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 June, 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: Accounting Standards
EMBARGO: 07.00 hours, Thursday 2 June 2005
Prudential plc
Economic Capital, Developments in Regulatory and Financial Reporting, and
Restatement of 2004 Full Year Results under International Financial Reporting
Standards and European Embedded Value
Prudential plc publishes today selected 2004 financial information restated
under European Embedded Value (EEV) and International Financial Reporting
Standards (IFRS). The Group's underlying capital strength, cashflow and dividend
policy are not affected by the adoption of either EEV or IFRS.
In addition, we are also explaining the Group's regulatory capital position
under the Financial Groups Directive (FGD) and the Group's economic capital
position as at 31 December 2004.
Prudential's Group Finance Director, Philip Broadley, said: "We are publishing
today a comprehensive picture of the Group's economic and regulatory capital
positions as at 31 December 2004 and the impact of adopting IFRS and EEV on our
2004 financial results. We believe that the presentation of this information
will enable investors to obtain a better understanding of the Group's capital
position and profitability."
European Embedded Value
Prudential believes that the EEV methodology represents an improvement over
existing embedded value reporting methods used across Europe and supports its
introduction. Prudential re-iterates its belief that embedded value reporting
provides investors with a truer measure of the underlying profitability of the
Group's long-term businesses and is a valuable supplement to statutory accounts.
As a signatory to the European CFO (Chief Financial Officers) Forum on European
Embedded Value (EEV) principles, Prudential will adopt EEV methodology for its
2005 year-end results. This will replace the Achieved Profit basis, the current
supplementary basis of reporting. The adoption of the EEV methodology by
Prudential results in a 1% reduction in the Group's total shareholders' funds to
GBP8.5bn 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. The EEV results also include the value of
future profits from service companies (including fund management operations)
that support the Group's long-term businesses and the UK defined benefit
pensions scheme deficit.
International Financial Reporting Standards
From 1 January 2005, all listed European Groups must prepare their financial
statements in accordance with EU approved International Financial Reporting
Standards (IFRS). The IFRS basis replaces the current Modified Statutory Basis.
The Financial Review section of Prudential's 2004 Annual Report gave extensive
explanation of the likely changes, which are confirmed in this announcement.
Restatement under IFRS Phase 1 gives rise to a GBP15m reduction in operating
profit for 2004 and an increase in shareholders funds of GBP470m.
In conjunction with the adoption of IFRS, Prudential has reviewed all its
accounting policies and is changing the method used to determine longer term
returns included within operating profits. This change, which is not required
under IFRS, increases operating profit by GBP91m, offset by a corresponding
reduction in short-term fluctuations in investment returns, leaving total profit
unchanged.
Groups Directive
Under the Insurance Groups Directive (IGD), introduced in January 2001, Group
solvency is calculated by aggregating the surplus capital held in the regulated
subsidiaries, then deducting group borrowings, other than those subordinated
debt issues that qualify as capital.
The Financial Groups Directive (FGD), which has applied to Prudential since 1
January 2005, involves a similar calculation of Group solvency as for the IGD,
but the solvency test under the FGD is a continuous requirement and a regulatory
obligation. Prudential has put in place a regulatory capital projection model
for all business units to ensure that the Group meets, at all times, the
continuous solvency requirements.
As at 31 December 2004, Prudential had a surplus of GBP845m on the IGD basis.
Economic Capital
Prudential has determined its economic capital requirement as the amount of
capital required to ensure that the Group can meet its existing contractual and
discretionary policyholder obligations and remain solvent at all times over a
25-year time horizon, within a strict target solvency level. Economic capital
methodology is different from the regulatory capital model used under IGD and
FGD in that it allows the Group to take account of its geographic spread and its
ability to diversify its risks across its businesses.
Prudential's economic capital model, which it has been developing over the past
three years, is integral to its capital and financial management at both Group
and business unit level. It provides Prudential with a measure of the impact of
taking on different risks in different parts of the world, both in terms of the
extreme events that have the potential to deplete its capital base, and the more
day-to-day volatility to which it is exposed.
As at 31 December 2004, Prudential had available capital of GBP3.4bn. This
represents a surplus of GBP1.6bn over required economic capital of GBP1.8bn.
Further details on each of these developments can be found in the attached
appendices:
Appendix A European Embedded Value Page 4
Appendix B International Financial Reporting Standards Page 14
Appendix C Groups Directive Page 42
Appendix D Economic Capital Page 44
-ENDS-
Enquiries to:
Rebecca Burrows, Group Communications Director 020 7548 3537
Media Investors/
Analysts
Clare Staley 020 7548 3719 Andrew Crossley 020 7548 3166
Joanne Davidson 020 7548 3708 James Matthews 020 7548 2007
Mike Kempster 020 7548 3738
Brunswick Group
Kate Holgate 020 7404 5959
1. A presentation to analysts and investors will take place at 9:30am at
Governor's House, Laurence Pountney Hill, London, EC4R 0HH. A webcast of
the presentation and the presentation slides will be available on the
Group's website, www.prudential.co.uk.
2. An interview with Philip Broadley (in video/audio/text) will be available
on www.cantos.com and www.prudential.co.uk from 7.00am on 2 June 2005.
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.
Appendix A
European Embedded Value (EEV) Principles
- Prudential releases today restated 2004 supplementary results on an EEV
basis. Key results are shown ahead of full adoption of the EEV principles
at the 2005 year end. Highlights of the results on an EEV basis are shown
below.
EEV basis AP basis
2004 2004
GBPm GBPm
--------------------------------------------------------- --------
New Business Profits 741 688
New Business Margin (1) 40% 37%
Long-term Business Operating Profit Before Tax (2) 1,238 1,148
Total EEV Shareholder Funds (3) 8,481 8,596
--------------------------------------------------------- --------
(1) Profits are expressed as a percentage of annual premium equivalent (APE) of
insurance sales.
(2) Excluding increase of GBP101m arising from the discretionary change of
accounting policy for longer term returns as explained in the IFRS section.
(3) Excluding increase of GBP166m brought about by changes described in the
IFRS section.
- The adoption of the EEV principles results in a small change to the
embedded value of the Group's business and an uplift in the value of
new business.
- The Group's underlying capital strength, cashflow, and dividend paying
ability are unaffected by the adoption of the EEV principles.
- The time value of options and guarantees granted to policyholders
included within the Group's embedded value as at 31 December 2004 is
GBP209m.
Prudential believes that EEV reporting represents an evolution from the current
achieved profits (AP) basis used for supplementary reporting, and it welcomes
the improved clarity of information that it will provide to investors by the
adopting companies. Prudential re-iterates its view that embedded value
information provides investors with a much truer picture of the underlying
profitability of long-term insurance business.
1. Background
In May 2004, the CFO Forum, representing the Chief Financial Officers of 19
European Insurers, published the EEV Principles which are designed to
improve the transparency and consistency of embedded value reporting.
Member companies agreed to adopt the principles for supplementary reporting
no later than the 2005 year-end. Prudential continues to play an active
role in the CFO Forum.
To enable analysts and investors to understand Prudential's approach and
the impact to the results Prudential has decided to provide today a
restatement of key 2004 achieved profits results under the EEV principles.
However, 2005 interim results will continue to be reported on an achieved
profits basis. Full disclosures in respect of the 2004 year end will be
provided in December 2005 before Prudential fully adopts the principles in
respect of full year 2005 results.
2. Key Results
1. Overview
The 2004 results under the EEV basis are shown below together with
previously reported achieved profits results.
EEV basis AP basis
GBPm GBPm
--------------------------------------------------- --------
New business Profits 741 688
New business Margin (1) 40% 37%
Long-term Business Operating Profit 1,238 1,148
Before Tax (2)
Total EEV Shareholder Funds (3) 8,481 8,596
--------------------------------------------------- --------
(1) Profits are expressed as a percentage of annual premium equivalent
(APE) of insurance sales.
(2) Excluding increase of GBP101m arising from the discretionary change of
accounting policy for longer term returns as explained in the IFRS
section.
(3) Excluding increase of GBP166m brought about by changes described in
the IFRS section.
The main drivers of change from an achieved profits basis are changed
capitalisation levels, an explicit valuation of the time value of
options and guarantees, and changed risk discount rates. The EEV
results also include the value of future profits on service companies
(including fund management operations) that support the Group's
long-term businesses and the UK defined benefit pension scheme
deficit. Core debt has been marked to market.
For EEV reporting, encumbered capital has been set at economic levels,
a bottom up approach has been used for the setting of risk discount
rates which are both product-specific and geographically specific,
whilst the time value of options and guarantees is explicitly valued
using stochastic techniques. Finally, the value of future service
company profits has been included within the in-force value of
long-term business. The value of the UK defined benefit pension scheme
deficit has been included on an IAS 19 basis.
2. New Business Results
2.2.1. Operating Profit from New Business
EEV Basis AP Basis
Before tax Before tax
GBPm GBPm
------------------------------------------ ----------
UK and Europe Insurance Operations 241 220
Jackson National Life 145 156
Asian Operations 355 312
Total 741 688
------------------------------------------ ----------
The table below reconciles the movement from an achieved profits
basis to an EEV basis.
GBPm
---------------------------------------------------- ------
Achieved Profits Basis 688
Economic Assumption Changes (3)
Time Value of Options and Guarantees (30)
Risk Discount Rates 91
JNL Variable Annuity Fees and Benefits 24
Inclusion of Fund Management Profits in respect of 17
Internal Funds
Modelling changes and other (18)
EEV Basis before change to JNL Tax Gross Up Approach 769
Change in JNL Gross Up Approach (28)
EEV Basis 741
---------------------------------------------------- ------
Total Group new business profits have risen 8 per cent. The overall
combined impact of the changed risk discount rates and explicit
valuation of options is positive at GBP61m and this reflects the high
proportion of bond-backed linked, non-profit and A&H (1) business,
which have lower risk discount rates and minimal options and
guarantees. There is no impact from using economic levels of capital
as, for the current mix of business, statutory requirements are
sufficient to meet our current assessment of economic capital
requirements. The current mix of new business has relatively little in
the way of options and guarantees.
(1) A&H is Accident and Health
For Jackson National Life (JNL), as part of the transition to
EEV, we have taken the opportunity to simplify the basis on which
we calculate the pre-tax results. Under EEV, the net profits are
grossed up for tax at the expected tax rate. There is no economic
impact from this presentational change. By way of comparison,
under the previous method that applied under achieved profits,
JNL's pre-tax new business profit would have been (around)
GBP173m.
Inclusion of Fund Management profits adds GBP17m to the new
business value.
The reconciliation in movement for each of the Group's Business
Units is shown in Appendix A1.
2.2.2. New Business Margin
EEV basis AP Basis
----------- ----------
% of % of % of % of
APE PVNBP APE PVNBP
-------------------- -------- -------- -------- --------
UK and Europe Insurance 30 3.4 27 n/a
Operations
Jackson National Life 32 3.2 34 n/a
Asian Operations 62 10.4 54 n/a
Total 40 5.0 37 n/a
-------------------- -------- -------- -------- --------
Note
PVBNBP is defined as the present value of new business premiums.
The comments in section 2.2.1 apply here also.
3. Total Shareholders' Funds
EEV Basis AP Basis
After tax After tax
GBPm GBPm
---------------------- ------------- -------------
UK and Europe Insurance 4,228 4,051
Operations
Jackson National Life 2,538 2,532
Asian Operations 1,567 1,672
Other 148 341
Total (1) 8,481 8,596
---------------------- ------------- -------------
(1) Excluding a change of GBP166m brought about by changes described
in the IFRS section.
The reconciliation from an achieved profits basis to an EEV basis is
shown below.
