20th Jun 2006 09:00
Prudential PLC20 June 2006 Embargo: 09.00 Tuesday 20 June 2006 COMPARATIVE EUROPEAN EMBEDDED VALUE BASIS RESULTS FOR THE SIX MONTHSENDED 30 JUNE 2005 Prudential plc publishes today its European Embedded Value (EEV) basis resultsfor the six months to 30 June 2005. Prudential has previously published EEV basis full year results for 2004 and2005. Today's announcement completes the disclosure of the comparative EEV basisresults to be included with the interim 2006 results to be published on 28 July2006. A summary of the EEV basis results are shown below: As previously published Half year Full year Full year 2005 2005 2004 £m £m £mNew business profits 416 867 741New business margin- As a percentage of annual premium equivalent of 37% 41% 40%insurance sales- As a percentage of present value of new business 4.5% 5.2% 5.0%premiumsLong-term business operating profit before tax 815 1,743 1,328Total operating profit before tax 799 1,712 1,274Total shareholders' funds 9,114 10,301 8,614 - ENDS - Enquiries Media Investors / analystsJon Bunn 020 7548 3559 James Matthews 020 7548 3561William Baldwin-Charles 020 7548 3719 Valerie Pariente 020 7548 3511Joanne Doyle 020 7548 3708 Notes to Editors: European Embedded Value basis of reporting. The EEV basis results have been prepared in accordance with the EEV principlesissued in May 2004 by the CFO Forum. The CFO Forum is a high-level discussion group formed and attended by the ChiefFinancial Officers of major European listed, and some non-listed, insurancecompanies. Its aim is to discuss issues relating to proposed new accountingregulations for their businesses and how they can create greater transparencyfor investors. The Forum was created in 2002. For more information go towww.cfoforum.nl. Annual Premium Equivalents Annual Premium Equivalents are calculated as the aggregate of regular newbusiness amounts and one-tenth of single new business amounts for insuranceproducts. *Prudential plc, a company incorporated and with its principal place of businessin the United Kingdom, and its affiliated companies constitute one of theworld's leading financial services groups. It provides insurance and financialservices directly and through its subsidiaries and affiliates throughout theworld. It has been in existence for over 150 years and has £234 billion inassets under management, (as at 31 December 2005). Prudential plc is notaffiliated in any manner with Prudential Financial, Inc, a company whoseprincipal place of business 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. European Embedded Value (EEV) basis supplementary information Interim Results 2005 Operating profit from continuing operations based on longer-term investmentreturns* Results analysis by business area Half Year Full Year Full Year 2005 2005 2004 Note £m £m £mUK operationsNew business 5 159 243 241Business in force 6 (15) 183 245Long-term business 144 426 486M&G 83 163 136Egg 13 44 61Total 240 633 683US operationsNew business 5 95 211 145Business in force 6 324 530 237Long-term business 419 741 382Broker-dealer and fund management 18 24 15Curian (6) (10) (29)Total 431 755 368Asian operationsNew business 5 162 413 355Business in force 6 90 163 105Long-term business 252 576 460Fund management 2 12 19Development expenses (8) (20) (15)Total 246 568 464Other income and expenditureInvestment return and other income 7 20 42 0Interest payable on core structural borrowings (84) (175) (154)Corporate expenditure:Group Head Office (36) (70) (51)Asia Regional Head Office (14) (30) (29)Charge for share-based payments for Prudential schemes (4) (11) (7)Total (118) (244) (241)Operating profit from continuing operations based on longer-term 799 1,712 1,274investment returnsAnalysed as profits (losses) from:New business 5 416 867 741Business in force 6 399 876 587Long-term business 815 1,743 1,328Asia development expenses (8) (20) (15)Other operating results (8) (11) (39)Total 799 1,712 1,274 *EEV basis operating profit from continuing operations based on longer-terminvestment returns excludes goodwill impairment charges, short-term fluctuationsin investment returns, the shareholders' share of actuarial and other gains andlosses on defined benefit pension schemes, the effect of changes in economicassumptions and changes in the time value of cost of options and guaranteescaused by economic factors. The amounts for these items are included in totalEEV profit. The directors believe that operating profit, as adjusted for theseitems, better reflects underlying performance. Profit on ordinary activities andbasic earnings per share include these items together with actual investmentreturns. This basis of presentation has been adopted consistently throughoutthis supplementary information. Summarised consolidated income statement - EEV basis Interim Results 2005 Half Year Full Year Full Year 2005 2005 2004 Note £m £m £mOperating profit from continuing operations based on longer-term investment returnsUK insurance operations 144 426 486M&G 83 163 136Egg 13 44 61UK operations 240 633 683US operations 431 755 368Asian operations 246 568 464Other income and expenditure (118) (244) (241)Operating profit from continuing operations based on longer-term 799 1,712 1,274investment returnsGoodwill impairment charge (95) (120) -Short-term fluctuations in investment returns 8 278 1,001 570Shareholders' share of actuarial and other gains and losses 9 (8) (47) (12)on defined benefit pension schemesEffect of changes in economic assumptions and time value of 10 (143) (302) (48)cost of options and guaranteesProfit from continuing operations before tax (including actual 831 2,244 1,784investment returns)Tax 11 (337) (653) (553)Profit from continuing operations for the period after tax before 494 1,591 1,231minority interestsDiscontinued operations (net of tax) 1 3 (94)Profit for the period 495 1,594 1,137Attributable to:Equity holders of the Company 490 1,582 1,138Minority interests 5 12 (1)Profit for the period 495 1,594 1,137 Earnings per share - EEV basis Interim Results 2005 Note Half Year Full Year Full Year 2005 2005 2004Continuing operationsFrom operating profit, based on longer-term investment 12 24.4p 56.6p 43.2preturns, after relatedtax and minority interests of £576m (£1,339m, £916 million)Based on profit from continuing operations after minority 12 20.7p 66.8p 56.8pinterests of £489m (£1,579m, £1,205m)Discontinued operationsBased on profit (loss) from discontinued operations after 0.0p 0.1p (3.1)pminority interests of£1m (£3m, £(67)m)Total - based on total profit for the period after minority 20.7p 66.9p 53.7pinterests of £490m (£1,582m, £1,138m)Average number of shares (millions) 2,361 2,365 2,121 Dividends per share Interim Results 2005 Half Year Full Year Full Year 2005 2005 2004Dividends relating to the reporting period:Interim dividend 5.30p 5.30p 5.19pFinal dividend - 11.02p 10.65pTotal 5.30p 16.32p 15.84pDividends declared and paid in the reporting period:Current year interim dividend - 5.30p 5.19pFinal dividend for prior year 10.65p 10.65p 10.29pTotal 10.65p 15.95p 15.48p Movement in shareholders' capital and reserves (excluding minority interests) -EEV basis Interim Results 2005 Half Year Full Year Full Year 2005 2005 2004 Note £m £m £mProfit for the period attributable to equity holders of the 490 1,582 1,138CompanyItems taken directly to equity:Cumulative effect of IAS 32, IAS 39 and IFRS 4, net of applicable (25) (25) -taxes, at 1 January 2005Unrealised valuation movement on securities classified as 4 (1) -available-for-sale at 1 January 2005Movement on cash flow hedges (7) (4) -Exchange movements 219 377 (239)Related tax 30 65 (1)Proceeds from Rights Issue, net of expenses - - 1,021Other new share capital subscribed 40 55 119Dividends (253) (380) (323)Reserve movements in respect of share-based payments 6 15 10Treasury shares:Movement in own shares in respect of share-based payment 1 0 (2)plansMovement on Prudential plc shares purchased by unit trusts (5) 3 14consolidated under IFRSNet increase in shareholders' capital and reserves 14 500 1,687 1,737Shareholders' capital and reserves, at beginning of period 8,614 8,614 6,877(excluding minority interests)Shareholders' capital and reserves at end of period 13, 9,114 10,301 8,614(excluding minority interests) 14Comprising:UK operations:Long-term business 4,598 5,132 4,228M&G:Net assets 272 245 297Acquired goodwill 1,153 1,153 1,153Egg 266 303 273 6,289 6,833 5,951US operations 3,092 3,418 2,570Asian operations:Net assets 1,692 2,070 1,631Acquired goodwill 197 172 292Other operations:Holding company net borrowings (1,443) (1,724) (1,299)Other net liabilities (713) (468) (531) 13, 9,114 10,301 8,614 14Net asset value per shareBased on EEV basis shareholders' capital and reserves of £9,114m 382p 432p 363p(£10,301m, £8,614m)Number of shares at end of reporting period (millions) 2,384 2,387 2,375 Summarised consolidated balance sheet - EEV basis 30 June 2005 Half Year Full Year Full Year 2005 2005 2004 Note £m £m £mTotal assets less liabilities, excluding insurance funds 160,379 174,258 148,682Less insurance funds:*Policyholder liabilities (net of reinsurers' share) and (155,400) (169,064) (144,193)unallocated surplus of with-profits fundsLess shareholders' accrued interest in the long-term 4,135 5,107 4,125business (151,265) (163,957) (140,068)Total net assets 14 9,114 10,301 8,614Share capital 119 119 119Share premium 1,561 1,564 1,558Statutory basis