. For the PAC with-profits sub-fund, transfers to and from unallocated surplus are recorded in the income statement so that after charging the total tax borne by the fund, the net balance reflects the statutory transfer from the fund for the year. For SAIF similar transfers are made to derive a net nil balance which reflects the lack of shareholder interest in the financial performance of the fund (other than through investment management arrangements). For unit-linked policies, pre-tax profits attributable to policyholders represent fees earned that are used to pay tax borne by the Company on policyholders’ behalf.
F5: Tax continued (ii) Reconciliation of tax charge on profits attributable to shareholders
Asian UK long-term insurance business Other operations JNL operations operations Total 2005 £m £m £m £m £m
Actual tax charge: Operating profit based on longer-term investment returns (117) (123) (63) 117 (186)
For 2004, the Group’s results reflect the application of IFRS standards with the exception of the standards IAS 32, IAS 39 and IFRS 4.
Supplementary information included within the Group’s Annual Report shows an analysis of 2004 profit on the pro forma basis as if IAS 32,
Notes (i) Expected tax rates for profit attributable to shareholders Expected tax rates shown in the table above reflect the corporate tax rates generally applied to taxable profits of the relevant country jurisdictions. For Asian operations the expected tax rates reflect the corporate tax rate weighted by reference to the source of profits of the operations contributing to the aggregate business unit result. The increase in total expected rate from 31 per cent in 2004 to 35 per cent in 2005 is due to the goodwill impairment charge of £120 million in 2005 not being allowable for tax.
F6: Discontinued operations The £3 million post-tax profit from discontinued operations (2004: £94 million post-tax loss) is comprised of the sum of the gain on disposal of operations and profit or loss generated by discontinued operations.
In October 2004, JNL sold Jackson Federal Bank for £166 million. After taking into account net assets and goodwill totalling £128 million at the date of disposal, the profit on sale was £38 million before tax. Jackson Federal Bank, made an operating profit up to the date of disposal of £17 million.
In August 2004, the Group sold its interest in Life Assurance Holding Corporation Limited for £41 million. After taking into account the carrying value of the investment of £34 million at the date of disposal, the profit on sale was £7 million before tax.
In July 2004, Egg announced that it intended to take the necessary steps to withdraw from the French market. Egg France was sold in 2004. The loss before tax of Egg France in 2004 was £150 million which was made up of a provision for exit costs of £113 million and other operating losses of £37 million.
During the year ended 31 December 2005, the exit process from France by Egg was completed. The final costs incurred were lower than the provision made in July 2004, therefore, £4 million of the provision was released in the year.
In addition, during 2005, Egg sold Funds Direct, its investment wrap platform business. The sale was completed in October 2005. Funds
Direct incurred losses before tax of £1 million (2004: £20 million) including exit costs in the year.
Fair value through profit Amortised Carrying and loss cost IFRS 4 value Fair value 2005 £m £m £m £m £m
Obligations under funding, stock lending and sale and repurchase agreements – 4,529 – 4,529 4,524
Investment contracts with discretionary participation features (note ii) – – 26,523 26,523 –
(ii) It is impractical to determine the fair value of investment contracts with discretionary participation features due to the lack of a reliable basis to measure such features.
(iii) As at 31 December 2005, £450 million of convertible bonds were included in debt securities and £311 million were included in borrowings.
The fair values of quoted investments are based on current bid prices, where appropriate. If the market for a financial asset is not active, the Group establishes fair value by using quotations from independent third parties such as brokers or by using valuation techniques. The valuation techniques include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis and option pricing models.
The loans and receivables have been shown net of provisions for impairment. The fair value of loans has been estimated from discounted cash flows expected to be received. The rate of discount used was the market rate of interest.
G1: Financial instruments – designation and fair values continued The fair value of borrowings is based on quoted market prices, where available.
The fair value of other financial liabilities is determined using discounted cash flows of the amounts expected to be paid.
In accordance with the Group’s risk management framework, all internally generated calculations are subject to independent assessment by the M&G Fair Value Committee which comprises members who are independent of the fund managers involved in the day-to-day trading in these assets.
Changing any one of the underlying assumptions used in determining the fair value would not have a significant impact on the value of the assets.
However, changing the implied volatility would not have had a significant impact on the fair value of the assets.
Of the Group’s financial investments of £151,083 million as at 31 December 2004, £115,294 million were listed investments. The amount of the Group’s total financial investments that were due to mature in less than one year was £15,409 million.
G2: Market risk continued The table below details the effective interest rates for applicable classes of financial assets and liabilities not held at fair value through profit and loss, notably financial assets designated as available-for-sale, loans and receivables and liabilities held at amortised cost: Balance of financial Range of effective instruments not at interest rates fair value through applicable as at profit and loss 31 Dec 2005 £m %
Obligations under funding, stocklending and sale and repurchase agreements 4,529 2.4 – 8.0
As at 31 December 2005, the Group held 18 per cent and 21 per cent of its financial assets and financial liabilities respectively, in currencies, mainly US dollar and Euro, other than the functional currency of the relevant business unit.
See also note E3 for details of the market risks faced by the banking business.
The Group uses the various interest rate derivative instruments, such as interest rate swaps to reduce exposure to interest rate volatility.
G3: Derivatives and hedging continued The UK insurance operations use various currency derivatives in order to limit volatility due to foreign currency exchange rate fluctuations arising on securities denominated in currencies other than Sterling. See also note G2 above. In addition, total return swaps and interest rate swaps are held for efficient portfolio management.
Some of the Group’s products, especially those sold in the US, have certain guarantee features linked to equity indexes. A mismatch between product liabilities and the performance of the underlying assets backing them exposes the Group to equity index risk. In order to mitigate this risk, the relevant business units purchase swaptions, equity options and futures to match asset performance with liabilities under equity-indexed products.
The US operations and some of the UK operations hold large amounts of interest rate sensitive investments that contain credit risks on which a certain level of defaults is expected. These entities have purchased some swaptions in order to manage the default risk on certain underlying assets and hence reduce the amount of regulatory capital held to support the assets.
Egg uses derivative instruments for the purpose of supporting the strategic and operational business activities and reducing and eliminating the risk of loss arising from changes in interest rates and foreign exchange rates. Derivatives are used solely to hedge risk exposures and
For the purpose of reducing interest rate risk, Egg uses a number of derivative instruments, including interest rate swaps and forward agreements. Additionally, swaps are used to provide caps to the funding cost of the credit card product.
The Group has formally assessed and documented the effectiveness of the following hedges: Fair value hedges
Egg has cash flow hedged certain balance sheet items which are subject to interest rate risk. As at 31 December 2005, the notional amount of this cash flow hedge was £2,296 million. The cash flows are periodically updated based on the underlying banking portfolios.
In November 2005, the Group’s US$500 million net investment hedge relating to the currency exposure of the US operations matured.
The Group has entered into securities lending (including repurchase agreements) whereby blocks of securities are loaned to third parties, primarily major brokerage firms. The agreements require that amounts between 102 per cent and 105 per cent of the fair value of the loaned securities be held as collateral, depending on the quality of the collateral, calculated on a daily basis. The loaned securities are not removed from the Group’s consolidated balance sheet, rather they are retained within the appropriate investment classification. Collateral typically consists of cash, debt securities, equity securities and letters of credit. At 31 December 2005, the Group had lent £10,594 million
(of which £8,250 million was lent by the PAC with-profits fund) of securities and held collateral under such agreements of £11,112 million
At 31 December 2005, the Group had entered into reverse repurchase transactions under which it purchased securities and had taken on the obligation to resell the securities for the purchase price, £1,214 million, together with accrued interest.
At 31 December 2005, the Group had pledged £403 million for liabilities and held collateral of £193 million in respect of over-the-counter derivative transactions.
During 2005, Egg transferred additional UK credit card receivables to its trust vehicle, Arch (Term) Limited, created in 2002 for the purpose of asset-backed securitisation, bringing the outstanding balance of assets in this vehicle to £2.8 billion (2004: £2.59 billion). The noteholders in securitisations from this vehicle have a proportional interest in each account balance in the trust. As at 31 December 2005, the value of this interest was £2.3 billion (2004: £2.23 billion). This securitisation does not qualify for derecognition under IAS 39 and the total portfolio is, therefore, included in loans and receivables. The funding giving rise to the note-holders interest is included within operational borrowings attributable to shareholder-financed operations.
The impairment losses have been recorded in ‘acquisition costs and other operating expenditure’.
Disposals (including, for 2005, goodwill of held for sale venture investment subsidiaries – see note H9) (333) (100)
The carrying value of goodwill is attributable to: The PAC with-profits fund (in respect of venture investment subsidiaries) 607 784
(£62 million). In 2005, goodwill disposals relate entirely to PAC with-profits fund venture subsidiaries.
H1: Goodwill continued The £5 million charge for impairments in 2004 related to the write-down of Funds Direct (£2 million) and Zebank (£3 million), parts of the
‘Other’ represents goodwill amounts allocated across cash generating units in Asia and US operations. These goodwill amounts are not individually material. There are no other intangible assets with indefinite useful lives other than goodwill.
With the exception of M&G and venture investment subsidiaries of the PAC with-profits fund the goodwill in the balance sheet relates to acquired life businesses. The Company routinely compares the aggregate of net asset value and acquired goodwill on an IFRS basis of acquired life business with the value of the business as determined using the EEV methodology, as described in section D1. Any excess of
IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine whether there is any indication that the goodwill in the IFRS balance sheet may be impaired.