GBPm
------------------------------------- ------
Achieved Profits Basis 8,596
Economic Assumption Changes 32
Use of Economic Capital (269)
Time Value of Options and Guarantees (209)
Risk Discount Rates 427
JNL VA fees and benefits 26
Inclusion of Fund Management Profits in respect of 200
Internal Funds
Inclusion of Service Company Profits in respect of (7)
Covered Business
Mark to Market Core Debt (193)
Modelling changes and other (122)
EEV Basis 8,481
------------------------------------- ------
The combined impact of increased encumbered capital, explicit
valuation of options and guarantees, and the changed risk discount
rates is broadly neutral, at GBP(51)m (less than 1 per cent of
shareholders' funds). Inclusion of future profits on fund management
businesses in respect of internal funds adds GBP200m to the embedded
value, whilst the explicit modelling of Variable Annuity (VA) fees and
benefits in the US adds GBP26m to the embedded value. There is no
impact from the changed gross-up approach for JNL described in section
2.2.1. as shareholders' funds are net of tax.
To reflect the leverage of shareholder cashflows, the Group's core
debt has been marked to market. This results in a reduction in
shareholders' funds of GBP193m.
The time value of options and guarantees included in total
shareholders' funds breaks down geographically as follows.
Time Value of
Options and
Guarantees
GBPm
----------------------- ------------------------
UK and Europe Insurance Operations 84
Jackson National Life 101
Asian Operations 24
Total 209
----------------------- ------------------------
Prudential's exposure to the time value of options and guarantees
based on the approach required by the EEV principles is relatively
small at GBP209m or 2.5 per cent of the total Group shareholders'
funds of GBP8.5bn. This is a direct result of Prudential's risk-based
approach to management. By ensuring that the guarantees offered on our
products are kept prudently low and by actively taking advantage of
the management actions open to us we are able to minimise our
shareholder exposures.
The UK and Asia numbers of GBP84m and GBP24m reflect the fact that the
majority of the guarantees are contained within with-profits products
which are supported by healthy estates, and that we have increased
encumbered capital to our target economic capital levels. JNL's number
is also low due to the explicit charges on VA products used to meet
the cost of any guarantees and the ability to change crediting rates
in line with credit experience on fixed annuity business.
4. Operating Profits
EEV Basis AP Basis
Before tax Before tax
GBPm GBPm
----------------------------- --------- -----------
In-force long-term Business Operating 497 460
Profits
Total long-term Business Operating 1,238 1,148
Profits
Total Group Operating Profits from 1,212 1,144
Continuing Operations
----------------------------- --------- -----------
The main reasons behind the change in the in-force long-term business
operating profits are increased unwind amounts, contribution from fund
management businesses and in Asia additional expected interest income on
economic capital notionally allocated to Asia (1) and the contribution from
fund management business.
(1) This results in an equal and opposite impact to interest income on central
shareholder funds
The impact of the discretionary changes in accounting policy for longer
term returns as described in the IFRS section is to increase the total
long-term business result by GBP101m whilst total operating profit for the
Group increases from GBP1,212m to GBP1,307m. Appendix A2 provides further
detail.
3. Basis of Preparation
1. Overall Approach
The results presented in section 2 have been prepared using the EEV
Principles for the Group's long-term business including fund
management operations and service companies that support the long-term
businesses. The results of the Group's other businesses have been
incorporated on a modified statutory basis. In adopting the principles
there has been no change in the definition of long-term new business.
The shareholders' interest in the Group's long-term business comprises,
- the 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;
- the locked-in ('encumbered') capital; and
- shareholders' net worth in excess of encumbered capital.
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 main
changes Prudential has made in moving to an EEV basis of reporting are
in the following areas.
- encumbered capital;
- valuation of financial options and guarantees;
- risk discount rates; and
- valuation of fund management companies that support the Group's
long-term businesses
In most other respects the approach that Prudential uses for its achieved
profits reporting already conforms to the requirements of the EEV
Principles so there has been no change in respect of these areas.
Further detail on Prudential's approach is given below.
3.2. Capital
In adopting the EEV principles, Prudential has decided to set
encumbered capital at its internal targets for economic capital, which
have been assessed using internal models but without any credit for
the significant geographical diversification benefits that exist
within the Prudential Group. For with-profits business written into a
segregated life fund, both in the UK and Asia, the capital available
within the fund is sufficient to meet the economic capital
requirements. For all shareholder-backed business we lock-in the
higher of economic capital and the local statutory minimum
requirement. In the 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). In the US, the level of capital that has
previously been locked in for achieved profits reporting, namely 235
per cent of the NAIC's (1) Company Action Level (CAL), is sufficient
to meet the economic capital requirement. In Asia, our economic
capital target is substantially higher than local statutory
requirements in total. Economic capital requirements vary by
territory, but in aggregate, the capital requirement is equivalent to
the Financial Groups Directive (FGD) requirement.
(1) NAIC is the National Association of Insurance Commissioners
(2) This is equivalent to 470% of the Authorised Control Level
(ACL)
The table below summarises the levels of encumbered capital for key
shareholder-backed business.
Capital as a
percentage of
Relevant
Statutory
Requirement
-------------------- --------------------------------
UK Annuity Business 100% of EU minimum
Jackson National Life 235% of CAL
Asian Operations 100% of FGD
-------------------- --------------------------------
3.3. Valuation of Options and Guarantees
Options and guarantees have two components of value, intrinsic value
and time value. The intrinsic value measures the value of the options
and guarantees on the chosen valuation assumptions (i.e. the extent to
which they are 'in the money'). The time value measures the additional
value of the options and guarantees that arises from changing future
financial conditions.
The intrinsic value of options and guarantees is directly included in
the embedded value calculated using deterministic assumptions while
the time value is captured through the use of stochastic techniques
for the embedded value calculation that involve the projection of
distributable profits under many (1,000 to 5,000) scenarios in which
economic and financial factors are allowed to vary in a manner that is
representative of possible future market behaviour. The time value is
then determined by taking the difference between the average present
value of distributable profits under all these scenarios and the
deterministic embedded value referred to above. As required by the EEV
principles, the option valuation is a real world one and not a market
consistent value and uses investment return and risk discount rate
assumptions which are consistent with the main deterministic models.
3.4. Risk Discount Rates
Principle G10.7 to G10.9 of the European Embedded Value Principles
state that,
"Discount rates used to determine the present value of future cash
flows should be 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.
Valuation of financing types of reinsurance and debt, including
subordinated and contingent debt, should ensure that the combined
impact of their servicing costs and discount rates assumption does not
distort the valuation of the underlying business.
Risk discount rates may vary between product groups and territories."
Prudential has adopted a bottom-up approach to the calculation of risk
discount rates as we believe the intention of the EEV principles in
this area is that they should relate to the risks within each product.
Having considered the various options, Prudential firmly believes that
a bottom-up approach is the best way to achieve this. The risk
discount rate so derived does not reflect a market cost of capital but
the risk of volatility associated with the casflows in the embedded
value model. Risk discount rates vary by major product group in each
territory and are derived using the formula,
risk discount rate = risk free rate + ( product specific beta x equity
risk premium ) + additional margin of 50 bps
The risk discount rates reflect the market risk inherent in each
product group and hence the volatility of product cashflows. 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. A further additional prudential margin
of 50bps has been added to all risk discount rates. In setting risk
discount rates any material financial options and guarantees that have
been explicitly valued are excluded from the calculation whilst
capital levels are consistent with the economic capital levels
described in section 3.2 above. Asset backing reflects the actual
assets held at the valuation date and projection assumptions used are
the same as those described in section 3.5 and 3.6. An example of the
calculation may be found at the Group's website
(www.prudential.co.uk).
For Prudential's UK annuity business, which is well matched, the
predominant financial risks are credit risk and interest rate 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.
Weighted average risk discount rates are given below for each business
unit
Business New Business Achieved
in-force Profits
---------------------- ------------ ----------- -----------
UK and Europe Insurance 7.1% 7.1% 7.2%
Operations
Jackson National Life 5.8% 6.1% 7.4%
Asian Operations 7.9% 8.0% 9.6%
Group 7.2% 7.3% 7.8%
---------------------- ------------ ----------- -----------
The in-force risk discount rate has been weighted using the value of
in-force whilst the new business risk discount rate has been weighted
by new business profits. It should be noted that these are just
weighted summaries of the risk discount rates and are shown to give an
indication of how they compare to achieved profits risk discount
rates. The rates actually used are those derived for each specific
product group.
3.5. Economic Assumptions and Stochastic Asset Model
3.5.1. Deterministic Calculations
The principles used to set economic assumptions are set out
below.
Economic assumptions vary by territory, with risk free rates
based on actual government bond yields at the date of the
valuation in territories with developed capital markets and on
the long-term view of Prudential's economists for those
territories in Asia with less developed capital markets. 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. In order to maintain
consistency with EEV reporting, the interim 2005 achieved profits
equity risk premium assumption will now rise to 3.0 per cent with
a corresponding increase in the AP risk discount rate. 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 assumptions.
EEV Basis AP Basis
---------------------------------- ---------- ----------
UK and Europe Insurance Operations
Pre-tax expected long-term nominal
rates of investment return:
UK equities 7.6% 7.1%
Overseas equities 7.3% to 8.3% 6.8% to 7.8%
Property 6.3% 6.3%
Gilts 4.6% 4.6%
Corporate bonds 5.5% 5.5%
Expected long-term rate of inflation 2.9% 2.9%
Post-tax expected long-term nominal
rate of return:
Pension business (where no tax 6.8% 6.5%
applies)
Life business 5.9% 5.7%
US Operations (Jackson National Life)
Expected long-term spread between
earned rate and rate credited to
policyholders for single premium 1.75% 1.75%
deferred annuity business
US 10 year treasury bond rate at 31 4.3% 4.3%
December 2004
US Equities 7.3% 7.3%
Asian Operations
Inflation 0.0% to 7.8% 0.0% to 7.8%
Government Bond Yield 1.9% to 13.0% 1.8% to 13.0%
Equity 4.9% to 15.8% 4.9% to 15.8%
---------------------------------- ---------- ----------
3.5.2. Stochastic Calculations
The economic assumptions used for the stochastic calculations are
consistent with those used for the deterministic calculations
described in section 3.5.1. 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 the
long-term views of Prudential's economists. 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 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 (1) Standard
Deviation (2)
---------------- ---------------- ----------------
Government Bond Yield 4.6% 1.9%
Corporate Bond Yield 5.5% 5.8%
Equities 7.6% 20.0%
Property 6.3% 15.0%
---------------- ---------------- ----------------
(1) Means have been derived as the annualised arithmetic average return
across all simulations and durations
(2) 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.
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, appropriately calibrated, as used in the
UK 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.
Mean Standard
Deviation
---------------- ---------------- ----------------
Government Bond Yield (3) 1.9% to 13.0% 0.7% to 3.7%
Equity Risk Premiums 2.8% to 5.3% 22.0% to 25.0%
---------------- ---------------- ----------------
(3) Long Government bond yield (10 year duration)
Management Actions
In deriving the in-force value various 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.
- Levels of reversionary bonuses and credited rates
- Total claim values
- Investment allocation decisions
In all instances the modelled actions are in accordance with approved
local practice and therefore reflect the options actually available to
management. In the UK, the actions assumed were the same as those
adopted for the realistic balance sheet (Pillar I, Peak 2) included in
the regulatory return.
3.6. Non-Economic Assumptions
Demographic Assumptions
Mortality and morbidity assumptions are based on an analysis of recent
experience and reflect expected future experience. Where relevant,
when calculating the time value of in-force business, policyholder
withdrawal rates are allowed to vary in line in line with the emerging
investment conditions according to management's expectations ("dynamic
lapses").
Expense Assumptions
Expense levels, including those of service companies that support the
company'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.
With Profits Business and Treatment of Estate
Where participating business is written into segregated life funds,
the time value of options and guarantees reflects established profit
participation rules.
Projected bonus rates are consistent with the projected investment
return and include the impact of management action taken in response
to emerging investment conditions.
In the UK, which has the largest life fund of the Group, 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.
In other territories with participating business, any required
shareholder injections required to meet contractual and other payments
required by local practice are also included in the time value of
options and guarantees. The shareholder's share in any positive
residual estate has been determined as the present value of 10 per
cent of that amount as at the end of the projection. Any deficits are
fully attributed to shareholders.
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.
Fund Management and Service Companies
The value of future profits or losses from fund management and service
companies that support the Group's long-term businesses are included
in the in-force value of the Group's long-term business. However, the
statutory profits actually emerging continue to be shown together with
profits from external fund management business. The excess or
shortfall of EEV profits over actual statutory profits is included
within the long-term business non-operating result.
