2006 Full Year Results - Pt 1

15th Mar 2007 07:03

Prudential PLC15 March 2007 Embargo: 7.00am Thursday 15 March 2007 PRUDENTIAL PLC 2006 FULL YEAR RESULTS New business profit up 20%, exceeding £1 billion for the first time; marginincreased • New business APE of £2,470 million, up 16%; PVNBP of £18.9 billion, up 12% • Total EEV operating profit of £1,976 million, up 15% • New business profit of £1,039 million, up 20%, with Group margin of 42% (2005: 41%) • Total IFRS statutory operating profit of £893 million, down 7%, includes £145m non-continuing Egg losses • EEV shareholders' funds up 15% to £11.9 billion* UK business focused on growing highly profitable core and enhancing future value • Strong UK new business performance: margin 30%, IRR 15% and strong growth in IFRS and EEV profit • Creation of focused Retail Retirement business comprising Individual Annuities, Equity Release and a new approach to Retirement Savings • Cost reduction target increased from £115 million** to £195 million • Nomination of Policyholder Advocate for potential reattribution of inherited estate Cash and dividend • Overall Group operating cash flow to be positive in 2008 • New dividend policy reflects the commitment to deliver a growing dividend • 2006 dividend increased by 5% to 17.14 pence per share All figures compared to 2005 at constant exchange rates unless stated; *atreported exchange rates ** Previously announced UK cost savings target of £150 million by 2009 included£35 million in relation to Egg, which was acquired by Citi in January 2007. Commenting, Mark Tucker, Group Chief Executive said: "These results demonstrate excellent continued progress in the delivery of theGroup's growth and value agenda. "Our new dividend policy reflects our confidence in the future and ourcommitment to providing shareholders with a cash return on the investments wemake on their behalf. "In Asia, the US and UK we have an enviable portfolio of businesses that willcontinue to deliver growth in profits and create value for our shareholders inthe coming years. "Our UK strategy, following the sale of Egg, builds on a strong performance in2006 and our industry-leading position in the retail retirement annuity sector,eliminates uneconomic products and sets the scene for an enhanced contributionto future earnings." Group Chief Executive's review The Group's strategy is centred on optimising our competitive advantages in lifeassurance, becoming a leading provider of financial services for the retirementmarket, and on the further development of our asset management businesses. Inimplementing this strategy our clear aim is to secure superior growth in valuefor our shareholders. In 2006 we continued to focus on developing our position in our chosen marketsof Asia, the US and the UK; markets that we believe offer the greatestopportunity for sustained profitable growth. Total Group operating profit before tax was £1,976 million on a EuropeanEmbedded Value (EEV) basis, an increase of 15 per cent, and the Group's returnon embedded value was 13.5 per cent (2005: 15.5 per cent). Statutory IFRSoperating profit before tax was £893 million (2005: £957 million). Across the Group's insurance operations new business increased by 16 per cent to£2,470 million, on an APE basis. Profits on new business exceeded £1 billion forthe first time, 20 per cent up on 2005. Average margins across the Groupremained strong and were 42 per cent (41 per cent in 2005) and returns on newbusiness have also improved. Operating profit from the insurance businesses was£2,209 million, on an EEV basis, increasing by 28 per cent on 2005, and IFRSoperating profit increased by 15% to £1,087 million. In asset management we delivered record net flows at M&G and in our rapidlygrowing retail businesses in Asia. Net inflows of £8.6 billion were 66% ahead of2005 and external funds under management increased to £57 billion (2005: £46billion). Operating profit from these businesses was £254 million, up 46 percent on 2005. Difficult trading conditions in the UK personal loans market led to losses atEgg, the Group's UK banking business, of £145 million (2005: profit £44million). In January 2007 we received an offer for Egg from Citi and thebusiness was sold for £575 million in cash, subject to completion adjustments.We expect this transaction to complete by the end of April 2007. The Group's cash flow developed strongly in 2006 and its capital positionremains robust. Taking into account our plans for sustained high levels ofgrowth and a normalised level of scrip dividend uptake we expect our operatingcash flow to be positive in 2008. In light of this the Board has reviewed itslonger term dividend policy. The Board recommends a final dividend of 11.72 pence per share, bringing thefull-year dividend to 17.14 pence per share, an increase of 5 per cent over thefull year 2005 dividend of 16.32 pence. The full year dividend is covered 1.52 times by post-tax IFRS operating profitfrom continuing operations. The Board will focus on delivering a growing dividend, which will continue to bedetermined after taking into account the Group's financial flexibility andopportunities to invest in areas of the business offering attractive returns.The Board believes that in the medium-term a dividend cover of around two-timesis appropriate. Insurance operations The Group's position in Asia continues to develop rapidly with the regionaccounting for almost 50 per cent of the Group's 2006 new business profits. Oneof the key priorities in the region in 2006 was to continue to build ourdistribution capability. Agency remains the major channel in the region andduring the year we added 115,000 agents, to total 285,000 agents by the end ofthe year. Building the agency force in a disciplined way in developing marketssuch as India, China and Indonesia is critical to success, whereas in some ofthe more developed markets in the region such as Hong Kong and Singapore whereagency numbers are more stable, the main focus is on increasing productivity.Non-agency distribution is also developing strongly and accounted for 30 percent of new business in 2006 (26 per cent in 2005) as we established a number ofnew and important relationships during the year. As well as experiencing rapidgrowth Asia became cash positive in 2006, in line with our previous forecast,with a net remittance of £28 million to the Group. In 2007 and beyond, Asia offers significant potential for profitable growth andwe are on track to deliver on our target to at least double 2005 new businessprofits by 2009. We are in all the region's major markets and see furtheropportunity to build distribution, improve productivity and efficiency andincrease sales of our market leading unit-linked products. We also see scope toincrease sales to our 7 million existing customers; to use our regional andGroup expertise to play a key role as the retirement market develops in a numberof Asian countries; to extend our direct distribution capabilities and toincrease selectively our presence in the Accident and Health product sectoracross a number of markets in the region. Our strategy in the US is to focus on the opportunities that exist in thegrowing retirement market as the US baby boomers retire, with a particularemphasis on variable annuities. We have market leading product flexibility andhigh levels of product innovation, a focus on advice-based distribution and onmaintaining high service levels at low cost. As a result our retail sales in2006 grew at more than double the rate of the market overall. Variable annuitysales increased by 48 per cent over 2005, and we have achieved compound growthof 45 per cent over a five year period. In 2007 our aim is to capitalise on the market position that the Jackson teamhave built, growing distribution and further developing the product range toaddress both existing and new market areas. For example, in January 2007 welaunched a new simplified retirement annuity aimed at mutual fundrepresentatives extending our distribution reach. We remain confident that wecan continue to outperform the market and gain profitable market share. In the UK, retail insurance new business increased by 14 per cent in 2006 andoverall new business sales were up 1 per cent. We continued to focus on writingfor value across the UK business with average margins increasing to 30 per cent(27 per cent in 2005). Returns on new business improved to 15 per cent andremain high compared with the rest of the UK market. Notwithstanding this strong performance, we have continued to assess thepositioning of our UK insurance operations, examining a broad range of potentialoptions with a clear goal of maximising value for our shareholders. We areconfident that there are profitable opportunities for the Group in theretirement income and savings market. We have significant competitive advantages in the retirement income market, inparticular our flow of internal vestings from our back book of personalpensions, and this market remains very attractive. We therefore see retailannuities and equity release and the nurturing of our existing policyholders askey parts of our strategy. In the wholesale annuity market we also have distinctcompetitive advantages but we will only write business that meets our requiredreturns. Much of our Wealth and Health business is low margin and our strategy will be toimprove returns through a much narrower business, exiting segments that areunprofitable and concentrating our effort only where we have a material andsustainable competitive advantage and where we can achieve returns significantlyin excess of the cost of capital. We have withdrawn from provision of front-endcommission individual pensions and will also exit front-end commissionunit-linked bonds, segments of the market where we do not see that adequatereturns can be made. We believe there is an opportunity in the retirement savings market for us tocapitalise on our proven low risk multi-asset investment capabilities. We willbring a new range of products to the market based on these capabilities and withimproved returns through a focus on trail, rather than front-end commission. Wewill concentrate our advice-based distribution activity on the significantnumber of investors approaching retirement who have substantial assets outsidepersonal or corporate pension plans, or have investments in poorly performingfunds, and require inflation protection. We also see opportunity to develop further our already strong position in thecorporate pensions market and we will improve returns by focusing on schemeswith higher case sizes and holding costs as volumes grow. We will participate in the health market through our existing joint venture withDiscovery, which will be expanded to include our new Flexible Protectionproduct. A combination of the strength of the Prudential brand in the UK,clearly differentiated products and the operational capabilities of Discoveryprovide an excellent base to deliver profitable growth in these markets. Thejoint venture will be led by Discovery. Actions are in place to realise 65% of the previously announced cost savingstarget of £115 million* for the UK insurance business. We have increased ourannualised target cost savings to £195 million by 2010 and our current estimateis that these savings will lead to a £60 million positive impact on embeddedvalue. Total restructuring costs are estimated to be up to £165 million*. We have initiated discussions with the regulator on the possible reattributionof the inherited estate of the Group's main with-profits fund in the UK,Prudential Assurance Company. An Independent Policyholder Advocate has beennominated to represent policyholders should a decision be taken to proceed. Wewill only proceed if there are clear benefits to both policyholders andshareholders. If a decision is taken to proceed a formal appointment of thePolicyholder Advocate could be expected to take place later this year. With a focused strategy in the UK based on our competitive advantages we seeopportunities for growth in the retail market at high margins and returnsrelative to the overall market. In the wholesale annuity market we will writebusiness that meets our required returns and by definition the flows will belumpy year on year. We are maintaining our 14% IRR target for new business andwe expect the UK's shareholder-backed business to become a net capital generatorfor the Group by 2010. Asset Management Maintaining superior investment performance is the key factor in the continuinggrowth and success of the Group's asset management businesses. In 2006, theperformance of M&G in the UK and Europe and our asset management businesses inAsia has again been very strong adding value to our insurance businessesworldwide, supporting record net inflows and continuing the growth of theGroup's external funds under management. In 2007, we will continue to build on the strong growth over recent years inboth M&G and in Asia. In addition, Jackson will enter the US retail mutual fundmarket for the first time, a significant market that continues to gain momentum,especially among the baby boomers. Group As a Group we are continuing to increase the level of co-operation and theexchange of ideas across our businesses. The Group's asset management businesses are using their global presence,exchanging information to support their investment decisions and to enable theefficient management of over £6 billion of cross border money. In our insurance businesses, which remain predominantly market specific,collaboration is taking place where there is a commercial benefit. Productdevelopment teams are working across the Group to access existing skills andexpertise. In distribution, the UK business has utilised the very successfultechniques developed by Jackson in the US, to segment the independent financialadviser market, saving time and cost and improving returns. Work is ongoing to consolidate our technology infrastructure in particularacross the UK and the US. A single Customer Service Desktop is now underdevelopment and will be launched in 2007. Central to the management of the Group is capital efficiency and capitalallocation. During 2006, we have made significant progress in the assessment of,and management of, risk on a group-wide basis. This understanding provides asolid foundation as we continue to embed decision making on a risk-adjustedbasis. Summary The Group goes into 2007 with strong momentum. I continue to see tremendousscope for the Group to build sustainable profitable growth and secure superiorgrowth in value for our shareholders. (* Previously announced UK cost savings target of £150 million by 2009 included£35 million in relation to Egg, which was acquired by Citi in January 2007.Previously announced restructuring costs of £110 million included £25 millionrelated to Egg.) ENDS Enquiries: Media Investors/AnalystsJon Bunn +44 20 7548 3559 James Matthews +44 20 7548 3561William Baldwin-Charles +44 20 7548 3719 Valerie Pariente +44 20 7548 3511 Notes to Editors: 1. The results in this announcement are prepared on two bases:International Financial Reporting Standards ('IFRS') and on the EuropeanEmbedded Value ('EEV') basis. The IFRS basis results form the basis of theGroup's financial statements. The supplementary EEV basis results have beenprepared in accordance with the principles issued by the CFO Forum of EuropeanInsurance Companies in May 2004 and expanded by the Additional Guidance on EEVdisclosures published in October 2005. Where appropriate the EEV basis resultsinclude the effects of IFRS. Period on period percentage increases are stated on a constant exchange ratebasis. 2. Annual premium equivalent (APE) sales comprise regular premium salesplus one-tenth of single premium insurance sales. 3. Present value of new business premiums (PVNBP) are calculated asequalling single premiums plus the present value of expected new businesspremiums of regular premium business, allowing for lapses and other assumptionsmade in determining the EEV new business contribution. 4. There will be a conference call today for wire services at 7.30am (GMT)hosted by Mark Tucker, Group Chief Executive and Philip Broadley, Group FinanceDirector. Dial in telephone number: 0800 358 2705. Passcode: 155439#. 5. A presentation to analysts will take place at 9.30am (GMT) at Governor'sHouse, Laurence Pountney Hill, London, EC4R 0HH. An audio cast of thepresentation and the presentation slides will be available on the Group'swebsite, www.prudential.co.uk 6. There will be a conference call for investors and analysts at 2.30pm(GMT) hosted by Mark Tucker, Group Chief Executive and Philip Broadley, GroupFinance Director. Please call from the UK 0208 609 0793 and from the US +1 866793 4279. Passcode: 487687#. A recording of this call will be available forreplay for one week by dialling: 0208 609 0289 from the UK or +1 866 676 5865from the US. The conference reference number is 160470. 7. An interview with Mark Tucker, Group Chief Executive, (in video/audio/text) will be available on www.cantos.com and www.prudential.co.uk from 7.00amtoday. 8. High resolution photographs are available to the media free of charge atwww.newscast.co.uk on +44 (0) 207 608 1000 or by calling Claire Glover on 0207548 2007. 9. Total number of Prudential plc shares in issue as at 31 December 2006was 2,444,312,425. 10. Financial Calendar 2007: Ex-dividend date 11 April 2007Record date 13 April 2007First Quarter New Business Figures 19 April 2007Annual General Meeting 17 May 2007Payment of 2006 final dividend 22 May 20072007 Interim Results / Second quarter New Business Figures 1 August 2007Ex-dividend date 15 August 2007Record Date 17 August 2007Payment of interim dividend 24 September 2007 11. In addition to the financial statements provided with this press release,additional financial schedules are available on the Group's website atwww.prudential.co.uk 12. About Prudential Prudential plc is a company incorporated and with its principal place ofbusiness in England, and its affiliated companies constitute one of the world'sleading financial services groups. It provides insurance and financial servicesdirectly and through its subsidiaries and affiliates throughout the world. Ithas been in existence for over 150 years and has £250.7 billion in assets undermanagement as at 31 December 2006. Prudential plc is not affiliated in anymanner with Prudential Financial, Inc, a company whose principal place ofbusiness is in the United States of America. Forward-Looking Statements This statement may contain certain "forward-looking statements" with respect tocertain of Prudential's plans and its current goals and expectations relating toits 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. Bytheir nature, all forward-looking statements involve risk and uncertaintybecause they relate to future events and circumstances which are beyondPrudential's control including among other things, UK domestic and globaleconomic and business conditions, market related risks such as fluctuations ininterest rates and exchange rates, and the performance of financial marketsgenerally; the policies and actions of regulatory authorities, the impact ofcompetition, inflation, and deflation; experience in particular with regard tomortality and morbidity trends, lapse rates and policy renewal rates; thetiming, impact and other uncertainties of future acquisitions or combinationswithin relevant industries; and the impact of changes in capital, solvency oraccounting standards, and tax and other legislation and regulations in thejurisdictions in which Prudential and its affiliates operate. This may forexample result in changes to assumptions used for determining results ofoperations or re-estimations of reserves for future policy benefits. As aresult, Prudential's actual future financial condition, performance and resultsmay differ materially from the plans, goals, and expectations set forth inPrudential's forward-looking statements. Prudential undertakes no obligation toupdate the forward-looking statements contained in this statement or any otherforward-looking statements it may make. REVIEW OF OPERATING AND FINANCIAL RESULTS GROUP OVERVIEW Results highlights CER RER (4) 2006 2005 Change 2005 Change £m £m % £m % Annual premium equivalent (APE) sales (1) 2,470 2,134 16% 2,138 16%Present value of new business premiums (PVNBP) (1) 18,947 16,860 12% 16,892 12%Net investment flows 8,633 5,183 67% 5,189 66%External funds under management 57,199 45,378 26% 46,329 23%New business profit (NBP) (1) 1,039 869 20% 867 20%NBP Margin (% APE) (1) 42% 41% 41%NBP Margin (% PVNBP) (1) 5.5% 5.2% 5.1%EEV basis operating profit from long-term business 2,209 1,722 28% 1,723 28%from continuing operations (2) (3)Total EEV basis operating profit from continuing 1,976 1,711 15% 1,712 15%operations (3)Total IFRS operating profit from continuing operations 893 958 (7%) 957 (7%)(3)EEV basis shareholders' funds (£bn) 11,883 9,991 19% 10,301 15%IFRS shareholders' funds (£bn) 5,488 4,986 10% 5,194 6%Holding company cash flow (104) (298) 65% (298) 65% (1) The details shown include the effect of the bulk annuity transfer from theScottish Amicable Insurance Fund (SAIF) to Prudential Retirement Income Limited,a shareholder