The recoverable amount for the M&G CGU has been determined by calculating its value in use. This has been calculated by aggregating the present value of future cash flows expected to be derived from the component businesses of M&G (based upon management projections) and its current surplus capital.
basis by aggregating fair values calculated for each entity less costs to sell these entities.
Guidelines which set out industry best practice for determining the fair value of private equity investments. The guidelines require that an enterprise value is calculated for each investment, typically using an appropriate multiple applied to the Company’s maintainable earnings.
Management believes that any reasonable change in the key assumptions would not give rise to an impairment charge.
H2: Other intangible assets Other intangible assets in the Group consolidated balance sheet consist of: £m £m
Deferred acquisition costs (DAC) related to insurance contracts as classified under
Deferred acquisition costs related to investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under
IFRS 4 (2004 – fund management contracts other than long-term business only) 104 8
Present value of acquired in-force policies for insurance contracts as classified under IFRS 4
Present value of future profits of acquired investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under
IFRS 4 (2004 – fund management contracts other than long-term business only) 9 0
IFRS 4, which is adopted from 1 January 2005, permits deferred acquisition costs for insurance contracts and investment contracts with discretionary participation features to be accounted for under existing GAAP. Under UK GAAP, acquisition costs are deferred with amortisation on a basis commensurate with the anticipated emergence of margins under the contract.
On 1 January 2005, the Group adopted FRS 27, ‘Life Assurance’ into existing GAAP as part of the adoption of IFRS 4 which is reflected in the transition adjustment in the table below. The effect of this is to derecognise deferred acquisition costs for with-profits contracts of the
H2: Other intangible assets continued The movement in deferred acquisition costs relating to insurance contracts and investment contracts with discretionary participation features is as follows: £m
Transition adjustment on application of IAS 32, IAS 39 and IFRS 4 (see note A6): Derecognition of deferred acquisition costs for UK regulated with-profits funds as a result of adopting FRS 27 (765)
Removal of deferred acquisition costs on investment contracts without discretionary participation features (38)
Shadow DAC and other impacts as a result of measurement changes in JNL’s investment portfolio (456)
Amortisation of this intangible asset is included in the ‘acquisition costs and other operating expenditure’ line in the income statement.
Transition adjustment on application of IAS 32, IAS 39 and IFRS 4 67
Prior to the adoption of IFRS 4, the present value of acquired in-force business (PVAIF) was accounted for under UK GAAP. On 1 January 2005, following the adoption of IFRS 4, PVAIF relating to investment contracts without discretionary participation features, which was included within long-term business, is removed and replaced by an asset representing the present value of the future profits of the investment management component of these contracts, where applicable. These contracts are accounted for under the provisions of IAS 18. The remainder of the PVAIF balance relates to insurance contracts and continues to be accounted for under UK GAAP as permitted by IFRS 4.
The amortisation charge is included in acquisition costs and other operating expenditure in the income statement.
Amortisation is charged to the ‘acquisition costs and other operating expenditure’ line in the income statement over the period of provision of investment management services as those profits emerge. Long-term Investment business management £m £m
Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying temporary differences can be deducted. The UK taxation regime applies separate rules to trading and capital profits and losses. The distinction between temporary differences that arise from items of either a capital or trading nature may affect the recognition of deferred tax assets. Accordingly, for the 2005 results and balance sheet position at 31 December 2005 the possible tax benefit of approximately £333 million (2004: £430 million), which may arise from capital losses valued at approximately £1.7 billion, is sufficiently uncertain that it has not been recognised. In addition, a potential deferred tax asset of £67 million, which may arise from trading losses of approximately £237 million, is sufficiently uncertain that it has not been recognised.
Of the £962 million (2004: £1,018 million) current tax liability, it is not practicable to estimate how much is expected to be settled in one year or less due to the uncertainty over when outstanding issues will be agreed with HM Revenue and Customs.
Unprovided deferred income tax liabilities on temporary differences associated with investment in subsidiaries, associates and interests in joint ventures are considered to be insignificant due to the availability of various UK tax exemptions and reliefs.
Of the £3,109 million (2004: £2,921 million) of accrued investment income and other debtors, £992 million (2004: £990 million) is expected to be settled after one year or more.
Of the above net book amounts, £125 million (2004: £193 million) of Group occupied property and £269 million (2004: £287 million)
of tangible assets are attributable to consolidated venture investment subsidiaries of the PAC with-profits fund at 31 December 2005.
Direct operating expenses (including repairs and maintenance expenses) arising from investment properties: That generated rental income during the year 133 119
Future minimum lease payments are due as follows: Less than 1 year 12 8
The present values of these minimum lease payments are: Less than 1 year 11 7
Contingent rent is that portion of the lease payments that is not fixed in amount but is based on the future value of a factor that changes other than with the passage of time. Contingent rent recognised as an expense in 2005 amounted to £21 million (2004: £27 million).
The total minimum future rentals to be received on non-cancellable sub-leases for land and buildings for the year ended 31 December 2005 are £4,006 million (2004: £3,760 million).
H8: Investments in participating interests The Group’s investments in participating interests at 31 December 2005 and 2004 comprise associates and joint ventures. Disclosures relating to these investments are provided below. The Group also had an interest of 15 per cent in Life Assurance Holding Corporation
The Group had one associate at 31 December 2005 and 2004 that is accounted for using the equity method, IfOnline Group Limited
The Group holds 38.6 per cent of the total issued share capital of IfOnline which comprises 29.9 per cent of the ordinary share capital and 96.0 per cent of the preference share capital. The Group also holds £1 Founder share capital and £1 AN share capital. IfOnline is not a listed investment. Equity accounting is applied based on its reporting period of the year to 30 November and is adjusted for material changes up to 31 December. Accordingly, the information is deemed to cover the same period as that of the Group.
H8: Investments in participating interests continued A summary of the movements in investments in associates accounted for using the equity method in 2005 and 2004 is set out below: Share of Share of Share of Total carrying capital reserves net assets Goodwill value £m £m £m £m £m
Share of loss for the year after tax – (1) (1) – (1)
The Group’s significant joint ventures, which are accounted for using proportionate consolidation, comprise various joint ventures relating to property investments where the Group has a 50 per cent interest as well as the following interests: Investment % held Principal activity Country
H8: Investments in participating interests continued CITIC Prudential Fund Management Company Limited and Prudential ICICI Asset Management Company Limited are new joint ventures in 2005. Prudential ICICI Asset Management Company Limited was previously a subsidiary with an ownership interest of 55 per cent.
Hotel Group Pty Ltd. The disposals of these subsidiaries were completed on 31 January 2006 and 6 February 2006, respectively. There were no venture subsidiaries classified as held for sale at 31 December 2004.
H10: Cash and cash equivalents Cash and cash equivalents consist of cash in hand, balances with banks, and certain short-term deposits and debt instruments. Cash and cash equivalents included in the cash flow statement comprise the following balance sheet amounts: £m £m
Cash and cash equivalents held in the parent company and finance subsidiaries are considered to be available for use by the Group. These funds amount to £263 million and £325 million in 2005 and 2004, respectively. The remaining amounts, generally not available for use by the Group, predominantly consist of cash and cash equivalents held for the benefit of policyholders and loans and advances to banks held by Egg.
and Euros 20 million (divided into 2,000,000,000 Euro preference shares of 1 cent each). None of the preference shares has been issued.
Transfer to retained earnings in respect of shares issued in lieu of cash dividends (116)
Transition adjustment on adoption of IAS 32, IAS 39 and IFRS 4 2
Transfer to retained earnings in respect of shares issued in lieu of cash dividends (51)
The cost of own shares of £97 million as at 31 December 2005 is deducted from retained earnings.
The Company has established trusts to facilitate the delivery of shares under employee incentive plans and savings-related share option schemes. In 2005, the Company purchased 1.4 million (2004: 1.0 million) shares in respect of employee incentive plans at a cost of £6 million (2004: £4 million). At 31 December 2005, 10.7 million (2004: 10.6 million) Prudential plc shares with a market value of £59 million (2004: £48 million) were held in such trusts. This was also the maximum number held at any time during the year. Of this total, 5.7 million (2004: 5.4 million) shares were held in trusts under employee incentive plans.
Of the total shares held in trust, 5 million (2004: 5.2 million) shares were held by a qualifying employee share ownership trust. These shares are expected to be fully distributed in the future on maturity of savings-related share option schemes at a weighted average exercise price of 286 pence (2004: 277 pence).
and the cost of acquiring these shares of £26 million (2004: £29 million) is included in cost of own shares. The market value of these shares as at 31 December 2005 was £28 million (2004: £27 million).
The hedging reserve at 31 December 2005 consists of the portion of the cash flow hedge that is determined to be an effective hedge, net of related tax. The available-for-sale reserve includes gains or losses arising from changes in fair value of available-for-sale securities, net of related tax. These reserves arise as a result of the application of IAS 39 which the Group has chosen to adopt at 1 January 2005 as permitted by IFRS 1.
H12: Insurance contract liabilities and unallocated surplus of with-profits funds Movement in year
Total at 31 December 2004 under IFRS (excluding IAS 32, IAS 39 and IFRS 4) 129,062 16,149
Transition adjustments on application of IAS 32, IAS 39 and IFRS 4 (note ii and note A6) (25,480) (7,807)
US operations: US$250m 8.15% Surplus Notes 2027 (note iii) 145 130
Notes (i) This balance represents convertible debt issued in 2004. The debt is exchangeable into preference shares. The proceeds of the issue have been used to pre-finance US$250 million debt maturing in 2005. Conversion of these securities into preference shares is at Prudential’s option.