The assumptions used to value these businesses are consistent with
those used to value the underlying long-term business. The value
ascribed to the Group's fund management businesses is shown as
follows.
Value of Fund
Management
Business
GBPm
----------------------- -----------------------
UK and Europe 123
Jackson National Life 20
Asia 57
Total 200
----------------------- -----------------------
The value of future profits from service companies is negligible at GBP(7)m .
Appendix A1: Reconciliation of Movement for New Business Profits
UK and Europe Insurance Operations
GBPm
---------------------------------- ---------
Achieved Profits Basis 220
Economic Assumptions 10
Time Value of Options and Guarantees (5)
Risk Discount Rates 6
Fund Management 10
EEV Basis 241
---------------------------------- ---------
JNL
GBPm
---------------------------------- ---------
Achieved Profits Basis 156
Economic Assumptions (8)
Time Value of Options and Guarantees (29)
Risk Discount Rates 30
JNL VA Fees and Benefits 24
Fund Management 4
Other (4)
EEV Basis before change to JNL Tax Gross Up Approach 173
Change to JNL Gross Up Approach (28)
EEV Basis 145
---------------------------------- ---------
Asian Operations
GBPm
---------------------------------- ---------
Achieved Profits Basis 312
Economic Assumptions (5)
Time Value of Options and Guarantees 0
Risk Discount Rates 55
Fund Management 3
Other (10)
EEV Basis 355
---------------------------------- ---------
Appendix A2: Total Operating Profit Before Tax and Impact of IFRS
AP Basis EEV Basis Impact of IFRS
GBPm GBPm GBPm
---------------------------- -------- -------- -----------
New Business Profits 688 741 741
In-force 460 497 598
Total Long-Term 1,148 1,238 1,339
Fund Management
- M&G 136 136 136
- US Broker Dealer, Curian and (14) (14) (14)
Fund Management
- Asia Fund Management 19 19 19
Asia Development Costs (15) (15) (15)
Egg 63 63 61
Other (193) (215) (219)
Total Profit Before Tax from 1,144 1,212 1,307
Continuing Operations
---------------------------- -------- -------- -----------
Note
The IFRS changes include the impact of associated discretionary changes.
APPENDIX B
INTERNATIONAL FINANCIAL REPORTING STANDARDS ("IFRS")
- Prudential has today released selected financial information of restated
2004 results following the adoption of International Financial Reporting
Standards.
- The adoption of IFRS has little impact on reported operating results (based
on longer-term returns).
- Proforma IFRS basis operating results before shareholder tax of GBP608m for
the year ended 31 December 2004 compare with operating results previously
published under UK GAAP of GBP623m.
- The adoption of IFRS gives rise to changed valuation bases of derivatives
and fixed income securities of Jackson National Life ("JNL"). These changes
are likely to give rise to increased volatility in total profits and
shareholders' equity.
- Notwithstanding this increased volatility, the Company is of the view that
the IFRS changes are not significant to an understanding of the Group's
financial position.
- In addition to the IFRS basis changes Prudential has chosen to make a
discretionary change to the basis of determining investment returns
included in operating profits for fixed income securities. This change is
so as to reflect longer-term returns rather than 5 year averaged credit
experience. After making this change, proforma IFRS basis operating profits
for continuing operations for 2004 are GBP699m. Total IFRS profit before
shareholder tax for continuing operations (including actual investment
returns) of GBP985m is unaffected by this change.
- The 2004 Achieved Profits basis ("AP basis") results have also been
restated for the relevant IFRS changes as described elsewhere in this
announcement.
1. Background
The European Union ("EU") requires that all listed European Groups prepare
their 2005 financial statements in accordance with EU approved IFRS. The
IFRS basis of reporting replaces UK GAAP.
The IFRS changes of themselves are not significant to an understanding of
the Group's financial position.
The Financial Review section of Prudential's 2004 Annual Report gave
extensive explanation of the likely changes, which are confirmed in this
announcement. The principal effect of the IFRS changes is that the reported
impact of JNL's hedging strategy and the financial position of the Group's
UK defined benefit pension schemes are brought more into focus.
2. Key Results
Detailed notes on the basis of preparation and main features of the changes
follow in sections 3 and 4 of this announcement. Also included with this
announcement are schedules of selected financial information (Schedules B1
to B6) which provide summary details of the IFRS and restated AP basis
results.
The changed basis of reporting also includes a discretionary change to the
presentation of investment returns for the Group's shareholder backed
non-participating business that is unrelated to IFRS. The IFRS changes and
the discretionary change give rise to the following summary impact on full
year 2004 IFRS and AP basis results and shareholders' funds at 1 January
2005.
IFRS Basis Results Discretionary Required
change for change Change
Previously longer-term to to
published*1 investment statutory Statutory proforma Proforma
(UK GAAP) returns IFRS IFRS*2 IFRS IFRS*2
Year ended 31 December GBPm GBPm GBPm GBPm GBPm GBPm
2004
------------------------ -------- -------- ------ ------- ------ -------
Operating profit based on
longer-term investment
returns, before
amortisation of goodwill
and shareholder tax of
continuing operations:
JNL 196 100 0 296 - 296
Other operations 427 (9) (6) 412 (9) 403
---- ---------------------- -------- -------- ------ ------- ------ -------
Total 623 91 (6)*3 708 (9)*3 699
=== ====================== ======== ======== ====== ======= ====== =======
Representing:
------- ------ -------
IFRS basis results 617 (9) 608
before discretionary
change for longer-term
investment returns
Effect of 91 - 91
discretionary change ------- ------ -------
of policy for
longer-term investment
returns
IFRS basis results 708 (9) 699
after discretionary
change for longer-term
investment returns
==== ====================== ======== ======== ====== ======= ====== =======
Total profit, including 758 - 92 850 135 985
actual investment return,
before shareholders' tax of
continuing operations
==== ====================== ======== ======== ====== ======= ====== =======
Shareholders' Equity
(capital and reserves)
- As at 31 4,281 - 209 4,490 261 4,751
December 2004
- Transition
adjustment - - 236 236 (261) (25)
following full
application of IAS
32, IAS 39 and
IFRS 4
- As at 1 January 4,281 - 445 4,726 - 4,726
2005
==== ====================== ======== ======== ====== ======= ====== =======
Achieved Profits ("AP") Basis Results Discretionary
--------------------------------------- change for
longer-term
Previously investment IFRS
published*1 returns change Restated
Year ended 31 December 2004 GBPm GBPm GBPm GBPm
------------------------------- -------- ---------- ------- -------
Group AP operating profit, based on 1,144 101 (6) 1,239
longer-term investment returns, before
tax of continuing operations
------------------------------- -------- ---------- ------- -------
Total Group AP profit, including actual 1,629 - 85 1,714
investment returns, before tax of
continuing operations
------------------------------- -------- ---------- ------- -------
Group AP Shareholders' Equity
- As at 31 December 2004 8,596 - 166 8,762
- Transition adjustment
following application of IAS39 - (25) (25)
and IFRS4
- As at 1 January 2005
8,596 141 8,737
------------------------------- -------- ---------- ------- -------
*1 Figures shown as 'previously published' relate to continuing operations and
exclude amounts attached to discontinued activities, including Egg's Funds
Direct operations.
*2 See notes a to d of section 3.1 for basis of preparation and context of
references to 'statutory' and 'proforma' bases of presentation.
*3 Total changes arising from IFRS shown above give rise to a reduction of
GBP15m in operating profit - as referred to in the overview press release.
The statutory IFRS basis financial information included within this announcement
establishes the results attributable to shareholders, on the basis of selected
financial information, to be included in the Group's interim 2005 results and
its first annual financial statements for the year ended 31 December 2005. Due
to the continuing work of the International Accounting Standards Board (IASB)
and possible amendments to the interpretative guidance, the Group's accounting
policies, and consequently the information presented, may change prior to the
publication of the first IFRS results in July 2005 and/or the 2005 full year
results to be published in mid March 2006.
Additional details on the basis of preparation, of the Group's principal
accounting policies, and supplementary results schedules are to be included on 2
June 2005 on the Group's website (www.prudential.co.uk) with the details of this
announcement.
3. IFRS basis results
1. Summary
Discretionary
change for Required
longer-term change
Previously investment to Statutory Change to Proforma
published*1 returns statutory IFRS*2 proforma IFRS*2
(UK GAAP) (note b) IFRS (note a) IFRS (note a)
Year ended 31 December GBPm GBPm GBPm GBPm GBPm GBPm
2004
-------------------- -------- -------- ------ ------ ------- -------
Operating profit based
on longer-term
investment returns,
before amortisation
of goodwill and
shareholder tax of
continuing
operations (note c)
JNL 196 100 0 296 0 296
Other operations 427 (9) (6) 412 (9) 403
---- ------------------ -------- -------- ------ ------ ------- -------
Total - see 623 91 (6) 708 (9) 699
section 3.2
==== ================== ======== ======== ====== ====== ======= =======
Representing:
------ ------- -------
IFRS basis results 617 (9) 608
before
discretionary
change for
longer-term
investment
returns
Effect of 91 - 91
discretionary ------ ------- -------
change of policy
for longer-term
investment returns
(note b)
IFRS basis results 708 (9) 699
after
discretionary
change for
longer-term
investment
returns
==== ================== ======== ======== ====== ====== ======= =======
Total profit, including 758 - 92 850 135 985
actual investment
return, before
shareholders' tax of
continuing operations
(note c) - see section
3.3
==== ================== ======== ======== ====== ====== ======= =======
Shareholders' Equity
(capital and reserves)
- See section 3.4
- As at 31
December 4,281 - 209 4,490 261 4,751
2004
- Transition
Adjustment - - 236 236 (261) (25)
following full
application of
IAS 39 and
IFRS 4
- As at 1
January 2005 4,281 - 445 4,726 - 4,726
==== ================== ======== ======== ====== ====== ======= =======
*1 Figures shown as 'previously published' relate to continuing operations and
exclude amounts attached to discontinued activities, including Egg's Funds
Direct operations.
*2 See notes a to d of section 3.1 for basis of preparation and context of
references to 'statutory and proforma bases of presentation'.
Notes on IFRS basis results
a. Statutory and Proforma IFRS basis results
The "statutory IFRS" basis results included in this announcement
reflect the accounting policies adopted by the Group as at 1st January
2004 but are not presented, and are not intended to be, in the format
required for IFRS financial statements for interim or full year
reporting.
References in the table above and throughout this announcement to
'Statutory IFRS' reflect the Group's adoption of all IFRS standards
other than IAS 32, IAS 39 and IFRS 4, for the 2004 comparative results
to be included in the Group's 2005 statutory basis financial
statements, in so far as they affect the selected financial
information included in this announcement. For the avoidance of doubt
the statutory IFRS results do not represent the Company's statutory
accounts, nor have they been extracted from statutory IFRS accounts.
In recognition of the difficulties in IFRS for the banking sector in
retrospectively applying IAS32 and IAS39 on financial instruments, the
IASB has permitted application of these standards from 1st January
2005. This is also permitted for IFRS4 on insurance contracts. For
Prudential, application of IAS32 and IAS39 for its banking subsidiary,
Egg plc, for 2004 would have given rise to results that are not
representative of the approach it intends to apply for hedge
accounting from 1st January 2005. The Group has therefore chosen to
utilise the IFRS 1 option to adopt these standards from 1st January
2005.
However, the application of IAS32 and IAS39 for Prudential's insurance
operations, particularly JNL, has a material impact on IFRS reported
results. The importance of providing information that is indicative of
the basis of reporting to be applied for 2005 for these operations is
recognised, and the Group has therefore chosen to present "Proforma
IFRS" basis results for 2004. These results reflect the estimated
impact of the application of those three additional standards, which
will be adopted from 1st January 2005, to the results of the Group's
insurance operations, as though they had been adopted at 1st January
2004.
The main additional changes included in the proforma information
relate to the valuation of JNL's fixed income securities and
derivatives. The main purpose of the proforma basis information is to
provide users of this financial information with results on a basis
that closely aligns with that to be applied for 2005, taking account
of the Group's chosen approach to application of IAS 39, particularly
for JNL.
