In 2005, operating profit grew 20 per cent to £163 million and underlying profits grew 25 per cent to £138 million.
Gross fund inflows increased by 35 per cent to £7.9 billion. Net fund inflows nearly doubled to £3.9 billion.
Independent financial adviser (IFA) helpline: 2005 overall group operating income was £527 million, up from £496 million in 2004.
Following Prudential’s offer for the minority shareholding, Egg shares were delisted on 20 February 2006.
EEV operating profit on continuing operations of £755 million, up 104 per cent on prior year.
Prudential plc is a holding company, subsidiaries of which are authorised and regulated by the Financial Services Authority.
Jackson National Life (JNL) is one of the largest life insurance companies in the United States with over three million policies and contracts in force.
In the UK, M&G is the fourth largest retail fund manager, with over one million unit holder accounts.
Also part of M&G Prudential Property Investment Managers (PruPIM) PPM Capital PPM South Africa
Egg has over five per cent share of the UK credit card market.
JNL offers fixed, fixed index, and variable annuities, term and permanent life insurance and institutional products. Through its affiliates and subsidiaries, JNL also provides asset management and retail brokerage services.
Effect of changes in economic assumptions and time value of cost of options and guarantees (302) (48)
Based on Based on statutory IFRS pro forma basis results IFRS results Supplementary IFRS basis information 2005 2004
Profit after tax attributable to equity holders of the Company £748m £602m
Operating earnings per share is calculated using operating profit from continuing operations based on longer-term investment returns after related tax and minority interests. This profit excludes goodwill impairment charges, the post-tax effects of short-term fluctuations in investment returns, the shareholders’ share of actuarial and other gains and losses of defined benefit pension schemes, the effect of changes in economic assumptions, and changes in the time value of cost of options and guarantees. The amounts for these items are included in the calculation of EEV basis basic earnings per share.
**IFRS basis results The basis of preparation reflects the formal adoption of IFRS basis reporting for the 2005 results. This basis of reporting was anticipated in the Company’s interim reporting in July 2005 and, on all substantive matters, the basis of measurement and presentation of IFRS basis results included in this Annual Report is the same as applied at that time.
Operating earnings per share is calculated using operating profit from continuing operations based on longer-term investment returns after related tax and minority interests. This profit excludes goodwill impairment charges, the post-tax effects of short-term fluctuations in investment returns, and the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes. The amounts for these items are included in the calculation of IFRS basis basic earnings per share.
2005 was a good year for Prudential’s businesses around the world. Each of our operations made strong progress, and finished the year well positioned to take advantage of the opportunities for profitable growth in 2006 and beyond.
European Embedded Value (EEV) basis increased 33 per cent to £1,712 million; operating profit under the International Financial
Reporting Standards (IFRS) basis increased 36 per cent to £957 million. The full year dividend per share has increased three per cent to 16.32 pence per share.
In the UK, where we are already a leading life and pensions company, we plan to extract significantly more value from the market as a whole by taking a more collaborative approach between our individual businesses. The decision to return Egg to full ownership within the Group has been an important step towards this, and gives us a strong base from which to pursue our ambition to build a broader retail financial services presence.
In Asia, the drivers of growth are as compelling as ever, and we expect to continue to expand aggressively in the region over the coming years, while still attaining our goal to go cash positive
Turning to our asset management businesses, we see these as significant and increasing contributors to the overall Group.
An integral part of our strategy is to ensure we build trusting, longterm relationships with consumers and, as part of this, we continue to support the communities in which we operate through a range of financial education initiatives. Details of our programme are given in the Corporate Responsibility section of this Report.
During the year, we made a number of Board changes. In addition to Mark Tucker’s appointment as Group Chief Executive in
We announced in April of this year that Lord Turnbull would join our Board following the Annual General Meeting in May. He was the Secretary of the Cabinet and Head of the Home Civil Service from 2002 to 2005, prior to which he was Permanent Secretary at
HM Treasury. Following the Annual General Meeting, Rob Rowley will step down from the Board and I would like to thank him for his significant contribution since he joined in 1999.
General Meeting we will put forward new long-term incentive arrangements for executive directors, which will replace the Group
One further matter on which I must comment is the proposal we received recently from Aviva that we should combine our two businesses. Your Board did not consider that the proposal made was in the best interests of Prudential’s shareholders, and it was subsequently withdrawn by Aviva. Your Board believes we are well placed: we have the business opportunities; the management depth; and the capital strength to continue to expand profitably our operations around the world and to generate further growth in the value of your Company. As always, the experience and talents of all our staff will be critical to our success, and I would like to thank them for their continued support and commitment.
The Group has continued to expand its insurance business strongly and our asset management businesses have also had an excellent year.
Statutory IFRS operating profit before tax was up 36 per cent at £957 million.
The continuing momentum of the Group can be seen in the growth of insurance premium income in 2005 to £13.8 billion
New business sales in our insurance operations increased by 15 per cent to £2,146 million on an annual premium equivalent
(APE) basis and each of our regional operations achieved doubledigit growth. New business profits increased by 15 per cent across the Group to £867 million, and operating profit before tax on the insurance business on an EEV basis increased by 30 per cent to £1,743 million.
In our asset management businesses, external funds under management increased to £46 billion up 23 per cent.
A final dividend of 11.02 pence per share has been recommended by the Board bringing the full year dividend to 16.32 pence per share, an increase of three per cent from 2004. The full year dividend is covered 1.7 times by post-tax IFRS profit after minority interests. We intend to maintain our current dividend policy, with the level of dividend growth being determined after considering the opportunities to invest in those areas of our business offering attractive growth prospects, our financial flexibility and the development of our statutory profits over the medium to long term.
Shareholders’ funds, on an EEV basis, grew strongly to £10.3 billion at the end of 2005 (2004: £8.6 billion) and the Group’s return on embedded value was 15.7 per cent (2004: 13.4 per cent) at reported exchange rates.
In May 2005, I set up a team of senior executives with a brief to identify the ambitions and business strategies best suited to maximise sustainable growth in value for the Group’s shareholders over the longer term.
The key conclusions of the review were that: ■ Demographic trends and the increasing concentration of wealth in the hands of those approaching retirement or already retired presents a major opportunity to establish the Group as a leading provider of ‘financial services for retirement’ by playing to our strengths and areas of competitive advantage; ■ the Group is well positioned in markets that offer highly attractive opportunities for strong organic growth over the next 10 years; ■ to exploit these opportunities fully we need to broaden our customer proposition and product range to align them more closely with anticipated retail financial sector profit pools; ■ in addition, we must complement our strong and important intermediary links by expanding the proportion of revenue derived from direct customers; and ensure that we build deep life-cycle relationships with our customers; ■ we should also develop the global reach and profile of our excellent asset management businesses.
We have also continued to develop our product range in 2005.
The UK insurance business has a balanced distribution model with strong positions across all major segments – IFA and multi-tie intermediaries, direct marketing and telesales, employee benefit consultants and a well developed single-tie Partnership channel.
We continued to make good progress in diversifying distribution, £1,712 million Total EEV operating profit from continuing operations up 33 per cent At constant exchange rates
National Australia Bank, St. James’s Place and with Royal London to provide pension annuities for vesting Scottish Life policies.
In retail banking, Egg’s UK operations delivered an underlying profit of £60 million (2004: £72 million). Egg was successful in testing market conditions improving its net interest margin against a background of falling base rates and also lowering its cost income ratio. There has been a general deterioration in consumer credit conditions, however, Egg’s experience here has been substantially better than the market average.
JNL continued to show strong growth in 2005, increasing new business sales by 13 per cent to £515 million APE with growth in variable annuities of 31 per cent. Both the margin and the internal rate of return on new business moved ahead strongly in the year.
Prudential has an unrivalled exposure and weighting to the high growth and high profit markets of Asia. Prudential Corporation
+15per cent New business APE sales of £2,146 million, up 15 per cent At constant exchange rates
I am pleased to report that, whilst continuing our programme of rapid expansion and profitable growth in Asia, we are also expecting the region to become cash positive in 2006, in line with our previous predictions.
Operating profit before tax across our asset management businesses in the UK, the US and Asia increased to £195 million up 16 per cent.
M&G in the UK had an excellent year with record gross and net inflows and strong profit growth. In Asia, underlying growth in retail funds under management was 29 per cent.
These businesses, together with PPMA, our asset management business in the US, continued to support their own sales growth and add significant value to the Group’s insurance operations through their excellent investment performance.
The priorities in asset management are to continue to target growth in external funds under management by capitalising on a growth in demand for transparent investment products, access to more global products, the continuing rise of open architecture platforms and a rapidly expanding role for cross-border sales off a common platform. We will create value through superior investment performance and capitalise on international opportunities through greater collaboration.
Conglomerates Directive, was around £825 million, little changed from the previous year. In July, we took advantage of good market conditions in the US retail market to raise US$300 million of perpetual capital securities, which qualifies as Group regulatory capital. The primary use of the proceeds will be to refinance a non-qualifying £150 million bond that matures in 2007.
In summary ■ The Group delivered strong results in 2005 across all its businesses; ■ we have compelling positions in the world’s leading retail financial services markets and the resources to capitalise on these; ■ in the UK, we have three excellent and profitable franchises in
As a result of improved sales in the UK, the US and Asia, the
Group delivered strong new business profits (NBP) in 2005. This, together with the significant increase in contributions from the in-force insurance business and fund management operations, drove European Embedded Value (EEV) basis operating profit up 33 per cent on 2004.
Earnings per share, based on EEV basis operating profit based on longer-term investment returns after tax and related minority interests were 56.6 pence, compared with a figure of 43.2 pence
Earnings per share, based on IFRS operating profit based on longer-term investment returns after tax and minority interests were 32.2 pence compared with a figure of 22.7 pence in 2004.
Changes in exchange rates from year to year have an impact on the Group’s results when these are converted into pounds sterling for reporting purposes. In some cases, these exchange rate fluctuations can mask underlying business performance.
In the business review and financial review, year-on-year comparisons of financial performance are on a CER basis, unless otherwise stated.
Prudential UK delivered double-digit growth in new business sales and IFRS operating profit. EEV NBP remained in line with 2004 at a time when certain product markets have shown increased levels of competition reflected in pricing.
APE sales of individual annuities were up two per cent on 2004 at £222 million, driven by strong sales through the Partnerships and
APE sales of unit-linked bonds increased 31 per cent to £64 million, reflecting Prudential’s growing presence in the IFA unit-linked bond market. This offset the year-on-year decrease in with-profits bond sales which fell 31 per cent.
Annual premium equivalent (APE) sales 2,146 1,867 15% 2,146 1,846 16%
*Based on longer-term investment returns from continuing operations – excluding Jackson Federal Bank (JFB) and Egg’s France business, which were discontinued in 2004.
This was driven by the increase in sales volumes which was offset by a fall in the NBP margin (from 30 per cent in 2004 to 27 per cent in 2005 on an APE basis). The movement in margin reflected the shift in product mix in 2005 as Prudential continued to expand its shareholder-backed product range, however, throughout the year there continued to be competitive pressure on margins across a range of products which Prudential substantially resisted.
Prudential’s Business to Business distribution channel delivers pension solutions to many of the FTSE 350 companies and is a market leader in the provision of pension schemes to the UK
public sector. During 2005, Prudential continued to expand the services it offers in this area to enable advisers to address the employee benefit challenges of their clients.
Prudential transferred its UK personal lines general insurance business to Winterthur in 2002 and formed a strategic alliance with
2006 is expected to be a year of change for the retirement savings market due to Government pensions reforms which come into force on 6 April (A-Day). Prudential believes the changes will have a positive impact and create an improved savings environment over time, although it is unclear how quickly consumers will respond to these new regulations.
Prudential has made a significant investment in its A-Day preparations including systems developments and customer communications. It currently expects pension arrangements will be compliant with the new regulations and that customers will be aware of the changes.
As a consequence of this, Prudential launched a new individual personal pension designed to offer greater transparency and flexibility. The new Pru Flexible Retirement Plan was launched in
Aa1 by Moody’s. The with-profits sub-fund delivered a pre-tax return of 20 per cent in 2005 and over the last five years, the fund has achieved a total return of 41 per cent against six per cent for the FTSE 100 total return index and 12 per cent for the FTSE All-
Much of this excellent investment performance was achieved through the active asset allocation of the fund. As part of its asset allocation process, Prudential constantly evaluates prospects for different markets. At the end of the first quarter of 2005, based on
Prudential increased its exposure to equities while decreasing its exposure to corporate bonds and direct property.
The closer partnership of Egg with Prudential’s UK life and pensions business, as announced in December, is expected to achieve revenue synergies and total annualised pre-tax cost savings across the combined business of £40 million by the end of 2007. This work to maximise the synergies between the two businesses has already started with PruHealth policies now being sold through Egg. This is an attractive opportunity for PruHealth and the first of what we believe will be a number of effective synergies between Prudential’s UK businesses.
Prudential UK will continue to pursue profitable opportunities in its chosen product areas and distribution channels.
Jackson National Life (JNL) operates in the largest retirement savings market in the world, with 67 per cent, or US$12.9 trillion
(Source: Cerulli Associates), of the world’s retirement savings assets concentrated in the US at the end of 2005. JNL provides retirement income and savings solutions in the mass and massaffluent segments of the US market, primarily to pre- and postretirees. It offers tools that help people plan for their retirement, and manufactures products with specialised features and guarantees to meet customer needs. By seeking to add value to both the representatives who sell JNL products, and to their customers,
JNL has built a strong position in the US retirement market.
JNL delivered APE sales of £515 million during 2005, representing a 13 per cent increase on the 2004 result. This result was achieved in an individual annuity market that was down two per cent on prior year (Source: LIMRA).
JNL’s NBP of £211 million were up 45 per cent on 2004, reflecting a 13 per cent increase in APE sales, and a significant improvement in new business margin to 41 per cent from 32 per cent in 2004.
product. The margin on institutional business improved due to the longer average duration contracts written by JNL during 2005.
Total EEV basis operating profit, based on longer-term investment returns, of £755 million was up 104 per cent on 2004. This reflects a 45 per cent increase in NBP and an in force profit of £530 million, up 123 per cent on the prior year. This result was driven by an operating assumption change following price increases introduced on two older books of term life business (£140 million), a favourable spread variance, and an increase in the unwind of the in-force business.
US$4.5 billion to US$7.7 billion, and has grown variable annuity reserves from US$5 billion to US$18 billion. JNL has also increased its ranking in the US annuity market from 15th to 12th since 1999, and has achieved this with a net capital inflow over the period of
United States £m unless otherwise stated 2005 (at CER) change 2005 (at RER) change
Total EEV basis operating profit* 755 370 104% 755 368 105%
*Based on longer-term investment returns from continuing operations (i.e. excluding Jackson Federal Bank (JFB) which was sold in October 2004 and including broker-dealer and fund management profits.
JNL, and which can be elected by customers according to their needs. JNL manages its exposure to equity market movements through a comprehensive derivative programme. Value movements in these derivatives are included in operating profit so as to broadly offset changes in policyholder liabilities caused by equity volatility.
During 2005, JNL again delivered record sales, with total APE sales for the year of £515 million up 13 per cent on 2004, and retail sales of £417 million, up 12 per cent. Variable annuity APE sales of £261 million were up 31 per cent on prior year, compared with market growth of 2.5 per cent during 2005 (Source: VARDS), primarily reflecting the continued success of its unbundled variable annuity contract ‘Perspective II’. Utilising the flexible product design enabled by leading technology, advisors can customise the product to meet the individual needs of the consumer, including individually priced benefit options and guarantees, such that consumers only pay for what they want.
Institutional APE sales of £98 million were up 15 per cent on 2004.
Seventy per cent of retail premiums received in 2005 were for products and product features that did not exist at the beginning of 2004. In January 2005, JNL launched its ‘Perspective Advisors II’
Perspective II benefits. These two products generated combined sales of US$678 million in the year. JNL also extended its range of life products during the year with the addition of ‘Ultimate
JNL continued to develop its wholesale distribution capability during 2005. JNL’s long-term commitment to meeting the needs of broker-dealers and their clients, through the provision of product flexibility, sales support tools, technology and customer service, continues to pay dividends. During 2005, JNL increased its share of variable annuity sales through the independent broker-dealer channel from 6.8 per cent to 9.1 per cent, and its share of the regional broker-dealer channel from 3.9 per cent to 4.9 per cent
National Planning Holdings (NPH), which is a network of four independent broker-dealers that represents approximately 2,600 registered advisors. NPH employs sophisticated technology that allows representatives to operate efficiently and productively.
US$434 million, after deducting the US$150 million of capital remitted to the parent company.
Curian Capital, which offers customised separately managed accounts, continues to build a strong position with net investment flows of £298 million in the year. Curian, which can be accessed with a minimum account balance of US$25,000, offers customers access to technology that enables individual portfolio construction, and access to institutional-quality money managers. Advisors benefit from the efficiencies of on-line processing and compliance.
Curian Capital now has US$1.7 billion (£973 million) of assets under management compared with US$1.1 billion (£615 million)
JNL’s main objectives will be to capture a proportion of these flows. With an emphasis on sales of low capital intensive variable annuity products, solid operating results and strong investment performance, JNL is capable of self-generating the capital necessary to support its future growth at the required returns and return a growing remittance to the parent company.
The ageing demographics of the US, with the first of the 77 million
Asia’s life insurance markets are very attractive with large scale and high growth rates supported by consistently strong economic growth, favourable demographics and market liberalisations.
respectively) and taking positions in the large North Asian markets of Taiwan, Japan and Korea. Prudential now has over seven million customers in Asia, up from 1.5 million in 2000.
Shandong, was added in January 2006. The main challenge facing foreign players trying to become established in China is the need to develop local management teams to support geographic expansion. Prudential has a real advantage in being able to leverage its existing Chinese speaking operations to help incubate new teams quickly. In 2005, new business APE for China increased by 47 per cent over 2004.
Strengthening distribution continues to be a major priority. In 2005 agent numbers grew by 26 per cent to over 170,000 with geographic expansion in India and China being a key driver (up 36 per cent and 37 per cent respectively). In Indonesia, the business has excellent momentum and has increased agent numbers by 89 per cent during the year. In the established markets, improving agency productivity is a key initiative and, whilst this improved in 2005, there is still significant room for growth. Prudential’s multi-channel distribution model in Korea is a real asset as, whilst volumes from direct campaigns such as a home shopping channel have waned and bank distribution has been limited by regulatory caps and industrial action, new business APE growth for 2005 of 88 per cent reflects great success in increasing the number of tied financial advisers (up 132 per cent) and extending the number of general agents (brokers).
