13th Dec 2005 07:02
Prudential PLC13 December 2005 EMBARGO: 07.00 hours, Tuesday 13 December 2005 Prudential plc Further detail on 2004 European Embedded Value Results previously published on 2 June 2005 Prudential plc publishes today its 2004 embedded value financial informationrestated from the Achieved Profits Basis to European Embedded Value (EEV)Principles, and also for the effects of International Financial ReportingStandards (IFRS) and other accounting policy changes implemented earlier in theyear. The Group's underlying capital strength, cashflow and dividend policy arenot affected by the adoption of either EEV or IFRS. Today's disclosure providesfurther detail to that given on 2 June 2005, and reflects certain minorrevisions to the methodology used. Prudential believes that the EEV methodology represents an improvement over thevarious embedded value reporting methods previously used across Europe andsupports its introduction. Prudential re-iterates its belief that embedded valuereporting provides investors with a more informed measure of the underlyingprofitability of the Group's long-term businesses and is an important supplementto statutory accounts. As a member of the CFO Forum Prudential will adopt European Embedded ValuePrinciples for its 2005 year-end results. This will replace the Achieved Profitbasis, the current supplementary basis of reporting. The adoption by Prudentialof the EEV methodology, together with IFRS, results in a 2% reduction in theGroup's total shareholders' funds to £8.6bn and an uplift of 8% in the value ofnew business for the year ending 31 December 2004 to £741m. The main impact on the results arises from the effect of changes to the assumedlevel of locked-in capital allocated to each business, the adoption ofproduct-specific risk discount rates, and an explicit valuation of the timevalue of options and guarantees. Highlights of the results on an EEV basis are shown below. AP basis EEV basis (3) Restated (3) 2004 2004 £m £mNew Business Profits 741 688New Business Margin (1) 40% 37%New Business Margin (2) 5% -Long-term Business Operating Profit Before Tax 1,328 1,249Total Operating Profit Before Tax 1,274 1,239Total EEV Shareholders' Funds 8,615 8,762 (1)EEV and AP basis profits expressed as a percentage of annual premiumequivalent (APE) of insurance sales. (2)EEV basis profits expressed as a percentage of the present value of newbusiness premiums. (3) Both the AP and EEV bases include the effects of IFRS and other accountingpolicy changes implemented earlier in the year. -ENDS- Enquiries to: Media Investors/Analysts Jon Bunn 020 7548 3559 James Matthews 020 7548 3561Joanne Davidson 020 7548 3708 Marina Novis 020 7548 3511William Baldwin-Charles 020 7548 3719 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 £187bn in assetsunder management, as at 31 December 2004. Prudential plc is not affiliated inany manner 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. Note: (1)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. (2)Revisions to methodology LT business Total operating EEV shareholders' operating profit profit before tax funds before taxEEV basis as published on 2 June 2005 before accounting £1,238m £1,212m £8,481mpolicy changesAccounting policy changes as published on 2 June 2005(1) £101m £95m £166mEEV basis reflecting accounting policy changes £1,339m £1,307m £8,647m Revisions to methodology: Reclassification of Asia profits(2) £(11)m £(11)mIntra-group adjustment (3) £(22)mMark to market value of JNL surplus note borrowings(4) £ (32)mEEV basis as published on 13 December 2005 £1,328m £1,274m £8,615m (1) The accounting policy changes for operating profits primarily reflectthe discretionary change of accounting policy for longer term returns aspublished on 2 June 2005. The £166m reflects the impact of IFRS changes aspublished on 2 June 2005. (2) Reflects a reclassification of profits from operating to non-operatingprofits with no effect on shareholders' funds. (3) The intra-group adjustment is made to deduct profits for internal fundmanagement business in respect of covered long-term business. (4) This reflects the mark to market value on JNL surplus note borrowings. EUROPEAN EMBEDDED VALUE (EEV) BASIS SUPPLEMENTARY INFORMATIONYEAR ENDED 31 DECEMBER 2004 RESULTS ANALYSIS BY BUSINESS AREA Achieved Profits (AP) basis EEV Restated 2004 2004 Note £m £mUK and Europe OperationsNew business 5. 15 241 220Business in force 6 245 230Long-term business 486 450M&G 136 136Egg 61 61Total 683 647US OperationsNew business 5. 15 145 156Business in force 6 237 271Long-term business 382 427Broker-dealer and fund management 15 15Curian (29) (29)Total 368 413Asian OperationsNew business 5. 15 355 312Business in force 6 105 60Long-term business 460 372Fund management 19 19Development expenses (15) (15)Total 464 376Other Income and ExpenditureInvestment return and other income 15 0 44Interest payable on core structural borrowings (154) (154)Corporate expenditure:Group Head Office (51) (51)Asia Regional Head Office (29) (29)Charge for share-based payments for Prudential schemes (7) (7)Total (241) (197)Operating profit from continuing operations based on longer-term investment returnsbefore exceptional items 1,274 1,239Analysed as profits (losses) from:New business 5 741 688Business in force 6 587 561Long-term business 1,328 1,249Asia development expenses (15) (15)Other operating results (39) 5Total 1,274 1,239 The Achieved Profits basis results shown for comparative purposes have been restated from those published in the2004 Annual Report and are as reported in the 2005 Interim Report published on 27 July 2005. The restatementreflects the application of the changes to accounting policy that the Group expects to apply in its full year2005 IFRS basis financial statements to the extent applicable. The results of long-term business operations aresignificantly altered only for the changed basis of determining longer-term investment returns credited tooperating results. Details of the altered basis, which is also applied for EEV basis reporting, are shown innote 4b. SUMMARISED CONSOLIDATED PROFIT AND LOSS ACCOUNT - EEV BASISYEAR ENDED 31 DECEMBER 2004 Achieved Profits (AP) basis EEV Restated 2004 2004 Note £m £mOperating profit from continuing operations based on longer-term investment returnsbefore exceptional itemsUK and Europe Insurance Operations 486 450M&G 136 136Egg 61 61UK and Europe Operations 683 647US Operations 368 413Asian Operations 464 376Other Income and Expenditure (241) (197)Operating profit from continuing operations based on longer-term investment returns 1,274 1,239before exceptional items+Short-term fluctuations in investment returns 7 570 587Shareholders' share of actuarial gains and losses on defined benefit pension schemes (12) (12)Effect of changes in economic assumptions and time value of cost of options and 8 (48) (100)guaranteesProfit from continuing operations before tax (including actual investment returns) 1,784 1,714Tax 9 (553) (491)Profit from continuing operations for the financial year after tax before minority 1,231 1,223interestDiscontinued operations (net of tax) (94) (94)Total profit for the year 1,137 1,129Attributable to:Equity holders of the parent company 1,138 1,130Minority interest (1) (1)Total profit for the year 1,137 1,129 + Operating profit and operating earnings per share