owned subsidiary of the Group. SAIF is a closed ring-fenced sub-fund of the PAC long-term fund established by acourt approved scheme of arrangement in September 1997, whose results are solelyfor the benefit of SAIF policyholders. (2) Long-term business profits after deducting Asia development expenses andbefore restructuring costs. (3) Based on longer term investment returns from continuing operations.Operating profit is stated excluding the effect of short-term fluctuations ininvestment returns against the long-term assumptions, the effect of changes ineconomic assumptions, actuarial gains and losses on defined benefit pensionschemes, the mark to market value movements on borrowings and goodwillimpairment charges. (4) Reported exchange rate (RER). In the Operating and Financial Review (OFR), year-on-year comparisons offinancial performance are on a constant exchange rate (CER) basis, unlessotherwise stated. The Group has delivered a strong set of results for 2006 as illustrated in thetable above. The Group delivered record total APE sales of £ 2,470 million (2005: £2,134million) and for the first time generated NBP in excess of £1 billion. This, together with the significant increase in contributions from the in-forcebusiness, drove a record EEV basis operating profit from the long-term businessto £2.2 billion. The following year-on-year comparisons are presented on a RER basis. The EEV basis result before tax and minority interests was a profit of £3,072million up 37 per cent on 2005. Within this, short-term fluctuations in investment return were £745 million(2005: £ 1,068 million), mainly driven by positive variances in the UK (£378million) and Asia (£286 million). Changes in economic assumptions were negative £1 million (2005: negative £349million). They include a positive change in the UK (£182 million), a negativechange in the US (£51 million), and a negative change in Asia (£132 million). EEV basis shareholders' funds were £11.9 billion (2005: £10.3 million), anincrease of £1.6 billion over last year, driven by a strong operatingperformance from all insurance and asset management business units. Earnings per share, based on EEV operating profit after tax and related minorityinterests, were 57.6 pence, compared with 56.6 pence in 2005. On an IFRS basis, operating profits (before tax) were £893 million (2005: £957million), down 7 per cent on last year principally due to the £145 million lossincurred by Egg. The Group delivered strong growth of 66 per cent in total net investment flowsfrom its asset management businesses of £8.6 billion (2005: £5.2 billion). Thisperformance contributed to the growth in total external investment funds undermanagement that grew from £46.3 billion in 2005 to £57.2 billion in 2006. Earnings per share, based on total IFRS operating profit after tax and minorityinterests, were 26.4 pence compared with 32.2 pence in 2005. Holding company cash flow improved significantly from a cash outflow of £298million in 2005 to a cash outflow of £104 million in 2006, reflecting highercapital remittances, and lower capital invested in the UK reflecting the benefitfrom a change in the Financial Services Authority (FSA) reserving regulations. The capital position of Prudential plc, measured under the FinancialConglomerate Directive (FCD) basis, will be submitted to the FSA by 30 April2007 but is currently estimated to be in the region of £1.0 billion. The total capital invested by the Group to support new business sales, in termsof both initial strain and required capital, was £554 million in 2006. Thisrepresents £22.4 million per £100 million sales in terms of APE and £2.9 millionper £100 million in terms of PVNBP sales. On 29 January 2007 Prudential announced that it had entered into a bindingagreement to sell Egg to Citi for a consideration of £575 million, subject toadjustment to reflect any change in net asset value between 31 December 2006 andcompletion. Impact of currency movements Prudential has a diverse international mix of businesses with a significantproportion of its profit generated outside the UK. In 2006, 74 per cent of NBPand 67 per cent of IFRS operating profit was delivered from overseas operations. In preparing the Group's consolidated accounts, results of overseas operationsare converted at rates of exchange based on the average of the year, whilstshareholders' funds are converted at year-end rates of exchange. Changes in exchange rates from year to year have an impact on the Group'sresults when these are converted into pounds sterling for reporting purposes. Insome cases these exchange rate fluctuations can mask underlying businessperformance. Consequently, the Board has for a number of years reviewed theGroup's international performance on a CER basis. This basis eliminates theimpact from conversion, the effects of which do not alter the long-term value ofshareholders' interests in Prudential's non-UK businesses. Basis of preparation of results The European Union (EU) requires that all listed European groups prepare theirfinancial statements in accordance with EU approved IFRS. Since 1 January 2005,Prudential has been reporting its primary results on an IFRS basis and 2006represents the second year-end of financial statements prepared under IFRS forthe Group. In addition, as a signatory to the European Chief Financial Officers' (CFO)Forum's EEV Principles, Prudential has also been reporting supplementary resultson an EEV basis for the Group's long-term business since 2005. These results arecombined with the IFRS basis results of the Group's other businesses to providea supplementary operating profit under EEV. Reference to operating profitrelates to profit based on longer-term investment returns that excludes goodwillimpairment charges, short-term fluctuations in investment returns, the mark tomarket movement on core borrowings, the shareholders' share of actuarial andother gains and losses on defined benefit pension schemes, the effect of changesin economic assumptions and changes in the time value of options and guaranteescaused by economic factors. In broad terms, IFRS profits for long-term business contracts reflect theaggregate of statutory transfers from with-profits funds and profits on atraditional accounting basis for other long-term business. Although thestatutory transfers from with-profits funds are closely aligned with cash flowgeneration, the pattern of IFRS profits over time from shareholder-backedlong-term businesses will generally differ from the cash flow pattern. Over thelife of a contract, however, aggregate IFRS profits will be the same asaggregate cash flow. In preparing its IFRS basis results the Group continues to provide supplementaryanalysis of the profit before shareholder tax so as to distinguish operatingresults based on longer-term investment returns, actuarial gains and losses ondefined benefit pension schemes, and exceptional items. Life insurance products are, by their nature, long term and the profit on thisbusiness is generated over a significant number of years. Accounting under IFRSdoes not, in Prudential's opinion, properly reflect the inherent value of thesefuture profit streams. Prudential believes that embedded value reporting provides investors with abetter measure of underlying profitability of the Group's long-term businessesand is a valuable supplement to statutory accounts. Sales and funds under management Prudential delivered strong sales growth during 2006 with total new insurancesales up 11 per cent to £15.1 billion at CER. This resulted in record insurancesales of £2.5 billion on the APE basis, an increase of 16 per cent on 2005. AtRER, APE was up 16 per cent on 2005. Strong growth came from the US, with APE upon 2005 by 21 per cent, and in Asia with APE up 30 per cent at CER. Sales under the PVNBP basis in 2006 increased by 12 per cent to £19 billion atCER. Total gross investment sales for 2006 were £33.9 billion, up 31 per cent on 2005at CER. Net investment flows of £8.6 billion were up 67 per cent on last year atCER. Total external funds under management in 2006 increased by 23 per cent from£46.3 billion in 2005 to £57.2 billion at RER, reflecting net investment flowsof £8.6 billion, and net market and other movements of £2.2 billion. At 31 December 2006, total insurance and investment funds under management were£251 billion, an increase of 7 per cent from 2005 at RER. EEV basis operating profit from continuing operations CER RER 2006 2005 Change 2005 Change £m £m % £m % Insurance business: UK 686 426 61% 426 61% US 708 731 (3%) 741 (4%) Asia 829 585 42% 576 44%Long-term business 2,223 1,742 28% 1,743 28%Development expenses (15) (20) (175%) (20) (75%)Fund management business: M&G 204 163 25% 163 25% US broker-dealer and fund management 18 24 (25%) 24 (25%) Curian (8) (10) 20% (10) 20% Asia fund management 50 11 355% 12 317% 264 188 40% 189 40%Banking: Egg (UK) (145) 44 (430%) 44 (430%) Other income and expenditure (298) (243) (23%) (244) (22%)Total EEV basis operating profit on continuing operations 2,029 1,711 19% 1,712 19%Restructuring costs (53) 0 0Total EEV basis operating profit on continuing operations after restructuring costs 1,976 1,711 15% 1,712 15% Total EEV basis operating profit from continuing operations based on longer-terminvestment returns was £1,976 million, up 15 per cent from 2005 at CER. At RER,the result was up 15 per cent. This result reflects profitable growth in theinsurance and funds management businesses. Prudential's insurance businesses achieved significant growth, both in terms ofNBP and in-force profit, resulting in a 28 per cent increase in operating profitover 2005 at CER. In 2006, the Group generated record NBP from insurance business of £1,039million, which was 20 per cent above 2005 at CER, driven by strong salesmomentum in US and Asia, achieved without compromising margins. At RER, NBP wasup 20 per cent. The average Group NBP margin was 42 per cent (2005: 41 per cent)on an APE basis and 5.5 per cent (2005: 5.2 per cent at CER) on a PVNBP basis.The overall margin has increased mainly driven by profitable sales of individualannuities in the UK and of variable annuities in the US. In-force profitincreased 36 per cent on 2005 at CER to £1,184 million. At RER, in-force profitwas up 35 per cent. In aggregate, net assumption changes were £38 millionpositive, and experience variances and other items were £111 million positive. The in-force profit in 2005 included a £148 million charge in respect of apersistency assumption change in the UK, and a credit in the US of £140 millionreflecting an operating assumption change following price increases introducedon two blocks of in-force term life business. Asia's development expenses (excluding the regional head office expenses) were£15 million, (2005: £20 million at CER). Results from the fund management business were £264 million (2005: £188million), up 40 per cent on 2005 at CER. Egg losses were £145 million (2005: profit £44 million). Other income and expenditure totalled a net expense of £298 million comparedwith £244 million in 2005 at RER. This result includes £36 million of costs forthe Asia head office costs (2005: £30 million); £83 million for the Group headoffice costs (2005: £70 million); net interest expense on central borrowings ofnegative £169 million (2005: £133 million); and a charge for share-based payments forPrudential schemes of £10 million (2005: £11 million). Total EEV basis operating profit includes £53 million in restructuring costs(nil in 2005), primarily related to the costs associated with the UK and Eggcost saving initiatives announced in July 2006. EV basis profit before tax and minority interests from continuing operations RER 2006 2005 £m £mTotal EEV basis operating profit on continuing operationsafter restructuring costs 1,976 1,712 Short term fluctuations in investment return: 745 1,068UK 378 994US 64 67Asia 286 41Other 17 (34)Actuarial gains and losses on definedbenefit pension schemes 207 (47)Effect of change in economicassumptions: (1) (349)UK 182 (81)US (51) (3)Asia (132) (265)Effect of change in time value of costof options and guarantees: 60 47UK 40 31US 6 11Asia 14 5Movement in mark to market value of core borrowings: 85 (67) US 3 (2)Other 82 (65)Goodwill impairment charge 0 (120) Profit from continuing operations before tax 3,072 2,244 The following year-on-year comparisons are presented on a RER basis. The EEV basis result before tax and minority interests was a profit of £3,072million up 37 per cent on 2005. This reflects in part an increase in operating profit from £1,712 million in2005 to £1,976 million in 2006. The profit before tax also includes £745 million in short-term fluctuations ininvestment returns (2005: £1,068 million), negative changes in economicassumptions of £1 million (2005: negative £349 million) and the effect of changein time value of options and guarantees of positive £60 million (2005: positive£47 million). The UK long-term business component of short-term fluctuations in investmentreturns of £378 million (2005: £994 million) primarily reflects the differencebetween the actual investment return for the with-profits life fund of 12.4 percent (2005: 20 per cent) and the long-term assumed return of 7.5 per cent. The US long-term business short-term fluctuations in investment returns of £64million primarily include a positive £46 million in respect of the differencebetween actual investment returns and long-term returns included in operatingprofit in respect of fixed income securities, related swap transactions andequity based investments. It also includes a positive £17 million in relationto changed expectations of future profitability on variable annuity business inforce due to the actual variable annuity investment account ('separate account')return exceeding the long-term return reported within operating profit, offsetby the impact of the associated hedging position. In Asia, long-term business short-term investment fluctuations were £286million, compared to £41 million last year. This reflects strong marketperformance across the region particularly in Vietnam, Hong Kong, Singapore andTaiwan. An actuarial gain on the defined benefit pension schemes was recorded in 2006for £207 million (2005: loss £47 million). This gain primarily represents thedifference between actual and expected investment returns for the schemes andthe reduction in liabilities due to an increase in the risk discount rateresulting from increases in corporate bond returns. Negative economic assumption changes of £1 million in 2006 compared withnegative economic assumption changes of £349 million in 2005. Economicassumption changes in 2006 comprised positive £182 million in the UK, negative£51 million in the US and negative £132 million in Asia. In the UK, economic assumption changes of positive £182 million reflect theimpact of the increase in the future investment return assumption offset by theincrease in the risk discount rate. In the US, economic assumption changes of negative £51 million primarily reflectincreases in the risk discount rates following an increase in the US 10-yearTreasury rate, partially offset by an increase in the separate account returnassumption. In Asia negative economic assumption changes were £132 million, of which £101million is due to Taiwan. This primarily reflects the effect of delaying for afurther year Prudential's assumption of a gradual rise in interest rates. Theeconomic scenarios used to calculate 2006 EEV basis results reflect theassumption of a phased progression of the bond yields from the current rates tothe long-term expected rates. The projections assume that, in the averagescenario, the current bond yields of around 2 per cent trend towards 5.5 percent at 31 December 2013. Allowance is made for the mix of assets in the fund,the future investment strategy and the market value depreciation of the bonds asa result of the assumed yield increases. This gives rise to an average assumedfund earned rate that trends from 2.1 per cent to 5.7 per cent in 2014. Theassumed fund earned rate falls to 1.4 per cent in 2007 and remains below 2.1 percent for a further five years due to the depreciation of bond values as yieldsrise. Thereafter, the fund earned rate fluctuates around a target of 5.9 percent. For the 2005 results the grading of bond yields, in the average scenario,was around 2 per cent towards 5.5 per cent at 31 December 2012. Consistent withthe Group's EEV methodology, a constant discount rate has been applied to theprojected cash flows. The change in the time value of cost of options and guarantees was positive £60million for the year (2005: positive £47 million), consisting of £40 million, £6million and £14 million for the UK, the US and Asia, respectively. The mark to market movement on core borrowings (excluding Egg) was a positive£85 million (2005: negative £67 million) reflecting the reduction in fair valueof core borrowings due to increases in interest rates. EEV basis profit after tax and minority interests RER 2006 2005 £m £m Profit from continuing operations before tax 3,072 2,244 Tax (859) (653)Profit from continuing operations for the financial year 2,213 1,591after tax before minority interests Discontinued operations (net of tax) 0 3Minority interests (1) (12) Profit for the year attributable to equityholders of the Company 2,212 1,582 The following year-on-year comparisons are presented on a RER basis. Profit after tax and minority interests was £2,212 million (2005: £1,582million). The tax charge of £859 million compares with a tax charge of £653million in 2005. Minority interests in the Group results were £1 million (2005:£12 million). The effective tax rate at an operating tax level was 30 per cent (2005: 21 percent), generally reflecting expected tax rates. The effective tax rate in 2005was unusually low due to a number of factors, including favourable settlementsreached with the tax authorities, and being able to take credit for Egg's Frenchlosses. The effective tax rate at a total EEV level was 28 per cent (2005: 29per cent) on a profit of £3,072 million. The higher rate of effective tax at atotal level for 2005 was primarily due to the effect of impairment of goodwill(which does not attract tax relief) and the impact of short-term fluctuationsand changes in economic assumptions not all of which are tax affected. Return on Embedded Value Prudential's return on embedded value for 2006 was 13.5 per cent (2005: 15.5 percent). This reduction is due to an increase in the opening shareholders' fundsat 1 January 2006, mainly affected by the UK short-term investment fluctuationsin 2005, which was higher than the corresponding growth in after-tax operatingprofit. The return is based on EEV operating profit from continuing operations after taxand minority interests as a percentage of opening embedded value (shareholders'funds on a EEV basis). IFRS basis operating profit (based on longer term investment returns) CER RER 2006 2005 Change 2005 ChangeIFRS basis operating profit based on longer term £m £m % £m %investment returnsInsurance business: UK 500 400 25% 400 25% US 398 344 16% 348 14% Asia 189 201 (6%) 195 (3%) Long-term business 1,087 945 15% 943 15% Development expenses (15) (20) (25%) (20) (25%)Fund management business: M&G 204 163 25% 163 25% US broker-dealer and fund management 18 24 (25%) 24 (25%) Curian (8) (10) 20% (10) 20% Asia fund management 50 11 355% 12 317% 264 188 40% 189 40%Banking: Egg (UK) (145) 44 (430%) 44 (430%) Other income and expenditure (248) (198) (25%) (199) (25%)Total IFRS basis operating profit based on longer term investment returns 943 959 (2%) 957 (1%) Restructuring costs (50) 0 0 Total IFRS basis operating profit based on longer term investment returns after restructuring costs 893 959 (7%) 957 (7%) Group operating profit before tax from continuing operations on the IFRS basisafter restructuring costs was £893 million, a reduction of 7 per cent on 2005 atCER. This figure includes £50 million of restructuring costs. Group operatingprofit before tax from continuing operations before restructuring costs was £943million, a reduction of 2 per cent on 2005 at CER. This reduction is mainlycaused by the loss of £145 million in Egg (2005: £44 million profit). At RER, operating profit before restructuring costs was down 1 per cent on theprior year. In the UK, IFRS operating profit for the long-term business increased 25 percent to £500 million in 2006. This primarily reflected a 22 per cent increase inprofits attributable to the with-profits business, a consequence of bonusdeclarations announced in February 2006 and 2007 and a benefit of £46 millionfrom a change in reserving requirements. This was due to the FSA's relaxation ofreserving requirements under the policy statement that effected the proposal inCP 06/16. The result of £500 million excludes restructuring costs of £31 millionin respect of implementation costs associated with Prudential UK and Egg costsaving initiatives announced in July 2006. In the US, IFRS operating profit of £408 million was up 14 per cent on 2005 atCER. IFRS operating profit for long-term business was £398 million, up 16 percent from £344 million in 2005 at CER. The US operations' results are based onUS