H13: Borrowings continued Operational borrowings attributable to shareholder-financed operations £m £m
Non-recourse borrowings of investment subsidiaries (notes i and iii) 133 183
Non-recourse borrowings of Piedmont and CDO funds (notes ii and iii) 952 972
Notes (i) These borrowings include senior and subordinated debt. The senior debt is secured on the investments held by the relevant subsidiaries. The weighted average interest rates on the senior debt are variable based on a market rate and were 4.48 per cent and 2.38 per cent at 31 December 2005 and 31 December 2004 respectively. The interests of the holders of the subordinated debt issued by these subsidiaries are subordinate to the entitlements of the holders of the senior debt.
(ii) Piedmont is an investment trust investing in certain asset-backed and mortgage-backed securities in the US. These borrowings pertain to debt instruments issued to external parties.
(v) Maturity analysis The following table sets out the maturity analysis of the Group’s operational borrowings attributable to shareholder-financed operations: £m £m
Non-recourse borrowings of venture fund investment subsidiaries of the PAC with-profits fund 988 1,167 £100m 8.5% Undated Subordinated Guaranteed Bonds of Scottish Amicable Finance plc (note i) 100 100
UK insurance operations, £10 million (2004: £nil) relating to closure costs in Japan and £1 million (2004: £17 million) relating to Egg.
In February 2001, Prudential announced the restructuring of the direct sales force and customer service channels of its UK insurance operations. In November 2001, Prudential announced further details of changes to the structure of those operations, in particular the intention to pursue a single brand strategy for life and pensions business including the integration of its Scottish Amicable operations under the Prudential brand. The changes also included a simplification of the organisational structure and plans for a significant reduction in operating costs. In September 2002, Prudential announced plans to establish an offshore service centre in India to improve customer contact service levels for its UK insurance operations customers and to achieve further cost savings to those announced in November 2001.
The new processing centre opened in May 2003 and was fully operational during 2004. As part of this restructuring, Prudential had planned to make 4,300 employees redundant, of which approximately 4,194 affected had been notified and 4,117 redundancies completed by 31 December 2005. The restructuring is expected to be completed in 2006.
H14: Provisions and contingencies continued In 2005, Japan closed its Financial Advisor distribution channel. A £10 million provision has been set up relating to closure and redundancy costs.
During 2005, another £27 million was provided and £10 million was paid. In 2004, a provision of £51 million was brought forward, an additional £36 million was provided, £2 million of unused provision was released and £8 million was paid. Other provisions also include £19 million (2004: £17 million) relating to various onerous contracts where, in 2005, an additional £6 million was provided and £4 million was used. In 2004, £5 million was released and £4 million was paid. The remaining provisions of £11 million (2004: £8 million) include
In 1988, the UK government introduced new pensions legislation intended to encourage more individuals to make their own arrangements for their pensions. During the period from April 1988 to June 1994, many individuals were advised by insurance companies, Independent
Personal Investment Authority, now the FSA), subsequently determined that many individuals were incorrectly advised and would have been better off not purchasing the private pension products sold to them. Industry participants are responsible for compensating the persons to whom private pensions were mis-sold. As a result, the FSA required that all UK life insurance companies review their potential cases of pension mis-selling and pay compensation to policyholders where necessary and, as a consequence, record a provision for the estimated costs. The Group met the requirement of the FSA to issue offers to all cases by 30 June 2002.
The table below summarises the change in the pension mis-selling provision for the years ended 31 December 2005 and 2004. The change in the provision is included in benefits and claims in the income statement and the movement in unallocated surplus of with-profits funds has been determined accordingly.
The change arising from the adoption of FRS 27 is due to two factors, namely: (i) Under the FRS 27 basis, which follows the FSA realistic Peak 2 approach, best estimate assumptions apply. Previously a margin for adverse deviation was incorporated; and
(ii) The pension mis-selling provision is the additional amount needed i.e. between the value of the guarantees given to policyholders and the values of the personal pension policies. The latter item is calculated differently under the previous Peak 1 and Peak 2 bases. The Peak 1 calculation is deterministic and excludes provision for terminal bonus. The Peak 2 calculation is stochastic and includes provision for terminal bonus.
In common with several other UK insurance companies, the Group used to sell low-cost endowment products related to repayment of residential mortgages. At sale, the initial sum assured is set at a level such that the projected benefits, including an estimate of the annual bonus receivable over the life of the policy, will equal or exceed the mortgage debt. Because of a decrease in expected future investment returns since these products were sold, the FSA is concerned that the maturity value of some of these products will be less than the mortgage debt. The FSA has worked with insurance companies to devise a program whereby the companies write to customers indicating whether they may have a possible shortfall and outline the actions that the customers can take to prevent this possibility.
Prudential Assurance used to sell guaranteed annuity products in the UK and at 31 December 2005 held a provision of £52 million
(2004: £49 million) within the main with-profits fund to honour guarantees on these products. The Group’s main exposure to guaranteed annuities in the UK is through SAIF and at 31 December 2005 a provision of £619 million (2004: £648 million) was held in SAIF to honour the guarantees. As SAIF is a separate sub-fund of the Prudential Assurance long-term business fund. The movement in this provision has no impact on shareholders.
As a proprietary insurance company, the Group is liable to meet its obligations to policyholders even if the assets of the long-term funds are insufficient to do so. The assets, represented by the ‘unallocated surplus of with-profits funds’, in excess of amounts expected to be paid for future terminal bonuses and related shareholder transfers (the excess assets) in the long-term funds could be materially depleted over time by, for example, a significant or sustained equity market downturn, costs of significant fundamental strategic change or a material increase in the pension mis-selling provision. In the unlikely circumstance that the depletion of the excess assets within the long-term fund was such that the Group’s ability to satisfy policyholders’ reasonable expectations was adversely affected, it might become necessary to restrict the annual distribution to shareholders or to contribute shareholders’ funds to the long-term funds to provide financial support.
Guarantee funds in both the UK and the US provide for payments to be made to policyholders on behalf of insolvent life insurance companies. These guarantee funds are financed by payments assessed on solvent insurance companies based on location, volume, and types of business. The Group estimated its reserve for future guarantee fund assessments for JNL to be £11 million at 31 December 2005
JNL has commitments for future payments related to equity index call options totalling £3 million at 31 December 2005 (2004: £8 million).
At 31 December 2005, JNL has unfunded commitments of £227 million (2004: £157 million) related to its investments in limited partnerships and of £104 million (2004: £101 million) related to commercial mortgage loans. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them.
The average number of staff employed by the Group during the year were: Business operations: UK operations 10,708 10,849
Pension actuarial (gains) losses (credited) charged to income statement (as shown on page 172) (155) 46
Venture investment subsidiaries of the PAC with-profits fund (see below) 206 253
Of the £206 million (2004: £253 million) costs of employment for venture investment subsidiaries, £169 million (2004: £219 million) relates to wages and salaries, £31 million (2004: £25 million) relates to social security costs and £6 million (2004: £9 million) relates to pension costs.
The Group business operations operate a number of pension schemes. The specific features of these plans vary in accordance with the regulations of the country in which the employees are located, although they are, in general, funded wholly by the Group and based either on a cash balance formula or on years of service and salary earned in the last year or years of employment. The largest defined benefit scheme is the principal UK scheme, namely the Prudential Staff Pension Scheme (PSPS). 90 per cent (2004: 90 per cent) of the liabilities of the Group defined benefit schemes are accounted for within PSPS.
The PSPS valuation as at 5 April 2005 is currently being finalised and it is expected to show a small deficit, by comparison with scheme liabilities on the actuarial basis. Following discussions with the Trustee, the Company expects that for 2006 and future years the employers’
Following extensive analysis of the source of contributions paid into the scheme over the last 10 years the allocation has been revised to 70/30, thus increasing the shareholders’ proportion. The effects of these changes and other movements on the financial positions of the
The Trustee reviews strategy, the asset mix benchmark and the Investment Managers’ objectives every three years, to coincide with the
Managers. In carrying out this responsibility, the Investment Managers are required by the Pensions Act 1995 to have regard to the need for diversification and suitability of investments. Subject to a number of restrictions contained within the relevant investment management agreements, the Investment Managers are authorised to invest in any class of investment asset. However, the Investment Managers will not invest in any new class of investment asset without prior consultation with the Trustee.
Using external actuarial advice provided by Watson Wyatt Partners for the valuation of PSPS and by Aon Limited for the M&G scheme, and internal advice for the Scottish Amicable scheme, the most recent full valuations have been updated to 31 December 2005, applying the principles prescribed by IAS 19.
The M&G pension scheme has invested £147 million at 31 December 2005 (2004: £125 million) in Prudential insurance policies. Additionally, the PSPS scheme has invested £106 million at 31 December 2005 (2004: £nil) in Prudential insurance policies. As required by IFRS, this amount of pension asset is eliminated against the policyholder liability and hence, for the purposes of preparing the consolidated balance sheet, the net pension liability is £253 million (2004: £125 million) greater than the ‘economic basis’ deficit of £543 million (2004: £700 million).