include investment returns at the expected long-term rate ofreturn but exclude exceptional items. The directors believe that operating profit, as adjusted for these items,better reflects underlying performance. Profit on ordinary activities and basic earnings per share include theseitems together with actual investment returns. This basis of presentation has been adopted consistentlythroughout this EEV basis supplementary information. EARNINGS PER SHARE - EEV BASISYEAR ENDED 31 DECEMBER 2004 Achieved Profits (AP) basis EEV Restated Note 2004 2004Continuing operationsFrom operating profit, based on longer-term investment returns, after tax andrelated minority interestof £916m (£880m) 10 43.2p 41.5pBased on profit from continuing operations after minority interest of £1,205m 10 56.8p 56.4p(£1,197m)Discontinued operationsBased on loss from discontinued operations after minority interest of £(67)m (3.1)p (3.1)p(£(67)m)Total - based on total profit for the financial year after minority interest of - 53.7p 53.3p£1,138m (£1,130m) Average number of shares (million) 2,121 2,121 DIVIDENDS PER SHAREYEAR ENDED 31 DECEMBER 2004 Achieved Profits (AP) basis EEV Restated 2004 2004Dividends relating to the financial year:Interim dividend 5.19p 5.19pFinal dividend 10.65p 10.65pTotal 15.84p 15.84pDividends declared and paid in the financial yearCurrent year interim dividend 5.19p 5.19pFinal dividend for prior year 10.29p 10.29pTotal 15.48p 15.48p MOVEMENT IN SHAREHOLDERS' CAPITAL AND RESERVES(EXCLUDING MINORITY INTEREST) - EEV BASISYEAR ENDED 31 DECEMBER 2004 Achieved Profits (AP) basis EEV Restated 2004 2004 Note £m £mProfit for the year (net of minority interest) 1,138 1,130Items taken directly to equityExchange movements (239) (240)Related tax (1) 12Proceeds from Rights Issue, net of expenses 1,021 1,021Other new share capital subscribed 119 119Dividends (323) (323)Reserve movements in respect of share-based payments 10 10Own shares:Own shares purchased in respect of share-based payment plans (4) (4)Movement on Prudential plc shares purchased by unit trusts newly consolidated 14 14under IFRSNet increase in shareholders' capital and reserves 12 1,735 1,739Shareholders' capital and reserves, at beginning of year (excluding minorityinterest): As previously reported on the Achieved Profits basis 7,005 7,005 Adjustments on implementation of statutory IFRS (excluding IAS 32, IAS 39 18 18 and IFRS 4) Adjustments on implementation of European Embedded Value (EEV) methodology (143) -As restated 12 6,880 7,023Shareholders' capital and reserves at end of year (excluding minority interest) 11,12,15 8,615 8,762 Analysed as: As previously reported on the Achieved Profits basis 8,596 8,596 Adjustments on implementation of statutory IFRS (excluding IAS 32, IAS 39 15 166 166 and IFRS 4) Adjustments on implementation of European Embedded Value (EEV) methodology 15 (147) - 8,615 8,762 Comprising:UK and Europe Operations: Long-term business 4,228 4,051 M&G: Net assets 300 300 Acquired goodwill 1,153 1,153 Egg 273 273 5,954 5,777US Operations 2,570 2,596Asian Operations: Net assets 1,631 1,736 Acquired goodwill 292 292Other operations: Holding company net borrowings (1,299) (1,106) Other net liabilities (533) (533) 11,12,15 8,615 8,762 NET ASSET VALUE PER SHAREBased on EEV (AP restated) basis shareholders' funds of £8,615m (£8,762m) 363p 369pNumber of shares at year end (million) 2,375 2,375 SUMMARISED CONSOLIDATED BALANCE SHEET - EEV BASIS31 DECEMBER 2004 Achieved Profits (AP) basis EEV Restated 2004 2004 Note £m £mTotal assets less liabilities, excluding insurance funds 148,639 148,639Less insurance funds*: Technical provisions (net of reinsurers' share) and unallocated surplus of (144,149) (144,149)with-profits funds Less shareholders' accrued interest in the long-term business 4,125 4,272 (140,024) (139,877)Total net assets 12, 15 8,615 8,762 Share capital 119 119Share premium 1,558 1,558Other statutory basis shareholders' profit (following adoption of IFRS) 2,813 2,813Additional EEV basis retained profit 4,125 4,272Shareholders' capital and reserves (excluding minority interest) 12, 15 8,615 8,762*Including liabilities in respect of insurance products classified as investmentcontracts under IFRS 4. NOTES ON THE EEV PROFITS BASIS SUPPLEMENTARY INFORMATION 1. BASIS OF PREPARATION The European Embedded Value ("EEV") results for the Group include the resultsfor the covered business on the EEV basis. These results are then combined withthe IFRS basis results of the 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 under Modified Statutory Basis and Achieved Profits basisreporting. Under the EEV principles, the results for covered business nowincorporate the projected margins of 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 andScottish Amicable scheme are excluded. These deficits are partiallyattributable to the PAC with-profits fund and shareholder backed long-termbusiness. Further details are explained in note 2f. The EEV basis results have been prepared in accordance with the EuropeanEmbedded Value principles issued by the CFO Forum of European InsuranceCompanies in May 2004 and expanded by the addition of Additional Guidance on EEVDisclosures published in October 2005. Where appropriate the EEV basis resultsinclude the effects of adoption of International Financial Reporting Standards. These statements also include comparative basis results on the Achieved Profitsbasis. The Achieved Profits basis results reflect the results of the Group'slong-term business operations on that basis and IFRS basis results of theGroup's other operations. The Achieved Profits basis results for long-termbusiness have been prepared in accordance with the guidance issued by theAssociation of British Insurers (ABI) in December 2001 'Supplementary Reportingfor Long-term Insurance Business (the Achieved Profits Method)'. The EEV and Achieved Profits basis information contained in these statements issupplementary to the Statutory Financial Statements included in the Group's 2004Annual Report. These statements should be read in conjuction with the financialstatements and supplementary Achieved Profits basis information published in theGroup's 2005 Interim Report. The Group's EEV basis results included in thesestatements may require adjustment before its inclusion as comparatives in theEEV Supplementary Information to the 2005 Statutory Financial Statements due tothe continuing work of the IASB and possible amendments to the interpretativeguidance and the Group's accounting policies. The Directors are responsible for the preparation of the SupplementaryInformation in accordance with the EEV Principles. 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.The shareholders' interest in the Group's long-term business comprises: * Present value of future shareholder cash flows from in-force covered business(value of in-force business), less a deduction for the cost of locked-in('encumbered') capital; * Locked-in ('encumbered') capital; and * Shareholders' net worth in excess of encumbered capital. The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results (as explained in notes 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 Modified Statutory Basis underUK GAAP. However, since the embedded value basis reflects discounted futurecash flows under this methodology the profit emergence is advanced, thus moreclosely aligning the timing of the recognition of profits with the efforts andrisks of current management actions, particularly with regard to business soldduring the year. 