SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 6-K
REPORT OF FOREIGN PRIVATE ISSUER
Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934
For the month of December, 2005
PRUDENTIAL PUBLIC LIMITED COMPANY
(Translation of registrant's name into English)
LAURENCE POUNTNEY HILL,
LONDON, EC4R 0HH, ENGLAND
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual reports
under cover Form 20-F or Form 40-F.
Form 20-F X Form 40-F
Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.
Yes No X
If "Yes" is marked, indicate below the file number assigned to the registrant
in connection with Rule 12g3-2(b): 82-
Enclosures: EEV 2004 Restatement
EMBARGO: 07.00 hours, Tuesday 13 December 2005
Prudential plc
Further detail on 2004 European Embedded Value Results previously published on 2
June 2005
Prudential plc publishes today its 2004 embedded value financial information
restated from the Achieved Profits Basis to European Embedded Value (EEV)
Principles, and also for the effects of International Financial Reporting
Standards (IFRS) and other accounting policy changes implemented earlier in the
year. The Group's underlying capital strength, cashflow and dividend policy are
not affected by the adoption of either EEV or IFRS. Today's disclosure provides
further detail to that given on 2 June 2005, and reflects certain minor
revisions to the methodology used.
Prudential believes that the EEV methodology represents an improvement over the
various embedded value reporting methods previously used across Europe and
supports its introduction. Prudential re-iterates its belief that embedded value
reporting provides investors with a more informed measure of the underlying
profitability of the Group's long-term businesses and is an important supplement
to statutory accounts.
As a member of the CFO Forum Prudential will adopt European Embedded Value
Principles for its 2005 year-end results. This will replace the Achieved Profit
basis, the current supplementary basis of reporting. The adoption by Prudential
of the EEV methodology, together with IFRS, results in a 2% reduction in the
Group's total shareholders' funds to GBP8.6bn and an uplift of 8% in the value
of new business for the year ending 31 December 2004 to GBP741m.
The main impact on the results arises from the effect of changes to the assumed
level of locked-in capital allocated to each business, the adoption of
product-specific risk discount rates, and an explicit valuation of the time
value of options and guarantees.
Highlights of the results on an EEV basis are shown below.
AP basis
EEV basis (3) Restated (3)
2004 2004
GBPm GBPm
New Business Profits 741 688
New Business Margin (1) 40% 37%
New Business Margin (2) 5% -
Long-term Business Operating Profit Before Tax 1,328 1,249
Total Operating Profit Before Tax 1,274 1,239
Total EEV Shareholders' Funds 8,615 8,762
(1)EEV and AP basis profits expressed as a percentage of annual premium
equivalent (APE) of insurance sales.
(2)EEV basis profits expressed as a percentage of the present value of new
business premiums.
(3) Both the AP and EEV bases include the effects of IFRS and other accounting
policy changes implemented earlier in the year.
-ENDS-
Enquiries to:
Media Investors/Analysts
Jon Bunn 020 7548 3559 James Matthews 020 7548 3561
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Prudential plc, a company incorporated and with its principal place of business
in the United Kingdom, and its affiliated companies constitute one of the
world's leading financial services groups. It provides insurance and financial
services directly and through its subsidiaries and affiliates throughout the
world. It has been in existence for over 150 years and has GBP187bn in assets
under management, as at 31 December 2004. Prudential plc is not affiliated in
any manner with Prudential Financial, Inc, a company whose principal place of
business is in the United States of America.
Forward-Looking Statements
This statement may contain certain "forward-looking statements" with respect to
certain of Prudential's plans and its current goals and expectations relating to
its future financial condition, performance, results, strategy and objectives.
Statements containing the words "believes", "intends", "expects", "plans", "
seeks" and "anticipates", and words of similar meaning, are forward-looking. By
their nature, all forward-looking statements involve risk and uncertainty
because they relate to future events and circumstances which are beyond
Prudential's control including among other things, UK domestic and global
economic and business conditions, market related risks such as fluctuations in
interest rates and exchange rates, and the performance of financial markets
generally; the policies and actions of regulatory authorities, the impact of
competition, inflation, and deflation; experience in particular with regard to
mortality and morbidity trends, lapse rates and policy renewal rates; the
timing, impact and other uncertainties of future acquisitions or combinations
within relevant industries; and the impact of changes in capital, solvency or
accounting standards, and tax and other legislation and regulations in the
jurisdictions in which Prudential and its affiliates operate. This may for
example result in changes to assumptions used for determining results of
operations or re-estimations of reserves for future policy benefits. As a
result, Prudential's actual future financial condition, performance and results
may differ materially from the plans, goals, and expectations set forth in
Prudential's forward-looking statements. Prudential undertakes no obligation to
update the forward-looking statements contained in this statement or any other
forward-looking statements it may make.
Note:
(1)CFO Forum
The CFO Forum is a high-level discussion group formed and attended by the Chief
Financial Officers of major European listed, and some non-listed, insurance
companies. Its aim is to discuss issues relating to proposed new accounting
regulations for their businesses and how they can create greater transparency
for investors. The Forum was created in 2002. For more information go to
www.cfoforum.nl.
(2)Revisions to methodology
LT business Total operating EEV shareholders'
operating profit profit before tax funds
before tax
EEV basis as published on 2 June 2005 before accounting GBP1,238m GBP1,212m GBP8,481m
policy changes
Accounting policy changes as published on 2 June 2005(1) GBP101m GBP95m GBP166m
EEV basis reflecting accounting policy changes GBP1,339m GBP1,307m GBP8,647m
Revisions to methodology:
Reclassification of Asia profits(2) GBP(11)m GBP(11)m
Intra-group adjustment (3) GBP(22)m
Mark to market value of JNL surplus note borrowings(4) GBP (32)m
EEV basis as published on 13 December 2005 GBP1,328m GBP1,274m GBP8,615m
(1) The accounting policy changes for operating profits primarily reflect
the discretionary change of accounting policy for longer term returns as
published on 2 June 2005. The GBP166m reflects the impact of IFRS changes as
published on 2 June 2005.
(2) Reflects a reclassification of profits from operating to non-operating
profits with no effect on shareholders' funds.
(3) The intra-group adjustment is made to deduct profits for internal fund
management business in respect of covered long-term business.
(4) This reflects the mark to market value on JNL surplus note borrowings.
EUROPEAN EMBEDDED VALUE (EEV) BASIS SUPPLEMENTARY INFORMATION
YEAR ENDED 31 DECEMBER 2004
RESULTS ANALYSIS BY BUSINESS AREA
Achieved
Profits
(AP) basis
EEV Restated
2004 2004
Note GBPm GBPm
UK and Europe Operations
New business 5. 15 241 220
Business in force 6 245 230
Long-term business 486 450
M&G 136 136
Egg 61 61
Total 683 647
US Operations
New business 5. 15 145 156
Business in force 6 237 271
Long-term business 382 427
Broker-dealer and fund management 15 15
Curian (29) (29)
Total 368 413
Asian Operations
New business 5. 15 355 312
Business in force 6 105 60
Long-term business 460 372
Fund management 19 19
Development expenses (15) (15)
Total 464 376
Other Income and Expenditure
Investment return and other income 15 0 44
Interest payable on core structural borrowings (154) (154)
Corporate expenditure:
Group Head Office (51) (51)
Asia Regional Head Office (29) (29)
Charge for share-based payments for Prudential schemes (7) (7)
Total (241) (197)
Operating profit from continuing operations based on longer-term investment returns
before exceptional items 1,274 1,239
Analysed as profits (losses) from:
New business 5 741 688
Business in force 6 587 561
Long-term business 1,328 1,249
Asia development expenses (15) (15)
Other operating results (39) 5
Total 1,274 1,239
The Achieved Profits basis results shown for comparative purposes have been
restated from those published in the 2004 Annual Report and are as reported in
the 2005 Interim Report published on 27 July 2005. The restatement reflects the
application of the changes to accounting policy that the Group expects to apply
in its full year 2005 IFRS basis financial statements to the extent applicable.
The results of long-term business operations are significantly altered only for
the changed basis of determining longer-term investment returns credited to
operating results. Details of the altered basis, which is also applied for EEV
basis reporting, are shown in note 4b.