On the ‘economic basis’, after including investments in Prudential insurance policies as scheme assets, the assets of the schemes at 31 December were: £m £m
The present value of the liabilities of the four schemes at 31 December 2005 was £5,418 million (2004: £4,917 million). The resulting scheme deficits arising from the excess of liabilities over assets at 31 December 2005 comprised £329 million (2004: £525 million)
attributable to the PAC with-profits fund and £214 million (2004: £175 million) attributable to shareholder operations.
The movements in the deficit on the ‘economic basis’ between scheme assets and liabilities were: £m £m
I1: Staff and pension plans continued Estimated pension scheme liability attributable to shareholder operations
Notes (i) Charge to operating results (based on longer-term investment returns) This comprises: £m £m
Total charge net of finance income (43) (37) Less: amount attributable to PAC with-profits fund 22 21
Actual less expected return on pension scheme assets 544 115 Experience gains (losses) on scheme liabilities 1 (17) Changes in assumptions underlying the present value of scheme liabilities (374) (141)
Actuarial gains (losses) attributable to shareholders 32 (7) Add: additional loss on change of estimate of allocation of opening deficit between shareholder operations and the PAC with-profits fund (63) –
Amounts attributed to the PAC with-profits funds for 2005 reflect the current estimate of 70 per cent for the PSPS scheme and 50 per cent for the Scottish Amicable scheme. For 2004, the amounts attributed reflect the then current estimates of 80 per cent and 50 per cent, respectively. The additional pre-tax loss to shareholder operations of £63 million reflects the changed estimate of the life fund share for the PSPS scheme.
Included within the charge for 2005 of £374 million for changes in assumptions is a credit for past service costs of £115 million for a reduction in the assumed level of discretionary increase for future pensions in payment for PSPS.
Movements on the pension scheme deficits (determined on the ‘economic basis’ under which PSPS scheme assets include investments in
Credit for Service revised cost less Actuarial estimate of net finance gains PSPS deficit Contributions income (losses) allocation paid by PAC At beginning (note i (note ii (note ii with-profits At end of year above) above) above) fund of year 2005 £m £m £m £m £m £m
Amicable, M&G and Taiwan schemes over the period were as follows: IAS 19 basis: change in IAS 19 basis: Investments present Economic change in in Prudential Economic value basis: fair value of insurance basis: of benefit net plan assets policies total assets obligation obligation 2005 £m £m £m £m £m
Fair value of plan assets, beginning of year 4,092 125 4,217 4,217
Less: PSPS scheme plan assets used to acquire Prudential insurance policy (99) 99 0 0
Fair value of plan assets, beginning of year 3,986 3,986 3,986
Fair value of plan assets, end of year 4,092 125 4,217
*The M&G pension scheme assets are wholly invested in Prudential insurance policies. For IFRS accounting purposes, the M&G scheme is in effect unfunded.
The IAS 19 basis net pensions deficit can be summarised as follows: £m £m
Less: expected return on investments of scheme assets in Prudential insurance policies (11) (8)
Net periodic pension credit (cost) (included within acquisition and other operating expenditure in the income statement) 101 (91)
I1: Staff and pension plans continued The long-term expected rate of return has been taken to be the weighted average (by market value) of the long-term expected rates of return on each major asset class shown below: Plan assets (IAS 19 basis)
The actual return on plan assets was £796 million (2004: £381 million) on an IAS 19 basis.
The Group maintains eight main share award and share option plans relating to Prudential plc shares, which are described below.
The Restricted Share Plan (RSP) is the Group’s long-term incentive plan for executive directors and other senior executives designed to provide rewards linked to the returns to shareholders. Each year participants are granted a conditional option to receive a number of shares.
I2: Share-based payments continued No rights are granted if the Company’s total shareholder return (TSR) performance as ranked against the comparator group is below 50th percentile. For performance at 50th percentile, an award of 25 per cent of the maximum award is made. The maximum grant is made only if the TSR ranking of the Company is 20th percentile or above. Between these points, the size of the grant made is calculated on a straight-line sliding scale. This performance measure was chosen when the RSP was introduced as it reflected a combination of market practice, an assessment of Prudential’s main competitors and the focus of UK investors at that time. In normal circumstances, directors may take up their right to receive shares at any time during the following seven years.
The Savings-Related Share Option Scheme is designed to foster share ownership among UK and certain non-UK employees. Permanent employees are eligible for this plan if they have been employed by the Group for the previous six months. At the outset, participants choose an option period (three, five or seven years, or a combination of these periods) and the amount of monthly contributions to be made from their earnings during the option period, which determines the number of options granted. The option price is fixed at the start and is based on a discount of 20 per cent to the market price. Participants may exercise their options within six months of the end of the option period. If options are not exercised, participants are entitled to receive a refund of their cash contributions plus interest.
Scheme, for employees in Hong Kong, Malaysia, Singapore, Taiwan, India and Korea.
The Annual Incentive Plan is designed so that a portion of any overall award may be made in the form of a deferred share award. A
The 1,000 Day LTIP plan is a UK insurance operations performance-based plan in which the UK Remuneration Committee may, at any time up to 5 October 2005, select employees at its absolute discretion, for participation in the plan. The performance period was 1,000 days and, based on the final performance level being at, or above, the threshold level, the committee shall grant participants 10 per cent of the allocated award in 2005, 20 per cent in 2006 and the remaining 70 per cent in 2007. There are no beneficial interests, or any rights to dividends until such time as the awards are released, at nil cost, to participants.
The weighted average share price of Prudential plc for the year ended 31 December 2005 was £5.01 compared to £4.51 for the year ended 31 December 2004.
Movements in share awards outstanding under the Group’s share-based compensation plans relating to Prudential plc shares at 31 December 2005 and 2004 were as follows: Number of Number of awards awards
The weighted average fair values of Prudential plc options and awards granted during the period are as follows: Weighted average fair value Weighted average fair value
The fair value amounts relating to RSP options and other options above were determined using the Black-Scholes and the Monte Carlo option-pricing models using the following assumptions: Other Other RSP options RSP options
Carlo model. Share options and awards are valued using the share price at the date of grant. The compensation costs for all awards and options are recognised in net income over the plans’ respective vesting periods. The Group uses the Black-Scholes model to value all options other than the RSP. For the RSP (nil cost option), the Group uses a Monte Carlo model in order to allow for the impact of the
Mourant & Co. Trustees Limited. At 31 December 2005, the trust held 3.4 million ordinary shares (2004: 3.4 million), with a market value of £4.2 million (2004: £3.4 million) which are intended to be used principally for delivery of shares under the employee incentive plans and a nominal value of £1.7 million (2004: £1.7 million). All of the remaining 3.4 million shares held by the trust were purchased on the open market at a cost of £4.5 million.
Egg made the vesting of awards subject to the satisfaction of performance conditions from January 2004 onwards. Previously the awards have been conditional on service completed. The arrangements for the distribution to employees of shares held in trust and for entitlement to dividend depend on the particulars of each award. Shares held in trust are conditionally gifted to employees. The costs of share awards are charged to the income statement evenly over the period of service for which awards are made for schemes granted after 7 November 2002.
I2: Share-based payments continued Egg sharesave scheme awards made prior to 7 November 2002.
Outstanding at beginning of year 0.7 1.5 1.16 1.19 0.4 0.7 1.20 1.19
Outstanding at beginning of year 3.0 0.8 0.85 1.17 1.0 0.2 0.84 1.17
Outstanding and exercisable at the end of year 3.2 3.0 0.86 0.85 0.9 1.0 0.83 0.84
The significant assumptions and inputs used to estimate the fair value of the options granted in 2005 are as follows: 3 Year 5 Year 3 Year 5 Year RSP Sharesave Sharesave RSP Sharesave Sharesave
Share price volatility of comparator group (%) (note iii) 20 – – 20 – –
Total expense recognised in the year in the consolidated financial statements related to share-based compensation is as follows: £m £m
I3: Key management remuneration Key management constitutes the directors of Prudential plc as they have authority and responsibility for planning, directing and controlling the activities of the Group.
Fees, excluding statutory audit fees, payable to KPMG Audit Plc and its associates include £6.7 million (2004: £4.6 million) for work performed in the UK. Audit fees include fees paid to KPMG where they are the auditors of PPM Capital consolidated entities.
In addition, the Company has transactions and outstanding balances with certain unit trusts, OEICs, collateralised debt obligations and similar entities, which are not consolidated and where a Group company acts as manager. These entities are regarded as related parties for the purposes of IAS 24. The balances are included in the Group’s balance sheet at fair value or amortised cost in accordance with their
IAS 39 classifications. The transactions are included in the income statement and include amounts paid on issue of shares or units, amounts received on cancellation of shares or units and paid in respect of the periodic charge and administration fee. Further details of the aggregate assets, liabilities, revenues, profits or losses and reporting dates of entities considered to be associates under IFRS are disclosed in note H8.
Various executive officers and directors of Prudential may from time to time purchase insurance, investment management or annuity products, or be granted mortgages or credit card facilities marketed by Prudential group companies in the ordinary course of business on substantially the same terms, including interest rates and security requirements, as those prevailing at the time for comparable transactions with other persons.
Apart from the transactions with directors referred to below, no director had an interest in shares, transactions or arrangements that requires disclosure, other than those given in the remuneration report. Key management remuneration is disclosed in note I3.
In 2005 (2004), three (four) directors had mortgages and other borrowings with Egg plc of £125,000 (2004: £171,000). One director had a life policy with a sum assured of £4.0 million (2004: £3.5 million). In 2005 and 2004, other transactions with directors were de-minimis both by virtue of their size and in the context of the directors’ financial positions. As indicated above, all of the above noted transactions are on terms equivalent to those that prevail in arm’s length transactions.