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 capitaland the discounted present value of the projected release of this capitalallowing for investment earnings (net of tax) on the capital. The annual result is impacted by the movement in this cost from year to yearwhich comprises a charge against new business profit and a release in respect ofthe reduction in capital requirements for business in force as this runs off. Where the capital is held within a with-profits long-term fund, the value 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 and Europe Insurance Operations The only significant financial options and guarantees in the UK and Europeinsurance operations arise in the with-profits sub-fund and Scottish AmicableInsurance Fund (SAIF). With-profits products provide returns to policyholdersthrough bonuses that are smoothed. There are two types of bonuses: annual andfinal. Annual bonuses are declared once a year, and once credited, areguaranteed in accordance with the terms of the particular product. Unlikeannual bonuses, final bonuses are guaranteed only until the next bonusdeclaration. The with-profits sub-fund held a provision on the pillar 1 peak 1basis of £49m at 31 December 2004 to honour guarantees on a small amount ofguaranteed annuity products. 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. The Group's main exposure to guaranteed annuities in the UK is through SAIF anda provision on the pillar 1 peak 1 basis of £648m was held in SAIF at 31December 2004 to honour the guarantees. With this exception, SAIF with-profitspolicies do not guarantee minimum rates of return to policyholders. Jackson National Life The principal options and guarantees valued under EEV for Jackson National Lifeare associated with the fixed annuity and variable annuity lines of business. Fixed annuities provide that at Jackson National Life's discretion it may resetthe interest rate credited to policyholders' accounts, subject to a guaranteedminimum. The guaranteed minimum return varies from 1.5% to 5.5%, depending onthe particular product, jurisdiction where issued, and date of issue. At 31December, 2004, 73% of the fund relates to policies with guarantees of 3% orless. The average guarantee rate is 3.3%. 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 berelated to (a) the amount of total deposits made to the contract adjusted forany partial withdrawals, (b) the total deposits made to the contract adjustedfor any 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 indexed 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 surrendervalues reflect 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 'intrinsicvalue'). The other part arises from the variability of economic outcomes in thefuture (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 byPillar I requirements being 4% of mathematical reserves (as used for achievedprofits reporting), which are also sufficient to meet Pillar II requirements asdetermined in the Individual Capital Assessment (ICA) submitted to the FinancialServices Authority (FSA). * 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) requirement. 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 existingachieved profits embedded values and risk discount rates have been carried overfollowing validation by comparison to a market consistent valuation. Allowance of Risk The risk allowance in the risk discount rate is determined as follows: * Market Risk Under Capital Asset Pricing Methodology ("CAPM") the discount rate is 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 addedfor non-diversifiable non-market risks and to cover Group level risks. Product-specific discount rates are used in order to reflect the risk profile ofeach major territory and product group. * 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 50bps has been added to the risk margin derived for marketrisk to cover the non-diversifiable non-market risks associated with thebusiness. Product-level betas are calculated each year. They are combined with the mostrecent product mix to produce appropriate betas and risk discount rates for eachmajor product grouping. 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 * 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 (PPFM). 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 principalscheme is the Prudential Staff Pension Scheme ("PSPS"). The other two muchsmaller schemes are the Scottish Amicable and M&G schemes. 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 the deficitwas allocated in the ratio 80/20. 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 11. 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, US and European long-termbusiness operations. For the Group's Asian operations, the active basis isappropriate for business written in Japan, Korea and US dollar denominatedbusiness written in 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 above risk free rates which compares to 2.5 per centpreviously used for achieved profits reporting. The equity risk premium in theUS is also 3.0 per cent, unchanged from achieved profits reporting. In Asia,equity risk premiums range from 2.8 per cent to 5.3 per cent. Assumptions forother asset classes, such as corporate bond spreads, are set consistently asbest estimate assumptions. 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 Achievedassumptions. EEV EEV Profits 31 Dec 2004 1 Jan 2004 (i) 31 Dec 2004UK and Europe Insurance OperationsRisk discount rateNew business 7.1% 7.2%In-force 7.1% 7.1% 7.2%Pre-tax expected long-term nominal rates ofinvestment return:UK equities 7.6% 7.8% 7.1%Overseas equities 7.3% to 8.3% 7.1% to 8.4% 6.8% to 7.8%Property 6.3% 6.6% 6.3%Gilts 4.6% 4.8% 4.6%Corporate bonds 5.5% 5.8% 5.5%Expected long-term rate of inflation 2.9% 3.0% 2.9%Post-tax expected long-term nominal rate of return:Pension business (where no tax applies) 6.8% 7.1% 6.5%Life business 5.9% 6.1% 5.7% US Operations (Jackson National Life)Risk discount rateNew business 6.1% 7.4%In-force 5.8% 5.5% 7.4%Expected long-term spread between earned rate andrate credited topolicyholders for single premium deferred annuity 1.75% 1.75% 1.75%businessUS 10 year treasury bond rate at 31 December 2004 4.3% 4.3% 4.3%Pre-tax expected long-term nominal rate of return for 7.3% 7.3% 7.3%US EquitiesExpected long-term rate of inflation 2.6% 2.3% 2.6% Asian Operations Hong China Kong (iv) India Indonesia Japan Korea EEV EEV EEV EEV EEV EEV 31 Dec 31 Dec 2004 31 Dec 31 Dec 31 Dec 31 Dec 2004 2004 2004 2004 2004Risk discount rate (ii)New business 10.0% 8.5% 16.0% 18.75% 5.0% 7.1%In-force 10.0% 7.4% 16.0% 18.75% 5.0% 7.1%Expected long-term rate of inflation 3.0% 2.3% 5.25% 7.75% 0.0% 2.75%Government bond yield 7.25% 4.9% 10.25% 13.0% 1.9% 3.86% Malaysia Philippines Singapore Taiwan Thailand Vietnam (iii) EEV EEV EEV EEV EEV EEV 31 Dec 31 Dec 2004 31 Dec 31 Dec 31 Dec 31 Dec 2004 2004 2004 2004 2004Risk discount rateNew business 9.0% 16.25% 6.3% 7.1% 13.5% 15.5%In-force 8.7% 16.25% 6.4% 8.2% 13.5% 15.5%Expected long-term rate of inflation 3.0% 5.25% 2.25% 2.25% 3.75% 4.5%Government bond yield 7.0% 10.5% 5.0% 5.5% 7.75% 9.75% Achieved EEV EEV Profits Asia Total Asia