Proforma IFRS basis results for 2004 will be included with the 2005
interim and full year results as additional information to the
statutory IFRS basis results to be reported in the Group's primary
statements. For the avoidance of doubt, it is emphasised that the
proforma IFRS results included in this announcement do not form part
of the Group's IFRS basis results for the purpose of compliance with
the relevant accounting requirements on adoption of IFRS.
(b) Operating profit based on longer-term investment returns
References to operating profit, based on longer-term investment
returns, before shareholders' tax, reflect the continuation of the
Group's approach to providing an analysis of results that demonstrates
underlying performance i.e. excluding short-term volatility in
investment returns. Profits determined on this basis are provided as
an additional analysis of the results to be included in the Group's
income statement and reflect the long-standing convention previously
advocated for UK insurers by the Statement of Recommended Practice
issued by the Association of British Insurers.
In determining the statutory and proforma IFRS basis operating results
based on longer-term investment returns included in this announcement,
the basis of determining the longer-term investment returns has been
refined. Previously for fixed income securities of JNL and other
non-participating shareholder backed businesses of the Group, the
basis for determining longer-term returns was estimated by recognising
realised gains and losses on a five-year averaged basis. For future
reporting under IFRS and restated 2004 IFRS basis results this has
been replaced with a combination of an annualised charge for long-term
expected default experience and amortisation of interest related
realised gains and losses to the period when the sold securities would
have otherwise matured.
The change more closely reflects the longer-term nature of the credit
cycle and refines the impact of realisations that are unrelated to
defaults and impairments. Prudential believes that the presentation of
operating profits based on longer-term investment returns better
reflects the Group's underlying performance.
(c) Basis of presentation of tax charge
References to operating profit and total profit before shareholder tax
reflect the continued presentation as additional information of tax
attributable to with-profits funds and unit linked policyholders as a
charge deducted in the determination of pre-shareholder tax results.
In determining the allocation of tax charges between those
attributable to with-profits funds, unit-linked policyholders and
shareholders, a methodology consistent with that previously
appropriate under UK GAAP (modified statutory basis) reporting has
been applied.
Technically under IFRS, which does not recognise the distinction
between taxes attributable to these different participants, total
formal IFRS pre-tax profit is required to be recorded in the income
statement before deduction of all taxes. In determining such pre-tax
profits, transfers to and from unallocated surplus of with-profits
funds are taken into account. These transfers are themselves a
function of the tax borne by with-profits funds. The total profit
before tax on an IFRS basis is not representative of profit before
taxes attributable to shareholders.
In order to provide pre-tax results that are relevant from a
shareholder perspective, the Group has elected to provide additional
analysis in its financial statements of the profits before shareholder
tax, but after deduction of policyholder tax. All results shown in
this announcement are presented on this basis.
(d) Accounting policies
The focus of this announcement is the impact of the changes in
accounting policies as they affect the results before shareholder tax
and as they affect shareholders' funds. The full set of IFRS policies
that will be implemented for the Group's 2005 financial statements
will incorporate changes from those previously applied under UK GAAP.
These will include policies covering the balance sheet changes,
incorporating the inclusion of assets and liabilities such as
investments, goodwill and non-recourse borrowings of investment,
property and venture fund subsidiaries that have hitherto not required
consolidation. These subsidiaries are primarily investments of the
Prudential Assurance Company ("PAC") with-profits fund, US investment
fund, and other special purpose vehicles.
1. Changes to IFRS operating results, based on longer-term investment
returns, for continuing operations
A summary of the changes to operating profit, based on longer-term
investment returns, before shareholder tax for continuing operations is as
follows:
Discretionary Required
change for change
longer-term to Change to
Previously investment statutory Statutory Proforma Proforma
Published*1 returns IFRS IFRS*2 IFRS IFRS*2
GBPm GBPm GBPm GBPm GBPm GBPm
---- ------------------ -------- -------- ------ ------- ------- -------
UK and Europe
operations
Insurance 305 0 0 305 (9) 296
operations (note
a)
M&G (note b) 136 0 0 136 N/A 136
Egg (note c) 63 0 (2) 61 N/A 61
---- ------------------ -------- -------- ------ ------- ------- -------
Total 504 0 (2) 502 (9) 493
---- ------------------ -------- -------- ------ ------- ------- -------
US operations
JNL (note d) 196 100 0 296 0 296
Broker dealer and (14) 0 0 (14) N/A (14)
fund management
---- ------------------ -------- -------- ------ ------- ------- -------
Total 182 100 0 282 0 282
---- ------------------ -------- -------- ------ ------- ------- -------
Asian operations (note e)
Long-term 126 (9) 0 117 0 117
business
Fund Management 19 0 0 19 N/A 19
Development (15) 0 0 (15) N/A (15)
Expenses
---- ------------------ -------- -------- ------ ------- ------- -------
Total 130 (9) 0 121 0 121
---- ------------------ -------- -------- ------ ------- ------- -------
Other income and
expenditure
Interest payable (154) 0 0 (154) N/A (154)
on core structural
borrowings
Other (note f) (39) 0 (4) (43) N/A (43)
---- ------------------ -------- -------- ------ ------- ------- -------
Total (193) 0 (4) (197) 0 (197)
---- ------------------ -------- -------- ------ ------- ------- -------
Total 623 91 (6) 708 (9) 699
==================== ======== ======== ====== ======= ======= =======
Representing:
------- ------- -------
IFRS basis results 617 (9) 608
before
discretionary
change for
longer-term
investment
returns
Effect of 91 0 91
discretionary ------- ------- -------
change of policy
for longer-term
investment
returns
IFRS basis results 708 (9) 699
after
discretionary
change for
longer-term
investment
returns
==== ================== ======== ======== ====== ======= ======= =======
N/A: not applicable - proforma basis changes are confined to insurance
operations
*1 Figures shown as 'previously published' relate to continuing operations and
exclude amounts attached to discontinued activities, including Egg's Funds
Direct operations.
*2 See notes a to d of section 3.1 for basis of preparation and context of
references to 'statutory and proforma bases of presentation'.
Notes on changes to operating results, based on longer-term investment returns,
of continuing operations.
(a) UK and Europe Insurance operations
The proforma IFRS basis result of GBP296m incorporates a GBP(9)m change on
applying IAS39 and IFRS4 to those unit-linked contracts that are classified
as investment contracts under IFRS 4. Under the changed basis of
classification:
# -Sterling reserves are no longer recognised.
# - Acquisition costs that are deferrable are restricted to
incremental costs.
# - Deferrable acquisition costs, front-end charges and
actuarial funding are amortised in line with service
provision.
For all other insurance contracts of UK and Europe
operations the basis of measurement of assets and
liabilities continues to be as applied under UK GAAP.
(b) M&G
For M&G, the zero change reflects the application of IAS19
for the M&G pension scheme (GBP(1)m) offset by altered
measurement of acquisition costs and front-end charges for
external investment management business (GBP1m).
(c) Egg
Operating profit, as previously published, shown above of
GBP63m is shown after adjusting for the losses of GBP20m
attaching to the now discontinued Funds Direct business.
The statutory IFRS changes to the 2004 comparative results
for Egg reflect only those adjustments arising from IFRS
standards other than from IAS32 and IAS39. GBP(3)m of the
change of GBP(2)m arises from the application of IFRS2 to
share based payment in respect of shares in Egg plc.
Consistent with the approach of many other banks, IAS32 and
IAS39 will be applied for the first time as at 1 January
2005. Prospectively, wholesale assets will be classified as
Available-for-Sale under IAS39 and held at fair value with
unrealised gains and losses reflected directly in equity.
Liabilities will be measured at amortised cost with no
effect compared to UK GAAP, except where set-up fees had
been previously expensed but will, under IFRS, be
capitalised and amortised.
Derivatives will be the only products for which changes in
fair value will affect the total result for the reporting
period. However, for interest rate swaps that economically
hedge fixed rate personal loans, by matching them against
the variable rate savings book, Egg will apply portfolio
cash flow hedge accounting under IAS39. Changes in the fair
value of these hedges will be recorded directly in equity in
the balance sheet and not the income statement.
(d) JNL
The discretionary change to reflect the altered basis of
recognition of longer-term investment return is unrelated to
the requirements of IFRS. The change primarily affects the
operating result of JNL as follows:
Previously published basis: GBPm
------------------------------------------ --------
Averaged losses on fixed income securities (102)
Statutory and proforma IFRS GBPm
------------------------------------------ --------
Longer-term default assumption (47)
Amortisation of interest related realised gains and losses 45
------------------------------------------ --------
(2)
============================================ ========
Net Change GBPm
------------------------------------------ --------
Gross change 110
Change to related amortisation of acquisition costs (10)
------------------------------------------ --------
100
============================================ ========
The change of GBP100m reflects the replacement of the 5 year averaging
of the exceptional default losses experienced in 2001 and 2002 with a
default assumption that reflects longer-term expectations, based on
historical precedent. The longer-term default provision has been
calibrated on a basis consistent with published rating agency risk
margin analyses and is reflective of the credit quality of individual
investments held in the JNL portfolio.
There are no significant changes to JNL's operating results for IFRS
changes. The accounting basis applied previously to JNL's contracts
aligns very closely to that required under IFRS.
(e) Asian Operations
With the exception of the altered basis of determining longer-term
returns, there is no change to operating profit for Asian operations.
Virtually all insurance contracts of the Group's Asian Operations
continue to be accounted for under UK GAAP as they are technically
classified as insurance rather than investment contracts under IFRS4.
(f) Other income and expenditure
The change of GBP(4)m comprises:
GBPm
------------------------------------------- ---------
Shareholders' share of pension costs not allocated to business (3)
operations
In respect of share based payments (1)
------------------------------------------- ---------
(4)
------------------------------------------- ---------
1. Changes to total IFRS profit before shareholder tax
A summary of changes to total profit before shareholder tax, including
actual investment returns, of continuing operations is as follows:
Discretionary Required
change for change
Previously longer-term to Change to
published*1 investment statutory Statutory Proforma Proforma
(UK GAAP) returns IFRS IFRS*2 IFRS IFRS*2
GBPm GBPm GBPm GBPm GBPm GBPm
---- ------------------ -------- -------- ------ ------- ------- -------
Operating profit, based 623 91 (6) 708 (9) 699
on longer-term
investment returns,
before shareholder
tax
Representing:
------- ------- -------
IFRS basis results 617 (9) 608
before
discretionary
change for
longer-term
investment
returns
Effect of 91 - 91
discretionary ------- ------- -------
change of policy
for longer-term
investment
returns
IFRS basis results 708 (9) 699
after
discretionary
change for
longer-term
investment
returns
Amortisation of (94) - 94 - - -
goodwill (note a)
Short-term fluctuations 229 (91) 11 149 144 293
in investment returns
(note b)
Shareholders' share of - - (7) (7) - (7)
actuarial gains and
losses on defined
benefit pension schemes
(note c)
---- ------------------ -------- -------- ------ ------- ------- -------
Total profit including 758 - 92 850 135 985
actual investment
returns, before
shareholder tax of
continuing operations
==================== ======== ======== ====== ======= ======= =======
*1 Figures shown as 'previously published' relate to continuing operations and
exclude amounts attached to discontinued activities, including Egg's Funds
Direct operations
*2 See notes a to d of section 3.1 for basis of preparation and context of
references to 'statutory and proforma bases of presentation'.
Notes on changes to total profit before shareholder tax of continuing
operations
(a) Amortisation of goodwill
Subject to annual impairment testing, goodwill is not amortised under IFRS.
(b) Short-term fluctuations in investment returns
The discretionary change of GBP(91)m reflects the revised basis of
determining longer-term returns, as discussed in section 3.1 (note b). The
GBP11m change to statutory IFRS principally reflects the share of profits
of property and venture fund investment subsidiaries, held by the PAC
with-profits fund, that are attributable to minority interests.
