2006 Full Year Results - Pt 2
Prudential PLC
15 March 2007
PART 2
PRUDENTIAL PLC 2006 PRELIMINARY ANNOUNCEMENT
RESULTS SUMMARY
European Embedded Value (EEV) Basis Results* 2006 2005
£m £m
UK Insurance Operations 686 426
M&G 204 163
Egg (145) 44
UK Operations 745 633
US Operations 718 755
Asian Operations 864 568
Other Income and Expenditure (298) (244)
UK restructuring costs (53)
-
Operating profit from continuing operations based on longer-term investment returns 1,976 1,712
Goodwill impairment charge (120)
-
Short-term fluctuations in investment returns 745 1,068
Mark to market value movements on core borrowings 85 (67)
Shareholders' share of actuarial and other gains and losses on defined benefit pension schemes 207 (47)
Effect of changes in economic assumptions and time value of cost of options and guarantees 59 (302)
Profit from continuing operations before tax 3,072 2,244
Operating earnings per share from continuing operations after related tax and minority interests* 57.6p 56.6p
Basic earnings per share 91.7p 66.9p
Shareholders' funds, excluding minority interests £11.9bn £10.3bn
International Financial Reporting Standard (IFRS) Basis Results*
Statutory IFRS basis results 2006 2005
Profit after tax attributable to equity holders of the Company £874m £748m
Basic earnings per share 36.2p 31.6p
Shareholders' funds, excluding minority interests £5.5bn £5.2bn
Supplementary IFRS basis information
Operating profit from continuing operations based on longer-term investment returns £893m £957m
Operating earnings per share from continuing operations after related tax and minority interests* 26.4p 32.2p
2006 2005
Dividends per share declared and paid in reporting period 16.44p 15.95p
Dividends per share relating to reporting period 17.14p 16.32p
Funds under management £251bn £234bn
*Basis of preparation
The EEV basis results have been prepared in accordance with the European
Embedded Value Principles issued by the CFO Forum of European Insurance
Companies in May 2004 and expanded by the Additional Guidance on EEV disclosures
published in October 2005. The basis of preparation of statutory IFRS basis
results and supplementary IFRS basis information is consistent with that applied
for the 2005 full year results and financial statements.
Consistent with previous reporting practice, the Group analyses its EEV basis
results and provides supplementary analysis of IFRS profit before tax
attributable to shareholders, so as to distinguish operating profit based on
longer-term investment returns from other constituent elements of total profit.
On both the EEV and IFRS bases, operating earnings per share are calculated
using operating profits from continuing operations based on longer-term
investment returns, after tax and minority interests. These profits exclude
goodwill impairment charges, short-term fluctuations in investment returns and
the shareholders' share of actuarial and other gains and losses on defined
benefit pension schemes. Under the EEV basis, where additional profit and loss
effects arise, operating profit based on longer-term investment returns also
excludes the mark to market value movements on core borrowings and the effect of
changes in economic assumptions and changes in the time value of cost of options
and guarantees arising from changes in economic factors. After adjusting for
related tax and minority interests, the amounts for these items are included in
the calculation of basic earnings per share.
EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS
SUMMARY CONSOLIDATED INCOME STATEMENT
2006 2005
£m £m
UK Insurance Operations 686 426
M&G 204 163
Egg (145) 44
UK Operations 745 633
US Operations 718 755
Asian Operations 864 568
Other Income and Expenditure (298) (244)
UK restructuring costs (53) -
Operating profit from continuing operations based on longer-term investment returns 1,976 1,712
Goodwill impairment charge (120)
-
Short-term fluctuations in investment returns 745 1,068
Mark to market value movements on core borrowings 85 (67)
Shareholders' share of actuarial and other gains and losses on defined benefit pension 207 (47)
schemes
Effect of changes in economic assumptions and time value of cost of options and guarantees 59 (302)
Profit from continuing operations before tax (including actual investment returns) 3,072 2,244
Tax (859) (653)
Profit from continuing operations for the financial year after tax before minority interests 2,213 1,591
Discontinued operations (net of tax) - 3
Profit for the year 2,213 1,594
Attributable to:
Equity holders of the Company 2,212 1,582
Minority interests 1 12
Profit for the year 2,213 1,594
Earnings per share (in pence) 2006 2005
From operating profit, based on longer-term investment returns, after related tax and
minority interests 57.6p 56.6p
Adjustment for goodwill impairment charge - (5.1)p
Adjustment from post-tax longer-term investment returns to post-tax actual investment returns
(after related minority interests) 22.0p 30.6p
Adjustment for mark to market value movements on core borrowings 3.5p (2.8)p
Adjustment for post-tax shareholders' share of actuarial and other gains and losses on
defined benefit pension schemes 6.0p (1.4)p
Adjustment for post-tax effect of changes in economic assumptions and time value of cost of
options and guarantees 2.6p (11.1)p
Based on profit from continuing operations after minority interests 91.7p 66.8p
Based on profit from discontinued operations after minority interests - 0.1p
Based on profit for the year after minority interests 91.7p 66.9p
Average number of shares (millions) 2,413 2,365
Dividends per share ( in pence) 2006 2005
Dividends relating to reporting period:
Interim dividend (2006 and 2005) 5.42p 5.30p
Final dividend (2006 and 2005) 11.72p 11.02p
Total 17.14p 16.32p
Dividends declared and paid in reporting period:
Current year interim dividend 5.42p 5.30p
Final dividend for prior year 11.02p 10.65p
Total 16.44p 15.95p
TOTAL INSURANCE AND INVESTMENT PRODUCTS NEW BUSINESS
INSURANCE PRODUCTS AND INVESTMENT PRODUCTS*
Insurance Products* Investment Products* Total
2006 2005 2006 2005 2006 2005
£m £m £m £m £m £m
UK Operations 7,192 7,193 13,486 7,916 20,678 15,109
US Operations 5,981 5,023 - - 5,981 5,023
Asian Operations 1,921 1,485 20,408 18,457 22,329 19,942
Group Total 15,094 13,701 33,894 26,373 48,988 40,074
INSURANCE PRODUCTS - NEW BUSINESS PREMIUMS AND CONTRIBUTIONS*
Single Regular Annual Premium Present Value of
and Contribution New Business
Equivalents Premiums
2006 £m 2005 £m 2006 £m 2005 £m 2006 £m 2005 £m 2006 £m 2005 £m
UK Insurance Operations
Direct to customer
Individual annuities 816 720 - - 82 72 816 720
Individual pensions and life 60 29 9 11 15 14 99 70
Department of Work and Pensions rebate 161 244 - - 16 24 161 244
business
Total 1,037 993 9 11 113 110 1,076 1,034
Business to Business
Corporate pensions 536 242 162 146 216 170 1,071 772
Individual annuities 264 212 - - 26 21 264 212
Bulk annuities 85 511 - - 8 51 85 511
Total 885 965 162 146 250 242 1,420 1,495
Intermediated distribution*
Life 961 1,112 5 6 101 118 995 1,149
Individual annuities 919 995 - - 92 100 919 995
Individual and corporate pensions 130 108 22 25 35 36 228 195
Total 2,010 2,215 27 31 228 254 2,142 2,339
Partnerships
Life 840 814 3 3 87 84 855 835
Individual and bulk annuities
Bulk annuity reinsurance from the Scottish 560 - - - 56 - 560 -
Amicable Insurance Fund*
Individual and other bulk annuities 1,500 1,814 - 150 182 1,500 1,814
-
Total 2,900 2,628 3 3 293 266 2,915 2,649
Europe
Life 159 201 - - 16 20 159 201
Total UK Insurance Operations 6,991 7,002 201 191 900 892 7,712 7,718
US Operations
Fixed annuities 688 788 - - 69 79 688 788
Fixed index annuities 554 616 - - 55 62 554 616
Variable annuities 3,819 2,605 - - 382 261 3,819 2,605
Life 8 11 17 14 18 15 147 137
Guaranteed Investment Contracts 458 355 - - 46 35 458 355
GIC - Medium Term Notes 437 634 - 44 63 437 634
-
Total US Operations 5,964 5,009 17 14 614 515 6,103 5,135
Asian Operations
China 27 17 36 23 39 25 198 144
Hong Kong 355 289 103 83 139 112 933 741
India (Group's 26% interest) 20 4 105 57 107 57 411 215
Indonesia 31 42 71 42 74 46 269 186
Japan 68 30 7 4 14 7 97 50
Korea 103 29 208 132 218 135 1,130 578
Malaysia 4 9 72 66 72 67 418 383
Singapore 357 284 72 58 108 86 803 704
Taiwan 92 124 139 150 148 162 743 912
Other 15 9 36 33 37 34 130 126
Total Asian Operations 1,072 837 849 648 956 731 5,132 4,039
Group Total 14,027 12,848 1,067 853 2,470 2,138 18,947 16,892
INVESTMENT PRODUCTS - FUNDS UNDER MANAGEMENT *
2006 1 Jan 2006 Gross Redemptions Market and 31 Dec 2006
inflows other movements
£m £m £m £m £m
UK Operations 36,196 13,486 (7,385) 2,649 44,946
Asian Operations 10,132 20,408 (17,876) (411) 12,253
Group Total 46,328 33,894 (25,261) 2,238 57,199
1 Jan 2005 Gross Redemptions Market and 31 Dec 2005
inflows other movements
2005 £m £m £m £m £m
UK Operations 28,705 7,916 (4,054) 3,629 36,196
Asian Operations 8,538 18,457 (17,130) 267 10,132
Group Total 37,243 26,373 (21,184) 3,896 46,328
* The format of the tables shown above is consistent with the distinction
between insurance and investment products as applied for previous financial
reporting periods. Products categorised as 'insurance' refer to those
classified as contracts of long-term insurance business for regulatory reporting
purposes, i.e. falling within one of the classes of insurance specified in part
II of Schedule 1 to the Regulated Activities Order under FSA regulations.