Asia £m unless otherwise stated 2005 (at CER) change 2005 (at RER) change
Taiwan’s macroeconomic environment remains challenging with interest rates currently at record lows leading to negative spread issues affecting the whole industry, particularly on tranches of business sold pre 2002. Prudential has a comparatively small book of this business and remains confident that any potential deficits are more than adequately supported by the profitable new business, particularly unit-linked, it has been writing for a number of years. The Taiwanese life insurance industry is currently dominated by players pursuing short-term volume whereas
Prudential’s increasing scale is enabling it to move ahead with plans for a step change in its operating platform. A new business processing hub was launched in Kuala Lumpur, Malaysia in early 2005 under the name Prudential Services Asia. This is already successfully processing business for the Malaysian and Singaporean life operations and plans are underway for a second hub to be launched in China.
Over the last year significant progress was made with embedding a risk management and compliance framework. Prudential employs
NBP margin was 56 per cent, compared to 61 per cent in 2004 representing changes in the average geographic mix (net two percentage points), economic assumption changes (net two percentage points) and product mix (net one percentage point).
Looking at these changes in more detail, Korea and India now contribute 26 per cent of total APE compared to 18 per cent in 2004, average NBP margins in these countries are 37 per cent and 29 per cent respectively. The impact attributed to economic assumption changes is driven principally by increases to the risk discount rates in China and Korea. This was more than offset by a favourable shift in product mix in Korea where average margins remained slightly ahead of 2004 at 37 per cent. The other main product mix related impact was due to the lower margins on the retirement linked product in Taiwan as discussed above which led to a change in average margins from 61 per cent to 51 per cent.
Long-term EEV operating profits of £576 million are up 22 per cent over 2004 and are driven by NBP of £413 million and unwind of discount of £162 million with small operating assumption changes and experience variances netting out to £1 million.
M&G has scale in all key asset classes: it is one of the largest active managers in the UK stockmarket, one of the largest bond investors in the UK and one of the UK’s largest property investors.
M&G’s operating profit based on longer-term investment returns in 2005 including performance-related fees (PRF) was £163 million, an increase of 20 per cent on last year. Underlying profit
(excluding PRF) of £138 million was 25 per cent higher than in 2004, an extremely strong result given that the previous year
Gross fund inflows into M&G’s retail businesses were their highest ever at £3.8 billion and were nearly double the previous year. Net retail fund inflows totalled £1.3 billion, more than triple those in 2004. In the UK, M&G generated the highest ever retail sales in its 75 year history across a combination of its equity, fixed income and property funds. M&G International, which sells funds in Germany,
The Asian fund management business had £26.2 billion of funds under management as at 31 December 2005, of which £10.1 billion related to third party funds in operations in India, Taiwan, Japan,
Korea, Malaysia, Singapore and Hong Kong. Prudential is a top five foreign provider of mutual funds in all countries in which it operates with the exception of Japan where significant progress has been made in a very competitive market. In 2005, the fund management business continued to expand geographically with the securing of fund management licences in China, through a joint venture with CITIC, and in Vietnam. This takes the total number of countries in which the business has a presence to nine.
Operating profit from the Asian fund management operations was £12 million for the year, the decrease from 2004 reflecting the exceptional costs of £16 million incurred due to bond fund restructuring required as a result of industry wide issues in Taiwan.
The geographic expansion of the past few years has been matched by growth in market share, with Korea, Japan, India and Malaysia being notable successes. Geographic diversification along with this growth in scale has resulted in a strong upward trend in profits with underlying profits increasing from £9 million in 2001 to £28 million in 2005.
Net inflows from third parties of £1.3 billion were driven by strong net inflows in Japan of £905 million and Korea of £926 million though these were offset by net outflows in Taiwan of £745 million due to an unsettled bond fund market.
IFRS operating profit based on longer-term investment returns, from continuing operations*: UK banking business 60 72 (17)%
*Continuing operations – excludes Egg France and Funds Direct, which were discontinued in 2004.
**2004 comparatives are on an IFRS basis, except for adjustments for IAS 32 and IAS 39 which have been adopted from 1 January 2005, as permitted by IFRS transition rules.
The capital position at the end of the year continued to be very strong with total capital ratio of 14.8 per cent, improving from 12.5 per cent in 2004.
This product concept also reflects Egg’s strategy of deepening its relationship with customers which is a key differentiator and route to higher levels of cross sales and ultimately a broader range of product offerings. Egg Money won an award from Which? for
On 23 January 2006, Prudential announced that it had received acceptances in respect of 80.3 per cent of the issued ordinary share capital that it did not already own bringing Prudential’s ownership of the Egg Group to 95.7 per cent. Prudential also announced its intention to extend the offer until further notice.
Prudential and Egg to capitalise on the product capabilities, customer relationships and brand strengths of Prudential, M&G
and Egg and will also facilitate the realisation of substantial annualised pre-tax cost savings, with £40 million expected to be realised by the end of 2007, as well as opportunities for revenue synergies.
From 1 January 2005, Prudential is required to account for its longterm insurance business on an International Financial Reporting
Standards (IFRS) basis. In broad terms, IFRS profits for long-term business contracts reflect the aggregate of statutory transfers from with-profits funds and profits on a traditional accounting basis for other long-term business. Although the statutory transfers from with-profits funds are closely aligned with cash flow generation, the pattern of IFRS profits over time from shareholder-backed long-term businesses will generally differ from the cash flow
pattern. Over the life of a contract, however, aggregate IFRS profits will be the same as aggregate cash flow.
In preparing its IFRS basis results the Group has chosen to continue to provide supplementary analysis of the profit before shareholder tax so as to distinguish operating results based on longer-term investment returns, actuarial gains and losses on defined benefit pension schemes, and exceptional items. The Group has also made a discretionary change of accounting policy at the same time as the adoption of IFRS standards. The change principally affects the determination of longer-term returns for JNL that are credited to operating results. Total profit before tax is unaffected by this change.
actuarial gains and losses on the Group’s defined benefit pension schemes, and is expected to be more volatile as a result. In addition, IFRS basis shareholders’ funds will be more volatile from period to period because of market value movements on fixed income securities of JNL which are classified as available for sale.
Life insurance products are, by their nature, long-term and the profit on this business is generated over a significant number of years. Accounting under IFRS does not, in Prudential’s opinion, properly reflect the inherent value of these future profit streams.
Prudential believes that embedded value reporting provides investors with a better measure of underlying profitability of the
Stochastic valuations have been undertaken to determine the value of in-force business including the cost of capital. A deterministic valuation of the in-force business is also derived using consistent assumptions, and the time value of the financial options and guarantees is derived as the difference between the two.
The Group EEV results also incorporate the effect of the discretionary change to the basis of determining longer-term investment returns included in operating profits and IFRS changes for pension scheme accounting and non-insurance operations as described below.
Prudential’s insurance business achieved significant growth, both in terms of new business profits (NBP) and in-force profit, resulting in a 30 per cent increase in operating profit over 2004 at CER.
was up 17 per cent. The average Group NBP margin was 41 per cent up from 40 per cent in 2004 on an APE basis and 5.2 per cent up from 5.0 per cent on a present value of premiums basis. The overall margin has been broadly maintained over the last two years, reflecting careful management of product mix within each business. In-force profit increased 48 per cent on 2004 at CER
Results from fund management and banking business were £233 million, an increase of 15 per cent at CER on 2004. This was mainly driven by the significant contribution from M&G.
Other income and expenditure was negative £244 million compared with negative £243 million at CER in 2004. This reflected an increase in investment return on centrally held assets and other income offset by higher interest payable and head office costs.
basis). The movement in margin reflected the shift in product mix in 2005 as Prudential continued to expand its shareholder-backed product range, however, throughout the year there continued to be competitive pressure on margins across a range of products which Prudential substantially resisted.
Prudential allocates shareholder capital to support new business growth across a wide range of products in the UK. The weighted average post-tax Internal Rate of Return (IRR) on the capital allocated to new business growth in the UK in 2005 was 14 per cent achieving the 2007 target set at the time of the Rights Issue two years early. This increase was achieved by broadly maintaining or improving individual product IRR’s during the year coupled with a favourable product mix.
UK in-force profit of £183 million was down 25 per cent on 2004.
EEV basis. In the case of Prudence Bond, which accounts for a significant proportion of the assumption change, Prudential expected surrenders to fall after the favourable bonus declaration in February 2005. In the event, following the bonus declaration, customers continued to surrender their policies leading to a strengthening of the assumption by 40 per cent. The assumption change reflects Prudential’s current experience and, post tax, represents three per cent of the overall embedded value of the
April 2006. This payout represents an overall annualised return of 6.1 per cent over each of the last 10 years net of tax and charges.
Prudential continues to actively manage the conservation of its in-force book and is currently running within assumptions.
During the year, Prudential carried out a review of its mortality experience across all of its non-profit annuity business. As a result of this review, it strengthened the realistic and statutory male assumptions and weakened the realistic female assumptions to align the realistic assumptions with recent experience. The total effect of the changes was to reduce operating profit by £47 million, of which the main reduction arose from increasing the cost of capital.
Other charges of £46 million in the UK include £45 million of costs associated with complying with new regulatory requirements including Sarbanes-Oxley, product development and distribution development; a negative £19 million expense variance; and a net positive £18 million of other items. Prudential believe the
Egg’s collaboration, together with other initiatives will lead to a lowering of the absolute cost base going forwards.
In 2005, Prudential wrote to 440,000 of its customers contractedout of the State Second Pension (S2P) and provided updated information and views to enable them to make an informed decision about whether to contract back into S2P or remain contracted-out, stating that Prudential believed that most people should contract back in for the 2005/6 tax year onwards. As a result of this we expect premiums from DWP rebate business to fall in 2006 and subsequent years.
In the US, EEV operating profit based on longer-term investment returns from long-term operations was £741 million, up 93 per cent at CER and up 94 per cent from prior year at RER.
APE sales, and a significant improvement in new business margin to 41 per cent from 32 per cent in 2004. On a present value of premiums basis, the margin increased from 3.2 per cent to 4.1 per cent. The improved margin reflects a favourable business mix; an increase in the spread assumption for fixed index annuities reflecting the spread being achieved; improved average policy sizes for variable and fixed annuities; economic assumption changes, including an increase in the equity risk premium; and benefits derived from product pricing. Pricing benefits include the fee increase, introduced in May 2004, on the Perspective II
The fixed index annuity margin has improved from the prior year due to an increase in the long-term spread assumption from 175bps to 190bps, reflecting the spread being achieved.
The increase in the unwind of discount reflects the increase in risk discount rates, following an increase in the equity risk premium from three per cent to four per cent. Improved spread variance of £89 million is up from £41 million in the prior year, and reflects achieved spreads in excess of the current weighted portfolio target on the regular portfolio. The spread variance in 2005 also includes a number of non-recurring items including mortgage prepayment fees, make-whole payments and total return swap income which together represent £60 million of the spread variance.
On the new basis, longer-term returns on fixed income securities comprise two elements. The first element is a risk margin reserve
(RMR) charge for long-term default experience of £58 million for 2005. The present value of future RMR charges is reflected in the opening embedded value. The second element is amortisation of £53 million of interest related realised gains and losses. These gains and losses are amortised to operating profit over the bonds’
Following this change of policy for JNL’s EEV basis operating profit, the component for longer-term returns for fixed income securities is expected in the future to be a more stable feature than on the previous basis, which was affected by the volatility of realised gains and losses over a five year period. Total profit, including actual investment returns, is unaffected by the change. Further details of the change of policy are explained in the notes to the
EEV and IFRS basis results. In 2005, JNL experienced a net realised gain of £1 million on its corporate bond portfolio. This is reflected in total EEV basis profit before tax.
In Asia, NBP of £413 million was up 13 per cent at CER on 2004 with increased sales offset partially by NBP margin. During 2005,
Asia compared to prior year were country mix (reduction of two percentage points), product mix – principally in Taiwan (reduction of one percentage point) and assumption changes (reduction of two percentage points).
Korea and India now contribute 26 per cent of total APE compared to 18 per cent in 2004. Average NBP margins in these countries are 37 per cent and 29 per cent respectively. The impact attributed to economic assumption changes is driven principally by increases to the risk discount rates in China and Korea. This was more than offset by a favourable shift in product mix in Korea where average margins remained slightly ahead of 2004 at 37 per cent. The other main product mix related impact was due to the lower margins on the new retirement unit-linked product in Taiwan which led to a change in average margins from 61 per cent to 51 per cent.
Underlying profit (excluding PRF) of £138 million was 25 per cent higher than in 2004, an extremely strong result given that the previous year included £7 million of non-recurring provision releases. Adjusting for this gives a like-for-like increase in profit of 34 per cent over 2004.
In the past few years, growth in income from M&G’s existing businesses has been reinforced by the successful development of revenue streams from new activities. These include Prudential
Managers (PruPIM), which increasingly manages assets for external investors. In its retail businesses, sales of equity funds have risen significantly in both the UK, as a result of strong investment performance, and overseas, where M&G continues to build new distribution channels in selected European and other markets.
The benefits of this business diversification are clearly demonstrated by the strong upward trend in profits that M&G has posted –
Curian, which provides innovative fee-based separately managed accounts, recorded losses of £10 million in 2005, improved from losses of £29 million in 2004, as the business continues to build scale. At year end 2005, Curian had grown assets under management to US$1.7 billion (£973 million) from US$1.1 billion
At the Group level, profit before tax includes £6 million in profit attributable to realising value created in India when ICICI increased its stake in Prudential’s Indian asset management joint venture from 45 per cent to 51 per cent. This amount is included in shortterm fluctuations but excluded from operating profit based on longer-term investment returns.
Egg’s total continuing operating profit in 2005 was £44 million, compared with £61 million in 2004. This reflected the increasingly challenging market conditions and £10 million restructuring costs incurred in the first half of 2005.
Operating profit of the core UK banking business was £60 million.
As a result of the effective cost management, together with the benefits of reorganisation early this year, Egg’s cost to income ratio continued its downward trend to 43 per cent for 2005, improving from 49 per cent and 53 per cent for 2004 and 2003 respectively.
The UK long-term business component of short-term fluctuations in investment returns of £995 million primarily reflects the difference between an actual investment return for the with-profits life fund of 20 per cent and the long-term assumed return of seven per cent.
The US long-term business short-term fluctuations in investment returns of £65 million include a positive £63 million in respect of the difference between actual investment returns and long-term returns included in operating profit. The primary factor was a return in excess of assumptions on limited partnership investments. It also includes a positive £4 million in relation to changed expectations of future profitability on variable annuity business in force due to the actual separate account return exceeding the long-term return reported within operating profit.
In the US, economic assumption changes of negative £3 million primarily reflect increases in the risk discount rates following the increase in the equity risk premium from three per cent to four per cent, partially offset by an increase in the separate account return assumption.
The effective tax rate at an operating profit level was 21 per cent
(2004: 27 per cent), reflecting the lower effective tax rates in the UK and certain Asian territories. The effective tax rate at a total EEV level was 29 per cent (2004: 31 per cent) on a profit of £2,244 million. The higher effective rate of tax compared with that at an operating profit level is primarily due to the effect of impairment of goodwill (which does not attract tax relief), and the impact of short-term fluctuations in investment returns and changes in economic assumptions not all of which are tax affected.
The reduction in the 2005 effective tax rate arises from a number of factors, including settlement of a number of outstanding issues with HMRC and benefit taken for prior year losses incurred in
A Opening 2005 EEV basis shareholders’ funds (+£8,614m) B New business EEV profits (+£867m) C In-force EEV profits (+£876m) D M&G (+£163m) E Egg (+£44m) F Other non-life operations (+£26m) G Other income and expenditure (incl Asia Dev exp) (-£264m) H Goodwill impairment charge (-£120m)
Prudential’s return on embedded value for 2005 was 15.7 per cent, up from 13.4 per cent in 2004 reflecting the Group’s continued focus on profitable growth. The return is based on post-tax EEV
Group operating profit before tax from continuing operations on the IFRS basis was £957 million, an increase of 36 per cent on the pro forma IFRS basis for 2004 at CER. At RER, operating profit was up 37 per cent on prior year. This reflects strong growth in insurance and funds management businesses.
The growth in the US operations’ long-term IFRS operating profit reflects a continued ability to deliver improved investment returns, with greater spread and fee income offset by higher amortisation of deferred acquisition costs (DAC). In 2005, spread income was £119 million higher than in 2004, and included a number of nonrecurring items including mortgage prepayment fees, make-whole payments and total return swap income which together represented £60 million of spread income. JNL achieved record fee income during 2005, driven by a 42 per cent increase in separate account assets held at year end, and improved returns on these assets.
The result also benefited from an improvement in PPMA profits, primarily due to a one-off £5 million revaluation of an investment vehicle managed by PPMA.
Prudential Corporation Asia’s operating profit for long-term business before development expenses of £20 million was £195 million, an increase of 64 per cent on 2004 at CER and included a net £44 million profit related to exceptional items reported at the half year subsequently reduced by £14 million in restructuring costs for Japan. At reported rates, operating profits were 67 per cent up on last year. The majority of this profit currently comes from the larger and more established operations of Singapore, Hong Kong and Malaysia, which represent £127 million of the total operating profit in 2005, excluding exceptional items, compared to £111 million last year. In addition, markets such as Indonesia and Vietnam are becoming larger contributors to operating profits. Five life operations made IFRS losses: China and
Total IFRS profits before tax attributable to shareholders and minority interests were £998 million in 2005, compared with £985 million on the pro forma basis for 2004. The increase reflects: growth in operating profit of £258 million offset by a goodwill impairment charge of £120 million in relation to the Japanese life business; decrease in short-term fluctuations in investment return, down £82 million from 2004; and a £43 million negative movement from the prior year in actuarial gains and losses attributable to shareholder-backed operations in respect of the Group’s defined benefit pension schemes.
Banking: Operating profit from continuing operations based on longer-term *The comparative IFRS results shown above are prepared on a ‘pro forma’ basis which reflects the estimated effect on the 2004 results as if IAS 32, IAS 39 and IFRS 4 had been applied from 1 January 2004 to the Group’s insurance operations together with the discretionary change for the basis of determining longer-term investment returns, as disclosed on 2 June 2005.