The GBP144m change to proforma IFRS arises from the market valuation of
derivatives used for economic hedging purposes by JNL. Previously, under UK
GAAP, the fixed income securities of JNL were, unless impaired, accounted
for at amortised cost with derivatives similarly treated. In applying IFRS
the Group will account for JNL's fixed income securities on an
'Available-for-Sale' basis whereby the fixed income securities are
accounted for at fair value with unrealised gains and losses being recorded
directly in equity rather than the income statement. In this respect the
treatment is as applied by many US insurers under US GAAP. Value movements
for JNL's derivatives will, however, be booked in the income statement
under IFRS from 1 January 2005 when the Group adopts IAS 32 and IAS 39.
The Group will not generally seek to hedge account for JNL's derivatives
under IAS 39 i.e. it will not attempt to match up value movements on hedged
assets, with the value movements in the derivatives, in the income
statement.
(c) Shareholders' share of actuarial gains and losses on defined benefit
pension schemes
The actuarial gains and losses comprise the effect of short-term
fluctuations in investment returns on scheme assets, and the effect of
changes in actuarial assumptions, after deduction of the proportion
absorbed by the PAC with-profits fund. Due to IFRS requirements, as they
apply to the share of actuarial gains and losses absorbed by with-profits
funds, the Group's policy is to record all actuarial gains and losses in
the income statement.
2. Changes to IFRS shareholders' equity (capital and reserves)
A summary of changes to shareholders' equity at 31 December 2004 is as
follows:
GBPm
----------------------------------------------- --------
Previously published under UK GAAP 4,281
Changes to statutory IFRS
--------
-Timing difference on recognition of accrued final
dividend (note a) 253
-Shareholders' share of deficits (net of tax) of UK
defined benefit pension schemes (note b) (115)
-Goodwill (note c)
94
-Other items (note d)
(23)
--------
209
----------------------------------------------- --------
Statutory IFRS basis shareholders' funds at 31 December 2004* 4,490
Changes to Proforma IFRS i.e. applying IAS 39 and IFRS 4 on
basis consistent with that to be applied prospectively for
insurance operations
-Valuation changes to fixed income securities and --------
derivatives (net of related changes to 273
deferred acquisition costs and deferred tax) of US
operations (note e)
-UK and Europe insurance operations (12)
--------
261
----------------------------------------------- --------
Proforma IFRS basis at 31 December 2004* 4,751
=============================================== ========
* See notes a to d of section 3.1 for basis of preparation and
context of references to 'statutory and proforma bases of
presentation'.
On formal adoption of IAS32, IAS39 and IFRS4 at 1 January 2005 for
the Group's insurance and other operations, the Group's IFRS basis
results will incorporate a transitional adjustment to shareholders'
equity. The changes are as follows:
Previously Statutory Proforma
published IFRS* IFRS*
GBPm GBPm GBPm
--- -------------------------------- -------- -------- -------
Shareholders' equity at 31 December 4,281 4,490 4,751
2004
Transition adjustments
Insurance operations N/A 261 N/A
--- -------------------------------- -------- -------- -------
N/A 4,751 4,751
Banking and other non-insurance N/A (25) (25)
operations
--- -------------------------------- -------- -------- -------
Shareholders' equity at 1 January 4,281 4,726 4,726
2005
=== ================================ ======== ======== =======
* See notes a to d of section 3.1 for basis of preparation and context
of references to 'statutory and proforma bases of presentation'.
Notes on changes to shareholders' equity (capital and reserves)
(a) Timing difference on recognition of accrued final dividend
Under IFRS dividends declared after the balance sheet date of the
reporting period are recognised for accounting purposes in the period
of declaration.
(b) Shareholders' share of deficits (net of tax) of UK defined benefit
pensions schemes
Under IAS 19 provision for pension scheme deficits is required on a
basis similar to that previously shown in the 2004 Annual Report as
memorandum disclosure under FRS 17. The deficits of the schemes
reflect the difference between the market value of the assets of the
schemes and projected liabilities for future cash flows discounted at
an AA graded corporate bond rate. The total deficits have been
apportioned, on a basis that reflects the activity of the members of
the schemes, between the PAC with-profits fund and shareholders'
funds. After deduction of attaching deferred tax, the net effect is to
reduce the unallocated surplus of the PAC with-profits fund at 31
December 2004 by GBP472m. Shareholders' funds are reduced by GBP115m.
(c) Goodwill
The charge for goodwill reflects the fact, subject to annual
impairment testing, that goodwill is not amortised from the date of
adoption of IFRS.
(d) Other items
Of the deduction of GBP23m, GBP27m relates to Prudential shares owned
by unit trusts that are consolidated under IFRS. These shares are
accounted for as Treasury shares and hence deducted from shareholders'
equity rather than being recorded as assets.
(e) Valuation changes to fixed income securities and derivatives of JNL.
Note (b) of section 3.3 above describes the altered basis of valuation
of JNL's fixed income securities and derivatives. After partially
offsetting 'shadow' accounting changes, in the balance sheet and
shareholder reserves, for deferred acquisition costs (DAC) and related
deferred tax, the altered valuation basis gives rise to an increase in
shareholders' equity of GBP273m. The uplift reflects the difference
between fair value (as applied under IFRS) and amortised cost (as
applied under UK GAAP unless securities are impaired). The movement in
this unrealised appreciation from period to period primarily reflects
the impact of changes of market interest rates and risk premium. In
future, IFRS shareholders' funds are likely to be more volatile for
this feature.
4. AP basis results
4.1 Summary
The changes applied on adoption of IFRS, primarily for the Group's
non-insurance operations, have consequential effects on the Group results
reported on the Achieved Profit (AP) basis. However, the AP value of
in-force long-term business, which reflects the discounted value of future
cash flows, is unaffected. The Group will apply the AP basis of reporting
for the final time for interim reporting for 2005. Full year supplementary
reporting for 2005 will be on the EEV basis.
The summary impact on full year 2004 AP basis results and shareholders'
funds at 1st January 2005 is as follows:
Discretionary
change for
longer-
Previously term investment IFRS Restated
published* returns change (note a)
Year ended 31 December GBPm GBPm GBPm GBPm
2004
---------------------------- ------- ----------- ------ -------
Group Achieved Profit basis 1,144 101 (6) 1,239
operating profit, based on
longer-term investment
returns, before tax of
continuing operations (note
b) - see section 4.2
---------------------------- ------- ----------- ------ -------
Total Group Achieved Profit 1,629 - 85 1,714
basis profit, including
actual investment returns,
before tax of continuing
operations - see section
4.3
---------------------------- ------- ----------- ------ -------
Group Achieved Profit basis
Shareholders' Equity - see
section 4.4
-As at 31 December
2004 8,596 - 166 8,762
-Transition
adjustment - (25) (25)
-As at 1 January
2005 following 8,596 141 8,737
application of IAS 39
and IFRS 4
---------------------------- ------- ----------- ------ -------
* Figures shown as 'previously published' relate to continuing
operations and exclude amounts attached to discontinued activities,
including Egg's Funds Direct operations
Notes on restated AP basis results
(a) Basis of restatement
The changes shown above reflect the application of:
i. The discretionary change to determination of longer-term returns
included in operating profit, (see note (b) below) and;
ii. Statutory IFRS basis changes for the Group's other than
long-term business operations, (i.e. IFRS changes arising from
the adoption of all standards other than IAS 32, IAS 39 and IFRS
4).
iii. An additional, consequential, change in respect of UK defined
benefit pension schemes for the shareholders' interest in the PAC
with-profits fund. (see note (c)).
(b) Operating profit based on longer-term investment returns
As for statutory (IFRS) basis results, it is the Group's intention to
continue with the approach of providing an analysis of the results
that demonstrates underlying performance, i.e. excluding short-term
volatility in investment returns. As for statutory (IFRS) basis
results, the basis of determining longer-term returns has been revised
- see 4.2 below.
(c) Additional change in respect of UK defined benefit pensions schemes
Item (iii) in respect of the provision for deficits of UK defined
benefit pension schemes reflects the AP basis methodology, whereby
shareholders' equity has, in addition to the IFRS deficit attributable
to shareholder backed operations (as for statutory basis (IFRS)
results), been adjusted to reflect the shareholders' 10 per cent
interest in the IAS19 basis deficit attributed to the PAC with-profits
fund. The latter item reflects the shareholders' interest on the AP
basis consistent with the basis of distribution of surplus from the
fund.
2. Changes to AP basis operating results, based on longer-term investment
returns
A summary of the changes to AP basis operating profit, based on longer-term
investment returns, before shareholder tax from continuing operations is as
follows:
Year ended 31 December
2004 Discretionary
AP basis operating change to
results, longer-term
based on longer-term Previously investment
investment returns published* returns IFRS changes Restated
before shareholder tax GBPm GBPm GBPm GBPm
----------------------- -------- ---------- -------- ---------
UK and Europe Insurance 450 0 450
Operations
M&G (note a) 136 0 136
Egg (Note b) 63 (2) 61
---- --------------------- -------- ---------- -------- ---------
Total 649 (2) 647
US Operations (note c) 303 110 0 413
Prudential Corporation 385 (9) 0 377
Asia (note c)
Other income & expenditure (193) (4) (197)
(noted d)
---- --------------------- -------- ---------- -------- ---------
Group Total 1,144 101 (6) 1,239
==== ===================== ======== ========== ======== =========
* Figures shown as 'previously published' relate to continuing operations and
exclude amounts attached to discontinued activities, including Egg's Funds
Direct operations
Notes on changes to AP basis operating profit, based on longer-term term
investment returns of continuing operations
(a) M&G
As described in section 3.2 (note (b)) the changes for M&G reflect the
application of IAS 19 for the M&G pension scheme and altered
measurement of acquisition costs and front end charges for external
investment management business.
(b) Egg
As described in section 3.2 (note(c)) the changes reflect only
adjustments needed that arise from IFRS standards other than IAS 32
and IAS 39.
(c) US and Asian Operations
As described in section 3.2 (notes (d) and (e)) the change reflects
the altered basis of longer-term investment returns. For US Operations
the change on AP basis excludes the related change to amortisation of
deferred acquisition cost (DAC) reflected for IFRS, as DAC is not part
of the AP methodology.
(d) Other income and expenditure
As described in section 3.2, (note (f)), the change of GBP(4)m relates
to stock based compensation and pension costs.
4.3 Changes to total AP basis profit before tax including actual
investment returns, of continuing operations
Discretionary
change for
longer-
Previously term investment IFRS
Total AP basis published* returns changes Restated
Profit before shareholder GBPm GBPm GBPm GBPm
tax
------------------------- -------- ----------- -------- -------
Operating profit, based on 1,144 101 (6) 1,239
longer-term investment
returns, before tax of
continuing operations
Amortisation of goodwill (94) - 94 -
(note a)
Short-term fluctuations in 679 (101) 9 587
investment returns (note b)
Shareholders' share of - - (12) (12)
actuarial gains and losses
on defined benefit pension
schemes
Effect of changes in (100) - (100)
economic assumptions
---- ----------------------- -------- ----------- -------- -------
Total profit, including 1,629 - 85 1,714
actual investment returns
before shareholder tax, of
continuing operations
==== ======================= ======== =========== ======== =======
* Figures shown as 'previously published' relate to continuing
operations and exclude amounts attached to discontinued activities,
including Egg's Funds Direct operations
Notes on changes to total AP basis profit before tax, including actual
investment returns, of continuing operations
(a) Amortisation of goodwill
Subject to annual impairment testing, goodwill is not amortised under
IFRS.
(b) Short-term fluctuations in investment returns
The change of GBP(92)m on restatement from GBP679m to GBP587m includes
GBP(101)m in respect of the altered basis of recognition of
longer-term returns for JNL and Asian Operations.
The changes reflected in the proforma statutory basis (IFRS)
short-term fluctuations in investment returns shown in section 3.3 for
JNL's derivatives will not feature in the AP basis results. As the
derivatives are part of the long-term business assets and liabilities,
which are modelled for cash flow projection purposes, valuation
adjustments, which are reported for statutory basis reporting, are not
relevant for AP basis results.