shareholders' reserves (following adoption 3,299 3,511 2,812of IFRS)Additional EEV basis retained profit 4,135 5,107 4,125Shareholders' capital and reserves (excluding minority 14 9,114 10,301 8,614interests)*Including liabilities in respect of insurance productsclassified as investment contracts under IFRS 4. Notes on the EEV basis supplementary information 1. Purpose and basis of preparation The preliminary EEV interim financial information for the six month period ended30 June 2005 has been prepared to provide the comparative financial informationexpected to be included in the Group's EEV interim report for the six monthperiod ending 30 June 2006. The EEV basis results have been prepared in accordance with the EEV principlesissued by the CFO Forum of European Insurance Companies in May 2004. Whereappropriate the EEV basis results include the effects of adoption ofInternational Financial Reporting Standards (IFRS). The EEV results for the Group include the results for the covered business onthe EEV basis. These results are then combined with the IFRS basis results ofthe Group's other operations. With two exceptions, covered business comprises the Group's long-term businessoperations. The definition of long-term business operations is consistent withprevious practice and comprises those contracts falling under the definition oflong-term insurance business for regulatory purposes together with, for USoperations, contracts that are in substance the same as guaranteed investmentcontracts (GICs) but do not fall within the technical definition. Under the EEVprinciples, the results for covered business incorporate the projected marginsof attaching internal fund management. The exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and inrespect of the Group's defined benefit pension schemes. SAIF is closed to newbusiness and the assets and liabilities of the fund are wholly attributable tothe policyholders of the fund. As regards the Group's defined benefit pensionschemes, the deficits attaching to the Prudential Staff Pension Scheme (PSPS)and Scottish Amicable scheme are excluded. These deficits are partiallyattributable to the Prudential Assurance Company (PAC) with-profits fund andshareholder-backed long-term business. Further details are explained in note 2f. The directors are responsible for the preparation of the supplementaryinformation in accordance with the EEV Principles. Previously, the Group has reported supplementary information on the achievedprofits basis for its interim and full year financial reporting. The adoption ofthe EEV basis reporting in place of achieved profits basis reporting reflectsdevelopments through the CFO Forum to achieve a better level of consistency andan improved embedded value methodology, and is applied by the major Europeaninsurance companies in their financial reporting. 2. Methodology a) Embedded value Overview The embedded value is the present value of the shareholders' interest in theearnings distributable from assets allocated to covered business aftersufficient allowance has been made for the aggregate risks in that business. Theshareholders' interest in the Group's long-term business comprises: • Present value of future shareholder cash flows from in-force covered business(value of in-force business), less a deduction for the cost of locked-in(encumbered) capital; • locked-in (encumbered) capital; and • shareholders' net worth in excess of encumbered capital. The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results (as explained in notes 4and 6) no smoothing of market or account balance values, unrealised gains orinvestment return is applied in determining the embedded value or the profitbefore tax. Value of in-force business The embedded value results are prepared incorporating best estimate assumptionsabout all relevant factors including levels of future investment return,expenses, surrender levels and mortality. These assumptions are used to projectfuture cash flows. The present value of the future cash flows is then calculatedusing a discount rate which reflects both the time value of money and the risksassociated with the cash flows that are not otherwise allowed for. The total profit that emerges over the lifetime of an individual contract ascalculated using the embedded value basis is the same as that calculated underthe IFRS basis and, prior to IFRS adoption, the MSB under UK Generally AcceptedAccounting Principles (GAAP). However, since the embedded value basis reflectsdiscounted future cash flows under this methodology the profit emergence isadvanced, thus more closely aligning the timing of the recognition of profitswith the efforts and risks of current management actions, particularly withregard to business sold during the reporting period. Cost of capital A charge is deducted from the embedded value for the cost of capital supportingthe Group's long-term business. This capital is referred to as encumberedcapital. The cost is the difference between the nominal value of the capital andthe discounted present value of the projected releases of this capital allowingfor investment earnings (net of tax) on the capital. The result for the period is impacted by the movement in this cost from periodto period which comprises a charge against new business profit and a release inrespect of the reduction in capital requirements for business in force as thisruns off. Where the capital is held within a with-profits long-term fund, the value placedon surplus assets in the fund is already discounted to reflect its release overtime and no further adjustment is necessary in respect of solvency capital.However, where business is funded directly by shareholders, the capital requiresadjustment to reflect the cost of that capital to shareholders. Financial options and guarantees Nature of options and guarantees in Prudential's long-term business UK insurance operations The only significant financial options and guarantees in the UK insuranceoperations arise in the with-profits sub-fund and SAIF. With-profits productsprovide returns to policyholders through bonuses that are smoothed. There aretwo types of bonuses: annual and final. Annual bonuses are declared once a year,and once credited, are guaranteed in accordance with the terms of the particularproduct. Unlike annual bonuses, final bonuses are guaranteed only until the nextbonus declaration. Beyond the generic features described above, and the provisions held in respectof guaranteed annuities, there are very few explicit options or guarantees ofthe with-profits sub-fund such as minimum investment returns, surrender values,or annuity at retirement and any granted have generally been at very low levels. Jackson National Life The principal options and guarantees valued under EEV for Jackson National Life(JNL) are associated with the fixed annuity and variable annuity lines ofbusiness. Fixed annuities provide that at JNL's discretion it may reset the interest ratecredited to policyholders' accounts, subject to a guaranteed minimum. Theguaranteed minimum return varies from 1.5 per cent to 5.5 per cent (full year2005 and 2004: 1.5 per cent to 5.5 per cent), depending on the particularproduct, jurisdiction where issued, and date of issue. At 30 June and 31December 2005, 73 per cent (2004: 73 per cent) of the fund relates to policieswith guarantees of 3 per cent or less. The average guarantee rate for the halfand full year 2005 is 3.3 per cent (2004: 3.3 per cent). Fixed annuities also present a risk that policyholders will exercise theiroption to surrender their contracts in periods of rapidly rising interest rates,possibly requiring JNL to liquidate assets at an inopportune time. Variable annuity contracts may contain guarantees of certain minimum payments inthe event of death, withdrawal or annuitisation. These guarantees may be relatedto (a) the amount of total deposits made to the contract adjusted for anypartial withdrawals, (b) the total deposits made to the contract adjusted forany partial withdrawals, plus a minimum annual return, or (c) the highestcontract value on a specified anniversary date adjusted for any withdrawalsfollowing the contract anniversary. These guarantees generally protect the policyholder's value in the event of poorequity market performance. JNL also issues fixed index annuities that enable policyholders to obtain aportion of an equity-linked return while providing a guaranteed minimum return.The guaranteed minimum returns would be of a similar nature as those describedabove for fixed annuities. In the case of the potential equity participation,JNL hedges this risk by purchasing futures and options on the relevant index. Asian operations Subject to local market circumstances and regulatory requirements, the guaranteefeatures described above in respect of UK business broadly apply to similartypes of participating contracts written in the PAC Hong Kong branch, Singaporeand Malaysia. Participating products have both guaranteed and non-guaranteedelements. Non-participating long-term products are the only ones where the insurer iscontractually obliged to provide guarantees on all benefits. The mostsignificant book of non-participating business in the Group's Asian operationsis Taiwan's whole of life contracts. For these contracts there are floor levelsof policyholder benefits that accrue at rates set at inception which are set byreference to minimum returns established by local regulation at the time