Profit after tax and minority interests was £748 million compared with £602 million in 2004. The effective rate of tax on operating profits, based on longer-term investment returns, was 19 per cent
(2004: 30 per cent). The effective rate of tax at the total IFRS profit level for continuing operations for 2005 was 24 per cent (2004: 29 per cent). The reduction in the 2005 effective tax rate arises from a number of factors, including settlement of a number of outstanding issues with HMRC and benefit taken for prior year losses incurred in France following a recent European Court of
Basic earnings per share, based on total EEV basis profit from continuing operations for the year after minority interests, were 66.8 pence, compared with a figure of 56.8 pence in 2004.
Basic earnings per share, based on IFRS profit from continuing operations for the year after minority interests, were 31.5 pence, in line with the 2004 figure.
Dividend cover based on reported post-tax IFRS operating profits from continuing operations is 1.9 times. Dividend cover based on reported IFRS operating profits from continuing operations and normalised tax rate of 30 per cent is 1.7 times.
Subordinated or hybrid debt is debt capital which has some equity like features and which would rank below other senior debt in the event of a liquidation. These features allow hybrid debt to be treated as capital for Financial Services Authority (FSA) regulatory purposes.
The FSA has established a structure for determining how much hybrid debt can count as capital which is similar to that used for banks. It categorises capital as Tier 1 (equity and preference shares), Upper Tier 2 debt and Lower Tier 2 debt. Up to 15 per cent of Tier 1 can be in the form of hybrid debt and called
In addition, reserve adequacy testing under a range of scenarios and dynamic solvency analysis is carried out, including certain scenarios mandated by the US, the UK and Asian regulators.
Prudential believes that this format gives a clearer presentation of the use of the Group’s resources than the format of the statement required by IFRS.
Capital invested in business units: Total capital invested in business units (418) (347)
(Decrease) increase in cash (298) 850 *In respect of prior year’s bonus declarations.
The Group holding company received £517 million in cash remittances from business units in 2005 (2004: £521 million)
This includes a special dividend of £100 million from the Prudential
Assurance Company (PAC) shareholders’ funds in respect of profit arising from earlier business disposals and a separate payment of
of tax. Tax received in 2004 of £34 million was after an exceptional payment of £60 million related to the sale of equity securities backing the general insurance business. The £107 million balance in 2005 represents surrendered tax losses reimbursed by the
Group. The Group invested £418 million (2004: £347 million) in its business units, comprising £249 million in its UK Operations and £169 million in Asia. During 2006, Prudential continues to expect that Asia will be a net capital provider to the Group.
Subordinated Capital Securities, the repayment of £171 million of short-term borrowings, exchange conversion losses of £98 million and IFRS adjustments noted above.
(negative outlook) and A2 (stable outlook) from Standard & Poor’s and Moody’s respectively, while short-term ratings are A1+ and P-1.
Based on EEV basis operating profit from continuing operations and interest payable on core structural borrowings (excluding Egg), interest cover was 10.8 times in 2005 compared with 9.3 times in 2004.
In the UK and Asia, Prudential uses derivatives to reduce equity risk, interest rate and currency exposures, and to facilitate efficient investment management. In the US, JNL uses derivatives to reduce interest rate risk, to facilitate efficient portfolio management and to match liabilities under fixed index policies.
Due to the geographical diversity of Prudential’s businesses, it is subject to the risk of exchange rate fluctuations. Prudential’s international operations in the US and Asia, which represent a significant proportion of operating profit and shareholders’ funds, generally write policies and invest in assets denominated in local currency. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon conversion of results into pounds sterling. The currency exposure relating to the conversion of reported earnings is not separately managed, as it is not in the economic interests of the Group to
The FCD requires a continuous parent company solvency test which requires the aggregating of surplus capital held in the regulated subsidiaries, from which Group borrowings are deducted, other than those subordinated debt issues which qualify as capital. No credit for the benefit of diversification is allowed for under this approach. The test is passed when this aggregate number is positive, and a negative result at any point in time is a notifiable breach of UK regulatory requirements. In practice, whether Prudential is classified as a financial conglomerate or insurance group, there is very little difference in application of the rules. This is because the FSA has decided to make the test mandatory from 31 December 2006 to all insurance groups.
There have been two additional FSA requirements applicable this year. Firstly, the elimination of goodwill in the valuation of noninsurance subsidiaries, for which we had already factored in the full impact in our disclosure of the 2004 IGD position, ahead of the
FSA’s rules coming into force. Secondly, accounting for pension fund deficits, which has had an approximate £0.1 billion impact this year to the 2005 FCD position.
The FCD position will be submitted to the FSA by 30 April 2006 but is currently estimated to be around £825 million.
Basel 2, the new approach is expected to be based on the concept of three pillars – minimum capital requirements, supervisory review of firms’ assessments of risk and enhanced disclosure requirements. In particular, companies will be encouraged to improve their risk management processes, including making use of internal economic capital models to enable a better understanding of the business. The emphasis on transparency and comparability would help ensure a level playing field.
represents the UK, to provide guidance on many technical aspects of the framework (Level 3). CEIOPS will also develop voluntary guidance for national regulators to ensure consistent interpretation of Level 2 measures. To this end, the EC and CEIOPS have jointly issued Calls for Advice in order to incorporate broader feedback from industry, for which Prudential has actively engaged in mainly through its participation in the European Chief Risk Officer
The fund is very strong with an inherited estate measured on an essentially deterministic valuation basis of around £9.0 billion compared with £6.8 billion at the end of 2004. On a realistic basis, with liabilities recorded on a market consistent basis, the free assets were valued at around £8.0 billion before a deduction for the risk capital margin.
Prudential’s main with-profits fund: Cash and other asset classes 4 5 5
‘bubble’ period. The fund remains extremely well diversified geographically, by asset type and within the underlying stock portfolios, which we believe is an attractive feature of the Prudential with-profits proposition. It helps reduce risk or expected volatility by insulating the total fund from potential weakness in any particular market or stock. The active management of the asset mix in recent years has had a substantial beneficial impact on investment returns. The broad asset mix will continue to be reviewed as the economic environment and market valuations change.
The investment return on the Prudential main with-profits fund was 20 per cent in the year to 31 December 2005 compared with the rise in the FTSE All Share (Total Return) Index of 22 per cent over the same period. Over the last 10 years the with-profits fund has consistently generated positive fund returns with three, five and 10-year compound returns of 16.6 per cent per annum, 7.1 per cent per annum and 10.1 per cent per annum respectively, compared with corresponding increases in the FTSE All Share
The capital adequacy position of JNL remains strong, having improved the capital ratio from 8.5 per cent in 2004 to 9.2 per cent in 2005. JNL’s statutory capital, surplus and asset valuation reserve position improved year-on-year by US$434 million, after deducting the US$150 million of capital remitted to the parent company.
Jackson National Life of New York but excluding policy loans and reverse repo leverage) is as follows: Bonds: Investment Grade Public 58 60 58
Both Singapore and Malaysia have discrete life funds, and in 2005 good investment returns saw their free asset ratios increase. The
The long-term fund contains the amount that the Company expects to pay out to meet its obligations to existing policyholders and an additional amount used as working capital. The amount payable over time to policyholders from the with-profits sub-fund is equal to the policyholders’ accumulated asset shares plus any additional payments that may be required for smoothing or to meet guarantees. The balance of the assets of the with-profits subfund is called the ‘inherited estate’ and represents the major part of the working capital of Prudential’s long-term fund which enables the Company to support with-profits business by: ■ Providing the benefits associated with smoothing and guarantees; ■ providing investment flexibility for the fund’s assets; ■ meeting the regulatory capital requirements, which demonstrate solvency; and
The Company believes that it would be beneficial if there were greater clarity as to the status of the inherited estate. In due course, after discussions with the FSA, the Company may therefore take steps to achieve that clarity, whether through guidance from the court or otherwise. In any event the Company expects that the entire inherited estate will need to be retained within the long-term fund for the foreseeable future to provide working capital, and so it is not considering any distribution of the inherited estate to policyholders and shareholders.
The costs associated with the mis-selling review of Prudential’s with-profits personal pensions have been met from the inherited estate. Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates.
In 1998, Prudential stated that deducting personal pensions mis-selling costs from the inherited estate of the with-profits sub-fund would not impact the Company’s bonus or investment policy. The Company gave an assurance that if this unlikely event were to occur, it would make available support to the fund from shareholder resources for as long as the situation continued, to ensure that policyholders were not disadvantaged.
UK, of which the principal scheme is the Prudential Staff Pension
Scheme (PSPS), and a small scheme in Taiwan. The level of surplus or deficit of assets over liabilities for defined benefit schemes is currently measured in three ways: the actuarial valuation, FRS 17
contributions for ongoing service of current employees will approximately double whilst, in addition, deficit funding amounts designed to eliminate the actuarial deficit over a 10-year period will be made. Total contributions to the Scheme for these two components are expected to be of the order of £70-75 million per annum over a 10-year period. This compares with contributions in
Under IAS 19 the basis of valuation differs markedly from the full triennial valuation basis. In particular, it would require assets of the Scheme to be valued at their market value at the year end, while pension liabilities would be required to be discounted at a rate consistent with the current rate of return on a high quality corporate bond. As a result, the difference between IAS 19 basis assets and liabilities can be volatile. For those schemes such as
PSPS, which hold a significant proportion of their assets in equity
IAS 19, for 2005, a £22 million pre-tax shareholder charge to operating results based on longer-term returns arises, outside the operating result, but included in total profits is a pre-tax shareholder charge of a further £51 million. This is comprised of two components. First, £31 million of net actuarial gains arises on the movement in the shareholders’ share of the scheme deficits.
The second component is a charge of £20 million which arises from the need under UK GAAP (when applied to the Group’s insurance contracts under IFRS) to set aside amounts for future expenses on certain contracts. The £20 million charge reflects the increase relating to the increased future contributions for ongoing service.
The Group operates a comprehensive planning process. Executive management and the Board receive regular reports on the financial position of the Group, actual performance against plan, together with updated forecasts. The insurance operations of the Group all prepare a financial condition report, which is reported on to the Board.
The Group’s risk management procedures are further described in the Corporate Governance Report. Further discussion on key risk factors of the Group is included on pages 201 to 203.
The internal rate of return (IRR) is equivalent to the discount rate at which the present value of the post-tax cash flows expected to be earned over the life time of the business written in shareholderbacked life funds is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is the initial capital in excess of the premiums received required to pay acquisition costs and set up the statutory capital requirement. The time value of options and guarantees are included in the calculation.
Prudential’s products are structured as either with-profits (or participating) products, or non-participating products including annuities in payment and unit-linked products. Depending upon the structure, the level of shareholders’ interest in the value of policies and the related profit or loss varies.
There is a substantial volume of in-force non-participating business in PAC’s with-profits sub-fund and that fund’s wholly owned subsidiary Prudential Annuities Limited (PAL) which is closed to new business; profits from this business accrue to the with-profits sub-fund.
JNL’s principal retail savings products are sold as single premium fixed, variable or fixed index deferred annuities.
They are used for retirement planning and for providing income in retirement. The policyholder pays JNL a premium, which is credited to the policyholder’s account. Periodically, interest is credited to the policyholder’s account and administrative charges are deducted, as appropriate. JNL may reset the interest rate on each policy anniversary, subject to a guaranteed minimum, in line with state regulations. When the annuity matures, JNL either pays the policyholder the amount in the policyholder account or begins making payments to the policyholder in the form of an immediate annuity product. This latter product is similar to a UK annuity in
payment. Fixed annuity policies provide for early surrender charges for the first six to nine years of the policy. In addition, the policy may be subject to a market value adjustment at the time of early surrender. JNL’s profits on fixed annuities arise primarily from the spread between the return it earns on investments and the interest credited to the policyholder’s account (net of any surrender charges or market value adjustment) less expenses.
The policyholder’s premiums are held apart from JNL’s general account assets, in a ‘separate’ account, which is analogous to a unit-linked fund. The policyholder can allocate the premiums between a variety of variable sub-accounts with a choice of fund managers and/or guaranteed fixed-rate options. The value of the portion of the separate account allocated to variable sub-accounts fluctuates with the underlying investment. Variable annuity policies provide for early surrender charges.
These include the guaranteed minimum death benefit (GMDB), which guarantees on death the policyholder receives a minimum value regardless of past market performance. These guaranteed death benefits might be expressed as the return of original premium, the highest past anniversary value of the policy, or as the original premium accumulated at a fixed rate of interest. In addition, there are two other types of guarantee, guaranteed minimum withdrawal benefits (GMWB) and guaranteed minimum income benefits
Prudential’s business in Asia is focused on regular premium products that provide both savings and protection benefits.
In 2005, the new business profit mix was 63 per cent unit-linked, 25 per cent non-linked and 12 per cent Accident and Health
Unit-linked products combine savings with protection and the cash value of the policy depends on the value of the underlying unitised funds. Participating products provide savings with 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 insurer. Non-participating products offer savings with protection where the benefits are guaranteed or determined by a set of defined market related parameters. A&H products provide mortality or morbidity benefits and include health, disablement, critical illness and accident covers. A&H products are commonly offered as supplements to main life policies but can also be sold separately.
However, the two methods recognise the emergence of that profit differently, with profits emerging earlier under the EEV basis than under IFRS. This section explains how the two bases operate and why they are used.
Prudential’s primary financial statements are prepared in accordance with the IFRS basis of reporting of long-term business.
In broad terms, IFRS profits for long-term business reflect the aggregate of statutory transfers from with-profits funds and profit on a traditional accounting basis for other long-term business.
From 1997, Prudential and other major UK quoted financial groups adopted the achieved profits basis, a form of embedded value reporting, as a supplementary accounting measure in order to give a better reflection of the value attaching to long-term insurance business. Achieved profits basis financial statements were prepared under guidance issued by the ABI in December 2001.
For Prudential, EEV reporting represents an evolution from the achieved profits basis previously used for supplementary reporting and we welcome the improved clarity and consistency of information that it will provide to investors. We reiterate our view that embedded value information provides investors with a more realistic reflection of the current performance of life insurance business. In summary, the principal changes from current achieved profits reporting are in respect of three areas: ■ Inclusion of an explicit allowance for the impact of options and guarantees. This will typically require stochastic calculations, under which a large number of simulations are performed that provide a representation of the future behaviour of financial markets; ■ more active allowance for the combined impact of risk profile, encumbered capital and explicit valuation of options and guarantees in the selection of discount rates. This will ensure that the risks to the emergence of shareholder cash flows are properly accounted for; and
Prudential believes that the EEV basis provides useful information for shareholders. In contrast, for many types of contract, the IFRS
Economic assumptions as to future investment returns and inflation are based on market data.
is a key metric used in the management of the business. The change in value of business in force at the start of the year demonstrates how the existing book is being managed. Together they provide management and shareholders with valuable information about the underlying development of the business and the success or otherwise of management actions.
The EEV basis can be illustrated by considering a theoretical individual contract. Using assumptions for the drivers of future income and expenditure (including levels of future investment return, expenses, surrender levels and mortality) a profile of future cash flows can be estimated. These cash flows are then discounted back to the point of sale to give a new business profit.
Illustration of IFRS basis and EEV basis cumulative profit profiles for a typical with-profits product
It is fundamental to how we operate and is a philosophy that is now embedded in the business.
Chairman’s Award’, was launched across the Group in December 2005. The initiative encourages employees to volunteer with charities within their local communities. The charities involved all address the needs of the elderly or children, and run projects that have aspects of financial literacy at their core, thereby supporting the Group’s CR
January 2005, to help the local residents in countries severely impacted by the devastating Asian tsunami. Over £800,000 was raised from voluntary employee donations, along with matched funding by Prudential’s business units in the UK, the US and Asia.
Stakeholder engagement enables our employees and relevant external groups to help shape what we do and ensure that their reasonable expectations are translated into business value. In 2005, the CR unit discussed the CR programme with customers and consumers in the
executive team and ask questions about both their own policies and broader issues, including the CR programme.
Our financial education programme is based on the recognition that we need to play our part in enabling consumers to make the right decisions for their individual needs. Such decisions range from debt management to savings needs.
Kingdom in 2001. Five years later, we are seeing significant progress.
Group, and works closely with individual business units to provide advice ensuring that our core values are maintained and assisting with the adaptation of Group-wide initiatives so that they meet local needs.
In 2005, we engaged KPMG LLP to conduct a review of our CR
KPMG provided a report to our senior management team, summarising recommendations for improvement. In particular,
In 2006, we have engaged KPMG to review the key CR performance indicators identified in our workshop, which we will use to help develop our CR risk management strategy for reporting and external assurance.
Children’ initiative. Our support will help improve the quality of education at over 90 primary schools by improving school management, community participation, and the entire teaching/learning process
M&G‘s approach to socially responsible investment (SRI) is set out in the booklet
Limited (PruPIM), a subsidiary of M&G, is one of the UK’s largest commercial property investment managers and accounts for approximately 80 per cent of Prudential’s direct environmental impact in the UK. Through participation in the Institutional Investors Group on climate change and our participation on the property working group of the
Finance Initiative (UNEP FI), PruPIM is creating awareness of the implications of climate change for property investment and how we should address this.
Engaging with employees and understanding their expectations about corporate values, transparency, career development, performance management, diversity and work-life balance is important. This understanding helps us to attract, retain and motivate our employees.
Further information about our approach to equal opportunities and employee involvement can be found on pages 58
As such, we will endeavour to ensure our policies and business actions promote the consideration of the environment.
PruPIM is the first UK property company to achieve full ISO14001 certification, the internationally recognised environmental management standard.
Mark Norbom has been an executive director of Prudential and Chief Executive, Prudential
General Electric Company. He has spent 23 years with General Electric in various posts in the United
Sir David Clementi has been Chairman of Prudential since 1 December 2002. In August 2005 he was appointed as President of the Investment Property
Council. In addition, Sir David is a non-executive director of Rio Tinto plc, which he joined on 28 January 2003. From September 1997 to August 2002 he was Deputy Governor of the Bank of
England. During this time he served as a member of the Monetary Policy Committee and as a nonexecutive director of the Financial Services
Executive of Prudential Corporation Asia, and also held senior positions in Prudential’s businesses in the UK and US. He first joined Prudential in 1986, having previously been a tax consultant at
Prudential and Group Finance Director since May 2000. In May 2005 he was appointed as a nonexecutive director of Egg plc, which delisted on 20 February 2006. He is currently Chairman of the 100 Group of Finance Directors and a member of the Insurance Advisory Group of the International
Accounting Standards Board. He is also President of the Przezornosc Charitable Foundation, which has been established in Poland in recognition of former policyholders with whom the Company lost contact.
