Full year results - Part 2

Prudential PLC 2 March 2005 PART 2 FINANCIAL REVIEW SALES AND FUNDS UNDER MANAGEMENT Prudential delivered strong growth in sales during 2004 with total new insurance sales up 40 per cent to Â£12.1 billion at constant exchange rates (CER). This resulted in record insurance sales of Â£1.85 billion on the annual premium equivalent (APE) basis, an increase of 26 per cent on 2003. At reported exchange rates, APE was up 19 per cent on 2003. In 2004, gross written premiums, including insurance renewal premiums, increased 19 per cent to Â£16.4 billion, reflecting the growth of new insurance sales in 2004 and the significant contribution from regular premium business written in previous years. Total gross investment sales for 2004 were Â£25.1 billion, up 21 per cent on 2003 at CER. Net investment sales of Â£3.6 billion were up 23 per cent on last year at CER. The strong growth across a number of markets offset the high level of redemptions in Taiwan, which was the result of market concern about the liquidity of bond funds across the Taiwanese mutual fund market. Total investment funds under management in 2004 increased by 19 per cent from Â£30.9 billion to Â£37.1 billion, reflecting net investment flows of Â£3.6 billion and net market and other movements of Â£2.6 billion. At 31 December 2004, total insurance and investment funds under management were Â£187 billion, an increase of 11 per cent from 2003. This marked a record level of funds under management and the increase was primarily due to the combination of changes in the market value of investments and the impact of net insurance and investment sales achieved during the year. Basis of preparation of results Prudential is required to account for its long-term insurance business on the modified statutory basis (MSB) of reporting under UK accounting standards. The Group's primary financial statements are therefore prepared on this basis and broadly reflect the UK solvency-based reporting regime and, for overseas territories, adjusted local or US GAAP. In broad terms, MSB profits for long-term business reflect the aggregate of statutory transfers from with-profits funds and profits on a traditional deferral and matching approach for other long-term business. Although the statutory transfers from with-profits funds are closely aligned with cash flow generation, the pattern of MSB profits over time from shareholder-backed long-term businesses will generally differ from the cash flow pattern. Over time however, aggregate MSB profits will be the same as aggregate cash flow. Life insurance products are, by their nature, long-term and the profit on this business is generated over a significant number of years. MSB profits do not, in Prudential's opinion, properly reflect the inherent value of these future profit streams. Accordingly, in common with other listed UK life assurers, Prudential also reports supplementary results for its long-term operations on the achieved profits basis. These results are combined with the statutory basis results of the Group's other operations, including fund management and banking businesses. Reference to operating profit relates to profit including investment returns at the expected long-term rate of return, but excludes amortisation of goodwill, exceptional items, short-term fluctuations in investment returns and the effect of changes in economic assumptions. In the directors' opinion, the achieved profits basis provides a more realistic reflection of the current performance of the Group's long-term insurance operations than results on the MSB basis, as it reflects the business performance during the accounting period under review, although both bases should be considered in forming a view of the Group's performance. ACHIEVED PROFITS BASIS RESULTS The achieved profits basis results for long-term business are prepared in accordance with the Association of British Insurers' (ABI) guidance for achieved profits reporting issued in December 2001. This guidance requires that for countries where capital markets are well developed, the economic assumptions used for the projection of cash flows are to be on an 'active' basis, which is primarily based on appropriate government bond returns at each period end. The effects of changed economic assumptions on the adjusted opening balance sheet value are reflected in the profit reported for the year and excluded from operating profit. The active basis is applied to UK and US operations, and those countries in Asia where there are well-developed government bond markets (Japan, Korea and US$-denominated business in Hong Kong). Assumptions in other Asian countries continue to be based on an assessment of long-term economic conditions. In 2004, use of the active basis resulted in a decrease in the risk discount rate applied to the UK insurance operations from 7.4 per cent to 7.2 per cent, and a decrease in the UK investment return assumption for the UK with-profits fund from 6.8 per cent to 6.5 per cent. The decrease primarily reflects decreases in the 15-year gilt yield from 4.8 per cent at the end of 2003 to 4.6 per cent at the end of 2004. The risk margin over the risk free rate was maintained at 2.6 per cent. The expected long-term inflation rate assumption decreased from 3.1 per cent to 2.9 per cent, reflecting the difference between conventional and index-linked gilts. These changes are a function of the active basis rather than a change in Prudential's long-term view of future returns and levels of price inflation. In the US, the risk discount rate has remained at 7.4 per cent. The level of capital required to support the business (the 'target surplus') has been taken, as in 2003, to be 200 per cent of the Company Action Level Risk Based Capital, calculated in accordance with the National Association of Insurance Commissioners' risk-based capital standards for life insurance companies. In Asia, each country has its own specific discount rate. The weighted average risk discount rate, which is determined by weighting each Asian country's economic assumptions by reference to the achieved profits basis operating results for new business written in 2004, was 9.6 per cent in 2004, a decrease from 10.4 per cent in 2003. The discount rates used in various country operations range between 5 per cent to 19 per cent. The weighted risk discount rate declined during 2004 principally due to lower pre-tax expected long-term nominal rates of investment return and lower weighted long-term rate of inflation assumptions due to changes in the geographic mix of business in 2004. The overall impact on the Group's achieved profits basis result for 2004 of using these revised economic assumptions compared with those used in 2003, was a reduction in new business achieved profit (NBAP) of around Â£13 million and a decrease in achieved profits basis shareholders' funds of Â£85 million. Achieved Profits Basis Operating Profits Total achieved profits basis operating profits from continuing operations were Â£1,124 million, up 39 per cent from 2003 at CER. At reported exchange rates, the result was up 31 per cent. This result reflects a combination of strong growth in all the insurance and funds management businesses. Achieved Profits Basis 2004 2003 Percentage 2004 2003 Percentage Operating Profits Change Change (as reported) (at 2004 (as reported) (as reported) exchange rate) Â£'m Â£'m Â£'m Â£'m Insurance business UK and Europe 450 359 25% 450 359 25% US 317 176 80% 317 197 61% Asia 381 328 16% 381 365 4% Development expenses (15) (24) 38% (15) (27) 44% ---- ---- ---- ---- ---- ---- 1,133 839 35% 1,133 894 27% ---- ---- ---- ---- ---- ---- Fund management business M&G 136 83 64% 136 83 64% US broker dealer and fund (14) (3) (367%) (14) (3) (367%) management Asia fund management 19 11 73% 19 13 46% ---- ---- ---- ---- ---- ---- 141 91 55% 141 93 52% ---- ---- ---- ---- ---- ---- Banking Egg (UK) 43 55 (22%) 43 55 (22%) Other income and expenditure (193) (178) (8%) (193) (181) (7%) ---- ---- ---- ---- ---- ---- Operating profits from 1,124 807 39% 1,124 861 31% continuing operations ---- ---- ---- ---- ---- ---- Prudential's insurance business achieved significant growth, both in terms of new business achieved profits (NBAP) and in-force profit, resulting in a 35 per cent increase in operating profit over 2003 at CER. NBAP of Â£688 million was up 23 per cent on the prior year at CER and up 14 per cent at reported exchange rates. In-force profit increased 51 per cent on 2003 at CER to Â£460 million. At reported exchange rates, in-force profit was up 46 per cent. Results from fund management and banking business were Â£184 million, an increase of 26 per cent at CER on 2003. This was mainly driven by the significant contribution from M&G. Other income and expenditure was negative Â£193 million compared with negative Â£178 million at CER in 2003. This reflected an increase in investment return on centrally held assets and other income offset by higher interest payable and head office costs. New Business Achieved Profits (NBAP) In 2004, the Group has generated record new business achieved profits (NBAP) from insurance business of Â£688 million which was 23 per cent above 2003 at CER, driven by strong sales momentum across all markets. At reported exchange rates, NBAP was up 14 per cent. The average Group NBAP margin of 37 per cent was slightly down from 38 per cent in 2003. The overall margin has been broadly maintained over the last two years, reflecting careful management of product mix within each business and across the three regions. NBAP from the UK and Europe Insurance Operations was Â£220 million, an increase of 40 per cent on 2003. This reflected increased APE sales and a balanced shift in sales mix. This positive movement arose due to increased sales of more profitable bulk annuities partially offset by reduced sales of high margin with-profit bonds and increased sales of less profitable executive pensions. Individual and bulk annuity margins remained strong at 43 per cent and 46 per cent respectively, partly as a consequence of nearly all annuity business now being written in Prudential Retirement Income Limited (PRIL), a shareholder backed business. 