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for PRIL which operates mainly in England and Wales. In February 2005, the proportion of ordinary shares of PCA Life Assurance Company Limited owned by the Company was increased from 97 per cent to 99 per cent.
Certain Group subsidiaries are subject to restrictions on the amount of funds they may transfer in the form of cash dividends or otherwise to the parent company. UK insurance companies are required to maintain solvency margins which must be supported by capital reserves and other resources, including unrealised gains on investments. JNL can pay dividends on its capital stock only out of earned surplus unless prior regulatory approval is obtained. Furthermore, without the prior regulatory approval, dividends cannot be distributed if all dividends made within the preceding 12 months exceed the greater of JNL’s statutory net gain from operations or 10 per cent of JNL
Georgia (see section (iii) below), at 31 December 2005, the maximum amount of dividends that could be paid by JNL without prior regulatory approval was nil (2004: US$221 million (£115 million)). The Group’s Asian subsidiaries, mainly the Singapore and Malaysia businesses, may remit dividends to the Group, in general, provided the statutory insurance fund meets the capital adequacy standard required under local statutory regulations.
The carrying value immediately prior to acquisition of the assets and liabilities of Life Insurance Company of Georgia was as follows: £m
Group revenue and consolidated net profit for the year ended 31 December 2005 are shown on a pro forma basis below as if the
Life Insurance Company of Georgia acquisition took place on 1 January 2005. These pro forma amounts have been derived by adding pre-acquisition revenue and other components of net profit to these items included in the Group’s consolidated income statement.
In addition to the acquisition of Life Insurance Company of Georgia, the PAC with-profits fund acquired a number of venture capital holdings through PPM Capital in which the Group is deemed to have a controlling interest, in aggregate with, if applicable, other holdings held by, for example, the PSPS. There were three such acquisitions during 2005: ■ Acquired 40 per cent of the voting equity interests of Aperio Group Pty Ltd (AeP), a flexible packaging manufacturing company, in May 2005; ■ acquired 75 per cent of the voting equity interests of Jost Luxembourg S.a.r.l. (JOST), a manufacturer of components of the truck and trailer industry, in August 2005; and
■ acquired 75 per cent of the voting equity interests of BST Safety Textiles Luxembourg S.a.r.l. (BST), an airbag production company, in August 2005.
These acquisitions are considered individually immaterial and therefore all 2004 information has been presented in aggregate throughout the note. As noted above, it is not practicable to provide certain information due to the nature of venture investments and hence these disclosures are not included in this note.
The net assets of Jackson Federal Bank at the date of disposal and at 31 December 2003 were as follows: At date of disposal 31 Dec 2003 £m £m
In addition, Oxoid a venture subsidiary of the PAC with-profits fund was disposed of on 1 March 2004 for cash consideration of £73 million.
The Group leases various offices to conduct its business. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease.
Later than 1 year and not later than 5 years 186 167
The total minimum future sublease rentals to be received on non-cancellable operating leases for land and buildings for the year ended 31 December 2005 was £2 million (2004: £2 million).
Local currency: £ 31 Dec 2005 for 2005 31 Dec 2004 for 2004 1 Jan 2004
The financial statements of the parent company on pages 186 to 195 were approved by the Board of Directors on 15 March 2006.
1. Nature of operations Prudential plc (the Company) is a parent holding company. The Company together with its subsidiaries (collectively, the Group) is an international financial services group with its principal operations in the UK, US and Asia. The Group operates in the UK through its subsidiaries, primarily The Prudential Assurance Company Limited, Prudential Annuities Limited, Prudential Retirement Income Limited,
2. Basis of preparation The financial statements of the Company, which comprise the balance sheet and related notes, are prepared in accordance with Section 226 of, and Schedule 4 to, the Companies Act 1985, which apply to companies generally. The Company has taken advantage of the exemption under Section 230 of the Companies Act 1985 from presenting its own profit and loss account.
PSPS deficit to the Company is to decrease shareholders’ funds at 1 January 2004 from the previously published amount by £77 million.
This has resulted in an increase in the profit before tax of £35 million (2004: increase of £1 million) and an increase in the tax charge of £11 million (2004: nil impact). Including the impact of actuarial gains and losses charged to the statement of total recognised gains and losses, FRS 17 has the effect of increasing the total recognised gains and losses after tax of the Company for the year by £3 million
The main effect of FRS 21 on the Company is that dividends declared after the balance sheet date in respect of the previous reporting period are no longer to be considered as ‘adjusting events’. Accordingly, an accrual is no longer made in the profit and loss account.
Instead, appropriate disclosure is made in the notes to the financial statements. The effect of the change in policy is to increase shareholders’ funds at 1 January 2005 from the previously published 31 December 2004 level by £252 million.
Listed entities, such as the Company, preparing their financial statements in accordance with UK requirements, are required to comply with the entire package of standards for accounting periods beginning on or after 1 January 2005.
The adoption of this standard has no impact on the results of the Company.
The presentation requirements of FRS 25 are applicable to the Company as at 1 January 2005. The Company has taken advantage of the provisions within FRS 25 that waive the requirement to restate comparatives. The main presentation adjustment resulting from FRS 25 relates to the Company’s derivatives. Previously, under UK GAAP, the Company’s carrying value of derivatives has been recorded on a basis that nets asset and liability amounts of individual derivatives. Under FRS 25, there is a requirement that assets and liabilities should not be netted in the balance sheet unless counterparty offset applies. Accordingly, under FRS 25, derivative assets and liabilities have been included gross in the balance sheet.
The Company has taken advantage of the exemption within FRS 25 from the disclosure requirements of this standard on the basis that the Company is included in the publicly available consolidated financial statements of the Group which include disclosures that comply with IAS 32, which is equivalent to FRS 25.
FRS 26 is based on the text of IAS 39, ‘Financial Instruments: Recognition and Measurement’ as at 31 March 2004, incorporating the revised version of IAS 39 issued by the IASB in December 2003 together with the amendments to IAS 39 on ‘Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk’ and those made by IFRS 4.
The adoption of FRS 26 has the impact of reducing the profit before tax for the year ended 31 December 2005 by £34 million and the shareholders’ funds at 31 December 2005 by £35 million. This FRS is to be applied retrospectively. However, the Company has taken advantage of the provisions within FRS 26 that allows comparative information not to be restated to comply with this standard.
Use of effective interest rate method on borrowings (1) 1 1 January 2005 (including adjustments for FRS 26) 1,004 2,683
Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.
Loans to subsidiary undertakings in the balance sheet of the Company are shown at cost, less provisions.
Company, depending on their nature and purpose, were either accounted for at fair value or treated as a hedge and accounted for on an accrual or deferral basis.
Under FRS 26, hedge accounting is permissible only if certain criteria are met regarding the establishment of documentation and continued measurement of hedge effectiveness. For derivative financial instruments designated as fair value hedges the movements in the fair value are recorded in the profit and loss account with the accompanying change in fair value of the hedged item attributable to the hedged risk.
Under FRS 26, borrowings are initially recognised at fair value, net of transaction costs, and subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds (net of related issue costs) is amortised through the profit and loss account to the date of maturity.
Prior to the adoption of FRS 21, shareholders’ dividends were accrued in the period to which they related regardless of when they were declared. Under FRS 21, dividends declared after the balance sheet date in respect of the prior reporting period are treated as a nonadjusting event. Dividends are now recognised in the period in which they are declared.
5. Subsidiary undertakings The principal subsidiary undertakings of the Company at 31 December 2005, all wholly owned except Egg Banking plc and PCA Life
Income Limited which operates mainly in England and Wales. In February 2005, the proportion of ordinary shares of PCA Life Assurance
Other borrowings: Currency translation net liability on swap transactions – 3 – 3
6. Borrowings continued Long-term loans Other borrowings Total £m £m £m £m £m £m
(ii) The ¤500 million borrowings have been swapped into borrowings of £333 million with interest payable at six month £Libor plus 0.962 per cent.
7. Derivative financial instruments The table below analyses the fair value of derivatives of the Company at 31 December 2005: Fair value Fair value assets liabilities £m £m
The change in fair value of the derivative financial instruments of the Company was a loss before tax of £85 million.
The fair value of the derivative financial instruments, except for £37 million of the £38 million fair value liabilities of forward foreign currency contracts, were included within amounts owed by or to subsidiary undertakings on the balance sheet as they were transactions with Prudential Finance (UK) plc, a subsidiary undertaking, which in turn transacted with external counterparties.
As permitted by the standard, the 2004 comparatives have not been restated to include certain derivative financial instruments at fair value in accordance with FRS 26. The nature and extent of the derivative financial instruments used by the Company in 2004 are similar to those used in 2005. The corresponding 2004 fair values for the derivative financial instruments of the Company would have been £27 million and the change in fair value which would have been included in the profit and loss account was a loss before tax of £9 million.