GAAP, adjusted where necessary to comply with IFRS as the Group's basis ofpresenting operating profit is based on longer-term investment returns. Indetermining the operating profit for US operations, longer-term returns forfixed income securities incorporate a risk margin reserve (RMR) charge forlonger-term defaults and amortisation of interest-related realised gains andlosses. The growth in the US operations' long-term IFRS operating profit mainlyreflects increased fee and spread income. The fee income was driven by a 51 percent increase in separate account assets held at year-end, and improved returnson these assets. One-off items affecting the spread-based income were £33 million(2005: £44 million), net of DAC amortisation. The operating profit fromnon-long-term business was £10 million, a reduction on 2005 (2005: £14 million).The 2005 result however, benefited from a one-off £5 million revaluation of aninvestment vehicle managed by PPM America (PPMA). Curian recorded losses of £8million in 2006, down from £10 million in 2005, as the business continues tobuild scale. Prudential Corporation Asia's operating profit for long-term business beforedevelopment expenses of £15 million was £189 million, a 6 per cent decrease on2005 at CER. However, this result was 11 per cent above prior year excluding anet positive £30 million contribution from exceptional items in 2005. Operatingprofit continues to be driven mainly by the established markets of Singapore,Malaysia and Hong Kong which represent £139 million of the total operatingprofit in 2006. There was an increased contribution from Indonesia and Vietnamas these operations continue to build scale. Four life operations made IFRSlosses: China, India and Korea which are relatively new businesses rapidlybuilding scale and Thailand which is marginally loss making. Within the netpositive £30 million of exceptional items in 2005 there was a write-off ofdeferred acquisition costs (DAC) in Taiwan of £21 million. No write-off wasrequired in 2006. The profits and recoverability of DAC in Taiwan are dependenton the rates of return earned and assumed to be earned on the assets held tocover liabilities and on future investment income and contract cash flows fortraditional whole of life policies. If interest rates were to remain at currentlevels in 2007 the premium reserve, net of DAC, would be broadly sufficient. Ifinterest rates were to remain at current levels in 2008 then some level ofwrite-off of DAC may be necessary. However, the amount of the charge currentlyestimated to be £70-90 million is sensitive to the above mentioned variables. The Asian fund management operations reported an 85 per cent growth in operatingprofits to £50 million (2005: £11 million), excluding negative £16 million ofexceptional items recorded in 2005, driven by strong contributions from theestablished markets of Singapore and Hong Kong. IFRS basis profit before tax for continuing operations RER 2006 2005 £m £mOperating profit from continuing operationsbased on longer-term investment returnsafter restructuring costs 893 957 Goodwill impairment charge 0 (120)Short-term fluctuations in investment returns 162 211Shareholders' share of actuarial andother gains and losses on defined benefit pension schemes 167 (50) Profit before tax from continuing operations 1,222 998 The following year-on-year comparisons are presented on a RER basis. Total IFRS basis profits before tax and minority interests were £1,222 millionin 2006, compared with £998 million for 2005. The increase reflects: a reductionin operating profit of £64 million; a decrease in short-term fluctuations ininvestment return, down £49 million from 2005; and a £217 million positivemovement from the prior year in actuarial gains and losses attributable toshareholder-backed operations in respect of the Group's defined benefit pensionschemes. In addition, in 2006 there is no goodwill impairment charge (2005: £120million). IFRS basis profit after tax RER 2006 2005 £m £m Profit before tax from continuing operations 1,222 998 Tax (347) (241)Profit from continuing operationsfor the financial year after tax 875 757 Discontinued operations (net of tax) 3Minority interests (1) (12) Profit for the year attributable to equity 874 748holders of the Company The following year-on-year comparisons are presented on a RER basis. Profit after tax and minority interests was £874 million compared with £748million in 2005. The effective rate of tax on operating profits, based onlonger-term investment returns, was 29 per cent (2005: 19 per cent). Theeffective rate of tax at the total IFRS profit level for continuing operationsfor 2006 was 28 per cent (2005: 24 per cent). The effective tax rate in 2006 wasclose to the expected tax rate of 31 per cent (which reflects the geographicsplit of profits). The effective tax rate in 2005 was unusually low due to anumber of factors, including favourable settlements reached with the revenueauthorities, and being able to take credit for Egg's French losses. Earnings per share Earnings per share, based on EEV basis operating profit from continuingoperations after tax and related minority interests, were 57.6 pence, comparedwith 56.6 pence in 2005. Earnings per share, based on IFRS operating profit from continuing operationsafter tax and related minority interests, were 26.4 pence, compared with 32.2pence in 2005. Basic earnings per share, based on total EEV basis profit after minorityinterests, were 91.7 pence, compared with 66.9 pence in 2005. Basic earnings per share, based on IFRS profit after minority interests, were36.2 pence, compared with 31.6 pence in 2005. Dividend per share The Board has reviewed its longer term dividend policy in light of itsexpectation that the overall operating cash flow of the Group will be positivefrom 2008. The directors recommend a final dividend for 2006 of 11.72 pence per sharepayable on 22 May 2007 to shareholders on the register at the close of businesson 13 April 2007. The interim dividend for 2006 was 5.42 pence per share. Thetotal dividend for the year, including the interim dividend and the recommendedfinal dividend, amounts to 17.14 pence per share compared with 16.32 pence pershare for 2005. The total cost of dividends in respect of 2006 was £418 million. The full year dividend is covered 1.5 times by post-tax IFRS operating profitfrom continuing operations. Dividend cover is calculated as operating profit after tax on an IFRS basis,divided by the current year interim dividend plus the proposed final dividend. The Board will focus on delivering a growing dividend, which will continue to bedetermined after taking into account the Group's financial flexibility andopportunities to invest in areas of the business offering attractive returns.The Board believes that in the medium term a dividend cover of around two timesis appropriate. Shareholders' funds On the EEV basis, which recognises the shareholders' interest in long-termbusinesses, shareholders' funds at 31 December 2006 were £11.9 billion, anincrease of £1.6 billion from the 2005 year-end level (2005: £10.3 billion).This 15 per cent increase primarily reflects: total EEV basis operating profitof £1,976 million; a £745 million favourable movement in short-term fluctuationsin investment returns; a £59 million positive movement due to changes ineconomic assumptions and in time value of options and guarantees; a positivemovement on the mark to market of core debt of £85 million; the proceeds for theshare capital issue of the parent company for £336 million, and a positivemovement in the actuarial gains on the defined benefit pension schemes of £207million. These were offset by: a tax charge of £859 million; the negative impactof £359 million for foreign exchange movements; the impact of the acquisition ofthe minority interest in Egg for £167 million, and dividend payments of £399million made to shareholders. At year-end 2006, the embedded value for the Asian long-term business as a wholewas £2.5 billion. The established markets of Hong Kong, Singapore and Malaysiacontribute £2.0 billion to the embedded value generated across the region withKorea (£191 million) and Vietnam (£198 million) making further substantialcontributions. Prudential's other markets of China, India, Indonesia, Japan,Thailand and the Philippines in aggregate contribute £336 million in embeddedvalue. Growth in embedded value for the Asian business as a whole has beenpartially offset by a negative embedded value in Taiwan of £216 million. This isan improvement from the reported negative £311 million in 2005, which includesthe associated cost of economic capital(1), and reflects the impact of the lowinterest rate environment in Taiwan on the in-force business. The current mix of new business in Taiwan is weighted heavily towardsunit-linked and protection products, representing 58 per cent and 17 per cent ofnew business APE in 2006, respectively. As a result, interest rates have littleeffect on new business profitability and a one per cent reduction in assumedinterest rates would reduce new business margins in Taiwan by only twopercentage points. However, the in-force book in Taiwan, predominantly made upof whole of life policies, has an embedded value that is sensitive to interestrate changes. A one per cent decrease in interest rates, along withconsequential changes to assumed investment returns for all asset classes,market values of fixed interest assets and risk discount rates, would result ina £165 million decrease in Taiwan's embedded value. A similar one per centpositive shift in interest rates would increase embedded value by £107 million.On the assumption that bond yields remained flat during 2007 and then trendedtowards 5.5 per cent in 2014 this would have reduced the 2006 Taiwan embeddedvalue by £88 million. Sensitivity of the embedded value to interest rate changesvaries considerably across the region. In aggregate, a one per cent decrease ininterest rates, along with all consequential changes noted above, would resultin a 5 per cent decrease to Asia's embedded value. Statutory IFRS basis shareholders' funds at 31 December 2006 were £5.5 billion.This compares with £5.2 billion at 31 December 2005. The increase primarilyreflects: profit after tax and minority interests of £874 million, the proceedsfrom the share capital issue of the Company for £336 million, offset by theimpact of the acquisition of Egg's minority interests for £167 million, negativeforeign exchange movements of £224 million, dividend payments to shareholders of£399 million, and the impact of unrealised holding losses on available for saleinvestments of £210 million. --------------------------(1) Economic capital is broadly considered to be the amount of capital afinancial services firm's own internal risk assessment determines it should holdto remain solvent following events that might be considered as unexpected, yetnot so unlikely that they might never occur in practice. Holding company cash flow 2006 2005 £m £mCash remitted by business units: UK life fund transfer* 217 194 UK other dividends (including special 0 103 dividend) Jackson 110 85 Asia 175 73 M&G 94 62 Total cash remitted to Group 596 517Net interest paid (128) (115)Dividends paid (399) (378)Scrip dividends and share options 91 55 Cash remittances after interest and 160 79dividendsTax received 122 107Corporate activities (67) (66) Cash flow before investment in businesses 215 120Capital invested in business units: UK (172) (249) Asia (147) (169) Total capital invested in business units (319) (418)Decrease in cash (104) (298) *In respect of current and prior year's bonus declarations. The table above shows the Group holding company cash flow. Prudential believesthat this format gives a clearer presentation of the use of the Group'sresources than the format of the statement required by IFRS. The Group holding company received £596 million in cash remittances frombusiness units in 2006 (2005: £517 million) comprising the shareholders'statutory life fund transfer of £217 million relating to the 2005 and 2006 bonusdeclarations from the UK business, and remittances of £110 million, £175million, and £94 million from Jackson, Asia and M&G respectively. The last of three special dividends of £100 million was paid from the PrudentialAssurance Company (PAC) shareholders' funds in 2005 to the Group holding companyin respect of profit arising from earlier business disposals. After net dividends and interest paid, there was a net cash inflow of £160million (2005: £79 million). During 2006, the Group holding company paid £67 million in respect of corporateactivities and received £122 million (2005: £107 million) in respect of Grouprelief on taxable losses. The Group invested £319 million (2005: £418 million)in its business units, comprising £172 million in its UK operations and £147million in Asia. In 2006, Asia became a net contributor to the Group holdingcompany cash flow for the first time, with a net remittance of £28 million. The capital investment in the UK was lower than planned reflecting a capitalbenefit from the FSA's change of reserving requirements. Without this reservingchange the UK business would have required capital of approximately £230million. In aggregate this gave rise to a decrease in cash of £104 million (2005: £298million decrease). In 2007 the Group cash flow is expected to be positive including the cashproceeds from the sale of Egg. At an operational level the cash outflow isexpected to be greater than in 2006, given the benefit this year of theregulatory change to the FSA reserving requirements in the UK. In 2007, the UK shareholders' statutory transfer relating to the bonusdeclarations made in February 2006 and 2007 will be £261 million. Depending on the mix of business written and the opportunities available, cashinvested to support the UK business in 2007 is expected to be less than in 2006,up to £160 million and with the expectation that the UK shareholder backedbusiness will become cash positive in 2010. Taking into account plans for future growth, a normalised level of scripdividend, the reducing UK capital requirement and increased remittances from theother life and asset management operations it is expected that the operatingcash flow of the Group holding company will be positive in 2008. New business capital usage 2006 2006 2006 2006 2006 £m £m £m £m £m Free Required Net Value Total surplus capital worth in force long-term business UK (221) 176 (45) 231 186 US (228) 196 (32) 200 168 Asia (105) 11 (94) 467 373 (554) 383 (171) 898 727 The Group wrote £2,470 million of sales on an APE basis and £18,947 million on aPVNBP basis in 2006. In support of this amount of new business sales, the Groupinvested £554 million of capital. This amount covers both new businessacquisition expenses, including commission, statutory reserves and the requiredcapital and amounts to approximately £22.4 million per £100 million of APE salesand £2.9 million per £100 million of sales on a PVNBP basis. In the UK business, £221 million of capital was invested in 2006 to support APEsales of £900 million and PVNBP sales of £7,712 million. This amounts toapproximately £24.6 million per £100 million of APE sales and £2.9 million per£100 million of sales on a PVNBP basis. In the US business, £228 million of capital was invested in 2006 to support APEsales of £614 million and PVNBP sales of £6,103 million. This amounts toapproximately £37.1 million per £100 million of APE sales and £3.7 million per£100 million of sales on a PVNBP basis. In the Asia business, £105 million of capital was invested in 2006 to supportAPE sales of £956 million and PVNBP sales of £5,132 million. This amounts toapproximately £11 million per £100 million of APE sales and £2.0 million per£100 million of sales on a PVNBP basis. BUSINESS UNIT REVIEW Insurance Operations United Kingdom CER RER 2006 2005 Change 2005 Change £m £m % £m %APE sales 900 892 1% 892 1%NBP 266 243 9% 243 9%NBP margin (% APE) 30% 27% 27%NBP margin (% PVNBP) 3.4% 3.1% 3.1%Total EEV basis operating profit* 686 426 61% 426 61%Total IFRS operating profit* 500 400 25% 400 25%*Based on longer-term investment returns. 1. Market review and summary of strategy The UK retirement market continues to remain attractive with an ageingpopulation driving demand for pre and post-retirement products. While many UK consumers remain overly indebted and are not saving enough forretirement, with a backdrop of reduced state and employer provision, theyincreasingly need to take control of their financial affairs. This positivedemographic trend, together with an increasing concentration of wealth in thehands of those approaching retirement or already retired, will continue to fuelthe opportunity for financial provision in, and preparing for, retirement. The impact of A-Day, the implementation of pensions simplification legislationin April 2006, initially dampened new business in certain areas, particularly inthe retail annuities market, but subsequently led to considerable market growthin individual pensions, Self Invested Personal Pensions (SIPPs) and annuities.Much of the market growth in pensions savings reflected recycling of money asconsumers consolidated existing pensions arrangements to one provider. The wholesale annuity and risk management market experienced increasedcompetition over 2006, as short-term demand slowed and several new entrantsstarted to participate. However, the long-term potential in this market remainsconsiderable, with approximately £900 billion of funds held across a number ofmarket segments. During 2006, Prudential UK Insurance Operations (Prudential UK) has continued totarget capital efficient returns through selective participation within itschosen markets, Retirement Income, Wealth and Health and Wholesale. Goingforward, Prudential UK will specifically focus on maximising value forshareholders through taking a leadership position in the retirement income andsavings market. This will be achieved by building on its longevity and assetallocation strengths, as well as utilising its brand strength with oldercustomers, targeting their specific retirement needs. This focus on maximisingvalue will be achieved alongside a programme of cost cutting initiatives forboth new business and Prudential UK's back book to ensure that greater operatingefficiencies are achieved. Prudential will not participate directly in healthcare and protection but willinstead expand its joint venture with Discovery Holding Limited ('Discovery'),the leading South African insurance company. It is expected that the FlexibleProtection Plan ('FPP') will be incorporated into the 50:50 Discovery jointventure during 2007. Both PruHealth and the FPP will utilise the successful 'Vitality' philosophy of a healthier lifestyle leading to lower protectionpremiums and have a dedicated sales force creating a more focused businessmodel. In addition, FPP will continue to benefit from distribution to financialintermediaries through Prudential UK's intermediary sales-force. As of February 2007, PruHealth had 450 employees and over 100,000 customers, andits customer base, in contrast to the rest of the industry, has been growing ata rate of 15 per cent per month during 2006. Product leadership through stronginnovation and multi-channel distribution strategy is expected to continue todeliver a significant market presence with 200,000 customers by the end of theyear. PruHealth's aim is to achieve breakeven in 2008 and to be profitablethereafter. Following the transfer of the protection business to the joint venture, the UKoperations will be structured into three business units: Wholesale, RetailRetirement and Mature Life and Pensions. The strategy in wholesale retirement income is to participate selectively inbulk and back book buyouts, where Prudential UK is able to win business based onits financial strength, operational capability and superior track record as wellas its extensive annuitant mortality risk assessment capabilities. PrudentialUK will maintain a strict focus on value, only participating in transactionsthat generate an acceptable rate of return. In addition, Prudential UK providespension management services (including full or partial buyouts) to corporateclients looking to manage or close pension deficits in cost-efficient ways.While there is currently limited activity in this market, Prudential UK believesopportunities will arise to help corporate clients manage significant amounts ofpension assets, which are non-core to their operations. Retail Retirement will focus on savings and income for those customers nearingor in retirement. Retirement income will drive profitable growth in the coreannuities business, building on the significant pipeline of vestings businessover the next 30 years from maturing policies in its individual and corporatepensions books. This is enhanced by a number of strategic partnerships withthird parties, where Prudential UK is the default annuity provider for customersvesting their pension at the point of retirement. The portfolio of retirementproducts also includes equity release products to provide more flexibility tocustomers with assets invested in property. Prudential UK has exited the unprofitable front end commission markets forindividual pensions and will transition from front end commission unit-linkedbonds, particularly moving away from those areas of low persistency. Instead,Prudential UK will focus on new low risk multi-asset products which utilisePrudential UK's strengths in asset allocation and use 'factory gate pricing'(negotiated between customer and adviser with separate advice costs). Theseproducts will target the significant number of retail investors approachingretirement who have substantial assets outside personal or corporate pensionplans, or have investments in poorly performing funds, and require inflationprotection. Prudential UK remains committed to the corporate pensions market but will moveto a tighter focus on larger schemes with better than average persistency andundertake a cost reduction programme. Together these are expected to deliver anIRR of 14 per cent by 2009. The corporate pensions book is an important sourceof vestings for the retail annuity business. Prudential UK will continue to deliver embedded value through the Mature Lifeand Pensions Business. It has an aggressive target to reduce per policy unitprocessing costs and is evaluating the best route for achieving this which willinclude one or all of internal cost cutting, further off-shoring or outsourcing. Prudential UK distributes products through both direct and intermediatedchannels. The direct channel will focus on capturing internal pension vestingbusiness and Prudential UK's equity release product via a specialistface-to-face direct sales-force. The indirect channel will distribute productsthrough retail intermediaries, strategic partners and through Employee BenefitConsultants ('EBCs') and consulting actuaries. Participation within theintermediary market will be selective, targeting those advisers who focus onvalue and building client relationships. Prudential UK continues to investigate the opportunity for wrap platformdevelopment and views this as an integral component to ensure future access todistribution. Any involvement is likely to be in partnership with a third party. 