Asia Total Total 31 Dec 2004 1 Jan 31 Dec 2004 2004Weighted risk discount rate (ii)New business 8.0% 10.3%In-force 7.9% 8.0% 9.6% (i) Economic assumptions shown for 1 January 2004 reflect the rates applied indetermining the value of in-force business at the start of 2004 as shown in note12. (ii) 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 in-force operating results. (iii) Under Achieved Profits for year end 2004, for the Taiwan life operation,the projections include assumptions of phased progression from current rates tothe long-term expected rate taking into account the effect on bond values ofrising interest rates. A similar approach has been adopted in preparing the EEVbasis results for full year 2004. The 2004 EEV basis results have been preparedon the assumption that bond rates, then at around 3 per cent, would trend to along-term assumption of 5.5 per cent by 31 December 2010. Allowance was made forthe mix of assets in the fund, our future investment strategy and the marketvalue depreciation already held by the fund as yields rise to the assumedlong-term yields. For full year 2004 EEV basis results this gave rise to anaverage assumed Fund Earned Rate that trends from 3.4 per cent to 5.9 per centby 31 December 2012. There is a slight decline in the Fund Earned rate in thefirst few years as the depreciation of long bonds exceeds the correspondingincome pick up as rates rise. Consistent with the EEV methodology a constantdiscount rate has been applied to the projected cashflows, as shown above. (iv) Hong Kong business is predominately US dollar denominated. (v) Assumed equity yields The most significant equity holdings in Asian operations are in Hong Kong,Singapore and Malaysia. The geometric average equity return assumptions forthese three territories at 31 December 2004 were 7.3%, 8.0% and 9.75%respectively. c) Principal Economic Assumptions Stochastic The economic assumptions used for the stochastic calculations are 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 and Europe 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 lognormaldistribution. \* 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. *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 as follows: Mean returns have been derived as the annualised arithmetic average returnacross all simulations and durations (i) Standard deviations have been calculated by taking the variance of theannualised average return in each year across all simulations, taking the squareroot and averaging overall durations. For interest rates the standard deviationrelates to the change in yield. The standard deviations applied are as follows: Standard DeviationGovernment Bond Yield 1.9%Corporate Bond Yield 5.8%Equities 20.0%Property 15.0% Jackson National Life *Interest rates are projected using a three-factor model calibrated to 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. *Variable Annuity equity and bond returns have been stochastically generatedusing a regime-switching lognormal model with parameters determined by referenceto historical data. The volatility of equity fund returns ranges from 17.5 percent to 28.0 per cent depending on risk class, and the volatility of bond fundsranges from 1.6 per cent to 4.7 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 valuations 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 fund returns ranges from 18 per centto 25 per cent, and the volatility of bond yields ranges from 0.7 per cent to3.7 per cent. d) Demographic Assumptions Mortality and morbidity assumptions are based on an analysis of recentexperience but also reflect expected future experience. Where relevant, whencalculating the time value of in-force business, policyholder withdrawal ratesare allowed to vary in line with the emerging investment conditions according tomanagement's expectations. e) 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 result asincurred. f) Inter-company Arrangements There are no inter-company arrangements such as re-insurance or loans associatedwith covered business for which adjustment has been required in preparing theEEV basis results. g) 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. h) 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 year isconsistent with the basis the Group intends to apply for analysis of IFRS basisprofits before shareholder taxes between operating and non-operating results.Operating results reflect the underlying results of the Group's continuingoperations including longer-term investment returns. Operating results includethe impact of routine changes of estimates and non-economic assumptions.Non-operating results include certain recurrent and exceptional items thatprimarily do not reflect the performance in the year of the Group's continuingoperations. b) Investment return Profit Before Tax With the exception of fixed income investments held by Jackson National Life,investment gains and losses during the period (to the extent that changes incapital values do not directly match changes in liabilities) are includeddirectly in the profit for the year and shareholders' funds as they arise. In the case of Jackson National Life, market value movements on fixed incomesecurities are initially recorded as movements in shareholder reserves,reflecting the available for sale categorisation under IFRS. Similarly thevalue movements on derivatives are recorded in the income statement. However,it is assumed that fixed income investments will normally be held untilmaturity. Therefore, unrealised gains and losses on these securities are notreflected in either the achieved profits or statutory basis results and, excepton realisation or impairment of investments, only income received and theamortisation of the difference between cost and maturity values are recognisedto the extent attributable to shareholders. This is consistent with the basisof valuation of future cash flows of in force business, which inter alia,reflects spread basis earnings which are not directly affected by short-termvalue movements in fixed income securities. Similar principles apply to valuemovements on Jackson's derivatives that are fair valued for IFRS reporting withvalue movements booked in the IFRS income statement. 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. Forequity-related investments of Jackson National Life, a long-term rate of returnis assumed, which reflects the aggregation of risk free rates and equity riskpremium. 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 profit and loss account. 