Scheme (PSPS). This scheme is primarily a defined benefit scheme but no employees with employment offers after 31 July 2003 are eligible for membership of the defined benefit section of the scheme. At 31 December 2005, on the FRS 17, ‘Retirement Benefits’
For the purposes of preparing consolidated financial statements, the Group has adopted IFRS basis accounting including IAS 19,
Using external actuarial advice provided by the professionally qualified actuaries, Watson Wyatt Partners, for the valuation of PSPS, the most recent full valuations have been updated to 31 December 2005 applying the principles prescribed by FRS 17. The scheme has assets held in a separate trustee administered fund. PSPS was last subject to a full actuarial valuation as at 5 April 2005 by Watson Wyatt
The assets and liabilities of PSPS were: Long-term Long-term Long-term expected rate expected rate expected rate
Allocated as: Attributable to the PAC with-profits fund (265) (470) (435)
After deduction of deferred tax attaching to the amounts attributable to the Company, the amounts reflected in the balance sheet are: (80) (83) (77)
The long-term expected rates of return have been determined after applying due consideration to the requirements of paragraph 54 of
FRS 17, in particular, taking account of the values of the assets and equity market levels at the balance sheet dates.
Credit (charge) to profit and loss account: Credit (charge) to statement of total recognised gains and losses: Net pension liability at 31 December 2004 (119) 36 (83)
Changes in assumptions underlying the present value of scheme liabilities (405) (128)
Total actuarial gains (losses) ((2)% (2004: 1%) of the present value of the scheme liabilities) 95 (49)
Less: additional losses on change of estimate of allocation of opening PSPS deficit between the Company and the PAC with-profits fund (59) –
9. Share capital and share premium The authorised share capital of the Company is £170 million (divided into 3,000,000,000 ordinary shares of 5 pence each and 2,000,000,000 sterling preference shares of 1 pence each) and US$20 million (divided into 2,000,000,000 US dollar preference shares of 1 cent each)
and ¤20 million (divided into 2,000,000,000 Euro preference shares of 1 cent each). None of the preference shares has been issued.
Statutory audit fees in respect of the Company were £0.1 million (2004: £0.1 million). Fees payable to the auditors in respect of other work were £0.6 million (2004: £0.5 million).
A reconciliation of movement in the shareholders’ funds of the Company for the years ended 31 December 2005 and 2004 is given below: Restated £m £m
Actuarial losses recognised on pension scheme (net of related tax) (21) (7)
Shareholders’ funds at beginning of year as originally reported 2,525 1,622
Prior year adjustments on adoption of FRS 17 and FRS 21 (note 3) 169 137
Shareholders’ funds at end of year 2004 as originally reported – 2,525
Shareholders’ funds at end of year (2004 as restated) 2,457 2,694 11. Directors’ remuneration Information on directors’ remuneration is given in the remuneration report section within this Annual Report. Further information on the transactions of the directors with the Company and the Group is given in notes I3 ‘Key management remuneration’ and I5 ‘Related party transactions’ of the notes on the financial statements of the Group.
12. Dividends 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.
The parent company financial statements are required by law to give a true and fair view of the state of affairs of the parent company.
In preparing the Group and parent company financial statements, the directors are required to: ■ Select suitable accounting policies and then apply them consistently; ■ make judgements and estimates that are reasonable and prudent; ■ for the Group financial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; ■ for the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and
■ prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the parent company will continue in business.
The directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the parent company and enable them to ensure that its financial statements comply with the Companies
Our responsibility is to audit the financial statements and the part of the directors’ remuneration report to be audited in accordance with relevant legal and regulatory requirements and International
Companies Act 1985 and whether, in addition, the Group financial statements have been properly prepared in accordance with
We also report to you if, in our opinion, the directors’ report is not consistent with the financial statements, if the Company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and other transactions is not disclosed.
IAS Regulation; ■ the parent company financial statements give a true and fair view, in accordance with UK Generally Accepted Accounting Practice, of the state of the parent company’s affairs as at 31 December 2005; and
■ the parent company financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985.
This information does not form part of the Group’s financial statements.
The statutory basis results included on pages 62 to 195 are for the years 2005 and 2004. These results reflect significant changes of accounting policies from those previously applied under UK Generally Accepted Accounting Principles (GAAP). For all except three
IFRS standards these changes have been applied consistently in preparing the results for both years. However, as permitted by the
IAS 39 and IFRS 4 had been applied from 1 January 2004 to the Group’s insurance operations.
Operating profit from continuing operations based on longer-term investment returns 1 957 699
Profit from continuing operations before tax attributable to shareholders (including actual investment returns) 998 985
Adjustment for post-tax shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (1.5)p (0.2)p
Additional IFRS basis information to enable consistent comparison of results for Prudential’s insurance operations
This information does not form part of the Group’s financial statements. Based on statutory IFRS Pro forma IFRS basis results basis results 2005 2004 Changes in equity (net of minority interest) £m £m
(as reflected in statement of changes in equity – see below) for impact of adoption of
Movement on own shares purchased in respect of share-based payment plans 0 (2)
Additional IFRS basis information to enable consistent comparison of results for Prudential’s insurance operations. This information does not form part of the Group’s financial statements.
1. Operating profit from continuing operations based on longer-term investment returns*
US operations: Movement in market value of derivatives used for economic hedging purposes 122 144
has recommended that annual reports of publicly held companies include a section on risk factors which discusses inherent risks in the business and trading environment. The US Securities and
Exchange Commission (SEC) requires listed companies to disclose prominently risk factors that are specific to the companies or their industries in their annual reports on Form 20-F filed with the SEC. The Accounting Standards Board’s Reporting Statement: Operating and Financial Review (OFR), recommends as best practice, that the OFR has a description of the principal risks and uncertainties facing the business. The European Union (EU)
A number of factors (risk factors) affect Prudential’s operating results, financial condition and trading price. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this report, is not updated, and any forward-looking statements are made subject to the reservations specified on the inside back cover of the Annual Report.
Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. In the UK, this is because a significant part of Prudential’s shareholders’ profit is related to bonuses for policyholders declared on its with-profits products, which are broadly based on historic and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns.
In the US, fluctuations in prevailing interest rates can affect results from Jackson National Life (JNL) which is predominantly a spreadbased business with the majority of its assets invested in fixed income securities. In particular, fixed annuities and stable value products in JNL expose the Group to the risk that changes in interest rates which are not fully reflected in the interest rates credited to customers will reduce spread. The spread is the difference between the amounts that JNL is required to pay under the contracts and the rate of return it is able to earn on its general account investments to support the obligations under the contracts. Declines in spread from these products or other spread businesses that JNL conducts could have a material impact on its businesses or results of operations.
Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, capital requirements and, consequently, reported results and financing requirements. For instance, regulators in jurisdictions in which Prudential operates may change the level of capital required to be held by individual businesses. Also these changes could include possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. In the UK, the
European financial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the Group level in respect of shareholder-owned entities. The test is a continuous requirement so that Prudential needs to maintain a somewhat higher amount of regulatory capital at the Group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, short-term movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. In addition, changes in the local regulatory regimes of designated territories could affect the calculation of the Group’s solvency position under FCD. The EU is also currently reviewing future solvency requirements (Solvency II)
Prudential’s reported results or on its relations with current and potential customers.
In the US, federal and state regulators have focused on, and continue to devote substantial attention to, the mutual fund, variable annuity and insurance product industries including new federal regulations in respect of broker-dealers. As a result of publicity relating to widespread perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms.
Although Prudential believes it has adequately reserved in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such reserves are sufficient.
The markets for the UK, US and Asian financial services are highly competitive, with several factors affecting Prudential’s ability to sell its products and continued profitability, including price and yields offered, financial strength and ratings, range of product lines and product quality, brand strength and name recognition, investment management performance, historical bonus levels, developing demographic trends and customer appetite for certain savings products. In some of its markets Prudential faces competitors that are larger, have greater financial resources or a greater market share, offer a broader range of products or have higher bonus rates or claims-paying ratios. Further, heightened competition for talented and skilled employees with local experience, particularly in Asia, may limit the Group’s potential to grow its business as quickly as planned.
Within the UK, Prudential’s principal competitors in the life market include many of the major stock and mutual retail financial services companies including, in particular, Aviva, Legal & General, HBOS
JNL’s competitors in the US include major stock and mutual insurance companies, mutual fund organisations, banks and other financial services companies. JNL’s principal life insurance company competitors in the US include AIG, Allstate Financial,
Allianz Life of North America, AXA Financial Inc, Hartford Life Inc.,
Within Asia, the Group’s main regional competitors are international financial companies, including AIG, Allianz, ING
Prudential’s ability to generate an appropriate return depends significantly upon its capacity to anticipate and respond appropriately to these competitive pressures.
Operational risks are present in all of Prudential’s businesses, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of complex transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. In addition, Prudential outsources several operations, including certain UK processing and IT functions. In turn, Prudential is reliant upon the operational processing performance of its outsourcing partners.
Prudential has not experienced or identified any operational risks in its systems or processes during 2005, or which have subsequently caused, or are expected to cause, a significant negative impact on its results of operations.
Prudential needs to make assumptions about a number of factors in determining the pricing of its products and for reporting the results of its long-term business operations.
As a holding company, Prudential’s principal sources of funds are dividends from subsidiaries, shareholder-backed funds, the shareholder transfer from Prudential’s long-term funds and any amounts that may be raised through the issuance of equity, debt and commercial paper.
Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures. Prudential’s ability to exercise management control over its joint venture operations and its investment in them depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued co-operation between, the joint venture participants.
Prudential may also face financial or other exposure in the event that any of its joint venture partners fails to meet its obligations under the joint venture or encounters financial difficulty. In addition, a significant proportion of the Group’s product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could affect Prudential’s results of operations.