4.4 Changes to total AP basis shareholders' equity (capital and
reserves) at 31 December 2004
A summary of changes to AP basis shareholders' equity at 31
December 2004 is as follows:
GBPm
---- ---------------------------------------- -----------
AP basis shareholders' equity at 31 December 2004 as 8,596
previously published
Changes arising from application of IFRS
-----------
-
Timing difference on recognition of accrued final -----------
dividend (note a) 253
-Shareholders' share of deficits (net of tax) of
UK defined benefit pension schemes
- Statutory (IFRS) basis (115)
- Additional change for shareholders' 10% interest on (47)
the AP basis,
in the deficit attributable to the PAC with-profits
fund (note b)
-Goodwill (note c)
94
-Other Items
(19)
-----------
166
---- ---------------------------------------- -----------
AP basis shareholders' equity at 31 December 2004 after 8,762
IFRS change
==== ======================================== ===========
Impact of adoption of IAS 32 and IAS 39 on AP basis shareholders' equity
at 31 December 2004
On formal adoption of IAS 32 and IAS 39 at 1 January 2005, the Group's
AP basis results will incorporate a transitional adjustment to
shareholders' equity. The changes are as follows:
Previously
published Restated
GBPm GBPm
----------------------------------- ---------- ----------
AP basis Shareholders' equity at 31 December 8,596 8,762
2004
Transition adjustment on adoption of IAS 32 and N/A (25)
IAS 39
----------------------------------- ---------- ----------
AP basis Shareholders equity at 1 January 2005 8,596 8,737
=================================== ========== ==========
Notes on changes to total AP basis shareholders' equity at 31 December 2004
(a) Timing difference on recognition of accrued final dividend
Under IFRS dividends are recognised for accounting purposes in the
period of declaration.
(b) Shareholders' share of deficits (net of tax) of UK defined pension
schemes
The additional deduction for the shareholders' share of the deficits
of the Prudential Staff Pension Scheme and Scottish Amicable Pension
Scheme reflect the fact that on the AP basis surpluses held within the
PAC with-profits fund are assumed to be distributed over time through
enhanced terminal bonuses with shareholders receiving 10% of the
surplus for distribution i.e. one-ninth cost of bonus.
(c) Goodwill
Subject to annual impairment testing, goodwill is not amortised under
IFRS.
PRUDENTIAL PLC
2004 Restated Results
IFRS AND ACHIEVED PROFITS BASIS RESULTS
PRELIMINARY SELECTED FINANCIAL INFORMATION INCLUDED WITH PRESS RELEASE
IFRS basis results
The IFRS basis results shown on schedules B1 to B3 have been prepared on two
bases, namely "Statutory IFRS" and "Proforma IFRS".
The "Statutory IFRS" results reflect those to form the basis of the comparative
results in the Group's half year 2005 consolidated financial statements after
adjustment for appropriate presentational and format changes, and to be
accompanied by additional disclosures required by the relevant IFRS standards
and UK listing authority requirements.
For the avoidance of doubt the "Statutory IFRS" results included in this
announcement are selected financial information and do not represent the Group's
statutory accounts.
The following points should also be noted:
a. The preliminary information has been prepared in accordance with the basis
of preparation set out in this announcement rather than the basis
applicable for a set of formal IFRS financial statements.
b. The disclosure and presentation requirements of formal IFRS financial
statements have not been adopted in the preliminary IFRS selected financial
information. The format of the presentation of the results in the
announcement will however be applied as part of future IFRS financial
statements.
c. The preliminary IFRS selected financial information does not include
details of the Group's consolidated cash flows, consolidated income
statement, or consolidated balance sheet presentation.
d. In accordance with IFRS1, no adjustments have been made for any changes in
estimates made at the time of approval of the previous UK GAAP interim and
annual financial statements on which the selected financial information is
based.
The "Statutory IFRS" results reflect the application of :
(i) Measurement changes arising from the adoption of all IFRS standards,
other than IAS32, IAS39 and IFRS4, from 1 January 2004, in so far as
they affect the selected financial information included in this
announcement.
(ii) Changes to the format of the income statement for discontinued
operations, and other presentational changes under IFRS, in so far as
they affect the presentation of the selected financial information
included in this announcement, and
(iii)A discretionary change of policy for the basis of determining
longer-term investment returns included in operating profits
The "Proforma IFRS" basis results are provided as supplementary
information and are not results that will form part of the company's
financial statements.
The "Proforma IFRS" results reflect the application of the "Statutory
IFRS" changes noted above and the estimated effect on the Group's
results for 2004 if IAS32, IAS39 and IFRS4 had been applied from 1st
January 2004 to the Group's insurance operations.
The "Proforma IFRS" results for 2004 will be provided as additional
information with the Group's half year 2005 consolidated financial
statements.
Schedule
----------
Summary results, supplementary profit measures, and earnings B1
per share
Operating profits, based on longer-term investment returns,
for continuing operations,
by business area B2
Movement in shareholders' equity (capital and reserves) B3
Achieved Profits basis results
The restated Achieved Profits basis results shown on schedules B4 to B6 have
been prepared after applying:
(i) Measurement changes arising from the adoption of all IFRS standards,
other than for IAS32, IAS39 and IFRS4, from 1 January 2004.
(ii) Changes to the format of the income statement for discontinued
operations, and other presentational changes under IFRS, in so far as
they affect the selected financial information included in this
announcement.
(iii)A discretionary change of policy for the basis of determining
longer-term investment returns included in operating profits.
The Half Year 2005 Achieved Profits basis results will reflect the
adoption of all IFRS standards, including IAS32, IAS39, and IFRS4.
These three standards will be adopted at 1 January 2005. The effect on
the Achieved Profits basis results of these three standards will be
confined to the Group's non-insurance operations.
Consolidated summary results and Earnings per Share B4
Operating profits, based on longer-term investment returns, for
continuing operations by
business area B5
Movement in shareholders' capital and reserves B6
Additional details on the basis of preparation and accounting policies applied
are included in a separate section of this announcement.
PRUDENTIAL PLC Schedule B1
2004 Restated Results
IFRS BASIS RESULTS
SUMMARY RESULTS, SUPPLEMENTARY PROFIT MEASURES, AND EARNINGS PER SHARE
PREVIOUSLY
PUBLISHED
UK GAAP basis STATUTORY IFRS basis 7PROFORMA IFRS basis
Half year Full year Half year Full year Half year Full year
2004 2004 2004 2004 2004 2004
SUMMARY RESULTS GBPm GBPm GBPm GBPm GBPm GBPm
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Long-term business:
Gross premiums written for 7,526 16,355 7,526 16,355 6,249 14,096
insurance contracts
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Profit from continuing
operations, before tax
attributable to shareholders 307 758 393 850 486 985
Tax attributable to (128) (246) (138) (240) (170) (290)
shareholders*
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Profit from continuing 179 512 255 610 316 695
operations after tax
Discontinued operations, net of (16) (94) (15) (94) (15) (94)
tax
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Total profit for the period 163 418 240 516 301 601
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Attributable to:
Equity holders of the 156 428 233 517 294 602
parent company
Minority interest 7 (10) 7 (1) 7 (1)
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Total profit for the period 163 418 240 516 301 601
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
SUPPLEMENTARY PROFIT MEASURES
-------------------------------
Operating profit from
continuing operations, based on
longer-
term investment returns, before 328 623 372 708 373 699
amortisation of goodwill
Amortisation of goodwill (48) (94)
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Operating profit from
continuing operations, based on
longer-
term investment returns 280 529 372 708 373 699
Short-term fluctuations in 27 229 (27) 149 65 293
investment returns
Shareholders' share of
actuarial gains and losses on
defined
benefit pension schemes 48 (7) 48 (7)
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Profit from continuing
operations, before tax
attributable
to shareholders 307 758 393 850 486 985
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
EARNINGS PER SHARE
--------------------
Continuing operations
From operating profit, based on
longer-term investment
returns, after tax and related
minority interest, before
amortisation of goodwill 10.7 p 20.5 p 12.9 p 24.7 p 13.0 p 24.2 p
Adjustment for amortisation of (2.3) p (4.4) p
goodwill
Adjustment from post-tax
long-term investment returns
to post-tax actual investment
returns (after related
minority
interest) (0.3) p 7.1 p (2.8) p 3.0 p 0.1 p 7.5 p
Adjustment for post-tax
shareholders' share of
actuarial gains
and losses on defined benefit 1.6 p (0.2) p 1.6 p (0.2) p
pension schemes
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Based on profit from continuing
operations after minority
interest 8.1 p 23.2 p 11.7 p 27.5 p 14.7 p 31.5 p
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Discontinued
operations
From post-tax profit/
loss from discontinued
operations,
including profits on
disposal and closure
costs, net of tax and
related minority (0.6) p (3.1) p (0.5) p (3.1) p (0.5) p (3.1) p
interest
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Based on total profit 7.5 p 20.1 p 11.2 p 24.4 p 14.2 p 28.4 p
for the period after
minority interests
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Average number of shares 2,084 ** 2,129 2,075 2,121 2,075 2,121
(million)
------------------------ -------- --- ------ --- ------- --- ------ --- ------ ---
Dividend per share *** 5.19 p 15.84 p 10.22 p 14.81 p 10.22 p 14.81 p
* Tax charges shown throughout this announcement exclude taxes
attributable to policyholders which are accounted for as a charge in
determining pre-shareholder tax results.
Additional details on the basis of presentation of the tax charge are
included within the accounting policies section of this announcement.
** The as "previously published" average number of shares for half year
2004 has been adjusted to reflect the impact of the rights issue in
late 2004.
*** In accordance with the changed requirements of IFRS the dividend per
share figures shown above reflect dividends declared in the period
rather than, as under UK GAAP, the period to which the dividend
relates. The dividend per share for the 2003 final dividend, declared
in February 2004, and the interim 2004 dividend, declared in July
2004, have been adjusted to reflect the bonus element in the 2004
rights issue.