SUMMARISED CONSOLIDATED PROFIT AND LOSS ACCOUNT - EEV BASIS
YEAR ENDED 31 DECEMBER 2004 Achieved
Profits
(AP) basis
EEV Restated
2004 2004
Note GBPm GBPm
Operating profit from continuing operations based on longer-term investment returns
before exceptional items
UK and Europe Insurance Operations 486 450
M&G 136 136
Egg 61 61
UK and Europe Operations 683 647
US Operations 368 413
Asian Operations 464 376
Other Income and Expenditure (241) (197)
Operating profit from continuing operations based on longer-term investment returns 1,274 1,239
before exceptional items+
Short-term fluctuations in investment returns 7 570 587
Shareholders' share of actuarial gains and losses on defined benefit pension schemes (12) (12)
Effect of changes in economic assumptions and time value of cost of options and 8 (48) (100)
guarantees
Profit from continuing operations before tax (including actual investment returns) 1,784 1,714
Tax 9 (553) (491)
Profit from continuing operations for the financial year after tax before minority 1,231 1,223
interest
Discontinued operations (net of tax) (94) (94)
Total profit for the year 1,137 1,129
Attributable to:
Equity holders of the parent company 1,138 1,130
Minority interest (1) (1)
Total profit for the year 1,137 1,129
+ Operating profit and operating earnings per share include investment returns
at the expected long-term rate of return but exclude exceptional items. 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 EEV
basis supplementary information.
EARNINGS PER SHARE - EEV BASIS
YEAR ENDED 31 DECEMBER 2004
Achieved
Profits
(AP) basis
EEV Restated
Note 2004 2004
Continuing operations
From operating profit, based on longer-term investment returns, after tax and
related minority interest
of GBP916m (GBP880m) 10 43.2p 41.5p
Based on profit from continuing operations after minority interest of GBP1,205m 10 56.8p 56.4p
(GBP1,197m)
Discontinued operations
Based on loss from discontinued operations after minority interest of GBP(67)m (3.1)p (3.1)p
(GBP(67)m)
Total - based on total profit for the financial year after minority interest of - 53.7p 53.3p
GBP1,138m (GBP1,130m)
Average number of shares (million) 2,121 2,121
DIVIDENDS PER SHARE
YEAR ENDED 31 DECEMBER 2004
Achieved
Profits
(AP) basis
EEV Restated
2004 2004
Dividends relating to the financial year:
Interim dividend 5.19p 5.19p
Final dividend 10.65p 10.65p
Total 15.84p 15.84p
Dividends declared and paid in the financial year
Current year interim dividend 5.19p 5.19p
Final dividend for prior year 10.29p 10.29p
Total 15.48p 15.48p
MOVEMENT IN SHAREHOLDERS' CAPITAL AND RESERVES
(EXCLUDING MINORITY INTEREST) - EEV BASIS
YEAR ENDED 31 DECEMBER 2004
Achieved
Profits
(AP) basis
EEV Restated
2004 2004
Note GBPm GBPm
Profit for the year (net of minority interest) 1,138 1,130
Items taken directly to equity
Exchange movements (239) (240)
Related tax (1) 12
Proceeds from Rights Issue, net of expenses 1,021 1,021
Other new share capital subscribed 119 119
Dividends (323) (323)
Reserve movements in respect of share-based payments 10 10
Own shares:
Own shares purchased in respect of share-based payment plans (4) (4)
Movement on Prudential plc shares purchased by unit trusts newly consolidated 14 14
under IFRS
Net increase in shareholders' capital and reserves 12 1,735 1,739
Shareholders' capital and reserves, at beginning of year (excluding minority
interest):
As previously reported on the Achieved Profits basis 7,005 7,005
Adjustments on implementation of statutory IFRS (excluding IAS 32, IAS 39 18 18
and IFRS 4)
Adjustments on implementation of European Embedded Value (EEV) methodology (143) -
As restated 12 6,880 7,023
Shareholders' capital and reserves at end of year (excluding minority interest) 11,12,15 8,615 8,762
Analysed as:
As previously reported on the Achieved Profits basis 8,596 8,596
Adjustments on implementation of statutory IFRS (excluding IAS 32, IAS 39 15 166 166
and IFRS 4)
Adjustments on implementation of European Embedded Value (EEV) methodology 15 (147) -
8,615 8,762
Comprising:
UK and Europe Operations:
Long-term business 4,228 4,051
M&G:
Net assets 300 300
Acquired goodwill 1,153 1,153
Egg 273 273
5,954 5,777
US Operations 2,570 2,596
Asian Operations:
Net assets 1,631 1,736
Acquired goodwill 292 292
Other operations:
Holding company net borrowings (1,299) (1,106)
Other net liabilities (533) (533)
11,12,15 8,615 8,762
NET ASSET VALUE PER SHARE
Based on EEV (AP restated) basis shareholders' funds of GBP8,615m (GBP8,762m) 363p 369p
Number of shares at year end (million) 2,375 2,375
SUMMARISED CONSOLIDATED BALANCE SHEET - EEV BASIS
31 DECEMBER 2004
Achieved
Profits
(AP) basis
EEV Restated
2004 2004
Note GBPm GBPm
Total assets less liabilities, excluding insurance funds 148,639 148,639
Less insurance funds*:
Technical provisions (net of reinsurers' share) and unallocated surplus of (144,149) (144,149)
with-profits funds
Less shareholders' accrued interest in the long-term business 4,125 4,272
(140,024) (139,877)
Total net assets 12, 15 8,615 8,762
Share capital 119 119
Share premium 1,558 1,558
Other statutory basis shareholders' profit (following adoption of IFRS) 2,813 2,813
Additional EEV basis retained profit 4,125 4,272
Shareholders' capital and reserves (excluding minority interest) 12, 15 8,615 8,762
*Including liabilities in respect of insurance products classified as investment
contracts under IFRS 4.
NOTES ON THE EEV PROFITS BASIS SUPPLEMENTARY INFORMATION
1. BASIS OF PREPARATION
The European Embedded Value ("EEV") results for the Group include the results
for the covered business on the EEV basis. These results are then combined with
the IFRS basis results of the Group's other operations.
With two exceptions, covered business comprises the Group's long-term business
operations. The definition of long-term business operations is consistent with
previous practice under Modified Statutory Basis and Achieved Profits basis
reporting. Under the EEV principles, the results for covered business now
incorporate the projected margins of attaching internal fund management.
The exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and in
respect of the Group's defined benefit pension schemes. SAIF is closed to new
business and the assets and liabilities of the fund are wholly attributable to
the policyholders of the fund. As regards the Group's defined benefit pension
schemes, the deficits attaching to the Prudential Staff Pension Scheme and
Scottish Amicable scheme are excluded. These deficits are partially
attributable to the PAC with-profits fund and shareholder backed long-term
business. Further details are explained in note 2f.
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 addition of 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.
These statements also include comparative basis results on the Achieved Profits
basis. The Achieved Profits basis results reflect the results of the Group's
long-term business operations on that basis and IFRS basis results of the
Group's other operations. The Achieved Profits basis results for long-term
business have been prepared in accordance with the guidance issued by the
Association of British Insurers (ABI) in December 2001 'Supplementary Reporting
for Long-term Insurance Business (the Achieved Profits Method)'.
The EEV and Achieved Profits basis information contained in these statements is
supplementary to the Statutory Financial Statements included in the Group's 2004
Annual Report. These statements should be read in conjuction with the financial
statements and supplementary Achieved Profits basis information published in the
Group's 2005 Interim Report. The Group's EEV basis results included in these
statements may require adjustment before its inclusion as comparatives in the
EEV Supplementary Information to the 2005 Statutory Financial Statements due to
the continuing work of the IASB and possible amendments to the interpretative
guidance and the Group's accounting policies.
The Directors are responsible for the preparation of the Supplementary
Information in accordance with the EEV Principles.
2. METHODOLOGY
a) Embedded Value
Overview
The embedded value is the present value of the shareholders' interest in the
earnings distributable from assets allocated to covered business after
sufficient allowance has been made for the aggregate risks in that business.
The shareholders' interest in the Group's long-term business comprises:
* Present value of future shareholder cash flows from in-force covered business
(value of in-force business), less a deduction for the cost of locked-in
('encumbered') capital;
* Locked-in ('encumbered') capital; and
* Shareholders' net worth in excess of encumbered capital.
The value of future new business is excluded from the embedded value.
Notwithstanding the basis of presentation of results (as explained in notes 4
and 6), no smoothing of market or account balance values, unrealised gains or
investment return is applied in determining the embedded value or the profit
before tax.
Value of In-Force Business
The embedded value results are prepared incorporating best estimate assumptions
about all relevant factors including levels of future investment return,
expenses, surrender levels and mortality. These assumptions are used to project
future cash flows. The present value of the future cash flows is then calculated
using a discount rate which reflects both the time value of money and the risks
associated with the cash flows that are not otherwise allowed for.
The total profit that emerges over the lifetime of an individual contract as
calculated using the embedded value basis is the same as that calculated under
the IFRS basis and, prior to IFRS adoption, the Modified Statutory Basis under
UK GAAP. However, since the embedded value basis reflects discounted future
cash flows under this methodology the profit emergence is advanced, thus more
closely aligning the timing of the recognition of profits with the efforts and
risks of current management actions, particularly with regard to business sold
during the year.