88 per cent of annuities business was written in shareholder backed funds in 2004, compared with 56 per cent in 2003. Previously, a substantial proportion of annuity business was written in a subsidiary of the with-profits fund. PRIL was established in September 2000, initially to write bulk annuity business. This was expanded to include external individual annuity business and Prudential-branded internal vestings (annuity business sales arising from maturing in-force pension books) in September 2001 and July 2004 respectively. Business to Business (B2B) corporate pensions saw a fall in NBAP margins to 9 per cent principally reflecting a change of mix towards the less profitable unit-linked products. Margins on with-profits bonds remained stable at 41 per cent. As the unit-linked business has gained scale, with sales growing by 219 per cent in 2004, margins have approached a break-even position. In the US, JNL's NBAP of Â£156 million was up 18 per cent on 2003 at CER and up 5 per cent at reported rates. This increase was principally volume driven as a result of high sales levels recorded during the year. The NBAP margin was 34 per cent in 2004, a slight reduction from 35 per cent in 2003 due to a shift in product mix and a small impact from economic assumption changes. Jackson National Life's expense ratio has fallen 3 basis points from 2002 to stand at 46 basis points at the end of 2004. We believe Jackson benefits from its considerable expense advantage relative to its principal competitors enabling it to maintain these attractive margins. The margin achieved on variable annuity business in 2004 was 37 per cent compared with 36 per cent in 2003. This improvement is a result of pricing changes instituted early in 2004. For fixed annuity business the margin declined by 9 per cent over the last 2 years to 32 per cent at the end of 2004. The reduction in margin is due to a lower fund earned rate as yields have declined, however target spreads have been maintained. In Asia, NBAP of Â£312 million was up 19 per cent at CER on 2003, reflecting a combination of increased sales and higher NBAP margin. During 2004, APE sales were up 14 per cent on 2003 and the NBAP margin was 54 per cent, compared with 52 per cent in 2003 at CER. The increase in margin was principally due to a combination of changes in country mix and product mix being offset by the impact of assumption changes. In-Force Achieved Profits Total in-force profit in 2004 was Â£460 million, an increase of 51 per cent on 2003 at CER. This was driven by the significant increase in the in-force profit in the US. UK and European in-force profit of Â£230 million was up 19 per cent on 2003. The profits arising from the unwind of discount from the in-force book were partially offset by adverse operating assumption changes and other experience charges. A charge of Â£66 million was made reflecting a 40 per cent strengthening of the persistency assumptions on the closed-book of personal pensions business sold through the closed direct sales force channel. This assumption change reflects Prudential UK's experience over the last three years and, post-tax, represents about 1 per cent of the overall embedded value of the UK business. Measures to manage and improve the conservation of in-force business have had a beneficial effect on persistency that Prudential UK expects to maintain or improve. Consequently, Prudential UK has not changed persistency assumptions for all other products. Other charges of Â£34 million include Â£21 million of costs associated with complying with new regulatory requirements and restructuring. In the US, the in-force profit of Â£161 million was more than three times higher than in 2003. This growth reflects improvements from 2003 in net experience variances to positive Â£33 million (an increase of Â£46 million at CER), changes in operating assumptions to negative Â£3 million (an increase of Â£16 million at CER) and changes in other items to positive Â£12 million (an increase of Â£37 million at CER). Included in other items is a Â£28 million favourable legal settlement. The Â£33 million positive total experience variance includes a Â£43 million positive spread variance (net of risk margin reserve) primarily reflecting a favourable variance in the fixed annuity portfolio. The assumed spread on new fixed annuity business is 155 basis points grading to 175 basis points over five years. Asia's in-force profit (before development expenses and the Asian fund management business) increased to Â£69 million in 2004 from Â£67 million in 2003 at CER. This reflects a higher unwind of the discount rate as the in-force business builds scale and lower experience variances, offset by assumption changes of Â£56 million. The assumption changes made in 2004 principally reflect a worsening persistency in Singapore and a revision to expense assumptions in Vietnam. Non-insurance Operations M&G M&G's operating profit was Â£136 million, an increase of 64 per cent on last year. This included Â£26 million in performance-related fees (PRF), of which Â£20 million was generated by PPM Ventures on the exceptionally profitable realisation of several investments during the year. Underlying profits of Â£110 million were 57 per cent higher than 2003, achieved as a result of a strong performance across all of M&G's business lines. Significant growth was delivered in the areas of fixed income, retail and property; attributable to the continued development of new business streams and the recovery in stock markets during 2004. In addition, underlying profits were also boosted by Â£7 million of one-off provision releases in 2004 that will not recur in future years. M&G's revenue growth continues to be combined with careful cost control. In 2004, M&G enjoyed the first full year of savings from the outsourcing of retail administration at the end of 2003. This, together with the tight management of overhead across the entire business, has resulted in costs remaining flat for the last four years. US broker dealer and fund management businesses The broker dealer and fund management operations, which includes Curian Capital, reported a total loss of Â£14 million, compared with a Â£3 million loss in 2003. This primarily reflects increased losses at Curian Capital as the business continues to build scale. Asian fund management business Profit from Asian fund management operations was Â£19 million, up 73 per cent from 2003, reflecting a combination of increasing scale and profitability in the retail business, particularly from the joint venture with ICICI in India, and higher management fees from the UK and Asian life businesses. Egg Egg's total continuing operating profit in 2004 was Â£43 million, compared with Â£55 million in 2003, reflecting an increase in profit from the UK business offset by a Â£17 million impairment charge on the underlying assets of Funds Direct. Egg's UK business delivered a good set of results with a particularly encouraging performance in the second half of 2004. For the full year, a profit of Â£74 million was recorded, compared with Â£73 million in 2003. This represents a solid result considering the increased competition and rising interest rates that have impacted the credit card and personal loan markets. Included in the continuing operating results was a charge of Â£3 million, which related to the migration and other exit costs associated with the transfer of the funds supermarket business to Fidelity FundsNetwork. The transfer will result in annual savings of around Â£3 million. Following the decision to dispose of its investment in Funds Direct, its investment wrap platform business, Egg provided for a Â£17 million impairment charge against the full carrying value of the underlying assets of Funds Direct. Others Asia's development expenses (excluding the regional head office expenses) reduced by 38 per cent at CER to Â£15 million, compared with Â£24 million in 2003. These development expenses primarily related to repositioning the insurance operation in Japan. Other net expenditure increased by Â£15 million to Â£193 million. This reflected an increase in investment return and other income offset by higher interest payable and head office costs. Head office costs (including Asia regional head office costs of Â£29 million) were Â£83 million, up Â£16 million on 2003. The increase mainly reflects the substantial work being undertaken for the implementation of International Financial Reporting Standards, Sarbanes Oxley and other regulatory costs. Total Achieved Profits Basis - Result Before Tax (Year-on-year comparisons below are based on reported exchange rates.) The result before tax and minority interests was a profit of Â£1,521 million, up 82 per cent on 2003. This primarily reflects the strong operating profit from continuing operations of Â£1,124 million and the lower negative effect of changes in economic assumption of Â£100 million, compared with negative Â£540 million in 2003. The result also benefited from strong investment performance which was ahead of the long-term investment assumptions. The UK component of short-term fluctuations in investment returns of Â£402 million reflects the difference between an actual investment return delivered for the with-profits life fund of 13.4 per cent and the long-term assumed return of 6.5 per cent. Short-term investment fluctuations in the US were Â£207 million. This includes a positive Â£161 million which represents the difference between actual net bond gains and the five-year average amount included in operating profit, and a positive Â£24 million in relation to changed expectations of future profitability on in-force variable annuity business, due to the separate account return exceeding the long-term return reported in operating profit. In 2004, actual net bond gains were Â£48 million, compared with Â£39 million of bond losses in 2003. In Asia, short-term investment fluctuations were Â£48 million, compared