ofinception. These rates do not vary subsequently with market conditions. Underthese contracts the cost of premiums are also fixed at inception based on anumber of assumptions at that time, including long-term interest rates,mortality assumptions and expenses. The guaranteed maturity and surrender valuesreflect the pricing basis. Time value The value of financial options and guarantees comprises two parts. One is givenby a deterministic valuation on best estimate assumptions (the intrinsic value).The other part arises from the variability of economic outcomes in the future(the time value). Where appropriate, a full stochastic valuation has been undertaken to determinethe value of the in-force business including the cost of capital. Adeterministic valuation of the in-force business is also derived usingconsistent assumptions and the time value of the financial options andguarantees is derived as the difference between the two. The economic assumptions used for the stochastic calculations are consistentwith those used for the deterministic calculations. Assumptions specific to thestochastic calculations such as equity volatility and credit losses reflectlocal market conditions and are based on a combination of actual market data,historic market data and an assessment of long-term economic conditions. Commonprinciples have been adopted across the Group for the stochastic asset models,for example, separate modelling of individual asset classes but with allowancefor correlation between the various asset classes. Details of the keycharacteristics of each model are given in note 3. b) Level of encumbered capital In adopting the EEV principles, Prudential has based encumbered capital on itsinternal targets for economic capital subject to it being at least the localstatutory minimum requirements. Economic capital is assessed using internalmodels, but when applying EEV Prudential does not take credit for thesignificant diversification benefits that exist within the Group. Forwith-profits business written in a segregated life fund, as is the case in theUK and Asia, the capital available in the fund is sufficient to meet theencumbered capital requirements. • UK: economic capital requirements for annuity business are fully met by PillarI requirements being 4 per cent of mathematical reserves (as used for achievedprofits reporting), which are also sufficient to meet Pillar II requirements; • US: level of capital that has previously been locked in for achieved profitsreporting, namely 235 per cent of the risk-based capital required by theNational Association of Insurance Commissioners at the Company Action Level(CAL), is sufficient to meet the economic capital requirement; • Asia: economic capital target is substantially higher than local statutoryrequirements in total. Economic capital requirements vary by territory, but inaggregate, the encumbered capital is equivalent to the amount required under theFinancial Conglomerates Directive (FCD). The table below summarises the levels of encumbered capital as a percentage ofthe relevant statutory requirement: Capital as a percentage of relevant statutory requirementUK business (excluding annuities) 100% of EU minimumUK annuity business 100% of EU minimumJackson National Life 235% of CALAsian operations 100% of FCD c) Risk discount rates Overview Under the CFO Forum Principles, discount rates used to determine the presentvalue of future cash flows are set equal to risk-free rates plus a risk margin.The risk margin should reflect any risk associated with the emergence ofdistributable earnings that is not allowed for elsewhere in the valuation.Prudential has selected a granular approach to better reflect changes in riskinherent in each product group. The risk discount rate so derived does notreflect a market beta but instead reflects the risk of volatility associatedwith the cash flows in the embedded value model. Since financial options and guarantees are explicitly valued under the EEVmethodology, discount rates under EEV are set excluding the effect of theseproduct features. For Prudential's UK annuity business, which is well matched, the predominantrisks are credit risk and longevity risk. For this line of business the achievedprofits methodology for embedded values has been carried over and the riskdiscount rate has been derived by comparison to a market consistent valuation. Allowance for risk The risk allowance in the risk discount rate is determined as follows: Market risk Under Capital Asset Pricing Methodology (CAPM) the discount rate is determinedas: Discount rate = risk-free rate + (beta x equity risk premium) Under CAPM, the beta of a portfolio or product measures its relative marketrisk. The risk discount rates reflect the market risk inherent in each product groupand hence the volatility of product cash flows. They are determined byconsidering how the profits from each product are impacted by changes inexpected returns on various asset classes, and by converting this into arelative rate of return it is possible to derive a product specific beta. CAPM does not include any allowance for non-market risks since these are assumedto be fully diversifiable. For EEV purposes, however, a risk margin is added fornon-diversifiable non-market risks and to cover Group level risks. Product-level betas are calculated at least annually. They are combined with themost recent product mix to produce appropriate betas and risk discount rates foreach major product grouping. Diversifiable non-market risks No allowance is required for non-market risks where these are assumed to befully diversifiable. The majority of non-market risks are considered to bediversifiable. Non-diversifiable, non-market risks Finance theory cannot be used to determine the appropriate component of beta fornon-diversifiable non-market risks since there is no observable risk premiumassociated with it that is akin to the equity risk premium. Recognising this, apragmatic approach has been used. A constant margin of 50 basis points has been added to the risk margin derivedfor market risk to cover the non-diversifiable non-market risks associated withthe business. d) Management actions In deriving the time value of financial options and guarantees, managementactions in response to emerging investment and fund solvency conditions havebeen modelled. Management actions encompass, but are not confined to, thefollowing areas: • Investment allocation decisions; • levels of reversionary bonuses and credited rates; and • total claim values. Bonus rates are projected from current levels and varied in accordance withassumed management actions applying in the emerging investment and fund solvencyconditions. In all instances the modelled actions are in accordance with approved localpractice and therefore reflect the options actually available to management. Forthe PAC with-profits sub-fund, the actions assumed are consistent with those setout in the Principles and Practices of Financial Management. e) With-profits business and the treatment of the estate For the PAC with-profits sub-fund, the shareholders' interest in the estate isderived by increasing terminal bonus rates so as to exhaust the estate over thelifetime of the in-force with-profits business. In those few extreme scenarioswhere the total assets of the life fund are insufficient to meet policyholderclaims in full, the excess cost is fully attributed to shareholders. f) Pension costs The Group operates three defined benefit schemes in the UK. The principal schemeis the Prudential Staff Pension Scheme (PSPS). The other two much smallerschemes are the Scottish Amicable and M&G schemes. There is also a small schemein Taiwan. Under IFRS the deficits attaching to these schemes are accounted for inaccordance with the provisions of IAS 19. The deficits represent the differencebetween the market value of the schemes' assets and the discounted value ofprojected future benefit payments to retired members and deferred pensionersand, to the extent of service to date, current employed members. For PSPS the deficit is allocated between the PAC with-profits sub-fund andshareholder-backed operations by reference to the activities of the members ofthe scheme during their period of service. For the 2004 year end and half year2005 the deficit was allocated in the ratio 80/20. For the 2005 year end,following further detailed consideration of the sourcing of previouscontributions by Group companies and funds, this ratio has been altered to 70/30for the allocation of the deficit between the with-profits sub-fund andshareholder-backed operations. Additional details on the effect of the movementon the deficits of the Group's defined benefit pension schemes is set out innote 9. Under the EEV basis the IAS 19 basis deficit is initially allocated in the samemanner. The shareholders' 10 per cent interest in the PAC with-profits sub-fundestate is determined after deduction of the portion of the IAS 19 basis deficitsattributable to the fund. Adjustments under EEV in respect of accounting fordeficits on deferred benefit schemes are reflected as part of other operations,as shown in note 13. Separately, the projected cash flows of in-force covered business includecontributions to the defined benefit schemes for future service based on thecontribution basis to the schemes applying at the time of preparation ofresults. g) Debt capital Core structural debt liabilities are carried at market value. 