2. Current year initiatives Over the course of 2006, Prudential UK has continued to deliver innovative newsolutions to the market building on the award-winning launches of PruHealth andthe Property Value Release Plan, Prudential's equity release product, inprevious years. The new Flexible Protection Plan was launched in July 2006 to the Direct channeland to a limited group of intermediaries specialising in the protection market.This innovative protection product is designed to pay critical serious illnessclaimants earlier and more often than traditional protection products with, onaverage, four times as many serious illnesses covered. Payments are based onseverity levels and multiple claims for the same illness or new illnesses arepossible. Early results have been encouraging and as a result the product wasrolled out nationally in February 2007 and is expected to be incorporated intothe Discovery joint venture during 2007. Towards the end of 2006, Prudential UK received 4 stars in both the Life &Pension Providers category and the Investment Providers & Packages category atthe FT Financial Adviser Practiv Services Awards. In addition, Prudential UK wasranked number 1 for service in the Life & Pension Annuities sector. These awardsare widely recognised throughout the industry as independent recognition of aprovider's proposition, as they are voted on by intermediary financial advisers,who base the ratings on the level of service they receive from providers for newbusiness processing, central processing, product support and commission payment. Prudential UK's strength in retirement provision continued to be well recognisedas it won the Moneywise Best Annuity Provider Award for the third year runningand was awarded the best lifetime mortgage provider at the 2006 Equity ReleaseAwards for the Property Value Release Plan, together with awards from Moneyfactsand Mortgage Strategy. In relation to its externally sourced annuity business, Prudential UK has signedfurther partnership agreements in 2006, including with Royal London which cameinto effect in September. This agreement allows Prudential UK to provide annuityquotes to all Royal London customers with maturing pensions which wereoriginally written under various brands within the Royal London Group. Inaddition, Prudential UK signed an exclusive 5-year agreement with Threadneedleas their supplier of annuities for their Stakeholder scheme, along with anyfuture defined contribution schemes that Threadneedle acquires. This is a newarea for Prudential UK that builds on its experience in providing annuities tothe customers of life insurance companies. With the future growth in definedcontribution schemes within the UK, Prudential UK expects more agreements ofthis type. Prudential UK and Save & Prosper have also signed a direct marketing agreementunder which Save & Prosper will offer Prudential's conventional annuity producton an exclusive basis to customers with maturing Save & Prosper pensions. Theagreement is expected to take effect from mid-2007 and will run for five years. Prudential UK's financial strength and continuing outstanding life fundinvestment returns have been well received by both customers and advisers havinga positive impact on with-profits product sales. Prudential UK has also signednew distribution agreements with National Australia Bank Group and Openwork forPruFund, Prudential UK's unitised and smoothed investment plan. 3. Financial results and performance Prudential UK delivered a strong retail performance in 2006. Total APE sales of£900 million increased 1 per cent on 2005 and there was a 9 per cent increase inNBP to £266 million, reflecting the significant increase in new business marginfrom 27 per cent to 30 per cent. This demonstrated the benefits of the selectiveparticipation strategy focusing on value pursued throughout 2006. This performance was driven by underlying growth in the UK retail business(excludes credit life, bulks and back books): • Retail APE sales of £688 million were 14 per cent higher than 2005 (£605 million); • Retail NBP of £190 million was 67 per cent higher than 2005 (£114 million); and • Retail New business margin has increased to 28 per cent (2005: 19 per cent). The Retail life and pensions sales performance was primarily driven by strongindividual annuity volumes, where Prudential UK has a 24 per cent market share(source: Association of British Insurers), together with increased sales ofwith-profits bonds and offshore bonds. These increases were offset by a declinein unit-linked bonds, protection and DWP rebate business. Individual annuity sales grew by 22 per cent to £271 million as the annuitymarket experienced increased activity in the second half of 2006 following theremoval of uncertainty around A-Day pension changes. Sales volume has beendriven primarily by the continued strength of internal vestings (whichcontributed around 50 per cent of individual annuity sales) together with thecumulative benefit of partnership deals signed in previous years. Individual annuity sales were also boosted by sales of with-profits annuitieswhere sales have more than doubled to £37 million compared with 2005, and areexpected to increase. From February 2007, customers are able to start usingtheir Protected Rights Funds to buy with-profits annuities. This new feature isthe first of its type and allows customers to combine 100 per cent of theirpension into an asset-backed annuity without having to buy two separateannuities. Protected Rights is a term used to describe the funds held in a moneypurchase scheme derived from National Insurance rebates for those who contractedout of the State Earnings Related Pension Scheme (which was replaced by StateSecond Pension). With-profits sales were supported by the excellent with-profits bonusannouncements in 2006, in respect of 2005, which were well received by bothcustomers and advisers. This was reflected in APE sales of with-profits bonds up44 per cent to £26 million. Corporate pension APE sales increased 23 per cent due in part to the continuingshift from defined benefit to defined contribution pension schemes but also dueto the impact of A-Day. The sales upturn is also a reflection of Prudential UK'sre-engineered and improved account management capability, where the companyworks in partnership with the major Employee Benefit Consultants. Individualpension APE sales increased 3 per cent to £35 million due to increased activityfollowing A-Day. PruHealth continues to grow strongly with full-year gross written premiums (GWP)up 300 per cent at £36 million (2005: £9 million). GWP from new lives (which isequivalent to new business APE) was £28 million. Contributing to this growth isthe number of companies adopting PruHealth for their employee healthcareschemes, including the British Airways voluntary scheme, Smith and Nephew andNorton Rose. In the wholesale market, bulks and back book business APE volumes of £143million were 70 per cent of those achieved in 2005. This reflected the selectiveparticipation strategy undertaken by Prudential UK to ensure margins andprofitability were maintained in a period when the market experienced increasedcompetition. Prudential UK completed two significant back book transactions in 2006. InJanuary, it reached agreement with Royal London to acquire the portfolio of in-payment pension annuities that had been written primarily under the Royal Londonbrand, but which also included some annuities written under the Refuge Assurancebrand. The transaction generated premium income of £66 million on an APE basis.In June, Prudential Assurance Company (PAC) agreed to reinsure the non-profitimmediate pension annuity portfolio of the Scottish Amicable Insurance Fund(SAIF) to Prudential Retirement Income Ltd (PRIL). SAIF is a closed sub-fundestablished by a court-approved Scheme of Arrangement in September 1997, inwhich Prudential shareholders have no economic interest. It contains a largeproportion of the business originally written by the Scottish Amicable LifeAssurance Society that was acquired by PAC in September 1997. The reinsurancepremium for this transaction was £56 million on an APE basis. In December, Prudential UK reached agreement with Save & Prosper to acquire itsportfolio of in-payment pension annuities. The book covers approximately 16,900policies (weighted average age 72) with assets of around £135 million (£13.5million APE). During 2007, the intention is for these annuity policies totransfer to Prudential, subject to legal and regulatory approvals, at whichpoint Prudential will take over direct responsibility for the payment of allannuitants. Total credit life APE sales of £69 million generated NBP of £26 million in 2006(£83 million and £35 million respectively in 2005). Credit life sales reducedin 2006 and will continue to do so in 2007 as Prudential UK's credit lifecontract with Lloyds TSB, which in 2006 contributed APE sales of £63 million andNBP of £20 million, has not been renewed. Prudential UK will continue toparticipate in the credit life market, pricing on a case-by-case basis. In 2002, Prudential UK transferred its UK personal lines general insurancebusiness to Winterthur, forming a strategic alliance with Churchill to offerPrudential-branded general insurance products for which Prudential receives acommission payment that has been offset against an advance payment made byWinterthur at completion resulting in a net payment to Prudential of £4 millionin 2006. From 2008, under the terms of the contractual arrangement, the advancepayment will have been fully offset therefore the UK is expected to receiveapproximately £30 million a year from the commission payments, although thiswill depend on the new business volumes and persistency rates. Prudential UK allocates shareholder capital to support new business growthacross a wide range of products in the UK. The weighted average post-tax IRR onthe capital allocated to new business growth in the UK in 2006 was 15 per cent,up by 1 percentage point from that achieved in 2005. The NBP increased 9 per cent to £266 million, primarily reflecting an increasein margin from 27 per cent in 2005 to 30 per cent in 2006. This reflects anincrease in profitability within the retail business, where the margin increasedsignificantly, driven principally by individual annuities offset by a change inbusiness mix following the lower sales of more profitable bulk annuities, creditlife business and DWP rebates. EEV basis operating profit based on longer-term investment returns of £686million, before restructuring costs of £34 million, were up 61 per cent on 2005.The in-force operating profit of £420 million was up 129 per cent on 2005, dueto the increase in profits arising from the unwind of discount from the in-forcebook (reflecting an increase in the risk discount rates together with anincreased opening embedded value); and because there were no operatingassumption changes required in 2006, in comparison to 2005 when a charge of £148million was made in respect of persistency. Other charges of £110 million include £32 million of costs associated withproduct and distribution development and complying with regulatory requirementsincluding Sarbanes-Oxley; £9 million negative persistency experience variance;£14 million for an annual fee paid by the shareholder business to the PACwith-profits sub-fund for the use of the Prudential and Scottish Amicabletrademarks; £16 million in respect of the tariff arrangement with SAIF, which isto be renegotiated in 2007; £26 million for tax related items and £13 million inrelation other items. Prudential continues to manage actively the retention of the in-force book.During 2006 Prudential saw surrenders within its personal pension and DWP rebatebusiness run ahead of assumptions following A-Day resulting in a small negativeexperience variance. All other lines of business performed in line withassumptions. IFRS operating profit before restructuring costs of £31 million increased 25 percent to £500 million in 2006. This reflects a 22 per cent increase in profitsattributable to the with-profits business, which contributed £368 millionreflecting the strong investment performance of the Life-Fund and its impact onterminal bonuses. In addition, the result benefited from a £46 million positiveimpact of changes in FSA reserving requirements for protection and unit-linkedproducts. 4. Outlook and forthcoming objectives While Prudential's retail APE sales volume growth may fall in the short term, asit refocuses its retirement savings products, Prudential expects the UKfinancial services environment to remain favourable, and expects to achievegrowth in line with the market (5 to 10 per cent) over the next five years. Prudential UK will continue to focus on profitable opportunities which delivercapital-efficient returns and will seek to maintain an aggregate 14 per cent IRRon new business. It will continue to pursue profitable opportunities in itschosen product areas and distribution channels in 2007. As previously announced, Prudential UK has targeted £150 million of cost savingsby 2008 through the integration of Egg and other shareholder cost savinginitiatives at a cost of £110 million. Of these target savings and costs, £35million and £25 million respectively were due to be realised by Egg. Followingthe sale, the revised target savings for Prudential is £115 million. PrudentialUK has, however, identified further cost saving initiatives which result intarget cost savings for the UK business being increased to £195 million, to beachieved by 2010. The savings when achieved, net of restructuring costs, willresult in a small positive assumption change on an EEV basis, estimated to bearound £60 million. The cost savings will be achieved through a combination ofinternal cost saving, further off-shoring or outsourcing. The work ofapproximately 3,000 people in the customer service, customer operations andinformation technology areas will be in the core scope of this review.Prudential will comply with its legal obligations to consult with unions andemployee representatives in relation to these proposals. The total cost ofachieving the £195 million of savings is expected to be up to £165 million andwill depend upon the final detail of the cost reduction programme. In connection with the sale of Egg, outline terms of a distribution agreementhave been agreed in principle with Citi through which Prudential UK will providelife and pension products to Egg's customers for a five-year period. PrudentialUK sees Egg's direct distribution capacity and access to its three millioncustomers as powerful strategic assets, and this agreement enables it topreserve these benefits while reducing the risk to its balance sheet. United States CER RER 2006 2005 Change 2005 Change £m £m % £m % APE sales 614 508 21% 515 19%NBP 259 208 25% 211 23%NBP margin (% APE) 42% 41% 41%NBP margin (% PVNBP) 4.2% 4.1% 4.1%Total EEV basis operating profit* 718 745 (4%) 755 (5%)Total IFRS operating profit* 408 358 14% 362 13%*Based on longer-term investment returns. 1. Market review and summary of strategy The United States is the largest retirement savings market in the world, with 67per cent, or US$12.9 trillion, of the world's retirement assets concentrated inthe US at the end of 2005 (Source: Cerulli Associates). As 78 million babyboomers (source: US Census Bureau), born between 1946 and 1964, approachretirement age, the aging demographics of the US are expected to increase annualretirement distributions to more than US$1 trillion per year by 2012. Thecombination of increasing average life expectancy and decreasing averageretirement age in the US is leading to an increase in the average timeindividuals will spend in retirement. At the same time, the responsibility forproviding income during retirement continues to shift away from institutions,such as government and employers, toward individuals. These changes, coupledwith historically low savings rates in the US, have resulted in an increasingrisk that individuals' finances will be insufficient to cover the cost of livingthrough retirement. These consumers will have a growing need for independentfinancial advice and increasingly seek guarantees and longevity protections fromthe financial products they purchase. Despite favourable demographics, US life insurers face challenges from bothwithin and outside the industry. The US life insurance industry remains highlyfragmented - the combination of all annuity companies ranked below the top 20annuity sellers have more than twice the market share of the top annuityprovider (Source: LIMRA) and competition for market share is expected tointensify. In addition to competing against each other, life insurers areincreasingly competing with other financial services providers, in particularmutual fund companies and banks, for a share of retirement savings assets in theUS. Sales of annuities in the career agency distribution channel continue todecline to the benefit of independent agents/broker-dealers due to increasingcosts and regulatory burdens, as well as a growing pool of sophisticatedinvestors increasingly seeking more independent investment advice. The US insurance industry faces continued regulatory scrutiny, particularly withrespect to index and variable annuity products. The National Association ofSecurities Dealers Inc. (NASD) has issued guidelines requesting that its memberfirms provide stricter supervision of the marketing and sales of indexannuities. In the variable annuity market, regulators continue to focus onproduct suitability in an effort to ensure that the products are soldappropriately to customers. There has also been regulatory pressure to reducefees and costs associated with variable annuities, which has increased advisordemand for providers to manufacture low-cost variable annuity options. Companies with quality distribution relationships, strong product manufacturingand below-industry-average cost structures are well positioned to competeeffectively and continue to grow profitably. Significant convergence in the USfinancial services industry has yet to occur. As noted, the market remainsfragmented with more business being consolidated organically among marketparticipants with significant scale and sophisticated risk management functions. During 2006 and 2005, the S&P index increased 13.6 per cent and 3.0 per cent,respectively, increasing the attractiveness of products providing access toequity based returns. During the same periods, interest rates trended upward.However, the short end of the yield curve rose more dramatically than the longend of the curve, resulting in a flat to inverted yield curve. This, combinedwith low spreads over Treasury bonds, created a difficult environment for thesale of properly priced fixed annuities. Jackson provides retirement income and savings solutions in the mass andmass-affluent segments of the US market, primarily to near- and post-retirees.It offers tools that help people plan for their retirement, and manufacturesproducts with specialised features and guarantees to meet customers' needs. Byseeking to add value to both the representatives