with Â£1 million last year. This mainly reflects the rising equity markets in a number of countries and falling bond yields in Singapore. In the UK, economic assumption changes of negative Â£19 million reflect the impact of the decrease in the future investment return assumption offset by the decrease in the risk discount rate. In the US, economic assumption changes were negative Â£53 million and included a reduction in the projected earned rate, a reduction in the spread assumption for equity-linked indexed annuities business in-force prior to 2002 and an increase in inflation rates. Asia's negative economic assumption change of Â£28 million primarily reflects a change in Taiwan as a result of an increase in the discount rate and a change in the fund earned rate assumption. Amortisation of goodwill was Â£97 million in 2004 compared to Â£98 million in 2003. Profits on the disposals of Jackson Federal Bank and the Group's 15 per cent interest in Life Assurance Holding Corporation Limited were Â£41 million and Â£7 million respectively. In France, an exit cost provision of Â£113 million was established in July 2004 following Egg's announcement of its intention to withdraw from the French market. Â£96 million of the provision had been used by 31 December 2004 and it is expected that the withdrawal can be completed within the provision established. Total Achieved Profits Basis - Result After Tax The result after tax of Â£485 million and minority interests of positive Â£10 million, was a profit of Â£1,046 million. The effective tax rate at an operating profit level was 29 per cent, reflecting the lower effective tax rates in the UK and certain Asian territories. The effective tax rate at a total achieved profit level was 32 per cent on a profit of Â£1,521 million. The higher effective rate of tax compared with that at an operating profit level is primarily due to amortisation of goodwill not being deductible for tax purposes. MODIFIED STATUTORY BASIS (MSB) RESULTS MSB Operating Profits MSB Operating Profits 2004 2003 Percentage 2004 2003 Percentage Change Change (as reported) (at 2004 (as reported) (as reported) exchange rate) Â£'m Â£'m Â£'m Â£'m Insurance business UK and Europe 305 256 19% 305 256 19% US 196 128 53% 196 143 37% Asia 126 77 64% 126 85 48% Development expenses (15) (24) 38% (15) (27) 44% ---- ---- ---- ---- ---- ---- 612 437 40% 612 457 34% ---- ---- ---- ---- ---- ---- Fund management business M&G 136 83 64% 136 83 64% US broker dealer and fund (14) (3) (367%) (14) (3) (367%) management Asia fund management 19 11 73% 19 13 46% ---- ---- ---- ---- ---- ---- 141 91 55% 141 93 52% ---- ---- ---- ---- ---- ---- Banking Egg (UK) 43 55 (22%) 43 55 (22%) Other income and expenditure (193) (178) 8% (193) (181) 7% ---- ---- ---- ---- ---- ---- Operating profits from 603 405 49% 603 424 42% continuing operations ---- ---- ---- ---- ---- ---- Reference to operating profit relates to profit including investment returns at the expected long-term rate of return but excludes amortisation of goodwill, exceptional items and short-term fluctuations in investment returns. Group operating profit from continuing operations on the modified statutory basis (MSB) was Â£603 million, an increase of 49 per cent from 2003 at CER. At reported exchange rates, operating profit was up 42 per cent on last year. This reflects strong growth in insurance and funds management businesses. In the UK, MSB operating profit was Â£305 million in 2004, an increase of 19 per cent on 2003. This included a four-fold increase in PRIL's profit from Â£31 million to Â£124 million. This more than offset the Â£17 million reduction in the profit from the with-profits fund, which fell due to lower annual and terminal bonus rates announced in February 2004. In the US, JNL's operating profit from continuing operations of Â£182 million was up 46 per cent on 2003. Total MSB operating profit for long-term business from continuing operations was Â£196 million, up 53 per cent from Â£128 million in 2003. Growth in the long-term business operating profit reflects JNL's clear focus on profitability and its ability to deliver improved investment returns. In 2004, spread income was Â£169 million higher than in 2003 and variable annuity fee income was at a record level due to the significant growth (47 per cent) in separate account assets. In addition, there were two one-off items, a favourable legal settlement of Â£28 million and a positive Â£8 million adjustment arising from the adoption of SOP 03-01 'Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration Contracts and for Separate Accounts'. This adjustment relates to a change in the method of valuing certain liabilities. Prudential Corporation Asia's operating profit for long-term business before development expenses of Â£15 million was Â£126 million, an increase of 64 per cent on 2003 at CER. At reported rates, operating profit was 48 per cent up on last year. The majority of this profit currently still comes from the larger and more established operations of Singapore, Hong Kong and Malaysia, which represented Â£110 million of the total in 2004, compared to Â£86 million last year. Five life operations made MSB losses; China, India and Korea reflecting their rapid building of scale while Thailand is marginally loss making and Japan's loss reduced significantly over 2003 due to lower new business strain, reduced management expenses and mark to market gains on investments. Total MSB Profits - Result Before Tax (Year-on-year comparisons below are based on reported exchange rates.) MSB profits before tax and minority interests were Â£650 million in 2004, compared with Â£350 million in 2003. This mainly reflects growth in operating profits of Â£227 million and improvement in short-term fluctuations in investment return, up Â£138 million from last year to positive Â£229 million. Amortisation of goodwill was Â£97 million in 2004 compared with Â£98 million in 2003. Profits on the disposals of Jackson Federal Bank and the Group's 15 per cent interest in Life Assurance Holding Corporation Limited were Â£41 million and Â£7 million respectively. In France, an exit cost provision of Â£113 million was established in July 2004 following Egg's announcement of its intention to withdraw from the French market. Â£96 million of the provision had been used by 31 December 2004 and it is expected that the withdrawal can be completed within the provision established. Total MSB Profits - Result After Tax MSB profit after tax and minority interests was Â£428 million, after a tax charge of Â£232 million. The effective tax rate at an operating profit level was 30 per cent, a blend of the effective tax rates of 35 per cent in the US, 33 per cent in Asia and 28 per cent in the UK. The effective tax rate of 28 per cent on the UK results reflects the basis of taxation on profits arising from the life fund. The effective tax rate at a total MSB profit level was 36 per cent on a profit of Â£650 million. The higher effective rate of tax compared with that at an operating profit level is primarily due to amortisation of goodwill not being deductible for tax purposes. Earnings per Share Earnings per share, based on achieved profits basis operating profit after tax and related minority interests, but before amortisation of goodwill, were up 11.8 pence to 37.2 pence. The 2003 figure has been restated from 26.4 pence to 25.4 pence to adjust for the bonus element of the Rights Issue. Earnings per share, based on MSB operating profit after tax and related minority interests, but before amortisation of goodwill, were 19.2 pence, compared with a restated 2003 figure of 12.4 pence. Basic earnings per share, based on total achieved profits basis profit for the year after minority interests, were 49.1 pence, compared with a restated figure of 23.4 pence in 2003. Basic earnings per share, based on MSB profit for the year after minority interests, were 20.1 pence, 10.1 pence up from a restated 2003 figure of 10.0 pence. Dividend per Share As outlined in the rights issue prospectus, Prudential has maintained its current dividend policy, with the proposed 2004 final dividend payment per share taking account of the bonus element of the rights issue. The shares issued as part of the rights issue were issued at a discount to market price (308 pence per share versus a closing share price of 458 pence per share on the day immediately preceding the announcement of the rights issue). It is therefore necessary to restate the Company's previously reported earnings and previously declared dividends per share for this bonus element. The bonus adjustment is equal to the closing share price on the final day Prudential's shares traded cum-rights (19 October 2004) divided by the theoretical ex-rights price (TERP) as outlined in the attached table: Market price cum-rights (Tuesday 19 October 2004) (pence) A 422.00 Rights issue price (pence) B 308.00 Number of shares pre rights issue (million) C 2,023.29 Number of shares issued through rights issue (million) D 337.22 (A x C) + (B x D) Theoretical ex-rights price (pence) TERP = ------------------ 405.71 C + D Bonus adjustment TERP / A 0.9614 The resulting bonus adjustment factor used for restating earnings and dividends per share using the methodology outlined above is 0.9614. The final dividend per share for 2003 was 10.3 pence after adjusting for the bonus element of the rights issue (10.7 pence before the adjustment). The interim dividend for 2004 was 5.4 pence (5.2 pence after adjustment for the rights issue). The Board recommends a full year dividend per share for 2004 of 15.84 pence, an increase of 3.0 per cent over the full year 2003 dividend of 15.38 pence, after adjustment for the bonus element of the rights issue. The 2004 dividend is covered 1.2 times by post-tax modified statutory basis profit for the financial year after minority interests. Balance sheet Explanation of Balance Sheet Structure The Group's capital on an MSB basis comprises of shareholders' funds Â£4,281 million; subordinated long term and perpetual debt of Â£1,429 million; other senior debt Â£1,761 million and the Fund for Future Appropriations (FFA) Â£16.7 billion. Shareholders' funds include the Â£1,021 million of new share capital allotted as a result of the rights issue in October 2004. 