3. Assumptions a) Best estimate assumptions Best estimate assumptions are used for the projections, where best estimate isdefined as the mean of the distribution of all possible outcomes. Theassumptions are reviewed actively and changes are made when evidence exists thatchanges in future experience are reasonably certain. Assumptions required in the calculation of the value of options and guarantees,for example relating to volatilities and correlations, or dynamic algorithmslinking liabilities to assets, have been set equal to the best estimates and,wherever material and practical, reflect any dynamic relationships between theassumption and the stochastic variables. b) Principal economic assumptions Deterministic In most countries, the long-term expected rates of return on investments andrisk discount rates are set by reference to period end rates of return on fixedinterest securities. This 'active' basis of assumption setting has been appliedin preparing the results of all the Group's UK and US long-term businessoperations. For the Group's Asian operations, the active basis is appropriatefor business written in Japan, Korea and US dollar denominated business writtenin Hong Kong. An exception to this general rule is that for countries where long-term fixedinterest markets are underdeveloped, investment return assumptions and riskdiscount rates are based on an assessment of longer-term economic conditions.Except for the countries listed above, this basis is appropriate for the Group'sAsian operations. Expected returns on equity and property asset classes are derived by adding arisk premium, also based on the long-term view of Prudential's economists inrespect of each territory, to the risk-free rate. In the UK the equity riskpremium is 3.0 per cent (full year 2005: 4.0 per cent, 2004: 3.0 per cent) aboverisk-free rates. The equity risk premium in the US is 3.0 per cent (full year2005: 4.0 per cent, 2004: 3.0 per cent). In Asia, equity risk premiums rangefrom 2.75 per cent to 5.25 per cent (full year 2005: 3.0 per cent to 5.75 percent, 2004: 2.8 per cent to 5.3 per cent). Assumptions for other asset classes,such as corporate bond spreads, are set consistently as best estimateassumptions. The investment return assumptions as derived above are applied to the actualassets held at the valuation date to derive the overall fund-earned rate. The table below summarises the principal financial assumptions: 30 Jun 31 Dec 31 Dec 2004 2005 2005 % % %UK insurance operationsRisk discount rate:New business 7.4 7.55 7.1In force 6.9 7.7 7.1Pre-tax expected long-term nominal rates of investment return:UK equities 7.2 8.1 7.6Overseas equities 7.0 to 7.9 8.1 to 7.3 to 8.3 8.75Property 6.5 6.4 6.3Gilts 4.2 4.1 4.6Corporate bonds 5.1 4.9 5.5Expected long-term rate of inflation 2.8 2.9 2.9Post-tax expected long-term nominal rate of return:Pension business (where no tax applies) 6.6 7.1 6.8Life business 5.8 6.3 5.9US operations (Jackson National Life)Risk discount rate:New business 5.8 6.9 6.1In force 5.3 6.1 5.8Expected long-term spread between earned rate and rate creditedto policyholders for single premium deferred annuity business 1.75 1.75 1.75US 10-year treasury bond rate at end of period 4.0 4.4 4.3Pre-tax expected long-term nominal rate of return for US equities 7.0 8.4 7.3Expected long-term rate of inflation 2.2 2.4 2.6 Asian operations Hong Taiwan Kong China (note India Indonesia Japan Korea Malaysia Philippines Singapore (note Thailand Vietnam iii) ii) 30 30 Jun 30 30 Jun 30 30 30 Jun 30 Jun 30 Jun 30 Jun 30 Jun 30 Jun Jun Jun Jun Jun 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 % % % % % % % % % % % %Riskdiscountrate:New 10.0 4.7 16.0 18.75 4.9 7.5 9.15 16.25 6.4 9.7 13.5 15.5businessIn force 10.0 5.1 16.0 18.75 4.9 7.5 8.7 16.25 6.65 9.5 13.5 15.5Expectedlong-termrate of 3.0 2.25 5.25 7.75 0.0 2.75 3.0 5.25 2.25 2.25 3.75 4.5inflationGovernment 7.25 4.9 10.25 13.0 1.7 4.4 7.0 10.5 5.0 5.5 7.75 9.75bond yield Hong Taiwan Kong China (note India Indonesia Japan Korea Malaysia Philippines Singapore (note Thailand Vietnam iii) ii) 31 31 Dec 31 31 Dec 31 31 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec Dec Dec Dec Dec 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 2005 % % % % % % % % % % % %Riskdiscountrate:New 12.0 5.9 16.5 17.5 5.0 10.3 9.4 16.5 6.7 9.0 13.75 16.5businessIn force 12.0 6.15 16.5 17.5 5.0 10.3 9.0 16.5 6.8 9.4 13.75 16.5Expectedlong-termrate of 4.0 2.25 5.5 6.5 0.0 2.75 3.0 5.5 1.75 2.25 3.75 5.5inflationGovernment 9.0 4.8 10.5 11.5 1.8 5.8 7.5 10.5 4.5 5.5 7.75 10.5bond yield Hong Taiwan Kong China (note India Indonesia Japan Korea Malaysia Philippines Singapore (note Thailand Vietnam iii) ii) 31 31 Dec 31 31 Dec 31 31 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec Dec Dec Dec Dec 2004 2004 2004 2004 2004 2004 2004 2004 2004 2004 2004 2004 % % % % % % % % % % % %Riskdiscountrate:New 10.0 4.7 16.0 18.75 5.0 7.1 9.0 16.25 6.3 7.1 13.5 15.5businessIn force 10.0 5.0 16.0 18.75 5.0 7.1 8.7 16.25 6.4 8.2 13.5 15.5Expectedlong-termrate of 3.0 2.25 5.25 7.75 0.0 2.75 3.0 5.25 2.25 2.25 3.75 4.5inflationGovernment 7.25 4.9 10.25 13.0 1.9 3.9 7.0 10.5 5.0 5.5 7.75 9.75bond yield Asia Asia Asia total total total 30 June 31 Dec 31 Dec 2005 2005 2004 % % %Weighted risk discount rate (note i)New business 9.4 9.8 8.0In force 7.2 8.4 7.9 Notes (i) The weighted discount rates for the Asian operations shown above have beendetermined by weighting each country's discount rates by reference to the EEVbasis operating result for new business and the closing value of in-forcebusiness. (ii) For traditional business in Taiwan, the economic scenarios used tocalculate the half year 2005 EEV basis results reflect the assumption of aphased progression of the bond yields from the current rates to the long-termexpected rates. In preparing the half year 2005 EEV basis results the same basishas been applied as was used and disclosed for the full year 2005 results. Thisbasis is that the projections assume that, in the average scenario, the currentbond yields of around 2 per cent trend towards 5.5 per cent at 31 December 2012.Allowance is made for the mix of assets in the fund, future investment strategyand the market value depreciation of the bonds as a result of the assumed yieldincreases. This gives rise to an average assumed Fund Earned Rate that trendsfrom 2.3 per cent to 5.4 per cent in 2013 and falls below 2.3 per cent for sevenyears due to the depreciation of bond values as yields rise. Thereafter, theFund Earned Rate fluctuates around a target of 5.9 per cent. This compares to agrading of 3.4 per cent at 31 December 2004 to 5.9 per cent by 31 December 2012for the 2004 results. Consistent with our EEV methodology, a constant discountrate has been applied to the projected cashflows. (iii) The assumptions shown are for US dollar denominated business whichcomprises the larger proportion of the in-force Hong Kong business. (iv) Assumed equity returns The most significant equity holdings in the Asian operations are in Hong Kong,Singapore and Malaysia. The mean equity return assumptions for those territoriesat 30 June 2005 were 7.3 per cent (31 December 2005: 8.6 per cent, 2004: 7.3 percent), 9.75 per cent (31 December 2005: 9.3 per cent, 2004: 9.75 per cent) and12.25 per cent (31 December 2005: 12.8 per cent, 2004: 12.25 per cent)respectively. To obtain the mean, an average over all simulations of theaccumulated return at the end of the projection period is calculated. The annualaverage return is then calculated by taking the root of the average accumulatedreturn minus 1. Stochastic The economic assumptions used for the stochastic calculations are consistentwith those used for the deterministic calculations described above. Assumptionsspecific to the stochastic calculations such as the volatilities of assetreturns reflect local market conditions and are based on a combination of actualmarket data, historic market data and an assessment of longer-term economicconditions. Common principles have been adopted across the Group for thestochastic asset models, for example, separate modelling of individual assetclasses but with allowance for correlation between the various asset classes. Details are given below of the key characteristics and calibrations of eachmodel. UK insurance operations • Interest rates are projected using a two-factor model calibrated to actualmarket data; • the risk premium on equity assets is assumed to follow a log-normaldistribution; • the corporate bond return is calculated as the return on a zero-coupon bondplus a spread. The spread process is a mean reverting stochastic process; and • property returns are modelled in a similar fashion to corporate bonds, namelyas the return on a riskless bond, plus a risk premium, plus a processrepresentative of the change in residual values and the change in value of thecall option on rents. The rates to which the model has been calibrated are set out below: Mean returns have been derived as the annualised arithmetic average returnacross all simulations and durations. Standard deviations have been calculated by taking the annualised variance ofthe returns over all the simulations, taking the square root and averaging overall durations in the projection. For bonds the standard deviations relate to theyields on bonds of the average portfolio duration. For equity and property, theyrelate to the total return on these assets. The standard