who sell Jackson products, andto their customers, Jackson has built a strong position in the US retirementsavings and income market with the fastest-growing variable annuity franchisemeasured by new sales growth during the past four years (Source: VARDS) andtop-10 sales rankings in fixed index annuities and individual traditionaldeferred fixed annuities (Source: LIMRA). Jackson's primary focus is manufacturing high-margin, capital-efficientproducts, such as variable annuities, and marketing these products toadvice-based channels through its relationship-based distribution model. Indeveloping new product offerings, Jackson leverages a low-cost, flexibletechnology platform to manufacture innovative, customisable products that can bebrought to the market quickly. In 2006, 81 per cent of Jackson's retail saleswere from products and features developed and launched in 2006 and 2005. Jackson's product offerings include variable, fixed and fixed index annuities,as well as life insurance and institutional products. Jackson's annuity productsare long-term personal retirement products, which offer tax-deferredaccumulation on the funds invested until proceeds are withdrawn from the policy.Fixed annuities offer customers a guarantee of principal and a minimumguaranteed rate of return on their deposits. Fixed index annuities also offerthese features, but vary from fixed annuities in that they offer the potentialfor additional interest to be credited based upon the performance of an equityindex over a specified period. Variable annuity products differ from the fixedannuity products in that the returns to the customer will depend upon theperformance of the underlying fund portfolio. Jackson's variable annuityproducts offer a range of protection options, such as death, income andwithdrawal benefits, which are priced separately by the company and can beelected by customers according to their individual needs. Jackson manages itsexposure to equity market movements through a comprehensive hedging program. Due to the increasing complexity of the retirement savings and income market andbroad array of financial products being brought to market, professional adviceis vital for customers to understand the choices available and to determinewhich products are best for their particular financial situation. Therefore,Jackson primarily markets its retail products through advice-based distributionchannels, including independent agents, independent broker-dealer firms,regional broker-dealers, banks and registered investment advisors. Beginning in2005, Jackson also began marketing products through its captive insuranceagency, acquired through the purchase of Life of Georgia (LOG). Jackson supports its network of independent agents and advisors withaward-winning marketing support and award-winning customer service. In 2006, theService Quality Measurement Group recognised Jackson with a World Class CustomerSatisfaction Award, and Jackson's marketing campaigns won awards for achievementin graphic design, editorial content and overall communications excellence.Jackson complements its award-winning marketing and customer service withvalue-added services such as the Seminar Systems Unit, which helps advisors hosteducational seminars for clients on a variety of financial planning topics. Inaddition, Jackson recently launched the Retirement and Wealth Strategies Group,a unit dedicated to helping advisors better address their clients' evolvingretirement planning needs. By manufacturing and distributing a broad suite of platform-based products thatcan be tailored to an individual customer's needs, Jackson has positioned itselfto compete effectively in all phases of the business cycle based upon thequality and value of the products and services it provides, rather than pricealone. Jackson's institutional products division markets institutional products such astraditional Guaranteed Investment Contracts (GICs), Funding Agreements andMedium Term Note (MTN) funding agreements. Jackson distributes its institutionalproducts directly to investors, through investment banks or through fundingagreement brokers. This is a market in which Jackson continues to participate onan opportunistic basis. In early 2003, Jackson entered the registered investment advisor channel withthe launch of Curian Capital. Curian provides innovative fee-based separatelymanaged accounts and investment products to advisors through a sophisticatedtechnology platform. In 1998, Jackson launched the National Planning Holdings (NPH) independentbroker-dealer network with the formation of National Planning Corporation. Sinceits formation, NPH has grown through acquisitions to comprise four broker-dealerfirms: INVEST Financial, Investment Centers of America, National PlanningCorporation, and SII Investments. By leveraging technology, NPH provides itsadvisors with the tools they need to operate their practices more efficiently.Through its relationship with NPH, Jackson has gained an important distributionoutlet, plus invaluable insight into the needs of financial advisors and theirclients. Jackson's focus on current retirees and those approaching retirement age is notunique among US financial institutions. As a result, competition in this segmentis expected to continue as the Baby Boomer generation retires and theirretirement savings assets are moved from pre-retirement accumulation accountsinto post-retirement income accounts. Jackson believes that its specialisedproduct offerings, advice-based distribution model, sophisticated riskmanagement function and low cost structure will offer a significant competitiveadvantage. As competition and regulatory challenges intensify, Jackson expectsconsolidation within the industry to continue at a measured pace. Furtherconsolidation will provide an excellent opportunity for Jackson to leverage itsefficient information technology platform and cost effective business model asan aggregator of annuity and life portfolios, as demonstrated with Jackson'sacquisition and integration of LOG in 2005. 2. Current year initiatives Jackson's focus on maximising its opportunities in the evolving US market isembedded in the development of current and future strategic initiatives. Thesegoals include a continued expansion of Jackson's share of the US annuities andretail asset management markets. Expansion of Jackson's share of the US annuities market will be largelycontingent on continued expansion of existing product offerings, additionalgrowth in new and existing distribution channels and opportunistic acquisitionactivity. Innovation in product design and speed to market continue to be key drivers ofJackson's competitiveness. In January, Jackson added a 5 per cent annual benefitincrease option to its popular lifetime guaranteed minimum withdrawal benefits(GMWBs). In February 2006, the company launched two new fixed index annuitycontracts, Elite Choice and Elite Choice Rewards, which expanded the number ofFIA products Jackson offers to five. In May, Jackson added five new GMWB optionsthat provide contract holders with a guaranteed return of premium and lifetimeincome. Additionally, Jackson expanded its variable annuity fund offering duringthe year. In the near-term, Jackson's product development strategy includes furtherenhancement of its variable annuity offerings and the introduction of newguarantees, including a Guaranteed Minimum Accumulation Benefit (GMAB). In early2007, Jackson launched a simplified retirement annuity that will serve as alow-cost option for financial advisors who are currently not participating inthe variable annuity market. Additionally, Jackson launched its first set ofretail mutual funds for distribution by existing wholesalers. Jackson's newmutual funds are marketed as an additional option for financial advisorscurrently selling variable annuity products. Jackson will continue to build its relationship-based distribution advantage inthe advice-based channels and explore additional distribution opportunities,including expansion into the wirehouse channel, as evidenced by the company'srecently announced distribution agreement with UBS. Jackson's organizational flexibility and excellence in execution, coupled withits product innovation, successful distribution model and strong serviceoffering, increased Jackson's share of the US variable annuity market to 4.6 percent in 2006 (VARDS), up from 3.6 per cent in 2005. Jackson also increased itsshare of variable annuity sales through the independent broker-dealer channel to10.8 per cent at the end of 2006, up from 9.2 per cent at the end of 2005. Jackson continues to seek opportunities to deploy capital through opportunistic,value-creating acquisitions. Jackson demonstrated its ability to efficientlyconsolidate annuity and life portfolios by meeting or exceeding performancetargets during the completion of its acquisition of LOG. Jackson integratedmore than 1.5 million policies onto its platform within eight months of theacquisition date. The IRR on the acquisition of LOG exceeded 13 per cent and thepurchase resulted in a gain of US$8.9 million (£4.8 million) as the net assetsacquired exceeded the purchase price paid. Jackson's continued expansion in the US retail asset management market will beled by the efforts of its independent broker-dealer network, NPH, and Curian.NPH was ranked the seventh largest independent broker-dealer network in the US(source: Investment News magazine) and generated nearly US$12 billion in grossproduct sales and nearly US$500 million in revenues in 2006. Curian continues tobe one of the fastest growing third-party separately managed account platformsin the US, with assets under management of US$2.4 billion at the end of 2006.Curian is expected to continue expansion of its product offerings and furtherimprove efficiencies through planned improvements to its core technology system.Curian also continues to expand its distribution relationships with keyfinancial institutions, as evidenced in recently announced agreements with AIGand Commonwealth Financial Group. 3. Financial results and performance Jackson has a diversified earnings base derived from spread, fee andunderwriting income. Through strong growth in its variable annuity businessduring 2006, Jackson increased the share of revenue received from fee income andfurther diversified its revenue streams. Underwriting revenue from lifeinsurance provides Jackson with stable cash flows to balance the volatility ofcash flows from fixed annuities, thereby providing the company with a morestable earnings base and greater flexibility in how assets are invested. Jackson achieved record APE sales of £614 million in 2006, representing a 21 percent increase on 2005, driven by strong growth in sales of variable annuities.On a PVNBP basis, new business sales were £6.1 billion. Retail APE sales in 2006of £524 million were up 27 per cent. APE sales in the fourth quarter of 2006were £147 million, up 43 per cent compared to the fourth quarter of 2005. Jackson delivered record variable annuity sales in 2006 of £3.8 billion, up 48per cent on last year. This reflects its distinct competitive advantages of aninnovative product offering, an efficient and flexible technology platform, arelationship-driven distribution model and award-winning service. Jackson'ssales result was achieved in a market that grew 18 per cent year-on-year in2006. Entry spreads for fixed annuities continued to be challenging during 2006, whichlimited the attractiveness of the market to Jackson. APE sales of £69 millionwere down 12 per cent on the same period in 2005. Fixed index annuity sales continued to be affected by the uncertain regulatoryenvironment in the US. APE sales of £55 million were 10 per cent down on 2005.Jackson's market share in 2006 was 3.7 per cent, compared to 3.8 per cent in theprior year. Institutional APE sales of £90 million were down 8 per cent from 2005. Jacksonparticipates in this market on an opportunistic basis. EEV basis NBP of £259 million was 24 per cent above the prior year, reflectingboth a 21 per cent increase in APE sales and an increase in margin from 41 percent to 42 per cent year on year. The increase in margin reflects a favourablebusiness mix, economic assumption changes, and positive effects from theincrease in election of high margin guaranteed benefit options on variableannuity contracts, offset by more prudent operating assumptions. The variable annuity new business margin decreased slightly from 50 per cent in2005 to 49 per cent in 2006. The fall in margin primarily reflects changes inassumptions for expenses and utilisation of lifetime guaranteed minimumwithdrawal benefits, offset by economic assumption changes and a more favourablemix due to the increased election of guaranteed minimum withdrawal benefits. The fixed annuity new business margin fell from 23 percent to 16 per centreflecting changes to expense and cash withdrawal assumptions partly offset byeconomic assumption changes. The new business margin on institutional business improved due to the largeraverage duration contracts written during 2006. The average IRR on new business was 18 per cent compared to 15 per cent in 2005. While product IRRs are generally in line with returns reported for 2005 newbusiness, the aggregate returns are higher due to a larger proportion ofvariable annuity sales in 2006 (64 per cent) as compared to 2005 (52 per cent).For variable annuities, the IRR has increased to 25 per cent in 2006 from 24 percent last year due to higher interest rates and therefore a higher separateaccount return assumption. Total EEV basis operating profit for Jackson for 2006 was £708 million comparedto £731 million in the prior year. In-force EEV profits of £449 million were 14per cent below prior year profit of £523 million, primarily reflecting theinclusion in 2005 of an operating assumption change relating to price increasesintroduced on two older books of term life business representing £140 million.This was partially offset by an increase in the unwind of the in-force businessduring 2006 as a result of a higher opening embedded value and a higher riskdiscount rate as long-term interest rates increased. On a normalised basis, theEEV basis operating profit was up by 19 per cent. One-off items affecting thespread income variance totalled £46 million. The growth in IFRS operating profit for total US operations of 14 per cent fromthe prior year to £408 million primarily reflects an increase in fee and spreadincome over 2005. The improved spread income primarily reflects higher netaverage invested assets. Higher fee income was primarily driven by higherseparate account assets given the growth in variable annuity sales, and animprovement in the average fees generated from those assets given the increasein election of high margin guaranteed optional benefits. In 2006, spread incomeincluded a number of non-recurring items including mortgage prepayment fees,make-whole payments and total return swap income which together represent £33million of spread, compared to £44 million in 2005, both net of DACamortisation. At 31 December 2006, Jackson had more than US$74 billion (£38 billion) in GAAPassets. Of this total, US$22 billion related to separate account assets, anincrease of more than US$7 billion compared to 2005 year-end, furtherdiversifying Jackson's earnings toward fee-based income. NPH had a strong year with pretax profits up 51 per cent to £6 million. NPH,which is a network of four independent broker-dealers, increased gross productsales through the network to US$11.9 billion (£6.5 million) in 2006, an increaseof 26 per cent over the prior year. NPH has also increased the number ofregistered advisors in its network to more than 2,600 at year-end, furtherextending Jackson's footprint in broker-dealer distribution. Curian recorded improved results with pretax losses of £8 million in 2006,improving from losses of £10 million in the prior year, as it continues to buildscale in assets under management. At 31 December 2006, Curian Capital had US$2.4billion (£1.2 billion) of assets under management compared with US$1.7 billion(£853 million at CER) at the same point in the prior year. Jackson continues to maintain a strong capital position through capitalconservation and strong earnings. At 31 December 2006, Jackson's capital waswell in excess of regulatory requirements with sufficient available capital tofund future bolt-on acquisitions. During 2006, Jackson increased the capitalremittance to the Group to US$200 million, with future increases expected withcontinued growth. 4. Outlook and forthcoming objectives Jackson continues to deliver growth in the attractive US market and has furtherenhanced its competitive advantage in the variable annuity market, offering theproduct and service solutions that both customers and advisors desire. With itscontinued focus on product innovation, a proven relationship-based distributionmodel, award-winning service and excellence in execution, Jackson is wellpositioned to take advantage of the changing demographics and resultingopportunities in the US market. Asia CER RER 2006 2005 Change 2005 Change £m £m % £m % APE sales 956 734 30% 731 31%NBP 514 418 23% 413 24%NBP margin (% APE) 54% 57% 56%NBP margin (% PVNBP) 10.0% 10.3% 10.2%Total EEV basis operating profit* 829 585 42% 576 44%Total IFRS operating profit* ** 189 201 (6%) 195 (3%)*Based on longer-term investment returns.** Excluding fund management operations, development and Asia regional head office expenses 1.The Asian opportunity Asia remains a very attractive region for growth opportunities due to its highlevels of economic activity translating into higher levels of personal wealth,greater disposable incomes and a growing appetite for good quality protectionand savings products. Within this environment, ageing demographics are alsobeginning to drive increased household savings rates and an emerging need forretirement solutions. Within Asia, each country typically has incumbent life insurers and assetmanagers and the majority of market share is concentrated in the top fiveplayers. For many years, these incumbents have used predominantly lower qualitytied agency distribution and life products have tended to be simple, often withsome form of guarantee that may be based on higher interest rates than thecurrent prevailing ones. The country markets within Asia are extremely diverse and a 'one size fits all'business model does not work. Regional players must accommodate different stagesof economic development, varying cultures, multiple languages, differing legaland regulatory regimes and competitors with different objectives and standards.Joint venture with local companies is also mandated in some markets and there isa limited pool of attractive partners. Regional players such as Prudential havehad considerable success across multiple Asian markets but, to date, this hasbeen the exception rather than the rule with local players tending to staywithin their markets and other international players, whilst successful in oneor two markets, have not developed their businesses across the region. Opportunities for foreign players to access the Asia protection and savingsmarkets have been increasing steadily and regulators in the region are becomingmore accommodating regarding product and distribution innovation. These includeunit-linked products, more professional non agency channels and mandatorylicensing of agents. Most notably, the significant markets of China and Indiahave greatly opened up within the last few years. Despite the increasing opportunities in Asia, there are also challenges toexpansion. Experienced staff and agents are very much in demand, particularly inmarkets such as China and India where the rapid growth of the industry hasresulted in limited pools of resources. There is also the potential formiss-selling where there can often be a difference between the customer'sperception of product features and the reality which may take several years tobecome apparent. These challenges can be exacerbated by a media that is becomingmore consumer focused as de-regulation continues. During 2006, economic activity in the region remained strong and equity marketperformance was robust. We anticipate the Asian economic outlook will remainstrong with domestic demand and foreign investment and capital inflow expectedto increase, resulting in average GDP growth across Asia being around 7 per centfor the next few years. 