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 FSA regulatory purposes. All of the Group's hybrid which qualifies in this way is held at the Group level and is therefore taken as capital into the parent solvency test under the Financial Groups Directive (FGD). 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 'Innovative Tier 1'. At 31 December 2004, the Group held Â£638 million of Innovative Tier 1 capital, in the form of perpetual securities, nil Upper Tier 2 and Â£921 million of Lower Tier 2 capital. Following the implementation of the FGD, it is advantageous to the Group from a regulatory capital standpoint to raise its long-term debt in hybrid form and it is the Group's policy to take advantage of favourable market conditions as they arise to do so. The FFA represents assets in the Life Fund which have not yet been allocated either to policyholders or shareholders and which are not available to the Group as a whole other than as they emerge through the statutory transfer of the shareholders' share of the surplus as it emerges from the fund over time. Asset and Liability Management Prudential manages its assets and liabilities locally, in accordance with local regulatory requirements and reflecting the differing types of liabilities Prudential has in each business. As a result of the diversity of products Prudential offers and the different regulatory environments in which it operates, Prudential employs different methods of asset/liability management on both an in-force and new business basis. Stochastic modelling of assets and liabilities is undertaken in the UK, the US and Asia to assess economic capital requirements for different confidence intervals and time horizons. 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, the UK and Asian regulators. Weighted Average Cost of Capital (WACC) Our commitment to our shareholders is to maximise the value of Prudential over time by delivering superior financial returns. Prudential's weighted average cost of capital (WACC) is 8.7 per cent, which is based on the net core debt and shares outstanding at the end of 2004, an equity market premium of 3 per cent and a market Beta of 1.6. Prudential's core debt at the end of 2004 is net of the rights issue proceeds which have increased the proportion of the Group's capital funded by equity and therefore increased the Group's WACC. Rights issue The strength of Prudential's businesses and positive developments in a number of its markets represent an opportunity to enhance its market position and generate improved returns for its shareholders. A strong financial position at a Group level will provide increased financial flexibility and allow Prudential to capitalise on these opportunities as they arise. In response to these developments the Board took the decision in October 2004 to launch a 1 for 6 Rights Issue. The majority of the net proceeds of the rights issue (Â£1,021 million) will be used to provide capital to support Prudential's growth plans for the UK and to fund a potential opportunity to increase its ownership from 26 per cent to 49 per cent of its joint venture life insurance business with ICICI in India. The remainder of the proceeds will be used to ensure that Prudential meets the parent company solvency test under the EU Financial Group Directive ('FGD') that became effective from 1 January 2005. The proceeds of the Rights issue have initially been invested centrally within the Group in fixed interest securities. Shareholders' Funds On the achieved profits basis, which recognises the shareholders' interest in long-term businesses, shareholders' funds at 31 December 2004 were Â£8.6 billion, up Â£1.6 billion from 31 December 2003. Modified statutory basis (MSB) shareholders' funds, which are not affected by fluctuations in the value of investments in the Group's with-profits funds were Â£4.3 billion, an increase of Â£1.1 billion from 31 December 2003. Internal rate of return (IRR) of insurance operations United Kingdom and Europe 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 2004 was 12 per cent. This reflected an IRR of 20 per cent for annuity products, 7 per cent for unit-linked bonds, 3 per cent for corporate pensions and 1 per cent for protection products. By the financial year ending 2007, Prudential is targeting an IRR of 14 per cent on the capital required to support new business sold in that year in the UK, including individual product targets of 20 per cent for annuity products, 8 per cent for unit-linked bonds, 15 per cent for corporate pensions and 15 per cent for protection products. United States For JNL, the average IRR on new business was 13 per cent which we believe to be above the returns being earned currently in the US life insurance industry. Asia In Asia we have target IRRs on new business at a country level of 10 per cent over the country risk discount rate. Risk discount rates vary from 5 per cent to 19 per cent depending upon the maturity of the market. These target rates of return are average rates and the marginal return on capital on a particular product could be above or below the target. We have, however, achieved or exceeded the target in each of Asia's markets in 2004 except for Thailand and Japan. In Japan the returns on capital are below our target, a result of restructuring and withdrawing from some business lines in 2003. The restructured business needs to build scale to achieve its target. In Thailand the returns on capital are below our target as this operation is relatively small. In aggregate, IRR on new business exceeded 20 per cent on average risk discount rates for 2004 of 9.6 per cent. Cash Flow The table below shows the Group holding company cash flow. Prudential believes that this format gives a clearer presentation of the use of the Group's resources than the FRS 1 statement required by UK GAAP. 2004 2003 Â£m Â£m ---- ---- Cash remitted by business units UK life fund transfer * 208 286 UK - other dividends (including special dividend) 100 120 JNL 62 48 Asia 67 48 M&G 84 84 ---- ---- Total cash remitted to group 521 586 Net interest paid (144) (127) Dividends paid (323) (447) Scrip dividends and share options 119 30 ---- ---- Cash remittances after interest and dividends 173 42 Tax received 34 77 Corporate activities (31) 58 ---- ---- Cash flow before investment in businesses 176 177 Capital invested in business units: UK and Europe (189) (23) JNL 0 0 Asia (158) (145) Other 0 (5) ---- ---- (Decrease) / increase in cash before rights issue proceeds (171) 4 Rights issues proceeds 1,021 0 ---- ---- Increase in cash 850 4 ---- ---- * - in respect of prior year bonus declarations The Group received Â£521 million in cash remittances from business units in 2004 (2003: Â£586 million) comprising the shareholders' statutory life fund transfer of Â£208 million relating to earlier bonus declarations, together with dividends and interest from subsidiaries of Â£313 million. The shareholder transfer in 2005 representing 2004's profits from the PAC with-profits fund, is expected to be approximately Â£198 million. Prudential UK Insurance Operations paid a Â£100 million special dividend from the PAC shareholders' funds in respect of profits arising from earlier business disposals. A similar amount will also be distributed from PAC shareholders' funds in 2005. The level of scrip dividend take-up in 2004 (for both the 2003 final and 2004 interim dividend) was greater than the corresponding take-up in 2003, in part due to the change in basis of the election offered to shareholders. After dividends and interest paid, there was a net inflow of Â£173 million (2003: Â£42 million). During 2004, the Group invested Â£31 million in corporate activities (2003: Â£58 million receipt, arising from disposal proceeds and exceptional tax receipts). The Group invested Â£347 million during 2004 in its business units (2003: Â£173 million). Investment in the UK Insurance Operations amounted to Â£189 million. This amount is expected to increase to around Â£250 million in 2005. Investment in Asia in 2004 of Â£158 million is expected to remain broadly the same in 2005. In 2006, based on current plans and expectations, Prudential expects Asia to be a net capital provider to the Group. Together with the proceeds from the rights issue of Â£1,021 million, there was a total increase in cash of Â£850 million (2003: Â£4 million). Shareholders' Borrowings and Financial Flexibility As a result of the holding company's net funds inflow of Â£850 million and exchange conversion gains of Â£49 million, net core borrowings at 31 December 2004 were Â£1,236 million, compared with Â£2,135 million at 31 December 2003. After adjusting for holding company cash and short-term investments of Â£1,561 million, core structural borrowings of shareholder-financed operations at the end of 2004 totalled Â£2,797 million, compared with Â£2,567 million at the end of 2003. This increase reflected the issue of US$250 million (Â£137 million at transaction rate) Perpetual Subordinated Capital Securities and additional short-term borrowings of Â£150 million, partially offset by exchange conversion gains of Â£57 million. Core long-term loans at the end of 2004 included Â£1,762 million at fixed rates of interest with maturity dates ranging from 2005 to perpetuity. Â£898 million of the core borrowings were denominated in US dollars, to hedge partially the currency exposure arising from the Group's investment in Jackson National Life (JNL). Prudential has in place an unlimited global commercial paper programme. At 31 December 2004 commercial paper of Â£517 million, US$761 million and â‚¬445 million had been issued under this programme. Prudential also has in place a Â£5,000 million medium-term note (MTN) programme. At 31 December 2004 subordinated debt outstandings under this programme were Â£435 million and â‚¬520 