deviations applied areas follows: Standard deviation Half Year 2005 %Government bond yield 2.0Corporate bond yield 5.5Equities:UK 18.0Overseas 16.0Property 15.0 Jackson National Life • Interest rates are projected using a log-normal generator calibrated to actualmarket data; • corporate bond returns are based on Treasury securities plus a spread that hasbeen calibrated to current market conditions and varies by credit quality; and • variable annuity equity and bond returns have been stochastically generatedusing a regime-switching log-normal model with parameters determined byreference to historical data. The volatility of equity fund returns ranges from18.6 per cent to 28.1 per cent, depending on risk class, and the volatility ofbond funds ranges from 1.4 per cent to 1.7 per cent. Asian operations The same asset return model, as used in the UK, appropriately calibrated, hasbeen used for the Asian operations. The principal asset classes are governmentand corporate bonds. Equity holdings are much lower than in the UK whilstproperty is not held as an investment asset. The stochastic cost of guarantees are only of significance for the Hong Kong,Singapore, Malaysia and Taiwan operations. The mean stochastic returns are consistent with the mean deterministic returnsfor each country. The volatility of equity returns ranges from 18 per cent to 25per cent, and the volatility of government bond returns ranges from 1.8 per centto 6.4 per cent. c) Demographic assumptions Persistency, mortality and morbidity assumptions are based on an analysis ofrecent experience but also reflect expected future experience. Where relevant,when calculating the time value of in-force business, policyholder withdrawalrates vary in line with the emerging investment conditions according tomanagement's expectations. d) Expense assumptions Expense levels, including those of service companies that support the Group'slong-term business operations, are based on internal expense analysisinvestigations and are appropriately allocated to acquisition of new businessand renewal of in-force business. Exceptional expenses are identified separatelyand reported separately. No productivity gains have been assumed. Asia development and Regional Head Office expenses are charged to EEV basisresults as incurred. No adjustment is made to the embedded value of coveredbusiness as the amounts of expenditure that relate to operating expenses are notmaterial. Similarly corporate expenditure for Group Head Office, to the extentnot allocated to the PAC with-profits fund, is charged to the EEV basis resultas incurred. e) Inter-company arrangements There are no inter-company arrangements such as reinsurance or loans associatedwith covered business for which adjustment has been required in preparing theEEV basis results. f) Taxation and other legislation Current taxation and other legislation has been assumed to continue unalteredexcept where changes have been announced and the relevant legislation passed. g) Fund management and service companies The value of future profits or losses from fund management and service companiesthat support the Group's covered businesses are included in the profits for newbusiness and the in-force value of the Group's long-term business. 4. Accounting presentation a) Analysis of profit before tax To the extent applicable, presentation of the EEV profit for the period isconsistent with the basis the Group applies for analysis of IFRS basis profitsbefore shareholder taxes between operating and non-operating results. Operatingresults reflect the underlying results of the Group's continuing operationsincluding longer-term investment returns. Operating results include the impactof routine changes of estimates and non-economic assumptions. Non-operatingresults include certain recurrent and exceptional items that primarily do notreflect the performance in the period of the Group's continuing operations. b) Investment return Profit before tax With the exception of debt securities held by JNL, investment gains and lossesduring the period (to the extent that changes in capital values do not directlymatch changes in liabilities) are included directly in the profit for the periodand shareholders' funds as they arise. In the case of JNL, market value movements on debt securities are initiallyrecorded as movements in shareholder reserves, reflecting the available-for-salecategorisation under IFRS. Similarly the value movements on derivatives arerecorded in the income statement. However, it is assumed that fixed incomeinvestments will normally be held until maturity. Therefore, unrealised gainsand losses on these securities are not reflected in either the EEV or statutorybasis results and, except on realisation or impairment of investments, onlyincome received and the amortisation of the difference between cost and maturityvalues are recognised to the extent attributable to shareholders. This isconsistent with the basis of valuation of future cash flows of in-forcebusiness, which inter alia, reflects spread basis earnings which are notdirectly affected by short-term value movements in fixed income securities.Similar principles apply to value movements on JNL's derivatives that are fairvalued for IFRS reporting with value movements booked in the IFRS incomestatement. Investment returns reflect those earned on a market basis over the periodwithout smoothing, but after appropriate adjustments for movements in theadditional shareholders' interest recognised on the EEV basis. Operating profit Investment returns, including investment gains, in respect of long-terminsurance business are recognised in operating results at the expected long-termrate of return. For the purposes of calculating longer-term investment return tobe included in operating results of UK operations, where equity holdings are asignificant proportion of investment portfolios, values of assets at thebeginning of the reporting period are adjusted to remove the effects ofshort-term market volatility. For the purposes of determining the long-term returns for debt securities ofshareholder-backed operations, a risk margin charge is included which reflectsthe expected long-term rate of default based on the credit quality of theportfolio. Interest-related realised gains and losses are amortised to theoperating results over the maturity period of the sold bonds. For equity-relatedinvestments of JNL, a long-term rate of return is assumed, which reflects theaggregation of risk-free rates and equity risk premium. c) Pension costs Profit before tax Movements on the shareholders' share of deficits of the Group's defined benefitpension schemes adjusted for contributions paid in the period are recordedwithin the income statement. Consistent with the basis of distribution ofbonuses and the treatment of the estate described in notes 2d) and 2e), theshareholders' share incorporates 10 per cent of the proportion of the deficitsattributable to the PAC with-profits sub-fund. The deficits are determined byapplying the requirements of IAS 19. Actuarial gains and losses Actuarial gains and losses comprise: • The difference between actual and expected return on the scheme assets; • experience gains and losses on scheme liabilities; and • the impact of altered economic and other assumptions on the discount value ofscheme liabilities. These items are recorded in the income statement but, consistent with the IFRSbasis of presentation, are excluded from operating results. For the full year 2005 results, as previously disclosed, additionalnon-recurrent gains and losses in respect of the Group's defined benefit pensionschemes have been recorded. These are explained in note 9. d) Effect of changes in economic assumptions and time value of cost of optionsand guarantees Movements in the value of in-force business caused by changes to economicassumptions and the time value of cost of options and guarantees, (which isprimarily due to economic experience over the period and changes in economicassumptions) are recorded in non-operating results. e) Results for fund management operations The results of the Group's fund management operations include the profits frommanagement of internal and external funds. For EEV basis reporting, Groupshareholders' other income is adjusted to deduct the expected margin for theperiod on management of covered business. The deduction is on a basis consistentwith that used for projecting the results for covered business. Group operatingprofit accordingly includes the variance between actual and expected profit inrespect of covered business. f) Capital held centrally for Asian operations In adopting the EEV principles Prudential has decided to set encumbered capitalat its internal targets for economic capital. In Asia, the economic capitaltarget is substantially higher than the local statutory requirements in total.Accordingly, capital is held centrally for Asian operations. For the purposes ofthe presentation of the Group's operating results, it is assumed that thecentrally held capital is lent interest free to the Asian operations. In turnthe results of the Asian operations include the return on that capital and Groupshareholders' other income for EEV basis reporting is consequently reduced. g) Taxation The EEV profit for the period for covered business is calculated initially atthe post-tax level. The post-tax profit is then grossed up for presentationpurposes at the effective rate of tax. In