2. Prudential's Asian strategy Since 1994 Prudential has implemented a strategy designed to build an Asianplatform with the breadth and depth to deliver material shareholder value thatis sustainable over the long term. This strategy has been executed by securingearly access to countries with high potential customer bases, building andprofessionalising core tied agency distribution that is complemented byalternative channels such as bank partnerships, launching capital efficientconsumer orientated products and supporting the entire structure with a sharpfocus on excellent customer service. Underpinning the strategy is an investment in recruiting and training with theobjective of retaining the best people in the industry. Prudential alsocontinues to leverage the significant advantages from its well respected UKheritage including a powerful brand, embodied by the Prudence icon, over 150years experience as a market leader and the governance and complianceinfrastructure associated with a leading international business. Today, Prudential has life operations in 12 countries, including joint ventureswith CITIC in China and ICICI in India. Prudential is a regional force in thelife insurance and fund management business, and, at 31 December 2006 had 7.2million customers in Asia and 14,000 staff. Brand recognition is high andPrudential's customer centric delivery has been acknowledged through a number ofawards, including 2nd most trusted life insurance and asset management brand inIndia. Life insurance new business APE has grown at a compound annual growthrate (CAGR) of 22 per cent since 2001 and funds under management, includingPrudential's market leading retail mutual fund business has grown at a CAGR of25 per cent over the same period. For the first time this year, Asia also becamea net contributor of cash to the Group, demonstrating the growing scale of thebusiness. 3. Business priorities An ongoing priority for Prudential is to continue building distribution to drivegrowth. The agency strategy is tailored to each market, with the more developedmarkets typically focussed on enhancing agency productivity and the newermarkets emphasising increased distribution reach through growth in agentnumbers. In China and India particularly this means increasing geographiccoverage through entering new cities and opening more branches. 2006 was a very successful year for the agency distribution channel withyear-end 2006 agent numbers increasing by 114,000 in India, 11,000 in Indonesiaand 5,000 in China compared to 2005. Agency productivity measured by APE peraverage agent also improved strongly during the year with Prudential's moredeveloped markets of Singapore, Hong Kong and Malaysia all showing double digitimprovement over 2005 of 23 per cent, 30 per cent and 32 per cent, respectively. Distribution from non-agency channels also grew strongly in 2006. Strong growthfrom bank distribution included record new business volumes from StandardChartered Bank (SCB) in Hong Kong, an increasing proportion of new business fromICICI Bank in India and encouraging growth from Maybank and Singpost inSingapore. In addition, a new direct distribution initiative, PRUcall, waslaunched in Thailand during 2006, posting strong results to date. Prudential's product strategy has been a key driver of its success. From theoutset, the focus has been on predominantly regular premium products designedand targeted to meet customer needs. In the more emerging markets this isillustrated by the success of products that focus on providing for children andtheir education such as PRUkid in Vietnam. However, in an older and moredeveloped market such as Korea, retirement orientated unit linked products suchas PRUretire are proving popular. Prudential has led product innovation in a number of markets often workingclosely with the regulators. As a result, Prudential has been first to marketwith unit linked products in Singapore, Malaysia, Taiwan, Indonesia, India, thePhilippines and Korea. Unit-linked products are now a well established part ofthe overall portfolio generating 61 per cent of total new business APE in 2006and, within the regulatory driven investment guidelines in each market,Prudential continues to expand the choice of investment funds available tocustomers, including third-party funds in markets where it makes sense. During 2006, Prudential launched a new universal life product in Malaysia togive customers more choice and in India, ICICI Prudential launched aground-breaking new diabetes care product. Prudential has also made its firstmove into the takaful market by forming a joint venture with Bank SimpananNasional (BSN) in Malaysia and successfully launching its first linked productin November. As a result of this strategic focus on regular premium policies, capitalefficient linked products and the high proportion of A&H riders, new businessprofit margins as a percentage of weighted sales tend to be higher in Asia thanare seen elsewhere. The focus on effective distribution and profitable life products has proven moredifficult to deliver in Japan. Neither tied agency nor general agencydistribution were found to be economically viable and, whilst a profitablevariable annuity product has been approved by the regulators, it has not beencommercially attractive when compared to some competitor products. The businessremains subscale and we continue to look for profitable growth opportunities inthe market. Further demonstrating the benefits of scale that Prudential is beginning torealise in Asia, costs as a proportion of gross written premiums have beendecreasing steadily from 16 per cent in 2002 to 11 per cent in 2006. However,continuing to increase efficiencies through greater use of common systems,platforms and processes across the region and the Group remains a priority. Prudential is committed to delivering material shareholder value from its Asianbusiness and, during 2006, a number of steps were taken to strengthen the Asiaregional management team with Barry Stowe becoming the new CEO in November 2006. Major market overviews China Prudential, with its joint venture partner CITIC, continues to be very wellplaced amongst the foreign players establishing themselves in this veryattractive market. In 2006, CITIC-Prudential retained its position as the numbertwo foreign player with new business APE growth of 56 per cent to £39 millionand continued to successfully implement its strategy of geographic expansionreceiving 6 new city licence awards from the regulators. New business profit margins of 43 per cent remain attractive but as would beexpected, the business is currently making IFRS losses and consuming capital asit invests in new cities. The reduction in margin from 51 per cent in 2005 isprimarily due to product mix and persistency assumption changes in 2006. Hong Kong The Hong Kong market grew strongly between 2000 and 2005 with a CAGR of 18 percent and Prudential has consistently outperformed the market with a CAGR of 22per cent over the same period. One reason for this is Prudential's successfulmulti channel model while most of the top five players in the market choose tofocus on only one distribution channel. In 2006 55 per cent of distributioncame from agency and 45 per cent from bank distribution with SCB. During 2006, Hong Kong successfully focused on recruiting and training agentswith average agent numbers and productivity up 7 per cent and 15 per cent,respectively. Another priority for the business is to continue leveraging itsstrong partnership with SCB and new business APE from this channel increased by32 per cent in 2006. NBP margins on APE increased from 60 per cent to 69 per cent during 2006reflecting improving experience. Hong Kong also generates material IFRS profitsand is a net remitter of capital to the Group. As in Singapore and Korea, there are significant opportunities in the retirementsector in Hong Kong and Prudential is well placed with a marketing campaignalready underway. India Prudential's strategy of working with top quality joint venture partners hasbeen very successful in India, where ICICI-Prudential Life is the clear leaderamongst the private sector insurers and, with its 9 per cent market share, isreally making headway. This is a remarkable achievement given it has only beenoperating for six years. As reflected by the over 280 new branches opened during the year and the 165 percent increase in agent numbers, the strategy in India has been to build scalerapidly. Bancassurance is also well established in India and generated 27 percent of ICICI -Prudential's new business in 2006. At 31 December 2006ICICI-Prudential had 2.6 million policies in force. Whilst 96 per cent of India's 2006 new business is made up of unit linkedproducts, margins are lower than in other Asian markets. This is drivenprimarily by relatively higher discount rates and more aggressive pricing. Themargin of 23 per cent in 2006 is lower than the 29 per cent reported for 2005primarily due to product mix and expense assumption changes. Prudential's ownership of this venture is capped at 26 per cent by law and,although there is much speculation that this limit may be increased to 49 percent in the future, there is no firm timetable in place. Prudential willconsider an increase in its stake as and when this becomes a feasible option.Resulting from the fast pace of expansion, the business currently makes a lossunder the IFRS basis and requires net capital injections. Indonesia Indonesia is a very attractive market with a population of 240 million and anincreasingly stable and productive economy. Prudential is already a wellestablished market leader and during 2006 has continued to aggressively expandits agency distribution with numbers up 49 per cent in the year. In addition tocontinuing to expand the agency force, Indonesia is expected to begin workingwith Citi in 2007 as announced at the time of the Egg sale. In 1997, Prudential successfully introduced unit linked products in Indonesia,which now account for virtually all new business sold. The business isprofitable under the IFRS basis and remitted surplus capital to the Group in2006. Japan Prudential's Japanese life insurance operation remains subscale, although 2006saw new business double. A review of opportunities in Japan is underway. Korea Prudential's Korean life operation has an impressive growth track record with aCAGR of 82 per cent since its acquisition in 2001 and is the fastest growingcompany in the industry. This has resulted primarily from successful implementation of a multi channel distribution and product innovationstrategy that has differentiated Prudential from the market. New business APE in 2006 of £218 million was driven principally by the tiedfinancial consultant channel (49 per cent) and the GA (broker) channel (38 percent). Bancassurance volumes are limited by regulatory constraints whichprescribe a maximum 25 per cent of banks' sales volume from any one lifeinsurer. This has negatively impacted bank distribution in Korea as Prudentialreached this limit early on in the year with all its major bank partners. Directdistribution accounted for 5 per cent in 2006 and this reflects the morecompetitive environment at present. In 2007 Prudential will continue building onits advantaged distribution model, including new bank partnerships with KoreaBank and Shinhan Bank. Prudential Korea has benefited significantly from its innovative stance in theretirement space; and has been hugely successful with its 'What's your Number'campaign. Whilst lower than some other markets, new business profit margins in Korearemain attractive at 35 per cent and are driven by the high proportion of unitlinked products at 84 per cent of APE. As a result of its rapid growth, investment in building scale and thecomparatively small size of the acquired in-force book, the business currentlymakes a loss under the IFRS basis and receives capital injections from theGroup. Malaysia Prudential Malaysia had a challenging year in 2006 in part due to regulatorydriven changes on illustrations which unsettled the industry. Against thisbackdrop Prudential Malaysia was able to grow by 6 per cent. Distribution inMalaysia is predominately tied agency as the current bank distributionregulations limit insurers to one bank partner. In 2007 the focus in Malaysiawill be to continue expanding the agency force and further broaden the productrange with a universal life product. For sometime Prudential has seen the potential for takaful products in Malaysiaand in 2006 formed a takaful joint venture with BSN, Prudential BSN Takaful.This launched in November and has started selling Shariah compliant linked lifeproducts through Prudential Malaysia's tied agency force. Malaysia generates significant IFRS profits and makes material contributions ofsurplus capital to the Group. Philippines Although it is a top 5 player in the Philippines, Prudential's operation issmall; during 2007 a major revamp of the agency channel and product portfoliowill begin. Singapore Prudential is a leading player in Singapore and, over the five year period 2001to 2005, consistently outgrew the market. During 2006 Prudential Singapore delivered strong APE growth of 23 per centdriven by its strategy of growing and rejuvenating the agency force against theindustry trend and implementing a number of agency productivity initiatives,including the operationalisation of a sophisticated sales force automation toolto simplify the application process. Third-party distribution through Maybankand Singpost is also beginning to make meaningful contributions to new business. Prudential Singapore continues to sell a higher proportion of unit linkedbusiness than the market supported by the strategy of enhancing the fund range. Given the size, longevity and quality of its in-force book, Singapore is a majorcontributor to Prudential Corporation Asia's IRFS profits and generates materialsurplus operating cash which is remitted back to the Group. Looking ahead, growth opportunities in Singapore remain promising, particularlyin the retirement space (both accumulation and drawn down). Taiwan Taiwan now has the highest life insurance penetration rate in the world measuredby premiums as a percentage of GDP. To a large extent, however, this has beendriven by competitors launching low margin tactical products which capitalise onthe current low interest rate environment. Prudential has deliberately avoidedthis tactic and its strategic priority continues to be to position the businessfor the long-term with quality, multi-channel distribution and profitableproducts. 2006 new business volumes decreased slightly compared to 2005 with agent numbersreducing by 7 per cent reflecting the focus on quality as non-performers wereterminated There are also good opportunities for bancassurance in Taiwan andPrudential has 5 agreements in place with the intention to expand these further. Prudential continues to sell a higher proportion of unit-linked business thanthe market and for 2006 this was 58 per cent compared to 39 per cent. NBPmargins at 55 per cent, are up from 51 per cent in 2005, at RER, primarily dueto product mix changes. The Taiwan business continues to receive capital support from the Group tomaintain solvency resulting from current negative spread on the back bookacquired in 1999. During 2006 interest rates did not increase from their current low levels asexpected, although the long term assumption remains that these will rise. Looking ahead priorities for the Taiwan life business include driving greaterrider attachments and direct marketing with A&H products. Thailand For many years, Prudential has struggled to make headway with agencydistribution in Thailand; however, during 2006 it launched a call centre insupport of its direct marketing operation. Although still small, the results todate have been very encouraging contributing to new business APE growing 81 percent in 2006. Vietnam In Vietnam, Prudential has retained its market leading position but the marketcontinues to be depressed following the initial post liberalisation boom. Thelonger term potential remains excellent and Prudential continues to develop andbuild its agency distribution. 4. Financial results and performance In financial terms, 2006 was another strong year. Prudential Corporation Asia'snew business APE grew by 30 per cent to £956 million. New business profitmargins remain robust at 54 per cent with the net 2 per cent change from 56 percent in 2005 at RER, principally attributed to higher proportion of new businessin the mix from lower margin geographies. The percentage of unit linkedproducts, which are more capital efficient, remained high at 64 per centcompared to 63 per cent in 2005. Long-term EEV operating profits of £829 million are up 42 per cent over 2005 andare principally driven by new business profits of £514 million and an 89 percent increase in in-force profits, from £167 million in 2005 to £315 million in2006. This includes the increase in unwind across all countries, positiveoperating assumption changes of £45 million together with positive experienceand other variances of £16 million. Operating assumption changes include positive mortality and persistencyassumption changes which are the net result of a number of small movements incountries across the region. In addition there are positive expense assumptionchanges, primarily the result of uplifting the Prudential Asset Management (PAM)profit assumptions across Asia. Within experience variances, there is a positive persistency experience variancewhich is the net result of a number of small variances in countries across theregion. There is negative expense experience in China and India, as expected,as these operations expand rapidly. Total EEV shareholders' funds at 31 December 2006 were £2.5 billion, up 28 percent on 31 December 2005. IFRS operating profits increased 11 per cent to £189 million, compared to 2005,excluding 2005 net exceptional items of positive £30 million. This reflects thesteady increase in profits from the established markets of Singapore, Malaysiaand Hong Kong with total IFRS operating profits of £139 million, and theemergence of profits on the IFRS basis from some of the newer operations as theybuild scale. Total shareholders' funds on the IFRS basis, of £1.29 billion,increased by 12 per cent compared to 2005. IRRs for Asia were in excess of 20 per cent for 2006. In Asia Prudential hastarget IRRs on new business at a country level of 10 percentage points over thecountry risk discount rate. Risk discount rates vary from 5 per cent to 18 percent depending upon the risks in each country market. These target rates ofreturn are average rates and the marginal return on capital on a particularproduct could be above or below the target. As expected, overall Prudential Asia became a net contributor of cash to theGroup with a net remittance of surplus capital of £28 million during 2006. 5. Outlook for 2007 The opportunities for profitable growth in Asia remain compelling and Prudentialis very well placed with an excellent platform. The focus going forward will be continuing to focus on developing its existingstrengths in terms of growing agency scale and productivity, improving andexpanding partnership distribution and continuing product innovation. There is also the opportunity to deepen and strengthen relationships with theover 9 million customers already on the books with a disciplined and systematicapproach. The retirement opportunity is clear and Prudential is developing acomprehensive approach to this in terms of accumulation, drawn down andassociated protection needs. Prudential Asia will be leveraging its verysuccessful Korean media campaign 'What's your number' to other markets during2007. Prudential has not leveraged its strengths to building scale direct distributionas yet and this will be a priority in the future. Prudential will also be re-examining its approach to health products as thereare significant opportunities to create value for shareholders and customerabove and beyond what is already being done. Prudential remains committed to the target of at least doubling its 2005 newbusiness profit by 2009, and expect to generate increasing levels of cash fromthe region. In summary, the outlook for the life insurance business in 2007 remains verypositive. Asset Management Global The Prudential Group's asset management businesses are very successful. Not onlydo they provide value to the insurance businesses within the Group, but also areimportant profit generators in their own right, with low capital requirementsand generating significant cash flow for the Group. The asset management businesses are well placed to capitalise on their leadingmarket positions and strong track records in investment performance to delivernet flows and profit growth as well as strategically diversifying the Group'sinvestment propositions in retail financial services (RFS) markets that areincreasingly favouring greater product transparency, greater cross-borderopportunities and more open-architecture investment platforms. Wholesale profitstreams are also growing. The Group's asset management businesses operate different models and underdifferent brands tailored to their markets and strengths, but are increasinglyworking together by managing money for each other with clear regionalspecialism, distributing each others' products and sharing knowledge andexpertise, such as credit research. Each business and its performance in 2006 is summarised below. M&G CER RER 2006 2005 Change 2005 Change £m £m % £m % Gross investment flows 13,486 7,916 70% 7,916 70%Net investment flows 6,101 3,862 58% 3,862 58%Underlying profit before PRF performance related fees 177 138 28% 138 28% Total IFRS operating profit* 204 163 25% 163 25% *Based on longer-term investment returns. 