Cost of Capital
A charge is deducted from the embedded value for the cost of capital supporting
the Group's long-term business. This capital is referred to as encumbered
capital. The cost is the difference between the nominal value of the capital
and the discounted present value of the projected release of this capital
allowing for investment earnings (net of tax) on the capital.
The annual result is impacted by the movement in this cost from year to year
which comprises a charge against new business profit and a release in respect of
the reduction in capital requirements for business in force as this runs off.
Where the capital is held within a with-profits long-term fund, the value placed
on surplus assets in the fund is already discounted to reflect its release over
time and no further adjustment is necessary in respect of solvency capital.
However, where business is funded directly by shareholders, the capital requires
adjustment to reflect the cost of that capital to shareholders.
Financial Options and Guarantees
Nature of Options and Guarantees in Prudential's long-term business
UK and Europe Insurance Operations
The only significant financial options and guarantees in the UK and Europe
insurance operations arise in the with-profits sub-fund and Scottish Amicable
Insurance Fund (SAIF). With-profits products provide returns to policyholders
through bonuses that are smoothed. There are two types of bonuses: annual and
final. Annual bonuses are declared once a year, and once credited, are
guaranteed in accordance with the terms of the particular product. Unlike
annual bonuses, final bonuses are guaranteed only until the next bonus
declaration. The with-profits sub-fund held a provision on the pillar 1 peak 1
basis of GBP49m at 31 December 2004 to honour guarantees on a small amount of
guaranteed annuity products.
Beyond the generic features described above, and the provisions held in respect
of guaranteed annuities, there are very few explicit options or guarantees of
the with-profits sub-fund such as minimum investment returns, surrender values,
or annuity at retirement and any granted have generally been at very low levels.
The Group's main exposure to guaranteed annuities in the UK is through SAIF and
a provision on the pillar 1 peak 1 basis of GBP648m was held in SAIF at 31
December 2004 to honour the guarantees. With this exception, SAIF with-profits
policies do not guarantee minimum rates of return to policyholders.
Jackson National Life
The principal options and guarantees valued under EEV for Jackson National Life
are associated with the fixed annuity and variable annuity lines of business.
Fixed annuities provide that at Jackson National Life's discretion it may reset
the interest rate credited to policyholders' accounts, subject to a guaranteed
minimum. The guaranteed minimum return varies from 1.5% to 5.5%, depending on
the particular product, jurisdiction where issued, and date of issue. At 31
December, 2004, 73% of the fund relates to policies with guarantees of 3% or
less. The average guarantee rate is 3.3%.
Fixed annuities also present a risk that policyholders will exercise their
option to surrender their contracts in periods of rapidly rising interest rates,
possibly requiring JNL to liquidate assets at an inopportune time.
Variable annuity contracts may contain guarantees of certain minimum payments in
the event of death, withdrawal or annuitisation. These guarantees may be
related to (a) the amount of total deposits made to the contract adjusted for
any partial withdrawals, (b) the total deposits made to the contract adjusted
for any partial withdrawals, plus a minimum annual return, or (c) the highest
contract value on a specified anniversary date adjusted for any withdrawals
following the contract anniversary.
These guarantees generally protect the policyholder's value in the event of poor
equity market performance.
JNL also issues fixed indexed annuities that enable policyholders to obtain a
portion of an equity-linked return while providing a guaranteed minimum return.
The guaranteed minimum returns would be of a similar nature as those described
above for fixed annuities. In the case of the potential equity participation,
JNL hedges this risk by purchasing futures and options on the relevant index.
Asian Operations
Subject to local market circumstances and regulatory requirements the guarantee
features described above in respect of UK business broadly apply to similar
types of participating contracts written in the PAC Hong Kong branch, Singapore
and Malaysia. Participating products have both guaranteed and non-guaranteed
elements.
Non-participating long-term products are the only ones where the insurer is
contractually obliged to provide guarantees on all benefits. The most
significant book of non-participating business in the Group's Asian operations
is Taiwan's whole of life contracts. For these contracts there are floor levels
of policyholder benefits that accrue at rates set at inception which are set by
reference to minimum returns established by local regulation at the time of
inception. These rates do not vary subsequently with market conditions. Under
these contracts the cost of premiums are also fixed at inception based on a
number of assumptions at that time, including long-term interest rates,
mortality assumptions and expenses. The guaranteed maturity and surrender
values reflect the pricing basis.
Time Value
The value of financial options and guarantees comprises two parts. One is given
by a deterministic valuation on best estimate assumptions (the 'intrinsic
value'). The other part arises from the variability of economic outcomes in the
future (the 'time value').
Where appropriate, a full stochastic valuation has been undertaken to determine
the value of the in-force business including the cost of capital. A
deterministic valuation of the in-force business is also derived using
consistent assumptions and the time value of the financial options and
guarantees is derived as the difference between the two.
The economic assumptions used for the stochastic calculations are consistent
with those used for the deterministic calculations. Assumptions specific to the
stochastic calculations such as equity volatility and credit losses reflect
local market conditions and are based on a combination of actual market data,
historic market data and an assessment of long-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 of the key
characteristics of each model are given in note 3.
b) 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 EEV 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.
* UK: Economic capital requirements for annuity business are fully met by
Pillar I requirements being 4% of mathematical reserves (as used for achieved
profits reporting), which are also sufficient to meet Pillar II requirements as
determined in the Individual Capital Assessment (ICA) submitted to the Financial
Services Authority (FSA).
* US: Level of capital that has previously been locked in for Achieved Profits
reporting, namely 235 per cent of the risk based capital required by the
National Association of Insurance Commissioners at the Company Action Level
(CAL), is sufficient to meet the economic capital requirement.
* Asia: Economic capital target is substantially higher than local statutory
requirements in total. Economic capital requirements vary by territory, but in
aggregate, the encumbered capital is equivalent to the amount required under the
Financial Conglomerates Directive (FCD) requirement.
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 Business (excluding Annuities) 100% of EU minimum
UK Annuity Business 100% of EU minimum
Jackson National Life 235% of CAL
Asian Operations 100% of FCD
c) Risk Discount Rates
Overview
Under the CFO Forum Principles, discount rates used to determine the present
value of future cash flows are set equal to risk free rates plus a risk margin.
The risk margin should reflect any risk associated with the emergence of
distributable earnings that is not allowed for elsewhere in the valuation.
Prudential has selected a granular approach to better reflect changes in risk
inherent in each product group. The risk discount rate so derived does not
reflect a market beta but instead reflects the risk of volatility associated
with the cash flows in the embedded value model.
Since financial options and guarantees are explicitly valued under the EEV
methodology, discount rates under EEV are set excluding the effect of these
product features.
For Prudential's UK annuity business, which is well matched, the predominant
risks are credit risk and longevity risk. For this line of business the existing
achieved profits embedded values and risk discount rates have been carried over
following validation by comparison to a market consistent valuation.
Allowance of Risk
The risk allowance in the risk discount rate is determined as follows:
* Market Risk
Under Capital Asset Pricing Methodology ("CAPM") the discount rate is determined
as:
Discount rate = risk free rate + (beta x equity risk premium)
Under CAPM, the beta of a portfolio or product measures its relative market
risk.
The risk discount rates reflect the market risk inherent in each product group
and hence the volatility of product cash flows. They are determined by
considering how the profits from each product are impacted by changes in
expected returns on various asset classes, and by converting this into a
relative rate of return it is possible to derive a product specific beta.
CAPM does not include any allowance for non-market risks since these are assumed
to be fully diversifiable. For EEV purposes, however, a risk margin is added
for non-diversifiable non-market risks and to cover Group level risks.
Product-specific discount rates are used in order to reflect the risk profile of
each major territory and product group.
* Diversifiable Non-Market Risks
No allowance is required for non-market risks where these are assumed to be
fully diversifiable. The majority of non-market risks are considered to be
diversifiable.
* Non-Diversifiable, Non-Market Risks
Finance theory cannot be used to determine the appropriate component of beta for
non-diversifiable non-market risks since there is no observable risk premium
associated with it that is akin to the equity risk premium. Recognising this, a
pragmatic approach has been used.
A constant margin of 50bps has been added to the risk margin derived for market
risk to cover the non-diversifiable non-market risks associated with the
business.
Product-level betas are calculated each year. They are combined with the most
recent product mix to produce appropriate betas and risk discount rates for each
major product grouping.
d) Management Actions
In deriving the time value of financial options and guarantees, management
actions in response to emerging investment and fund solvency conditions have
been modelled. Management actions encompass, but are not confined to, the
following areas.
* Investment allocation decisions
* Levels of reversionary bonuses and credited rates
* Total claim values
Bonus rates are projected from current levels and varied in accordance with
assumed management actions applying in the emerging investment and fund solvency
conditions.