Prudential since January 2002. He is also President and Chief Executive Officer of Jackson National
National Life, which he joined in 1995. Prior to that, he was Senior Vice President and Chief Actuary for SunAmerica Inc, and prior to that Consulting
Michael McLintock has been an executive director of Prudential since September 2000. He is also
Independent non-executive director and member of the Audit and Remuneration Committees. Aged 60
Keki Dadiseth has been an independent nonexecutive director of Prudential since April 2005.
Care, responsible for the HPC business of Unilever worldwide, a Board member of Unilever PLC and
The Turkish Prime Minister’s Advisory Group and the WTO (World Trade Organization) Business
Mortgage Association (Fannie Mae). She was previously Chairman and Chief Executive Officer of
Independent non-executive director and Chairman of the Remuneration Committee. Aged 60
Kathleen O’Donovan has been an independent non-executive director of Prudential since May 2003. She is a non-executive director and Chairman of the Audit Committees of EMI Group plc and
Great Portland Estates PLC. She is also Chairman of the Invensys Pension Scheme. Previously, she was a non-executive director and Chairman of the Audit
James Ross has been an independent non-executive director since May 2004. He holds non-executive directorships with McGraw Hill and Datacard in the
Chairman of the Audit Committee and member of the Nomination Committee. Aged 56
Rob Rowley has been an independent nonexecutive director of Prudential since July 1999. He was appointed as Chairman of the Audit Committee in June 2000 and as Senior Independent Director of
We have applied the principles of the Code in the manner described below and in the remuneration report.
Group and the implementation of Board strategy and policy on the
Company’s Senior Independent Director, to whom concerns may be conveyed by shareholders if they are unable to resolve them through the existing mechanisms for investor communications, or where such channels are inappropriate. The Chairman meets, at least annually, with the non-executive directors without the executive directors being present.
The table on page 42 details the number of Board and Committee meetings attended by each director throughout the year. A further six Board Committee meetings took place during the year. In addition, the Chairman met with the non-executive directors without the executive directors being present in March, July and December.
The Board’s terms of reference, which are regularly reviewed, set out those matters specifically reserved to it for decision, in order to ensure that it exercises control over the Group’s affairs. These include, amongst other things, approval of the annual and interim results, strategy and corporate objectives, operating plans, significant transactions and matters affecting the Company’s share capital.
The chief executive of each business unit, who in respect of his business unit responsibilities reports to the Group Chief Executive, has authority for management of that business unit and has established a management board comprising its most senior executives. In accordance with the Group Governance Framework, business unit chief executives are required to certify annually their compliance with the requirements of the framework. The Board has adopted a Code of Business Conduct, which sets out the behaviour expected of staff in their dealings with shareholders, customers, fellow employees, suppliers and other stakeholders of the Group. A copy of the Company’s Code of Business Conduct may be found on the website www.prudential.co.uk/prudentialplc /cr/managementpolicies/codeofconduct
All directors have direct access to the services of the Company
Chairman in providing tailored induction programmes for new directors and on-going training for all directors.
Other commitments of the Chairman and changes during the year are detailed in his biography on page 36. The Board is satisfied that
The Board has established the following standing committees of non-executive directors with written terms of reference which are kept under regular review: Audit Committee report
At Prudential, the Audit Committee is a key element of the governance framework. This report sets out its responsibilities and the work the Committee has done to meet its objectives.
All the members of the Audit Committee are independent nonexecutive directors. The members of the Committee are: Rob Rowley FCMA (Chairman)
The Board has designated Rob Rowley as its Audit Committee financial expert for Sarbanes-Oxley Act purposes; he also has recent and relevant financial experience for the purposes of the Code.
The Committee continued to receive detailed presentations from senior management throughout the year. These presentations were designed to keep members up to date and aware of the impact on the business of changes to international accounting standards and practices, including International Financial Reporting
The Audit Committee met nine times during the year. Additionally, by invitation, the Chairman of the Board, Group Chief Executive,
Committee’s meetings includes: ■ Half year and full year results, press releases and annual report and accounts; ■ accounting policies and key judgmental areas, Group policies for compliance with relevant regulations worldwide, including
During the year, the Committee’s standing agenda items also included reports from Group Internal Audit, Group Risk, Group
The chairman of these committees is approved by the Chairman of the Group Audit Committee. The committees are attended by
business unit senior management including the Chief Executive and heads of finance, risk, compliance and internal audit. Business unit committees have similar terms of reference to the Group Audit
From 31 December 2006, the Group must undertake an annual assessment of the effectiveness of internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. In common with other companies, which must comply with this legislation, this has required the Group to undertake a significant project to document and test its internal controls over financial reporting. The Committee has overseen the progress of this project through regular status reports submitted by management in 2005. During the year, the Group’s external auditor, KPMG
The Audit Committee regards its relationship with internal audit as a particularly important one. Group Internal Audit plays an important role in supporting the Committee to fulfil its responsibilities under the Code and the Sarbanes-Oxley Act. Each of the Group’s business units has an internal audit team, the heads of which, from 1 January 2006, report to the Group-wide Internal Audit Director.
The Committee assesses the effectiveness of internal audit through a review carried out by external advisers, and through ongoing dialogue with the Group-wide Internal Audit Director. An internal review of internal audit arrangements and standards was also conducted in 2005, to ensure that the activities and resources of internal audit are most effectively organised to support the oversight responsibilities of the Committee.
The Audit Committee has a key oversight role in relation to the external auditor, KPMG Audit Plc, whose primary relationship is with the Committee. The Group’s Auditor Independence
Audit Committee undertakes a formal review to assess whether the external audit should be re-tendered. The external audit was last put out to competitive tender in 1999 when the present auditor was appointed. In both February 2004 and July 2005, the
accounting requirements, Sarbanes-Oxley requirements and other regulatory changes, and also to due diligence work related to the
acquisition of the Egg minority. A more detailed analysis is set out in note I4 on page 180.
The Audit Committee reviewed the interim and annual financial statements before their submission to the Board, paying particular attention to critical accounting policies and practices and any changes in them; decisions requiring a major element of judgement; unusual transactions; clarity of disclosures; significant audit adjustments; the going concern assumption; compliance with accounting standards; and compliance with obligations under the
As described above, the Committee is regularly briefed by senior management on developments in international accounting standards, and during the year it continued to review the progress of the Group’s project to implement IFRS and EEV reporting.
During the year, the Audit Committee undertook a formal review of its own effectiveness and the Committee is satisfied, based on the findings of this review, that it had been operating as an effective Audit Committee, meeting all applicable legal and regulatory requirements. Further reviews of the effectiveness of the Audit Committee will be undertaken annually.
Schedule A to the Code. The remuneration report prepared by the Board is set out in full on pages 46 to 57. In preparing the report, the Board has followed the provisions of the Code and
Committee’s proposals relating to the remuneration of all executive directors. Following the publication of the Code in July 2003, the terms of reference of the Committee were reviewed and amended.
Committee has access to professional advice inside and outside the Company.
Committee, in consultation with the Board, evaluates the balance of skills, knowledge and experience on the Board and makes recommendations regarding appointments based on merit and against objective criteria and the requirements of the Group’s business. In appropriate cases, search consultants are used to identify suitable candidates.
Executive on 6 May 2005, and Nick Prettejohn as executive director on 1 January 2006. Full biographical details of these new directors are set out on page 36.
During the year, the Nomination Committee continued the search for additional non-executive directors and employed professional search consultants who oversaw the initial process. This process is ongoing.
Company announced its intention to acquire the remaining 21 per cent of Egg plc. Mr Mendoza and Mr Broadley did not participate in discussions at Egg regarding this acquisition. Nor did they form part of the Independent Committee of the board of Egg recommending the Offer from the Company. Since the year-end
**During 2005 there were eight scheduled Audit Committee meetings and one additional meeting.
1. Resigned as a director on 5 May 2005 but not required to attend Board or Committee meetings on or after 24 March 2005.
3. Attended all scheduled meetings, but was unable to attend additional meetings because of prior commitments and submitted his comments to the Chairman prior to each additional meeting.
5. Resigned as a director on 17 October 2005 but not required to attend Board meetings on or after 16 October 2005.
on 20 February 2006, Egg delisted its shares from the London
It is proposed that Keki Dadiseth will be appointed a director of ICICI Prudential Life Insurance Company Limited, an Indian company which is owned 26 per cent by Prudential, and of
Prudential ICICI Asset Management Company Limited, an Indian company which is owned 49 per cent by Prudential. The Board does not consider that these appointments will in any way affect
The Group is one of the UK’s largest institutional investors and the Board does not believe that this situation compromises the independence of those non-executive directors who are also on the boards of companies in which the Company has a shareholding.
Non-executive directors are appointed initially for a three-year term. The terms and conditions of appointment of non-executive directors are available for inspection at the Company’s registered office during normal business hours and at the Annual General
Meeting. Their appointment is reviewed towards the end of this period against performance and the requirements of the Group’s businesses. Upon appointment, all directors embark upon a wideranging induction programme covering, amongst other things, the principal bases of accounting for the Group’s results, the role of the Audit Committee and the ambit of the internal audit function.
In addition, they receive detailed briefings on the Group’s principal businesses, its product range, the markets in which it operates and the overall competitive environment. Other areas addressed include legal issues affecting directors of financial services companies, the Group’s governance arrangements, its investor relations programme, as well as its remuneration policies.
All directors are required to submit themselves for re-election at the Annual General Meeting at least every three years, and annually following their reaching the age of 70.
The evaluation of the Board as a whole and of the Chairman was carried out by an independent consultant, following a briefing by the Chairman and the Senior Independent Director. Interviews were conducted with each Board member by the independent consultant. The interview questions were based on the Code and sought views on the effectiveness of the Board and on the
Board in February 2006. The non-executive directors met, under the leadership of the Senior Independent Director, to consider the report of the independent consultant and to review the performance of the Chairman. The performance of individual nonexecutive directors and the Group Chief Executive was evaluated by the Chairman in a meeting with each non-executive director and with the Group Chief Executive. The Group Chief Executive individually appraised the performance of the executive directors.
As a major institutional investor, the Company is acutely aware of the importance of maintaining good relations with its shareholders.
Director gave feedback to the Board on issues raised with them by major shareholders. Should major shareholders wish to meet newly appointed directors they are welcome to do so.
EC4V 3DB on 18 May 2006 at 11.00am. The Company believes the
Annual General Meeting is an important forum for both institutional and private shareholders and encourages attendance by all its shareholders. At its Annual General Meeting in 2005, the Company indicated the balance of proxies lodged for and against each resolution after it had been dealt with on a show of hands, and the total percentage of share capital voted on all resolutions. This practice provides shareholders present with sufficient information regarding the level of support and opposition to each resolution. The Company discloses the number of the proxy votes cast on each resolution on its website after the Annual General Meeting. At the 2006 Annual
General Meeting, as with last year’s meeting, shareholders will be given the opportunity to put questions to the Board on matters relating to the Group’s operation and performance.
The Group maintains a corporate website www.prudential.co.uk containing a wide range of information of interest to private and institutional investors including the Group’s financial calendar.
Group has established are designed to manage, rather than eliminate, the risk of failure to meet business objectives and can only provide reasonable and not absolute assurance against material mis-statement or loss. The system of internal control includes financial, operational and compliance controls and risk management. Aspects are delegated to the Group-level risk committees and Group Executive Committee as well as to senior management within the Group and business units.
As part of the annual preparation of its business plan, all of the
Group’s businesses and functions are required to carry out a review of risks. This involves an assessment of the impact and likelihood of key risks and of the effectiveness of the controls in place to manage them. The assessment is reviewed regularly throughout the year. In addition, business units review opportunities and risks to business objectives regularly with the Group Chief
Group Risk Framework and that they have reviewed the effectiveness of the system of internal control. The results of this review are reported to and reviewed by the Group Audit
The Group Risk Framework requires that all of the Group’s businesses and functions establish processes for identifying, evaluating and managing the key risks faced by the Group. The
Risk Committees, Group Chief Risk Officer and the Group Risk function working with counterparts in the business units, in addition to other Group functions, including Group Compliance and Group Security. The third line of defence is independent assurance on the effectiveness of the Group’s and business unit control and risk management systems provided by internal audit reporting to business unit and Group Audit Committees. During 2005, a Group Chief Risk Officer was appointed, reporting directly to the Group Chief Executive. The Group Chief Risk Officer oversees the Group Risk function, Group Compliance, Group
This demonstrates the importance which the Board and management attach to risk management within Prudential. It also increases the Group’s ability to manage risk in a co-ordinated way and benefit from optimising the management of the risk oversight and compliance functions under the Group Chief Risk Officer.
The Group Balance Sheet Management Committee is the senior management forum responsible for oversight of the Group’s balance sheet strategy, including debt capacity and capital structure. Its membership includes senior management involved in the operation of the Group’s policies for balance sheet management, including liquidity, financing and capital adequacy.
The Group Chief Risk Officer and the Group Risk Committees are supported by the Group Risk function and the risk committees and risk functions in each business unit. Quarterly risk reports from the business units and Group are reported to Group Risk covering risks of Group significance. Regular reports are also made to the Group and business unit audit committees by management, internal audit and compliance functions. Updates on the Group Risk Framework and the Group’s risk profile have been reported to the Group
Executive Committee and Group Audit Committee and Board during 2005. This has included the Group Executive Committee assessment of Group-level risks.
Committee. Group Risk acts as adviser in respect of all risks faced by Prudential Group, and establishes and maintains the risk management agenda across the Group, including through the design, implementation and maintenance of economic capital models, a consistent and harmonised risk management framework and policies, including recommendations as to risk appetite and risk-adjusted profitability. The Group Economic Capital Framework includes the modelling and quantification of the Group’s financial and non-financial operational risk economic capital position.
Business units undertake risk self-assessments in accordance with the Group Risk Framework, with dedicated risk functions and named individuals responsible for the operation of the Group Risk
Framework within each business unit. The operation of this includes business units’ communication and application of the
Group Risk Framework internally, including risk co-ordinators, identified risk owners, and regular risk reviews. Quarterly risk reports from the business units and Group are reported to Group
Risk and the Group-level risk committees covering risks of Group significance. Regular reports are also made to the Group and business unit audit committees by management, internal audit, compliance and legal functions.
Congress in July 2002 to establish new or enhanced standards for corporate accountability in the US. As a result of the listing of its securities on the New York Stock Exchange, the Company must comply with the relevant provisions of the Act.
The provisions of Section 404 of the Act require Prudential’s management to report on the effectiveness of internal control over financial reporting in its annual report on Form 20-F which is filed with the US Securities and Exchange Commission. The first requirement for this report is for the year ended 31 December 2006, and in common with other companies which have to comply with this requirement, the Group has undertaken a significant project to document and test its internal control over financial reporting in the format required by the Act.
This report to shareholders sets out: ■ The role of the Remuneration Committee; ■ our remuneration policy for executive directors for 2005 and 2006; and
■ tables of information showing details of the remuneration paid and share interests of all the directors for the year ended
Remuneration Committee is key to ensuring that executive directors’ remuneration is aligned with shareholders’ interests and enhances the competitiveness of the Company. The terms of reference of the Remuneration Committee are available on the Company’s website and a copy may be obtained from the
Committee the setting of the remuneration policy and individual remuneration packages for the Chairman and the executive directors. The fees of non-executive directors are a matter for the
The members of the Remuneration Committee during 2005, who are listed below, were all independent non-executive directors: Roberto Mendoza (Chairman)
Deringer to advise on legal matters. Towers Perrin and McLagan provided the Company with survey information on remuneration and Freshfields Bruckhaus Deringer provided other legal advice.
Deloitte also provided certain risk and other advisory services to the Company.
General Meeting inviting them to consider and approve it. This report complies with the requirements of the Regulations and
During the year, the Company has complied with Schedule A and
The aim of the Company’s remuneration policy is to enable the
The Remuneration Committee recognises that a successful remuneration policy needs to be sufficiently flexible to take account of changes in the Company’s business environment. The Committee will keep the policy under review, consulting with major shareholders before making any material changes. Any changes to the policy will be described in future remuneration reports.
Total remuneration means basic salary, short- and long-term incentives and pension. Award levels for the Group Chief Executive are set by the Remuneration Committee by reference to the total remuneration levels of other chief executives of major companies.
The remuneration package for the Company’s executive directors comprises the following elements: Remuneration report For year ended 31 December 2005
■ A basic salary; ■ an annual incentive; ■ long-term incentives, paid in cash or shares depending on the plan; and
The basic salaries of the executive directors at 1 January 2006 are: Philip Broadley £530,000 per annum
Receipt of these shares is deferred and the shares are normally only released after three years. Dividends accumulate for the benefit of award holders during the deferral period. For 2006, this structure has been extended to include the Chief Executive of
Committee came to the conclusion that in order to bring the total compensation opportunity for target performance closer towards the median market practice, the annual bonus award at target and maximum for Mark Tucker should be increased from the 2005 level of 50 per cent of basic salary for target and 110 per cent of basic salary for maximum. The levels for the other directors remain unchanged and for 2006 the maximum award levels are as follows: Notes Clark Manning is also eligible to receive an annual bonus which provides for a percentage share of a bonus pool based on the profits of JNL. He is additionally eligible to participate in a US tax qualified all-employee profit sharing plan.
The proposed new plan, in which all executive directors will participate, delivers shares subject to performance measured over three years. To improve the alignment with our shareholders’ longterm interests, participants will be entitled to receive the value of reinvested dividends over the performance period for those shares that vest.
The comparator companies have been carefully selected to represent the international industry in which Prudential operates: Aegon; Allianz; Aviva; Axa; Friends Provident; Generali; ING; Legal & General; Manulife and Old Mutual. The Remuneration
TSR will be measured on a local currency basis. This approach is considered to have the benefits of simplicity and directness of comparison with the performance of the comparator companies.
2006 awards will vest on the basis of the schedule set out below: Vesting between each performance point is on a straight-line sliding scale basis.
The Remuneration Committee must also be satisfied that the quality of the underlying financial performance justifies the level of award delivered at the end of the performance period and would adjust awards accordingly at its discretion.
Shareholder approval is being sought for the introduction of a new
Business Unit Performance Plan. This plan provides a common framework under which awards will be made to the Chief
TSR relative to the Index at the end of the third year Percentage of award that vests
M&G Chief Executive Long-term Incentive Plan as described in the section on 2005 long-term incentive plans on page 49.