European Embedded Value (EEV) basis supplementary information Year ended 31 December 2005
Profit from continuing operations before tax (including actual investment returns) 2,244 1,784
Earnings per share – EEV basis Year ended 31 December 2005
Based on profit from continuing operations after minority interests of £1,579m (2004: £1,205m) 12 66.8p 56.8p
Total – based on total profit for the financial year after minority interests of £1,582m (2004: £1,138m) 66.9p 53.7p
Unrealised valuation movement on securities classified as available-for-sale at 1 January 2005 (1) –
Treasury shares: Movement in own shares in respect of share-based payment plans 0 (2)
Based on EEV basis shareholders’ capital and reserves of £10,301m (2004: £8,614m) 432p 363p
Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds (169,064) (144,193)
With two exceptions, covered business comprises the Group’s long-term business operations. The definition of long-term business operations is consistent with previous practice under modified statutory basis (MSB) and achieved profits basis reporting and comprises those contracts falling under the definition of long-term insurance business for regulatory purposes together with, for US operations, contracts that are in substance the same as guaranteed investment contracts (GICs) but do not fall within the technical definition. Under the EEV principles, the results for covered business now incorporate the projected margins of attaching internal fund management.
Previously, the Group has reported supplementary information on the achieved profits basis for its interim and full year financial reporting.
The adoption of the EEV basis reporting in place of achieved profits basis reporting reflects developments through the CFO Forum to achieve a better level of consistency and an improved embedded value methodology, and is applied by the major European insurance companies in their financial reporting.
The value of future new business is excluded from the embedded value.
Notwithstanding the basis of presentation of results (as explained in notes 4 and 6) no smoothing of market or account balance values, unrealised gains or investment return is applied in determining the embedded value or the profit before tax.
The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of future investment return, expenses, surrender levels and mortality. These assumptions are used to project future cash flows. The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the risks associated with the cash flows that are not otherwise allowed for.
A charge is deducted from the embedded value for the cost of capital supporting the Group’s long-term business. This capital is referred to as encumbered capital. The cost is the difference between the nominal value of the capital and the discounted present value of the projected releases of this capital allowing for investment earnings (net of tax) on the capital.
The annual result is impacted by the movement in this cost from year to year which comprises a charge against new business profit and a release in respect of the reduction in capital requirements for business in force as this runs off.
The only significant financial options and guarantees in the UK insurance operations arise in the with-profits sub-fund and SAIF.
Beyond the generic features described above, and the provisions held in respect of guaranteed annuities, there are very few explicit options or guarantees of the with-profits sub-fund such as minimum investment returns, surrender values, or annuity at retirement and any granted have generally been at very low levels.
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision on the Pillar 1 Peak 2 basis of £619 million
The principal options and guarantees valued under EEV for Jackson National Life (JNL) are associated with the fixed annuity and variable annuity lines of business.
Fixed annuities provide that at JNL’s discretion it may reset the interest rate credited to policyholders’ accounts, subject to a guaranteed minimum. The guaranteed minimum return varies from 1.5 per cent to 5.5 per cent (2004: 1.5 per cent to 5.5 per cent), depending on the particular product, jurisdiction where issued, and date of issue. At 31 December 2005, 73 per cent (2004: 73 per cent) of the fund relates to policies with guarantees of 3 per cent or less. The average guarantee rate is 3.3 per cent (2004: 3.3 per cent).
The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations.
A constant margin of 50 basis points has been added to the risk margin derived for market risk to cover the non-diversifiable non-market risks associated with the business.
In deriving the time value of financial options and guarantees, management actions in response to emerging investment and fund solvency conditions have been modelled. Management actions encompass, but are not confined to, the following areas: ■ Investment allocation decisions; ■ levels of reversionary bonuses and credited rates; and
The Group operates three defined benefit schemes in the UK. The principal scheme is the Prudential Staff Pension Scheme (PSPS).
Under the EEV basis the IAS 19 basis deficit is initially allocated in the same manner. The shareholders’ 10 per cent interest in the PAC
Separately, the projected cash flows of in-force covered business include contributions to the defined benefit schemes for future service based on the contribution basis to the schemes applying at the time of preparation of results.
UK and US long-term business operations. For the Group’s Asian operations, the active basis is appropriate for business written in Japan,
Expected returns on equity and property asset classes are derived by adding a risk premium, also based on the long-term view of Prudential’s economists in respect of each territory, to the risk-free rate. In the UK the equity risk premium is 4.0 per cent (2004: 3.0 per cent) above risk-free rates. The equity risk premium in the US is also 4.0 per cent (2004: 3.0 per cent). In Asia, equity risk premiums range from 3.0 per cent to 5.75 per cent. Assumptions for other asset classes, such as corporate bond spreads, are set consistently as best estimate assumptions.
The investment return assumptions as derived above are applied to the actual assets held at the valuation date to derive the overall fund-earned rate.
Pre-tax expected long-term nominal rates of investment return: UK equities 8.1 7.6
US 10-year treasury bond rate at end of period 4.4 4.3
(ii) For traditional business in Taiwan, 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 2 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.
(iii) Assumptions for US dollar denominated business which comprises the larger proportion of the in-force Hong Kong business.
UK insurance operations ■ Interest rates are projected using a two-factor model calibrated to actual market data; ■ the risk premium on equity assets is assumed to follow a log-normal distribution; ■ the corporate bond return is calculated as the return on a zero-coupon bond plus a spread. The spread process is a mean reverting stochastic process; and
3. Assumptions continued The rates to which the model has been calibrated are set out below: Mean returns have been derived as the annualised arithmetic average return across all simulations and durations.
Standard deviations have been calculated by taking the annualised variance of the returns over all the simulations, taking the square root and averaging over all durations in the projection. For bonds the standard deviations relate to the yields on bonds of the average portfolio duration. For equity and property, they relate to the total return on these assets. The standard deviations applied are as follows: Standard deviation %
The same asset return model, as used in the UK, appropriately calibrated, has been used for the Asian operations. The principal asset classes are government and corporate bonds. Equity holdings are much lower than in the UK whilst property is not held as an investment asset.
Exceptional expenses are identified separately and reported separately. No productivity gains have been assumed.
Asia development and Regional Head Office expenses are charged to EEV basis results as incurred. No adjustment is made to the embedded value of covered business as the amounts of expenditure that relate to operating expenses are not material. Similarly corporate expenditure for Group Head Office, to the extent not allocated to the PAC with-profits fund, is charged to the EEV basis result as incurred.
basis profits before shareholder taxes between operating and non-operating results. Operating results reflect the underlying results of the Group’s continuing operations including longer-term investment returns. Operating results include the impact of routine changes of estimates and non-economic assumptions. Non-operating results include certain recurrent and exceptional items that primarily do not reflect the performance in the year of the Group’s continuing operations.
In the case of JNL, market value movements on debt securities are initially recorded as movements in shareholder reserves, reflecting the available-for-sale categorisation under IFRS. Similarly the value movements on derivatives are recorded in the income statement.
JNL, a long-term rate of return is assumed, which reflects the aggregation of risk-free rates and equity risk premium.
For 2005 additional non-recurrent gains and losses in respect of the Group’s defined benefit pension schemes have been recorded. These are explained in note 9.
d) Effect of changes in economic assumptions and time value of cost of options and guarantees
The results of the Group’s fund management operations include the profits from management of internal and external funds. For EEV
In adopting the EEV principles Prudential has decided to set encumbered capital at its internal targets for economic capital. In Asia, the economic capital target is substantially higher than the local statutory requirements in total. Accordingly, capital is held centrally for
Asian operations. For the purposes of the presentation of the Group’s operating results, it is assumed that the centrally held capital is lent interest free to the Asian operations. In turn the results of the Asian operations include the return on that capital and Group shareholders’
Foreign currency profit and losses have been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year end rates of exchange. The purpose of translating the profit and losses at average exchange rates, notwithstanding the fact that EEV profit represents the incremental value added on a discounted cash flow basis, is to maintain consistency with the methodology applied for IFRS basis reporting.
Pre-tax Tax Post-tax Pre-tax Tax Post-tax £m £m £m £m £m £m
Annual of new New business premiums premium business Pre-tax new New business margin equivalent premiums business Single Regular (APE) (PVNBP) contribution (APE) (PVNBP)
New business margins are shown on two bases, namely the margins by reference to Annual Premium Equivalents (APE) and the Present
Value of New Business Premiums (PVNBP). APEs are calculated as the aggregate of regular new business premiums and one tenth of single new business premiums. PVNBPs are calculated as equalling single premiums plus the present value of expected new business premiums of regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
Unwind of discount and other expected returns (note i) 162 120
Notes (i) For UK insurance and Asian operations, unwind of discount and other expected returns is determined by reference to the value of in-force business, required capital and surplus assets at the start of the year as adjusted for the effect of changes in economic and operating assumptions reflected in the current year. For the unwind of discount for UK insurance operations included in operating results based on longer-term returns a further adjustment is made. For UK insurance operations the amount represents the unwind of discount on the value of in-force business at the beginning of the year (adjusted for the effect of current year assumption changes), the expected return on smoothed surplus assets retained within the main with-profits fund and the expected return on shareholders’ assets held in other UK long-term business operations. Surplus assets retained within the main with-profits fund are smoothed for this purpose to remove the effects of short-term investment volatility from operating results. In the balance sheet and for total profit reporting, asset values and investment returns are not smoothed. For JNL the return on surplus assets is shown separately. Also for JNL the 2004 unwind of discount and ‘other’ profits have been adjusted by £26 million and £(26) million respectively for refinement to the basis of calculation.