1. Market review and summary of strategy M&G is Prudential's UK and European fund management business and has £164billion of funds under management, of which £119 billion relates to Prudential'slong-term business funds. M&G aims to maximise profitable growth by operatingin markets where it has a leading position and competitive advantage, includingretail fund management, institutional fixed income, pooled life and pensionfunds, property and private finance. M&G also manages Prudential's balancesheet for profit. M&G is an investment-led business with a demonstrable focus on performancedelivery and aims to offer attractive products in a variety of macro-economicenvironments. M&G has scale in all key asset classes: it is one of the largestactive managers in the UK stock market, one of the largest bond investors in theUK and one of the UK's largest property investors. M&G is made up of three distinct and autonomous businesses - Retail, Wholesaleand Prudential Finance - each with its own strategy for the markets in which itoperates. The UK and European retail asset management industry has grown strongly during2006 as rising stock markets have increased the value of existing funds undermanagement and attracted investors back into the market. M&G's retail strategyis to maximise the leverage of its strong investment performance, multi-channeldistribution and efficient operating platform. The asset management sector has continued to benefit from the increasing shiftby retail investors from opaque to transparent investment products, such as unittrusts, and M&G's range of market leading funds has positioned it well tobenefit from this trend. European cross-border distribution has accelerated andthe trend in favour of 'Open Architecture' in both the UK and Europe hascontinued to open up significant bank and life company distributionopportunities. Parallel to this, distribution of mutual funds has becomeincreasingly intermediated and has been accompanied by the rise of professionalbuyers who demand higher levels of service and investment information, areas inwhich M&G has considerable expertise. Institutional markets are demanding increasingly sophisticated and tailoredproducts and 2006 saw a rising awareness of asset/liability matching and acontinued shift from balanced to specialist mandates. These trends, plus theincreased role of fixed income within portfolios, continue to play to thestrength and scale of M&G's wholesale business. M&G's wholesale strategy is twofold: to add value to its internal clientsthrough investment performance, liability matching and investment in innovativeand attractive areas of capital markets and to utilise the skills developedprimarily for internal funds to build new business streams and diversifyrevenues. Examples of new business streams include leveraged loans,collateralised debt obligations (CDOs), infrastructure finance and the Episodeglobal macro hedge fund. Demand has increased for alternative investments andstructured credit expertise, meaning that managers who offer value-addingskills, such as M&G, are able to command attractive margins. With its strongtrack record and market leading reputation, M&G remains well placed to continueto benefit from this trend. Prudential Finance was set up to manage Prudential's balance sheet for profit.In addition to acting as the internal banker to the Prudential Group and itssubsidiaries, Prudential Finance's strategy is to leverage Prudential's and M&G's positioning and skills for profit. Its activities include bridgingtransactions, property financing and securities lending with a focus on dealswhich have high profitability and capital velocity but low capital usage. 2. Current year initiatives M&G maintained its reputation for strong fund performance and product innovationduring 2006 and continued to expand its multi-channel distribution model. In the retail market, the excellent fund performance of M&G's fund range wasrecognised by M&G being named Best Equity Group (Large) and Best Non UK EquityGroup (Large) at the Lipper Fund Awards 2006. M&G continued to innovate duringthe year by extending its fixed income and property fund ranges with the launchof two new funds, the M&G Optimal Income Fund and the M&G European PropertyFund. M&G expanded its retail distribution in 2006 by adding Spain to theEuropean countries in which it operates and in the UK significantly expanded itslinks with life company platforms. In the wholesale marketplace, M&G benefited from increasing demand from clientsfor specialist mandates and liability matching, both of which are core areas ofexpertise for M&G. Strong fund performance was maintained with 86 per cent ofsegregated funds beating their benchmark over one year and 90 per cent overthree years. M&G continued to develop its market leading positions in structuredcredit and leveraged loans and also its position in infrastructure finance.Utilising skills developed for the internal funds, M&G has built significant newbusiness streams with external third parties over the past five years. Instructured credit, seven new CDOs were launched in 2006 and M&G was named CDOmanager of the year by the International Securitisation Report. M&G'sinfrastructure fund, InfraCapital, made its first purchase as part of aconsortium which made a successful bid for Associated British Ports plc. Following a soft launch in August 2005, M&G rolled out its Episode global macrohedge fund in February last year, a fund which again uses investment expertiseoriginally developed for internal funds. Episode has been a notable success withexternal clients and by year-end had reached assets under management of US$1.5billion. 3. Financial results and performance M&G delivered significant profit growth during 2006 on the back of rising marketlevels, strong net inflows and continued business diversification. Operatingprofits, which include performance related fees (PRF), increased 25 per cent to£204 million. Underlying profits, excluding PRF, were £177 million, an increaseof 28 per cent compared to the previous year. PRF increased by 11 per cent over2005, totalling £27 million for 2006. As a result, M&G's cost income ratioimproved from 66 per cent to 64 per cent in 2006. In addition to adding significant value via the management of Prudential'sinternal funds, M&G remains an important generator of earnings and cash for thePrudential Group. Since 2002, M&G has delivered strong profit growth which hasseen underlying profits more than triple. Outstanding fund performance led to record fund inflows into M&G's retail andwholesale businesses during 2006. Gross fund inflows were £13.5 billion, anincrease of 70 per cent on the previous year. Net fund inflows were theirhighest ever, increasing by 58 per cent to £6.1 billion. External funds undermanagement grew significantly, up 24 per cent to £45 billion, and at this levelrepresent over a quarter of M&G's total funds under management. In the retail marketplace, demand remained strong for M&G's high alpha equityand competitive fixed income and property offerings, with gross fund inflowsincreasing by 75 per cent to £6.7 billion and net fund inflows more thandoubling to £3.1 billion. Product innovation has remained key for opening upnew markets for M&G and 66 per cent of gross mutual fund inflows in 2006 throughUK and European distribution channels were into funds launched or re-engineeredwithin the past six years. Sales were strong across all retail markets. Excellent progress was made in theUK and across the European markets of Germany, Austria, Switzerland, Luxembourg,Italy and Spain. In Germany, the first European market entered (in 2002), M&G isnow the number three foreign provider and in just four years has risen to numbernine in net sales against all providers in the German marketplace. In anofficial FERI ranking of the best selling funds by UK fund managers across theUK and Europe in 2006, M&G had three funds represented in the top 20. In SouthAfrica, M&G's business was last year ranked number one by net inflows in themarket only five years on from launch. M&G's wholesale business also saw substantial growth, with gross fund inflowsincreasing by 66 per cent to £6.8 billion and net inflows rising 19 per cent to£3 billion. M&G's scale and market reputation in fixed income continued toposition it very favourably in both traditional areas of the market, such assegregated funds, and alternative areas such as structured credit. 4. Outlook and forthcoming objectives M&G's priorities for the year ahead are to: • deliver investment outperformance to its clients; • distribute through existing channels and exploit new opportunities; • leverage its scale and capabilities to develop innovative products for the retail and wholesale marketplaces; • deliver attractive returns to Prudential. Asia CER RER 2006 2005 Change 2005 Change £m £m % £m % Net investment flows 2,532 1,321 92% 1,327 91%Total IFRS operating profit* 50 11 355% 12 317%*Based on longer-term investment returns. 1. Market review The mutual fund market in Asia(2) has grown at a CAGR of 22 per cent from end2003 to end 2006 with £720 billion of assets under management at 31 December2006 with Japan and Korea accounting for over three quarters of the total FUM.China and India have been the fastest growing markets over this period withannual growth rates of 57 per cent and 31 per cent respectively. Over the past few years, appetite for risk based products has gradually beenincreasing and during 2006, Asian investors have shown increased interest inequity-focused funds. Regulatory change has also continued to drive demand forLuxembourg based offshore products. 2. Prudential's strategy Prudential's fund management business serves both the life companies in Asia bymanaging the life funds and by designing and managing the funds underlying theinvestment linked products and third-party customers through a growing mutualfund business. Given that the majority of individuals' personal financial assets currentlyreside in bank deposits in Asia (Source: Citi Asia Pacific Household BalanceSheets 2005), Prudential continues to grow its third-party mutual fund businessby developing strong customer propositions to cater to an estimated potential450 million customers for mutual fund products in Asia. Prudential's strategyis underpinned by building local operating entities with local market knowledgeand expertise and supporting these with strong regional capabilities. Given the significance of bank distribution, broadening distribution reachinvolves developing strong relationships with regional and local bankdistributors and providing better servicing. Continued delivery of strong and consistent fund performance is essential inmaintaining the credibility of the Prudential brand in this market. Today, Prudential's fund management business in Asia is the 2nd largest retailfund management company in terms of Asia (ex Japan) sourced retail FUM as ofJune 2006 (Source: Asia Asset Management Sept 2006 for survey participants)(3).Including institutional and insurance assets, Prudential's fund managementbusiness was ranked in June 2006 as the third largest asset manager in terms ofoverall assets sourced in Asia ex Japan, compared with its 5th ranking in 2005. --------------------------(2) Asia here refers to the eight countries of China, India, Korea, Japan,Taiwan, Singapore, Malaysia(Private Funds) and Hong Kong(Local retail funds)Sources: Cerulli Associates, Monetary Authority of Singapore, Association ofMututal Fund in India, Securities Inv Trust Association, KITCA (3) Source: Asia Asset Management Sep 2006. 3. Progress in 2006 In 2006, Prudential entered three new markets: China, Vietnam and the UAE. InChina, Prudential's joint venture with CITIC launched two retail mutual fundsduring the year and raised £414 million (Prudential share at £137 million). InVietnam, Prudential launched its first mutual fund and an offshore fundinvesting in Vietnam, together raising £ 163 million. A licence was obtained fordoing business in the UAE, with an office in Dubai. Prudential continued to build on its existing platform in Asia with specificfocus on the markets of India, Korea and Japan. In India, Prudential's jointventure with ICICI Bank grew assets under management by 53 per cent;in Korea, Prudential's business grew assets by 33 per cent and in Japan - theregion's largest market - assets grew by 20 per cent. PRUPIM Singapore - a joint venture with PruPIM in the UK - was established withits first core fund with a gross asset value of US$616 million. This gives thebusiness an entry into the real estate space which is a fast growing andattractive segment of the business. 4. Financial results and performance Prudential's fund management business achieved record net inflows for 2006, with£2.5 billion being almost twice that of 2005. This reflects the strengths of theAsian Fund Management's geographic and product diversification. Prudential's total FUM as at 31 December were £29.2 billion and included £6.2billion of assets from the Group, £10.6 billion from Prudential CorporationAsia's life funds and £12.3 billion from the retail operations. This is anincrease of 22 per cent from 31 December 2005, though mutual funds through theretail operations grew by 33%. IFRS profits from fund management operations were £50 million, up 85 per cent on2005, excluding 2005 exceptional items. 5. Outlook for 2007 The main focus for 2007 will be to continue to pursue profitable opportunitiesin all markets but more specifically in the key growth markets of China andIndia and the large Japanese and Korean markets. The fund range will continue tobe expanded through expanding both onshore and offshore funds and developingreal estate and Islamic funds. Distribution will be broadened and deepenedthrough relationships with channel partners in the individual countries andregionally. PPM America 1. Market review and summary of strategy PPMA manages assets for Prudential's US, UK and Asian affiliates. PPMA alsoprovides investment services to other affiliated and unaffiliated institutionalclients including CDOs, private investment funds, institutional accounts, andmutual funds. PPMA's strategy is focused on effectively managing existing assets, maximizingsynergies with international asset management affiliates and leveraginginvestment management capabilities across the Prudential Group. A summary of PPMA's year-end 2006 assets under management follows: PPMA funds under management (US$ billions) US UK Asia Total Insurance 45.5 16.3 0.5 62.3Retail 0.0 2.5 5.0 7.5Institutional 0.2 0.0 0.0 0.2CDOs 3.6 0.0 0.0 3.6Total 49.3 18.8 5.5 73.6 2. Current year initiatives During 2006, PPMA executed several initiatives to improve operationaleffectiveness and scalability, including the enhancement of fixed incomeanalytical capabilities. Initiatives designed to maximise synergies within theGroup included leveraging PPMA's capabilities to manufacture financial productsdistributed by affiliates. 3. Financial results and performance Investment performance was favourable in 2006, particularly across US affiliateportfolios, the US public equity and fixed income components of the portfoliosmanaged for UK affiliates and CDOs. IFRS operating profit in 2006 was £12 million versus £20 million in 2005. The2005 results benefited from a £5 million positive non-recurring item related torevaluation of a CDO. 4. Outlook and forthcoming objectives The 2007 outlook is positive driven by current momentum, favourable economic andmarket conditions, and the growth prospects of internal clients. Banking Egg 1. Market review and summary of strategy The high level of consumer indebtedness has led to a sharp increase in thenumber of individuals seeking to restructure their credit obligations. This hasbeen observed through higher levels of personal bankruptcies and individualvoluntary arrangements: the number of personal insolvencies has risen at anannual rate of over 50 per cent. These factors have given rise to increased baddebt provisions across the UK banking industry. In January 2007, Prudential concluded that its current banking business does notrepresent the best opportunity for it to drive profitable growth in the futureand it announced the sale of Egg to Citi for £575 million, with the transactionexpected to complete later in 2007, subject to regulatory approvals. Citi is thelargest credit card issuer in the world and a group that is well placed todevelop and grow Egg's franchise. As part of the transaction, Prudential hasagreed in principle outline terms of a five-year agreement to distribute lifeand pension products through Egg. Prudential has also been selected as astrategic provider to Citi for the distribution of life insurance products toCiti's consumer banking customers in Thailand, Indonesia and the Philippines.The transaction will improve Prudential's capital position and is expected toincrease Prudential's solvency surplus under FCD by an estimated £300 million. 2. Financial results and performance Egg's total operating loss in 2006 was £145 million, compared with a profit of£44 million in 2005. This result reflects a marked deterioration inindustry-wide consumer behaviour. This has resulted in a reduction of netborrowing on credit cards as consumers reduce their spending and borrowing. Inaddition, bad debt experience is considerably worse than expected, particularlyin relation to personal loans. During 2006, Egg made a number of changes to its lending approach. On unsecuredloans, Egg's strategy was to tactically reduce its exposure and it tightened theacceptance criteria throughout the year. This resulted in a significantlyreduced level of sales, and associated insurance income. Egg also changed itsapproach to the management of the credit card book, and it adopted the standardindustry policy of charging variable interest rates in relation to a customer'sexpected risk profile. Throughout the industry, 2006 saw an increase in the application of balancetransfer fees therefore reducing the levels of balance transfer activity. Egg's net interest income of £330 million increased 6 per cent in 2006.Slightly lower customer balances were offset by the effects of a higher interestrate environment. Non-interest income reduced by 36 per cent to £138 million following asignificant reduction in personal loan insurance income as Egg reduced itsexposure to the unsecured loans business. Total new loan sales reduced to83,000, which is approximately 50 per cent of the new volumes achieved in 2005.In addition, payment protection insurance (PPI) penetration rates were far lowerthan that experienced in 2005. Other non-interest card income is lower than2005, reflecting consumer spend patterns and continuing regulatory focus on thecreditor insurance market, resulting in reductions in commission revenue earned. Egg's loan book performance reflects the industry wide increase in consumersusing individual voluntary arrangements, debt management companies and in somecases bankruptcy to alleviate their debt burden. Within the Egg personal loanportfolio, the number of customers employing debt management companies in thelast quarter increased 18 per cent on the prior quarter. These arrangementstypically result in lower recoveries from customers than have historically beenachieved via Egg's collection strategies. The overall deterioration in creditled to the total charge for bad debts increasing by £143 million to £382million. Restructuring costs of £12 million were incurred during 2006. OTHER CORPORATE INFORMATION Balance sheet Explanation of balance sheet structure The Group's capital on an IFRS basis comprises of shareholders' funds of £5,488million, subordinated long-term and perpetual debt of £1,989 million, other corestructural borrowings of £1,074 million and the unallocated surplus ofwith-profits funds of £13.6 billion. Subordinated or hybrid debt is debt capital which has some equity-like featuresand which would rank below other senior debt in the event of a liquidation.These features allow hybrid debt to be treated as capital for FSA regulatorypurposes. All of the Group's hybrid debt which qualifies in this way is held atthe Group level and is therefore taken as capital into the parent solvency testunder the FCD. The FSA has established a structure for determining how much hybrid debt cancount as capital which is similar to that used for banks. It categorises capitalas Tier 1 (equity and preference shares), Upper Tier 2 debt and Lower Tier 2debt. Up to 15 per cent of Tier 1 can be in the form of hybrid debt and called 'Innovative Tier 1'. At 31 December 2006, the Group held £763 million ofInnovative Tier 1 capital, in the form of perpetual securities, £201 million ofUpper Tier 2 and £1,152 million of Lower Tier 2 capital. Following theimplementation of the FCD, it is advantageous to the Group from a regulatorycapital standpoint to raise its long-term debt in hybrid form and it is theGroup's policy to take advantage of favourable market conditions as they ariseto do so. The unallocated surplus of the with-profits funds represents assets in the lifefund which have not yet been allocated either to policyholders or shareholders.They are not generally available to the Group other than as they emerge throughthe statutory transfer of the shareholders' share of the surplus as it emergesfrom the Fund over time. Weighted Average Cost of Capital (WACC) Prudential's commitment