Annual premium and contribution equivalents are calculated as the aggregate of
regular new business amounts and one tenth of single new business amounts.
The tables shown above are provided as an indicative volume measure of
transactions undertaken in the reporting period that have the potential to
generate profits for shareholders. The amounts shown are not, and not intended
to be, reflective of premium income recorded in the IFRS income statement.
The tables above include a bulk annuity transaction with the Scottish Amicable
Insurance Fund (SAIF) with a premium of £560m. The transaction reflects the
arrangement entered into in June 2006 for the reinsurance of non-profit
immediate pension annuity liabilities of SAIF to Prudential Retirement Income
Limited (PRIL), a shareholder owned subsidiary of the Group. SAIF is a closed
ring-fenced sub-fund of the PAC long-term fund established by a Court approved
Scheme of Arrangement in October 1997, which is solely for the benefit of SAIF
policyholders. Shareholders have no interest in the profits of this fund,
although they are entitled to investment management fees on this business.
Accordingly, it is not part of covered business for EEV reporting purposes. The
inclusion of the transaction between SAIF and PRIL as new business in the tables
above reflects the transfer from SAIF to Prudential shareholders' funds of
longevity risk, the requirement to set aside supporting capital and the
entitlement to surpluses arising on this block of business from the reinsurance
arrangement.
Consistent with the transfer from uncovered to covered business and reflecting
the transfers above, the transaction has been accounted for as new business for
EEV basis reporting purposes.
The details shown above for insurance products include contributions for
contracts that are classified under IFRS 4 'Insurance Contracts' as not
containing significant insurance risk. These products are described as
investment contracts or other financial instruments under IFRS. Contracts
included in this category are primarily certain unit-linked and similar
contracts written in UK Insurance Operations and Guaranteed Investment Contracts
and similar funding agreements written in US Operations.
New business premiums for regular premium products are shown on an annualised
basis. Department of Work and Pensions rebate business is classified as single
recurrent business. Internal vesting business is classified as new business
where the contracts include an open market option.
UK and Asian investment products referred to in the table for funds under
management above are unit trusts, mutual funds and similar types of retail fund
management arrangements. These are unrelated to insurance products that are
classified as 'investment contracts' under IFRS 4, as described in the preceding
paragraph, although similar IFRS recognition and measurement principles apply to
the acquisition costs and fees attaching to this type of business. US
investment products are no longer included in the table above as they are assets
under administration rather than funds under management.
In previous periods new business premiums for intermediated distribution of UK
Insurance Operations have included Department of Work and Pensions (DWP) rebate
business for SAIF. As shareholders have no interest in SAIF, these are now
excluded from the table above with comparatives restated accordingly. The
amounts of new SAIF DWP rebate business written were £60m for 2006 and £83m for
2005.
EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS
OPERATING PROFIT FROM CONTINUING OPERATIONS BASED ON LONGER-TERM INVESTMENT
RETURNS*
Results Analysis by Business Area 2006 2005
£m £m
UK Operations
New business 266 243
Business in force 420 183
Long-term business 686 426
M&G 204 163
Egg (145) 44
Total 745 633
US Operations
New business 259 211
Business in force 449 530
Long-term business 708 741
Broker-dealer and fund management 18 24
Curian (8) (10)
Total 718 755
Asian Operations
New business 514 413
Business in force 315 163
Long-term business 829 576
Fund management 50 12
Development expenses (15) (20)
Total 864 568
Other Income and Expenditure
Investment return and other income 8 42
Interest payable on core structural borrowings (177) (175)
Corporate expenditure:
Group Head Office (83) (70)
Asia Regional Head Office (36) (30)
Charge for share-based payments for Prudential schemes (10) (11)
Total (298) (244)
UK restructuring costs (53) -
Operating profit from continuing operations based on longer-term investment returns 1,976 1,712
Analysed as profits (losses) from:
New business 1,039 867
Business in force 1,184 876
Long-term business 2,223 1,743
Asia development expenses (15) (20)
Other operating results (179) (11)
UK restructuring costs (53) -
Total 1,976 1,712
* EEV basis operating profit from continuing operations based on longer-term
investment returns excludes goodwill impairment charges, short-term fluctuations
in investment returns, the mark to market value movements on core borrowings,
the shareholders' share of actuarial and other gains and losses on defined
benefit pension schemes, the effect of changes in economic assumptions and
changes in the time value of cost of options and guarantees caused by economic
factors. The amounts for these items are included in total EEV profit. The
directors believe that operating profit, as adjusted for these items, better
reflects underlying performance. Profit on ordinary activities and basic
earnings per share include these items together with actual investment returns.
This basis of presentation has been adopted consistently throughout this
preliminary announcement.
EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS
MOVEMENT IN SHAREHOLDERS' CAPITAL AND RESERVES (excluding minority interests)
2006 2005
£m £m
Profit for the year attributable to equity holders of the Company 2,212 1,582
Items recognised directly in equity:
Cumulative effect of changes in accounting policies on adoption of IAS - (25)
32, IAS 39 and IFRS 4, net of related tax, at 1 January 2005
Unrealised valuation movements on Egg securities classified as (2) (1)
available-for-sale
Movement on cash flow hedges 7 (4)
Exchange movements (359) 377
Related tax (74) 65
Dividends (399) (380)
Acquisition of Egg minority interests (167) -
New share capital subscribed 336 55
Reserve movements in respect of share-based payments 15 15
Treasury shares:
Movement in own shares in respect of share-based payment plans 6 0
Movement in Prudential plc shares purchased by unit trusts consolidated 0 3
under IFRS
Cumulative adjustment at 31 December 2006 net of related tax, for Jackson 7 -
National Life assets backing surplus and required capital (note 8)
Net increase in shareholders' capital and reserves 1,582 1,687
Shareholders' capital and reserves at beginning of year (excluding 10,301 8,614
minority interests)
Shareholders' capital and reserves at end of year (excluding minority 11,883 10,301
interests)
Comprising:
UK Operations:
Long-term business 5,813 5,132
M&G:
Net assets 230 245
Acquired goodwill 1,153 1,153
Egg 292 303
7,488 6,833
US Operations 3,360 3,418
Asian Operations:
Net assets 2,637 2,070
Acquired goodwill 172 172
Other Operations:
Holding company net borrowings (at market value) (1,542) (1,724)
Other net liabilities (232) (468)
Shareholders' capital and reserves at end of year (excluding minority 11,883 10,301
interests)
EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS
SUMMARISED CONSOLIDATED BALANCE SHEET
2006 2005
£m £m
Total assets less liabilities, excluding insurance funds 183,130 174,231
Less insurance funds*:
Policyholder liabilities (net of reinsurers' share) and unallocated (177,642) (169,037)
surplus of with-profits funds
Less shareholders' accrued interest in the long-term business 6,395 5,107
(171,247) (163,930)
Total net assets 11,883 10,301
Share capital 122 119
Share premium 1,822 1,564
Statutory basis shareholders' reserves 3,544 3,511
Additional EEV basis retained profit 6,395 5,107
Shareholders' capital and reserves (excluding minority interests) 11,883 10,301
* Including liabilities in respect of insurance products classified as
investment products under IFRS 4.
NET ASSET VALUE PER SHARE (in pence)
2006 2005
Based on EEV basis shareholders' funds of £11,883m (£10,301m) 486p 432p
Number of shares issued at year end (millions) 2,444 2,387
EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS
NOTES ON THE EEV BASIS RESULTS
(1) Basis of preparation of results
The EEV basis results have been prepared in accordance with the EEV Principles
issued by the CFO Forum of European Insurance Companies in May 2004 and expanded
by the Additional Guidance on EEV Disclosures published in October 2005. Where
appropriate the EEV basis results include the effects of adoption of
International Financial Reporting Standards (IFRS).
The EEV results for the Group are prepared for 'covered business', as defined by
the EEV Principles. Covered business represents the Group's long-term insurance
business for which the value of new and in-force contracts is attributable to
shareholders. The EEV basis results for the Group's covered business are then
combined with the IFRS basis results of the Group's other operations.