In all instances the modelled actions are in accordance with approved local
practice and therefore reflect the options actually available to management. For
the PAC with-profits sub-fund, the actions assumed are consistent with those set
out in the Principles and Practices of Financial Management (PPFM).
e) With-Profits Business and the treatment of the Estate
For the PAC with-profits sub-fund, the shareholders' interest in the estate is
derived by increasing terminal bonus rates so as to exhaust the estate over the
lifetime of the in-force with-profits business. In those few extreme scenarios
where the total assets of the life fund are insufficient to meet policyholder
claims in full, the excess cost is fully attributed to shareholders.
f) Pension Costs
The Group operates three defined benefit schemes in the UK. The principal
scheme is the Prudential Staff Pension Scheme ("PSPS"). The other two much
smaller schemes are the Scottish Amicable and M&G schemes.
Under IFRS the deficits attaching to these schemes are accounted for in
accordance with the provisions of IAS 19. The deficits represent the difference
between the market value of the schemes' assets and the discounted value of
projected future benefit payments to retired members and deferred pensioners
and, to the extent of service to date, current employed members.
For PSPS the deficit is allocated between the PAC with-profits sub-fund and
shareholder backed operations by reference to the activities of the members of
the scheme during their period of service. For the 2004 year end the deficit
was allocated in the ratio 80/20.
Under the EEV basis the IAS 19 basis deficit is initially allocated in the same
manner. The shareholders' 10 per cent interest in the PAC with-profits sub-fund
estate is determined after deduction of the portion of the IAS 19 basis deficits
attributable to the fund. Adjustments under EEV in respect of accounting for
deficits, on deferred benefit schemes are reflected as part of other operations,
as shown in note 11.
Separately, the projected cash flows of in force covered business include
contributions to the defined benefit schemes for future service based on the
contribution basis to the schemes applying at the time of preparation of
results.
g) Debt capital
Core structural debt liabilities are carried at market value.
3. ASSUMPTIONS
a) Best Estimate Assumptions
Best estimate assumptions are used for the projections, where best estimate is
defined as the mean of the distribution of all possible outcomes. The
assumptions are reviewed actively and changes are made when evidence exists that
changes in future experience are reasonably certain.
Assumptions required in the calculation of the value of options and guarantees,
for example relating to volatilities and correlations, or dynamic algorithms
linking liabilities to assets, have been set equal to the best estimates and,
wherever material and practical, reflect any dynamic relationships between the
assumption and the stochastic variables.
b) Principal 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 fixed
interest securities. This 'active' basis of assumption setting has been applied
in preparing the results of all the Group's UK, US and European 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 underdeveloped, 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 3.0 per cent above risk free rates which compares to 2.5 per cent
previously used for achieved profits reporting. The equity risk premium in the
US is also 3.0 per cent, unchanged from achieved profits reporting. In Asia,
equity risk premiums range from 2.8 per cent to 5.3 per cent. Assumptions for
other asset classes, such as corporate bond spreads, are set consistently as
best estimate assumptions.
The investment return assumptions as derived above are applied to the actual
assets held at the valuation date to derive the overall fund-earned rate.
The table below summarises the principal financial Achieved
assumptions.
EEV EEV Profits
31 Dec 2004 1 Jan 2004 (i) 31 Dec 2004
UK and Europe Insurance Operations
Risk discount rate
New business 7.1% 7.2%
In-force 7.1% 7.1% 7.2%
Pre-tax expected long-term nominal rates of
investment return:
UK equities 7.6% 7.8% 7.1%
Overseas equities 7.3% to 8.3% 7.1% to 8.4% 6.8% to 7.8%
Property 6.3% 6.6% 6.3%
Gilts 4.6% 4.8% 4.6%
Corporate bonds 5.5% 5.8% 5.5%
Expected long-term rate of inflation 2.9% 3.0% 2.9%
Post-tax expected long-term nominal rate of return:
Pension business (where no tax applies) 6.8% 7.1% 6.5%
Life business 5.9% 6.1% 5.7%
US Operations (Jackson National Life)
Risk discount rate
New business 6.1% 7.4%
In-force 5.8% 5.5% 7.4%
Expected long-term spread between earned rate and
rate credited to
policyholders for single premium deferred annuity 1.75% 1.75% 1.75%
business
US 10 year treasury bond rate at 31 December 2004 4.3% 4.3% 4.3%
Pre-tax expected long-term nominal rate of return for 7.3% 7.3% 7.3%
US Equities
Expected long-term rate of inflation 2.6% 2.3% 2.6%
Asian Operations Hong
China Kong (iv) India Indonesia Japan Korea
EEV EEV EEV EEV EEV EEV
31 Dec 31 Dec 2004 31 Dec 31 Dec 31 Dec 31 Dec
2004 2004 2004 2004 2004
Risk discount rate (ii)
New business 10.0% 8.5% 16.0% 18.75% 5.0% 7.1%
In-force 10.0% 7.4% 16.0% 18.75% 5.0% 7.1%
Expected long-term rate of inflation 3.0% 2.3% 5.25% 7.75% 0.0% 2.75%
Government bond yield 7.25% 4.9% 10.25% 13.0% 1.9% 3.86%
Malaysia Philippines Singapore Taiwan Thailand Vietnam
(iii)
EEV EEV EEV EEV EEV EEV
31 Dec 31 Dec 2004 31 Dec 31 Dec 31 Dec 31 Dec
2004 2004 2004 2004 2004
Risk discount rate
New business 9.0% 16.25% 6.3% 7.1% 13.5% 15.5%
In-force 8.7% 16.25% 6.4% 8.2% 13.5% 15.5%
Expected long-term rate of inflation 3.0% 5.25% 2.25% 2.25% 3.75% 4.5%
Government bond yield 7.0% 10.5% 5.0% 5.5% 7.75% 9.75%
Achieved
EEV EEV Profits
Asia Total Asia Asia
Total Total
31 Dec 2004 1 Jan 31 Dec
2004 2004
Weighted risk discount rate (ii)
New business 8.0% 10.3%
In-force 7.9% 8.0% 9.6%
(i) Economic assumptions shown for 1 January 2004 reflect the rates applied in
determining the value of in-force business at the start of 2004 as shown in note
12.
(ii) 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 in-force operating results.
(iii) Under Achieved Profits for year end 2004, for the Taiwan life operation,
the projections include assumptions of phased progression from current rates to
the long-term expected rate taking into account the effect on bond values of
rising interest rates. A similar approach has been adopted in preparing the EEV
basis results for full year 2004. The 2004 EEV basis results have been prepared
on the assumption that bond rates, then at around 3 per cent, would trend to a
long-term assumption of 5.5 per cent by 31 December 2010. Allowance was made for
the mix of assets in the fund, our future investment strategy and the market
value depreciation already held by the fund as yields rise to the assumed
long-term yields. For full year 2004 EEV basis results this gave rise to an
average assumed Fund Earned Rate that trends from 3.4 per cent to 5.9 per cent
by 31 December 2012. There is a slight decline in the Fund Earned rate in the
first few years as the depreciation of long bonds exceeds the corresponding
income pick up as rates rise. Consistent with the EEV methodology a constant
discount rate has been applied to the projected cashflows, as shown above.
(iv) Hong Kong business is predominately US dollar denominated.
(v) Assumed equity yields
The most significant equity holdings in Asian operations are in Hong Kong,
Singapore and Malaysia. The geometric average equity return assumptions for
these three territories at 31 December 2004 were 7.3%, 8.0% and 9.75%
respectively.
c) Principal Economic Assumptions
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 and Europe 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 lognormal
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.
*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 as follows:
Mean returns have been derived as the annualised arithmetic average return
across all simulations and durations
(i) Standard deviations have been calculated by taking the variance of the
annualised average return in each year across all simulations, taking the square
root and averaging overall durations. For interest rates the standard deviation
relates to the change in yield. The standard deviations applied are as follows:
Standard Deviation
Government Bond Yield 1.9%
Corporate Bond Yield 5.8%
Equities 20.0%
Property 15.0%
Jackson National Life
*Interest rates are projected using a three-factor model 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.
*Variable Annuity equity and bond returns have been stochastically generated
using a regime-switching lognormal model with parameters determined by reference
to historical data. The volatility of equity fund returns ranges from 17.5 per
cent to 28.0 per cent depending on risk class, and the volatility of bond funds
ranges from 1.6 per cent to 4.7 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 valuations are 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 fund returns ranges from 18 per cent
to 25 per cent, and the volatility of bond yields ranges from 0.7 per cent to
3.7 per cent.
d) Demographic Assumptions
Mortality and morbidity assumptions are based on an analysis of recent
experience but also reflect expected future experience. Where relevant, when
calculating the time value of in-force business, policyholder withdrawal rates
are allowed to vary in line with the emerging investment conditions according to
management's expectations.
e) Expense Assumptions
Expense levels, including those of service companies that support the Group's
long-term business operations, are based on internal expense analysis
investigations and are appropriately allocated to acquisition of new business
and renewal of in-force business. Exceptional expenses are identified separately
and reported separately. No productivity gains have been assumed.