The remaining half will be paid in cash. Participants will normally be entitled to receive the value of reinvested dividends over the performance period for those shares that vest.
Capital Value will be based on the figure disclosed in the Annual
The Remuneration Committee must also be satisfied that the quality of the underlying financial performance justifies the level of award delivered at the end of the performance period, and would adjust awards accordingly at its discretion.
The proposed awards for 2006 under the new plans are set out below.
The 2006 policy for pensions is described in the section on directors’ pensions and life assurance on page 56.
The remuneration policy for 2005 was the same as for 2006 with the exception of the long-term incentive plans, the annual incentive plan for Mark Tucker and pensions. The 2005 long-term incentive awards are described below and the 2005 policy for pensions is described in the section on directors’ pensions and life assurance on page 56.
Awards vest on the basis of the schedule set out below: Vesting between each performance point is on a straight-line sliding scale basis.
Philip Broadley, Clark Manning, Mark Norbom and Mark Wood, the awards were equivalent to 160 per cent of basic salary and for
Provided the phantom share options have value, they may be exercised in part or in full during annual exercise periods after three to seven years from the start of the performance period. For 2005 the phantom option award had a face value of £367,800.
For performance between these points payouts are on a straight line sliding scale basis.
The Chairman is paid annual fees and the contractual notice periods are 12 months from either party. The Chairman participates in a medical insurance scheme, has life assurance cover and has the use of a car and driver. He is entitled to a supplement to his fees, intended for pension purposes. He is not a member of any
Executive directors have contracts that terminate on their normal retirement date, which is the date of their 60th birthday. The normal notice of termination that the Company is required to give executive directors is 12 months, although for newly appointed directors there may be an initial contractual period of up to two years before the 12 months’ notice period applies. The service contracts for all current executive directors contain a 12 months’
notice period from the Company. When considering termination of service contracts, the Remuneration Committee will have regard to the specific circumstances of each case, including a director’s obligation to mitigate his loss.
The contract for Clark Manning is a renewable one-year fixed-term contract. The contract is renewable automatically upon the same terms and conditions unless the Company or Clark Manning gives at least 90 days’ notice prior to the end of the relevant term. In the case of the former, Clark Manning is entitled to continued payment of salary and benefits for the period of one year from the day such notice is delivered to him. The contract can also be terminated by the Company or Clark Manning by giving 12 months’ notice.
Payments of Clark Manning’s salary during the period following the termination of employment will be reduced by the amount of any compensation earned by him from any subsequent employer or from any person for whom he performs services. Benefits to be provided during such period will also be cancelled to the extent that comparable benefits are available to him from these alternative sources.
Executive directors, with the exception of Michael McLintock, are required to give 12 months’ notice of termination to the
*The contract can also be terminated by issuing a non-renewal notice as described above.
Jonathan Bloomer resigned from the Company and his employment ended on 5 May 2005.
*Under the terms of their letters of appointment, the non-executive directors serve for an initial term of three years following their election by shareholders at the Annual General Meeting after their appointment by the Board.
Related Share Option Scheme. Options granted under these schemes are not subject to performance conditions.
Subject to the Board’s approval, executive directors are able to accept external appointments as non-executive directors of other organisations.
Their fees are determined by the Board and reflect their individual responsibilities including committee membership as appropriate.
Annually, the non-executive directors use the net value of £25,000 of their total annual fees to purchase shares in the Company.
The current shareholding policy is that as a condition of serving, all executive and non-executive directors are required to have beneficial ownership of 2,500 ordinary shares in the Company. This interest in shares must be acquired within two months of appointment to the
Board if the director does not have such an interest in that number upon appointment.
As stated on page 50, non-executive directors have also used a proportion of their fees to purchase additional shares in the Company on a quarterly basis.
The interests of directors in ordinary shares of the Company are set out below and include shares acquired under the Share Incentive
Plan, the deferred annual incentive awards that are detailed in the table on other share awards on page 55, and Mark Norbom’s interests in the shares awarded on appointment that are detailed in the same table.
Sir David Clementi 16,615 23,849 23,849 *Or date of appointment if later.
Nick Prettejohn joined as a director on 1 January 2006 and at 15 March 2006 had a beneficial interest in 2,570 Prudential plc shares.
2. The shares in the table include shares purchased under the Prudential Services Limited Share Incentive Plan together with Matching Shares (on a 1:4 basis) that will only be released if the employee remains in employment for three years. For Philip Broadley the total number of Matching Shares at 31 December 2005 was 49.
Keki Dadiseth (from 1 April 2005; notes 13 to 15) 37 37 –
6. In 2005 a deferred share award valued at £157,795 from his 2004 annual bonus was made to Mark Norbom. This is included in the 2004 total and further details are shown in the section on other share awards on page 55.
7. It is intended that a deferred share award valued at £119,790 from his 2005 annual bonus will be made to Mark Norbom. This is included in the 2005 bonus figure.
8. In 2005 Mark Norbom was also paid £90,349 in dividend equivalents from the awards detailed in the section on other share awards on page 55. This amount is included in the column headed other payments.
9. Mark Norbom’s benefits include those that reflect his expatriate status, which include costs of £146,943 related to housing.
The table below shows all outstanding awards under the RSP: Rights granted under the Restricted Share Plan
Conditional 2005 award granted Conditional Date of Year of share awards Conditional on date upon share awards end of initial outstanding award of grant vesting outstanding at performance Name award at 1 Jan 2005 in 2005 (pence) in 2005 31 Dec 2005 period
The 2005 RSP awards are described in detail on pages 48 and 49. The 2004 RSP awards had the same performance conditions. For RSP awards prior to 2004, no rights are granted if the Company’s TSR performance as ranked against the comparator group is at the 60th percentile or below. 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 basis. In normal circumstances, directors may take up their right to receive shares at any time during the following seven years.
Restricted Share Plan (RSP) continued Notes continued 3. For the 2005 conditional RSP award to Jonathan Bloomer, the ranking of the Company’s TSR in the month prior to his leaving date was 14th and as a result 11.11 per cent of his award was released. This percentage takes into account pro-rating for his service during the three-year performance period.
Rights that were exercised under the RSP during 2005 are shown in the following table.
Year of 1 Jan 2005 in 2005 in 2005 31 Dec 2005 performance
Mark Wood Business cash LTIP 2002 450 Nil – 31 Dec 04
Michael McLintock Michael McLintock’s 2002 and 2003 cash long-term incentive plans had the same performance conditions as described for his business-specific long-term incentive plan described on page 49. For both awards, the phantom share price at the beginning of the performance period was £1. For the 2002 award the phantom share price at the end was £2.33. This resulted in a payment from the phantom share award of £524,250 and a phantom option award of 367,800 units. He did not exercise any of these options. For the 2003 award, the phantom share price at the end was £2.03. This resulted in a phantom share award of £456,750.
Mark Norbom Mark Norbom’s 2004 and 2005 cash long-term incentive plans had the same performance conditions as described for his business-specific long-term incentive plan described on page 49.
remuneration table on page 52. The number of shares is calculated using the average share price over the three business days commencing on the day of the announcement of the Group’s annual financial results for the relevant year. For the 2004 awards the average share price was 492 pence.
2. In order to secure the appointment of Mark Norbom, he has been awarded rights to Prudential plc shares, which vest as set out in the table. These awards will normally vest dependent on continuing employment at the date of vesting except for the element compensating for the loss of supplemental pension rights which vests on his leaving Prudential providing this is after 20 February 2013. If there is a change of control of Prudential or a sale of all or part of the Asian business, he may become entitled to retain any unvested awards in accordance with the vesting schedules above. The equivalent of dividend distributions will be made from these awards during the restricted period and the cash dividend equivalents paid in 2005 from these awards are included in the directors’ remuneration table on page 52.
3. Mark Wood resigned as a director with effect from 17 October 2005 and as part of the terms of the termination of his employment, his deferred shares under the 2004 annual incentive plan will be released subject to non-competition and non-solicitation conditions. The award is expected to be released on or before 15 July 2006.
Scheme is open to all UK and certain overseas employees. Options under this scheme up to HM Revenue and Customs limits are granted at a 20 per cent discount and cannot normally be exercised until a minimum of three years has elapsed. No payment has been made for the grant of any options. The price to be paid for exercise of these options is shown in the table below. No variations to any outstanding options have been made.
Notes 1. No gains were made by directors in 2005 on the exercise of share options (2004: £559,020).
It is the Company’s policy to offer executive directors the facility to save for retirement through efficient pension vehicles and UK
Changes to UK pensions regulations take effect from April 2006 (A-Day). Executive directors will not be compensated for the effects of any change in their taxation position as a result of these changes. The Company has reviewed its policy and for future executive director appointments its policy will be a simple salary supplement for executive directors of 25 per cent of salary. This would include, where relevant, any company contributions to the staff defined contribution pension plan, which directors would be eligible to join. For defined benefit schemes, the policy will be to retain a notional scheme earnings cap, replicating the HM Revenue and Customs earnings cap, which will no longer exist after A-Day. The effect of this will be to maintain the current policy for pension provision for executive directors who are currently eligible for defined benefit arrangements.
The description below applies to both 2005 and 2006, with the exception that, after A-Day, where the HM Revenue and Customs earnings cap is referred to, this will mean the notional scheme earnings cap and the Funded Unapproved Retirement Benefit Scheme
On death in service a total sum from all these schemes of four times pensionable salary plus spouse’s and children’s pensions are payable.
Mark Tucker is provided with a salary supplement only. Philip Broadley and Michael McLintock are entitled to supplements based on the portion of their basic salary not covered for pension benefits under an HM Revenue and Customs approved scheme, as were Jonathan
Bloomer and Mark Wood. These supplements are paid directly to them, or to a FURBS established in their name up to A-Day. They are provided with life assurance cover related to salary over the HM Revenue and Customs earnings cap. The cover is broadly equivalent to the death in service benefits provided under the relevant UK HM Revenue and Customs approved pension scheme.
Clark Manning participates in a US tax-qualified defined contribution plan (a 401k plan). He is also provided with life assurance cover of two times basic salary.
Details of directors’ pension entitlements under HM Revenue and Customs approved defined benefit schemes and the pre-tax amount of any salary supplements and contributions to FURBS or other pension arrangements paid by the Company are set out below: Additional pension earned during year ended
Mark Norbom 47 – – – – – – – 155
Mark Tucker 48 – – – – – – – 127
Total contributions to directors’ pension arrangements were £1,111,602 (2004: £1,124,000) of which £361,145 (2004: £353,000) related to money purchase schemes.
Prudential plc is the Group holding company and the principal activity of its subsidiary undertakings is the provision of financial services in the UK, the US and Asia. Particulars of principal subsidiary undertakings are given in note I6 on page 181. The
Executive’s review on pages 4 to 7, the business review on pages 8 to 15 and the financial review on pages 16 to 33, which contain details of the development of the businesses of the Group during the financial year and of the Group’s position at the end of it.
Important events affecting the Company after the end of the financial year are detailed in note I8 on page 185.
It is the policy of the Group to agree terms of payment when orders for goods and services are placed and to pay in accordance with those terms. Trade creditor days, based on the ratio of amounts which were owed to trade creditors at the year-end to the aggregate of the amounts invoiced by trade creditors during the year, were 22 days.
A list of the present directors is set out on pages 36 and 37.
Mark Tucker and Nick Prettejohn will retire and offer themselves for election at the Annual General Meeting on 18 May 2006.
Meeting and offer themselves for re-election. Details of each director’s interests in shares and debentures of the Company and its subsidiary, Egg plc, which was listed until 20 February 2006, are set out in the remuneration report on page 51. Protections afforded to directors, including qualifying third party indemnities under the provisions of the Companies Act 1985, are detailed in the remuneration report on page 50.
It is Group policy to give full and fair consideration and encouragement to the employment of applicants with suitable aptitudes and abilities, and to continuing the employment of staff who become disabled, and to providing training and career development opportunities to disabled employees.
The Group has effective communication channels through which employees’ views can be sought on issues which concern them.
Throughout the Group there is close consultation between management and other employees on appropriate matters of concern, with a view to keeping employees informed about the progress of the Group’s business and the economic factors affecting it. Communication with employees is achieved in a number of ways, including one-to-one staff briefings and through the Group’s intranet site. Prudential’s European Employee Forum provides an opportunity for elected employee representatives to consult with senior management on strategic European business issues. M&G’s Staff Consultative Committee and UK Insurance
During 2005, further improvements were made to staff consultative arrangements following a review by all Prudential UK based operations started in 2004. This review was given impetus by the
UK legislation on Information and Consultation and was conducted with a view to improving the effectiveness of arrangements, consulting trade unions and other staff groups as appropriate.
Prudential Savings-Related Share Option Scheme. The Scheme has now been operating for 22 years and 60 per cent of UK staff currently participate. The Prudential International Savings-Related
Employees (ISSOSNE) for its agents in Hong Kong. Currently eight per cent of agents participate.
Following shareholder agreement in 2000 to authorise the Board to introduce a Share Incentive Plan, The Prudential UK Share
Services Limited. This plan enables employees to buy Prudential shares on a tax-efficient basis. For every four Partnership shares bought, an additional Matching share is granted. Currently 29 per cent of eligible staff participate.
It is the Group’s policy not to make donations to political parties or to incur political expenditure, within the meaning of those expressions as defined in the Political Parties, Elections and
Referendums Act 2000, and the Group did not make any such donations or incur any such expenditure in 2005.
Companies Act 1985. This authority will expire at the end of the
Annual General Meeting to be held in 2006 or 18 months from the date granted, whichever is earlier.
The number of accounts on the share register at 31 December 2005 was 60,942 (2004: 69,632). Further information about shareholdings in the Company is given on page 231. As at 15 March 2006 the Company had received notification in accordance with
The following tables show the results reported in the statutory financial statements on pages 62 to 195, supplementary IFRS basis information on pages 198 to 200 and supplementary EEV basis results on pages 204 to 229. This page does not form part of the statutory financial statements.
Operating profit from continuing operations based on longer-term investment returns 957 699
Profit before tax from continuing operations attributable to shareholders (including actual investment returns) 998 985
Profit after tax attributable to equity holders of the Company 748 602
Operating earnings per share from continuing operations after related tax and minority interests 32.2p 22.7p
(2004: 5.19p) and final dividend of 11.02p (2004: 10.65p) declared after the end of the reporting period) 16.32p 15.84p
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (47) (12)
Notes IFRS basis results References to ‘statutory IFRS basis’ results above reflect the IFRS basis of results applied in the Group financial statements. In particular, the standards IAS 32, IAS 39 and IFRS 4, which address the measurement of financial instruments and insurance contract assets and liabilities have been applied from 1 January 2005 rather than, as applied for all other IFRS standards, 1 January 2004. The ‘pro forma IFRS’ results shown above are extracted from supplementary information and are not results that form part of the Group’s financial statements. The pro forma IFRS results reflect the application of the statutory IFRS basis together with the estimated effect on the Group’s results for 2004 if IAS 32, IAS 39 and IFRS 4 had been applied from 1 January 2004 to the Group’s insurance operations, but not to the Group’s banking operations, in particular in relation to hedge accounting.
Supplementary information The results shown above distinguish ‘operating profits’ based on longer-term investment returns from ‘profits before tax’. The reconciling items are presented in accordance with the Group’s policy as described in the Group’s financial statements and supplementary information. Items excluded from operating profit based on longer-term investment returns represent primarily the effects of altered investment market conditions (short-term fluctuations), actuarial gains and losses on defined benefit pension schemes, and exceptional items, including goodwill impairment. For EEV, the operating profit based on longer-term investment returns figure also excludes the effect of changes in economic assumptions and the time value of the cost of options and guarantees.
Changes from previous accounting basis and reconciliation to previously published 2004 results on first-time adoption of IFRS A5
Items recognised directly in equity: Movement on cash flow hedges (4) (4) 1 (3)
Total income and expense for the year 748 333 (292) (3) 786 13 799
Share Share Retained Translation Shareholders’ Minority Total capital premium earnings reserve equity interests equity
Total income and expense for the year 517 (160) 357 (1) 356
Change in minority interests arising principally from purchase and sale of venture investment companies and property partnerships of the PAC with-profits fund 1 1
Proceeds from Rights Issue, net of expenses H11 17 1,004 1,021 1,021
Transfer to retained earnings in respect of shares issued in lieu of cash dividends H11 (116) 116 0 0
At beginning of year: As previously reported under UK GAAP 100 553 2,587 3,240 107 3,347
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements G1 4,529 3,819
Effect of exchange rate changes on cash and cash equivalents 92 (70)
Cash and cash equivalents at end of year H10 3,586 4,341 *Profit before tax represents income net of post-tax transfers to unallocated surplus of with-profits funds, before tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders’ profits. It does not represent profit before tax attributable to shareholders.
IAS 39, ‘The Fair Value Option’ and IAS 19, ‘Employee Benefits’ (as amended in 2004).
Financial Reporting Standards’ in relation to the standards IAS 32, IAS 39 and IFRS 4.
The Group has chosen to report separately pro forma results, as supplementary information that does not form part of the Group financial statements, that show the 2004 results attributable to shareholders as if the Group had applied these standards to its insurance operations from 1 January 2004. The pro forma results are shown on pages 198 to 200.
With the exception of contracts described in note D1, the Group’s life assurance contracts are classified as insurance contracts and investment contracts with discretionary participating features. As permitted by IFRS 4, assets and liabilities of these contracts (see below)
are accounted for under previously applied GAAP. Accordingly, except as described below, the modified statutory basis (MSB) of reporting as set out in the revised Statement of Recommended Practice (SORP) issued by the Association of British Insurers (ABI) in
A3: Critical accounting policies, estimates and judgements continued From 1 January 2005 the Group has chosen to improve its accounting for UK regulated with-profits funds by the voluntary application of the UK accounting standard FRS 27, ‘Life Assurance’. Under this standard, the main accounting changes that are required for UK
The primary effect of these changes is to fundamentally alter the basis of accounting and carrying value of deferred acquisition costs
Under UK GAAP, the fund for future appropriations (FFA) represents the excess of assets over policyholder liabilities for the Group’s with-profit funds. Under IFRS the FFA is termed unallocated surplus and the Group has opted to account for it wholly as a liability with no allocation to equity. This treatment reflects the fact that shareholders’ participation in the cost of bonuses arises only on distribution.