The definition of long-term business operations is consistent with previous
practice and comprises those contracts falling under the definition of long-term
insurance business for regulatory purposes together with, for US Operations,
contracts that are in substance the same as guaranteed investment contracts
(GICs) but do not fall within the technical definition. Under the EEV
Principles, the results for covered business incorporate the projected margins
of attaching internal fund management.
With two principal exceptions, covered business comprises the Group's long-term
business operations. The principal exceptions are for the closed Scottish
Amicable Insurance Fund (SAIF) and for the presentational treatment of the
financial position of two of the Group's defined benefit pension schemes. A very
small amount of UK group pensions business is also not modelled for EEV
reporting purposes.
SAIF is a ring-fenced sub-fund of the PAC long-term fund, established by a Court
approved Scheme of Arrangement in October 1997. SAIF is closed to new business
and the assets and liabilities of the fund are wholly attributable to the
policyholders of the fund. In 2006, a bulk annuity arrangement between SAIF and
Prudential Retirement Income Limited (PRIL), a shareholder-owned subsidiary took
place, as explained in note 5. Reflecting the altered economic interest from
SAIF policyholders to Prudential shareholders, this arrangement represents a
transfer from business of the Group that is not 'covered' to business that is
'covered' with consequential effect on the EEV basis results.
As regards the Group's defined benefit pension schemes, the surplus or deficit
attaching to the Prudential Staff Pension Scheme (PSPS) and Scottish Amicable
Pension scheme are excluded from the value of UK Operations and included in the
total for Other Operations. The surplus and deficit amounts are partially
attributable to the Prudential Assurance Company (PAC) with-profits fund and
shareholder-backed long-term business and partially to other parts of the Group.
In addition to the IFRS surplus or deficit, the shareholders' 10 per cent share
of the PAC with-profits sub-fund's interest in the movement on the financial
position of the schemes is recognised for EEV reporting purposes.
The directors are responsible for the preparation of the supplementary
information in accordance with the EEV Principles.
The EEV basis results for 2006 and 2005 have been derived from the EEV basis
results supplement to the Company's statutory accounts for 2006. The supplement
included an unqualified audit report from the auditors.
(2) Economic assumptions
Deterministic
In most countries, the long-term expected rates of return on investments and
risk discount rates are set by reference to period end rates of return on cash
or fixed interest securities. This 'active' basis of assumption setting has been
applied in preparing the results of all the Group's UK and US long-term business
operations. For the Group's Asian Operations, the active basis is appropriate
for business written in Japan, Korea and US dollar denominated business written
in Hong Kong.
An exception to this general rule is that for countries where long-term fixed
interest markets are less established, investment return assumptions and risk
discount rates are based on an assessment of longer-term economic conditions.
Except for the countries listed above, this basis is appropriate for the Group's
Asian operations.
Expected returns on equity and property asset classes are derived by adding a
risk premium, also based on the long-term view of Prudential's economists in
respect of each territory, to the risk-free rate. In the UK the equity risk
premium is 4.0 per cent (2005: 4.0 per cent) above risk-free rates. The equity
risk premium in the US is 4.0 per cent (2005: 4.0 per cent). In Asia, equity
risk premiums range from 3.0 per cent to 5.8 per cent (2005: 3.0 per cent to
5.75 per cent). Best estimate assumptions for other asset classes, such as
corporate bond spreads, are set consistently.
Assumed investment returns reflect the expected future returns on the assets
held and allocated to the covered business at the valuation date.
The table below summarises the principal financial assumptions:
2006 2005
% %
UK Insurance Operations
Risk discount rate:
New business 7.8 7.55
In force 8.0 7.7
Pre-tax expected long-term nominal rates of investment return:
UK equities 8.6 8.1
Overseas equities 8.6 to 9.3 8.1 to 8.75
Property 7.1 6.4
Gilts 4.6 4.1
Corporate bonds 5.3 4.9
Expected long-term rate of inflation 3.1 2.9
Post-tax expected long-term nominal rate of return for the
with-profits fund:
Pension business (where no tax applies) 7.5 7.1
Life business 6.6 6.3
US Operations (Jackson National Life)
Risk discount rate:
New business 7.6 6.9
In force 6.7 6.1
Expected long-term spread between earned rate and rate credited to 1.75 1.75
policyholders for single premium deferred annuity business
US 10 year treasury bond rate at end of period 4.8 4.4
Pre-tax expected long-term nominal rate of return for US equities 8.8 8.4
Expected long-term rate of inflation 2.5 2.4
Asian Operations
China Hong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand Vietnam
Kong (notes (notes
(notes iv, v) (notes ii, v)
iii, iv, iv, v)
v)
31 31 Dec 31 31 Dec 31 31 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
Dec Dec Dec Dec
2006 2006 2006 2006 2006 2006 2006 2006 2006 2006 2006 2006
% % % % % % % % % % % %
Risk discount
rate:
New business 12.0 6.6 16.5 17.5 5.3 9.5 9.5 16.5 6.9 8.8 13.75 16.5
In force 12.0 6.8 16.5 17.5 5.3 9.5 9.2 16.5 6.9 9.3 13.75 16.5
Expected 4.0 2.25 5.5 6.5 0.0 2.75 3.0 5.5 1.75 2.25 3.75 5.5
long-term rate
of inflation
Government 9.0 4.7 10.5 11.5 2.1 5.0 7.0 10.5 4.5 5.5 7.75 10.5
bond yield
China Hong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand Vietnam
Kong (notes (notes (notes
(notes iv, v) iv, v) ii, v)
iii, iv,
v)
31 31 Dec 31 31 Dec 31 31 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
Dec Dec Dec Dec
2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005
% % % % % % % % % % % %
Risk
discount
rate:
New business 12.0 5.9 16.5 17.5 5.0 10.3 9.4 16.5 6.7 9.0 13.75 16.5
In force 12.0 6.15 16.5 17.5 5.0 10.3 9.0 16.5 6.8 9.4 13.75 16.5
Expected 4.0 2.25 5.5 6.5 0.0 2.75 3.0 5.5 1.75 2.25 3.75 5.5
long-term rate
of inflation
Government 9.0 4.8 10.5 11.5 1.8 5.8 7.0 10.5 4.5 5.5 7.75 10.5
bond yield
Asia total Asia total
31 Dec 2006 31 Dec 2005
% %
Weighted risk discount rate (note i)
New business 9.8 9.8
In force 8.8 8.4
Notes
(i) The weighted discount rates for the Asian operations shown above have
been determined by weighting each country's discount rates by reference to the
EEV basis operating result for new business and the closing value of in-force
business.
(ii) For traditional business in Taiwan, the economic scenarios used to
calculate the 2006 and 2005 EEV basis results reflect the assumption of a phased
progression of the bond yields from the current rates applying to the assets
held to the long-term expected rates.
The projections assume that in the average scenario, the current bond yields of
around 2 per cent trend towards 5.5 per cent at 31 December 2013 (2005: 2 per
cent trend towards 5.5 per cent at 31 December 2012).
In projecting forward the Fund Earned Rate allowance is made for the mix of
assets in the fund, future investment strategy, and further market value
depreciation of bonds held as a result of assumed future yield increases. These
factors, together with the assumption of the phased progression in bond yields
give rise to an average assumed Fund Earned Rate that trends from 2.1 per cent
for 2006 to 5.7 per cent in 2014. The assumed Fund Earned Rate falls to 1.4 per
cent in 2007 and remains below 2.1 per cent for a further five years. This
feature is due to the depreciation of bond values as yields rise. Thereafter,
the assumed Fund Earned Rate fluctuates around a target of 5.9 per cent. This
projection compares with that applied for the 2005 results of a grading from an
assumed rate of 2.3 per cent for 2005 to 5.4 per cent for 2013. Consistent with
the EEV methodology applied, a constant discount rate has been applied to the
projected cashflows.
(iii) The assumptions shown are for US dollar denominated business which
comprises the larger proportion of the in-force Hong Kong business.
(iv) Assumed equity returns
The most significant equity holdings in the Asian operations are in Hong Kong,
Singapore and Malaysia. The mean equity return assumptions for those territories
at 31 December 2006 were 8.7 per cent (31 December 2005: 8.6 per cent), 9.3 per
cent (31 December 2005: 9.3 per cent) and 12.8 per cent (31 December 2005: 12.8
per cent) respectively. To obtain the mean, an average over all simulations of
the accumulated return at the end of the projection period is calculated. The
annual average return is then calculated by taking the root of the average
accumulated return minus 1.
(v) For Singapore, Malaysia, Taiwan and Hong Kong, cash rates are used in
setting the risk discount rates.