million, and senior debt outstandings were US$18 million. In addition the holding company has access to Â£1,400 million committed revolving credit facilities, provided by 14 major international banks and a Â£500 million committed securities lending liquidity facility. These facilities have not been drawn on during the year. The commercial paper programme, the MTN programme, the committed revolving credit facilities and the committed securities lending liquidity facility are available for general corporate purposes and to support the liquidity needs of the parent company. The Group is funded centrally, except for Egg, which is responsible for its own financing. The Group's core debt is managed to be within a target level consistent with its current debt ratings. At 31 December 2004, the gearing ratio, on an achieved profit basis including hybrid debt (net of cash and short-term investments) was 13 per cent compared with 23 per cent at 31 December 2003. Prudential plc enjoys strong debt ratings from both Standard & Poor's and Moody's. Prudential long-term senior debt is rated AA- (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 the achieved profits basis operating profit from continuing operations and interest payable on core structural borrowings, interest cover was 8.3 times in 2004 compared with 6.6 times in 2003 (or 7.0 times based on restated achieved profit in 2003). Fund for Future Appropriations During 2004, the fund for future appropriations, which represents the excess of assets over policyholder liabilities for the Group's with-profits funds on a statutory basis, grew to Â£16.7 billion from Â£12.7 billion in 2003. This reflects an increase in the cumulative retained earnings arising on with-profits business that have yet to be allocated to policyholders or shareholders. The change in 2004 predominantly reflects the positive investment return earned by the PAC with-profits fund as a result of investment gains in the UK equity market. Developments in Regulatory Solvency Requirements The Financial Groups Directive ('FGD'), which affects groups with significant cross-sector activities in insurance and banking/investment services, came into force for Prudential from 1 January 2005. Prior to this, since 1 January 2001 Prudential was required to meet the solvency requirements of the Insurance Groups Directive ('IGD'), as implemented by the Financial Services Authority ('FSA'). The FSA has implemented the FGD by applying the sectoral rules of the largest sector, hence a group such as Prudential is classified as an insurance-led conglomerate and is required to focus on the capital adequacy requirements of the IGD, the Fourth Life Directive and the Insurance Company Accounts Directive. The FGD 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. The test is passed when this aggregate number is positive. A negative result at any point in time is a notifiable breach of UK regulatory requirements. Additionally, the FSA has indicated that it will require public disclosure of the FGD solvency position from 31 December 2005, for which the detailed rules on disclosure have yet to be published. 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, and requires public disclosure of the group solvency position from 31 December 2005. Due to the geographically diverse nature of Prudential's operations, the application of these requirements to Prudential are complex. In particular, for many of our Asian operations, the assets, liabilities and capital requirements have to be recalculated based on FSA regulations as if the companies were directly subject to FSA regulation. Our current estimate of our FGD position is that at the end of the year we have a surplus of at least Â£800 million. The European Union is continuing to develop a new prudential framework for insurance companies, 'the Solvency II project'. The main aim of this framework is to ensure the financial stability of the insurance industry and protect policyholders through establishing solvency requirements better matched to the true risks of the business. Like 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. Solvency II is being lead by the European Commission's (EC) Internal Market Director-General. The EC have directed the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) to provide input on many technical aspects of the framework. To this end, the EC and CEIOPS have jointly issued Calls for Advice in order to incorporate broader feedback from industry. The expected outcome of the CEIOPS working groups is a draft directive for the Commission. Final agreement on the terms of the new Directive is not expected before 2007 followed by implementation in 2009. Financial Strength of Insurance Operations United Kingdom A common measure of financial strength in the United Kingdom for long-term insurance business is the free asset ratio. The free asset ratio is the ratio of assets less liabilities to liabilities, and is expressed as a percentage of liabilities. On a comparable basis with 2003, the free asset (or previous regulatory Form 9) ratio of the Prudential Assurance Company (PAC) long-term fund was approximately 14.8 per cent at the end of 2004, compared with 10.5 per cent at 31 December 2003. The valuation has been prepared, in our opinion, on a conservative basis in accordance with the current FSA valuation rules, and without the use of implicit items. No allowance has been taken for the present value of future profits and the PAC long-term fund has not entered into any financial reinsurance contracts. Certain reinsurance treaties with a value of approximately Â£49 million, which were transferred from Scottish Amicable Life when that Company's business transferred into the PAC long-term fund at the end of 2002, were converted into a contingent loan during 2004. The fund is very strong with an inherited estate measured on an essentially deterministic valuation basis of more than Â£6.5 billion compared with approximately Â£6 billion at the end of 2003. On a realistic basis, with liabilities recorded on a market consistent basis, the free assets are valued at around Â£5 billion before a deduction for the risk capital margin. The PAC long-term fund is rated AA+ by Standard & Poor's and Aa1 by Moody's. The table below shows the change in the investment mix of Prudential's main with-profits fund: 1999 2003 2004 % % % UK equities 58% 33% 33% International equities 14% 15% 15% Bonds 13% 31% 29% Property 11% 17% 18% Cash and other asset classes 4% 4% 5% Total 100% 100% 100% For the UK main with-profits fund 86 per cent of fixed income securities are investment grade with 23 per cent rated AA or above. For Prudential Annuities Limited 98 per cent of the fixed income securities are investment grade with 46 per cent rated AA or above. For Prudential Retirement Income Limited 98 per cent of total assets are investment grade with 57 per cent rated AA or above. With-profits contracts are long-term contracts with relatively low guaranteed amounts, the nature of which permits Prudential to invest primarily in equities and property. However, over the period from 1999 to mid-2001 the fund reduced its exposure to equities. There was also a re-weighting within equities out of the UK and into overseas equities. This change in asset mix reflected Prudential's view that equity valuations were high and that other assets, particularly corporate bonds, were relatively attractive. The change within equities improved the fund's diversification and reduced expected fund volatility. The change in 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 13.4 per cent in the year to 31 December 2004 compared with the rise in the FTSE All Share (Total Return) Index of 12.8 per cent over the same period. Over the last ten years the with-profits fund has consistently generated positive fund returns with 3, 5 and 10 year compound returns of 6.7 per cent per annum, 3.8 per cent per annum and 10.3 per cent per annum respectively. These returns demonstrate the benefits of the fund's strategic asset allocation and long-term outperformance. During 2004 there was no change to the strategic asset allocation of the fund. There has been no significant reduction in the level of the fund's equity holdings during the year or subsequently. United States The capital adequacy position of Jackson National Life remains strong, with a strong risk-based capital ratio of 4.3 times the NAIC Company Action Level Risk Based Capital. JNL's financial strength is rated AA by Standard & Poor's (negative outlook) and A1 by Moody's. JNL's invested asset mix on a US regulatory basis (including Jackson National Life of New York but excluding policy loans and reverse repo leverage) is as follows: 2002 2003 2004 % % % Bonds: Investment Grade Public 60 58 60 Investment Grade Private 20 19 19 Non Investment Grade Public 4 5 4 Non Investment Grade Private 3 2 2 Commercial Mortgages 8 10 11 Private equities and real estate 3 4 3 Equities, cash and other assets 2 2 1 Total 100% 100% 100% Asia Prudential Corporation Asia maintains solvency margins in each of its operations so that these are at or above the local regulatory requirements. Across the region less than 20 per cent of non-linked funds are invested in equities. In the life operations with larger in-force books, both Singapore and Malaysia have discrete life funds, good investment returns and in 2004 saw their free asset ratios increase. The Hong Kong life operation is a branch of UK's Prudential Assurance Company Limited and its solvency is covered by that operation. Taiwan has Risk Based Capital regulatory solvency margins and Prudential ensures sufficient capital is retained in the business to cover these requirements. Inherited Estate 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 Sub-Fund 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: â€¢ providing the benefits associated with smoothing and guarantees; â€¢ providing investment flexibility for the fund's assets; â€¢ meeting the regulatory capital requirements, which demonstrate solvency; â€¢ absorbing the costs of significant events, or fundamental changes in its long-term business without affecting 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. The Company believes that it would be beneficial if there were greater clarity as to the status of the inherited estate and therefore it has discussed with the Financial Services Authority (FSA) the principles that would apply to any re-attribution of the inherited estate. No conclusions have been reached. Furthermore, 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 has not considered 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. Hence policyholders' pay-out values have been unaffected by personal pension mis-selling. 