Asia development and Regional Head Office expenses are charged to EEV basis
results as incurred. No adjustment is made to the embedded value of covered
business as the amounts of expenditure that relate to operating expenses are not
material. Similarly corporate expenditure for Group Head Office, to the extent
not allocated to the PAC with-profits fund is charged to the EEV basis result as
incurred.
f) Inter-company Arrangements
There are no inter-company arrangements such as re-insurance or loans associated
with covered business for which adjustment has been required in preparing the
EEV basis results.
g) Taxation and Other Legislation
Current taxation and other legislation has been assumed to continue unaltered
except where changes have been announced and the relevant legislation passed.
h) Fund Management and Service Companies
The value of future profits or losses from fund management and service companies
that support the Group's covered businesses are included in the profits for new
business and the in-force value of the Group's long-term business.
4. ACCOUNTING PRESENTATION
a) Analysis of profit before tax
To the extent applicable, presentation of the EEV profit for the year is
consistent with the basis the Group intends to apply for analysis of IFRS basis
profits before shareholder taxes between operating and non-operating results.
Operating results reflect the underlying results of the Group's continuing
operations including longer-term investment returns. Operating results include
the impact of routine changes of estimates and non-economic assumptions.
Non-operating results include certain recurrent and exceptional items that
primarily do not reflect the performance in the year of the Group's continuing
operations.
b) Investment return
Profit Before Tax
With the exception of fixed income investments held by Jackson National Life,
investment gains and losses during the period (to the extent that changes in
capital values do not directly match changes in liabilities) are included
directly in the profit for the year and shareholders' funds as they arise.
In the case of Jackson National Life, market value movements on fixed income
securities are initially recorded as movements in shareholder reserves,
reflecting the available for sale categorisation under IFRS. Similarly the
value movements on derivatives are recorded in the income statement. However,
it is assumed that fixed income investments will normally be held until
maturity. Therefore, unrealised gains and losses on these securities are not
reflected in either the achieved profits or statutory basis results and, except
on realisation or impairment of investments, only income received and the
amortisation of the difference between cost and maturity values are recognised
to the extent attributable to shareholders. This is consistent with the basis
of valuation of future cash flows of in force business, which inter alia,
reflects spread basis earnings which are not directly affected by short-term
value movements in fixed income securities. Similar principles apply to value
movements on Jackson's derivatives that are fair valued for IFRS reporting with
value movements booked in the IFRS income statement.
Investment returns reflect those earned on a market basis over the period
without smoothing, but after appropriate adjustments for movements in the
additional shareholders' interest recognised on the EEV basis.
Operating Profit
Investment returns, including investment gains, in respect of long-term
insurance business are recognised in operating results at the expected long-term
rate of return. For the purposes of calculating longer-term investment return to
be included in operating results of UK operations, where equity holdings are a
significant proportion of investment portfolios, values of assets at the
beginning of the reporting period are adjusted to remove the effects of
short-term market volatility.
For the purposes of determining the long-term returns for debt securities of
shareholder backed operations a risk margin charge is included which reflects
the expected long-term rate of default based on the credit quality of the
portfolio. Interest related realised gains and losses are amortised to the
operating results over the maturity period of the sold bonds. For
equity-related investments of Jackson National Life, a long-term rate of return
is assumed, which reflects the aggregation of risk free rates and equity risk
premium.
c) Pension costs
Profit Before Tax
Movements on the shareholders' share of deficits of the Group's defined benefit
pension schemes adjusted for contributions paid in the period are recorded
within the profit and loss account. Consistent with the basis of distribution of
bonuses and the treatment of the estate described in Notes 2d) and 2e) the
shareholders' share incorporates 10 per cent of the proportion of the deficits
attributable to the PAC with-profits sub-fund. The deficits are determined by
applying the requirements of IAS 19.
Actuarial Gains and Losses
Actuarial gains and losses comprise
* The difference between actual and expected return on the scheme assets.
* Experience gains and losses on scheme liabilities.
* The impact of altered economic and other assumptions on the discount value of
scheme liabilities.
These items are recorded in the profit and loss account but, consistent with the
IFRS basis of presentation, excluded from operating results.
d) Effect of changes in economic assumptions and cost of guarantees
Movements in the value of in-force business caused by changes to economic
assumptions and the cost of guarantees, (which is primarily due to economic
experience over the period and changes in economic assumptions) are recorded in
non-operating results.
e) Results for fund management operations
The results of the Group's fund management operations includes the profits from
management of internal and external funds. For EEV basis reporting Group
shareholders' other income is adjusted to deduct the expected margin for the
year on management of covered business. The deduction is on a basis consistent
with that used for projecting the results for covered business. Group operating
profit accordingly includes the variance between actual and expected profit in
respect of covered business.
f) Capital held centrally for Asia operations
In adopting the EEV principles Prudential has decided to set encumbered capital
at its internal targets for economic capital. In Asia, the the economic capital
target is substantially higher than the local statutory requirements in total.
Accordingly, capital is held centrally for Asian operations. For the purposes
of the presentation of the Group's operating results it is assumed that the
centrally held capital is loaned interest free to the Asian operations. In turn
the results of the Asian operations include the return on that capital and Group
shareholders' other income for EEV basis reporting is consequently reduced.
g) Taxation
The EEV profit for the year for covered business is calculated initially at the
post-tax level. The post-tax profit is then grossed up for presentation
purposes at the effective rate of tax. In general, the effective rate
corresponds to the corporation tax rate on shareholder profits of the business
concerned. Under Achieved Profits, except for Jackson National Life, this basis
also applied. For Jackson National Life, under achieved profits pre-tax results
were determined by applying the risk discount rate to pre-tax cash flows
adjusted for the impact of capital charges.
h) Foreign currency translation
Foreign currency profit and losses have been translated at average exchange
rates for the year. Foreign currency assets and liabilities have been
translated at year end rates of exchange. The purpose of translating the profit
and losses at average exchange rates, notwithstanding the fact that EEV profit
represents the incremental value added on a discounted cash flow basis, is to
maintain consistency with the methodology applied for IFRS basis reporting.
The principal exchange rates applied are:
Closing rate Average Opening rate
at at
Local Currency: GBP 31 December for 2004 1 January
2004 2004
Hong Kong 14.92 14.27 13.90
Japan 196.73 198.08 191.85
Malaysia 7.30 6.96 6.80
Singapore 3.13 3.10 3.04
Taiwan 60.84 61.10 60.78
USA 1.92 1.83 1.79
5. OPERATING PROFIT AND MARGINS FROM NEW BUSINESS
a) Profit
EEV AP Basis
2004 2004
Pre-tax Tax Post-tax Pre-tax Tax Post-tax
GBPm GBPm GBPm GBPm GBPm GBPm
UK and Europe Insurance Operations 241 (61) 180 220 (66) 154
Jackson National Life(i) 145 (51) 94 156 (82) 74
Asian Operations 355 (105) 250 312 (78) 234
Total 741 (217) 524 688 (226) 462
i) Jackson National Life net of tax
profit
Before capital charge 106 95
Capital charge (12) (21)
After capital charge 94 74
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.
b) Margins
EEV AP basis
Annual Present New New
premium Value of Pre-Tax New business Business Business
New Business equivalent New New business Margin Profit Margin
Premiums Business
Single Regular (APE) Premiums Contribution (APE) (PVNBP) (APE)
(PVNBP)
2004 2004 2004 2004 2004 2004 2004 2004
GBPm GBPm GBPm GBPm GBPm % % GBPm %
UK and Europe 6,357 181 817 7,012 241 30 3.4 220 27
Insurance Operations
Jackson National Life 4,408 12 453 4,506 145 32 3.2 156 34
Asian Operations 662 510 576 3,404 355 62 10.4 312 54
Total 11,427 703 1,846 14,922 741 40 5.0 688 37
New Business premiums reflect those premiums attaching to covered business
including premiums for contracts classified as investment products for IFRS
basis reporting. 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 premium business. Internal vesting annuity
business is classified as new business where the contracts include an open
market option.
New business margins are shown on two bases, namely the margins by reference to
Annual Premium Equivalents (APE) and the Present Value of New Business Premiums
(PVNBP). APEs are calculated as the aggregate of regular new business premiums
and one tenth of single new business premiums. PVNBPs are calculated as
equalling single premiums plus the present value of expected new business
premiums of regular premium business, allowing for lapses and other assumptions
made in determining the EEV new business contribution.