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. * The impact of altered economic and other assumptions on the discount value ofscheme liabilities. These items are recorded in the profit and loss account but, consistent with theIFRS basis of presentation, excluded from operating results. d) Effect of changes in economic assumptions and cost of guarantees Movements in the value of in-force business caused by changes to economicassumptions and the cost of guarantees, (which is primarily due to economicexperience over the period and changes in economic assumptions) are recorded innon-operating results. e) Results for fund management operations The results of the Group's fund management operations includes the profits frommanagement of internal and external funds. For EEV basis reporting Groupshareholders' other income is adjusted to deduct the expected margin for theyear 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 Asia operations In adopting the EEV principles Prudential has decided to set encumbered capitalat its internal targets for economic capital. In Asia, the the economic capitaltarget is substantially higher than the local statutory requirements in total.Accordingly, capital is held centrally for Asian operations. For the purposesof the presentation of the Group's operating results it is assumed that thecentrally held capital is loaned 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 year for covered business is calculated initially at thepost-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 Jackson National Life, this basisalso applied. For Jackson National Life, under achieved profits pre-tax resultswere determined by applying the risk discount rate to pre-tax cash flowsadjusted for the impact of capital charges. h) Foreign currency translation Foreign currency profit and losses have been translated at average exchangerates for the year. Foreign currency assets and liabilities have beentranslated at year end rates of exchange. The purpose of translating the profitand losses at average exchange rates, notwithstanding the fact that EEV profitrepresents the incremental value added on a discounted cash flow basis, is tomaintain consistency with the methodology applied for IFRS basis reporting. The principal exchange rates applied are: Closing rate Average Opening rate at atLocal Currency: £ 31 December for 2004 1 January 2004 2004 Hong Kong 14.92 14.27 13.90Japan 196.73 198.08 191.85Malaysia 7.30 6.96 6.80Singapore 3.13 3.10 3.04Taiwan 60.84 61.10 60.78USA 1.92 1.83 1.79 5. OPERATING PROFIT AND MARGINS FROM NEW BUSINESS a) Profit EEV AP Basis 2004 2004 Pre-tax Tax Post-tax Pre-tax Tax Post-tax £m £m £m £m £m £mUK and Europe Insurance Operations 241 (61) 180 220 (66) 154Jackson National Life(i) 145 (51) 94 156 (82) 74Asian Operations 355 (105) 250 312 (78) 234Total 741 (217) 524 688 (226) 462 i) Jackson National Life net of taxprofitBefore capital charge 106 95Capital charge (12) (21)After capital charge 94 74 In determining the EEV basis value of new business written in the year thepolicies incept, premiums are included in projected cash flows on the same basis of distinguishing annual and single premiumbusiness as set out for statutory basis reporting. b) Margins EEV AP basis Annual Present New New premium Value of Pre-Tax New business Business Business New Business equivalent New New business Margin Profit Margin Premiums Business Single Regular (APE) Premiums Contribution (APE) (PVNBP) (APE) (PVNBP) 2004 2004 2004 2004 2004 2004 2004 2004 £m £m £m £m £m % % £m %UK and Europe 6,357 181 817 7,012 241 30 3.4 220 27Insurance OperationsJackson National Life 4,408 12 453 4,506 145 32 3.2 156 34Asian Operations 662 510 576 3,404 355 62 10.4 312 54Total 11,427 703 1,846 14,922 741 40 5.0 688 37 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 shownon an 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. New business contributions are determined by applying the economic andnon-economic assumptions applying at the end of the period. The contributionsrepresent profits at the end of the period. 6. OPERATING PROFIT FROM BUSINESS IN FORCE Achieved Profits (AP) basis EEV Restated 2004 2004 £m £mUK and Europe Insurance OperationsUnwind of discount(i) 351 330Cost of strengthened persistency assumption(ii) (73) (66)Other items(ii) (33) (34) 245 230Jackson National LifeUnwind of discount 97 139Return on surplus assets (over target 36 36surplus)Spread experience variance 41 43Amortisation of interest related realised gains 54 54and lossesLoss from changes to other operating assumptions (4) (3)Other 13 2 237 271Asian OperationsUnwind of discount 120 113Change in operating assumptions (24) (56)(iii)Experience variances and other 9 3items 105 60Total 587 561 (i) Unwind of discount is determined by reference to the value of in-forcebusiness at the start of the period as adjusted for the effect of changes ineconomic and operating assumptions reflected in the current period. For theunwind of discount for UK and Europe Insurance Operations included in operatingresults based on longer-term returns a further adjustment is made. For UK andEurope Insurance Operations the amount represents the unwind of discount on thevalue of in-force business at the beginning of the year (adjusted for the effectof current year assumption changes), the expected return on smoothed surplusassets retained within the main with-profits fund and the expected return onshareholders' assets held in other UK and Europe 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. (ii) The £73m cost of strengthened persistency assumption relates to the closedbook of personal pension policies sold by the now discontinued direct salesforce. The £33m charge for other items includes £21m of costs associated withcomplying with new regulatory requirements and restructuring and £12m ofnegative experience variances. (iii) The difference in the effect of change in operating assumptions for theGroup's Asian Operations between those recorded on the Achieved Profits and EEVbasis mainly relates to the change in the treatment of investment expenses inthe Taiwanese operations which under the EEV methodology is reflected in theopening shareholders' funds rather than as a change in operating assumptions. 7. SHORT-TERM FLUCTUATIONS IN INVESTMENT RETURNS Achieved Profits (AP) basis EEV Restated 2004 2004 £m £mLong-term business:UK and Europe Insurance Operations (i) 408 402Jackson National Life (including mark to market value of core 103 97debt) (ii)Asian Operations (iv) 91 57Share of investment return of funds managed by PPM Americathat are consolidated into Group resultsbut attributable to external investors 9 9 Share of profits of venture investment companies and property partnerships of the PACwith-profits fund that are consolidated into Group results but are attributable to external investors 9 9Movement in mark to market value of core debt held centrally (63) -Other Operations 13 13Total 570 587 (i) Short-term fluctuations in investment returns represent for UK and EuropeInsurance Operations the difference between actual investment returns in theyear attributable to shareholders and the expected returns as described in note3. (ii) Short-term fluctuations for Jackson National Life comprise: Achieved Profits (AP) basis EEV Restated 2004 2004 £m £mActual investment return on investments less long-term returns included within 73 73operating profit (iii)Investment return related gain due primarily to changed expectation of profits on 36 24in-force variable annuity business in future periods based on current period equity returns*Mark to market value of core debt (6) - 103 97 * This adjustment arises due to market returns being higher than the assumedlong-term rate of return. This gives rise to higher than expected year endvalues of variable annuity assets under management with a resulting effect onthe projected value of future account values, and hence future profitability. (iii) Jackson National Life - Actual investment return on investments less longer-term returns Achieved Profits (AP) basis EEV Restated 2004 2004 £m £mActual realised gains less default assumption and amortisation of interest related realised 51 51gains and losses for fixed maturity securitiesActual less long-term return on equity based investments and other items 22 22 73 73 (iv) Short-term fluctuations for Asian operations for full year 2004 on the EEVbasis are significantly higher than on the AP basis. This is due to movements inthe EEV value of surplus assets of the PAC with-profits sub-fund for the HongKong branch for which an altered allocation as at 1 January 2004 has beenapplied. 