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. The assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing. This review was completed on 30 June 2002 and consequently the assurance has not applied to new business issued since 1 January 2004. New business in this context consists of new policies, new members to existing pension schemes plus regular and single premium top-ups, transfers and switches to existing arrangements. The assurance will continue to apply to any policy in force as at 31 December 2003, both for premiums paid before 1 January 2004 and for subsequent regular premiums (including future fixed, retail price index or salary related increases and Department for Work and Pensions rebates). The maximum amount of capital support available under the terms of the assurance will reduce over time as claims are paid on the policies covered by it. The bonus and investment policy for each type of with-profits policy is the same irrespective of whether the assurance applies. Hence removal of the assurance for new business has had no impact on policyholder returns and this is expected to continue for the foreseeable future. Defined Benefit Pension Schemes The Group operates three defined benefit schemes in the UK, of which the principal scheme is the Prudential Staff Pension Scheme (PSPS). The level of surplus or deficit of assets over liabilities for defined benefit schemes is currently measured in three ways, namely the actuarial valuation, SSAP 24, and FRS 17 bases. Defined benefit schemes are generally required to be subject to full actuarial valuation every three years to assess the appropriate level of funding for schemes having regard to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds. PSPS was last actuarially valued as at 5 April 2002 and this valuation demonstrated the Scheme to be 110 per cent funded, with an excess of actuarially determined assets over liabilities of 10 per cent, representing a fund surplus of Â£376 million. As a result, no change in employers' contributions from the current 12.5 per cent of salaries was required. The employers' contribution is required to be paid as a minimum in future years, irrespective of assets in the Scheme and, under the current Scheme rules, access to the surplus through refunds from the Scheme is not available. Accordingly, the surplus is not recognised as an asset in the Group's financial statements that would normally, subject to amortisation, be appropriate under the requirements of SSAP 24 which the Group continues to adopt rather than FRS 17. The continued use of SSAP 24 is permitted under the provisions of FRS 17 until 2005, at which point the requirements of International Accounting Standards, in particular IAS 19, will apply. In the meantime, companies are required to publish details of pension scheme surpluses and deficits on the FRS 17 basis by way of disclosure. Under FRS 17 the basis of valuation differs markedly from the full triennial valuation and SSAP 24 bases. 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 FRS 17 basis assets and liabilities can be volatile for value movements in assets and a basis of setting inflation assumptions that is referenced to market expectations implied within index-linked bonds. For those schemes such as PSPS, which hold a significant proportion of their assets in equity investments, the volatility can be particularly significant. If FRS 17 had been fully implemented for 2004, a Â£10 million shareholder charge (after tax) in the profit and loss account, and a shareholder charge of Â£6 million (after tax) in the statement of total recognised gains and losses would have been reported. Surpluses and deficits on the Group's defined benefit schemes are apportioned to the Prudential Assurance Company (PAC) life fund and shareholders' funds depending on an estimation of the activity of the personnel involved. Such apportionment is necessary to properly reflect the economic interests in and exposures to the schemes' financial position. The aforementioned volatility can be illustrated by considering the movements in the surplus and deficit over the last three years. For the PAC life fund the estimated interest, net of tax, in the pension schemes' FRS 17 basis financial position has changed from a surplus at 31 December 2001 of Â£392 million to a deficit at 31 December 2002 of Â£380 million, a deficit at 31 December 2003 of Â£411 million and a deficit at 31 December 2004 of Â£444 million. For the shareholders' fund the estimated interest, net of tax in the pension schemes' FRS 17 basis financial position has changed from a surplus at 31 December 2001 of Â£101 million to a deficit at 31 December 2002 of Â£85 million, a deficit at 31 December 2003 of Â£101 million, and a deficit at 31 December 2004 of Â£109 million. The modest changes in 2003 and 2004 reflect the negative impact of increased inflation assumptions, that are implicit within the yields on index-linked gilts, being offset by the positive value movements in scheme assets arising from the strong recovery in equity markets. The large reduction in 2002 reflects the steep fall in equity markets in that year. ACHIEVED PROFITS BASIS RESULTS Summarised Consolidated Profit and Loss Account 2004 Â£m 2003 Â£m ---- ---- Operating profit before amortisation of goodwill UK and Europe Insurance Operations 450 359 M&G 136 83 Egg - continuing operations 43 55 - discontinued operations (37) (89) ---- ---- UK and Europe Operations 592 408 US Operations - continuing operations 303 194 - discontinued operations 17 22 Prudential Asia 400 378 Other Income and Expenditure (including Asia development expenses) (208) (208) ---- ---- Operating profit before amortisation of goodwill 1,104 794 ---- ---- Analysed as: Operating profit from continuing operations 1,124 861 Operating loss from discontinued operations (20) (67) ---- ---- Amortisation of goodwill (97) (98) Short-term fluctuations in investment returns 679 682 Effect of changes in economic assumptions (100) (540) Profit or loss on the sale or termination of discontinued operations: Profit on business disposals 48 - Egg France closure cost (113) - ---- ---- Profit on ordinary activities before tax (including actual investment returns) 1,521 838 Tax (485) (355) ---- ---- Profit for the year before minority interests 1,036 483 Minority interests 10 2 ---- ---- Profit for the year after minority interests 1,046 485 Dividends (362) (320) ---- ---- Retained profit for the year 684 165 ---- ---- Earnings Per Share* Based on operating profit after tax and related minority interests before amortisation of goodwill of Â£791m (Â£527m) 37.2p 25.4p Adjustment for amortisation of goodwill (4.6)p (4.7)p Adjustment from post-tax long-term investment returns to post-tax actual investment returns (after related minority interests) 21.5p 22.4p Adjustment for post-tax effect of changes in economic assumptions (3.4)p (19.7)p Adjustment for post-tax profit on business disposals 1.4p - Adjustment for post-tax Egg France closure cost (3.0)p - ---- ---- Based on profit for the year after minority interests of Â£1,046m (Â£485m) 49.1p 23.4p ---- ---- Average number of shares 2,129m 2,076m ---- ---- Dividend Per Share* 15.84p 15.38p ---- ---- * Earnings per share and dividend per share figures for 2003 have been restated to take account of the Rights Issue in 2004. TOTAL INSURANCE AND INVESTMENT NEW BUSINESS Insurance Products and Investment Insurance Products Investment Products Products Gross Premiums Gross Inflows Total 2004 Â£m 2003 Â£m 2004 Â£m 2003 Â£m 2004 Â£m 2003 Â£m ---- ---- ---- ---- ---- ---- UK and Europe Operations 6,538 4,128 5,845 3,797 12,383 7,925 US Operations 4,420 4,066 418 159 4,838 4,225 Prudential Asia 1,172 989 18,845 18,157 20,017 19,146 ---- ---- ---- ---- ---- ---- Group Total 12,130 9,183 25,108 22,113 37,238 31,296 ---- ---- ---- ---- ---- ---- Insurance Products - New Business Single Regular Annual Premium Equivalents Premiums 2004 Â£m 2003 Â£m 2004 Â£m 2003 Â£m 2004 Â£m 2003 Â£m ---- ---- ---- ---- ---- ---- UK and Europe Insurance Operations Direct to customer Individual annuities 630 657 - - 63 66 Individual pensions and life 19 22 10 12 12 14 Department of Work and Pensions 265 280 - - 27 28 rebate business ---- ---- ---- ---- ---- ---- Total 914 959 10 12 102 108 ---- ---- ---- ---- ---- ---- Business to Business Corporate pensions 153 168 137 127 152 144 Individual annuities 229 223 - - 23 22 Bulk annuities 474 287 - - 47 29 ---- ---- ---- ---- ---- ---- Total 856 678 137 127 222 195 ---- ---- ---- ---- ---- ---- Intermediated distribution Life 1,001 818 5 22 105 104 Individual annuities 1,180 828 - - 118 83 Individual and corporate pensions 189 120 25 29 44 41 Department of Work and Pensions 89 103 - - 9 10 rebate business ---- ---- ---- ---- ---- ---- Total 2,459 1,869 30 51 276 238 ---- ---- ---- ---- ---- ---- Partnerships Life 790 293 2 - 81 29 Individual and bulk annuities 1,249 52 - - 125 5 ---- ---- ---- ---- ---- ---- Total 2,039 345 2 - 206 34 ---- ---- ---- ---- ---- ---- Europe 89 87 2 - 11 9 ---- ---- ---- ---- ---- ---- Total UK and Europe Insurance 6,357 3,938 181 190 817 584 Operations ---- ---- ---- ---- ---- ---- US Operations Fixed annuities 1,130 1,375 - - 113 138 Equity linked indexed annuities 429 255 - - 43 25 Variable annuities 1,981 1,937 - - 198 194 Life 16 - 12 13 14 13 Guaranteed Investment Contracts 180 183 - - 18 18 