New business contributions are determined by applying the economic and
non-economic assumptions applying at the end of the period. The contributions
represent profits at the end of the period.
6. OPERATING PROFIT FROM BUSINESS IN FORCE Achieved
Profits
(AP) basis
EEV Restated
2004 2004
GBPm GBPm
UK and Europe Insurance Operations
Unwind of discount(i) 351 330
Cost of strengthened persistency assumption(ii) (73) (66)
Other items(ii) (33) (34)
245 230
Jackson National Life
Unwind of discount 97 139
Return on surplus assets (over target 36 36
surplus)
Spread experience variance 41 43
Amortisation of interest related realised gains 54 54
and losses
Loss from changes to other operating assumptions (4) (3)
Other 13 2
237 271
Asian Operations
Unwind of discount 120 113
Change in operating assumptions (24) (56)
(iii)
Experience variances and other 9 3
items
105 60
Total 587 561
(i) Unwind of discount is determined by reference to the value of in-force
business at the start of the period as adjusted for the effect of changes in
economic and operating assumptions reflected in the current period. For the
unwind of discount for UK and Europe Insurance Operations included in operating
results based on longer-term returns a further adjustment is made. For UK and
Europe Insurance Operations the amount represents the unwind of discount on the
value of in-force business at the beginning of the year (adjusted for the effect
of current year assumption changes), the expected return on smoothed surplus
assets retained within the main with-profits fund and the expected return on
shareholders' assets held in other UK and Europe long-term business operations.
Surplus assets retained within the main with-profits fund are smoothed for this
purpose to remove the effects of short-term investment volatility from operating
results. In the balance sheet and for total profit reporting, asset values and
investment returns are not smoothed.
(ii) The GBP73m cost of strengthened persistency assumption relates to the
closed book of personal pension policies sold by the now discontinued direct
sales force. The GBP33m charge for other items includes GBP21m of costs
associated with complying with new regulatory requirements and restructuring and
GBP12m of negative experience variances.
(iii) The difference in the effect of change in operating assumptions for the
Group's Asian Operations between those recorded on the Achieved Profits and EEV
basis mainly relates to the change in the treatment of investment expenses in
the Taiwanese operations which under the EEV methodology is reflected in the
opening shareholders' funds rather than as a change in operating assumptions.
7. SHORT-TERM FLUCTUATIONS IN INVESTMENT RETURNS
Achieved
Profits
(AP) basis
EEV Restated
2004 2004
GBPm GBPm
Long-term business:
UK and Europe Insurance Operations (i) 408 402
Jackson National Life (including mark to market value of core 103 97
debt) (ii)
Asian Operations (iv) 91 57
Share of investment return of funds managed by PPM America
that are consolidated into Group results
but attributable to external investors 9 9
Share of profits of venture investment companies and property partnerships of the PAC
with-profits fund that are consolidated into Group results but are attributable to
external investors 9 9
Movement in mark to market value of core debt held centrally (63) -
Other Operations 13 13
Total 570 587
(i) Short-term fluctuations in investment returns represent for UK and Europe
Insurance Operations the difference between actual investment returns in the
year attributable to shareholders and the expected returns as described in note
3.
(ii) Short-term fluctuations for Jackson National Life comprise:
Achieved
Profits
(AP) basis
EEV Restated
2004 2004
GBPm GBPm
Actual investment return on investments less long-term returns included within 73 73
operating profit (iii)
Investment return related gain due primarily to changed expectation of profits on 36 24
in-force variable annuity
business in future periods based on current period equity returns*
Mark to market value of core debt (6) -
103 97
* This adjustment arises due to market returns being higher than the assumed
long-term rate of return. This gives rise to higher than expected year end
values of variable annuity assets under management with a resulting effect on
the projected value of future account values, and hence future profitability.
(iii) Jackson National Life - Actual investment return on investments less
longer-term returns
Achieved
Profits
(AP)
basis
EEV Restated
2004 2004
GBPm GBPm
Actual realised gains less default assumption and amortisation of interest related realised 51 51
gains and losses for fixed maturity securities
Actual less long-term return on equity based investments and other items 22 22
73 73
(iv) Short-term fluctuations for Asian operations for full year 2004 on the EEV
basis are significantly higher than on the AP basis. This is due to movements in
the EEV value of surplus assets of the PAC with-profits sub-fund for the Hong
Kong branch for which an altered allocation as at 1 January 2004 has been
applied.
8. EFFECT OF CHANGES IN ECONOMIC ASSUMPTIONS AND THE TIME VALUE OF COST OF
OPTIONS AND GUARANTEES
The profits (losses) on changes in economic assumptions and time value of cost
of options and guarantees for in-force business included within the profit on
ordinary activities before tax arise as follows:
EEV
Change in
time value
of
EEV cost of
Change in options
economic and EEV
assumptions guarantees Total AP
2004 2004 2004 2004
GBPm GBPm GBPm GBPm
UK and Europe Insurance Operations 40 46 86 (19)
Jackson National Life (53) 6 (47) (53)
Asian Operations (113) 26 (87) (28)
Total (126) 78 (48) (100)
9. TAXATION CHARGE
The profit for the year for covered business is in most cases calculated
initially at the post-tax level. The post-tax profit for covered business is
then grossed up for presentation purposes at the effective rates of tax
applicable to the countries and periods concerned. In the UK this is the UK
corporation tax rate of 30%. For Jackson National Life this is generally the
federal rate of 35%. For Asia, similar principles apply subject to the
availability of taxable profits.
Achieved
Profits
The tax charge comprises: (AP) basis
EEV Restated
2004 2004
GBPm GBPm
Tax on operating profit of continuing operations
Long-term business:
UK and Europe Insurance Operations 142 134
Jackson National Life 116 135
Asian Operations(i) 119 96
377 365
Other Operations (27) (14)
Total tax charge on operating profit of continuing 350 351
operations
Tax on items not included in operating profit
Tax charge on short-term fluctuations in investment 189 174
returns
Tax credit on actuarial gains and losses of defined benefit pension schemes (5) (5)
Tax charge (credit) on effect of changes in economic assumptions and time value of cost of 19 (29)
options and guarantees
Total tax charge on items not included in operating profit of continuing 203 140
operations
Tax charge on profit on ordinary activities from continuing operations (including tax on actual 553 491
investment returns)
(i) Including tax relief on development expenses.
10. EARNINGS PER SHARE (EPS) Achieved
Profits
(AP) basis
EEV Restated
2004 2004
GBPm GBPm
Operating EPS from continuing operations
Operating profit before tax 1,274 1,239
Tax (350) (351)
Minority interest (8) (8)
Operating profit after tax and minority interest from 916 880
continuing operations
Operating EPS from continuing operations 43.2p 41.5p
Total EPS from continuing operations
Total profit before tax 1,784 1,714
Tax (553) (491)
Minority interest (26) (26)
Total profit after tax and minority interest from 1,205 1,197
continuing operations
Total EPS from continuing operations 56.8p 56.4p
Average number of shares (million) 2,121 2,121
11. SHAREHOLDERS' FUNDS - SEGMENTAL ANALYSIS Achieved
Profits
EEV (AP) basis
Restated
2004 2004
GBPm GBPm
UK and Europe Operations
Long-term business operations: (i),(ii) 4,228 4,051
M&G(vi)
Net assets of operations 300 300
Acquired goodwill(iv) 1,153 1,153
Egg (vi) 273 273
5,954 5,777
US Operations
Jackson National Life (i), (net of surplus note borrowings of GBP162m (v))
Before capital charge:
Excluding assets in excess of target surplus 1,785 1,749
Assets in excess of target surplus 801 949
2,586 2,698
Capital charge (iii) (80) (166)
After capital charge 2,506 2,532
Broker-dealer, fund management and Curian operations (vi) 64 64
2,570 2,596
Asian Operations
Long-term business (i)
Net assets of operations - EEV basis shareholders' funds 1,565 1,670
Acquired goodwill(iv) 231 231
Fund management (vi)
Net assets of operations 66 66
Acquired goodwill(iv) 61 61
1,923 2,028
Other Operations
Holding company net borrowings(v) (1,299) (1,106)
Pension scheme deficits (net of tax) attributable to shareholders (152) (152)
(vi)
Other net liabilities (vi) (381) (381)
(1,832) (1,639)
Total 8,615 8,762
(i) A charge is deducted from the annual result and balance sheet value for the
cost of capital for the Group's long-term business operations. The cost is the
difference between the nominal value of solvency capital and the present value,
at risk discount rates, of the projected release of this capital and the
investment earnings on the capital. Where solvency capital is held within a
with-profits long-term fund, the value placed on surplus assets in the fund is
already discounted to reflect its release over time and no further adjustment is
necessary in respect of solvency capital.
(ii) 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.