general, the effective ratecorresponds to the corporation tax rate on shareholder profits of the businessconcerned. Under achieved profits, except for JNL, this basis also applied. ForJNL, under achieved profits pre-tax results were determined by applying the riskdiscount rate to pre-tax cash flows adjusted for the impact of capital charges. h) Foreign currency translation Foreign currency profit and losses have been translated at average exchangerates for the period. Foreign currency assets and liabilities have beentranslated at period end rates of exchange. The purpose of translating theprofit and losses at average exchange rates, notwithstanding the fact that EEVprofit represents the incremental value added on a discounted cash flow basis,is to maintain consistency with the methodology applied for IFRS basisreporting. The principal exchange rates applied are: Local Closing Average for Closing Average Closing Average for Openingcurrency: £ Rate at 30 Half Year rate at 31 for Full rate at rate at Jun 2005 2005 Dec 2005 Year 2005 Full year 1 Jan 2004 31 Dec 2004 2004Hong Kong 13.93 14.6 13.31 14.15 14.92 14.27 13.90Japan 198.62 198.56 202.63 200.13 196.73 198.08 191.85Malaysia 6.81 7.12 6.49 6.89 7.30 6.96 6.80Singapore 3.02 3.08 2.85 3.03 3.13 3.10 3.04Taiwan 56.67 58.88 56.38 58.47 60.84 61.10 60.78US 1.79 1.87 1.72 1.82 1.92 1.83 1.79 5. Operating profit and margins from new business a) Profit Half Full Full Year Year Year 2005 2005 2004 Pre-tax Tax Post-tax Pre-tax Tax Post-tax Pre-tax Tax Post-tax £m £m £m £m £m £m £m £m £mUK insurance 159 (48) 111 243 (73) 170 241 (72) 169operationsJackson National 95 (33) 62 211 (74) 137 145 (51) 94Life (note i)Asian operations 162 (52) 110 413 (124) 289 355 (105) 250Total 416 (133) 283 867 (271) 596 741 (228) 513(i) Jackson National Lifenet of tax profitBefore capital 68 150 106chargeCapital charge (6) (13) (12)After capital 62 137 94charge In determining the EEV basis value of new business written in the period thepolicies incept, premiums are included in projected cash flows on the same basisof distinguishing annual and single premium business as set out for statutorybasis reporting. Included within pre-tax new business profits shown in the table above areprofits arising from fund management business falling within the scope ofcovered business of: Half Year Full Year Full Year 2005 2005 2004 £m £m £mUK insurance operations 5 7 10Jackson National Life 1 2 4Asian operations 3 10 3 9 19 17 b) Margins Present value Annual of new premium business Pre-tax new New business premiums equivalent premiums business New business margin Single Regular (APE) (PVNBP) contribution (APE) (PVNBP)Half Year 2005 £m £m £m £m £m % %UK insurance 4,510 90 541 4,797 159 30 3.3operationsJackson National Life 2,700 5 275 2,749 95 35 3.5Asian operations 401 273 313 1,734 162 52 9.3Total 7,611 368 1,129 9,280 416 37 4.5 Present value Annual of new premium business Pre-tax new New business premiums equivalent premiums business New business margin Single Regular (APE) (PVNBP) contribution (APE) (PVNBP)Full Year 2005 £m £m £m £m £m % %UK insurance 7,085 191 900 7,593 243 27 3.2operationsJackson National Life 5,009 14 515 5,135 211 41 4.1Asian operations 837 648 731 4,039 413 56 10.2Total 12,931 853 2,146 16,767 867 41 5.2 Present value Annual of new premium business Pre-tax new New business premiums equivalent premiums business New business margin Single Regular (APE) (PVNBP) contribution (APE) (PVNBP)Full Year 2004 £m £m £m £m £m % %UK insurance 6,357 181 817 7,012 241 30 3.4operationsJackson National Life 4,408 12 453 4,506 145 32 3.2Asian operations 662 510 576 3,404 355 62 10.4Total 11,427 703 1,846 14,922 741 40 5.0 New business premiums reflect those premiums attaching to covered businessincluding premiums for contracts classified as investment products for IFRSbasis reporting. New business premiums for regular premium products are shown onan annualised basis. Department of Work and Pensions rebate business isclassified as single recurrent premium business. Internal vesting annuitybusiness is classified as new business where the contracts include an openmarket option. New business margins are shown on two bases, namely the margins by reference toAnnual Premium Equivalents (APE) and the Present Value of New Business Premiums(PVNBP). APEs are calculated as the aggregate of regular new business premiumsand one tenth of single new business premiums. PVNBPs 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. The table of new business margins above excludes SAIF new business. New business contributions are determined by applying the economic andnon-economic assumptions applying at the end of the reporting period. Thecontributions represent profits at the end of the reporting period. 6. Operating profit from business in force Half Year Full Year Full Year 2005 2005 2004 £m £m £mUK insurance operationsUnwind of discount and other expected returns (note 181 424 351i)Cost of strengthened persistency assumption (note ii) (148) (148) (73)Mortality related cost of capital charge (note iii) - (47) -Other items (note iv) (48) (46) (33) (15) 183 245Jackson National LifeUnwind of discount and other expected returns: (notei)On value of in-force and required capital 67 160 123On surplus assets (over target surplus) 23 52 36Spread experience variance 47 89 41Amortisation of interest-related realised gains and 26 53 54lossesProfit on repricing Term contracts 136 140 -Profit (loss) from changes to other operating 11 10 (4)assumptionsOther 14 26 (13) 324 530 237Asian operationsUnwind of discount and other expected returns (note 85 162 120i)Change in operating assumptions 7 (9) (24)Experience variances and other items (2) 10 9 90 163 105Total 399 876 587 Notes (i) For UK insurance and Asian operations, unwind of discount and other expectedreturns is determined by reference to the value of in-force business, requiredcapital and surplus assets at the start of the period as adjusted for the effectof changes in economic and operating assumptions reflected in the currentperiod. For the unwind of discount for UK insurance operations included inoperating results based on longer-term returns a further adjustment is made. ForUK insurance operations the amount represents the unwind of discount on thevalue of in-force business at the beginning of the period (adjusted for theeffect of current period assumption changes), the expected return on smoothedsurplus assets retained within the main with-profits fund and the expectedreturn on shareholders' assets held in other UK long-term business operations.Surplus assets retained within the main with-profits fund are smoothed for thispurpose to remove the effects of short-term investment volatility from operatingresults. In the balance sheet and for total profit reporting, asset values andinvestment returns are not smoothed. For JNL the return on surplus assets isshown separately. (ii) The £148 million cost of strengthened persistency assumption relates to anumber of products, primarily in respect of with-profits bonds. The £73 millioncost of strengthened persistency assumption for 2004 relates to the closed bookof personal pension policies sold by the now discontinued direct sales force. (iii) The £47 million charge for full year 2005 primarily relates to the cost ofcapital attaching to liability strengthening on the regulatory basis for annuitybusiness. (iv) Other charges of £48m for half year 2005 reflect adverse expense experiencevariances, the costs of new regulatory requirements and restructuring and otheritems. The full year 2005 other charges of £46 million include £45 million ofcosts associated with complying with regulatory requirements includingSarbanes-Oxley, product and distribution development, £19 million of negativeexperience variances and other net positive items of £18 million. In determiningthe appropriate expense assumptions for full year 2005 account has been taken ofthe cost synergies that are expected to arise with some certainty from theinitiative announced on 1 December 2005 from UK insurance operations workingmore closely with Egg and M&G. Without this factor there would have been acharge for altered expense assumptions of approximately £55 million. The £33million charge for other items for 2004 includes £21 million of costs associatedwith complying with new regulatory requirements and restructuring and £12million of negative experience variances. 