to its shareholders is to maximise the value ofPrudential over time by delivering superior financial returns. Prudential's weighted average cost of capital (WACC) is circa 9.6 per cent,which is based on the net core debt and shares outstanding at the end of 2006,an equity market premium of four per cent and a market beta of 1.4. Prudential'sWACC has increased since the end of 2005 largely due to an increase in interestrates and to equity forming a greater proportion of capital. Shareholders' borrowings and financial flexibility Net core structural borrowings at 31 December 2006 were £1,493 million comparedwith £1,611 million at 31 December 2005. This reflects the net cash outflow of£104 million, exchange conversion gains of £240 million and other adjustments of£18 million. After adjusting for holding company cash and short-term investments of £1,119million, core structural borrowings of shareholder-financed operations(excluding Egg) at the end of 2006 totalled £2,612 million, compared with £2,739million at the end of 2005. This decrease reflected exchange conversion gains of£135 million and other adjustments of £8 million. Core long-term loans at the end of 2006 included £1,626 million at fixed ratesof interest with maturity dates ranging from 2007 to perpetuity. £890 million ofthe core borrowings were denominated in US dollars, to hedge partially thecurrency exposure arising from the Group's investment in Jackson. Prudential has in place an unlimited global commercial paper programme. At 31December 2006, commercial paper of £198 million, US$3,449 million and €85million has been issued under this programme. Prudential also has in place a£5,000 million medium-term note (MTN) programme. At 31 December 2006,subordinated debt outstanding under this programme was £435 million and €520million, and senior debt outstanding was US$18 million and £5 million. Inaddition, the holding company has access to £1,600 million committed revolvingcredit facilities, provided by 16 major international banks and a £500 millioncommitted securities lending liquidity facility. These facilities have not beendrawn on during the year. The commercial paper programme, the MTN programme, thecommitted revolving credit facilities and the committed securities lendingliquidity facility are available for general corporate purposes and to supportthe liquidity needs of the parent company. The Group's insurance and asset management operations are funded centrally. Egg,as a separate bank, is responsible for its own financing. The Group's core debtis managed to be within a target level consistent with its current debt ratings.At 31 December 2006, the gearing ratio (debt, net of cash and short-terminvestments, as a proportion of EEV shareholders' funds plus debt) was 11.2 percent compared with 13.5 per cent at 31 December 2005. Prudential plc enjoys strong debt ratings from both Standard & Poor's andMoody's. Prudential long-term senior debt is rated A+ (stable outlook), A2(stable outlook) and AA- from Standard & Poor's, Moody's and Fitchrespectively, while short-term ratings are A1, P-1 and F1+. Based on EEV basis operating profit from continuing operations and interestpayable on core structural borrowings (excluding Egg), interest cover was 12.2times in 2006 compared with 10.8 times in 2005. Treasury policy The Group operates a central treasury function, which has overall responsibilityfor managing its capital funding programme as well as its central cash andliquidity positions. The aim of Prudential's capital funding programme, which includes the £5,000million MTN programme together with the unlimited commercial paper programme, isto maintain a strong and flexible funding capacity. In the UK and Asia, Prudential uses derivatives to reduce equity risk, interestrate and currency exposures, and to facilitate efficient investment management.In the US, Jackson uses derivatives to reduce interest rate risk, to facilitateefficient portfolio management and to match liabilities under fixed indexpolicies. It is Prudential's policy that all free-standing derivatives are used to hedgeexposures or facilitate efficient portfolio management. Amounts at risk are covered by cash or by corresponding assets. Due to the geographical diversity of Prudential's businesses, it is subject tothe risk of exchange rate fluctuations. Prudential's international operations inthe US and Asia, which represent a significant proportion of operating profitand shareholders' funds, generally write policies and invest in assetsdenominated in local currency. Although this practice limits the effect ofexchange rate fluctuations on local operating results, it can lead tosignificant fluctuations in Prudential's consolidated financial statements uponconversion of results into pounds sterling. The currency exposure relating tothe conversion of reported earnings is not separately managed, as it is not inthe economic interests of the Group to do so. The impact of gains or losses oncurrency conversions is recorded as a component of shareholders' funds withinthe statement of recognised income and expense. The impact of exchange ratefluctuations in 2006 is discussed elsewhere in this OFR. Unallocated surplus of with-profits During 2006, the unallocated surplus, which represents the excess of assets overpolicyholder liabilities for the Group's with-profits funds on a statutorybasis, grew from £11.3 billion at 1 January to £13.6 billion at 31 December.This reflects an increase in the cumulative retained earnings arising onwith-profits business that have yet to be allocated to policyholders orshareholders. The change in 2006 predominantly reflects the positive investmentreturn earned by the PAC with-profits fund as a result of investment gains inthe UK equity market. Regulatory capital requirements The Financial Conglomerates Directive, which affects groups with significantcross-sector activities in insurance and banking/investment services, came intoforce for Prudential from 1 January 2005. Prior to this, since 1 January 2001Prudential was required to meet the solvency requirements of the InsuranceGroups Directive ('IGD'), as implemented by the FSA. The FSA has implemented theFCD by applying the sectoral rules of the largest sector, hence a group such asPrudential is classified as an insurance conglomerate and is required to focuson the capital adequacy requirements of the IGD, the Consolidated Life Directiveand the Insurance Company Accounts Directive. The FCD requires a continuous parent company solvency test which requires theaggregating of surplus capital held in the regulated subsidiaries, from whichGroup borrowings are deducted, other than those subordinated debt issues whichqualify as capital. No credit for the benefit of diversification is allowed forunder this approach. The test is passed when this aggregate number is positive,and a negative result at any point in time is a notifiable breach of UKregulatory requirements. Due to the geographically diverse nature of Prudential's operations, theapplication of these requirements to Prudential is complex. In particular, formany of our Asian operations, the assets, liabilities and capital requirementshave to be recalculated based on FSA regulations as if the companies weredirectly subject to FSA regulation. The FCD position will be submitted to the FSA by 30 April 2007 but is currentlyestimated to be around £1.0 billion. A further gain of £0.3 billion is expectedto arise in 2007 from the sale of Egg Banking. The sale of Egg Banking impliesthat Prudential may again be designated an 'insurance group' rather than itscurrent treatment as a financial conglomerate, and thus will be required to meetthe requirements of the IGD. This should not have a significant impact on theGroup, as the FSA's prudential requirements pertaining to insurance groups arevery similar to those applying to insurance conglomerates, in particular becausethe FSA has decided to make the continuous parent solvency test mandatory from31 December 2006 for all insurance groups. The European Commission is continuing to develop a new prudential framework forinsurance companies, 'the Solvency II project' that will update the existinglife, non-life and insurance groups directives. The main aim of this frameworkis to ensure the financial stability of the insurance industry and protectpolicyholders through establishing solvency requirements better matched to thetrue risks of the business. Like Basel 2, the new approach is expected to bebased on the concept of three pillars - minimum capital requirements,supervisory review of firms' assessments of risk and enhanced disclosurerequirements. However, the scope is wider than Basel 2 and will covervaluations, the treatment of insurance groups, the definition of capital and theoverall level of capital requirements. A key aspect of Solvency II is the focus on risks and, for example, capitalrequirements will be calibrated to a one year Value at Risk with a 99.5%confidence level. Companies will be encouraged to improve their risk managementprocesses and will be allowed to make use of internal economic capital models toenable a better understanding of risks. The emphasis on transparency andcomparability would ensure a level playing field but not delivering this remainsone of the key risks for the project. Prudential is actively engaged in policy discussions mainly through itsparticipation in the Chief Risk Officer (CRO) Forum of major European insurancefirms. Prudential has been emphasising the importance of level playing fields,in particular in connection with the treatment of operations outside the EU. The Commission intends to adopt proposals for a framework directive in mid 2007which will contain high-level principles. These principles will be supplementedby implementing measures that will be adopted by the Commission and EU memberstates. Solvency II is then intended to be implemented around 2010. It isimportant that the EU policy makers keep up the progress to enableimplementation by the suggested date. During 2006, the Committee of European Insurance and Occupational PensionsSupervisors (CEIOPS) invited EU insurance industry to participate in the secondquantitative impact study, which provided useful input for supervisors andindustry alike. The EU insurance industry will be participating in anotherquantitative impact study during the first half of 2007 with a view to providequantitative input into the calibration of the capital requirements.Participation in these exercises involves a substantive commitment and isexpected to yield benefits by providing evidence leading to a truly risk-basedcapital requirement. Financial strength of insurance operations United Kingdom The PAC's long-term fund remains very strong. On a realistic valuation basis,with liabilities recorded on a market consistent basis, the free assets arevalued at approximately £8.7 billion at 31 December 2006, before a deduction forthe risk capital margin. The fund is rated AA+ by Standard & Poor's, Aa1 byMoody's and AA+ by Fitch Ratings. The with-profits sub-fund delivered a pre-tax return of 12.4 per cent in 2006,and over the last five years the fund has achieved a total return of 63.8 percent against 41.1 per cent for the FTSE 100 total return and 50.2 per cent forthe FTSE All-Share (Total Return) index (figures are to 31 December 2006, beforetax and charges). Much of this excellent investment performance was achievedthrough the active asset allocation of the fund. As part of its asset allocationprocess, Prudential UK constantly evaluates prospects for different markets andasset classes. During the year Prudential UK decreased its exposure to equitieswhile increasing its exposure to corporate bonds and alternative assets,reflecting Prudential UK's view that increased diversification in the assets ofthe with-profits sub-fund was appropriate. The table below shows the change in the investment mix of Prudential UK's mainwith-profits fund: 2006 2005 2004 % % % UK equities 36 40 33International equities 17 19 15Property 15 15 18Bonds 25 21 29Cash and other assets classes 7 5 5 Total 100 100 100 United States The capital adequacy position of Jackson remains strong, having improved thecapital ratio from 9.2 per cent in 2005 to 9.8 per cent in 2006. Jackson'sstatutory capital, surplus and asset valuation reserve position improvedyear-on-year by US$193 million, after deducting the US$200 million of capitalremitted to the parent company. Jackson's financial strength is rated AA byStandard & Poor's and A1 by Moody's. Jackson's invested asset mix on a US regulatory basis (excludes policy loans andreverse repo leverage) is as follows: 2006 2005 2004 % % % Bonds:Investment Grade Public 60 58 60Investment Grade Private 18 19 19Non-Investment Grade Public 4 5 4Non-Investment Grade Private 1 2 2Commercial mortgages 12 11 11Private equities and real estate 3 3 3Equities, cash and other assets 2 2 1 Total 100 100 100 Asia Prudential Corporation Asia maintains solvency margins in each of its operationsso that these are at or above the local regulatory requirements. Across theregion less than 40 per cent of non-linked funds are invested in equities. BothSingapore and Malaysia have discrete life funds, and have strong free assetratios. The Hong Kong life operation is a branch of Prudential Assurance CompanyLimited and its solvency is covered by that business. Taiwan has Risk BasedCapital regulatory solvency margins and Prudential ensures sufficient capital isretained in the business to cover these requirements. Redress of mortgage endowment products PAC's main long-term business with-profits fund paid compensation of £'11million in 2006 in respect of mortgage endowment product mis-selling claims andheld a provision of £60 million at 31 December 2006 to cover further claims.These compensation payments and provisions have had no impact on policyholders'asset shares. As a result, policyholders' bonuses and the shareholders' share ofthese bonuses are unaffected, resulting in no impact on the Group's profitbefore tax. A provision of £5 million was held at 31 December 2006 by shareholders' funds tocover potential compensation in respect of mis-selling claims for ScottishAmicable mortgage endowment products sold since the acquisition of ScottishAmicable in 1997. In addition, a provision of £45 million was held at 31December 2006 for the closed Scottish Amicable Insurance Fund (SAIF) in respectof mortgage endowment products sold prior to acquisition. This provision has noimpact on shareholders. No further Scottish Amicable mortgage endowment productswere sold after April 2001. In May 2006, the Group introduced a deadline for both Prudential and ScottishAmicable mortgage endowment complaints. Impacted customers have three years tolodge a mis-selling complaint in line with the time limit prescribed by the FSAand the ABI. Inherited estate of Prudential Assurance The assets of the main with-profits fund within the long-term insurance fund ofPAC comprise the amounts that it expects to pay out to meet its obligations toexisting policyholders and an additional amount used as working capital. Theamount payable over time to policyholders from the with-profits fund is equal tothe policyholders' accumulated asset shares plus any additional payments thatmay be required by way of smoothing or to meet guarantees. The balance of theassets of the with-profits fund is called the 'inherited estate' and hasaccumulated over many years from various sources. The inherited estate represents the major part of the working capital of PAC'slong-term insurance fund. This enables PAC to support with-profits business byproviding the benefits associated with smoothing and guarantees, by providinginvestment flexibility for the fund's assets, by meeting the regulatory capitalrequirements that demonstrate solvency and by absorbing the costs of significantevents or fundamental changes in its long-term business without affecting thebonus and investment policies. The size of the inherited estate fluctuates fromyear to year depending on the investment return and the extent to which it hasbeen required to meet smoothing costs, guarantees and other events. PAC believes that it would be beneficial if there were greater clarity as to thestatus of the Inherited Estate. As a result PAC has announced that it has beguna process to determine whether it can achieve that clarity through areattribution of the inherited estate. As part of this process a PolicyholderAdvocate has been nominated to represent policyholders' interests. Thisnomination does not mean that a reattribution will occur. Given the size of the Group's with-profits business any proposal is likely to betime consuming and complex to implement and is likely to involve a payment topolicyholders from shareholders funds. If a reattribution is completed theinherited estate will continue to provide working capital for the long-terminsurance fund. Defined benefit pension schemes The Group operates four defined benefit schemes, three in the UK, of which theprincipal scheme is the Prudential Staff Pension Scheme (PSPS), and a smallscheme in Taiwan. The level of surplus or deficit of assets over liabilities fordefined benefit schemes is currently measured in three ways: the actuarialvaluation, FRS 17 (for subsidiary accounting in the UK), and IAS 19 for theGroup financial statements. FRS 17 and IAS 19 are very similar. As at 31December 2006 the shareholders' share of the £65 million surplus for PSPS andthe deficits of the other schemes amounted to an £8 million deficit net ofrelated tax relief. Defined benefit schemes in the UK are generally required to be subject to fullactuarial valuation every three years to assess the appropriate level of fundingfor schemes having regard to their commitments. These valuations includeassessments of the likely rate of return on the assets held within the separatetrustee administered funds. PSPS was last actuarially valued as at 5 April 2005and this valuation demonstrated the Scheme to be 94 per cent funded, with ashortfall of actuarially determined assets to liabilities of 6 per cent,representing a deficit of £243 million. The finalisation of the valuation as at 5 April 2005 was accompanied by changesto the basis of funding for the scheme. For 2006 and future years deficitfunding amounts designed to eliminate the actuarial deficit over a 10-yearperiod have been and are being made. Total contributions to the Scheme fordeficit funding and employer's contributions for ongoing service for currentemployees are expected to be of the order of £70-75 million per annum over a10-year period. However in 2006 total contributions, including amounts inarrears for the scheme year to 5 April 2006, were £137 million. Under IAS 19 the basis of valuation differs markedly from the full triennialvaluation basis. In particular, it requires assets of the Scheme to be valued attheir market value at the year-end, while pension liabilities are required to bediscounted at a rate consistent with the current rate of return on a highquality corporate bond. As a result, the difference between IAS 19 basis assetsand liabilities can be volatile. For those schemes such as PSPS, which hold asubstantial proportion of their assets in equity investments, the volatility canbe particularly significant. For 2006, a £28 million pre-tax shareholder chargeto operating results based on longer-term returns arises. In addition, outsidethe operating result, but included in total profits is a pre-tax shareholdercredit of £167 for net actuarial gains. These gains primarily represent thedifference between actual and expected investment returns for the schemes andthe reduction in liabilities caused by an increase in the discount rate causedby increases in corporate bond returns. In 2006 the PSPS asset allocation was altered away from equity investments suchthat at 31 December 2006 the market value of equities for the Group's definedbenefit schemes represented 31 per cent (2005: 52 per cent) of the total assetvalue, whilst the bond portfolio accounted for 43 per cent (2005: 34 per cent). Surpluses and deficits on the Group's defined benefit schemes are apportioned tothe PAC life fund and shareholders' funds based on estimates of employees'service between them. At 31 December 2005, the deficit on the PSPS Scheme wasapportioned in the ratio 70/30 between the life fund and shareholder-backedoperations. This ratio was determined following extensive analysis of the sourceof the cumulative funding for the scheme to that date. This basis has beenapplied for 2006 to the assets and liability movements relating to the startposition and also to the deficit funding paid in the year. However, the IAS 19service cost for the year and employer contributions for ongoing service ofcurrent employees have been apportioned in the ratio relevant to currentactivity. At 31 December 2006, the total share of the surplus on PSPS and thedeficit on the much smaller Scottish Amicable scheme attributable to the PAClife fund amounted to a net surplus of £66 million net of related tax relief. MORE TO FOLLOW This information is provided by RNS The company news service from the London Stock Exchange

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