Stochastic
The economic assumptions used for the stochastic calculations are consistent
with those used for the deterministic calculations described above. Assumptions
specific to the stochastic calculations such as the volatilities of asset
returns reflect local market conditions and are based on a combination of actual
market data, historic market data and an assessment of longer-term economic
conditions. Common principles have been adopted across the Group for the
stochastic asset models, for example, separate modelling of individual asset
classes but with allowance for correlation between the various asset classes.
Details are given below of the key characteristics and calibrations of each
model.
UK Insurance Operations
• Interest rates are projected using a two-factor model calibrated to
actual market data;
• The risk premium on equity assets is assumed to follow a log-normal
distribution;
• The corporate bond return is calculated as the return on a
zero-coupon bond plus a spread. The spread process is a mean reverting
stochastic process; and
• Property returns are modelled in a similar fashion to corporate
bonds, namely as the return on a riskless bond, plus a risk premium, plus a
process representative of the change in residual values and the change in value
of the call option on rents.
The rates to which the model has been calibrated are set out below.
Mean returns have been derived as the annualised arithmetic average return
across all simulations and durations.
Standard deviations have been calculated by taking the annualised variance of
the returns over all the simulations, taking the square root and averaging over
all durations in the projection. For bonds the standard deviations relate to the
yields on bonds of the average portfolio duration. For equity and property, they
relate to the total return on these assets. The standard deviations applied to
both years presented in these statements are as follows:
%
Government bond yield 2.0
Corporate bond yield 5.5
Equities:
UK 18.0
Overseas 16.0
Property 15.0
Jackson National Life
• Interest rates are projected using a log-normal generator calibrated
to actual market data;
• Corporate bond returns are based on Treasury securities plus a
spread that has been calibrated to current market conditions and varies by
credit quality; and
• Variable annuity equity and bond returns have been stochastically
generated using a regime-switching log-normal model with parameters determined
by reference to historical data. The volatility of equity fund returns ranges
from 18.6 per cent to 28.1 per cent (2005: 18.6 per cent to 28.1 per cent),
depending on risk class, and the volatility of bond funds ranges from 1.4 per
cent to 2.0 per cent (2005: 1.4 per cent to 1.8 per cent).
Asian Operations
The same asset return model, as used in the UK, appropriately calibrated, has
been used for the Asian operations. The principal asset classes are government
and corporate bonds. Equity holdings are much lower than in the UK whilst
property is not held as an investment asset.
The stochastic cost of guarantees is only of significance for the Hong Kong,
Singapore, Malaysia and Taiwan operations.
The mean stochastic returns are consistent with the mean deterministic returns
for each country. The volatility of equity returns ranges from 18 per cent to 25
per cent (2005: 18 per cent to 26 per cent), and the volatility of government
bond yields ranges from 1.4 per cent to 2.5 per cent (2005: 1.3 per cent to 2.2
per cent).
(3) Level of encumbered capital
In adopting the EEV Principles, Prudential has based encumbered capital on its
internal targets for economic capital subject to it being at least the local
statutory minimum requirements. Economic capital is assessed using internal
models, but when applying the EEV principals Prudential does not take credit for
the significant diversification benefits that exist within the Group. For
with-profits business written in a segregated life fund, as is the case in the
UK and Asia, the capital available in the fund is sufficient to meet the
encumbered capital requirements.
The table below summarises the levels of encumbered capital as a percentage of
the relevant statutory requirement.
Capital as a percentage of relevant statutory
requirement
UK Insurance Operations 100% of EU Minimum
Jackson National Life 235% of Company Action Level
Asian Operations 100% of Financial Conglomerates Directive
requirement
(4) Margins on new business premiums and contributions
2006 New Business Annual Present Pre-Tax New New Business
Premiums Premium and value of Business Margin
Contribution New
Equivalents Business
Premiums
Single Regular (APE) (PVNBP) Contribution (APE) (PVNBP)
£m £m £m £m £m % %
UK Insurance Operations 6,991 201 900 7,712 266 30 3.4
Jackson National Life 5,964 17 614 6,103 259 42 4.2
Asian Operations 1,072 849 956 5,132 514 54 10.0
Total 14,027 1,067 2,470 18,947 1,039 42 5.5
2005 New Business Annual Present Pre-Tax New New Business
Premiums Premium and value of Business Margin
Contribution New
Equivalents Business
Premiums
Single Regular (APE) (PVNBP) Contribution (APE) (PVNBP)
£m £m £m £m £m % %
UK Insurance Operations 7,002 191 892 7,718 243 27 3.1
Jackson National Life 5,009 14 515 5,135 211 41 4.1
Asian Operations 837 648 731 4,039 413 56 10.2
Total 12,848 853 2,138 16,892 867 41 5.1
New business margins are shown on two bases, namely the margins by reference to
Annual Premium and Contribution Equivalents (APE) and the Present Value of New
Business Premiums (PVNBP). APEs are calculated as the aggregate of regular new
business amounts and one-tenth of single new business amounts. PVNBPs are
calculated as equalling single premiums plus the present value of expected new
business premiums of regular premium business, allowing for lapses and other
assumptions made in determining the EEV new business contribution.
The table of new business premiums and margins above excludes SAIF DWP rebate
premiums. Comparatives for premiums for this business, which were previously
included in the totals have been restated.
In determining the EEV basis value of new business written in the year the
policies incept, premiums are included in projected cash flows on the same basis
of distinguishing annual and single premium business as set out for statutory
basis reporting.
New business contributions represent profits determined by applying the economic
and non-economic assumptions applying at the end of the reporting period.
(5) Bulk annuity reinsurance from the Scottish Amicable Insurance Fund to
Prudential Retirement Income Limited
In June 2006 Prudential Retirement Income Limited (PRIL), a shareholder-backed
subsidiary of the Company, entered into a bulk annuity reinsurance arrangement
with the Scottish Amicable Insurance Fund (SAIF) for the reinsurance of
non-profit immediate pension annuity liabilities with a premium of £560m. SAIF
is a closed ring-fenced sub-fund of the PAC long-term fund, which is solely for
the benefit of SAIF policyholders. Shareholders have no interest in the profits
of this sub-fund and, accordingly, it is not part of covered business for EEV
reporting purposes.
Consistent with the transfer from uncovered to covered business and reflecting
the transfer of longevity risk, requirement for capital support, and entitlement
to surpluses on this block of business from SAIF to Prudential shareholders, the
transaction has been accounted for as new business for EEV basis reporting
purposes.
(6) UK restructuring costs
The charge of £53m for restructuring costs comprises £50m recognised on the IFRS
basis and an additional £3m recognised on the EEV basis for the shareholders'
share of costs incurred by the PAC with-profits sub-fund. The costs relate to
the initiative announced in December 2005 for UK Insurance Operations to work
more closely with Egg and M&G.
(7) UK Insurance Operations expense assumptions
The 2005 EEV basis financial statements included note disclosure explaining that
in determining the appropriate expense assumptions for 2005 account had been
taken of the cost synergies that were expected to arise with some certainty from
the initiative announced in December 2005 from UK Insurance Operations working
more closely with Egg and M&G. Without this factor there would have been a
charge for altered expense assumptions of approximately £55m. The half year 2006
EEV basis results were prepared on the same basis.
The initiative was expected to provide annual savings to the cost base of UK
Operations in aggregate of £40m. In addition, at the interim results stage, it
was announced that an end to end review of the UK business, with the aim of
reducing the overall cost base was underway. Total UK annual savings, including
the £40m mentioned above, were noted as being expected to be £150m per annum
comprising £100m for Egg and shareholder-backed business of UK Insurance
Operations and £50m attaching to the with-profits sub-fund. The savings for the
UK Insurance Operations cover both acquisition and renewal activity. Reflecting
the underlying trend in unit costs, the interim results announcement noted that
the element of the additional savings of £110m that relate to long-term business
was expected to be neutral in its effect on EEV basis results.
With the agreement to sell Egg Banking Plc, the actions necessary to implement
these plans have been reassessed and additional initiatives put in place, as
announced on 15 March 2007.
In preparing the 2006 EEV basis results for UK Insurance Operations, account has
been taken of the expense savings that are expected to arise from these
initiatives. Without this factor the effect on the 2006 results would have been
an additional charge of £44m for the net effect of revised assumptions in line
with 2006 unit costs. The size of this change reflects the lagged effect of the
implementation of the previously announced initiatives which have affected
run-rate savings as at 31 December 2006 but not translated to the same extent in
unit costs over 2006 as a whole.
(8) Cumulative adjustment at 31 December 2006 for Jackson National life
(JNL) assets backing surplus and required capital
Previously the valuation placed on the JNL assets backing surplus and required
capital reflected the fact that generally they are held for the longer-term and
excluded the short-term differences between market value and amortised cost. For
the balance sheet at 31 December 2006 and prospectively these short-term value
adjustments are incorporated. At 31 December 2006 the balance sheet adjustment,
net of related tax is an increase of £7m. For 31 December 2005 the adjustment,
if it had been booked at that date, was an increase of £19m. Future movements
for this item, consistent with the basis applied under IFRS for
available-for-sale securities, will be booked in the statement of movement in
shareholders' capital and reserves.