7. Investment return and other income Half Year Full Year Full Year 2005 2005 2004 £m £m £mIFRS basis 45 87 44Less: allocation of investment return on centrally held capital (10) (21) (22)in respect of Asian business to operating result of AsianoperationsLess: projected fund management result in respect of covered (15) (24) (22)business incorporated in opening EEV valueEEV basis 20 42 0 8. Short-term fluctuations in investment returns Half Year Full Year Full Year 2005 2005 2004 £m £m £mLong-term business:UK insurance operations (note i) 267 994 408Jackson National Life (including mark to market value of core 16 65 103structural borrowings) (note ii)Asian operations 24 41 91Share of investment return of funds managed by PPM America that 0 0 9are consolidated into Group results but attributable to externalinvestorsShare of profits of venture investment companies and property 3 1 9partnerships of the PAC with-profits fund that are consolidatedinto Group results but are attributable to external investorsMovement in mark to market value of core structural borrowings (19) (65) (63)held centrallyOther operations (13) (35) 13Total 278 1,001 570 Notes (i) Short-term fluctuations in investment returns represent for UK insuranceoperations the difference between actual investment returns in the periodattributable to shareholders and the expected returns as described in note 3. (ii) Short-term fluctuations for JNL comprise: Half Year Full Year Full Year 2005 2005 2004 £m £m £mActual investment return on investments less long-term returnsincluded within operating profit:Actual realised gains less default assumption and amortisation 2 5 51of interest-related realised gains and losses for fixed maturitysecuritiesActual less long-term return on equity-based investments and 53 58 22other itemsInvestment return related (loss) gain due primarily to changed (29) 4 36expectation of profits on in-force variable annuity business infuture periods based on current period equity returns*Mark to market value of core structural borrowings (10) (2) (6) 16 65 103 \* This adjustment arises due to market returns being (lower) higher than theassumed long-term rate of return. This gives rise to (lower) higher thanexpected period end values of variable annuity assets under management with aresulting effect on the projected value of future account values, and hencefuture profitability. 9. Actuarial and other gains and losses on defined benefit pension schemes The charge of £8 million (full year 2005: £47 million, 2004: £12 million)included in total profit reflects the shareholders' share of actuarial and othergains and losses on the Group's defined benefit pension schemes. On the EEVbasis, this includes a 10 per cent share of the actuarial gains and losses onthe share of the deficit attributable to the PAC with-profits fund for thePrudential Staff and Scottish Amicable Pension Schemes. The 2005 full yearcharge of £47 million includes a charge of £43 million for altered renewalexpense assumptions arising from the prospective increase in employercontributions for the Prudential Staff Pension Scheme for future service ofactive members (as distinct from deficit funding). 10. Effect of changes in economic assumptions and time value of cost of options and guarantees The profits (losses) on changes in economic assumptions and time value of costof options and guarantees resulting from changes in economic factors forin-force business included within the profit on ordinary activities before taxarise as follows: Half Year Full Year Full Year 2004 2005 2005 Change in Change in Change in time value time value time value Change in of cost of Change in of cost of Change in of cost of economic options economic options economic options and and and assumptions guarantees Total assumptions guarantees Total assumptions guarantees Total £m £m £m £m £m £m £m £m £mUK insurance 29 1 30 (81) 31 (50) 40 46 86operationsJackson 33 1 34 (3) 11 8 (53) 6 (47)National LifeAsian (207) 0 (207) (265) 5 (260) (113) 26 (87)operations(note i)Total (145) 2 (143) (349) 47 (302) (126) 78 (48) Note (i) Consistent with prior periods for the Taiwan operation, the projectionsinclude an assumption of phased progression of the bond yields of around 2 percent towards 5.5 per cent at 31 December 2012 as described in note 3b(ii). Thistakes into account the effect on bond values of interest rate movements. Theprincipal cause of the £207 million (full year 2005: £265 million) charge forthe effect of changed economic assumptions is the reduction in short-term earnedrates in Taiwan. This reduction has the effect of delaying the emergence of theexpected long-term rate. 11. Taxation charge The tax charge comprises: Half Year Full Year Full Year 2005 2005 2004 £m £m £mTax on operating profit from continuing operationsLong-term business:UK insurance operations 45 127 142Jackson National Life 126 204 116Asian operations* 61 162 119 232 493 377Other operations (11) (130) (27)Total tax charge on operating profit from continuing operations 221 363 350Tax on items not included in operating profitTax charge on short-term fluctuations in investment returns 107 343 189Tax credit on actuarial and other gains and losses of defined (2) (14) (5)benefit pension schemesTax charge (credit) on effect of changes in economic assumptions 11 (39) 19and time value of cost of options and guaranteesTotal tax charge on items not included in operating profit from 116 290 203continuing operationsTax charge on profit on ordinary activities from continuing 337 653 553operations (including tax on actual investment returns) *Including tax relief on development expenses. The profit for the period for covered business is in most cases calculatedinitially at the post-tax level. The post-tax profit for covered business isthen grossed up for presentation purposes at the effective rates of taxapplicable to the countries and periods concerned. In the UK this is the UKcorporation tax rate of 30 per cent. For JNL the federal rate of 35 per cent isapplied to gross up movements on the value of in-force business. Effects onstatutory tax for the period affect the overall tax rate. For Asia, similarprinciples apply subject to the availability of taxable profits. 12. Earnings per share (EPS) Half Full Full Year Year Year 2004 2005 2005 £m £m £mOperating EPS from continuing operations:Operating profit before tax 799 1,712 1,274Tax (221) (363) (350)Minority interests (2) (10) (8)Operating profit after tax and minority interests from continuing 576 1,339 916operationsOperating EPS from continuing operations 24.4p 56.6p 43.2pTotal EPS from continuing operations:Total profit before tax 831 2,244 1,784Tax (337) (653) (553)Minority interests (5) (12) (26)Total profit after tax and minority interests from continuing 489 1,579 1,205operationsTotal EPS from continuing operations 20.7p 66.8p 56.8pAverage number of shares (millions) 2,361 2,365 2,121 13. Shareholders' funds - segmental analysis Half Year Full Year Full Year 2005 2005 2004 £m £m £mUK operationsLong-term business operations (notes ii and iii):Smoothed shareholders' funds (note i) 4,369 4,558 4,067Actual shareholders' funds less smoothed shareholders' funds 229 574 161EEV basis shareholders' funds 4,598 5,132 4,228M&G (note vii):Net assets of operations 272 245 297Acquired goodwill (note v) 1,153 1,153 1,153Egg (note vii) 266 303 273 6,289 6,833 5,951US operationsJackson National Life (net of surplus note borrowings of £184m(2005: £183m, 2004: £162m) note vi):Before capital charge:Excluding assets in excess of target surplus 2,345 2,566 1,817Assets in excess of target surplus 750 899 769 3,095 3,465 2,586Capital charge (note iv) (79) (117) (80)After capital charge 3,016 3,348 2,506Broker-dealer, fund management and Curian operations (note vii) 76 70 64 3,092 3,418 2,570Asian operationsLong-term business (note ii):Net assets of operations - EEV basis shareholders' funds 1,646 1,988 1,565Acquired goodwill (note v) 136 111 231Fund management (note vii):Net assets of operations 46 82 66Acquired goodwill (note v) 61 61 61 1,889 2,242 1,923Other operationsHolding company net borrowings (note vi) (1,443) (1,724) (1,299)Pension scheme deficits (net of tax) attributable to shareholders (157) (142) (152)(note vii)Other net liabilities (note vii) (556) (326) (379) (2,156) (2,192) (1,830)Total 9,114 10,301 8,614 Notes (i) UK long-term business smoothed shareholders' funds reflect an adjustment tothe assets of the PAC with-profits sub-fund, for the purposes of determining theunwind of discount included in operating profits, to remove the short-termvolatility in market values of assets. Shareholders' funds in the balance sheetare determined on an unsmoothed basis. (ii) A charge is deducted from the result for the period and balance sheet valuefor the cost of capital for the Group's long-term business operations. The costis the difference between the nominal value of solvency capital and the presentvalue, at risk discount rates, of the projected releases of this capital and theinvestment earnings on the capital. Where solvency capital is held within awith-profits long-term fund, the value placed on surplus assets in the fund isalready discounted to reflect its release over time and no further adjustment isnecessary in respect of solvency capital. (iii) The proportion of surplus allocated to shareholders from the UKwith-profits business has been based on the present level of 10 per cent. Futurebonus rates have been set at levels which would fully utilise the assets of thewith-profits fund over the lifetime of the business in force. (iv) In determining the cost of capital of JNL, it has been assumed that anamount equal to 235 per cent of the risk-based capital required by the NationalAssociation of Insurance Commissioners (NAIC) at the Company Action Level mustbe retained. The impact of the related capital charge is to reduce JNL'sshareholders' funds by £79m (2005: £117 million, 2004: £80 million). (v) Under IFRS, subject to impairment testing, goodwill is no longer amortisedfrom the date of adoption i.e. 1 January 2004. Acquired goodwill of the Japanlife business has been subject to an impairment charge included in the half year2005 results of £95m (full year 2005: £120 million). Goodwill attaching to venture fund investment subsidiaries of the PACwith-profits fund that are consolidated under IFRS are not included in the tableabove as the goodwill attaching to these companies is not relevant to