8. EFFECT OF CHANGES IN ECONOMIC ASSUMPTIONS AND THE TIME VALUE OF COST OFOPTIONS AND GUARANTEES The profits (losses) on changes in economic assumptions and time value of costof options and guarantees for in-force business included within the profit onordinary activities before tax arise as follows: EEV Change in time value of EEV cost of Change in options economic and EEV assumptions guarantees Total AP 2004 2004 2004 2004 £m £m £m £mUK and Europe Insurance Operations 40 46 86 (19)Jackson National Life (53) 6 (47) (53)Asian Operations (113) 26 (87) (28)Total (126) 78 (48) (100) 9. TAXATION CHARGE The profit for the year for covered business is in most cases 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%. For Jackson National Life this is generally thefederal rate of 35%. For Asia, similar principles apply subject to theavailability of taxable profits. Achieved ProfitsThe tax charge comprises: (AP) basis EEV Restated 2004 2004 £m £mTax on operating profit of continuing operationsLong-term business:UK and Europe Insurance Operations 142 134Jackson National Life 116 135Asian Operations(i) 119 96 377 365Other Operations (27) (14)Total tax charge on operating profit of continuing 350 351operationsTax on items not included in operating profitTax charge on short-term fluctuations in investment 189 174returnsTax credit on actuarial gains and losses of defined benefit pension schemes (5) (5)Tax charge (credit) on effect of changes in economic assumptions and time value of cost of 19 (29)options and guaranteesTotal tax charge on items not included in operating profit of continuing 203 140operationsTax charge on profit on ordinary activities from continuing operations (including tax on actual 553 491investment returns)(i) Including tax relief on development expenses. 10. EARNINGS PER SHARE (EPS) Achieved Profits (AP) basis EEV Restated 2004 2004 £m £mOperating EPS from continuing operations Operating profit before tax 1,274 1,239 Tax (350) (351) Minority interest (8) (8) Operating profit after tax and minority interest from 916 880continuing operations Operating EPS from continuing operations 43.2p 41.5pTotal EPS from continuing operations Total profit before tax 1,784 1,714 Tax (553) (491) Minority interest (26) (26) Total profit after tax and minority interest from 1,205 1,197continuing operations Total EPS from continuing operations 56.8p 56.4pAverage number of shares (million) 2,121 2,121 11. SHAREHOLDERS' FUNDS - SEGMENTAL ANALYSIS Achieved Profits EEV (AP) basis Restated 2004 2004 £m £mUK and Europe OperationsLong-term business operations: (i),(ii) 4,228 4,051M&G(vi)Net assets of operations 300 300Acquired goodwill(iv) 1,153 1,153Egg (vi) 273 273 5,954 5,777US OperationsJackson National Life (i), (net of surplus note borrowings of £162m (v))Before capital charge:Excluding assets in excess of target surplus 1,785 1,749Assets in excess of target surplus 801 949 2,586 2,698Capital charge (iii) (80) (166)After capital charge 2,506 2,532Broker-dealer, fund management and Curian operations (vi) 64 64 2,570 2,596Asian OperationsLong-term business (i)Net assets of operations - EEV basis shareholders' funds 1,565 1,670Acquired goodwill(iv) 231 231Fund management (vi)Net assets of operations 66 66Acquired goodwill(iv) 61 61 1,923 2,028Other OperationsHolding company net borrowings(v) (1,299) (1,106)Pension scheme deficits (net of tax) attributable to shareholders (152) (152)(vi)Other net liabilities (vi) (381) (381) (1,832) (1,639)Total 8,615 8,762 (i) A charge is deducted from the annual result and balance sheet value for thecost of capital for the Group's long-term business operations. The cost is thedifference between the nominal value of solvency capital and the present value,at risk discount rates, of the projected release 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. (ii) The proportion of surplus allocated to shareholders from the UKwith-profits business has been based on the present level of 10%. Future bonusrates have been set at levels which would fully utilise the assets of thewith-profits fund over the lifetime of the business in force. (iii) In determining the cost of capital of Jackson National Life, it has beenassumed that an amount equal to 235 per cent of the risk based capital requiredby the National Association of Insurance Commissioners (NAIC) at the CompanyAction Level must be retained. The impact of the related capital charge is toreduce Jackson National Life's shareholders' funds by £80m (EEV basis) £166m (APbasis). (iv) 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. 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. (v) Net core structural borrowings of shareholder financed operations comprise: EEV AP 2004 2004 £m £mHolding company cash and short-term investments 1,561 1,561Core structural borrowings - central funds (2,860) (2,667)Holding company net borrowings (1,299) (1,106)Core structural borrowings - Jackson National Life (162) (130) (1,461) (1,236) The altered carrying value of core structural borrowings under EEV reflects theapplication of market values rather than IFRS basis values. (vi) 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 thestatutory net of tax IFRS provision of £105m, augmented by £47m for theshareholders' share of the net of tax deficit attributable to the PACwith-profits fund. 12. RECONCILIATION OF MOVEMENT IN SHAREHOLDERS' FUNDS Long-term business operations UK and Total Europe Jackson long-term Insurance National Asian business Other Group Operations Life Operations operations operations total £m £m £m £m £m £mOperating profit (including investmentreturnBased on long-term rates of returns)Long-term business:New business (note 5) 241 145 355 741 741Business in-force (note 6) 245 237 105 587 587 486 382 460 1,328 1,328Asia development expenses (15) (15) (15)M&G 136 136Egg 61 61Asian Fund Management Operations 19 19US broker-dealer and fund management 15 15Curian (29) (29)Other income and expenditure (241) (241)Operating profit (loss) from continuing 486 382 445 1,313 (39) 1,274operationsShort-term fluctuations in investment 408 103 91 602 (32) 570returns (note 7)Actuarial gains and losses on defined benefit 2 2 (14) (12)pension schemesEffect of changes in economic assumptions and time 86 (47) (87) (48) (48)value of cost of options and guarantees(note 8)Profit (loss) on ordinary activities 980 438 451 1,869 (85) 1,784before tax(including actual investment returns)Tax on profits (losses) of continuing operations(note 9):Tax on operating profit (142) (116) (119) (377) 27 (350)Tax on short-term fluctuations in (126) (39) (18) (183) (6) (189)investment returnsTax on actuarial gains and losses on defined 0 0 5 5benefit pension schemesTax on effect of changes in economic assumptions (28) 16 (7) (19) (19)and time value of cost of options and guaranteesTotal tax (charge) credit (296) (139) (144) (579) 26 (553)Discontinued operations (net of tax) 33 33 (127) (94)Minority interests 1 1Profit (loss) for the financial year 684 332 307 1,323 (185) 1,138 Exchange movements (175) (86) (261) 22 (239)Related tax (1) (1) (1)Development costs included above (net of tax) 2 2 (2) 0borne centrallyIntra group dividends (including statutory (130) (66) (44) (240) 240 0transfer)External dividends (323) (323)Stock based compensation - fair value adjustment 10 10(net of tax)Investment in operations(i) 173 15 147 335 (335) 0Adjustment for net of tax losses of CurianSubsidiary owned by Jackson National Life (12) (12) 12 0Adjustment for economic capital for Asia (15) (15) 15 0operations held centrallyAdjustment for net of tax fund managementprojectedprofits of covered business (14) (2) (16) 16 0Consideration paid for own shares (4) (4)Movement in Prudential plc shares purchased byunit trustsnewly consolidated under IFRS 14 14Proceeds from issues of share capital by parent 1,140 1,140companyNet increase in shareholders' capital and 713 94 308 1,115 620 1,735reserves Shareholders' capital and reserves at 1January 2004:As previously reported on the Achieved 3,424 2,419 1,358 7,201 (196) 7,005Profits basisChange on adoption of IFRS (excluding IAS 32, (4) (4) 22 18IAS 39 and IFRS 4)Adjustments on implementation of European Embedded 91 (7) (97) (13) (130) (143)Value (EEV) methodology (ii)As restated 3,515 2,412 1,257 7,184 (304) 6,880 Shareholders' capital and reserves at 31 4,228 2,506 1,565 8,299 316 8,615December 2004 (note 11) (i) Investment in operations reflects increases in share capital. This includescertain non-cash items as a result of timing differences. (ii) The £(130)m deduction for other operations at 1 January 2004 reflects themarking to market value of the Group's core structural borrowings heldcentrally. Long-term business operations UK and Total Europe Jackson long-term Insurance National Asian business Other Group Operations Life Operations operations operations total £m £m £m £m £m £mAnalysed as:Statutory IFRS basis shareholders' funds 877 2,568 750 4,195 556 4,751Additional retained profit on an EEV basis 3,351 (62) 815 4,104 (240) 3,864EEV basis shareholders' funds at 31 December 2004 4,228 2,506 1,565 8,299 316 8,615Comprising:Free surplus 206 769 (275) 700Required capital 433 955 814 2,202Value of in-force business before deduction of 3,796 963 1,432 6,191cost of capital and of guaranteesCost of capital (123) (80) (382) (585)Cost of time value of guarantees (84) (101) (24) (209) 4,228 2,506 1,565 8,299 EEV basis shareholders' funds at 1 January 2004 Long-term business operations UK and Total Europe Jackson long-term Insurance National Asian business Other Group Operations Life Operations operations operations total £m £m £m £m £m £mAnalysed as:Statutory IFRS basis shareholders' funds 608 2,470 562 3,640 (128) 3,512Additional retained profit on an EEV basis 2,907 (58) 695 3,544 (176) 3,368EEV basis shareholders' funds at 1 January 2004 3,515 2,412 1,257 7,184 (304) 6,880ComprisingFree surplus 256 624 (314) 566Required capital 165 964 752 1,881Value of in-force business before deduction of 3,272 998 1,188 5,458cost of capital and of guaranteesCost of capital (66) (82) (332) (480)Cost of time value of guarantees (112) (92) (37) (241) 3,515 2,412 1,257 7,184 13. RECONCILIATION OF NET WORTH AND VALUE OF IN-FORCE BUSINESS Total Free Required Total Value of Long-term Note Surplus Capital Net Worth In-Force businessReconciliation of Net Worth and Value of In-force £m £m £m £m £mbusiness Shareholders' capital and reserves at 1 January 566 1,881 2,447 4,737 7,1842004: New business contribution 5 (396) 254 (142) 666 524 Expected return on existing business 35 35 413 448 Existing business - transfer to net worth 635 (95) 540 (540) 0 Changes of operating assumptions and experience (1) (39) (40) 4 (36)variances Non-operating change of assumption and experience variances 45 74 119 235 354 Profit after tax from continuing operations 318 194 512 778 1,290 Exchange rate movements 12 (71) (67) (138) (124) (262)Discontinued operations, net of tax 33 33 33Amounts injected, released and transferred to/from life and (146) 194 48 6 54related businesses Shareholders' capital and reserves at 31 December 700 2,202 2,902 5,397 8,2992004 (i) Net worth consists of statutory solvency capital (or economic capital wherehigher) and unencumbered capital. (ii) Value of in-force business includes the value of future margins fromcurrent in-force business less the cost of holding encumbered capital. 14. SENSITIVITY OF RESULTS TO ALTERNATIVE ASSUMPTIONS a) Sensitivity Analysis - Economic Assumptions The tables below show the sensitivity of the embedded value as at 31 December2004 and the new business contribution after the effect of required capital forthe full year 2004 to: *1% increase in the discount rates *1% increase and decrease in interest rates, including all consequential changes(assumed investment returns for all assets classes, market values of fixedinterest assets, risk discount rates) *1% rise in equity and property yields *10% fall in market value of equity and property assets (not applicable for newbusiness contribution) *Holding company statuatory minimum capital (by contrast to economic capital) In each sensitivity calculation, all other assumptions remain unchanged exceptwhere they are directly affected by the revised economic conditions. UK and Europe Jackson Asian Total Insurance National operations long-term Operations Life £m £m £m £mNew business profitAs reported (note 5) 241 145 355 741 Discount rates - 1% increase (40) (22) (42) (104)Interest rates - 1% increase (4) (1) (5) (10)Interest rates - 1% decrease (1) (33) 3 (31)Equity/property yields - 1% rise 13 16 13 42 Embedded value of long-term operationsAs reported 4,228 2,506 1,565 8,299 Discount rates - 1% increase (366) (83) (218) (667)Interest rates - 1% increase 144 (109) (14) 21Interest rates - 1% decrease (179) 30 (32) (181)Equity/property yields - 1% rise 264 24 98 386Equity/property market values - 10% (416) (54) (44) (514)fallStatutory minimum capital 0 43 326 369 b) Sensitivity Analysis - Non-Economic Assumptions The tables below show the sensitivity of the embedded value as at 31 December2004 and the new business contribution after the effect of required capital forthe full year 2004 to: *10% proportionate decrease in maintenance expenses (a 10% sensitivity on a baseexpense assumption of £10 p.a. would represent an expense assumption of £9 p.a. *10% proportionate decrease in lapse rates (a 10% sensitivity on a baseassumption of 5% would represent a lapse rate of 4.5% p.a.) *5% proportionate decrease in base mortality and morbidity rates (i.e increasedlongevity) UK and Europe Jackson Asian Total Insurance National operations long-term Operations Life £m £m £m £mNew business profitAs reported (note 5) 241 145 355 741 Maintenance expenses - 10% decrease 7 4 12 23Lapse rates - 10% decrease 9 13 28 50Mortality and morbidity - 5% decrease (24) 3 8 (13)Change representing effect on:Life business 1 1 8 10Annuity business (i) (25) 2 0 (23) Embedded value of long-term operationsAs reported 4,228 2,506 1,565 8,299 Maintenance expenses - 10% decrease 32 33 45 110Lapse rates - 10% decrease 67 44 78 189Mortality and morbidity - 5% decrease (68) 69 43 44Change representing effect on:Life business 3 65 43 111Annuity business (i) (71) 4 0 (67) (i) The