GIC - Medium Term Notes 672 303 - - 67 30 ---- ---- ---- ---- ---- ---- Total 4,408 4,053 12 13 453 418 ---- ---- ---- ---- ---- ---- Prudential Asia China 9 7 16 11 17 12 Hong Kong 255 189 78 83 103 102 India (Group's 26% interest) 5 4 33 16 33 16 Indonesia 38 27 28 31 32 34 Japan 17 9 7 35 9 36 Korea 36 19 60 30 64 32 Malaysia 7 11 61 59 62 60 Singapore 199 181 47 57 67 75 Taiwan 88 28 143 132 151 135 Other 8 7 37 53 38 53 ---- ---- ---- ---- ---- ---- Total 662 482 510 507 576 555 ---- ---- ---- ---- ---- ---- Group Total 11,427 8,473 703 710 1,846 1,557 ---- ---- ---- ---- ---- ---- Annual Premium Equivalents are calculated as the aggregate of regular new business premiums and one tenth of the single new business premiums. Investment Products - Funds Under Management (FUM) FUM Gross Redemptions Market and FUM other 1 Jan 2004 Inflows Movements 31 Dec 2004 ---- ---- ---- ---- ---- Â£m Â£m Â£m Â£m Â£m UK and Europe Operations 24,192 5,845 (3,841) 2,509 28,705 US Operations 148 418 (31) 15 550 Prudential Asia 6,596 18,845 (17,647) 38 7,832 ---- ---- ---- ---- ---- Group Total 30,936 25,108 (21,519) 2,562 37,087 ---- ---- ---- ---- ---- ACHIEVED PROFITS BASIS RESULTS Operating Profit before Amortisation of Goodwill Restated Results Analysis by Business Area 2004 Â£m 2003 Â£m ---- ---- UK and Europe Operations Insurance Operations: New business 220 166 Business in force 230 193 ---- ---- Long-term business 450 359 M&G 136 83 Egg* 43 55 ---- ---- Total* 629 497 ---- ---- US Operations New business 156 148 Business in force* 161 49 ---- ---- Long-term business* 317 197 Broker dealer and fund management (14) (3) ---- ---- Total* 303 194 ---- ---- Prudential Asia New business 312 291 Business in force 69 74 ---- ---- Long-term business 381 365 Fund management 19 13 Development expenses (15) (27) ---- ---- Total 385 351 ---- ---- Other Income and Expenditure Investment return and other income 44 29 Interest payable on core structural borrowings (154) (143) Corporate expenditure: Group Head Office (54) (43) Asia Regional Head Office (29) (24) ---- ---- Total (193) (181) ---- ---- Operating profit from continuing operations before amortisation of goodwill 1,124 861 ---- ---- Analysed as profits (losses) from: New business 688 605 Business in force 460 316 ---- ---- Long-term business 1,148 921 Asia development expenses (15) (27) Other operating results (9) (33) ---- ---- Total 1,124 861 ---- ---- * The results for Egg and US Operations exclude the results of discontinued operations as set out below: Egg France (37) (89) Jackson Federal Bank 17 22 ---- ---- Operating loss from discontinued operations before amortisation of goodwill (20) (67) ---- ---- ACHIEVED PROFITS BASIS RESULTS Restated Summarised Consolidated Balance Sheet 2004 Â£m 2003 Â£m ---- ---- Total assets less liabilities, excluding insurance funds 149,050 136,346 Less insurance funds: Technical provisions (net of reinsurers' share) 128,083 120,449 Fund for future appropriations 16,686 12,657 Less shareholders' accrued interest in the long-term business (4,315) (3,765) ---- ---- 140,454 129,341 ---- ---- Total net assets 8,596 7,005 ---- ---- Share capital 119 100 Share premium 1,558 553 Statutory basis retained profit 2,604 2,587 Additional achieved profits basis retained profit 4,315 3,765 ---- ---- Shareholders' capital and reserves 8,596 7,005 ---- ---- Restated Movement in Shareholders' Capital and Reserves 2004 Â£m 2003 Â£m ---- ---- Profit for the year after minority interests 1,046 485 Exchange movements, net of related tax of Â£12m (Â£18m) (229) (348) Proceeds from Rights Issue, net of expenses 1,021 - Other new share capital subscribed 119 30 Dividends (362) (320) Consideration paid for own shares (4) (3) Movement in cost of own shares - 1 ---- ---- Net increase (decrease) in shareholders' capital and reserves 1,591 (155) Shareholders' capital and reserves at beginning of year: As originally reported 7,043 7,196 Prior year adjustment on implementation of UITF 38 (38) (36) ---- ---- As restated 7,005 7,160 ---- ---- Shareholders' capital and reserves at end of year 8,596 7,005 Comprising ---- ---- UK and Europe Operations: Long-term business 4,051 3,424 M&G 312 336 Egg 269 348 ---- ---- 4,632 4,108 US Operations 2,596 2,490 Prudential Asia 1,738 1,419 Other operations (including central goodwill and borrowings) (370) (1,012) ---- ---- 8,596 7,005 ---- ---- ACHIEVED PROFITS BASIS RESULTS Basis of Preparation of Results The achieved profits basis results have been prepared in accordance with the guidance issued by the Association of British Insurers in December 2001 'Supplementary Reporting for long-term insurance business (the achieved profits method)'. Under this guidance, the basis for setting long-term expected rates of return on investments and risk discount rates are, for countries with developed long-term fixed income securities markets, set by reference to period end rates of return on fixed income securities. This 'active' basis of assumption setting has been applied in preparing the results of the Group's UK, Europe and US operations. For the Group's Asian operations, the active basis is appropriate for business written in Japan and Korea and US dollar denominated business written in Hong Kong. For countries where long-term fixed income securities markets are underdeveloped, investment return assumptions and risk discount rates are based on an assessment of long-term economic conditions. Except for the countries listed above, this basis is appropriate to the Group's Asian operations. The key economic assumptions are set out below: 2004 2003 UK and Europe Insurance Operations Pre-tax expected long-term nominal rate of investment return: UK equities 7.1% 7.3% Overseas equities 6.8% to 7.8% 6.6% to 7.9% Property 6.3% 6.6% Gilts 4.6% 4.8% Corporate bonds 5.5% 5.8% PAC with-profits fund assets (applying the rates listed above to the investments held by the fund) 6.5% 6.8% Expected long-term rate of inflation 2.9% 3.1% Post-tax expected long-term nominal rate of return: Pension business (where no tax applies) 6.5% 6.8% Life business 5.7% 5.9% Risk margin included within the risk discount rate 2.6% 2.6% Risk discount rate 7.2% 7.4% US Operations (Jackson National Life) Expected long-term spread between earned rate and rate credited to policyholders 1.75% 1.75% US 10 year treasury bond rate at end of year 4.3% 4.3% Risk margin included within the risk discount rate 3.1% 3.1% Risk discount rate 7.4% 7.4% Prudential Asia Weighted pre-tax expected long-term nominal rate of investment return* 6.6% 7.4% Weighted expected long-term rate of inflation 3.0% 3.4% Weighted risk discount rate 9.6% 10.4% The Prudential Asia weighted economic assumptions have been determined by weighting each country's assumptions by reference to the Achieved Profits basis operating results for new business written in the relevant year. * Consistent with prior periods, for the Taiwan operation, the projections include an assumption of phased progression from current rates to the long-term expected rates over a remaining period of 8 years. This takes into account the effect on bond values of rising interest rates. ACHIEVED PROFITS BASIS RESULTS Notes on the Achieved Profits Basis Results (1) The results for 2004 and 2003 have been derived from the achieved profits basis supplements to the Company's statutory accounts for those years. The supplements included unqualified audit reports from the auditors. (2) Under the achieved profits basis, the operating profit from new business represents the profitability of new long-term insurance business written in the year, and the operating profit from business in force represents the profitability of business in force at the start of the year. These results are combined with the statutory basis results of the Group's other operations including banking and fund management business. The effects of short-term fluctuations in in investment returns and the impact of changes in economic assumptions on shareholders' funds at the start of the reporting period are excluded from operating profit but included in total profit. In the directors' opinion, the achieved profits basis results provide a more realistic reflection of the performance of the Group's long-term business than results under the statutory basis. (3) The proportion of surplus allocated to shareholders from the UK with-profits business has been based on the present level of 10%. Future bonus rates have been set at levels which would fully utilise the assets of the with- profits fund over the lifetime of the business in force. STATUTORY BASIS RESULTS Summarised Consolidated Profit and Loss Account 2004 Â£m 2003 Â£m ---- ---- Long-term business gross premiums written (note 3) 16,355 13,781 ---- ---- Profit on ordinary activities before tax 650 350 Tax (note 4) (232) (144) ---- ---- Profit for the year before minority interests 418 206 Minority interests 10 2 ---- ---- Profit for the year after minority interests 428 208 Dividends (note 5) (362) (320) ---- ---- Retained profit (loss) for the year 66 (112) ---- ---- Reconciliation of operating profit to profit on ordinary activities Operating profit (loss) before amortisation of goodwill: Continuing operations 603 424 Discontinued operations (note 6) (20) (67) ---- ---- 583 357 Amortisation of goodwill (97) (98) ---- ---- Operating profit based on long-term investment returns 486 259 Short-term fluctuations in investment returns 229 91 Profit or loss on the sale or termination of discontinued operations: Profit on business disposals (note 6) 48 - Egg France closure cost (note 6) (113) - ---- ---- Profit on ordinary activities before tax 650 350 ---- ---- Earnings Per Share* Based on operating profit after tax and related minority interests before amortisation of goodwill of Â£408m (Â£257m) 19.2p 12.4p Adjustment for amortisation of goodwill (4.6)p (4.7)p Adjustment from post-tax long-term investment returns to post-tax actual investment returns (after related minority interests) 7.1p 2.3p Adjustment for post-tax profit on business disposals 1.4p - Adjustment