PRUDENTIAL PLC Schedule B2
2004 Restated Results
IFRS BASIS RESULTS
OPERATING PROFITS, BASED ON LONGER-TERM INVESTMENT RETURNS, FROM CONTINUING
OPERATIONS
PREVIOUSLY PUBLISHED
UK GAAP basis STATUTORY IFRS basis PROFORMA IFRS basis
Half year Full year Half year Full year Half year Full year
2004 2004 2004 2004 2004 2004
RESULTS ANALYSIS BY GBPm GBPm GBPm GBPm GBPm GBPm
BUSINESS AREA
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
UK and Europe
operations
Insurance operations 152 305 152 305 153 296
M&G 79 136 79 136 79 136
Egg 30 63 31 61 31 61
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
Total 261 504 262 502 263 493
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
US operations
Jackson National Life 106 196 157 296 157 296
Broker dealer and fund (2) (14) (2) (14) (2) (14)
management
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
Total 104 182 155 282 155 282
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
Asian operations
Long-term business 64 126 58 117 58 117
Fund management 10 19 10 19 10 19
Development costs (10) (15) (10) (15) (10) (15)
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
Total 64 130 58 121 58 121
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
Other income and
expenditure
Investment return and 16 44 16 44 16 44
other income
Interest payable on core (74) (154) (74) (154) (74) (154)
structural borrowings
Corporate expenditure
Group Head (25) (54) (25) (54) (25) (54)
Office
Asia Regional (18) (29) (18) (29) (18) (29)
Head Office
Additional IFRS pension 0 0 (2) (4) (2) (4)
and share based payment
costs not allocated to
business operations
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
Total (101) (193) (103) (197) (103) (197)
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
Operating profit, based
on longer-term
investment
returns, from continuing 328 623 372 708 373 699
operations
------------------------ -------- --- ------ --- ------- --- ------ --- ------- --- -----
PRUDENTIAL PLC Schedule B3
2004 Restated Results
IFRS BASIS RESULTS
MOVEMENT IN SHAREHOLDERS' CAPITAL AND RESERVES ATTRIBUTABLE TO SHAREHOLDERS OF
PARENT COMPANY
PREVIOUSLY PUBLISHED
UK GAAP basis STATUTORY IFRS basis PROFORMA IFRS basis
CONSOLIDATED STATEMENT OF Half year Full year Half year Full year Half year Full year
RECOGNISED INCOME 2004 2004 2004 2004 2004 2004
AND EXPENSE GBPm GBPm GBPm GBPm GBPm GBPm
------------------------- -------- ------ -------- ------ ------- ------
Profit for the period (net 156 428 233 517 294 602
of minority interest)
Items taken directly to
equity:
Exchange movements (33) (173) (32) (172) (37) (191)
Value movements on fixed
income securities
classified as
available for sale:
Gross valuation (562) (106)
movements
Related change to 265 74
amortisation of
acquisition costs
Related tax 5 12 5 12 113 23
------------------------- -------- ------ -------- ------ ------- ------
Total recognised income for
the period (net of
minority
interest) 128 267 206 357 73 402
------------------------- -------- ------ -------- ------ ------- ------
RECONCILIATION OF MOVEMENT
ON CONSOLIDATED
SHAREHOLDERS' EQUITY
Total recognised income for
the period (net of minority
interest)
- as above 128 267 206 357 73 402
Proceeds from rights issue, 1,021 1,021 1,021
net of expenses
Other new share capital 61 119 61 119 61 119
subscribed
Dividends (109) (362) (214) (323) (214) (323)
Stock based compensation -
fair value adjustment (net
of
related tax) 3 10 3 10
Own shares
Own shares purchased in
respect of stock
compensation
plans (4) 0 (4) 0 (4)
Movement on Prudential
plc shares purchased by
unit trusts
newly consolidated under 0 14 0 14
IFRS
------------------------- -------- ------ -------- ------ ------- ------
Net increase (decrease) in
shareholders' capital and
reserves 80 1,041 56 1,194 (77) 1,239
------------------------- -------- ------ -------- ------ ------- ------
Shareholders' capital and
reserves at 1 January 2004
As previously reported 3,240 3,240 3,240 3,240 3,240 3,240
Adjustments on 56 56 272 272
implementation of
statutory/proforma
IFRS
--- ------------------------ -------- ------ -------- ------ ------- ------
As re-stated 3,240 3,240 3,296 3,296 3,512 3,512
--- ------------------------ -------- ------ -------- ------ ------- ------
Shareholders' capital and
reserves at end of period
(see
note) 3,320 4,281 3,352 4,490 3,435 4,751
------------------------- -------- ------ -------- ------ ------- ------
Note
------
Reconciliation to shareholders' capital and reserves at 1st January 2005 on adoption of IAS32, IAS39, and
IFRS4
-----------------------------------------------------------------------------------------------------------
Capital and reserves at 31 December 2004 (as above) 4,490 4,751
Transition adjustment at 1 January 2005 on adoption of
IAS32,
IAS39, and IFRS4:
Long-term business operations 261
Other than long-term business operations (25) (25)
------------------------- -------- ------ -------- ------ ------- ------
Shareholders' capital and reserves at 1 January 2005 -
Statutory IFRS basis 4,726 4,726
------------------------- -------- ------ -------- ------ ------- ------
PRUDENTIAL PLC Schedule B4
2004 Restated Results
ACHIEVED PROFITS BASIS RESULTS RESTATED FOR CHANGES APPLIED ON IMPLEMENTATION OF
STATUTORY IFRS
CONSOLIDATED SUMMARY RESULTS AND EARNINGS PER SHARE
PREVIOUSLY PUBLISHED RESTATED
Half year Full year Half year Full year
2004 2004 2004 2004
CONSOLIDATED SUMMARY RESULTS ON THE GBPm GBPm GBPm GBPm
ACHIEVED PROFITS BASIS
----------------------------------- ------ --- ------- --- ------ --- ------ ---
UK and Europe Insurance 240 450 240 450
operations
M&G 79 136 79 136
Egg 30 63 31 61
----------------------------------- ------ --- ------- --- ------ --- ------ ---
UK and Europe operations 349 649 350 647
US operations 164 303 220 413
Asian operations 175 385 169 376
Other income and expenditure (101) (193) (103) (197)
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Operating profit, based on 587 1,144 636 1,239
longer-term investment returns,
from continuing operations
Amortisation of goodwill (48) (94)
Short-term fluctuations in (26) 679 (76) 587
investment returns
Shareholders' share of actuarial 67 (12)
gains and losses on defined benefit
pension schemes
Effect of changes in economic 21 (100) 21 (100)
assumptions
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Profit from continuing operations 534 1,629 648 1,714
before tax (including actual
investment returns)
Tax (197) (499) (215) (491)
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Profit from continuing operations 337 1,130 433 1,223
after tax before minority
interest
Discontinued operations (net of (16) (94) (15) (94)
tax)
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Total profit for the period 321 1,036 418 1,129
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Attributable to:
Equity holders of the parent 314 1,046 411 1,130
company
Minority interest 7 (10) 7 (1)
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Total profit for the period 321 1,036 418 1,129
----------------------------------- ------ --- ------- --- ------ --- ------ ---
EARNINGS PER SHARE ON THE ACHIEVED
PROFITS BASIS
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Continuing operations
From operating profit, based on
longer-term investment returns,
after tax and related
minority interest 19.5 p 38.5 p 21.0 p 41.5 p
Amortisation of goodwill (2.3) p (4.4) p
Adjustment from post-tax long-term
investment returns to post-tax
actual investment
returns (after related minority (2.0) p 21.5 p (3.5) p 18.6 p
interest)
Adjustment for post-tax
shareholders' share of actuarial
gains and losses on
defined benefit pension schemes - - 2.3 p (0.3) p
Adjustment for post-tax effects of 0.5 p (3.4) p 0.5 p (3.4) p
changes in economic assumptions
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Based on profit from continuing 15.7 p 52.2 p 20.3 p 56.4 p
operations after minority
interest
Discontinued operations
From post-tax profit/loss from
discontinued operations, including
profits on disposal
and closure costs, net of tax and (0.6) p (3.1) p (0.5) p (3.1) p
related minority interest
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Based on total profit for the 15.1 p 49.1 p 19.8 p 53.3 p
period after minority interests ------ --- ------- --- ------ --- ------ ---
-----------------------------------
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Average number of shares 2,084 * 2,129 2,075 2,121
----------------------------------- ------ --- ------- --- ------ --- ------ ---
Dividend per share ** 5.19 p 15.84 p 10.22 p 14.81 p
----------------------------------- ------ --- ------- --- ------ --- ------ ---
* The 'previously published' average number of shares for half year 2004
has been adjusted to reflect the impact of the rights issue in late
2004
** In accordance with the changed requirements of IFRS the dividend per
share figures shown above reflect dividends declared in the period
rather than, as under UK GAAP, the period to which the dividend
relates. The dividend per share for the 2003 final dividend, declared
in February 2004, and the interim 2004 dividend, declared in July
2004, have been adjusted to reflect the bonus element in the 2004
rights issue.
PRUDENTIAL PLC Schedule B5
2004 Restated Results
ACHIEVED PROFITS BASIS RESULTS RESTATED FOR CHANGES APPLIED ON IMPLEMENTATION OF
STATUTORY IFRS
OPERATING PROFITS, BASED ON LONGER-TERM INVESTMENT RETURNS, FROM CONTINUING
OPERATIONS
PREVIOUSLY PUBLISHED RESTATED
Half year Full year Half year Full year
2004 2004 2004 2004
RESULTS ANALYSIS BY BUSINESS GBPm GBPm GBPm GBPm
AREA
------------------------- -------- ------- ------ ------ -------
UK and Europe operations
New business 88 220 88 220
Business in force 152 230 152 230
--- ----------------------- -------- ------- ------ ------ -------
Long-term business 240 450 240 450
M&G 79 136 79 136
Egg 30 63 31 61
------------------------- -------- ------- ------ ------ -------
Total 349 649 350 647
------------------------- -------- ------- ------ ------ -------
US operations
New business 82 156 82 156
Business in force 84 161 140 271
--- ----------------------- -------- ------- ------ ------ -------
Long-term business 166 317 222 427
Broker dealer and fund (2) (14) (2) (14)
management
------------------------- -------- ------- ------ ------ -------
Total 164 303 220 413
------------------------- -------- ------- ------ ------ -------
Asian operations
New business 135 312 135 312
Business in force 40 69 34 60
--- ----------------------- -------- ------- ------ ------ -------
Long-term business 175 381 169 372
Fund management 10 19 10 19
Development costs (10) (15) (10) (15)
------------------------- -------- ------- ------ ------ -------
Total 175 385 169 376
------------------------- -------- ------- ------ ------ -------
Other income and expenditure
Investment return and other 16 44 16 44
income
Interest payable on core (74) (154) (74) (154)
structural borrowings
Corporate expenditure
Group Head Office (25) (54) (25) (54)
Asia Regional Head (18) (29) (18) (29)
Office
Additional IFRS pension and 0 0 (2) (4)
share based payment costs not
allocated to business
operations
------------------------- -------- ------- ------ ------ -------
Total (101) (193) (103) (197)
------------------------- -------- ------- ------ ------ -------
Operating profit, based on
longer-term investment
returns, from continuing 587 1,144 636 1,239
operations
------------------------- -------- ------- ------ ------ -------
Analysed as operating profits
from:
Long-term business
New business 305 688 305 688
Business in force 276 460 326 561
--- --- ---------------------- -------- ------- ------ ------ -------
581 1,148 631 1,249
Other operations 6 (4) 5 (10)
--- ----------------------- -------- ------- ------ ------ -------
Total 587 1,144 636 1,239
--- ----------------------- -------- ------- ------ ------ -------
PRUDENTIAL PLC Schedule B6
2004 Restated Results
ACHIEVED PROFITS BASIS RESULTS RESTATED FOR CHANGES APPLIED ON IMPLEMENTATION OF
STATUTORY IFRS
MOVEMENT IN ACHIEVED PROFITS BASIS SHAREHOLDERS' CAPITAL AND RESERVES
ATTRIBUTABLE TO SHAREHOLDERS OF THE PARENT COMPANY
PREVIOUSLY PUBLISHED RESTATED
Half Full Half Full
year year year year
2004 2004 2004 2004
CONSOLIDATED STATEMENT OF RECOGNISED INCOME AND EXPENSE GBPm GBPm GBPm GBPm
------------------------------------ ------ ------ ------ ------ ------
Profit for the period (net of minority interest) 314 1,046 411 1,130
Items taken directly to equity:
Exchange movements (54) (241) (53) (240)
Related tax 5 12 5 12
------------------------------------ ------ ------ ------ ------ ------
Total recognised income for the period (net of minority interest) 265 817 363 902
------------------------------------ ------ ------ ------ ------ ------
RECONCILIATION OF MOVEMENT ON CONSOLIDATED SHAREHOLDERS' EQUITY
Total recognised income for the period (net of minority interest) - as 265 817 363 902
above
Proceeds from rights issue, net of expenses 1,021 1,021
Other new share capital subscribed 61 119 61 119
Dividends (109) (362) (214) (323)
Stock based compensation - fair value adjustment (net of related tax) 3 10
Own shares:
Own shares purchased in respect of stock compensation plans (4) (4)
Movement on Prudential plc shares purchased by unit trusts newly 14
consolidated under IFRS
------------------------------------ ------ ------ ------ ------ ------
Net increase in shareholders' capital and reserves 217 1,591 213 1,739
------------------------------------ ------ ------ ------ ------ ------
Shareholders' capital and reserves at 1 January 2004
As previously reported 7,005 7,005 7,005 7,005
Adjustments on implementation of statutory IFRS - - 18 18
--- ----------------------------------- ------ ------ ------ ------ ------
As re-stated 7,005 7,005 7,023 7,023
--- ----------------------------------- ------ ------ ------ ------ ------
Shareholders' capital and reserves at end of period 7,222 8,596 7,236 8,762
------------------------------------ ------ ------ ------ ------ ------
Analysed as:
Statutory IFRS basis shareholders' capital and reserves 3,320 4,281 3,352 4,490
Additional shareholders' interest on the Achieved Profits basis 3,902 4,315 3,884 4,272
--- ----------------------------------- ------ ------ ------ ------ ------
Shareholders' capital and reserves at end of period (see note) 7,222 8,596 7,236 8,762
------------------------------------ ------ ------ ------ ------ ------
Note
------
Reconciliation to shareholders' capital and reserves at 1 January 2005
on adoption of IAS32, IAS39, and IFRS4
----------------------------------------
Capital and reserves at 31 December 2004 (as above) 8,762
Transition adjustment at 1 January 2005 on adoption of IAS32, IAS39,
and IFRS4:
Statutory basis transition adjustment 236
Less: long-term business element subsumed within
adjustment to additional shareholders' interest (261)
--- ----------------------------------- ------ ------ ------ ------ ------
Achieved Profits basis transition adjustment (25)
--- ----------------------------------- ------ ------ ------ ------ ------
Shareholders' capital and reserves at 1 January 2005 8,737
------------------------------------ ------ ------ ------ ------ ------
Analysed as:
Statutory IFRS basis shareholders' capital and reserves 4,726
Additional shareholders' interest on the Achieved Profits basis 4,011
--- ----------------------------------- ------ ------ ------ ------ ------
Shareholders' capital and reserves at 1 January 2005 8,737
------------------------------------ ------ ------ ------ ------ ------
APPENDIX C
Insurance Groups Directive ("IGD") and Financial Groups Directive ("FGD")
- Prudential plc announces today an IGD surplus of GBP845m for 31 December
2004 in excess of its GBP2bn capital resources requirements.