(9) Taiwan - effect of altered economic assumptions and sensitivity of
results to future market conditions
In 2006, as explained in note 2, the expected long-term bond yield has been
maintained at 5.5 per cent. However, the date at which the expected long-term
yield is projected to be attained has been altered from 31 December 2012, as
applied for the 2005 results, to 31 December 2013. This change of assumption
together with the associated effect of the resulting change on the economic
capital requirement has given rise to a pre-tax charge of £101m.
The sensitivity of the embedded value at 31 December 2006 of the Taiwan
operation to altered economic assumptions and future market conditions to:
(a) A 1 per cent increase or decrease in the projected long-term bond
yield, (including all consequential changes to investment returns for all
classes, market values of fixed interest assets and risk discount rates), is
£107m and £(165)m respectively (31 December 2005: £106m and £(174)m
respectively); and
(b) A 1 per cent increase or decrease in the starting bond rate for the
progression to the assumed long-term rate is £116m and £(125)m respectively (31
December 2005: £104m and £(108)m respectively).
If a delay of a further year to 31 December 2014 for the start and end of the
progression period had been assumed in preparing the 2006 results, there would
have been an additional charge of £(88)m.
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) BASIS RESULTS
CONSOLIDATED INCOME STATEMENT
2006 2005
£m £m
Gross premiums earned 16,157 15,225
Outward reinsurance premiums (171) (197)
Earned premiums, net of reinsurance 15,986 15,028
Investment income 17,904 24,013
Other income 2,055 2,084
Total revenue, net of reinsurance (note B) 35,945 41,125
Benefits and claims and movement in unallocated surplus of (28,421) (33,100)
with-profits funds
Acquisition costs and other operating expenditure (5,243) (5,552)
Finance costs: interest on core structural borrowings of (210) (208)
shareholder-financed operations
Goodwill impairment charge - (120)
Total charges (note B) (33,874) (38,980)
Profit before tax* (note B) 2,071 2,145
Tax attributable to policyholders' returns (849) (1,147)
Profit before tax attributable to shareholders (note C) 1,222 998
Tax expense (note E) (1,196) (1,388)
Less: tax attributable to policyholders' returns 849 1,147
Tax attributable to shareholders' profit (note E) (347) (241)
Profit from continuing operations after tax 875 757
Discontinued operations (net of tax) - 3
Profit for the year 875 760
Attributable to:
Equity holders of the Company 874 748
Minority interests 1 12
Profit for the year 875 760
Earnings per share (in pence) 2006 2005
Basic (based on 2,413m and 2,365m shares respectively):
Based on profit from continuing operations attributable to the 36.2p 31.5p
equity holders of the Company (note F)
Based on profit from discontinued operations attributable to the - 0.1p
equity holders of the Company
36.2p 31.6p
Diluted (based on 2,416m and 2,369m shares respectively):
Based on profit from continuing operations attributable to the 36.2p 31.5p
equity holders of the Company
Based on profit from discontinued operations attributable to the - 0.1p
equity holders of the Company
36.2p 31.6p
Dividends per share (in pence) 2006 2005
Dividends relating to reporting period:
Interim dividend (2006 and 2005) 5.42p 5.30p
Final dividend (2006 and 2005) (note G) 11.72p 11.02p
Total 17.14p 16.32p
Dividends declared and paid in reporting period:
Current year interim dividend 5.42p 5.30p
Final dividend for prior year 11.02p 10.65p
Total 16.44p 15.95p
* 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.
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
2006
Share Share Retained Trans- Avail- Hedging Share- Minority Total
capital premium earnings lation able- reserve holders' interests equity
reserve for- equity
sale
secur-
ities
reserve
£m £m £m £m £m £m £m £m £m
Reserves
Profit for the year 874 874 1 875
Items recognised directly
in equity:
Exchange movements (224) (224) (224)
Movement on cash flow 7 7 7
hedges
Unrealised valuation
movements on securities
classified as
available-for-sale:
Unrealised holding losses (210) (210) (210)
arising during the year
Less losses included in the 7 7 7
income statement
Unrealised investment (203) (203) (203)
losses, net
Related change in 75 75 75
amortisation of deferred
income and acquisition
costs
Related tax (74) 50 (2) (26) (26)
Total items recognised (298) (78) 5 (371) (371)
directly in equity
Total income and expense 874 (298) (78) 5 503 1 504
for the year
Dividends (399) (399) (399)
Reserve movements in 15 15 15
respect of share-based
payments
Change in minority 43 43
interests arising
principally from purchase
and sale of venture
investment companies and
property partnerships of
the PAC with-profits fund
and of other investment
funds
Acquisition of Egg minority (167) (167) (84) (251)
interests (note J)
Share capital and share
premium
New share capital 3 333 336 336
subscribed (note H)
Transfer to retained (75) 75
earnings in respect of
shares issued in lieu of
cash dividends (note H)
Treasury shares
Movement in own shares in 6 6 6
respect of share-based
payment plans
Movement in Prudential plc 0 0 0
shares purchased by unit
trusts consolidated under
IFRS
Net increase (decrease) in 3 258 404 (298) (78) 5 294 (40) 254
equity
At beginning of year 119 1,564 3,236 173 105 (3) 5,194 172 5,366
At end of year 122 1,822 3,640 (125) 27 2 5,488 132 5,620
2005
Share Share Retained Trans- Avail- Hedging Share- Minority Total
capital premium earnings lation able- reserve holders' interests equity
reserve for- equity
sale
secur-
ities
reserve
£m £m £m £m £m £m £m £m £m
Reserves
Profit for the year 748 748 12 760
Items recognised directly
in equity:
Exchange movements 268 268 268
Movement on cash flow (4) (4) 1 (3)
hedges
Unrealised valuation
movements on securities
classified as
available-for-sale:
Unrealised holding losses (773) (773) (773)
arising during the year
Less losses included in the 22 22 22
income statement
Unrealised investment (751) (751) (751)
losses, net
Related change in 307 307 307
amortisation of deferred
income and acquisition
costs
Related tax 65 152 1 218 218
Total items recognised 333 (292) (3) 38 1 39
directly in equity
Total income and expense 748 333 (292) (3) 786 13 799
for the year
Cumulative effect of 2 (173) 397 226 (3) 223
changes in accounting
policies on adoption of IAS
32, IAS 39 and IFRS 4, net
of applicable taxes at 1
January 2005 (note M)
Dividends (380) (380) (380)
Reserve movements in 15 15 (1) 14
respect of share-based
payments
Change in minority 26 26
interests arising
principally from purchase
and sale of venture
investment companies and
property partnerships of
the PAC with-profits fund
Share capital and share
premium
New share capital 0 55 55 55
subscribed
Transfer to retained (51) 51
earnings in respect of
shares issued in lieu of
cash dividends
Treasury shares
Movement in own shares in 0 0 0
respect of share-based
payment plans
Movement in Prudential plc 3 3 3
shares purchased by unit
trusts consolidated under
IFRS
Net increase (decrease) in 6 264 333 105 (3) 705 35 740
equity
At beginning of year 119 1,558 2,972 (160) 4,489 137 4,626
At end of year 119 1,564 3,236 173 105 (3) 5,194 172 5,366
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) BASIS RESULTS
CONSOLIDATED BALANCE SHEET
2006 2005
(note
£m N) £m
Assets
Intangible assets attributable to shareholders:
Goodwill 1,341 1,341
Deferred acquisition costs and acquired in force value of 2,497 2,405
long-term business contracts
3,838 3,746
Intangible assets attributable to PAC with-profits fund (note N):
In respect of venture fund investment subsidiaries 830 679
Deferred acquisition costs 31 35
861 714
Total 4,699 4,460
Other non-investment and non-cash assets:
Property, plant and equipment 1,133 910
Reinsurers' share of policyholder liabilities 945 1,278
Deferred tax assets 1,012 755
Current tax recoverable 404 231
Accrued investment income 1,900 1,791
Other debtors 1,052 1,305
Total 6,446 6,270
Investments of long-term business, banking and other operations:
Investment properties 14,491 13,180
Investments accounted for using the equity method 6 5
Financial investments:
Loans and receivables 11,573 13,245
Equity securities and portfolio holdings in unit trusts 78,892 71,985
Debt securities 81,719 82,471
Other investments 5,401 3,879
Deposits 7,759 7,627
Total 199,841 192,392
Held for sale assets 463 728
Cash and cash equivalents 5,071 3,586
Total assets 216,520 207,436
Equity and liabilities
Equity
Shareholders' equity (note H) 5,488 5,194
Minority interests 132 172
Total equity 5,620 5,366
Liabilities
Banking customer accounts 5,554 5,830
Policyholder liabilities and unallocated surplus of with-profits
funds:
Insurance contract liabilities 123,213 120,436
Investment contract liabilities with discretionary participation 28,733 26,523
features
Investment contract liabilities without discretionary 13,042 12,026
participation features
Unallocated surplus of with-profits funds 13,599 11,330
Total 178,587 170,315