for post-tax Egg France closure cost (3.0)p - ---- ---- Based on profit for the year after minority interests of Â£428m (Â£208m) 20.1p 10.0p ---- ---- Average number of shares 2,129m 2,076m ---- ---- Dividend Per Share* 15.84p 15.38p ---- ---- * Earnings per share and dividend per share figures for 2003 have been restated to take account of the Rights Issue in 2004. STATUTORY BASIS RESULTS Operating Profit before Amortisation of Goodwill Restated Results Analysis by Business Area 2004 Â£m 2003 Â£m ---- ---- UK and Europe Operations UK and Europe Insurance Operations 305 256 M&G 136 83 Egg* 43 55 ---- ---- Total* 484 394 ---- ---- US Operations Jackson National Life* 196 143 Broker dealer and fund management (14) (3) ---- ---- Total* 182 140 ---- ---- Prudential Asia Long-term business 126 85 Fund management 19 13 Development expenses (15) (27) ---- ---- Total 130 71 ---- ---- Other Income and Expenditure Investment return and other income 44 29 Interest payable on core structural borrowings (154) (143) Corporate expenditure: Group Head Office (54) (43) Asia Regional Head Office (29) (24) ---- ---- Total (193) (181) ---- ---- Operating profit from continuing operations before amortisation of goodwill 603 424 ---- ---- * The results for Egg and Jackson National Life exclude the results of discontinued operations as set out below: Egg France (37) (89) Jackson Federal bank 17 22 ---- ---- Operating profit from discontinued operations before amortisation of goodwill (20) (67) ---- ---- STATUTORY BASIS RESULTS Consolidated Statement of Total Recognised Gains and Losses 2004 Â£m 2003 Â£m ---- ---- Profit for the year after minority interests 428 208 Exchange movements, net of related tax of Â£12m (Â£18m) (161) (253) ---- ---- Total recognised gains (losses) relating to the financial period 267 (45) ---- ---- Restated (note 2) Movement in Shareholders' Capital and Reserves 2004 Â£m 2003 Â£m ---- ---- Total recognised gains (losses) relating to the financial period 267 (45) Proceeds from Rights Issue, net of expenses 1,021 - Other new share capital subscribed 119 30 Dividends (362) (320) Consideration paid for own shares (4) (3) Movement in cost of own shares - 1 ---- ---- Net increase (decrease) in shareholders' capital and reserves 1,041 (337) ---- ---- Shareholders' capital and reserves at beginning of year: As previously reported 3,278 3,613 Prior year adjustment on implementation of UITF 38 (38) (36) ---- ---- As restated 3,240 3,577 ---- ---- Shareholders' capital and reserves at end of year 4,281 3,240 ---- ---- STATUTORY BASIS RESULTS Restated Summarised Consolidated Balance Sheet 2004 Â£m 2003 Â£m ---- ---- Assets Goodwill 1,367 1,504 Investments in respect of non-linked business: Land and Buildings 12,367 10,965 Equities 38,426 34,877 Fixed income securities 66,750 64,591 Deposits with credit institutions 6,125 4,088 Other investments 5,987 5,719 ---- ---- 129,655 120,240 Assets held to cover linked liabilities 23,830 19,921 Reinsurers' share of technical provisions 1,018 924 Banking business assets 11,995 12,629 Cash at bank and in hand 1,415 1,221 Deferred acquisition costs 2,908 2,952 Other assets* 2,352 2,318 ---- ---- Total assets 174,540 161,709 ---- ---- Liabilities Share capital 119 100 Share premium 1,558 553 Statutory basis retained profit 2,646 2,625 Cost of shares held in trusts for employee incentive plans* (42) (38) ---- ---- Shareholders' capital and reserves* 4,281 3,240 Minority interests 71 107 Subordinated liabilities (note 7) 1,429 1,336 Fund for future appropriations* 16,686 12,657 Technical provisions in respect of non-linked business 104,964 101,178 Technical provisions for linked liabilities 24,137 20,195 Deferred tax 1,522 1,154 Debenture loans (note 7) 1,761 1,781 Other borrowings (note 7) 1,483 1,328 Banking business liabilities 11,217 11,681 Obligations of Jackson National Life under funding and stocklending arrangements 3,308 3,762 Tax 1,017 851 Final dividend 253 214 Other liabilities* 2,411 2,225 ---- ---- Total liabilities* 174,540 161,709 ---- ---- * The 2003 figures for these lines have been restated as a result of the implementation of UITF 38. STATUTORY BASIS RESULTS FRS1 Consolidated Cash Flow Statement 2004 Â£m 2003 Â£m ---- ---- Operations Net cash inflow from operating activities 93 88 ---- ---- Servicing of finance Interest paid (207) (172) ---- ---- Tax Tax received 72 128 ---- ---- Acquisitions and disposals Net cash inflow from disposal of European business - 27 ---- ---- Equity dividends Equity dividends paid (323) (447) ---- ---- Net cash outflow before financing (365) (376) ---- ---- Financing Issue of borrowings 111 829 Reduction in credit facility utilised by investment subsidiaries managed by PPM America (31) (151) Issues of ordinary share capital, net of expenses of Â£23m (Â£nil) 1,140 30 ---- ---- Net cash inflow from financing 1,220 708 ---- ---- Net cash inflow for the year 855 332 ---- ---- The net cash inflow was invested as follows: Net purchases (sales) of portfolio investments 843 (149) Increase in cash and short-term deposits, net of overdrafts 12 481 ---- ---- 855 332 ---- ---- In accordance with FRS 1, this statement excludes the cash flows of long-term business funds. The reconciliation from operating profit to net cash inflow from operating activities is summarised below: 2004 Â£m 2003 Â£m ---- ---- Operating profit before amortisation of goodwill 583 357 Add back interest charged to operating profit* 213 189 Adjustments for non-cash items: Tax on long-term business profits (195) (150) Amounts retained in long-term business operations and Egg, timing differences and other items (508) (308) ---- ---- Net cash inflow from operating activities (as shown above) 93 88 ---- ---- *This adjustment comprises interest payable on core structural borrowings, commercial paper and other borrowings, non-recourse borrowings of investment subsidiaries managed by PPM America and structural borrowings of Egg. Interest payable on long-term business with-profits fund borrowings and other trading activities has been excluded from this adjustment. STATUTORY BASIS RESULTS Notes on the Statutory Basis Results (1) The financial information set out above does not constitute the Company's statutory accounts for the years ended 31 December 2004 and 2003 but is, with the exception for 2003 of the change in accounting policy explained in Note 2 below, derived from those accounts. Statutory accounts for 2003 have been delivered to the Registrar of Companies and those for 2004 will be delivered following the Company's Annual General Meeting. The auditors have reported on both those accounts; their reports were unqualified and did not contain statements under section 237 (2) or (3) of the Companies Act 1985. (2) The Company has implemented UITF Abstract 38 - 'Accounting for ESOP Trusts' in preparing its 2004 results which requires the Company to present the cost of acquiring shares held in trusts for employee incentive plans as a deduction in determining shareholders' funds. The effect of the change in policy is to reduce shareholders' funds at 1 January 2004 from the previously published 31 December 2003 level by Â£38m. Comparative balance sheet amounts have been restated accordingly. The impact on the profit and loss account is immaterial. (3) An analysis of long-term business gross premiums written is set out below: 2004 Â£m 2003 Â£m ---- ---- UK and Europe Insurance Operations 9,186 7,264 US Operations 4,717 4,369 Prudential Asia 2,452 2,148 ---- ---- 16,355 13,781 ---- ---- (4) The tax charge of Â£232m (Â£144m) comprises Â£26m (Â£22m) UK tax and Â£206m (Â£122m) overseas tax. (5) The directors recommend that the shareholders declare a final dividend for 2004 of 10.65p per share payable on 25 May 2005 to shareholders on the register at the close of business on 18 March 2005. A scrip dividend alternative will be offered to shareholders. After adjusting for the bonus element of the Rights Issue in 2004, the interim dividend for 2004 was 5.19p per share (actual amount paid was 5.4p per share). The total dividend for the year, including the recommended final dividend and the adjusted interim dividend, amounts to 15.84p per share and the total cost of the dividend declared in respect of 2004 is Â£362m. (6) In July 2004, Egg announced that it intended to take the necessary steps to withdraw from the French market at an expected cost of Â£113m. This business, which has been treated as discontinued operations, incurred losses up to the date of announcement of Â£37m (Â£89m). In October 2004, Jackson National Life sold Jackson Federal Bank and realised a profit on sale of Â£41m before tax. This business, which has also been treated as discontinued operations, made an operating profit up to the date of disposal of Â£17m (Â£22m). In August 2004, the Company sold its 15% interest in Life Assurance Holding Corporation Limited and realised a profit on sale of Â£7m before tax. (7) An analysis of borrowings is set out below: 2004 Â£m 2003 Â£m ---- ---- Net core structural borrowings of shareholder financed operations 1,236 2,135 Add back holding company cash and short-term investments 1,561 432 ---- ---- Core structural borrowings of shareholder financed operations 2,797 2,567 Commercial paper and other borrowings that support a short-term fixed income securities reinvestment programme 1,079 1,074 Non-recourse borrowings of investment subsidiaries managed by PPM America 183 214 Egg debenture loans 451 451 UK and Europe Operations long-term business with-profits fund borrowings 144 120 Other borrowings of shareholder financed operations 19 19 ---- ---- 4,673 4,445 ---- ---- This total is recorded in the statutory basis summarised consolidated balance sheet as: Subordinated liabilities 1,429 1,336 Debenture loans 1,761 1,781 Other borrowings 1,483 1,328 ---- ---- 4,673 4,445 ---- ---- (8) The Preliminary Announcement was approved by the Board of Directors on 1 March 2005. This information is provided by RNS The company news service from the London Stock Exchange

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