- If Prudential had chosen to seek permission from the FSA to apply
transitional rules applicable up to 31 December 2004 which allowed
externally generated goodwill to be included in the valuation of certain
subsidiaries, Prudential's underlying IGD surplus would have been
approximately GBP2.2bn.
- The IGD has applied to Prudential since 1 January 2001. This requires the
determination of group solvency through the aggregation of surplus capital
held in its subsidiaries, from which group borrowings are deducted, other
than subordinated debt issues which qualify as capital.
- The FGD has applied to Prudential since 1 January 2005. A similar
calculation of group solvency as for the IGD is required, although the test
under the FGD is a continuous requirement and a regulatory obligation.
1.0 Background
At 31 December 2004, Prudential was required to meet the solvency
requirements of the IGD, as implemented by the Financial Services Authority
(FSA). The IGD introduced specific legislation for the prudential
supervision of insurance groups, which introduced a test of solvency at the
parent company level which requires it to hold capital in excess of the
aggregate of all the minimum solvency requirements of its subsidiaries. In
particular, the IGD prohibits "double gearing", i.e. where the same
regulatory capital is used more than once to cover the separate capital
requirements of different insurers in the Group, and "excessive leveraging"
or "down-streaming", where the proceeds of debt issuance is used as equity
for the regulated subsidiaries.
Due to the geographically diverse nature of Prudential's operations, the
application of these requirements to Prudential is complex. In particular,
for many of our Asian operations, the assets, liabilities and capital
requirements have to be recalculated on bases required by the FSA.
The FGD, which affects groups with significant cross-sectoral activities in
insurance and banking/investment services, came into force for Prudential
from 1 January 2005. The FSA has implemented the FGD by applying the
sectoral rules of the largest sector; hence an insurance-led conglomerate
such as Prudential is required to focus on the capital adequacy
requirements of the IGD, the Consolidated Life Insurance Directive and the
Insurance Company Accounts Directive.
The FGD requires a continuous parent company solvency test, which requires
the aggregation of surplus capital held in the subsidiaries, from which
group borrowings are deducted, other than subordinated debt which qualifies
as capital. The test is passed when this aggregate number is positive. A
negative result at any point in time becomes a notifiable breach of UK
regulatory requirements. Prudential has put in place a regulatory capital
projection model taking into account FSA basis capital resources and
requirements of all Business Units to monitor the continuous solvency
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 aligned the requirements of the FGD with the IGD and
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.
2.0 Results
At 31 December 2004, Prudential had surplus of GBP845m in excess of its
GBP2bn capital resources requirements.
The contribution to this IGD surplus, by Business Unit is as follows:
GBPm
Business Unit Entities
------------------------
Insurers
UK Insurance Operations (shareholders) 520
Jackson National Life 1,418
Prudential Corporation Asia* (586)
Non-Insurers
M&G 244
Egg 59
Other 41
-------
Total Business Unit Entities 1,696
-------
Holding Company
-----------------
Assets in the Holding Company 229
Core Debt (2,509)
Add back qualifying Subordinated Debt 1,429
-------
Total Holding Company (851)
-------
Group Surplus 845
-------
* The Prudential Corporation Asia contribution of (GBP586m) above
compares to approximately GBP300m of local regulatory basis surplus of
capital resources over capital resources requirements.
This excludes the impact of transitional rules applicable up to 31
December 2004 by the FSA, which allowed externally generated goodwill
to be included in the valuation of certain subsidiaries. Had
Prudential applied for, and been given permission to use these
transitional rules, its underlying IGD position would have been a
surplus of approximately GBP2.2bn.
APPENDIX D
Economic Capital
- Prudential plc announces today an Economic Capital surplus for 31 December
2004 in respect of its in-force business of GBP1.6bn against its internal
Group capital target.
- This is based on the results of Prudential's internal Economic Capital
assessment, which shows an Economic Capital requirement of GBP1.8bn taking
into account diversification benefits compared to available capital of
GBP3.4bn.
- Economic Capital is the amount required to ensure that Prudential can meet
its existing contractual and discretionary policyholder obligations and
remain solvent at all times over a 25-year time horizon, within a strict
target solvency level.
- Prudential initiated the Economic Capital project three years ago in order
to enhance its group-wide platform for business management, with particular
focus on capital management and risk governance.
1.0 Background
Prudential initiated the Economic Capital project three years ago in order
to enhance its group-wide platform for business management. In particular,
there were three key business objectives of the project:
- Increase value creation through improved capital allocation and
performance management
- Enhance risk governance as part of a comprehensive risk management
framework
- Demonstrate financial strength.
Economic Capital is integral to Prudential's capital and financial
management at Group and Business Unit level. It informs Prudential's risk
appetite for taking on different risks in different geographies, both in
terms of the extreme events that have the potential to deplete its capital
base, and the more day-to-day volatility to which it is exposed. It
supports the asset-liability management both through optimisation of the
asset allocation process and through supporting crediting and bonus
declaration strategies for Prudential's policyholders. More broadly, it
will be used in the assessment and driving of value creation via
risk-adjusted return on capital measures. Finally, it provides a more
realistic adjunct to the various regulatory solvency calculations, in
particular the Insurance Groups Directive, and will be an input into
Prudential's discussions with the Financial Services Authority (FSA) in
respect of its Individual Capital Guidance.
2.0 Framework and Approach
The calculation of Economic Capital is based on three key principles,
namely that it should:
- Capture diversification benefits and capital mobility inherent in the
business of an internationally diversified insurer such as Prudential
- Use a multi-year time horizon tailored to the multi-year nature of the
life insurance business
- Have comprehensive coverage but with key focus on major risk types and
operations.
Economic capital is the amount required to ensure that Prudential can
meet its existing contractual and discretionary policyholder
obligations and remain solvent at all times over a 25-year time
horizon, within a strict target solvency level.
Prudential has adopted a framework whereby cash flows and capital
requirements for each of the main Business Units in the UK, US and
Asia are projected over many internally consistent
stochastically-generated simulations. This process, using a Group
Solvency Model, captures 80 percent of the business, the other 20
percent being modelled on a standalone basis and aggregated with the
main results using a correlation matrix approach. This is a standard
method of aggregation used by banks and other financial institutions.
The explicit stochastic modelling of global asset return scenarios,
which are directly correlated between asset classes and between
geographies, enables diversification benefits to be captured for each
individual scenario. For each simulation, and in each of the projected
25 years, Business Units calculate their capital surplus, transfers or
requirements using their asset-liability models. These projected
capital transfers to and from Business Units are aggregated together
at Group level, together with Group level cash flows such as interest
on debt and expenses. This gives a Group level capital balance for
each scenario in each of the 25 years.
In order to take into account restrictions on mobility of capital
across the Group, capital transfers to and from Business Units are
triggered at a solvency level that reflects a suitable level of
operating capital, based on local regulatory solvency targets, over
and above basic liabilities. This includes restrictions on the
availability to the Group of the full estate of the various
with-profits funds throughout the Group, which are excluded from
initial available capital. The Economic Capital requirement includes
sufficient capital to meet this working requirement as well as to
cover the risks in the business.
Using an iterative modelling process, Economic Capital is calculated
as the amount required at the calculation date such that the
cumulative number of projected defaults (defined as a negative Group
capital balance) is less than a pre-determined rate reflecting
Prudential's internal target solvency level. Prudential's internal
target solvency level has been set as equivalent to the historic
default rate on a AA-rated bond (equivalent to a cumulative
probability of default of 44 out of 1,000 simulations over 25 years).
The Economic Capital framework thus assesses the capital required to
meet Prudential's obligations with at least this level of confidence
taking into account extreme events.
The definition of available capital is consistent with the definition
of Capital Resources in the FSA's Integrated Prudential Sourcebook for
Insurers, with some adjustments for valuation differences between the
FSA and Economic Capital bases.
Stochastic risk scenarios are generated by Prudential's in-house
Generator of Stochastic Investment Scenarios ("GeneSIS") which uses
models of individual risks from academic literature, together with a
set of correlations to produce integrated risk scenarios that reflect
the range and probability of different outcomes as they affect the
Group.
Prudential's Economic Capital model covers all material risks in each
business, including (where relevant):
- Financial risks
- Asset-liability matching (driven by equity, property, interest
rates, bond returns and inflation)
- Credit risk
- Insurance and business risks
- Underwriting (mortality, longevity and morbidity)
- Persistency
- Operational risk
As well as the more standard approaches to market risks, Prudential
has developed a detailed model for credit risk, which captures spread
volatility, credit migration and default over the multi-year period.
GeneSIS produces asset returns in each scenario and for each projected
time period. These are based on the scenario and time-specific
risk-free return, an additional risk premium and an appropriate level
of volatility. The risk-free component of the model has been
calibrated to current market prices (risk free bonds and interest rate
derivatives) and observed historic behaviour. The risk premium and
volatility assumptions, which vary by asset class, have been derived
from market prices and assumptions produced by the Portfolio
Management Group, Prudential's internal economists, who are
responsible for investment strategy for the GBP98bn of assets relating
to Prudential's long-term funds.
To the extent it can be reasonably projected, the systematic behaviour
of policyholders and the ability of management to react to extreme
events (subject to policyholders' reasonable expectations) have been
modelled. The multi-year approach also allows accumulative risks such
as longevity to be captured in full.
Prudential's approach to modelling operational risk involves examining
the possible operational events to which it could be exposed, with
particular focus on the low frequency, but high severity events that
threaten the Group's solvency, and using a stochastic model that
simulates these events based on assumptions around incidence and size.
This has been implemented in each of the Business Units and tailored
to their own profiles, and the results are captured as part of the
Economic Capital requirement.
3.0 Results
As at 31 December 2004, Prudential required GBP1.6bn of capital to
cover the risks to its existing contractual and discretionary
insurance liabilities, on an economic basis and at its internal target
solvency level. This number is after allowance for diversification
across risks and geographies and the capturing of future shareholders'
transfers from the Business Units. This compares to available capital
of GBP3.4bn on an equivalent basis.
This requirement has been analysed into its contributory parts, by
risk type and by Business Unit, as follows:
Risk Type Percentage of Group Economic
Capital Requirement
Asset-Liability Matching 28%
Credit 47%
Underwriting (mortality, longevity 10%
and morbidity)
Persistency 2%
Operational 13%
Business Unit Percentage of Group Economic Capital
Requirement
Prudential UK Shareholder 21%
Prudential UK 0%
With-Profits
Jackson National Life (JNL) 45%
Prudential Corporation 16%
Asia
M&G 5%
Egg 12%
Prudential Group 1%
Headquarters
The largest risk exposure on a diversified basis, credit risk, reflects the
relative size of the exposure to JNL (30 per cent), Prudential UK shareholder
annuities business (5 per cent) and Egg (10 per cent).
Prudential UK with-profits capital requirements are fully covered by the
internal estate within the 90:10 fund.
JNL is the largest shareholder operation at Prudential, and the 45% share of
Economic Capital requirements reflects this.
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 15 June, 2005
PRUDENTIAL PUBLIC LIMITED COMPANY
By: /s/ Clare Staley
Clare Staley
Head of Group Media Relations