Core structural borrowings of shareholder-financed operations:
Subordinated debt (other than Egg) 1,538 1,646
Other 1,074 1,093
2,612 2,739
Egg subordinated debt 451 451
Total 3,063 3,190
Other borrowings:
Operational borrowings attributable to shareholder-financed 5,609 6,432
operations (note I)
Borrowings attributable to with-profits funds (note I) 1,776 1,898
Other non-insurance liabilities:
Obligations under funding, securities lending and sale and 4,232 4,529
repurchase agreements
Net asset value attributable to unit holders of consolidated unit 2,476 965
trusts and similar funds
Current tax liabilities 1,303 962
Deferred tax liabilities 3,882 3,077
Accruals and deferred income 517 506
Other creditors 1,398 1,478
Provisions 464 972
Other liabilities 1,652 1,770
Held for sale liabilities 387 146
Total 16,311 14,405
Total liabilities 210,900 202,070
Total equity and liabilities 216,520 207,436
CONSOLIDATED CASH FLOW STATEMENT
2006 2005
£m £m
Cash flows from operating activities
Profit before tax (note i) 2,071 2,145
Changes in operating assets and liabilities:
Investments (13,748) (21,462)
Banking customer accounts (276) (861)
Other non-investment and non-cash assets (232) (957)
Policyholder liabilities (including unallocated surplus) 13,540 21,113
Other liabilities (including operational borrowings) 1,136 180
Interest income and expense and dividend income included in profit (10,056) (8,410)
before tax
Other non-cash items 198 0
Operating cash items:
Interest receipts 6,466 5,946
Dividend receipts 3,633 2,680
Tax paid (523) (573)
Net cash flows from operating activities 2,209 (199)
Cash flows from investing activities
Purchases of property, plant and equipment (174) (160)
Proceeds from disposal of property, plant and equipment 34 6
Costs incurred on purchase of Egg minority interests (6) -
Acquisition of subsidiaries, net of cash balances (note ii) (70) (68)
Disposal of subsidiaries, net of cash balances (note ii) 114 252
Net cash flows from investing activities (102) 30
Cash flows from financing activities
Structural borrowings of the Group:
Shareholder-financed operations (note iii):
Issue - 168
Redemption (1) (308)
Interest paid (204) (204)
With-profits operations (note iv):
Interest paid (9) (9)
Equity capital (note v):
Issues of ordinary share capital 15 3
Dividends paid to shareholders (323) (328)
Net cash flows from financing activities (522) (678)
Net increase (decrease) in cash and cash equivalents 1,585 (847)
Cash and cash equivalents at beginning of year 3,586 4,341
Effect of exchange rate changes on cash and cash equivalents (100) 92
Cash and cash equivalents at end of year (note vi) 5,071 3,586
Notes
(i) 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.
(ii) Acquisitions and disposals of subsidiaries shown above include venture
investment subsidiaries of the PAC with-profits fund as shown in note J. In
2005, this also includes the purchase of Life Insurance Company of Georgia.
(iii) Structural borrowings of shareholder-financed operations consist of
the core debt of the parent company and related finance subsidiaries, Jackson
National Life surplus notes and Egg subordinated debt. Core debt excludes
borrowings to support short-term fixed income securities programmes and
non-recourse borrowings of investment subsidiaries of shareholder-financed
operations. Cash flows in respect of these borrowings are included within cash
flows from operating activities.
(iv) Structural borrowings of with-profits operations relate solely to the
£100m 8.5 per cent undated subordinated guaranteed bonds which contribute to the
solvency base of the Scottish Amicable Insurance Fund (SAIF), a ring-fenced
sub-fund of the PAC with-profits fund. Cash flows on other borrowings of
with-profits funds, which principally relate to venture investment subsidiaries,
are included within cash flows from operating activities.
(v) Cash movements in respect of equity capital exclude scrip dividends and
share capital issued in respect of the acquisition of Egg minority interests.
(vi) Of the cash and cash equivalents amounts reported above, £437m (2005:
£263m) represents cash and cash equivalents of the parent company and related
finance subsidiaries.
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) BASIS RESULTS
NOTES ON THE STATUTORY IFRS BASIS RESULTS
A Basis of preparation and audit status
The statutory basis results included in this announcement have been extracted
from the audited financial statements of the Group for the year ended 31
December 2006. These statements have been prepared in accordance with
International Financial Reporting Standards (IFRS) as adopted by the European
Union (EU) as required by EU law (IAS Regulation EC1606/2002).
The auditors have reported on the 2006 statutory accounts. The financial
information set out above does not constitute the Company's statutory accounts
for the years ended 31 December 2006 or 2005 but is derived from those accounts.
The auditors' report was (i) unqualified, (ii) did not include reference to any
matters to which the auditors drew attention by way of emphasis without
qualifying their report and (iii) did not contain a statement under section 237
(2) or (3) of the Companies Act 1985.
In 2005, the Group adopted the amendments to IAS 39, 'The Fair Value Option' and
IAS 19, 'Employee Benefits' (as amended in 2004). These amendments were
mandatory for accounting periods beginning on or after 1 January 2006.
There are no other new or revised accounting standards and interpretations
issued by the International Accounting Standards Board (IASB) or the
International Financial Reporting Interpretations Committee (IFRIC) of the IASB,
effective in 2006, that have an impact on the results of the Group.
The following amendments and interpretations to published standards were
mandatory for accounting periods beginning on or after 1 January 2006 and are
relevant to the Group's operations but their adoption did not have an impact on
the Group's results:
(i) Amendment to IAS 39, 'Cash Flow Hedge Accounting of Forecast
Intra-group Transactions'.
(ii) Amendment to IAS 39 and IFRS 4, 'Financial Guarantee Contracts'.
(iii) Amendments to IAS 21, 'Net Investment in a foreign operation'.
B Segment disclosure
2006 2005
£m £m
Revenue
Long-term business 34,197 39,296
Banking 914 1,115
Broker-dealer and fund management 1,080 895
Unallocated corporate 38 98
Intra-group revenue eliminated on consolidation (284) (279)
Total revenue, net of reinsurance, per income statement 35,945 41,125
Charges (before income tax attributable to policyholders and
unallocated surplus of long-term insurance funds)
Long-term business, including post-tax transfers to unallocated (32,162) (36,997)
surplus of with-profits funds
Banking (1,064) (1,071)
Broker-dealer and fund management (797) (741)
Unallocated corporate (135) (450)
Intra-group charges eliminated on consolidation 284 279
Total charges per income statement (33,874) (38,980)
Segment results - revenue less charges (continuing operations)
Long-term business 2,035 2,299
Banking* (150) 44
Broker-dealer and fund management 283 154
Unallocated corporate (97) (352)
Profit before tax** 2,071 2,145
Tax attributable to policyholders' returns (849) (1,147)
Profit before tax attributable to shareholders 1,222 998
Tax attributable to shareholders' profits (347) (241)
Profit from continuing operations after tax 875 757
Segment results - discontinued operations (net of tax)
Banking - 3
Profit for the year 875 760
* The segment result for banking represents the operating profit based on
longer-term investment returns net of restructuring costs, and short-term
fluctuations in investment returns.
** 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.
C Supplementary analysis of profit from continuing operations before tax
attributable to shareholders
2006 2005
Results analysis by business area £m £m
UK Operations
UK Insurance Operations (note D) 500 400
M&G 204 163
Egg (145) 44
Total 559 607
US Operations
Jackson National Life (note D) 398 348
Broker-dealer and fund management 18 24
Curian (8) (10)
Total 408 362
Asian Operations
Long-term business (note D) 189 195
Fund management 50 12
Development expenses (15) (20)
Total 224 187
Other Income and Expenditure
Investment return and other income 58 87
Interest payable on core structural borrowings (177) (175)
Corporate expenditure:
Group Head Office (83) (70)
Asia Regional Head Office (36) (30)
Charge for share-based payments for Prudential schemes (10) (11)
Total (248) (199)
UK restructuring costs (note L) (50) -
Operating profit from continuing operations based on longer-term 893 957
investment returns
Goodwill impairment charge (note i) - (120)
Short-term fluctuations in investment returns on 162 211
shareholder-backed business (note ii)
Shareholders' share of actuarial and other gains and losses on 167 (50)
defined benefit pension schemes (note iii)
Profit from continuing operations before tax attributable to 1,222 998
shareholders
Notes
(i) Goodwill impairment charge
The charge for goodwill impairment in 2005 relates to the Japanese life
business.