For JNL, applying the MSB as applicable to overseas operations, the assets and liabilities of insurance contracts are accounted for under insurance accounting prescribed by US GAAP. For Asian operations the local GAAP is applied with adjustments, where necessary, to comply with UK GAAP. For Asian operations in countries where local GAAP is not well established and in which the business written is primarily non-participating business, US GAAP is used as the most appropriate proxy to local GAAP.
Valuation and accounting presentation of fair value movements of derivatives and debt securities of JNL
For derivative instruments of JNL, the Group has considered at length whether it is appropriate to undertake the necessary operational changes to qualify for hedge accounting so as to achieve matching of value movements in hedging instruments and hedged items in the performance statements. In reaching the decision a number of factors were particularly relevant. These were: ■ IAS 39 hedging criteria has been designed primarily in the context of hedging and hedging instruments that are assessable as financial instruments that are either stand-alone or separable from host contracts, rather than, for example, duration characteristics of insurance contracts; ■ the high hurdle levels under IAS 39 of ensuring hedge effectiveness at the level of individual hedge transactions for specific transactions; ■ the difficulties in applying the macro hedge provisions under IAS 39 (which are more suited to banking arrangements) to JNL’s derivative book; ■ the complexity of asset and liability matching of US life insurers such as those with JNL’s product range; and finally
Under IAS 39, unless carried at amortised cost (subject to impairment provisions where appropriate) under the held-to-maturity category, debt securities are also carried at fair value. The Group has chosen not to classify any financial assets as held-to-maturity. Debt securities of JNL are designated as available-for-sale with value movements being recorded as movements within shareholders’ equity.
With the exception of debt securities held by JNL and Egg and assets classified as loans and receivables, all financial investments are designated as fair value through profit and loss. Short-term fluctuations in investment returns on such assets held by with-profits funds, and those of investment property for the accounting treatment is similarly based, do not affect reported shareholder results. This is because (i) unallocated surplus of with-profits funds are accounted for as liabilities and (ii) excess or deficits of income and expenditure of the funds over the required surplus for distribution are transferred to or from unallocated surplus. However, for shareholder-backed businesses the short-term fluctuations affect the result for the year and the Group provides additional analysis of results to provide information on results beforehand after short-term fluctuations in investment returns.
Of the Group’s financial investments, assets with a fair value of £4.9 billion are not quoted on active markets. Their fair values are determined in full or in part by using valuation techniques. These techniques include discounted cash flow analysis, option-adjusted spread models and enterprise valuation and may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these instruments.
Financial investments carried on an available-for-sale basis, such as JNL’s debt securities portfolio, are considered to be impaired if there has been a significant and prolonged period of decline in fair value below its amortised cost or if there is objective evidence of impairment.
The consideration of this requires management’s judgement. Among the factors considered is whether the decline in fair value results from a change in quality of the security itself, or from a downward movement in the market as a whole and the likelihood of recovering the carrying value based on the current and short-term prospects of the issuer. Unrealised losses that are considered to be primarily the result of market conditions, such as increasing interest rates, unusual market volatility, or industry-related events, and where the Group also believes there is a reasonable expectation for recovery and, furthermore, it has the intent and ability to hold the investment until maturity or the market recovery, are usually determined to be temporary. Prudential’s review of fair value involves several criteria including economic conditions, credit loss experience, other issuer-specific developments and future cash flows. These assessments are based on the best available information at the time. Factors such as market liquidity, the widening of bid/ask spreads and a change in cash flow assumptions can contribute to future price volatility. If actual experience differs negatively from the assumptions and other considerations used in the consolidated financial statements, unrealised losses currently in equity may be recognised in the income statement in future periods.
For financial assets carried at amortised cost, the Group measures the amount of the impairment loss by comparing the carrying amount of the asset with the present value of its estimated future cash flows.
The risks inherent in reviewing the impairment of any investment include the risk that market results may differ from expectations; facts and circumstances may change in the future and differ from estimates and assumptions; or the Group may later decide to sell the security as a result of changed circumstances.
Contracts that transfer financial risk but not significant insurance risk are termed investment contracts. Furthermore, some contracts, both insurance and investment, contain discretionary participation features representing the contractual right to receive additional benefits as a supplement to guaranteed benefits. Accordingly, insurers must perform a product classification exercise across their portfolio of contracts issued to determine the allocation to these various categories. Further details of this exercise are given in note D1.
The Group’s insurance contracts and investment contracts with discretionary participation features are primarily with-profits and other protection type policies. For UK regulated with-profits funds for 2005 the contract liabilities are valued by reference to the UK FSA’s realistic basis. This is described in note D2. For other contracts, and for UK with-profits contracts in 2004, the liabilities are estimated using actuarial methods based on assumptions relating to premiums, interest rates, investment returns, expenses, mortality and surrenders. The assumptions to which the estimation of these reserves is particularly sensitive are the interest rate used to discount the provision and the assumed future mortality experience of policyholders. Further information on valuation assumptions in respect of the Group’s insurance contracts is provided in section D. From the perspective of shareholder’s results, the key sensitivity relates to assumed future investment returns for the Taiwan life operation. This sensitivity is discussed in more detail in note D4(h).
The deferral and amortisation of acquisition costs is of most relevance to the Group’s reported profits for shareholder-financed long-term business operations, principally JNL in the US. In 2005 and 2004, except as described in sections D3(f) and D4(f), the amortisation of deferred acquisition costs was at expected levels.
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 the available evidence, it can be regarded as more likely than not that there will be suitable taxable profits against which the losses can be relieved. 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. The judgements made, and uncertainties considered, in arriving at deferred tax balances included in the financial statements are discussed in note H4.
With the three exceptions, referred to in note A3(a) above, all IFRS standards have been adopted on transition to IFRS from 1 January 2004 on the basis described in this note. The effect of adoption of these standards on previously published 2004 results is explained in note A5.
In summary, the accounting bases applied across the two years reflect the following: Financial instruments (other than long-term business contracts classified as financial instruments)
For 2004, previous UK GAAP has been applied. For 2005, the adoption of the standards IAS 32 and IAS 39 gives rise to presentation, recognition and measurement changes. The most significant changes relate to the measurement basis of the debt securities and derivatives of JNL. The accounting policies are described in note (b) (i) below.
UK GAAP has been applied in both 2004 and 2005. In this respect UK GAAP also reflects the MSB. For overseas operations local GAAP
All other items are accounted for in both the 2004 and 2005 results and notes on the financial statements under the relevant IFRS standard.
Presentation of supplementary analysis of profit before tax attributable to shareholders
The summary above should be read in conjunction with the full description of significant accounting policies described elsewhere in this note and in notes A5 and A6 for a comprehensive explanation.
(i) Financial instruments (other than long-term business contracts classified as financial instruments under IFRS 4)
Previous UK GAAP has been applied as follows: Other than banking business
Equity securities were carried at fair value. Debt securities were carried at fair value, except those held by JNL which, subject to provision for permanent diminutions in value, were carried at amortised cost. Fair value was based on quoted market prices for listed securities, and on quotations provided by external fund managers, brokers, independent pricing services or values as determined by the directors for unlisted securities. Changes in fair value were recognised in investment returns during the year of the change. Debt securities held by
Derivative instruments were accounted for in a manner consistent with the assets and liabilities or positions being hedged. Profits or losses and interest on these instruments were recognised in accordance with the accounting treatment of the underlying transaction as an adjustment to interest receivable or interest payable.
The accounting policies for financial instruments in 2005 are changed in a number of areas, as described in note A6. In general, where a fair value basis of measurement was applied for 2004, this basis has been continued for 2005. However, for instruments previously carried at cost, or amortised cost, the general effect of the standards adopted is for the use of fair value to be extended. The most significant changes relate to the measurement basis of the debt securities and derivatives of JNL.
The accounting policies applied in 2005 are as follows: Investment classification
Upon initial recognition, financial investments are measured at fair value. Subsequently, the Group is permitted, subject to specific criteria, to designate its investments as either financial investments at fair value through profit and loss, financial investments held on an available-for-sale basis, financial investments held to maturity, or loans and receivables. The Group holds financial investments on the following bases: (i) Financial investments at fair value through profit and loss – this comprises assets designated by management as fair value through profit and loss on inception. These investments are measured at fair value with all changes thereon being recognised in investment income.
In cases where the Group takes possession of the collateral under its securities lending programme, the collateral, and corresponding obligation to return such collateral are recognised in the consolidated balance sheet. To further minimise credit risk, the financial condition of counterparties is monitored on a regular basis.
Where the transfer does not result in the Group transferring the right to receive the cash flows of the financial assets, but does result in the Group assuming a corresponding obligation to pay the cash flows to another recipient, the financial assets are also accordingly derecognised providing the following conditions are met: ■ The Group has no obligation to pay amounts to the eventual recipients unless it collects the equivalent amounts from the original asset; ■ the Group is prohibited by the terms of the transfer contract from selling or pledging the original asset; or
■ the Group has no obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay.
Egg has issued debt securities in order to finance certain portfolios of loan and investment assets. These obligations are secured on Egg’s assets. The securitised assets and the related liabilities are presented gross within the relevant headings in the balance sheet under the
The Group has designated under IAS 39 classification, certain financial liabilities at fair value through profit and loss as these instruments are managed and their performance evaluated on a fair value basis. These instruments include liabilities related to consolidated collateralised debt obligations and net assets attributable to unit holders of consolidated unit trusts and similar funds.
Premium and annuity considerations for conventional with-profits policies and other protection type insurance polices are recognised when due. Premiums and annuity considerations for linked policies, unitised with-profits and other investment type policies are recognised when received or, in the case of unitised or unit-linked policies, when units are issued. These amounts exclude any taxes or duties assessed based on premiums.
Premiums and claims include receipts and payments on deposit style ‘investment contracts’ where the insurance risk in the contracts is insignificant.
(DAC), which are included as an asset in the balance sheet. The DAC asset is amortised against margins in future revenues on the related insurance policies, to the extent that the amounts are recoverable out of the margins. Recoverability of the unamortised DAC asset is assessed at the time of policy issue, and reviewed if profit margins have declined.
Under IFRS, investment contracts (excluding those with discretionary participation features) are required to be accounted for as financial liabilities in accordance with IAS 39 and, where relevant, the provisions of IAS 18, in respect of the attaching investment management features of the contracts. The Group’s investment contracts primarily comprise of certain unit-linked savings contracts in the UK and Asia and contracts with fixed and guaranteed terms in the US (such as guaranteed investment contracts and annuity-certains).
Group’s Asian operations and subject to local market and regulatory conditions. Such policies are called ‘with-profits’ policies. Prudential maintains with-profits funds within the Group’s long-term business funds, which segregate the assets and liabilities and accumulate the returns related to that with-profits business. The amounts accumulated in these with-profits funds are available to provide for future policyholder benefit provisions and for bonuses to be distributed to with-profits policyholders. The bonuses, both annual and final, reflect the right of the with-profits policyholders to participate in the financial performance of the with-profits funds. Shareholders’ profits with respect to bonuses declared on with-profits business correspond to the shareholders’ share of the cost of bonuses as declared by the
Future policyholder benefit provisions on conventional with-profits and other protection-type policies were calculated using the net premium valuation method. The net premium was calculated such that it would be sufficient at the outset of the policy to provide only for the discounted value of the original guaranteed death and maturity benefits on the chosen valuation assumptions. The provision was then calculated by subtracting the present value of future net premiums from the present value of future benefits (including vested bonuses)
Under the net premium valuation method, vested bonuses were included in the cash flows assessed but future allocations of bonuses are not included explicitly, although they were implicitly taken into account in the discount rate used, which was based on the return available on suitable investments. The detailed methodology for UK companies is included in regulations contained in the FSA rules. In particular, the returns available from equity and property assets are based on expected income and/or earnings and no allowance was made for potential future capital growth.
For PAC business, the calculation was based on a valuation under which future reversionary bonuses were added to the guaranteed liabilities existing at the valuation date. The provision was then calculated as the present value of future policyholder benefits plus the present value of future expenses, without assumption for withdrawals.
An addition was made in respect of future premiums if this produced a higher provision. The assumptions to which the estimation of the long-term business provision was particularly sensitive included the assumed future reversionary bonuses, the interest rate used to discount the provision, the assumed future per policy expenses and the assumed future mortality experience of policyholders.
■ the surrender or transfer value which, having regard to policyholders’ reasonable expectations, would be payable at the valuation date, or, if greater, the value of the guaranteed liabilities excluding final bonus calculated on a gross premium bonus reserve method.
The amounts shown in the consolidated balance sheet for the year ended 31 December 2004, for with-profits contracts and unallocated surplus of the PAC with-profits fund have been determined in accordance with the MSB. With the exception of minor accounting adjustments, the technical provisions reflect the UK regulatory basis of reporting that has applied for many years, and which effectively constitutes the Peak 1 basis under the new FSA regime.
For 2005, the basis described above has been replaced under a policy improvement to align with the UK accounting standard FRS 27,
Under the Peak 1 basis there is an allowance on a deterministic basis for the intrinsic value of these costs.
Company employs and therefore the stochastic modelling incorporates a range of management actions that would help to protect the fund in adverse scenarios. Substantial flexibility has been included in the modelled management actions in order to reflect the discretion that the Company retains in adverse investment conditions, thereby avoiding the creation of unreasonable minimum capital requirements.
Under FRS 27, the main changes that are required for UK with-profits funds are: ■ Derecognition of deferred acquisition costs and related deferred tax; and
(shortfall) of income over expenditure of the with-profits funds, after declaration and attribution of the cost of bonuses to policyholders and shareholders, is transferred to (from) the unallocated surplus each year through a charge (credit) to the income statement. The balance retained in the unallocated surplus represents cumulative income arising on the with-profits business that has not been allocated to policyholders or shareholders. The balance of the unallocated surplus is determined after full provision for deferred tax on unrealised appreciation on investments.
UK GAAP has been applied in both 2004 and 2005. UK GAAP for these contracts reflects the MSB. Under this basis the following approach applies.
For the business of JNL, the determination of the expected emergence of margins, against which the amortisation profile of the DAC
In 2005, JNL accounts for the majority of its investment portfolio on an available-for-sale basis (see investment policies above) whereby unrealised gains and losses are recognised directly in equity. As permitted by IFRS 4, JNL has used shadow accounting. Under shadow accounting, to the extent that recognition of unrealised gains or losses on available-for-sale securities causes adjustments to the carrying value and amortisation patterns of deferred acquisition costs and deferred income, these adjustments are recognised directly in equity to be consistent with the treatment of the gains or losses on the securities.
adjusted to comply, where necessary, with UK GAAP. For the Hong Kong business, which is a branch of the PAC, and the Singapore and
Malaysian operations the valuation principles and sensitivities to changes of assumptions of conventional with-profits and other protectiontype policies are similar to those described above for equivalent products written by the UK operations.
For investment contracts with discretionary participation features, the accounting basis in 2005 and 2004 is consistent with the accounting for similar with-profits insurance contracts. For investment contracts without discretionary participation features, UK GAAP has been applied for 2004. For 2005, investment contracts are accounted for on a basis that reflects the hybrid nature of the arrangements whereby part is accounted for as a financial instrument under IAS 39 and the investment management service component is accounted for under
On contract inception the liability is measured at fair value less incremental, directly attributable, acquisition costs. Remeasurement at future reporting dates is on an amortised cost basis utilising an effective interest rate methodology whereby the interest rate utilised discounts to the net carrying amount of the financial liability.
The Group consolidates those entities it is deemed to control. The degree of control is determined by the ability of the Group to govern the financial and operating policies of an entity in order to obtain benefits. Consideration is made of other factors such as potential voting rights.
The Group has consolidated some special purpose entities (SPE), such as funds holding collateralised debt obligations (CDO) where equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. These SPEs are consolidated because the Group is deemed to control them under IFRS.
The Group’s investments in joint ventures are recognised using proportional consolidation whereby the Group’s share of an entity’s individual balances are combined line-by-line with similar items into the Group financial statements.
Investments in tenant occupied leasehold and freehold properties are carried at fair value, with changes in fair value included in the income statement. Properties are valued annually either by the Group’s qualified surveyors or professional external valuers using The
Royal Institution of Chartered Surveyors (RICS) guidelines. The RICS guidelines apply separate assumptions to the value of the land, buildings, and tenancy associated with each property. Each property is externally valued at least once every three years. The cost of additions and renovations is capitalised and considered when estimating fair value.
For the Group’s defined benefit schemes, if the present value of the defined benefit obligation exceeds the fair vale of the schemes assets, then a liability is recorded in the Group’s balance sheet. The Group utilises the projected unit credit method to calculate the defined benefit obligation. Estimated future cash flows are then discounted at a high-quality corporate bond rate to determine its present value.
The aggregate of the actuarially determined service costs of the currently employed personnel and the unwind of discount on liabilities at the start of the period, less the expected investment return on scheme assets at the start of the period, is charged to the income statement.
The Group’s UK subsidiaries each file separate tax returns. JNL and other foreign subsidiaries, where permitted, file consolidated income tax returns. In accordance with UK tax legislation, where one domestic UK company is a 75 per cent owned subsidiary of another UK
Different tax rules apply under UK law depending upon whether the business is life insurance or pension business. Tax on the life insurance business is based on investment returns less expenses attributable to that business. Tax on the pension business is based on the shareholders’
Leasehold improvements to owner occupied property are depreciated over the life of the lease. Assets held under finance leases are capitalised at their fair value.
Business acquisitions are accounted for by applying the purchase method of accounting, which adjusts the net assets of the acquired company to fair value at the date of purchase. The excess of the costs of acquisition over the fair value of the acquired entity is recorded as goodwill. Should the fair value of the identifiable assets and liabilities of the entity exceed the cost of acquisition then this is recognised immediately in the income statement. Income and expenses of acquired entities are included in the income statement from the date of acquisition. Revenues and expenses of entities sold during the period are included in the income statement up to the date of disposal.
The gain or loss on disposal is calculated as the difference between sale proceeds net of selling costs less the net assets of the entity at the date of disposal.
In accordance with IAS 14, ‘Segment Reporting’ the Group reports its results and certain other financial information by primary and secondary segments. The Group’s primary segments are its business segments, namely, long-term business, banking and broker-dealer and fund management. The Group’s secondary segments are its geographical segments, namely, UK, US and Asia.
Where there is no obligation to transfer assets, shares are classified as equity. The difference between the proceeds received on issue of the shares, net of share issue costs, and the nominal value of the shares issued, is credited to share premium. Where the Company purchases shares for the purposes of employee incentive plans, the consideration paid, net of issue costs, is deducted from retained earnings. Upon issue or sale any consideration received is credited to retained earnings net of related costs.