(iii) In determining the cost of capital of Jackson National Life, it has been
assumed that an amount equal to 235 per cent of the risk based capital required
by the National Association of Insurance Commissioners (NAIC) at the Company
Action Level must be retained. The impact of the related capital charge is to
reduce Jackson National Life's shareholders' funds by GBP80m (EEV basis) GBP166m
(AP basis).
(iv) Under IFRS, subject to impairment testing, goodwill is no longer amortised
from the date of adoption i.e. 1 January 2004. Acquired goodwill of the Japan
life business has been subject to an impairment charge included in the half year
2005 results of GBP95m.
Goodwill attaching to venture fund investment subsidiaries of the PAC
with-profits fund that are consolidated under IFRS are not included in the table
above as the goodwill attaching to these companies is not relevant to the
analysis of shareholders' funds.
(v) Net core structural borrowings of shareholder financed operations comprise:
EEV AP
2004 2004
GBPm GBPm
Holding company cash and short-term investments 1,561 1,561
Core structural borrowings - central funds (2,860) (2,667)
Holding company net borrowings (1,299) (1,106)
Core structural borrowings - Jackson National Life (162) (130)
(1,461) (1,236)
The altered carrying value of core structural borrowings under EEV reflects the
application of market values rather than IFRS basis values.
(vi) With the exception of the share of pension scheme deficits attributable to
the PAC with-profits fund the amounts shown for the items in the table above
that are referenced to this note have been determined on the statutory IFRS
basis. The deficit for the defined benefit pension scheme reflects the
statutory net of tax IFRS provision of GBP105m, augmented by GBP47m for the
shareholders' share of the net of tax deficit attributable to the PAC
with-profits fund.
12. RECONCILIATION OF MOVEMENT IN SHAREHOLDERS' FUNDS
Long-term business operations
UK and Total
Europe Jackson long-term
Insurance National Asian business Other Group
Operations Life Operations operations operations total
GBPm GBPm GBPm GBPm GBPm GBPm
Operating profit (including investment
return
Based on long-term rates of returns)
Long-term business:
New business (note 5) 241 145 355 741 741
Business in-force (note 6) 245 237 105 587 587
486 382 460 1,328 1,328
Asia development expenses (15) (15) (15)
M&G 136 136
Egg 61 61
Asian Fund Management Operations 19 19
US broker-dealer and fund management 15 15
Curian (29) (29)
Other income and expenditure (241) (241)
Operating profit (loss) from continuing 486 382 445 1,313 (39) 1,274
operations
Short-term fluctuations in investment 408 103 91 602 (32) 570
returns (note 7)
Actuarial gains and losses on defined benefit 2 2 (14) (12)
pension schemes
Effect of changes in economic assumptions and time 86 (47) (87) (48) (48)
value of cost of options and guarantees
(note 8)
Profit (loss) on ordinary activities 980 438 451 1,869 (85) 1,784
before tax
(including actual investment returns)
Tax on profits (losses) of continuing operations
(note 9):
Tax on operating profit (142) (116) (119) (377) 27 (350)
Tax on short-term fluctuations in (126) (39) (18) (183) (6) (189)
investment returns
Tax on actuarial gains and losses on defined 0 0 5 5
benefit pension schemes
Tax on effect of changes in economic assumptions (28) 16 (7) (19) (19)
and time value of cost of options and guarantees
Total tax (charge) credit (296) (139) (144) (579) 26 (553)
Discontinued operations (net of tax) 33 33 (127) (94)
Minority interests 1 1
Profit (loss) for the financial year 684 332 307 1,323 (185) 1,138
Exchange movements (175) (86) (261) 22 (239)
Related tax (1) (1) (1)
Development costs included above (net of tax) 2 2 (2) 0
borne centrally
Intra group dividends (including statutory (130) (66) (44) (240) 240 0
transfer)
External dividends (323) (323)
Stock based compensation - fair value adjustment 10 10
(net of tax)
Investment in operations(i) 173 15 147 335 (335) 0
Adjustment for net of tax losses of Curian
Subsidiary owned by Jackson National Life (12) (12) 12 0
Adjustment for economic capital for Asia (15) (15) 15 0
operations held centrally
Adjustment for net of tax fund management
projected
profits of covered business (14) (2) (16) 16 0
Consideration paid for own shares (4) (4)
Movement in Prudential plc shares purchased by
unit trusts
newly consolidated under IFRS 14 14
Proceeds from issues of share capital by parent 1,140 1,140
company
Net increase in shareholders' capital and 713 94 308 1,115 620 1,735
reserves
Shareholders' capital and reserves at 1
January 2004:
As previously reported on the Achieved 3,424 2,419 1,358 7,201 (196) 7,005
Profits basis
Change on adoption of IFRS (excluding IAS 32, (4) (4) 22 18
IAS 39 and IFRS 4)
Adjustments on implementation of European Embedded 91 (7) (97) (13) (130) (143)
Value (EEV) methodology (ii)
As restated 3,515 2,412 1,257 7,184 (304) 6,880
Shareholders' capital and reserves at 31 4,228 2,506 1,565 8,299 316 8,615
December 2004 (note 11)
(i) Investment in operations reflects increases in share capital. This includes
certain non-cash items as a result of timing differences.
(ii) The GBP(130)m deduction for other operations at 1 January 2004 reflects the
marking to market value of the Group's core structural borrowings held
centrally.
Long-term business operations
UK and Total
Europe Jackson long-term
Insurance National Asian business Other Group
Operations Life Operations operations operations total
GBPm GBPm GBPm GBPm GBPm GBPm
Analysed as:
Statutory IFRS basis shareholders' funds 877 2,568 750 4,195 556 4,751
Additional retained profit on an EEV basis 3,351 (62) 815 4,104 (240) 3,864
EEV basis shareholders' funds at 31 December 2004 4,228 2,506 1,565 8,299 316 8,615
Comprising:
Free surplus 206 769 (275) 700
Required capital 433 955 814 2,202
Value of in-force business before deduction of 3,796 963 1,432 6,191
cost of capital and of guarantees
Cost of capital (123) (80) (382) (585)
Cost of time value of guarantees (84) (101) (24) (209)
4,228 2,506 1,565 8,299
EEV basis shareholders' funds at 1 January 2004 Long-term business operations
UK and Total
Europe Jackson long-term
Insurance National Asian business Other Group
Operations Life Operations operations operations total
GBPm GBPm GBPm GBPm GBPm GBPm
Analysed as:
Statutory IFRS basis shareholders' funds 608 2,470 562 3,640 (128) 3,512
Additional retained profit on an EEV basis 2,907 (58) 695 3,544 (176) 3,368
EEV basis shareholders' funds at 1 January 2004 3,515 2,412 1,257 7,184 (304) 6,880
Comprising
Free surplus 256 624 (314) 566
Required capital 165 964 752 1,881
Value of in-force business before deduction of 3,272 998 1,188 5,458
cost of capital and of guarantees
Cost of capital (66) (82) (332) (480)
Cost of time value of guarantees (112) (92) (37) (241)
3,515 2,412 1,257 7,184
13. RECONCILIATION OF NET WORTH AND VALUE OF IN-FORCE BUSINESS
Total
Free Required Total Value of Long-term
Note Surplus Capital Net Worth In-Force business
Reconciliation of Net Worth and Value of In-force GBPm GBPm GBPm GBPm GBPm
business
Shareholders' capital and reserves at 1 January 566 1,881 2,447 4,737 7,184
2004:
New business contribution 5 (396) 254 (142) 666 524
Expected return on existing business 35 35 413 448
Existing business - transfer to net worth 635 (95) 540 (540) 0
Changes of operating assumptions and experience (1) (39) (40) 4 (36)
variances
Non-operating change of assumption and experience variances 45 74 119 235 354
Profit after tax from continuing operations 318 194 512 778 1,290
Exchange rate movements 12 (71) (67) (138) (124) (262)
Discontinued operations, net of tax 33 33 33
Amounts injected, released and transferred to/from life and (146) 194 48 6 54
related businesses
Shareholders' capital and reserves at 31 December 700 2,202 2,902 5,397 8,299
2004
(i) Net worth consists of statutory solvency capital (or economic capital where
higher) and unencumbered capital.
(ii) Value of in-force business includes the value of future margins from
current in-force business less the cost of holding encumbered capital.
14. SENSITIVITY OF RESULTS TO ALTERNATIVE ASSUMPTIONS
a) Sensitivity Analysis - Economic Assumptions
The tables below show the sensitivity of the embedded value as at 31 December
2004 and the new business contribution after the effect of required capital for
the full year 2004 to:
*1% increase in the discount rates
*1% increase and decrease in interest rates, including all consequential changes
(assumed investment returns for all assets classes, market values of fixed
interest assets, risk discount rates)
*1% rise in equity and property yields
*10% fall in market value of equity and property assets (not applicable for new
business contribution)
*Holding company statuatory minimum capital (by contrast to economic capital)
In each sensitivity calculation, all other assumptions remain unchanged except
where they are directly affected by the revised economic conditions.