JNL annuity sensitivity for mortality and morbidity relatesto variable annuity business 15. Reconciliation of Achieved Profits to EEV basis results New business profits 2004 UK/Europe JNL Asia Total £m £m £m £mImpact of adoption of European Embedded Value basis:Changes in economic assumptions 10 (8) (5) (3)Time value of options and guarantees (5) (29) 4 (30)Changes in risk discount rates 6 30 55 91Fund management business falling within the scope of covered business 10 4 3 17Other changes 0 (8) (14) (22)Total changes 21 (11) 43 53Achieved profits basis operating profit from new business - as previously 220 156 312 688publishedEuropean Embedded Value basis operating profit from new business - as restated 241 145 355 741 Investment return and other income 2004 Total £mImpact of adoption of European Embedded Value basis:Allocation of investment return in respect of centrally held capital, in respect of Asian (22)businesses,to operating result of Asian businessProjected Fund Management result for 2004 in respect of covered business (22)incorporated in opening EEV valueTotal changes (44)Achieved Profits and IFRS basis result 44European Embedded Value basis 0 Shareholders' funds (excluding minority interest) at 31 December 2004 2004 Total £mChanges consequent on adoption of IFRS:Timing difference on recognition of dividend declared after balance sheet date 253Shareholders' share of deficit on UK defined benefit pension schemes (net ofdeferred tax):Statutory IFRS basis (115)Additional change for shareholders' 10% interest on the achieved profits basisin the deficitAttributable to the PAC with-profits fund (47)Goodwill 94Other items (net of related tax) (19)Total changes 166Achieved profits basis shareholders' funds, net of minority interest - as 8,596previously publishedAchieved profits basis shareholders' funds, net of minority interest - as 8,762restatedImpact of adoption of European Embedded Value basis:Changes in economic assumptions 32Changes in the cost of required capital (269)Time value of options and guarantees (209)Changes in risk discount rates 427Fund management business falling within the scope of covered business 200Marking core debt to market value (225)Other changes (103)Total changes (147)European Embedded Value basis shareholders' funds, net of minority interest 8,615 INDEPENDENT AUDITOR'S REPORT TO PRUDENTIAL PLC ON THE EUROPEAN EMBEDDED VALUEBASIS SUPPLEMENTARY INFORMATION In accordance with the terms of our engagement letter, we have audited theEuropean Embedded Value ('EEV') basis supplementary information of Prudentialplc ("the Company") as at 31 December 2004. As described in the basis of preparation the EEV basis supplementary informationhas been prepared in accordance with the European Embedded Value Principlesissued in May 2004 by the European CFO Forum ("the EEV Principles"). Our report was designed to meet the agreed requirements of the Companydetermined by the Company's needs at the time. Our report should not thereforebe regarded as suitable to be used or relied on by any party wishing to acquirerights against us other than the Company for any purpose or in any context. Anyparty other than the Company who chooses to rely on our report (or any part ofit) will do so at its own risk. To the fullest extent permitted by law, KPMGAudit Plc will accept no responsibility or liability in respect of our report toany other party. 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 EEV supplementary information inaccordance with the EEV Principles. It has been prepared as part of theCompany's conversion of its supplementary information, previously prepared inaccordance with the guidance issued in December 2001 by the Association ofBritish Insurers entitled "Supplementary Reporting for Long Term InsuranceBusiness (the Achieved Profits Method)" ("the Achieved Profits basis") to an EEVbasis. Our responsibilities as independent auditors are established in theUnited Kingdom by the Auditing Practices Board, our profession's ethicalguidance and the terms of our engagement. Under the terms of engagement we are required to report to you our opinion as towhether the EEV basis supplementary information has been properly prepared, inall material respects, in accordance with EEV Principles using the methodologyand assumptions set out in the notes. We also report to you if, in our opinion,we have not received all the information and explanations we require for ouraudit. Basis of audit opinion We conducted our audit having regard to Auditing Standards issued by the U.K.Auditing Practices Board. An audit includes examination, on a test basis, orevidence relevant to the amounts and disclosures in the EEV basis supplementaryinformation. It also includes an assessment of the significant estimates andjudgements made by the directors in the preparation of the EEV basissupplementary information, and of whether the accounting policies areappropriate to the group's circumstances, consistency applied and adequatelydisclosed. We planned and performed our audit so as to obtain all the information andexplanations which we considered necessary in order to provide us withsufficient evidence to give reasonable assurance that the EEV basissupplementary information is free from material misstatement, whether caused byfraud or other irregularity or error. In forming our opinion we also evaluatedthe overall adequacy of the presentation of information in EEV basissupplementary information. Emphasis of matter Without qualifying our opinion we draw your attention to the following matters. * As described in the basis of preparation note to the EEV basis supplementaryinformation, the next annual financial statements of the Group will be preparedin accordance with IFRS adopted for use in the European Union. The accountingpolicies that have been adopted in preparing the IFRS financial information,which forms the starting point of the EEV basis supplementary information, areconsistent with those that the directors currently intend to use in the nextannual financial statements. There is, however, a possibility that thedirectors may determine that some changes to these policies are necessary whenpreparing the full annual financial statements for the first time in accordancewith those IFRS adopted for use by the European Union. *As described in the basis of preparation note to the EEV basis supplementaryinformation, as part of its conversion from the Achieved Profits basis to an EEVbasis, the Company has prepared the EEV basis supplementary information for theyear ended 31 December 2004 to provide the comparative supplementary informationexpected to be included in the Company's first complete set of EEV basissupplementary information to be included in the annual report for the yearending 31 December 2005. Our report has been prepared for the Company solely in connection with theCompany's conversion of its supplementary information, previously prepared onthe Achieved Profits basis, to an EEV basis. Opinion In our opinion, the accompanying EEV basis supplementary information for theyear ended 31 December 2004 has been properly prepared, in all materialrespects, in accordance with the EEV Principles using the methodology andassumptions set out in the notes. KPMG Audit PlcChartered AccountantsLondon12 December 2005 This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
Prudential