The Group’s consolidated financial statements are presented in pound sterling, the Group’s presentation currency. Accordingly, the results and financial position of foreign subsidiaries must be translated into the presentation currency of the Group from their functional currencies i.e. the currency of the primary economic environment in which the entity operates. All assets and liabilities of foreign subsidiaries are converted at year end exchange rates whilst all income and expenses are converted at average exchange rates where this is a reasonable approximation of the rates prevailing on transaction dates. The impact of these currency translations is recorded as a separate component of equity.
(iv) Presentation of supplementary analysis of profit before tax attributable to shareholders
Under IFRS, the Group continues to use operating profit based on longer-term investment returns as a supplemental measure of its results as explained in notes A3 and A6. For the purposes of measuring operating profit based on longer-term investment returns, investment returns on shareholder-financed business continue to be based on the expected longer-term rate of return. However, for debt securities, the five year averaging approach described above has been replaced with a basis that more closely reflects longer-term experience.
A5: Changes from previous accounting basis and reconciliation to previously published 2004 results on first-time adoption of IFRS The changes of accounting policies from those applied for UK GAAP that arise on the conversion to IFRS basis reporting are numerous and extend to many elements of income, expenditure, assets and liabilities. The policy changes from the previously published 2004
UK GAAP audited financial statements which are of significance to reported results are detailed below. These changes affect the basis of preparation for the results for 2004, 2005 and, subject to policy changes, future accounting periods. In addition to these changes, significant additional policy changes arose in 2005. These additional changes are not required to be retrospectively applied to the 2004 results. The additional changes that affect the 2005 results are described in note A6.
Under UK GAAP, the Group’s consolidated financial statements were previously prepared in accordance with applicable accounting standards under UK GAAP including being in accordance with the SORP issued in November 2003 by the ABI.
standards on a basis prescribed or permitted by those standards in the preparation of its consolidated financial statements.
Significant exemptions from full retrospective application elected by the Group are as follows: Business combinations
equity for any historical business combination. Consistent with this approach, goodwill recognised in the opening balance sheet at 1 January 2004 for acquired businesses that have previously been consolidated, is the same as previously shown under UK GAAP.
Goodwill on newly consolidated entities, for example on venture subsidiaries of the PAC with-profits fund, is determined by reference to net identifiable assets at transition date.
Group’s US and Asia fund management operations to long-term business funds are recorded within inter-segment revenue and expenditure as set out in note D but eliminated on consolidation in the income statement.
Previously, under UK GAAP, the assets and liabilities and results of entities were consolidated where Prudential had a controlling interest under the terms of Companies Act legislation, FRS 2, ‘Accounting for Subsidiary Undertakings’ and other relevant UK GAAP interpretations.
Under UK Listing Authority rules, profit before tax is required to be presented. This requirement, coupled with the fact that IFRS does not contemplate tax charges which are attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies, necessitates the reporting of total tax charges within the presented results. The result before all taxes i.e. ‘profit before tax’ as shown in the income statement 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. Separately, within the income statement
Under IAS 19, ‘Employee Benefits’, the impact of the surplus or deficit of defined benefit pension schemes on the consolidated net assets of the Group is determined by the difference between the fair value of assets held within the schemes and the net present value of projected future cash flows based on accrued liabilities. The net present value is determined by applying a discount rate based on the yield at the balance sheet date on high-quality corporate bonds.
The deficits on the Group’s defined benefit pension schemes are apportioned between shareholders’ equity and unallocated surplus of the PAC with-profits fund based on the weighted cumulative activity attaching to the contributions paid into the schemes in the past.
The IFRS income statement charge for pension costs normally comprises two items, namely: (a) The aggregate of the actuarially determined service cost of the currently employed personnel, the unwind of discount on liabilities at the start of the year, less the expected investment return on the scheme assets at the start of the reporting year; and
Under UK GAAP, with effect from 1 January 1998, goodwill arising from acquisitions was recognised as an asset on the balance sheet and amortised through the consolidated profit and loss account on a straight-line basis over its estimated useful life, not exceeding 20 years.
Under IFRS, subject to reassessment of previously recognised assets and liabilities in accordance with IFRS 1, the goodwill balance at 1 January 2004 reflects the carrying value of UK GAAP goodwill for previously consolidated entities at that date on the basis described above, as well as goodwill on certain newly consolidated entities. Under IFRS, goodwill is no longer amortised. However, impairment testing is required annually and on adoption. In addition, as prescribed by IFRS 1. Goodwill previously charged to shareholders’ funds on transition is not transferred to the income statement upon disposal of the relevant entity. For 2005, an impairment charge in respect of goodwill attaching to the Japan life insurance business was required.
The Group offers share awards and option plans for certain key employees and a SAYE plan for all UK and certain overseas employees.
Under IFRS, share-based payments are accounted for on a fair value basis. The fair value is recognised in the income statement over the relevant vesting period and adjusted for lapses and forfeitures with the number of shares expected to lapse or be forfeited estimated at each balance sheet date prior to the vesting date. The only exception is where the share-based payment depends upon vesting outcomes attaching to market-based performance conditions such as in the case of the Restricted Share Plan (RSP). Under these circumstances additional modelling is required to take into account these market-based performance conditions which effectively estimate the number of shares expected to vest. No subsequent adjustment is then made to the fair value charge for shares that do not vest on account of these performance conditions not being met.
A5: Changes from previous accounting basis and reconciliation to previously published 2004 results on first-time adoption of IFRS continued Reconciliation of income statement for 2004
Benefits and claims and movement in unallocated surplus of with-profits funds (26,598) (83) 88 (26,593)
Profit for the year 418 98 516 *Profit before tax represents income net of post-tax transfers to unallocated surplus of with-profits funds, before tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders’ profits.
(ii) Recognition, measurement and other changes for results attributable to shareholders Changes to profit from continuing operations (including actual investment returns) before and after tax attributable to shareholders, for 2004 reflect the effects of IFRS adoption. In summary the effects are for: £m
Egg – primarily relates to charges for share-based payments in respect of Egg shares (2) Additional pension costs and share-based payments costs in respect of Prudential plc shares not allocated by business unit (4) Amortisation of goodwill not applied under IFRS 94 Actuarial gains and losses of defined benefit schemes recognised under IFRS (7) Value movements of US investment funds newly consolidated under IFRS 2 Share of profits of venture investment companies and property partnerships of the PAC with-profits fund, newly consolidated under IFRS, that is attributable to external investors 9
(iii) Recognition, measurement and other changes for results attributable to the with-profits funds Changes to revenue, charges, and related tax of the Group’s with-profits funds principally relate to measurement differences on investments, consolidation criteria for venture fund and other investment subsidiaries, and pension cost accounting. These amounts have been reflected by changes of an equal and opposite amount to transfers to unallocated surplus with no net effect on shareholder results.
Treasury shares adjustment for Prudential plc shares held by unit trusts newly consolidated under IFRS (note i) (40) (40)
Timing difference on recognition of dividend declared after balance sheet date (note iii) 214 214
UK GAAP and the IFRS balance sheet included in the comparatives to the 2005 financial statements.
At 31 December 2004 £m £m £m £m £m £m £m
Policyholder liabilities and unallocated surplus of with-profits funds: Unallocated surplus of with-profits funds 16,686 (31) (472) (34) (537) 16,149
Under IFRS, the cash flow statement includes a number of format and presentational differences to that under UK GAAP. The most significant difference relates to long-term business fund cash flows.
A6: Changes of accounting policy in 2005 The accounting policy changes from those applied previously for UK GAAP consist of those described in note A5 and the additional changes described in this note.
As previously noted, the Group has chosen to apply the exemption within IFRS that allows comparative information presented in the first year of adoption of IFRS not to comply with IAS 32, IAS 39 and IFRS 4. These standards have been formally adopted on 1 January 2005.
On adoption of these standards, the measurement basis of assets and liabilities of long-term business contracts is dependent upon the classification of the contracts under IFRS 4 as either ‘insurance’ contracts, if the level of insurance risk in the contracts is significant, or
‘investment’ contracts, if the risk is insignificant. Insurance contracts are permitted to be accounted for under previously applied GAAP.
The Group has chosen to apply this approach. However, as an improvement to accounting policy, permitted by IFRS 4, the Group has applied the requirements of the UK standard FRS 27 to its UK with-profits funds as explained in note A4. For those ‘investment’ contracts with discretionary participation features, IFRS 4 also permits the continued application of previously applied GAAP. The Group has chosen to apply this approach.
The investment contract classification applies primarily to certain unit-linked and similar contracts in the UK insurance operations and guaranteed investment contracts (GICs) of JNL. Significant differences between the timing of recognising profits under UK GAAP and
The changes from UK GAAP to the basis applied from 1 January 2005 arising from these valuation requirements are concentrated on the accounting for the investments and derivatives of JNL. Previously, the debt securities of JNL, unless impaired, were accounted for at amortised cost with derivatives similarly treated. On adoption of IAS 39, the Group has decided to account for JNL’s debt securities on an available-for-sale basis whereby the debt securities are accounted for at fair value with movements in fair value being recorded in the statement of changes in equity i.e. directly to shareholders’ reserves rather than the income statement. Value movements for
The changes of policy for Egg arising from the adoption of IAS 39 arise primarily in respect of determination of effective interest rates, impairment losses on loans and advances to customers, carrying values of wholesale financial instruments and equity savings products.
For credit card receivables, under UK GAAP, the carrying amount of credit card receivables with low or zero rate interest on balance transfers are carried at cost with interest being accrued at 0 per cent during the incentive period and then at the standard rate thereafter.
Under IAS 39, these receivables are measured on an amortised cost basis.
Certain equity savings products contain embedded derivatives. These contracts have been separated under IFRS with the host contract accounted for on an amortised cost basis and the embedded derivatives on a fair value basis.
The following table demonstrates the effects of adoption of IAS 32, IAS 39 and IFRS 4 on the IFRS balance sheet at 31 December 2004.
Effect of adoption of IAS 32, IAS 39 and IFRS 4
At 31 Dec insurance insurance and other 2004 operations JNL operations format At 1 Jan
Financial investments: Equity securities and portfolio holdings in unit trusts 54,466 (21) (21) 54,445
A6: Changes of accounting policy in 2005 continued Effect of adoption of IAS 32, IAS 39 and IFRS 4
Unallocated surplus of the with-profits funds: Reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds 8,342 8,342 8,342
Technical provisions in respect of non-linked business 104,996 7,020 (51) (111,965) (104,996)
Total other non-insurance liabilities 11,756 (68) 443 (65) 76 386 12,142
A6: Changes of accounting policy in 2005 continued (b) Changes to insurance assets and liabilities of the PAC with-profits fund following the improvement of accounting policy applied on adoption of IFRS 4. The changes correspond to those applicable if the Group had adopted FRS 27 under UK GAAP. As a result of the policy improvement, liabilities, deferred acquisition costs, deferred tax and unallocated surplus of UK regulated with-profits funds are remeasured as described in note A4. At 1 January 2005, the unallocated surplus is subject to a transition adjustment of £(7.8) billion. Shareholders’ equity is not affected by this change.
(ii) Jackson National Life Under IAS 39, JNL’s debt securities and derivative financial instruments are remeasured to fair value from the lower of amortised cost and, if relevant, impaired value. Fair value movements on debt securities, net of ‘shadow’ changes to deferred acquisition costs and related deferred tax are recorded directly to equity. Fair value movements on derivatives are recorded in the income statement.
Supplemental earnings information and discretionary non-IFRS change of policy for longer-term investment returns
Under IFRS, the Group continues to use operating profit based on longer-term investment returns as a supplemental measure of its results, as explained in notes A3 and A4. For the purposes of measuring operating profit based on longer-term investment returns, investment returns on shareholder-financed business continue to be based on the expected longer-term rate of return. However, for debt securities, the five year averaging approach previously applied under UK GAAP has been replaced with a basis that more closely reflects longer-term experience. The amounts included in operating results for longer-term capital returns comprises two components. These are a risk margin reserve based charge for expected defaults, which is determined by reference to the credit quality of the portfolio, and amortisation of interest-related realised gains and losses to operating results based on longer-term investment returns to the date when sold bonds would have otherwise matured. This change has been applied following a comprehensive review of the Group’s accounting policies and is unrelated to the requirements of IFRS. The change is of most importance to the determination of the operating results based on longerterm investment returns of JNL. Total profits are unaffected by the change of basis in determining longer-term investment returns.
Consequential amendments have been made to other standards as a result of the release of IFRS 7, notably IAS 1, ‘Presentation of
As a result of the issue of IFRS 7, IAS 1 was amended in August 2005 to include a requirement to disclose information on the entity’s objectives, policies and processes for managing capital. This amendment will become effective for annual periods beginning on or after
Amendments in respect of cash flow hedge accounting of forecast intra-group transactions were issued in April 2005 to clarify the accounting treatment of certain foreign currency cash flow hedges. The amendments are effective for annual periods beginning on or after 1 January 2006.
The Group is currently assessing the impact of the aforementioned standards, revisions and amendments on its financial statements.
The Group has not early-adopted any of the above noted items.
Other income and expenditure Investment return and other income 87 44 Interest payable on core structural borrowings (175) (154) Corporate expenditure: Group Head Office (70) (51) Asia Regional Head Office (30) (29)
Operating profit from continuing operations based on longer-term investment returns (note ii) 957 708 Goodwill impairment charge (note v) (120) – Short-term fluctuations in investment returns on shareholder-backed business (note vi) 211 149 Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (note vii) (50) (7)
Notes (i) Basis of preparation Except in respect of three IFRS standards the 2005 and 2004 results in the table above have been prepared consistently. However, as permitted by the IFRS transition rules, and consistent with the approach of groups with significant banking operations where retrospective application is complex and onerous, the results include the effects of the adoption of the standards IAS 32, IAS 39 and IFRS 4 from 1 January 2005 rather than 1 January 2004. The 2004 comparative results are therefore prepared on an inconsistent basis from those for 2005. Pro forma basis comparative results for 2004, as if these standards had been applied by the Group’s insurance operations from 1 January 2004, are provided as supplementary information to this report. The pro forma results for 2004 are not audited and do not form part of these financial statements either directly or by cross reference. The principal area of inconsistency between the bases of measurement applied in 2004 and 2005 as it affects profits is related to the valuation of derivatives of Jackson National Life (JNL). The value movements on these derivatives are recorded in the income statement for 2005. In the analysis shown above, the movements are included in short-term fluctuations in investment returns (see note (vi) below). For 2004, the derivatives were recorded at amortised cost so value movements do not feature. Other smaller valuation differences for investment contracts measured under IAS 39 also slightly affect the comparison of operating profits.
(ii) Operating profit based on longer-term investment returns Operating profit based on longer-term investment returns is a supplemental measure of results. For the purposes of measuring operating profit, investment returns on shareholderfinanced business are based on expected long-term rates of return. The expected long-term rates of return are intended to reflect historical real rates of return and, where appropriate, current inflation expectations adjusted for consensus economic and investment forecasts. The significant operations that require adjustment for the difference between actual and long-term investment returns are JNL and certain businesses of the Group’s Asian operations. The amounts included in operating results for long-term capital returns for debt securities comprise two components. These are a risk margin reserve based charge for expected defaults, which is determined by reference to the credit quality of the portfolio, and amortisation of interest-related gains and losses for operating results based on longer-term results to the date when sold bonds would otherwise have matured.
(v) Goodwill impairment charge The charge for goodwill impairment of £120 million relates to the Japan life business. Further details of the Group’s goodwill are shown in note H1.
US operations: Movements in market value of derivatives used for economic hedging purposes (2004 not applicable as described in note (i) above) 122 – Actual less longer-term investment returns for other items 56 61
Asian operations 32 37 Other operations (including £6m (2004: nil) on sale of partial stake in Indian subsidiary – see note H8) 1 51
B1: Supplementary analysis of profit before tax attributable to shareholders continued Notes continued (vii) Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes £m £m
Non-recurrent credit (charge) Shareholders’ share of credit arising from reduction in level of assumed future discretionary increases for Prudential Staff Pension Scheme (PSPS) for pensions in payment to 2.5% 35 – Losses on re-estimation of shareholders’ share of deficits arising from the PSPS (a) (63) – Strengthening in actuarial provisions for increase in ongoing contributions for future service of active scheme members (b) (20) –
(b) As a result of the April 2005 scheme valuation and subsequent discussions, the contribution levels for future ongoing service of active members will approximately double. The charge of £20 million reflects the actuarial provision for this increase in expenses for certain insurance contracts.
Net of tax Basic Diluted Before tax Tax Minority and minority earnings earnings (note B1) (note F5) interests interests per share per share 2005 £m £m £m £m Pence Pence
Based on operating profit based on longer-term investment returns 708 (210) (8) 490 23.1p 23.1p
Weighted average shares for calculation of basic earnings per share 2,365 2,121
Weighted average shares for calculation of diluted earnings per share 2,369 2,124
Parent company: Interim dividend (2005: 5.30p, 2004: 5.19p per share) 126 109
Final dividend for prior period (2004: 10.65p, 2003: 10.29p per share) 252 214
Asian operations *The format of the tables shown above is consistent with the distinction between insurance and investment products as applied for previous financial reporting periods. With the exception of some US institutional business, products categorised as ‘insurance’ refer to those classified as contracts of long-term insurance business for regulatory reporting purposes, i.e. falling within one of the classes of insurance specified in part II of Schedule 1 to the Regulated Activities Order under FSA regulations.
The details shown above for insurance products include contributions for contracts that are classified under IFRS 4, ‘Insurance Contracts’
UK and Asian investment products referred to in the tables above are unit trust, mutual funds and similar types of retail fund management arrangements. US investment products relate to assets under administration in Curian. These are unrelated to insurance products that are classified as ‘investment contracts’ under IFRS 4, as described above, although similar IFRS recognition principles apply to the acquisition costs and fees attaching to this type of business.
B5: Group balance sheet The Group’s primary reporting segments are long-term business, banking, and broker-dealer and fund management. The Group’s secondary reporting segments are geographical namely UK, US, and Asia. Details of disclosures in accordance with the requirements of IAS 14 for segment assets and liabilities are shown below.