UK and
Europe Jackson Asian Total
Insurance National operations long-term
Operations Life
GBPm GBPm GBPm GBPm
New business profit
As reported (note 5) 241 145 355 741
Discount rates - 1% increase (40) (22) (42) (104)
Interest rates - 1% increase (4) (1) (5) (10)
Interest rates - 1% decrease (1) (33) 3 (31)
Equity/property yields - 1% rise 13 16 13 42
Embedded value of long-term operations
As reported 4,228 2,506 1,565 8,299
Discount rates - 1% increase (366) (83) (218) (667)
Interest rates - 1% increase 144 (109) (14) 21
Interest rates - 1% decrease (179) 30 (32) (181)
Equity/property yields - 1% rise 264 24 98 386
Equity/property market values - 10% (416) (54) (44) (514)
fall
Statutory minimum capital 0 43 326 369
b) Sensitivity Analysis - Non-Economic Assumptions
The tables below show the sensitivity of the embedded value as at 31 December
2004 and the new business contribution after the effect of required capital for
the full year 2004 to:
*10% proportionate decrease in maintenance expenses (a 10% sensitivity on a base
expense assumption of GBP10 p.a. would represent an expense assumption of
GBP9 p.a.
*10% proportionate decrease in lapse rates (a 10% sensitivity on a base
assumption of 5% would represent a lapse rate of 4.5% p.a.)
*5% proportionate decrease in base mortality and morbidity rates (i.e increased
longevity)
UK and Europe Jackson Asian Total
Insurance National operations long-term
Operations Life
GBPm GBPm GBPm GBPm
New business profit
As reported (note 5) 241 145 355 741
Maintenance expenses - 10% decrease 7 4 12 23
Lapse rates - 10% decrease 9 13 28 50
Mortality and morbidity - 5% decrease (24) 3 8 (13)
Change representing effect on:
Life business 1 1 8 10
Annuity business (i) (25) 2 0 (23)
Embedded value of long-term operations
As reported 4,228 2,506 1,565 8,299
Maintenance expenses - 10% decrease 32 33 45 110
Lapse rates - 10% decrease 67 44 78 189
Mortality and morbidity - 5% decrease (68) 69 43 44
Change representing effect on:
Life business 3 65 43 111
Annuity business (i) (71) 4 0 (67)
(i) The JNL annuity sensitivity for mortality and morbidity relates
to variable annuity business
15. Reconciliation of Achieved Profits to EEV basis results
New business profits
2004
UK/Europe JNL Asia Total
GBPm GBPm GBPm GBPm
Impact of adoption of European Embedded Value basis:
Changes in economic assumptions 10 (8) (5) (3)
Time value of options and guarantees (5) (29) 4 (30)
Changes in risk discount rates 6 30 55 91
Fund management business falling within the scope of covered business 10 4 3 17
Other changes 0 (8) (14) (22)
Total changes 21 (11) 43 53
Achieved profits basis operating profit from new business - as previously 220 156 312 688
published
European Embedded Value basis operating profit from new business - as restated 241 145 355 741
Investment return and other income
2004
Total
GBPm
Impact of adoption of European Embedded Value basis:
Allocation of investment return in respect of centrally held capital, in respect of Asian (22)
businesses,
to operating result of Asian business
Projected Fund Management result for 2004 in respect of covered business (22)
incorporated in opening EEV value
Total changes (44)
Achieved Profits and IFRS basis result 44
European Embedded Value basis 0
Shareholders' funds (excluding minority interest) at 31 December 2004 2004
Total
GBPm
Changes consequent on adoption of IFRS:
Timing difference on recognition of dividend declared after balance sheet date 253
Shareholders' share of deficit on UK defined benefit pension schemes (net of
deferred tax):
Statutory IFRS basis (115)
Additional change for shareholders' 10% interest on the achieved profits basis
in the deficit
Attributable to the PAC with-profits fund (47)
Goodwill 94
Other items (net of related tax) (19)
Total changes 166
Achieved profits basis shareholders' funds, net of minority interest - as 8,596
previously published
Achieved profits basis shareholders' funds, net of minority interest - as 8,762
restated
Impact of adoption of European Embedded Value basis:
Changes in economic assumptions 32
Changes in the cost of required capital (269)
Time value of options and guarantees (209)
Changes in risk discount rates 427
Fund management business falling within the scope of covered business 200
Marking core debt to market value (225)
Other changes (103)
Total changes (147)
European Embedded Value basis shareholders' funds, net of minority interest 8,615
INDEPENDENT AUDITOR'S REPORT TO PRUDENTIAL PLC ON THE EUROPEAN EMBEDDED VALUE
BASIS SUPPLEMENTARY INFORMATION
In accordance with the terms of our engagement letter, we have audited the
European Embedded Value ('EEV') basis supplementary information of Prudential
plc ("the Company") as at 31 December 2004.
As described in the basis of preparation the EEV basis supplementary information
has been prepared in accordance with the European Embedded Value Principles
issued in May 2004 by the European CFO Forum ("the EEV Principles").
Our report was designed to meet the agreed requirements of the Company
determined by the Company's needs at the time. Our report should not therefore
be regarded as suitable to be used or relied on by any party wishing to acquire
rights against us other than the Company for any purpose or in any context. Any
party other than the Company who chooses to rely on our report (or any part of
it) will do so at its own risk. To the fullest extent permitted by law, KPMG
Audit Plc will accept no responsibility or liability in respect of our report to
any other party.
Respective responsibilities of directors and KPMG Audit Plc
As described in the basis of preparation, the directors of the Company are
responsible for the preparation of the EEV supplementary information in
accordance with the EEV Principles. It has been prepared as part of the
Company's conversion of its supplementary information, previously prepared in
accordance with the guidance issued in December 2001 by the Association of
British Insurers entitled "Supplementary Reporting for Long Term Insurance
Business (the Achieved Profits Method)" ("the Achieved Profits basis") to an EEV
basis. Our responsibilities as independent auditors are established in the
United Kingdom by the Auditing Practices Board, our profession's ethical
guidance and the terms of our engagement.
Under the terms of engagement we are required to report to you our opinion as to
whether the EEV basis supplementary information has been properly prepared, in
all material respects, in accordance with EEV Principles using the methodology
and assumptions set out in the notes. We also report to you if, in our opinion,
we have not received all the information and explanations we require for our
audit.
Basis of audit opinion
We conducted our audit having regard to Auditing Standards issued by the U.K.
Auditing Practices Board. An audit includes examination, on a test basis, or
evidence relevant to the amounts and disclosures in the EEV basis supplementary
information. It also includes an assessment of the significant estimates and
judgements made by the directors in the preparation of the EEV basis
supplementary information, and of whether the accounting policies are
appropriate to the group's circumstances, consistency applied and adequately
disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the EEV basis
supplementary information is free from material misstatement, whether caused by
fraud or other irregularity or error. In forming our opinion we also evaluated
the overall adequacy of the presentation of information in EEV basis
supplementary information.
Emphasis of matter
Without qualifying our opinion we draw your attention to the following matters.
* As described in the basis of preparation note to the EEV basis supplementary
information, the next annual financial statements of the Group will be prepared
in accordance with IFRS adopted for use in the European Union. The accounting
policies that have been adopted in preparing the IFRS financial information,
which forms the starting point of the EEV basis supplementary information, are
consistent with those that the directors currently intend to use in the next
annual financial statements. There is, however, a possibility that the
directors may determine that some changes to these policies are necessary when
preparing the full annual financial statements for the first time in accordance
with those IFRS adopted for use by the European Union.
*As described in the basis of preparation note to the EEV basis supplementary
information, as part of its conversion from the Achieved Profits basis to an EEV
basis, the Company has prepared the EEV basis supplementary information for the
year ended 31 December 2004 to provide the comparative supplementary information
expected to be included in the Company's first complete set of EEV basis
supplementary information to be included in the annual report for the year
ending 31 December 2005.
Our report has been prepared for the Company solely in connection with the
Company's conversion of its supplementary information, previously prepared on
the Achieved Profits basis, to an EEV basis.
Opinion
In our opinion, the accompanying EEV basis supplementary information for the
year ended 31 December 2004 has been properly prepared, in all material
respects, in accordance with the EEV Principles using the methodology and
assumptions set out in the notes.
KPMG Audit Plc
Chartered Accountants
London
12 December 2005
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date 13 December 2005
PRUDENTIAL PUBLIC LIMITED COMPANY
By: /s/ Jon Bunn
Director of Public Relations