(ii) Short-term fluctuations in investment returns on shareholder-backed
business
2006 2005
£m £m
US Operations:
Movement in market value of derivatives used for economic 34 122
hedging purposes
Actual less longer-term investment returns for other items 20 56
Asian Operations 134 32
Other Operations (26) 1
162 211
(iii) Actuarial and other gains and losses on defined benefit pension
schemes
2006 2005
£m £m
Actuarial gains and losses
Actual less expected return on scheme assets 156 544
Experience gains on liabilities 18 1
Gains (losses) on changes of assumptions for scheme 311 (489)
liabilities*
485 56
Less: amount attributable to the PAC with-profits fund (318) (58)
167 (2)
Non-recurrent credit (charge)
Shareholders' share of credit arising from reduction in - 35
assumed level of future discretionary increases for pensions
in payment of the Prudential Staff Pension Scheme to 2.5%
Loss on re-estimation of shareholders' share of deficit on the - (63)
Prudential Staff Pension Scheme at 31 December 2005 to 30%
Effect of strengthening in actuarial provisions for increase - (20)
in ongoing contributions for future service of active scheme
members
- (48)
167 (50)
* The gains and losses on changes of assumptions for scheme liabilities
primarily reflect movements in yields on good quality corporate bonds. These
yields are used to discount the projected pension scheme benefit payments.
The discount rates applied for the Group's UK defined benefit schemes, and
reflected in the gains and losses shown above, are as follows:
31 December 2006 5.2%
31 December 2005 4.8%
D Effect of changes in assumptions, estimates and bases used to measure
insurance assets and liabilities
(a) UK Insurance Operations
2006
In 2006, the FSA made regulatory changes for UK regulated non-participating
business. These changes were proposed in the consultative paper CP 06/16 and
confirmed in December 2006 policy statement PS 06/14.
The changes to the FSA rules allow insurance technical provisions to incorporate
more economic realism. In particular this is achieved by;
• Setting technical provisions for expenses not directly attributable
to one particular contract at a homogenous risk level and not, as previously, at
an individual contract level for all non-profit business.
• Recognising the economic effect of making a prudent lapse rate
assumption. Previously, no lapses were assumed.
The effect of this change is accounted for as a change in estimate and there is
a consequent increase in operating profit based on longer-term investment
returns of £46m.
In addition, a charge of £4m was recognised in 2006 for the effect of change of
assumption for renewal and termination expenses mainly in respect of PAC.
2005
For shareholder-backed non-participating business a number of changes of
assumptions were made in 2005. Taken together these changes had the effect of
reducing operating profit based on longer-term investment returns before
shareholder tax by £36m with a consequent increase in liabilities.
(b) US Operations
2006
Several assumptions were modified in 2006 to conform to more recent experience
resulting in a net decrease of £7m. These changes included revisions to the
assumption regarding utilisation of free partial withdrawal options, resulting
in a decrease in deferred acquisition costs of £12m. Other smaller changes
included changes relating to lapse rates, mortality rates and other assumptions,
which resulted in an increase of £6m in deferred acquisition costs.
2005
Several assumptions were modified in 2005 to conform to more recent experience
resulting in a net decrease to pre-tax profits of £7m. The most significant
changes included a write-down of deferred acquisition costs of £21m for Single
Premium Deferred Annuities, partial withdrawal changes and a Universal Life SOP
03-1, 'Accounting and Reporting by Insurance Enterprises for Certain
Non-traditional Long Duration Contracts and for Separate Accounts' reserve
increase of £13m due to increasing the mortality assumption. Other smaller
changes included changes relating to Single Premium Whole Life surrenders and
annuity mortality and annuitisation rates, which resulted in a £19m benefit on
adjusting amortisation of deferred acquisition costs.
(c) Asian Operations
2006
There are no changes of assumptions that had a material impact on the 2006
results of Asian operations.
2005
The 2005 results for Asian operations were affected in two significant ways for
changes of basis or assumption.
For the Singapore life business, the adoption of the Singapore risk-based
capital framework in 2005 resulted in a change of estimate and reduction in the
liability of £73m.
The second item reflects the application of liability adequacy testing for the
Taiwan life business which resulted in a write-off of deferred acquisition costs
of £21m in 2005.
E Tax charge
The total tax charge of £1,196m for 2006 (2005: £1,388m) comprises £653m (2005:
£1,119m) UK tax and £543m (2005: £269m) overseas tax. This tax charge comprises
tax attributable to policyholders and unallocated surplus of with-profits funds,
unit-linked policies and shareholders. The tax charge attributable to
shareholders of £347m for 2006 (2005: £241m) comprises £97m (2005: £(21)m) UK
tax and £250m (2005: £262m) overseas tax.
F Supplementary analysis of earnings per share from continuing operations
2006 2005
£m £m
Operating profit based on longer-term investment returns 26.4p 32.2p
after related tax and minority interests
Adjustment for goodwill impairment charge - (5.1)p
Adjustment from post-tax longer-term investment returns to 5.0p 5.9p
post-tax actual investment returns (after related minority
interests)
Adjustment for post-tax shareholders' share of actuarial and 4.8p (1.5)p
other gains and losses on defined benefit pension schemes
Based on profit from continuing operations after tax and 36.2p 31.5p
minority interests
G Dividend
A final dividend of 11.72p per share was proposed by the directors on 14 March
2007. This dividend will absorb an estimated £287m of shareholders' funds.
Subject to shareholder approval, the dividend will be paid on 22 May 2007 to
shareholders on the register at the close of business on 13 April 2007. A scrip
dividend alternative will be offered to shareholders.
H Shareholders' equity
2006 2005
£m £m
Share capital 122 119
Share premium 1,822 1,564
Reserves 3,544 3,511
Total 5,488 5,194
I Other borrowings
2006 2005
£m £m
Operational borrowings attributable to shareholder-financed
operations
Borrowings in respect of short-term fixed income securities 2,032 1,472
programmes
Non-recourse borrowings of investment subsidiaries managed 743 1,085
by PPM America
Borrowings in respect of banking operations 2,819 3,856
Other borrowings 15 19
Total 5,609 6,432
Borrowings attributable to with-profits funds
Non-recourse borrowings of venture fund investment 926 988
subsidiaries of the PAC with-profits fund
Structural borrowings (subordinated debt of a subsidiary of 100 100
the Scottish Amicable Insurance Fund)
Other borrowings (predominantly external funding of 750 810
consolidated investment vehicles)
Total 1,776 1,898
J Acquisitions and disposals
(i) Shareholder acquisitions and disposals
In December 2005, the Company announced its intention to acquire the minority
interests in Egg representing approximately 21.7 per cent of the existing issued
share capital of Egg. The whole of the minority interests were acquired in the
first half of 2006. Under the terms of the offer, Egg shareholders received
0.2237 new ordinary shares in the Company for each Egg share resulting in the
issue of 41.6m new shares in the Company.
The Company accounted for the purchase of minority interests using the economic
entity method. Accordingly, £167m has been charged to retained earnings
representing the difference between the consideration paid (including expenses)
of £251m and the share of net assets acquired of £84m.
On 29 January 2007, Prudential announced that it had reached agreement with Citi
to sell Egg for £575m in cash, subject to adjustments to reflect any change in
net asset value between 31 December 2006 and completion. The transaction is
subject to regulatory approval and is expected to complete by the end of April
2007.
(ii) PAC with-profits fund acquisitions and disposals of venture fund
investments subsidiaries
In 2006 the PAC with-profits fund acquired three new venture capital holdings
through PPM Capital in which the Group is deemed to have a controlling interest,
in aggregate with, if applicable, other holdings held by, for example, the
Prudential Staff Pension Scheme. These acquisitions were for:
• 53 per cent of the voting equity interests of Histoire D'or, a
jewellery retail company, in April 2006;
• 51 per cent of the voting equity interests of Azzuri Communications,
a business IT services company, in June 2006: and
• 60 per cent of the voting equity interests of Paramount plc, a
restaurant company, in September 2006.
The results of the aggregated venture acquisitions in 2006 have been included in
the consolidated financial statements of the Group commencing on the respective
dates of acquisition and contributed a loss of £7.7m within the income
statement, which is also reflected as part of the movement in unallocated
surplus of the with-profits fund.
The table below identifies the net assets of these acquisitions and minor
business purchases by existing venture holdings. This reconciles the net assets
to the consideration paid
Fair value on
acquisition
£m
Cash and cash equivalents 18
Other current assets 31
Property, plant and equipment 45
Intangible assets other than goodwill 139
Other non-current assets 100
Less liabilities, including current liabilities and (581)
borrowings
Net assets acquired (248)
Goodwill 336
Cash consideration 88
Aggregate goodwill of £336m has been recognised for the excess of the cost over
the Group's interest in the net fair value of entities' assets.
In 2006, Upperpoint Distribution Limited, Taverner Hotel Group Pty Ltd, Orefi,
Aperio Group Pty Ltd and BST Safety Textiles Luxemborg S.a.r.l., all venture
subsidiaries of the PAC with-profits fund, were disposed of for cash
consideration of £133m. Goodwill of £46m and cash and cash equivalents of £19m
were disposed of. In addition, one venture subsidiary was classified as held for
sale at 31 December 2006.