This segment comprises long-term products that contain both a significant and insignificant element of insurance risk. The products are managed together and not classified in this way other than for accounting purposes. This segment also includes activity of the PAC
The investment management segment is comprised of both internal and third-party asset management services, inclusive of portfolio and mutual fund management, where the Group acts as an advisor, and broker-dealer activities. The nature of the products and the managing of the business differ from the risks inherent in the other business segments, and the regulatory environment of the investment management industry differs from that of the other business segments.
B5: Group balance sheet continued UK insurance US Asian operations Egg Total UK operations operations Unallocated Intra-group Group (note D2) M&G (note E) operations (note D3) (note D4) to a segment eliminations total £m £m £m £m £m £m £m £m £m
Other intangible assets (primarily deferred acquisition costs): PAC with-profits fund 35 – – 35 – – – – 35
Core structural borrowings of shareholderfinanced operations (note H13): Subordinated debt (other than Egg) – – – – – – 1,646 – 1,646
Egg subordinated debt (note H13) – – 452 452 – – – – 452
Borrowings attributable to with-profits funds (notes G1 and H13) 1,898 – – 1,898 – – – – 1,898
The Group Risk Framework requires that all of the Group’s businesses and functions establish processes for identifying, evaluating and managing the key risks faced by the Group. During the year, the risk management of the Group was given additional focus by the establishment of a newly created role of Group Chief Risk Officer (CRO). The CRO oversees all aspects of the Group’s risk management, including Financial Risk, Operational Risk, Compliance, and for management purposes, Internal Audit. Additional information on the the
Group’s risk framework, including the Group and business unit level risk committees, is included in the corporate governance section of the Group’s Annual Report.
Group’s businesses and functions are required to carry out a review of risks. This involves an assessment of the impact and likelihood of key risks and of the effectiveness of the controls in place to manage them. The assessment is reviewed regularly throughout the year.
In addition, business units review opportunities and risks to business objectives regularly with the Group Chief Executive, Group Finance
Framework and that they have reviewed the effectiveness of the system of internal control. The results of this review were reported to and reviewed by the Audit Committee, and confirmed that the processes described above and required by the Group Risk Framework were in place throughout the period covered by this report, and complied with Internal Control: Guidance on the Combined Code (the
Prudential faces foreign exchange risk, primarily because its presentation currency is pounds sterling, whereas approximately 55 per cent of Prudential’s operating profit from continuing operations based on longer-term investment returns, as described in note B1, for the year ended 31 December 2005 came from Prudential’s US and Asian operations. The exposure relating to the translation of reported earnings is not separately managed although its impact is reduced by interest payments on foreign currency borrowings and by the adoption of average exchange rates for the translation of foreign currency revenues.
In practice, most of Prudential’s invested assets are marketable securities. This, combined with the fact that a large proportion of the liabilities contain discretionary surrender values or surrenders charges, reduces the liquidity risk. The Group maintains committed borrowing and securities lending facilities.
Credit risk is the risk that a counterparty or an issuer of securities, which Prudential holds in its asset portfolio, defaults or another party fails to perform according to the terms of the contract. Some of Prudential’s businesses, in particular JNL, Egg, the PAC with-profits fund and Prudential’s UK pension annuity business, hold large amounts of interest-sensitive investments that contain credit risk on which a certain level of defaults is expected. These expected losses are considered when Prudential determines the crediting rates, deposit rates and premium rates for the products that will be supported by these assets. The key shareholder businesses exposed to credit risks are JNL
Further analysis of the credit risks for JNL is shown in note D3 and for Egg in note E7.
Compliance risk includes the possibility that transactions may not be enforceable under applicable law or regulation as well as the cost of rectification and fines, and also the possibility that changes in law or regulation could adversely affect Prudential’s position. Prudential seeks to minimise compliance risk by seeking to ensure that transactions are properly authorised and by submitting new or unusual transactions to legal advisers for review.
Prudential is exposed to certain fiscal risks arising from changes in tax laws and enforcement policies and in reviews by taxation authorities of tax positions Prudential has taken in recent years. Prudential manages this risk and risks associated with changes in other legislation and regulation through ongoing review by relevant departments of proposed changes to legislation and by membership of relevant trade and professional committees involved in commenting on draft proposals in these areas.
Prudential manages its assets and liabilities locally, in accordance with local regulatory requirements and reflecting the differing types of liabilities Prudential has in each business. As a result of the diversity of products offered by Prudential and the different regulatory environments in which it operates, Prudential employs different methods of asset/liability management, on both an in-force and new business basis. Stochastic modelling of assets and liabilities is undertaken in the Group’s insurance operations to assess economic capital requirements for different confidence intervals and time horizons. In addition, reserve adequacy testing under a range of scenarios and dynamic solvency analysis is carried out, including under certain scenarios mandated by the US, UK and Asian regulators.
For businesses that are most sensitive to equity price changes, Prudential uses stochastic modelling and scenario testing to look at the expected future returns on its investments under different scenarios that best reflect the large diversity in returns that equities can produce. This allows Prudential to devise an investment and with-profits policyholder bonus strategy that, on the model assumptions, allows it to optimise returns to its policyholders and shareholders over time while maintaining appropriate financial strength. Prudential uses this method extensively in connection with its UK with-profits business.
As indicated above, insurance contracts, as defined under IFRS 4 are those contracts that contain significant insurance risk and these contracts may continue to be accounted for using previously applied GAAP. Under UK GAAP, the assets and liabilities of contracts are prepared in accordance with the MSB of reporting as set out in the revised SORP issued by the ABI in November 2003.
Limited, and other categories of non-participating UK business; ■ Jackson National Life – fixed and variable annuity business and life insurance; and
■ Prudential Corporation Asia – minor amounts for a number of small categories of business.
Under UK GAAP, acquisition expenses are deferred with amortisation on a basis commensurate with the anticipated emergence of margins under the contract. Under IFRS, acquisition costs are deferred to the extent that it is appropriate to recognise an asset that represents the entity’s contractual right to benefit from providing investment management services and are amortised as the entity recognises the related revenue. IAS 18 further reduces the costs potentially capable of deferral to incremental costs only. Deferred acquisition costs are amortised to the income statement in line with service provision.
Under UK GAAP, reflecting the regulatory approach in the UK, prudent provisions are established for possible future expenses not covered by future margins at a policy level. Under IFRS, such provisions are no longer permitted.
An example of the diversification benefits for Prudential is that adverse scenarios do not affect all business units in the same way, providing natural hedges within the Group. For example, the Group’s US business is sensitive towards increasing interest rates, whereas, in contrast, several business units in Asia benefit from increasing rates. Conversely, these Asian business units are sensitive towards low interest rates, whereas the US benefits from falling interest rates. The economic capital project also takes into account situations where factors are correlated, for example the extent of correlation between Asian and US economies.
business also has products with guaranteed annuity option features, mostly within SAIF, as described in section D2(b). There is little exposure to financial options and guarantees in the shareholder-backed business of the UK operations. The US business annuity products have a variety of option and guarantee features as described in section D3(b). JNL’s derivative programme seeks to manage the exposures as described in section D3(c). The most significant exposure for the Group arises on Taiwan whole of life policies as described in section D4(h).
(d) Amount, timing and uncertainty of future cash flows from insurance contracts
Under Capital Asset Pricing Methodology (CAPM), the discount rate is determined as the aggregate of the risk-free rate and the risk margin for market risk. The latter is calculated as the ‘beta’ times the equity risk premium. Under CAPM, the beta of a portfolio or product measures its relative market risk. The risk discount rates reflect the market risk inherent in each product group and hence the volatility of product cash flows. They are determined by considering how the profits from each product are impacted by changes in expected returns on various asset classes, and by converting this into a relative rate of return it is possible to derive a product specific beta.
Product specific discount rates are used in order to reflect the risk profile of each major territory and product group. No allowance is required for non-market risks where these are assumed to be fully diversifiable. The majority of non-market risks are considered to be diversifiable. Finance theory cannot be used to determine the appropriate component of beta for non-diversifiable non-market risks since there is no observable risk premium associated with it that is akin to the equity risk premium. Recognising this, a pragmatic approach has been used. A constant 50 basis points has been added to the risk margin for market risk to cover the non-diversifiable non-market risks associated with the business.
Product level betas are calculated each year. They are combined with the most recent product mix to produce appropriate beta and risk discount rates for each major product grouping.
Details of the key assumptions and sensitivity of the EEV value of in-force business are shown in the sections for each geographic segment that follow in this note. The sensitivity of the present value of the discounted future cash flows under the EEV methodology is of particular interest. The sensitivity provides an indication of the movement in the net value ascribable to potential variations in the amounts and timing of future cash flows to shareholders and the uncertainty attached to those cash flows.
The factors that may significantly affect IFRS results due to changes of experience or assumptions vary significantly between business units. The most significant items are summarised below.
UK insurance operations ■ With-profits business – investment performance subject to smoothing through declared bonuses; ■ unit-linked business – investment performance through fund management fees; and
■ annuity business – mortality experience and assumptions, and credit risk.
Where appropriate these issues are discussed in notes D2, D3 and D4.
Lapse risk is not mentioned above and has variable impacts. In the UK, adverse persistency experience has led to losses in embedded value in 2004 and 2005 reflecting a reduced level of projected statutory transfers from the PAC with-profits fund. However, in any given year the statutory transfer recognised in IFRS profits is only marginally affected by altered persistency trends.
Amicable Excluding Prudential Prudential unit-linked Insurance Prudential Annuities Retirement and other UK insurance
Assets Goodwill attributable to PAC with-profits fund – 607 – 607 – – – 607 Other intangibles: PAC with-profit fund 6 29 – 29 – – – 35
Other non-investment and non-cash assets 314 2,263 273 2,536 236 1,384 1,620 4,470
Unallocated surplus of with-profit funds (reflecting application of ‘realistic’ provisions for UK regulated with-profits funds) – 9,683 1,589 11,272 – – – 11,272
Borrowings attributable to with-profit funds 118 1,780 – 1,780 – – – 1,898
(iv) Excluding policyholder liabilities of the Hong Kong branch of PAC.
(v) Within policyholder liabilities of £19,906 million for the non-profit unit-linked and other business is £16,639 million for unit-linked business.
These products are written primarily in: ■ One of three separate sub-funds of the PAC long-term fund, namely the with-profits sub-fund, the SAIF, and the non-profit sub-fund; ■ Prudential Annuities Limited, which is owned by the PAC with-profits sub-fund; ■ Prudential Retirement Income Limited, a shareholder-owned subsidiary; or
Within the balance sheet of UK insurance operations, there are policyholder liabilities of £73.2 billion and unallocated surplus of £11.3 billion that relate to the WPSF. The WPSF mainly contains with-profits business but it also contains some non-profit business (unit-linked, term assurances and annuities). The WPSF’s profits are apportioned 90 per cent to its policyholders and 10 per cent to shareholders as surplus for distribution is determined via the annual actuarial valuation.
‘final’. Annual bonuses are declared once a year, and once credited, are guaranteed in accordance with the terms of the particular product.
Unlike annual bonuses, final bonuses are guaranteed only until the next bonus declaration.
When determining policy payouts, including final bonuses, Prudential considers policyholders’ reasonable expectations, the need to smooth claim values and payments from year to year and competitive considerations, together with ‘asset shares’ for specimen policies.
The WPSF held a provision of £52 million at 31 December 2005 (2004: £49 million) to honour guarantees on a small amount of guaranteed annuity products. SAIF’s exposure to guaranteed annuities is described below.
Beyond the generic guarantees described above, there are very few explicit options or guarantees such as of minimum investment returns, surrender values or annuity at retirement and any granted have generally been at very low levels.
The RPI annuities that Prudential offers provide for a regular annuity payment to which an additional amount is added periodically based on the increase in the UK RPI. Prudential’s with-profits annuities, which are written in the WPSF, combine the income features of annuity products with the investment smoothing features of with-profits products and enable policyholders to obtain exposure to investment return on the WPSF’s equity shares, property and other investment categories over time.
At 31 December 2005, £25.3 billion of investments relate to annuity business of PAL and PRIL. These investments are predominantly in debt securities (including retail price index-linked bonds to match retail price index-linked annuities), loans and deposits and are duration matched with the estimated duration of the liabilities they support.
Amicable Life Assurance Society in 1997. No new business may be written in SAIF, although regular premiums are still being paid on policies in force at the time of the acquisition and incremental premiums are permitted on these policies.
The process for determining policyholder bonuses of SAIF with-profits policies, which constitute the vast majority of obligations of the funds, is similar to that for the with-profit policies of the WPSF. However, in addition, the surplus assets in SAIF are allocated to policies in an orderly and equitable distribution over time as enhancements to policyholder benefits i.e. in excess of those based on asset share.
D2: UK insurance operations continued Provision is made for the risks attaching to some SAIF unitised with-profits policies that have MVR – free dates and for those SAIF products which have a guaranteed minimum benefit on death or maturity of premiums accumulated at 4 per cent per annum.
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision of £619 million was held in SAIF at 31 December 2005 (2004: £648 million) to honour the guarantees. As SAIF is a separate sub-fund solely for the benefit of policyholders of SAIF this provision has no impact on the financial position of the Group’s shareholders’ funds.
For with-profits business, the absence of guaranteed surrender values and the flexibility given by the operation of the bonus system means that the majority of the investments backing the with-profits business are in equities and real estate with the balance in debt securities, deposits and loans.
Additional assumptions required are persistency and the management actions under which the fund is managed. Assumptions used for market consistent valuation typically do not contain margins, whereas those used for the valuation of other classes of business do.
Mortality assumptions are set based on the results of the most recent experience analysis looking at the experience over recent years of the relevant business. For non-profit business, a margin for adverse deviation is added. Different assumptions are applied for different product groups. For annuitant mortality, assumptions for current mortality rates are based on recent experience investigations and expected future improvements in mortality. The expected future improvements are based on recent experience and projections of the business and industry generally.
Maintenance and, for some classes of business, termination expense assumptions are expressed as per policy amounts. They are set based on the expenses incurred during the year, including an allowance for ongoing investment expenditure and allocated between entities and product groups in accordance with the operation’s internal cost allocation model. For non-profit business a margin for adverse deviation is added to this amount. Expense inflation assumptions are set consistent with the economic basis and based on the difference between nominal gilts and index-linked gilts; unit expenses are assumed not to increase in future years at a faster rate than this difference.
The assumptions for investment management expenses are based on the charges specified in agreements with the Group’s investment management operations, plus a margin for adverse deviation for non-profit business.
The policyholder liabilities reported for the WPSF are primarily for two broad types of business. These are accumulating and conventional with-profits contracts.
The provisions at 31 December 2005 have been determined on a basis consistent with the detailed methodology included in regulations contained in the FSA’s rules for the determination of regulatory reporting reserves on the FSA’s ‘realistic’ Peak 2 basis. In aggregate, the regime has the effect of placing a value on the liabilities of UK with-profits contracts, which reflects the amounts expected to be paid based on the current value of investments held by the with-profits funds and current circumstances. These contracts are a combination of insurance and investment contracts with discretionary participation features, as defined by IFRS 4.
Asset shares are calculated as the accumulation of all items of income and outgo that are relevant to each policy type. Income comprises credits for premiums, investment returns (including unrealised gains), and miscellaneous profits. Outgo comprises charges for tax
Company employs and therefore the stochastic modelling incorporates a range of management actions that would help to protect the fund in adverse investment scenarios. Substantial flexibility has been included in the modelled management actions in order to reflect the discretion that the Company retains in adverse investment conditions, thereby avoiding the creation of unreasonable minimum capital requirements. The management actions assumed are consistent with our management policy for with-profit funds and our disclosures in the publicly available Principles and Practices of Financial Management.
The contract liabilities for with-profits business also required assumptions for persistency. These are set based on the results of the
The amounts shown in the consolidated balance sheet at 31 December 2004 for technical provisions and unallocated surplus (fund for future appropriations) for with-profit business of the WPSF and SAIF have been determined in accordance with the MSB of accounting applicable at that time. With the exception of minor accounting adjustments, the technical provisions reflect the UK regulatory basis of reporting that has applied for many years, and which effectively constitutes the Peak 1 basis under the new FSA regime.
The assumptions to which the estimate of the technical provisions for conventional with-profit contracts at 31 December 2004 were particularly sensitive were the interest rates used to discount the provision and the future mortality experience of policyholders. The net premium reserves were calculated using assumptions for interest, mortality, morbidity, and expense but without assumptions for withdrawals.
D2: UK insurance operations continued For accumulating with-profit business, the calculation of technical provisions at 31 December 2004 was based on a gross premium bonus reserve valuation. In general terms, a gross premium valuation basis is one in which the premiums brought into account are the full amounts receivable under the contract. The method includes explicit estimates of premiums, expected claims, future regular bonuses, costs of maintaining contracts and future renewal expenses. Cash flows are discounted at the valuation rate of interest. The methodology for UK companies is included in the FSA rules. The discount rate is based on the expected return on the assets deemed to back the liabilities as prescribed by the FSA rules.
For the purposes of calculating the liabilities using the bonus reserve method the assumed interest rates ranged from 2.5 per cent to 5.0 per cent at 31 December 2004, while future reversionary bonuses were assumed to fall immediately from then current levels to zero.
The contract liabilities are the discounted value of future claim payments, adjusted for investment expenses and future administration costs. The interest rate used for discounting claim payments is derived from the yield on the assets held with an allowance for default and mismatching risk. At 31 December 2005, the interest rates applied ranged from 1.0 per cent to 4.6 per cent (2004: 1.5 per cent to 5.0 per cent).
of medium cohort improvement table with a minimum annual improvement of 0.75%
The change of mortality table for PAL explained in section D2(d) increased liabilities by £144 million. As PAL is owned by the WPSF
As described in section A4, the Group provides supplementary analysis of its profit before shareholder tax, distinguishing operating profit based on longer-term investment returns from short-term fluctuations in investment returns, actuarial gains and losses on defined benefit pension schemes, and exceptional items. In addition to the £36 million charge described above, an additional £20 million charge for the effect of change of assumption for renewal expenses, which relates to an increase in ongoing future pensions scheme contributions as described in section B1, has been recorded as part of actuarial and other gains and losses excluded from operating profit but included in total profit before shareholder tax.
The net charge of £36 million comprises amounts in respect of PAC (£35 million charge), Prudential Holborn Life (£2 million credit), and
Risk discount rate for in-force business at the start of the year 7.7
Pre-tax expected long-term nominal rates of investment return: UK equities 8.1
Mortality and morbidity – 5% decrease in base rates (i.e. increased longevity) (62)