(iv) Other charges of £46 million include £45 million of costs associated with complying with regulatory requirements including Sarbanes-Oxley, product and distribution development, £19 million of negative experience variances and other net positive items of £18 million. In determining the appropriate expense assumptions for 2005 account has been taken of the cost synergies that are expected to arise with some certainty from the initiative announced on 1 December 2005 from UK insurance operations working more closely with Egg and M&G. Without this factor there would have been a charge for altered expense assumptions of approximately £55 million. The £33 million charge for other items for 2004 includes £21 million of costs associated with complying with new regulatory requirements and restructuring and £12 million of negative experience variances.
Jackson National Life (including mark to market value of core structural borrowings) (note ii) 65 103
with-profits fund that are consolidated into Group results but are attributable to external investors 1 9
Movement in mark to market value of core structural borrowings held centrally (65) (63)
Notes (i) Short-term fluctuations in investment returns represent for UK insurance operations the difference between actual investment returns in the year attributable to shareholders and the expected returns as described in note 3.
Investment return related gain due primarily to changed expectation of profits on in-force variable annuity business in future periods based on current period equity returns* 4 36
9. Actuarial and other gains and losses on defined benefit pension schemes The charge of £47 million (2004: £12 million) included in total profit reflects the shareholders’ share of actuarial and other gains and losses on the Group’s defined benefit pension schemes. On the EEV basis, this includes a 10 per cent share of the actuarial gains and losses on the share of the deficit attributable to the PAC with-profits fund for the Prudential Staff and Scottish Amicable Pension Schemes. The 2005 charge of £47 million includes a charge of £43 million for altered renewal expense assumptions arising from the prospective increase in employer contributions for the Prudential Staff Pension Scheme for future service of active members (as distinct from deficit funding).
Tax credit on actuarial and other gains and losses of defined benefit pension schemes (14) (5)
Total tax charge on items not included in operating profit from continuing operations 290 203
Tax charge on profit on ordinary activities from continuing operations (including tax on actual investment returns) 653 553 *Including tax relief on development expenses.
Long-term business (note ii): Net assets of operations – EEV basis shareholders’ funds 1,988 1,565
Pension scheme deficits (net of tax) attributable to shareholders (note vii) (142) (152)
Notes (i) UK long-term business smoothed shareholders’ funds reflect an adjustment to the assets of the PAC with-profits sub-fund, for the purposes of determining the unwind of discount included in operating profits, to remove the short-term volatility in market values of assets. Shareholders’ funds in the balance sheet are determined on an unsmoothed basis.
(iv) In determining the cost of capital of JNL, it has been assumed that an amount equal to 235 per cent of the risk-based capital required by the National Association of Insurance Commissioners (NAIC) at the Company Action Level must be retained. The impact of the related capital charge is to reduce JNL’s shareholders’ funds by £117 million (2004: £80 million).
Goodwill attaching to venture fund investment subsidiaries of the PAC with-profits fund that are consolidated under IFRS are not included in the table above as the goodwill attaching to these companies is not relevant to the analysis of shareholders’ funds.
Holding company cash and short-term investments 1,128 1,561 Core structural borrowings – central funds (2,852) (2,860)
Operating profit (loss) from continuing operations 426 741 556 1,723 (11) 1,712
Tax on profits (losses) from continuing operations (note 11): Tax on short-term fluctuations in investment returns (299) (23) (12) (334) (9) (343)
Development costs included above (net of tax) borne centrally 2 2 (2)
Intra group dividends (including statutory transfer) (234) (226) (53) (513) 513
Adjustment for economic capital for Asian operations held centrally (15) (15) 15
Net increase in shareholders’ capital and reserves 904 842 423 2,169 (482) 1,687
Total UK long-term insurance Asian business Other Group operations JNL operations operations operations total
EEV basis shareholders’ funds at 31 December 2005 £m £m £m £m £m £m
EEV basis shareholders’ funds at 31 December 2005 5,132 3,348 1,988 10,468 (167) 10,301
Comprising: Value of in-force business before deduction of cost of capital
Analysed as: Statutory IFRS basis shareholders’ funds* 877 2,568 750 4,195 520 4,715
15. Reconciliation of net worth and value of in-force business Value of
Total net in-force Total Free Required worth business long-term surplus capital (note i) (note ii) business Reconciliation of net worth and value of in-force business for 2005 £m £m £m £m £m
Shareholders’ capital and reserves at 1 January 2005 636 2,264 2,900 5,399 8,299
Changes of operating assumptions and experience variances 46 10 56 7 63
16. Sensitivity of results to alternative assumptions a) Sensitivity analysis – economic assumptions
The tables below show the sensitivity of the embedded value as at 31 December 2005 (2004) and the new business contribution after the effect of required capital for 2005 and 2004 to: ■ 1 per cent increase in the discount rates; ■ 1 per cent increase and decrease in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); ■ 1 per cent rise in equity and property yields; ■ 10 per cent fall in market value of equity and property assets (not applicable for new business contribution); and
■ holding company statutory minimum capital (by contrast to economic capital).
UK insurance Asian Total operations JNL operations long-term 2005 £m £m £m £m
Change representing effect on: *The JNL annuity sensitivity for mortality and morbidity relates to variable annuity business.
UK insurance Asian 2004 operations JNL operations Total £m £m £m £m
Impact of adoption of EEV basis: Changes in economic assumptions 10 (8) (5) (3)
Achieved profits basis operating profit from new business – as previously published 220 156 312 688
EEV basis operating profit from new business 241 145 355 741
17. Reconciliation of 2004 achieved profits basis results to EEV basis results continued Shareholders’ funds (excluding minority interests) at 31 December 2004
Shareholders’ share of deficit of UK defined benefit pension schemes (net of deferred tax): Statutory IFRS basis (115)
Fund management business falling within the scope of covered business 200
EEV Principles; ■ identified and described the business covered by the EVM; ■ applied the EVM consistently to the covered business; ■ determined assumptions on a realistic basis, having regard to past, current and expected future experience and to any relevant external data, and then applied them consistently; ■ made estimates that are reasonable and consistent; and
■ described the basis on which business that is not covered business has been included in the supplementary information, including any material departures from the accounting framework applicable to the Group’s financial statements.
We have audited the EEV basis supplementary information (the supplementary information) on pages 204 to 229 in respect of the year ended 31 December 2005. The supplementary information has been prepared in accordance with the EEV Principles issued in
EEV supplementary information should be read in conjunction with the Group’s financial statements which are on pages 62 to 195.
UK by the Auditing Practices Board, by our profession’s ethical guidance and the terms of our engagement.
Under the terms of engagement we are required to report to the Company our opinion as to whether the supplementary information has been properly prepared in accordance with the
EEV Principles using the methodology and assumptions set out on pages 208 to 214. We also report if we have not received all the information and explanations we require for this audit.
Shareholders are encouraged to elect to receive shareholder documents electronically by registering with Shareview at www.shareview.co.uk This would save on printing and distribution costs, helping to conserve natural resources. If you do this, you will be sent an email notification to say when shareholder documents are available on our website and you will be provided with a link to that information. You will need your shareholder reference number which can be found on your share certificate or proxy form.
P O Box 3408, South Hackensack, New Jersey 07606-3408, US, telephone 001 201 680 6630 or log on to www.adr.com
with the SEC. Copies of Form 20-F can be found on the Company’s website at www.prudential.co.uk or on the SEC’s website at www.sec.gov
Prudential is a leading life and pensions provider in the United Kingdom.
M&G is Prudential’s UK and European fund manager with £149 billion of funds under management as at 31 December 2005.
Egg plc is an innovative financial services company, providing a range of banking and financial services products through its internet site, www.egg.com
Prudential has life insurance operations in 12 countries and in 2005 was awarded six new life licences for cities in China, making a total of 10 operational in 2005. Prudential also has fund management operations in nine Asian countries following the addition of China and Vietnam in 2005.
Products ■ Annuities ■ Corporate pensions ■ With-profits and unit-linked bonds ■ Savings and investments ■ Protection ■ Equity release ■ Health insurance
Internal business ■ M&G manages assets on behalf of Prudential’s long-term business funds, including with-profits and unit-linked funds, annuities and corporate pension products.
JNL markets products in 50 states and the District of Columbia (in the State of New York through Jackson National Life Insurance Company of New York) through independent broker-dealers, independent agents, banks, regional broker-dealers and the registered investment adviser channel.
It pioneered unit-linked products in Singapore, Malaysia, Indonesia, the Philippines and Taiwan.
Currently, Prudential Corporation Asia has a network of over 170,000 agents serving more than seven million customers around the region.
IFRS operating profit of £157 million, up 67 per cent on 2004.
Contents 1 Group financial highlights 2 Chairman’s statement 4 Group Chief Executive’s review 8 Business review 16 Financial review 34 Corporate responsibility review 36 Board of directors 38 Corporate governance report 46 Remuneration report 58 Directors’ report 60 Summary of statutory and supplementary IFRS and EEV basis results 61 Index to the Group financial statements 62 Consolidated income statement 63 Statement of changes in equity 65 Consolidated balance sheet 67 Consolidated cash flow statement 68 Notes on the Group financial statements 186 Balance sheet of the parent company 187 Notes on the parent company financial statements 196 Statement of directors’ responsibilities in respect of the Annual
Report and the financial statements 197 Independent auditor’s report to the members of Prudential plc 198 Supplementary International Financial Reporting Standards (IFRS)