K Bulk annuity reinsurance from the Scottish Amicable Insurance Fund
(SAIF) to Prudential Retirement Income Limited (PRIL)
In June 2006, PRIL, a shareholder-backed subsidiary of the Group, entered into a
bulk annuity reinsurance arrangement with SAIF for the reinsurance of non-profit
immediate pension annuity liabilities with a premium of £560m. SAIF is a closed
ring-fenced sub-fund of the PAC long-term fund, established by a Court approved
Scheme of Arrangement in 1997, which is solely for the benefit of SAIF
policyholders. As explained in the notes to the tables for the supplementary
transaction measure of new business, the economic substance of the arrangement
is a transfer of risks and rewards attaching to this business from SAIF
policyholders to Prudential shareholders. Accordingly, for the purpose of those
tables the reinsurance transaction has been recorded as 'new business'. For
Group reporting purposes the amounts recorded by SAIF and PRIL for the premium
are eliminated on consolidation.
L UK restructuring costs
In December 2005, the Group announced an initiative for UK Insurance Operations
to work more closely with Egg and M&G and in the process facilitate the
realisation of substantial annualised pre-tax cost savings and opportunities for
revenue synergies. The one-off restructuring cost of achieving the savings was
estimated to be £50m.
In the first half of 2006 the level of current and projected restructuring
activity increased as a result of an end to end review of the UK business, that
was aimed at reducing the overall cost base. The total cost of implementing this
and the previously announced restructuring (as noted above) was estimated at
£110m to be incurred in 2006 and 2007, of which £70m was anticipated to be borne
by the shareholder-backed UK Insurance Operations and Egg and £40m by the PAC
with-profits fund.
As at 31 December 2006, £50m of cost attributable to shareholder-backed
operations had been incurred.
UK restructuring costs have been incurred as follows:
£m
UK Insurance Operations 31
M&G 2
Egg 12
Unallocated corporate 5
50
M Effect of adoption of IAS 32, IAS 39, and IFRS 4
The impact on total equity of adopting IAS 32, IAS 39 and IFRS 4 at 1 January
2005 was as follows:
Shareholders' Minority Total
equity interests equity
£m £m £m
Changes on adoption of IAS 32, IAS 39 and IFRS 4
relating to:
UK Insurance Operations (note i) (22) (22)
Jackson National Life (note ii) 273 273
Banking and non-insurance operations (note iii) (25) (3) (28)
Total 226 (3) 223
Notes
The changes shown above reflect the impact of re-measurement for :
(i) UK Insurance Operations
The reduction in shareholders' equity of £22m includes £20m relating to certain
unit-linked and similar contracts that do not contain significant insurance risk
and are therefore categorised as investment contracts under IFRS 4.
(ii) Jackson National Life
Under IAS 39, JNL's debt securities and derivative financial instruments are
re-measured 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 recognised directly
in equity. Fair value movements on derivatives are recorded in the income
statement.
(iii) Banking and non-insurance operations
Under IAS 39, for Egg, changes to opening equity at 1 January 2005 arise from
altered policies for effective interest rate on credit card receivables,
impairment losses on loans and advances, fair value adjustments on wholesale
financial instruments and embedded derivatives in equity savings products. The
net effect on shareholders' equity of these changes, after tax, is a deduction
of £15m. A further £10m reduction in equity arises on fair valuation of certain
centrally held financial instruments and derivatives.
N 2005 comparative balance sheet
Minor presentational adjustments have been made for refinements to the
acquisition accounting for intangible assets of venture investment subsidiaries
of the PAC with-profits fund. These adjustments affect the carrying value of
goodwill and other intangible assets, with minor consequential effects on some
other balance sheet categories. Shareholders' profit and equity are unaffected
by these adjustments.
O Sensitivity of IFRS basis results for Taiwan life business to economic
assumptions and market conditions
The in-force business of the Taiwan life operation includes traditional whole of
life policies where the premium rates have been set by the regulator at
different points for the industry as a whole. Premium rates were set to give a
guaranteed minimum sum assured on death and a guaranteed surrender value on
early surrender based on prevailing interest rates at the time of policy issue.
Premium rates also included allowance for mortality and expenses. The required
rates of guarantee have fallen over time as interest rates have reduced from a
high of 8 per cent to current levels of around 2 per cent. The current low level
of bond rates in Taiwan gives rise to a negative spread against the majority of
these policies. The current cash costs of funding in force negative spread in
Taiwan is around £40m a year.
The profits attaching to these contracts are particularly affected by the rates
of return earned, and estimated to be earned, on the assets held to cover
liabilities and on future investment income and contract cash flows. Under IFRS,
the insurance contract liabilities of the Taiwan business are determined on the
US GAAP basis as applied previously under UK GAAP. Under this basis the policy
liabilities are calculated on sets of assumptions, which are locked in at the
point of policy inception, and a deferred acquisition cost is held in the
balance sheet.
The adequacy of the insurance contract liabilities is tested by reference to
best estimates of expected investment returns on policy cash flows and
reinvested income. The assumed earned rates are used to discount the future cash
flows. The assumed earned rates consist of a long-term best estimate determined
by consideration of long-term market conditions, and rates assumed to be earned
in the trending period. For 2005, it was projected that rates of return for
Taiwanese bond yields would trend from the then current levels of some 2 per
cent to 5.5 per cent by 31 December 2012. For 2006, it has been assumed that the
long-term bond rate will be attained one year later, i.e. by 31 December 2013.
The liability adequacy test results are sensitive to the attainment of the
trended rates during the trending period. Based on the current asset mix,
margins in other contracts that are used in the assessment of the liability
adequacy tests, and currently assumed future rates of return, if interest rates
were to remain at current levels in 2007, and the target date for attainment of
the long-term bond yield deferred to 31 December 2014, the premium reserve, net
of deferred acquisition costs, would be broadly sufficient. If interest rates
were to remain at current levels in 2008 with a further one year delay in the
progression period then some level of write-off of deferred acquisition costs
may be necessary. However, the amount of the charge based on current in-force
business which is estimated at between £70m and £90m, is sensitive for the
previously mentioned variables.
Furthermore, the actual amount of any write-off would be affected by the impact
of new business written between 31 December 2006 and the future reporting dates
to the extent that the business is taken into account as part of the liability
adequacy testing calculations for the portfolio of contracts.
The adequacy of the liability is also sensitive to the level of the projected
long-term rate. The current long-term assumption of 5.5 per cent has been
determined on a prudent best estimate basis by reference to detailed assessments
of the financial dynamics of the Taiwanese economy. In the event that the rate
applied was altered the carrying value of the deferred acquisition costs and
policyholder liabilities would be potentially affected.
At 31 December 2006, if the assumed long-term bond yield applied had been
reduced by 0.5 per cent from 5.5 per cent to 5.0 per cent and continued to apply
the same progression period to 31 December 2013, by assuming bond yields
increase from current levels in equal annual instalments to the long-term rate,
the premium reserve, net of deferred acquisition costs, would have been
insufficient and there would have been a charge of some £60m to the income
statement. The impact of reducing the long-term rate by a further 0.5 per cent
to 4.5 per cent would have increased this charge by some £160m. The primary
reason for the lower level of charge for the initial 0.5 per cent reduction is
the current level of margins in the liability adequacy calculation. The effects
of additional 0.5 per cent reductions in the assumed long-term rate below 4.5
per cent would be of a similar or slightly higher level to the £160m noted
previously.
The effects of changes in any one year reflect the combination of the short-term
and long-term factors described above.
P Inherited Estate of the PAC long-term fund
The assets of the main with-profits fund within the long-term fund of PAC
comprise the amounts that it 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 fund is equal to
the policyholders' accumulated asset shares plus any additional payments that
may be required by way of smoothing or to meet guarantees. The balance of the
assets of the with-profits fund is called the 'inherited estate' and has
accumulated over many years from various sources.
The inherited estate represents the major part of the working capital of PAC's
long-term insurance fund. This enables PAC to support with-profits business by
providing the benefits associated with smoothing and guarantees, by providing
investment flexibility for the fund's assets, by meeting the regulatory capital
requirements that demonstrate solvency and by absorbing the costs of significant
events or fundamental changes in its long-term business without affecting the
bonus and investment policies. The size of the inherited estate fluctuates from
year to year depending on the investment return and the extent to which it has
been required to meet smoothing costs, guarantees and other events.
PAC believes that it would be beneficial if there were greater clarity as to the
status of the Inherited Estate. As a result, PAC has announced that it has begun
a process to determine whether it can achieve that clarity through a
reattribution of the Inherited Estate. As part of this process a Policyholder
Advocate has been nominated to represent policyholders' interests. This
nomination does not mean that a reattribution will occur.
Given the size of the Group's with-profits business any proposal is likely to be
time consuming and complex to implement and is likely to involve a payment to
policyholders from shareholders funds. If a reattribution is completed the
inherited estate will continue to provide working capital for the long-term
insurance fund.
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