theanalysis of shareholders' funds. (vi) Net core structural borrowings of shareholder-financed operations comprise: Half Year Full Year Full Year 2005 2005 2004 £m £m £mHolding company cash and short-term investments 1,319 1,128 1,561Core structural borrowings - central funds (2,762) (2,852) (2,860)Holding company net borrowings (1,443) (1,724) (1,299)Core structural borrowings - Jackson National Life (184) (183) (162) (1,627) (1,907) (1,461) The altered carrying value of core structural borrowings under EEV reflects theapplication of market values rather than IFRS basis values. (vii) With the exception of the share of pension scheme deficits attributable tothe PAC with-profits fund, the amounts shown for the items in the table abovethat are referenced to this note have been determined on the statutory IFRSbasis. The deficit for the defined benefit pension scheme reflects the statutorynet of tax IFRS provision of £110m (full year 2005: £113 million, 2004: £105million), augmented by £47m (2005: £29 million, 2004: £47 million) for theshareholders' share of the net of tax deficit attributable to the PACwith-profits fund. 14. Reconciliation of movement in shareholders' funds Long-term business operations Total UK long-term insurance Asian business Other Group operations JNL operations operations operations total £m £m £m £m £m £mOperating profit (including investmentreturnbased on long-term rates of returns)Long-term business:New business (note 5) 159 95 162 416 416Business in force (note 6) (15) 324 90 399 399 144 419 252 815 815Asia development expenses (8) (8) (8)M&G 83 83Egg 13 13Asian fund management operations 2 2US broker-dealer and fund management 18 18Curian (6) (6)Other income and expenditure (118) (118)Operating profit (loss) from continuing 144 419 244 807 (8) 799operationsGoodwill impairment charge (95) (95)Short-term fluctuations in investment 270 16 24 310 (32) 278returns (note 8)Actuarial and other gains and losses on (8) (8)definedbenefit pension schemes (note 9)Effect of changes in economicassumptions and timevalue of cost of options and guarantees 30 34 (207) (143) (143)(note 10)Profit (loss) on ordinary activitiesbefore tax(including actual investment returns) 444 469 61 974 (143) 831Tax on profits (losses) from continuingoperations (note 11):Tax on operating profit (45) (126) (61) (232) 11 (221)Tax on short-term fluctuations in (80) (9) (18) (107) 0 (107)investment returnsTax on actuarial and other gains andlosseson defined benefit pension schemes 2 2Tax on effect of changes in economicassumptionsand time value of cost of options and (9) (12) 10 (11) (11)guaranteesTotal tax (charge) credit (134) (147) (69) (350) 13 (337)Discontinued operations (net of tax) 1 1Minority interests (3) (3) (2) (5)Profit (loss) for the period 307 322 (8) 621 (131) 490Transition adjustment, net of tax, on (25) (25)adoption of IAS 32, IAS 39 and IFRS 4at 1 January 2005Unrealised valuation movements on 4 4securities classified asavailable-for-saleMovement in cash flow hedges (7) (7)Exchange movements 186 76 262 (43) 219Related tax 30 30Development costs included above (net 4 4 (4)of tax) borne centrallyIntra group dividends (including (33) (139) (36) (208) 208statutory transfer)External dividends (253) (253)Reserve movements in respect of 6 6share-based paymentsInvestment in operations (note i) 104 146 53 303 (303)Adjustment for net of tax losses of (3) (3) 3Curian subsidiary owned by JNLAdjustment for economic capital for (7) (7) 7Asian operations held centrallyAdjustment for net of tax fundmanagement projectedprofits of covered business (8) (2) (1) (11) 11Treasury shares:Movement in own shares in respect of 1 1share-based payment plansMovement in Prudential plc sharespurchased by unit trustsconsolidated under IFRS (5) (5)Proceeds from issues of share capital 40 40by parent companyNet increase in shareholders' capital 370 510 81 961 (461) 500and reservesShareholders' capital and reserves at 1 4,228 2,506 1,565 8,299 315 8,614January 2005Shareholders' capital and reserves at30 June 2005(note 13) 4,598 3,016 1,646 9,260 (146) 9,114 Notes (i) Investment in operations reflects increases in share capital. This includescertain non-cash items as a result of timing differences. Long-term business operations Total UK long-term insurance Asian business Other Group operations JNL operations operations operations totalEEV basis shareholders' funds at 30 £m £m £m £m £m £mJune 2005Analysed as:Statutory IFRS basis shareholders' 1,080 2,858 928 4,866 113 4,979fundsAdditional retained profit on an EEV 3,518 158 718 4,394 (259) 4,135basisEEV basis shareholders' funds at 30 4,598 3,016 1,646 9,260 (146) 9,114June 2005 (ii)Comprising:Free surplus 164 750 (272) 642Required capital 586 1,136 931 2,653Value of in-force business beforededuction ofcost of capital and of guarantees 4,099 1,343 1,517 6,959Cost of capital (163) (79) (516) (758)Cost of time value of guarantees (88) (134) (14) (236) 4,598 3,016 1,646 9,260 Long-term business operations Total UK long-term insurance Asian business Other Group operations JNL operations operations operations totalEEV basis shareholders' funds at 31 £m £m £m £m £m £mDecember 2005Analysed as:Statutory IFRS basis shareholders' 1,141 2,899 1,034 5,074 120 5,194fundsAdditional retained profit on an EEV 3,991 449 954 5,394 (287) 5,107basisEEV basis shareholders' funds at 31 5,132 3,348 1,988 10,468 (167) 10,301December 2005 (ii)Comprising:Free surplus 148 899 (212) 835Required capital 710 1,198 974 2,882Value of in-force business beforededuction ofcost of capital and of guarantees 4,529 1,511 1,771 7,811Cost of capital (192) (117) (539) (848)Cost of time value of guarantees (63) (143) (6) (212) 5,132 3,348 1,988 10,468 (ii) Included in the EEV basis shareholders' funds of long-term businessoperations of £9,260 million (31 December 2005: £10,468 million, 31 December2004: £8,299 million) is £170 million (31 December 2005: £174 million, 31December 2004: £200 million) in respect of fund management business fallingwithin the scope of covered business as follows: Half Year Full Year Full Year 2005 2004 2005 £m £m £mUK insurance operations 127 120 123Jackson National Life 11 12 20Asian operations 32 42 57 170 174 200 Special Purpose Review Report of KPMG Audit Plc to Prudential Plc ('theCompany') on its Preliminary European Embedded Value ('EEV') InterimSupplementary Information for the six months to 30 June 2005 We have reviewed the preliminary EEV interim supplementary information for thesix month period ended 30 June 2005 ("the preliminary EEV interim supplementaryinformation"). The preliminary EEV interim supplementary information has beenprepared in accordance with the European Embedded Value Principles issued in May2004 by the European CFO Forum using the methodology and assumptions set out innotes 2 and 3. The EEV supplementary information presented for the 12 month periods ending 31December 2005 and 2004 which has previously been published, is excluded from thescope of this report. This report is made solely to the Company in accordance with the terms of ourengagement. Our work has been undertaken so that we might state to the Companythose matters we have been engaged to state in this report and for no otherpurpose. To the fullest extent permitted by law, we do not accept or assumeresponsibility to anyone other than the Company for our work, this report, orfor the opinions that we have formed. Respective responsibilities of directors and KPMG Audit Plc As described in the basis of preparation, the directors of the Company areresponsible for the preparation of the preliminary EEV interim supplementaryinformation on an EEV basis in accordance with the EEV principles. Our responsibilities under the terms of our engagement are to report to theCompany our review conclusion as to whether we are aware of any materialmodifications that should be made to the preliminary EEV interim supplementaryinformation. Basis of review conclusion We conducted our review having regard to Bulletin 1999/4: Review of interimfinancial information issued by the Auditing Practices Board for use in theUnited Kingdom. A review consists principally of making enquiries of groupmanagement and applying analytical procedures to the preliminary EEV interimsupplementary information and underlying financial data and, based thereon,assessing whether the EEV Principles have been consistently applied unlessotherwise disclosed. A review is substantially less in scope than an auditperformed in accordance with Auditing Standards and therefore provides a lowerlevel of assurance than an audit. Accordingly we do not express an audit opinionon the preliminary EEV interim supplementary information. Review conclusion On the basis of our review we are not aware of any material modifications thatshould be made to the preliminary EEV interim supplementary information aspresented for the six month period ended 30 June 2005. Emphasis of matter Without qualifying our opinion we draw your attention to the following matter. The Company has prepared the EEV basis supplementary information for the sixmonth period ended 30 June 2005 to provide the comparative supplementaryinformation expected to be included in the Company's EEV basis supplementaryinformation to be included in the interim report for the six months ending 30June 2006. KPMG Audit PlcChartered AccountantsLondon 19 June 2006 This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
Prudential